Alaska Communications Systems Group, Inc.
Q4 2016 Earnings Call Transcript

Published: 15 Mar 2017

[Operator:]

Good day and welcome to the Alaska Communications Systems Fourth Quarter and Year-End 2016 Earnings Conference 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.

[Tiffany Smith:]

Thank you. Good afternoon and welcome to the Alaska Communications Fourth Quarter and Year-End 2016 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 Web-site, www.alsk.com, click on the Events section, go to the Fourth Quarter and Year-End 2016 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 Web-site. 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. Starting with Slide 5, going forward you will hear me discuss three distinct levers to drive shareholder value creation. Our first lever starts with operating performance. I am pleased to report our third consecutive year of top line growth. For 2016, overall revenues grew 3.2%, driven primarily by Business and Wholesale revenue growth of 8.2% and broadband revenue growth of 10.5%. This combined with strong adjusted EBITDA and adjusted free cash flow performance creates a good launch-pad for 2017, where we expect another year of solid operating performance. Our second lever is through capital allocation. We will seek to prudently balance our capital allocation strategies between investing for growth, deleveraging the balance sheet and shareholder friendly actions. Laurie will discuss in further detail our recent credit agreement and recently approved share repurchase program. Lastly, we intend to actively pursue strategic actions to help us build scale and geographic diversification. These actions will always be thoughtful, strategic and accretive, offering another alternative for value creation for our shareholders. Turning to Slide 6, let me begin with our market, where we are focused on the areas of highest opportunity. Our market is growing, driven by broadband and managed IT services. The competitive environment is favorable. The macro environment in Alaska is forcing businesses to look at every opportunity to save money and technology offers the best solutions for businesses, large and small, providing a basis for our growth. Turning to Slide 7, Business and Wholesale will continue to drive our top line performance. First, increased migration to the cloud is driving increased consumption of broadband by businesses. We intend to claim our fair share of this increased demand. We are a 21% market share company in a wireline broadband market that has limited facilities-based competition. We have a three year track record of year-over-year growth, bringing on new strategic relationships several years in a row. We expect to further this trend with continued share gains, particularly as the Quintillion partnership and capacity agreements open new opportunities. Managed IT services represents a clear area of opportunity, no doubt not the same margin profile as broadband but profitable nonetheless and enabling us to go after a larger share of wallet and make our services to cater the customer. Partnerships like the one we have established with Microsoft will provide us differentiation in this space. Slide 8 provides further detail on our work with Quintillion Networks. As you are aware, we entered in a joint venture with Quintillion in 2015 to acquire certain fiber optic network assets from ConocoPhillips. Since then, Quintillion has made substantial progress in deploying the Alaska phase of their network plan. We expect this network to be operational later in 2017, opening new opportunities for revenue growth in 2018 and beyond. Moving to Slide 9, the consumer market presents a different set of opportunities in three areas. First, we will continue to sell into the network we have. There is further opportunity to be had in upgrading existing customers and securing new customers on our network. Second, we have an intense focus on continuing to rationalize our cost structures. Our increasing migration to online ordering is one example of this emphasis. Concurrently, we have very successfully tested a new model of operation in buildings in the local military base here in Anchorage, with an in-building Wi-Fi solution with online-only sign up and credit card pre-pay billing with no paper bills. This has been very well received by service personnel on base while offering us a high gross margin product. Last but not least, Connect America Fund Phase II or CAF II provides stability in our regulatory revenues, with $20 million of annual support over the next nine years while presenting growth opportunities on the retail side. Our near-term focus is on completing the engineering workful deployment while enabling 30% of our target locations by the end of 2018. For this work, we expect to deploy between $8 million and $10 million in capital cumulatively over 2017 and 2018. As we enable all 26,000 new unserved locations, we expect about a 50% take rate, providing a modest growth trajectory for the consumer business over time. Also, as you would expect, we are actively evaluating alternate deployment technologies, including fixed wireless, that will allow us to meet and exceed our service obligations. Clearly, operating to our core business plan is an important lever for value creation and will always have high attention. Laurie will now cover further details on our performance and discuss recent developments on our credit agreement and the share repurchase program. With that, let me hand the call to Laurie. Laurie?

[Laurie Butcher:]

Thank you, Anand. As shown on Slide 11, we're pleased to report strong performance for both the quarter and the full year. Total wireline revenue increased 2.1% year-over-year for the quarter and 3.2% year-over-year for the full year. Fueling our growth, Business and Wholesale, representing over 60% of our total revenue, grew year-over-year 4.6% for the quarter and 8.2% for the full year. This was driven by Business and Wholesale broadband growth which increased year-over-year 9.6% for the quarter and 14.7% for the full year. As expected, Consumer and Regulatory revenues decreased year-over-year, reflecting ongoing general industry trends as customers moved from more traditional telco services to new technologies. Consumer revenue, representing 17% of revenue, declined 3.3% year-over-year for the quarter and 5.7% for the full year. While consumer broadband revenue declined 2.5% for the full year, it grew 3.8% from the prior year quarter and 1.8% sequentially from the third quarter of 2016. This shift is consistent with our expectation that consumer revenue will stabilize in 2017. Regulatory revenues, representing 23% of our revenue, declined 0.5% for the quarter and 2% for the full year. As Anand mentioned, we are pleased we now have certainty on $20 million or 38% of our existing regulatory revenue for the next nine years. We ended the year with total wireline revenue of $226.9 million, an increase of 3.2% over 2015. Adjusted EBITDA was $58.2 million, growing 16.6% over last year. We were able to reduce net capital spending coming in at $30.9 million for the year, primarily due to the nature of customer opportunities in our sales funnel as well as operational efficiencies around capital governance. Adjusted free cash flow was $9.8 million, compared to a negative $3.7 million in 2015. This was possible due to our improved cost structure in our first full year after the Wireless Sale, lower interest payments and lower capital spending. We ended the quarter with net debt of $162.8 million and total debt of $179.6 million. Moving to Slide 12, we are pleased to announce that yesterday we signed the closing documents for our new credit agreement. This transaction, which will fund later this month, allows us to refinance our existing debt and extend maturities, thus removing uncertainty from our balance sheet. Our new senior credit facility consists of a two-tranche term loan totaling $180 million and a $15 million revolver. Tranche one of the term loan is for $120 million at a rate of LIBOR plus 5%, maturing in 2022. The second tranche is for $60 million at a rate of LIBOR plus 7%, maturing in 2023. Principal payments on the new debt will be due quarterly beginning December 31, 2017. The senior credit facility will be subject to customary covenants, including two key financial ratios. The first is a net leverage coverage ratio, not to exceed 3.75-to-1, stepping down over time. The second is a fixed charge coverage ratio of not less than 1.05 to 1. The agreement also includes a $10 million starter basket to repurchase the Company's outstanding stock, subject to certain conditions, including excess free cash flow and liquidity requirements. Purchases in excess of $10 million and other shareholder-friendly actions may be allowed under the facility if among other things an additional net leverage test is met. The agreement also provides for incremental loans up to an additional $50 million. Under our new facility, the blended cost of borrowing is similar to that of our existing debt structure. As part of the process, we worked with a number of quality advisors to reach the best possible structure in terms. Given many of the factors relative to our business, including the size of the debt instrument and our market cap, both of which are below typical institutional thresholds, we are pleased with the terms of our new financing. As part of our balance sheet restructuring activity, we also expect to initiate a cash tender offer to repurchase the Company's 6.25% convertible notes, which otherwise mature in May of 2018. It is expected the tender offer will launch in the near future. Moving to Slide 13, our Board has also authorized a stock repurchase program. The stock repurchase program provides for an amount not to exceed $10 million and has been authorized through December 31 of 2019. The program is scheduled to begin no earlier than the second quarter of 2017. Shares repurchased under the program will be designated as treasury shares and may be used for management incentive compensation as an alternative to issuing new stock. On Slide 14, let's look ahead to 2017. We are setting guidance for total wireline 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 which includes our planned expenditures for CAF II. We expect to provide 2017 guidance for adjusted free cash flow on our first quarter 2017 earnings call, following the completion of the refinancing and convertible note tender process. In summary, we are pleased with our performance in 2016. We continue to show growth in our bottom line and stabilizing our balance sheet with yet one more important step in setting a strong foundation for our future. With that, let me hand the call back to Anand. Anand?

[Anand Vadapalli:]

Thank you, Laurie. Slide 15 summarizes the three levers we have for creating value for our shareholders. Our emphasis relative to operation performance is all about adjusted free cash flow growth, driven by top line performance. We have high confidence in the opportunity for growth in Alaska and we are well-positioned to perform to this opportunity. Capital allocation will be a prudent balance between investing for growth, deleveraging via our credit agreement amortization and taking shareholder-friendly actions. Lastly, like you, we believe scale and diversification are important. As a Board and management team, we will be open to and actively seek strategic opportunities that leverage the strong portfolio of competencies we have built over the years. We will approach these opportunities thoughtfully to ensure we maximize the value creating optionality for our shareholders. I look forward to reporting progress on all fronts over the upcoming several quarters. Thank you for joining us today. With that, let me open the call for questions. Operator?

[Operator:]

[Operator Instructions] We'll now take our first question. Caller, please go ahead. Your line is now open.

[Barry M. Sine:]

This is Barry Sine with Drexel Hamilton. Couple of questions if you don't mind. First of all, a lot of news in the release today, so a lot of questions, on the relationship that you have announced with Quintillion, they are obviously going to be going live with that fiber and they're going to be dropping that fiber in a number of markets, Barrow, Nome, Kotzebue. What exactly are you doing in those markets? It's my understanding you are not the ILEC in those markets, so you don't have fiber distribution. Are you going to be putting additional fiber in from their coastal drop and I guess you'll then be providing broadband services in those markets?

[Anand Vadapalli:]

Barry, it's good to hear from you and thank you for the question. So, yes, our focus in these markets where Quintillion has their landing stations is largely going to be focused on what I would call the business and more institutional kind of opportunities, focused on education, on healthcare, on public safety, on other government and research kind of applications that may exist there. And over time, over the next five, seven, ten years, as we see more work being done in the Arctic, we believe that there'll be additional opportunities that come up there as well. So, the intent there is to go after these kinds of opportunities, and in so far as we need local access network, if you will, the last mile, the so-called last mile, I think we are open to how we go about doing that. We look forward to working with some of the RLECs who are the incumbents in those markets, we have good working relationships with all of them, and where necessary we can step in if we need to, because these are all going to be very targeted, very focused kinds of opportunities that we go after. So we could look at a range of options as to how we go after the last mile.

[Barry M. Sine:]

Okay. And then you also talk about in the earnings deck a new business opportunity on military bases where you are offering wireless broadband. Now obviously you sold your cellular network a couple of years ago. So how are you doing that, are you putting up a 4G cell, is that Wi-Fi, and if you could talk a little bit more about that opportunity please?

[Anand Vadapalli:]

Yes, Barry, this is on the consumer side and it is Wi-Fi on the military bases, which we can do even after we sold the mobile part of the business a couple of years ago. And as I've said in my prepared remarks, we have lit up a couple of buildings, fiber into those buildings, a Wi-Fi network – in fact I would offer to you that the Wi-Fi solution that we deployed in these buildings is very similar to the Wi-Fi solution that we deployed in the various buildings on the North Slope. So we are leveraging our experience and expertise there. And what I like about this business model is, once Wi-Fi is deployed and service personnel come up, they will fire up their tablet or their laptop, they log into the Wi-Fi, it's like how we do in a hotel room, and they will sign up for Wi-Fi service, put their credit card number, and they can use up to five of their devices for using their user name and password. So, a very simple, self-service model, no paper billing, it's all credit card pre-pay billing. So really for us, compared to the typical DSL-based Internet service that we do for home Internet, this is a low-touch high-quality experience, and we are able to provide some extremely attractive speeds. We are Wi-Fi. In fact, we have tested speeds north of 50 megabits per second on the Wi-Fi network there. So this is an attractive solution and certainly something that we think we can leverage in other areas. Really, we ran a couple of pilots and very encouraged with the results we have seen.

[Barry M. Sine:]

Okay. And then my last question, just the general competitive environment in the consumer market, if I look at your fourth quarter numbers, on the voice line to consumer, you had a relatively good quarter in terms of line loss is very low in relation to your run rate, and then in terms of broadband additions, again a pretty strong quarter. And I know you have cable competitors out in the market with 1 gigabit offering. So can you talk a little bit about the competitive environment? And I know you have some pretty optimistic hopes for 2017 performance in consumer.

[Anand Vadapalli:]

Thank you, Barry. I mean, you are correct. I mean certainly our competition on the consumer side has a more ubiquitous network and footprint than we do, and we've been pretty open about that. We have always tended to be far more focused in terms of how we go after the consumer market and really we are selling into the network we have with speeds between 10 to 50 megabits per second. I think our value proposition remains a simple, all you can use home Internet product, and I think that continues to resonate with our customers. Really there are no overage charges, there is no throttling. And we continue to hear that as something that our customers find attractive. And again, part of this is also, Barry, if you recall, in prior calls we talked about management attention. We did designate a leader behind this line of business who has now been in this role for coming on – this is his second year – and part of this is paying attention to that market and looking ahead. Certainly as I mentioned in the call, as we begin to deploy our CAF II locations, which are 26,000 new unserved locations, and if you take our assumption of a 50% take rate over the next many years, that's north of 10,000 new connections that we would hope to turn up. And we think that's a nice opportunity on the retail side, setting aside of course the certainty that we have in terms of the capital support revenues. So again, consumer, to be clear, on the top line we are trying to manage the top line. A lot of our focus though is in taking cost out of that business so that we can fund the growth in Business and Wholesale. Business and Wholesale are the crown jewels of this business and we are growing, we are growing well. We see significant opportunity there and we need to find a way to fund that growth in a way that expands our margin and expands our free cash flow. Really inside the Company, that is my mantra, how do we grow top line while we are growing free cash flow, and that's really resource allocation decisions that we are making every single day inside the organization.

[Barry M. Sine:]

Okay. Thank you very much.

[Operator:]

We'll now take our next question. Caller, please go ahead. Your line is now open.

[Blaine Marder:]

Blaine Marder from Cramer Rosenthal McGlynn. Thank you so much for the shareholder-friendly actions, quite refreshing, thank you so much for that, and congratulations on completing 2016. And I was just going to ask, Anand, are you guys planning on the new credit facility to swap out the floating portion to fixed?

[Laurie Butcher:]

We will still have a swap on 50% of the debt. So yes, the plan is to swap out 50%. So $90 million of the $180 million will be swapped.

[Blaine Marder:]

Okay. And just for cost, you'll let the other 50% float?

[Laurie Butcher:]

Yes.

[Blaine Marder:]

Okay. And then as we look to 2017, I'm wondering the guidance is somewhat tepid just for sort of slight, ever so slight top line and EBITDA growth. Are you just being conservative, is there something you see in the mix of business that would cause you to sort of be a little cautious on guidance in terms of the year-over-year growth rate?

[Anand Vadapalli:]

Blaine, this is Anand. First of all, thank you for your questions and kind comments at the start of the call. I appreciate it. One comment on the debt before I answer your question on the guidance. We do expect to file an 8-K with the credit agreement here in the next day or so. So, you and all our investors will have all of that visibility through the 8-K, and then obviously we'll be filing our 10-K here shortly as well. So, there's a lot more information that is forthcoming that I think everyone will find useful. I just wanted to get that out there.

[Laurie Butcher:]

Yes, thank you.

[Anand Vadapalli:]

And then back to your question on the guidance, I think we are comfortable with the guidance. We are demonstrating growth, which in this environment I have not seen very many of our peers signing up for any growth at all. We feel comfortable with the guidance that we have out there. We feel very comfortable with the opportunity set that is out there. In fact, if I may take this as an opportunity to look at some of the particularly our IT partnerships that are creating some nice tailwinds for us, the partnership we have with Microsoft and the ExpressRoute connection to the Azure Cloud, if you are a business in Alaska looking to host your services on the Microsoft Cloud, we are the only ones who can offer a secure and a private connection. In fact, the state of Alaska used that to set up their first cloud implementation quite recently on our ExpressRoute connection. So I used that as an example to convey my strong confidence in the opportunities ahead. We feel comfortable with the guidance and certainly we look forward to delivering on our promises like we've been doing for years in a row now.

[Blaine Marder:]

Okay, very good. Thank you. And just finally, if I look down the cash flow statement and I take your guidance for CapEx and EBITDA sort of coming out with a free cash flow number of $8 million-ish, $9 million-ish, $10 million-ish, something like that, and you mentioned the cost of the tender offer, any other sort of one-time items or working capital items to consider in 2017?

[Anand Vadapalli:]

Blaine, I think we'll hold our guidance on free cash flow here for the next couple of months. As Laurie mentioned, we will come back to you all with a guidance for the year on our first quarter call. We need to go through, close out the refi process and go through the tender process, and then we'll come back to you.

[Blaine Marder:]

Understood. Very good. Thanks so much.

[Operator:]

We'll now take our next question. Caller, please go ahead. Your line is now open.

[Toby Moore:]

This is Toby Moore from Pinnacle Investment Advisors, Tulsa, Oklahoma. My first question, if I can go back to Slide 7, it mentions your leading competitor has a 51% market share. Can you disclose who that competitor is?

[Anand Vadapalli:]

I mean there are two facilities-based providers here in the state, large state-wide facilities-based providers. There are other smaller ones of course. But predominantly, we complete against GCI, and GCI certainly has the dominant share in the market, and we see ourselves as a challenger creating value for our customers and fueling our revenue growth.

[Toby Moore:]

All right. Moving back onto the refinance, you said an 8-K was forthcoming here in the next few days. Will the cash tender offer be mentioned in that 8-K or is that another story a little more further down the road?

[Anand Vadapalli:]

The 8-K is regarding the credit agreement that we have executed.

[Toby Moore:]

All right. And regarding this credit agreement, did the Company consider possibly another bond issue either with a convertible or a non-convertible bond when they were considering going with the first thing that you ultimately chose, and if so, what was the best deal you could make on a bond issue?

[Anand Vadapalli:]

Toby, thank you for the question. I think as Laurie mentioned, we certainly went through an extensive process. We are very comfortable with the advisors we have worked with and we are also very pleased with the outcome that we have here. So, I think I will restrict my comments to that at this time.

[Toby Moore:]

Very well. It's all I got.

[Operator:]

Thank you. That does conclude today's question-and-answer session. I'd like to turn it back over to management for any additional or closing remarks.

[Anand Vadapalli:]

Thank you all for joining us and we look forward to reporting progress on our upcoming calls. Have a great day.

[Operator:]

Thank you. That does conclude today's conference. Thank you all for your participation.