Alaska Communications Systems Group, Inc.
Q1 2015 Earnings Call Transcript

Published: 8 May 2015

[Operator:]

Good day, and welcome to the Alaska Communications Systems first quarter 2015 earnings call. Today's conference is being recorded. At this time, I’d like to turn the conference over to Mr. Leonard Steinberg, General Counsel. Please go ahead, sir.

[Leonard Steinberg:]

Good day, and welcome to the Alaska Communications first quarter 2015 conference call. I am Leonard Steinberg, General Counsel, and with me today are Anand Vadapalli, President and Chief Executive Officer; Wayne Graham, Chief Financial Officer; and Laurie Butcher, VP of Finance. 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 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 2015 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 three 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 on our website. Following our remarks, we will open the line up for questions. With that, I would like to turn the call over to Anand. Anand?

[Anand Vadapalli:]

Thank you, Leonard. Good morning and thank you for joining us today. Starting with slide five, we'll cover four key themes in the call today. First, our core business is strong, doing well and we posted another quarter of industry leading top line performance. Second, with respect to the wireless transaction, the headline is that we are at or ahead of schedule in achieving our straighter synergies. This puts us well on track to achieve our run rate EBITDA target for the year. Third, we've made an opportunistic investment to accelerate our growth by acquiring certain fiber optic network assets from ConocoPhillips. At the same time, signing a long-term services contract. This investment exceeds our return thresholds and we expect this investment to be EBITDA accretive, starting 2016. Lastly, we're making good progress in refinancing our senior secured facility and we expect to bring that process to a close in the next couple of months. Turning to slide six, first and foremost, our core business is doing well. This is reflected in our industry leading top line performance where we recorded 2% total wireline revenues growth, fueled by broadband revenue growth of 10% and business and wholesale revenue growth of 8%. This performance continues to demonstrate the underlying market dynamics that support our growth. We have an exceptional operational team that has exceeded our service delivery expectations in the first quarter, which bodes well for revenue generation through the rest of the year. Last but not least, our continued emphasis on using LEAN to drive customer service and operational improvements provides us a platform for long-term sustainable performance. Moving to slide seven, let me provide further detail on our synergies plan related to the sale of our wireless operations. We closed the transaction in the first week of February and in aggregate, we are either on or ahead of schedule. Following the close, we had certain obligations related to post close transition services to the buyer. I'm pleased that we have concluded these transition services as of mid-April and are now moving forward with various actions related to taking out the costs associated with our wireless operations. We expect to substantially complete our actions through the course of the third quarter and remain comfortable with our guidance of $54 million to $56 million of run rate adjusted EBITDA, exiting this year. Moving on to slide eight, in a reflection of our balance sheet position, we are now able to make strategic investments to accelerate future growth and value creation for our shareholders. Our investment in a fibre-optic network in the North Slope is a perfect example. Let me begin first by providing some context of where these assets are situated. You will note from the inset map at the bottom right-hand corner, the location of the North Slope in Alaska. The main map provides further detail of the North Slope, noting areas of current production as well as future growth. We are pleased to have partnered with Quintillion Holdings in the acquisition of this asset from ConocoPhillips, one of Alaska's leading energy produces. Quintillion Holdings is an Alaska-based middle mile fiber provider with plans for fiber infrastructure to certain north-west Alaska communities, including a fibre-optic route from the North Slope to Fairbanks where they can interconnect with the Alaska Communications network. Slide nine provides further insight into this investment and our expected returns. The energy sector is a big driver of Alaska's economy and recent volatility in oil prices notwithstanding, will continue to be a driver of our economy for years to come. Our revenues and market share in this important sector have been traditionally very limited. Recognizing this, we invested in a team of a few talented individuals with deep connections in this sector. Over the last two years, we've been building a book of business from the oil and gas industry in large part leading with IT managed services. This asset allows us to take what was essentially a private asset and monetize it by offering capacity to other business and carrier customers. Importantly, building a relationship with customers on the Slope allows us to pursue other opportunities in other parts of Alaska, including connectivity to the Lower 48 operations. The extensibility of these relationships is what makes it compelling. In dollar terms, we expect to fund with cash on hand approximately $6 million over 2015 and ’16 in the acquisition of this asset. 2015 will largely be focused in standing up our operations in the North Slope and taking over certain ConocoPhillips network operations. We expect revenues in 2016 to be in the $2 million to $3 million range with accretive EBITDA. We expect EBITDA to be breakeven in 2015 and we are not updating either revenue or EBITDA guidance for this year as a result. This investment is strategic and long-term in nature and meets our 20% IRR thresholds. As we move past 2016, we expect this investment to become a significant mover of the dial over the longer term. I’ll now hand the call to Wayne to cover financial highlights as well as provide an update on our balance sheet. Wayne?

[Wayne Graham:]

Thanks, Anand. Turning to slide 11. We’re pleased to report strong performance for the first quarter. On the left hand side of the slide, you can see total service and other revenue grew 2%. Business and wholesale, which makes up 52.9% of total wireline revenues grew 7.7% with managed IT services comprising 24% of that growth. Consumer revenue grew 0.6%. Other revenue did show a drop-off that is partially driven by the fact that we recognized $1.4 million in revenue reserve releases in Q1 2014. Our headline number for total wireline growth was 2%, but if you normalize for this event, operating results performed even better, posting growth of 4.6%. On the right hand of the slide, you can see what makes us unique. Our revenue performance consistently outpaces our peers and it is our intention to continue to do so for many quarters to come. Turning to slide 12. You can see a deeper dive into a key area of our growth, broadband revenues. We consistently performed well in this area and we posted growth of 10.1% for the quarter. As you can see on the right hand side of the slide, as with total revenue, we continue to outpace our peers. With revenue performance strong and synergies tracking, we feel very comfortable with our prospects for continued value creation. Slide 13 summarizes our overall balance sheet. We are now one of the lowest levered companies in our industry. Overall cash balances are ahead of expectations. However, we will dip into some of these cash reserves that cover wind down transaction and other expenses from the wireless business sale. As we’ve been saying, with the wireless business transaction closed, our focus is on refinancing our term loan facility. We are working with a lead bank and are going to the process to syndicate a facility sized at $100 million to $120 million. $80 million will be used to replace our existing term loan facility, which matures next year and the remainder will be a delayed draw facility targeted to selected purchases of our convertible notes which mature in 2018. We are under no pressure to repurchase the converts and if we do, it will be need to be a price point that makes sense for our shareholders, which we believe to be around par value. If we can do repurchases around this level, we are quite comfortable holding them until maturity. Slide 14 provides an update on guidance. We are reaffirming our expectations. As we indicated previously, 2015 will be a transitional year as we eliminate the cost of the wireless business and focus on being a pure play wireline provider. With transition complete, we are actively reducing our cost structure and we expect to deliver on our run rate adjusted EBITDA target as we enter the year. With that, let me hand the call back to Anand. Anand?

[Anand Vadapalli:]

Thank you, Wayne. As we turn to our last slide 15, let me leave with you a few important messages. First, our core business is doing well. We are seeing expected levels of topline growth and we expect this growth to fuel future cash flow expansion. We are now in the wind down mode for the wireless operations. Ahead of schedule in terms of synergies and sitting on a solid balance sheet, driven by industry-leading leverage ratio. We expect strategic investments like the North Slope fiber assets to accelerate our growth over time. Equally important, our ability to add marquee names like the State of Alaska and ConocoPhillips to our customer roster creates attractive growth opportunities. We are well on our path to refinancing our balance sheet, moving out the maturities of our term loan and reducing our cost of capital, all of which are shareholder-friendly actions. We are confident in our future and will develop on the track record we’ve created of meeting or exceeding expectations with a deep commitment to continuously enhancing shareholder value. Thank you for joining us today. With that, let me open the call for questions. Operator?

[Operator:]

[Operator Instructions] We’ll move first to Barry Sine with Drexel Hamilton.

[Barry Sine:]

Good afternoon, gentlemen. Congratulations on the North Slope fiber transaction. I know that’s an area that you’ve wanted to get fiber asset into for quite some time. So, very nice announcement.

[Anand Vadapalli:]

Thank you. Very good afternoon.

[Barry Sine:]

On that transaction, could you help us explain understand the legal structure? Are you taking an equity stake in Quintillion, or you creating a joint venture that will jointly own that North Slope fiber? And I know what Quintillion is doing there, partnering with undersea fiber and building the landing points. I assume you’re not involved there. And then lastly on the Fairbanks to Deadhorse fiber length, it does not sound like you’re going to invest in that or own a stake in that, but it sounds like you will be a purchaser of a wholesale capacity on that to sell to your customers?

[Anand Vadapalli:]

Barry, thank you for the question. We are excited about this opportunity in the North Slope. As you rightly pointed out, this is an area that we have not traditionally played given our lack of assets, so the fact that this opportunity opened itself, where we had an option to go buy some assets from ConocoPhillips and more importantly to go in a with a multi-year long term anchor tenancy relationship with ConocoPhillips, all of those are goodness and I am particularly excited about our ability to do this. With respect to Quintillion Holdings, again this is one of those occasions where two companies have very complementary and supporting interests. As you've pointed, Quintillion has, through its arrangements, landing rights to construct fiber into certain Northwest Alaska communities. And as part of those arrangements, Quintillion is also planning on building fiber from the North Slope down to Fairbanks where they will intend to connect with the Alaska Communications network going south of Fairbanks. So as part of this, it was important for Quintillion to have access to connect from their landing station to their proposed North Slope to Fairbanks route. For us, it was important to have access to the oilfields where all the oil work is happening and provide services to the producers and operators on the Slope. So we both entered into this relationship where essentially we purchase was, in relationship from Alaska Communications with ConocoPhillips and at the back end we entered into a relationship with Quintillion where Quintillion owns part of the asset, also Alaska Communications and Quintillion have entered in a joint venture to handle carrier sales. So you are correct, we are not an equity investor in Quintillion, but we are partnering with them both in terms of funding the asset purchase as well as future opportunities. And again, you are correct in assuming that we intend to procure capacity from Quintillion on the Fairbanks to not sloper-out which will bring competition and really open up this market, which is why I am really excited about the long term opportunities. This is just great news for us and in the long term we think it will very meaningful to our business.

[Barry Sine:]

And a follow-up on that. So as part of that, you pick up a pretty significant customer in the energy industry in Alaska, ConocoPhillips which is a nice anchor customer to have. I am assuming that now that you have access to these networks you have a presence on the North Slope that this is your entree to hopefully from your perspective win greater market share with the other energy companies that are active on the North Slope?

[Anand Vadapalli:]

Absolutely, a relationship with someone as important as ConocoPhillips in our state provides us a great marquee reference account that really helps us with other customers and in fact we are seeing that happen already and we are delighted to be able to participate there. So it's a long term relationship with ConocoPhillips. We are excited about it and certainly it's a privilege to have them as our customers. And we look forward to other business from other producers and operators and the whole eco-system that's there on the Slope in support of oil production. So this is goodness for us on many levels.

[Barry Sine:]

And in that market, could you remind us who your competitors are from a network standpoint? I believe GCI has some fiber up there and I know that you provide service for their satellite network, who are you competing with there?

[Anand Vadapalli:]

It's a good question, Barry. So interestingly the infield fiber network, given the unique characteristics there, this is the only fiber asset that goes to all of the infield oil production sites from Deadhorse, which is kind of the main town going west. All of the oil fields, this is the only fiber asset that really goes into those. So this is a very differentiated and unique asset that we now have access to. There are a few microwave networks and then there are obviously satellite connections, but this is now a differentiated fiber network that we are pleased to offer to our customers there.

[Barry Sine:]

Okay. And my last question. Switching gears a little bit on the shutdown of the wireless business, did I read the slide correctly that it looks like the closing of the retail stores is going to be delayed beyond the original schedule, moved into fourth quarter? If so, why? What are you doing with those stores? You still have them open and you are selling your broadband service and how are you doing in terms of being able to exit leases without having to pay them the full freight on the remaining lease commitment?

[Anand Vadapalli:]

Yeah. Very good question. I will give you some flavor there from a business perspective and then I will hand it to Wayne who can provide some more color in terms of our overall schedule around this. So overall, we are actually ahead of where we thought we would be at this point. We already have arrangements to exit the leases we have with retail source for many of our retail source. There are only a couple of locations, particularly in mall locations where it will take us a little bit of more time, which is why you have seen that extension there. But in aggregate, we feel very comfortable that we are operating well within our schedule and budget that we have for synergies. I’ll hand it to Wayne to see if he wants to add some more color for you.

[Wayne Graham:]

Thanks, Anand. Hey, Barry, it’s like any other big complicated projects, there are some things that are ahead of schedule and some things that are a little bit behind schedule. Generally, we’re bullish that you started thinking about the wind down activities on the labor front where we are well ahead of schedule. We will be taking some charges in the second quarter as we incur those costs for leasing the employees. The real estate ones is just taking us a little bit longer, it will slip into the third quarter and maybe in the fourth, but we are pretty optimistic we’re going to get there and our overall cost of synergies budget that we have, we’re going to do better than that. So for us, the plan is good. We will take – puts and takes that go into big plan and we’ll get to our EBITDA number as we end the year.

[Barry Sine:]

So you’ve already shuttered those stores, it’s just a financial, it’s not as if you still have them open and you’re selling broadband, you already just closed those stores, correct?

[Anand Vadapalli:]

Yeah, Barry. So we have shut down some stores, some stores are still open and they will be for a couple of months and they are available for customer service functions for broadband. And over the next couple of months, we will start shutting down more stores, and after that it’s just a matter of negotiating on case-by-case basis for a couple of outliers.

[Barry Sine:]

Okay. Thank you very much.

[Wayne Graham:]

You bet, Barry. Thank you for your questions.

[Barry Sine:]

Thanks, Wayne.

[Operator:]

[Operator Instructions] We will now move to Blaine Marder with Cramer Rosenthal.

[Blaine Marder:]

Hey, guys. First of all, thank you for being a good steward of our capital in regards to restructuring the balance sheet. Next on the EBITDA, it came in a lot higher than I thought. I was thinking you sort of – Wayne, as you had outlined in the past, sort of started low and as those synergies get baked in, you would hit your run rate by the end of the year. If you just annualize the first quarter, you’re almost at – you’re at a $50 million level and you originally outlined 12 million of synergies for closing down that retail operation. Am I missing something here, where you – why wouldn’t I layer 12 million on top of the run rate you’re doing now?

[Wayne Graham:]

That’s a good question, Blain. So Q1 is a little wonky for us because we have a tough period of wireless. We also had transition services revenue for that period. And so it’s hard to look at Q1 from an EBITDA perspective. That’s why during the call, we really focused on the topline. If our topline performance is steady, and we continue to compound on that growth, good things are going to happen. What you’re going to see on EBITDA as we go through the next couple of quarters is Q2 will actually be probably what you expected to be, it will be lower and we will have quite a few one-time costs associated with our wind down activities, the severance costs, the store buyout really starting to hit us pretty heavy in Q2. We carve those out of adjusted EBITDA, so people can kind of see how we are progressing, it will hit net income. So Q2 I think will be more in-line with what you would think. And then when we get to Q3 as a lot of the costs are behind us, we will start to really provide visibility to shareholders as to we’re getting close to that 54 to 56 run rate number and then when we get to the fourth quarter we our goal is to be at the guidance. Hope that provides a little bit of clarity for you.

[Blaine Marder:]

It does, thanks a lot.

[Wayne Graham:]

I’d also like to add Blaine on the issue of being a steward on capital, we do get calls occasionally about, are we interested in doing – on certain converts, would we convert those into equity, would we take the converts and extend them into a different tranche of converts. And just to set the record straight, unequivocally we have no interest in those kind of structures, we’re really focused on refinancing a senior term facility.

[Blaine Marder:]

Terrific. Thanks guys.

[Wayne Graham:]

You bet.

[Anand Vadapalli:]

Thank you, Blaine.

[Operator:]

[Operator Instructions] We will now move to Adam Steinberg with Waveny Capital.

[Adam Steinberg:]

Hey, guys, thanks for taking the question. Hoping you we could come back to ConocoPhillips deal for a minute. I thought you had mentioned at the start of the call that there are opportunities in the lower 48 as well. I was hoping maybe you could just expand on that so we can try to get a sense of what is included in the guidance and what is maybe incremental for the guidance?

[Anand Vadapalli:]

Andrew [ph], good morning. This is Anand, thank you for the question. So what I was alluding to is, as we start entering into relationships with the oil companies, the energy sectors, totally many of these companies have their offices, their IT headquarters, their IT staffs located in those 48. So the opportunities in front of us are not just on the North Slope, but certainly there are some of those definitely but also in other markets in Alaska itself, like for example in Anchorage, in the Cook Inlet where they have you know these companies have other parts of their operations and also to connect to their facilities in the lower 48. So that's what I was intending to communicate, so thank you for the question.

[Adam Steinberg:]

Got it, okay. And then, just turning to the capital structure, one last one, obviously using the excess cash from the new term loan to buyback converts at par that's a you know two sided negotiation. If you're not able to purchase them at par or close to par, what happens to the cash then, if I'm not mistaken, you now have with the old term loan, the ability to pay a dividend on the common, maybe the ability to do buybacks, what you do with that cash if you can't source the paper at par?

[Wayne Graham:]

Well, right now, we haven't closed on any of the term loan, we're early in the process, so we need to go to the syndication and once we complete that we can provide with better visibility to the term. I mean, we would like to reduce the amount of converts, Adam and we do think there is an opportunity to buy them back at par. We've done this in the past and we think if we're patient; we have the means to do that over a period of time. That's really our baseline strategy, if we're not successful on that, we'll really just have $80 million term facility and we'll hope to convert, our cash on our balance sheet will be higher than we've historical had and that will provide some options from us.

[Anand Vadapalli:]

And Andrew to further elaborate, I think as we mentioned in our prepared remarks, we are looking at trying to structure this term loan, this new facility in the form of a delayed drop, so that we've not -- we don't have a negative carry of additional cash that we don't need and we'll drawn on that only if we think we can buyback converts at the right price.

[Adam Steinberg:]

Got it, all right but at these levels, I guess this is more of a comment than a question, it seems like the stock is -- the security is also undervalued and if you have the wherewithal to initiative buybacks, I guess we'll see how it plays out but that's one thing to consider.

[Anand Vadapalli:]

Well Andrew thank you. And if I may share some thoughts on that, certainly we appreciate some of the increased recognition that we've gotten in terms of equity value over the last month, month and a half, that's pleasing to see. But we do concur with you that the stock is still undervalued and there is options for growth. And again, we do hope that our fundamental business performance is something that is a clear indication to equity holders. You look at our growth profile; we have one of the strongest growth profiles in the sector. And from our perspective, I think again, this opportunistic investment in the North Slope should be an indication of how we think about the business. If we think that they are 20% plus IRRs and return on capital that is pretty attractive and that's something that we think is really good for our shareholders. So the more of those opportunities we can find, the more of those we'd be interested in doing. And the more of those we do, the better free cash flow performance our business will have which creates real optionality of the Board to do more of the things that add value to shareholders including some of the ones that you just talked about. So from our perspective, we are just insanely focused on the fundamentals of our business, which we think are strong and we are looking forward to it.

[Adam Steinberg:]

Right, well we look forward to more updates as the year progresses.

[Anand Vadapalli:]

Indeed we will, thank you Andy.

[Operator:]

We'll now take a question from Jason Bernstein with Odeon Capital.

[Jason Bernstein:]

Hi guys, nice quarter. Question on the port payments, I know there was something issued by the FCC regarding how much money was going to be available in the future and I know the payments are currently frozen, any sort of guidance on where those discussions stand and how we can get an idea of the trajectory of the support going forward?

[Wayne Graham:]

So the FCC issued a recent cap order that address cap rules for the lower 48 price cap carriers receiving support under the FCC's model. This order did not address cap support for Alaska but we do have a good idea of where we're heading and that's because Alaska Communications has been receiving approximately $19.5 million a year of frozen high cost USF for the last several years and the FCC has previously acknowledged that while it's model does not work well for Alaska, Alaska should continue to receive the $19.5 million a year of frozen USF and we expect an order later this year to that effect.

[Jason Bernstein:]

Great, thank you very much.

[Operator:]

And it appears there are no further questions.

[Anand Vadapalli:]

Thank you all for joining the call and we look forward to talking to all soon and have a good day.

[Operator:]

And once again, that does conclude today's conference, we thank you all for your participation.