Alaska Communications Systems Group, Inc.
Q4 2014 Earnings Call Transcript

Published: 6 Mar 2015

[Operator:]

Good day, and welcome to the Alaska Communications Systems fourth quarter and year-end 2014 earnings call. Today's conference is being recorded. At this time, I’d like to turn the conference over to Leonard Steinberg, General Counsel. Please go ahead, sir.

[Leonard Steinberg:]

Good day, and welcome to the Alaska Communications fourth quarter and year-end 2014 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 fourth quarter and year end 2014 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 on our website. Following our remarks, we will open the line up for questions. With that, I'd like to turn the call over to Anand. Anand?

[Anand Vadapalli:]

Thank you, Leonard. Good afternoon, and thank you for joining us today. Starting with slide five, 2014 was another year of stellar operating performance. We met our revenue guidance, coming in at $315 million, while exceeding our EBITDA guidance, coming in above $92 million. We continue our track record of industry leading broadband and total wireline revenue growth. Equally important, business and wholesale, which is already over 50% of our revenues, recorded year over year growth above 9%. This aligns with expectations we previously set about growing this line of revenue at about 8% CAGR. We enter 2015 on a strong footing. We concluded the sale of our wireless operations on February 2. As we will cover in greater detail later in the call, we have a clear operational path to removing the costs associated with our wireless business and are comfortable with [unintelligible] our synergies target. We made a call that when we announced the transaction, we’d set a run rate EBITDA target of $54 million exiting 2015. We now believe we can outperform this target. There is ample room for growth in our market, and we continue to gain market share. We are well-positioned to end the year with one of the lowest leverage ratios in our industry. Slide six provides an overview of our target market post the wireless transaction. Telecom services are an $800 million market in Alaska, where we have about a 20% market share. The IT managed services market is a further $700 million market where we have less than 2% share today. The competitive nature of these markets is quite different as well. On the telecom side, we have one main competitor. This has been an important driver of our performance, which, when combined with our strong value proposition to customers, provides continued confidence in our future performance. The IT managed services market, on the other hand, is highly fragmented, with no clear leader. In fact, with less than $10 million of revenue in this area, we are in the top 10 providers in the state. In addition to organic growth, we see opportunities to acquire other providers as we plan to secure our leadership position in this space. Importantly, more than 85% of our target market opportunity is focused on business customers. With our seasoned sales team and our strong network, we are well-positioned for growth in both markets. Moving to slide seven, I’d like to address up front the many questions we get regarding the Alaska economy, given the recent trend in oil prices. While the state is, indeed, facing a budget deficit this year, Alaska has had the foresight to build reserves for precisely this kind of situation. With current reserves north of $12 billion, if the current trend in revenues and expenditures were to continue with no changes, the state has reserves that last through 2022. That being said, in many ways, external pressures are oftentimes required for organizations to do something different, to move away from status quo. As businesses statewide seek to get greater value for their dollar, we, as a company with 20% market share, now have the opportunity to demonstrate that value and gain additional revenues. Bottom line, we will not use oil prices or the economy as a reason we cannot perform, and we remain confident about our ability to drive top line growth for the company. Turning to page eight, I’d like to remind you that a lot of our success is built on our network. Six years ago, we made a substantial $200 million investment in our submarine cables and in-state long-haul fiber network. Since then, we’ve continued to strengthen our last mile access network. A lot of our growth today derives from these investments. Over the years, we’ve built strong capabilities in selling and delivering into this network and have built an exceptional roster of customer relationships that now fuel our growth. Our network differentiation is most evident for our high-end enterprise and carrier class customers. Our certifications from the Metro Ethernet Forum provide a differentiated and standards-based network that separates us from our competition. Turning to slide nine, we are a strong company today that is positioned well in the market. A unique competitive situation and our investments in network and sales have created a growth platform for us. Our operational emphasis on continuous improvement through Lean methodology will enable us to improve service quality while we eliminate waste and inefficiencies. We rigorously measure and hold ourselves accountable to high levels of customer service. All this bodes well in securing our leadership in broadband and managed IT services. Business and wholesale revenues are already over 50% of our revenues and will drive our growth over the upcoming years. We expect to see returns in excess of 20% from our success based capital, which will continue to drive EBITDA and cash flow expansion. When combined with our strong balance sheet, our shareholders should have high expectations of value creation over the months and years to come. With that, let me hand the call to Wayne. Wayne?

[Wayne Graham:]

Thanks, Anand. Turning to slide 11, we’re pleased to report strong performance for the fourth quarter and year overall. Focusing on the quarter, on the left-hand side of the slide, you can see that total service and other revenue grew 5.9%. Business and wholesale, which makes up 51.9% of total revenues, grew 8.7%, with the impact of TekMate constituting 32% of that growth. Consumer revenue grew 1.7% and other revenue, which includes equipment sales, also showed solid performance, up 3.9%. On the right hand side of the slide, you can see year to date numbers which are equally strong, with total service and other revenue up 8% for the year. Our revenue performance continues, and our focus on broadband drives our growth. Overall broadband grew 8.3% for the quarter and 10.4% for the year. Turning to slide 12, you can see that we’ve continued to lead our industry with top line performance. Our growth in broadband and total service and other revenue continues to outpace our peers. It is core to the value proposition we deliver to our shareholders. Slide 13 shows our performance relative to guidance for the full year. We met our guidance for revenue, exceeded our guidance for adjusted EBITDA, and outperformed on our overall leverage ratio. During the year, we continued rigorous management of working capital, which fortified our cash balances. In the fourth quarter, we chose to spend success based capex that impacted free cash flow, but did not impact cash balances. On a GAAP reporting basis, we incurred $9.6 million in nonrecurring charges in the quarter as follows

[Anand Vadapalli:]

Thank you, Wayne. Let’s turn to slide 17. It’s not often that a company can point to a milestone and say that we are different now. Indeed, with the recent closing of the wireless transaction, Alaska Communications has turned a page. Our unique market opportunity and competitive situation provides a platform for growth. Our network, combined with sales and service focus, enables us to take advantage of this opportunity. We have a clear operational path for wireless synergies this year, where we feel good about exceeding our initial synergy estimates. Our long term approach to Lean will improve customer service while expanding margins and cash flows. Most importantly, we have the talent pool to do all this. We have a skilled workforce, supported by a management team with solid depth. Our people are what our customers value. It is our people that give me the most confidence about our future for many years to come. Before I wrap, I’ll note that we are planning an investor roadshow the first week of April being organized by our IR firm, LHA. If you would like to learn more or meet with us, please contact our IR manager, Tiffany Dunn. Thank you for contacting us today. With that, let me open the call for questions. Operator?

[Operator:]

[Operator instructions.] We’ll take our first question from Barry Sine with Drexel Hamilton.

[Barry Sine:]

Saw a little bit of a sequential downtick in business in wholesale revenue from Q3 to Q4, and I know there’s a lot of seasonality in the Alaskan market. Some businesses will shut down. The tourism industry. So I’m not sure what’s a normal number, what’s driving that. Could you kind of elaborate on the sequential change that we’re seeing there?

[Wayne Graham:]

It’s all wholesale voice business, and it’s entirely attributable to seasonality on a quarter over quarter basis.

[Barry Sine:]

And you’ve given consolidated revenue guidance. Would you be willing to go into the different categories of revenue and talk about what you’re expecting in terms of growth for each of those categories that would get you to that $220 million of revenue?

[Wayne Graham:]

There’s a slide in the deck where we provide more context behind some of the numbers. If you go back to that page, we talk about some of our additional revenue categories, of how you can derive that number.

[Anand Vadapalli:]

Just to provide more color to what Wayne just said, and this is there on the slide, but for all the listeners on the call, we’ve said that our business and wholesale component of our revenues will be the driver of growth, which we expect at about 8%. We’re generally saying that our consumer revenue should be flat, and that leaves what we call access and support revenues, and our expectation is that our [frozen] high cost support revenues should continue, and we are in dialog on that front. And we’ve always said that our access revenues is something that declines about 5% a year. So that’s kind of the way this component. But you add up all these moving parts and you come to the total service and other revenue, we expect a continued uptick at the aggregate level on a go forward basis.

[Barry Sine:]

And on consumer broadband, you’ve seen a little bit of a tick down in terms of the number of connections. You’re losing one of your distribution outlets as you close the wireless stores. I know you also sell consumer broadband in there. Is that all that significant? Or has that not been a significant channel? What’s the expectation on consumer broadband subscriptions into 2015?

[Anand Vadapalli:]

Good question. Actually, the downturn in connections is a very deliberate move on our part, as we have stopped selling any speeds less than 10 MBS per second. We made that decision in the first half of last year, and what you’re seeing towards the end of the year is that result in play. Essentially, we are moving to only selling higher speeds. The speeds that we have in market today for the residential side are 10 MBS, 15 MBS, and 30 MBS and 50 MBS. And of course, as we continue to deploy fiber in and around town for business customers, we will increase speeds for residential customers in those areas. So our value proposition continues to be truly unlimited usage for customers and we are still not competing on price, as you know, which is the reason why you continue to see revenues holding their own while the connections have dropped a little bit lower. But that, again, is a deliberate strategy, and looking forward, from our perspective, we’ll be working hard to keep the consumer revenue line flat, but a lot of our effort on the consumer side will be continued margin improvement by looking at how we do business differently, in a manner that we can continue to provide the quality of service our customers expect, but look at different ways we can do business. Product choices is one example that I’ve just used, but there are other ways we can conduct business that would help us improve margins. So, as we look at margin expansion on the consumer side, it’s really taking cost out of the business on the business side, margin expansion comes by growing top line.

[Barry Sine:]

Last question, maybe just clarify, you talked about exit run rate EBITDA when you give the EBITDA guidance. I looked at it, I think it was slide 15 when you talked about some of the timeline on the cost reductions. That’s going to go through the fourth quarter. When I hear that term, I think if I could just take fourth quarter, multiply it by four, and that would get me the run rate number. Is that how I should think about that, the way you’re giving guidance, or is it a different [unintelligible]?

[Wayne Graham:]

That’s how you should think about it.

[Operator:]

And we’ll take our next quarter from Jason Bernstein with Odeon Capital Group.

[Jason Bernstein:]

Could you guys talk about the current status of the FCC reforms?

[Anand Vadapalli:]

With respect to the CAF-II process, as I noted in one of my previous answers, the FCC has been in discussions with us about the continuation of frozen levels of support, and we are in dialog with them. We do not have a timeline for you at this time. As you can imagine, there’s a lot going on there, and cannot say exactly when this will come to pass, but until such time the frozen levels will continue, and we are actively talking with them about continuing that. And that’s how we are thinking about that particular line item of revenue as well.

[Operator:]

We’ll take our next question from Phil Larson with Millstreet Capital Management.

[Phil Larson:]

I was just wondering if you could give any guidance on 2015 EBITDA, not as a run rate, but just for the full year?

[Wayne Graham:]

That’s a good question. It’s going to be lower than our run rate, and we’re really staying away from guiding for that, the year. And it really has to do with the journey we need to go through in the next couple of quarters with the transition services period. That could be a short period, it could take a few extra months. And so there’s some variability in our numbers that we’re managing to. For us, what we’re really focusing on is completing that transition services agreement, accelerating our synergies, and how we measure success is getting to that run rate EBITDA, which will provide the free cash flow and just a platform to do better year over year over year. What we can say is that it’s going to be lower, but we’re staying away from giving an absolute dollar amount for the year, because our success is that run rate target.

[Phil Larson:]

And then just to confirm, after the debt paydown with the proceeds from the wireless sale, there’s now about $80 million outstanding on the term loan?

[Wayne Graham:]

That’s right.

[Phil Larson:]

And then in the process of looking to refinance the term loan, have you thought about the converts at all? Would you look to do a tender offer for those, or just leave them outstanding?

[Wayne Graham:]

We’re looking at our entire balance sheet. The market’s good, and we have a range of options, and I think we’ll be in the marketplace this year. How we work [unintelligible] those options are a little bit TBD right now, but we are looking at our total balance sheet.

[Operator:]

And it looks like we’ll take a follow up question from Barry Sine with Drexel Hamilton.

[Barry Sine:]

You’ve given guidance on capital spending, and I know you’re spending a lot on fiber and I’m assuming a lot of that is [tail] circuits. But could you articulate in a little bit more detail what kind of projects you look to spend? Are there any new markets, like Fairbanks, that you’d go into with metro fiber?

[Anand Vadapalli:]

Let me start and we’ll see if Wayne wants to add any more color. But I think the breakout that we guided to during the call, which is a maintenance capital of about $20 million and a $16 million allocation for success based capital, is a good way to think about it. The $16 million of success based capital is largely going to be driven by business customer opportunities. If I were to use examples, for example from last year, in 2014, the work we did for [unintelligible] school district is a good example. The work we did for what we call the large carrier customer opportunity is a good example. These are examples of success based capital. So the deployments, you’re correct, we’re looking to deploy more and more fiber into the access network and those are going to be customer opportunity driven. Certainly, a category of investments within that envelope that we would be looking at is if there are interesting managed services firms in Alaska or that we may look at, and if we find something that would be accretive that adds to our capabilities, frankly, in or out of state, we would look at those as well. So that $16 million is not entirely spoken for, but it’s something that we would evaluate the opportunities very carefully and rigorously, and move with that through the course of the year.

[Wayne Graham:]

I would just add, it’s intentional that we’re really breaking out the success based element to our capital spending. In the last few years, we’ve just guided to a total number, and we have return thresholds we like to meet, and if there’s opportunities to spend it to get those return thresholds, it will pass that test. So it’s not foretold that we’re just going to spend that $16 million. The opportunity has to be there.

[Barry Sine:]

Okay, and you could also exceed if the opportunity was there as well?

[Wayne Graham:]

If it would represent an upside to our plan.

[Operator:]

Ladies and gentlemen, at this time, we are done with our question and answer session, and I’d like to turn the call back over to our speakers for any closing and additional remarks.

[Anand Vadapalli:]

Thank you all for joining us today, and hopefully, we’ll meet some of you in early April. Thanks for joining. Have a good day.