Alaska Communications Systems Group, Inc.
Q3 2018 Earnings Call Transcript

Published: 7 Nov 2018

[Operator:]

Good day and welcome to the Alaska Communications Systems Third Quarter 2018 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Ms. Tiffany Smith, Manager, Investor Relations. Please go ahead, ma'am.

[Tiffany Smith:]

Thank you. Welcome to the Alaska Communications Third Quarter 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 can go to our investor website, www.alsk.com, click on the Events section, go to the third quarter 2018 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 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. Following our remarks, we will open the line for questions. 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. We are pleased to report solid performance for the quarter and year to date. Once Laurie reports in our financial results, I intend to undertake a fulsome conversation of our business performance and shareholder value creation. But first let me turn the call over to Laurie Butcher, who will review our quarterly and year-to-date performance. Laurie?

[Laurie Butcher:]

Thank you, Anand. Turning to Slide 5, let me start with our year-over-year performance for the quarter and year-to-date periods ended September 30. Total revenue increased 2.7% in the quarter and 1.1% year-to-date. Business and wholesale representing approximately 62% of our total revenue, grew 4.2% in the quarter and 1.5% year-to-date, with business in wholesale broadband showing a decline of 1.4% in the quarter and 1.7% year-to-date, reflecting the impact of lower Rural Health Care revenue, in which I'll elaborate on in a minute. Consumer revenue, representing approximately 16% of our total revenues, declined 0.5% in the quarter and increased 0.7% year-to-date. Consumer broadband grew 3.4% in the quarter and 2.7% year-to-date, while voice revenue declined 8.9% in the quarter and 3.9% year-to-date. Regulatory revenue, representing approximately 22% of our total revenue remained relatively flat for both the quarter and year-to-date. We continued to show growth in business and wholesale, both for the quarter and the year. This growth has been largely driven by our performance in several verticals, including federal, education, oil and gas, and commercial, more than offsetting the anticipated declines in Rural Health Care. Let me cover the Rural Health vertical first, as I believe it's best to compartmentalize this line item. Rural Health Care year-to-date is about 8% of our total revenues compared to 11% for the same period in 2017. For the full year, we expect Rural Health Care to close out at approximately 7% of total revenues, reflecting a decline of about $4 million over the prior year. Importantly, the FCC and the USAC have processed substantially all of our contracts for 2017 funding year that ended on June 30, 2018. This is a positive development on several fronts. First, we've received a substantial portion of the outstanding cash related to that funding year, and second, our methodologies for rate setting for the 2018 funding year, which began on July 1 of this year, are consistent with the approach we took for the previous year, giving us confidence in receiving approvals for the current period. I'll also note that we've conservatively projected not receiving any further cash related to this program for the rest of the year, and we anticipate remaining in full compliance with all of our debt covenants despite such assumptions. This is an aberration in our steady march forward and not an indication of any downward trend or pressure in our market performance. This is demonstrated by the fact that business and wholesale grew about $1.6 million or 1.5% for the first nine months, fully offsetting the $5.2 million reduction in the Rural Health Care revenue. This highlights growth of $6.8 million or 6.4% in all other aspects of business in wholesale market. Verticals like commercial, federal, state and local government, education, and oil and gas, are all performing well. And the continued improvements in the Alaska economy provide macro-level tailwinds for us. We're directing our sales and our CapEx resources where we see the most opportunity. These market opportunities are reflected in our Board approving the additional success-based capital expenditures for this year in support of customer contracts. In fact, for the year, we expect success capital to be at approximately two-thirds of our total capital expenditures. Turning to Slide 6, all of our financial metrics are performing to plan. Total revenue was $58.2 million in the third quarter and $173.8 million for the first nine months of the year. Adjusted EBITDA reached $14.8 million for the quarter and $46.1 million year to date, an increase of 12% and 8.9% compared to the same periods in 2017. This also highlights our performance in terms of cost management. Our SG&A is down year-over-year by 5.6% for the first nine months of 2019. As Anand will discuss in his upcoming remarks, this reflects our continued attention to cost management over the long-term. I'm proud of our employees who have supported the various measures we've instituted, and continue to serve our customers with the utmost diligence and care. For the quarter and year-to-date respectively, net capital spending was $8.4 million and $25.4 million. And adjusted free cash flow was $2.4 million and $8.4 million. Looking at our balance sheet at September 30, total debt was $171.8 million and net debt was $159.1 million, compared to $186 million and $177.2 million, respectively at December 31, 2017. Cash was $18.9 million compared to $16.2 million for the same periods. As I discussed earlier with additional investments approved by our board in growth capital, we are increasing our guidance for net capital spending to $37 million to $39 million. As Anand will note, we've had meaningful returns on our growth capital, and we anticipate similar or higher returns going forward. We are reaffirming the rest of our financial guidance for 2018 for total revenue, adjusted EBITDA and adjusted free cash flow. We look forward to reporting our progress to guidance in our year-end call. With that, let me hand the call back to Anand. Anand?

[Anand Vadapalli:]

Thank you, Laurie. Our strong results for this year reaffirm my conviction about the strength of our business plan and the opportunity to create value for all of us, our shareholders, our customers and our employees. I also acknowledge and share some of the frustrations of our shareholders. I hope this discussion about our business plan performance will demonstrate the significant opportunity for value creation in front of us. Turning to Slide 8. Let me first start with revenues. This is a telecom sector. We must deal with our legacy as telephone companies and the legacy of our investments in technologies like copper. You will note that Alaska Communications is not immune to these secular trends. Our legacy revenues have declined at about 4% annualized rate over the last several years. That said legacy revenues have also come down from about 53% of our total revenue to about 42% of our total revenues. The most positive thing about our sector is that broadband consumption is exploding with no signs of abating demand. While price compression in our sector mitigates revenue growth, nonetheless, revenue opportunity continues to expand. Investments in technology like fiber, and more recently 5G technologies, including fixed wireless access, have fueled our growth revenues with close to 7% CAGR over the last five years. Our group revenues now represent close to 58% of our total revenues, more than offsetting our legacy revenue declines and supporting total revenue growth of about 1.6% CAGR. In fact, if not for the RHC-related matters Laurie discussed earlier, we would have demonstrated even higher growth. I'll note that we are one of the few companies in our sector to accomplish this milestone of sustained top line growth. We expect this trend to continue, driven by a combination of our unique market dynamics, our network and technology innovation and our deep customer relationships. This ties into the question that I know is top of mind for many shareholders. The question on capital expenditures and returns thereof. Turning to Slide 9. We've consistently said we have two broad categories of CapEx

[Operator:]

Thank you. [Operator Instructions] And we'll take our first question.

[Unidentified Analyst:]

Hi, Anand, this is [Bob Gruvan] [ph]. How are you?

[Anand Vadapalli:]

Bob, good afternoon, I'm well. How are you?

[Unidentified Analyst:]

Good, good. I guess, I wanted to drill down a little bit on some of the - what you said about the growth CapEx and that's been, kind of, a pinch point for some of the shareholder base over the last several years. Now your board has just authorized another $4 million, and I was kind of curious, I mean, you've been very consistent in this $14 million of maintenance and another $20 million of growth CapEx. Why here at the end of the Q4 was this authorized? And I'm only bringing that up, because we're going into the winter of Alaska. And I'm wondering why this capital allocation couldn't have been made in 2019, especially with a leverage test that we have coming up pretty shortly? I know Laurie had mentioned that during compliance through the end of the year, but the way I calculate this, you've really tight if you spend this $1 million on meeting that leverage test in 2019? So it seems to me fixed at first, allocate the capital in 2019, and then you start a dividend or a stock buyback? So I'm kind of curious what was so exciting about this $1 million allocation that had to have been pulled in through Q4?

[Anand Vadapalli:]

Yeah, Bob, thank you for the questions. So let me first start with the leverage test and the covenant calculations. We remain very comfortable with our ability to have - not just comply with those covenants, but have adequate cushion that's something as you can expect that we monitor closely that the board monitors closely. So on that front, I believe, we are in good shape. And I think as Laurie also mentioned, we certainly are taking a conservative view in terms of cash receipts from Rural Health Care where we are not projecting any further receipts through the end of the year. Though of course, we continue to work with the FCC to make sure that they release the money as soon as possible in this year as well. So that's as far as the covenant analysis goes. With respect to your question on growth capital, so you're right. I mean, we've said typically that you should think about our CapEx in the $35 million to $40 million range. We've said that often times in the past. We've also said that typically we tend to allocate about half of that towards growth and about half of that toward maintenance. In fact, what we are seeing though, Bob, is in more recent years, there is an increased allocation towards growth over maintenance. Part of it is reflecting the opportunities in the customer contracts we are signing. And part of it also, the more we invest in newer technologies like fiber, the more we deploy fixed wireless access. What you will see over time is a reduction in our need for maintenance capital, because we are upgrading our network. And candidly, in the capital program, the more we can allocate towards growth CapEx, the more it drives growth revenues, and the marginal dollar EBITDA contributions from growth revenues are very material. They are meaningful. And as to the timing of this CapEx, please keep in mind that this is all a function of - as in fact Laurie said in her remarks, this is not on spec. This is actually in support of signed customer contracts, which we believe are very accretive to the business. And from a construction and deployment perspective, we've been pretty engaged in the field with respect to deployment and which is why we expect to see elevated levels of CapEx in the fourth quarter. So we think we are generally tracking to this increased guidance. It is in support of signed customer opportunities that we have, that are going to create returns for all of us going forward. And I think 2019 will bring more opportunities. I mean, in all candor, what we have is what I would characterize a good problem where the opportunities are so significant that to some degree we're capital constrained in going after the opportunities we have. And I think from my vantage point, that's a good problem to have. But…

[Unidentified Analyst:]

Sticking with that - so sticking with that for a second, Anand, this $4 million, and I would expect it to be only versus signed contracts, can you give us an idea what the breakeven time is on that $4 million?

[Anand Vadapalli:]

So, Bob, without specifically mentioning the specifics of individual business cases of what goes into this incremental CapEx, what I can tell you is what I've said before, where typically we evaluate success capital for IRRs in the 20% range, and for payback periods, typically the 3 to 5 year range. And I'll give you the rationale for the 3 to 5 years, typically that's the duration of our customer contracts. And we try and work very hard to try and keep the payback within the term of the initial customer contract though we know we'll get a lot more benefit and run rate from that going forward. But also, if I may, if I could point you to some of the charts that I put up earlier in my presentation, if you look at the increase in growth revenues over the last 4 or 5 years and you look at the deployment of success capital, and again, as I mentioned in my prepared remarks if you assume that the EBITDA contribution on a marginal dollar of revenue is in the 75% range, we've run the math, I'm sure you can do that as well probably better than us, and you will see that the returns on growth capital are actually very meaningful. And we are very diligent about payback as well. So this is something that, again, clearly, when we took this request back to the Board, it was with all of the analysis of where the capital is going and what customer contracts were driving this, et cetera. There was a fair bit of governance and oversight behind this.

[Unidentified Analyst:]

Okay. So the $60 million to $80 million that we spent over the last 3 to 4 years, can you break down how that actually - what the payback periods have been? I mean is it all in the 36 to 48 month range? Do you have anything that's in the 18 to 24 or 24 to 36 month payback period? Or - because as we look at the spend, it looks like it's coming in slower than we would expect. But can you break that down for us?

[Anand Vadapalli:]

We actually break that down as we analyze our own capital expenditures. We evaluate that regularly. And what I can tell you is, obviously, not every contract is 36 months or 48 months or 60 months, some are less, same can be a little bit more. But that's the general range as what we look at. And we are actually very comfortable that the payback period for the capital expenditures that we've made are generally in the ranges that we are looking at.

[Unidentified Analyst:]

Okay, okay. So you're confident than that for 2019 we won't need a modification of the credit line or a waiver to meet our leverage test?

[Anand Vadapalli:]

As we are thinking about where we are, Bob, with respect to our credit agreement, we are very comfortable with the credit agreement and the cushions thereof.

[Unidentified Analyst:]

Okay. I'll let somebody else ask a question.

[Anand Vadapalli:]

All right, thank you.

[Unidentified Analyst:]

Thank you.

[Operator:]

And that will conclude today's question-and-answer session. At this time, I'd like to turn the conference over to management for any additional or closing comments.

[Anand Vadapalli:]

Thank you. So we always welcome the opportunity to speak with our shareholders. If you are interested in having meetings with us by phone or in person during future road-shows, please do reach out to Tiffany Smith and Investor Relations. Also, I'll note that I will be on schedule to speak at the LD Micro Conference on December 4. And I look forward to meeting any shareholders who may be attending that particular event. With that, thank you all for joining us today and have a great day.

[Operator:]

That does conclude today's conference call. Thank you for your participation. You may now disconnect.