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Alaska Communications Systems Group, Inc (NASDAQ:ALSK)

Q42012 Earnings Call

February 28, 2013 5:00 pm ET


Leonard A. Steinberg - Senior Vice President - Legal, Regulatory and Government Affairs, Corporate Secretary

Anand Vadapalli - President, Chief Executive Officer, Director

Wayne Graham - Chief Financial Officer


Frank Louthan - Raymond James

Barry Sine - Drexel Hamilton


Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the Alaska Communications Systems fourth quarter earnings call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions). This conference is being recorded today, February 28, 2013.

I would now like to turn the conference over to Leonard Steinberg, General Counsel. Please go ahead.

Leonard Steinberg

Good afternoon, and welcome to the Alaska Communications fourth quarter 2012 conference call. I am Leonard Steinberg, General Counsel, and with me today are Anand Vadapalli, President and Chief Executive Officer and Wayne Graham, Chief Financial Officer.

During this call, company participants will make forward-looking statements as defined under U.S. security 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. Important risk factors regarding our expected results such as Verizon's entry into the Alaska market and FCC reforms have substantial disclosures in our most recent SEC filings.

Any non-GAAP measurements referred to during this call have been reconciled to their nearest GAAP measure. You may find these reconciliations in today's press release and our SEC filings on our investor website at 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, Leonard, and welcome to everyone on the call today. 2012 was our first year of performing to our updated business plan that we shared with you a year ago. We operate in a billion-dollar telecom market in Alaska, growing 5% to 6% a year and assertively stake our claim to participate in this growth by making appropriate investments in network, product, sales and service, and process simplification. With this recap of our business plan as a backdrop, let me briefly review our performance this past year.

Our top line performance, particularly in our core wireline operations was exemplary. Year-over-year, business and wholesale revenues increased 8% to $108.5 million, while overall revenues not tied to wireless increased 4.4% to $207.9 million. We believe this is industry leading growth for wireline services, validating the opportunity we said is available to us.

On the flipside, our wireless service performance as discouraging. Two main factors contributed to the subscriber loss. One is the new lifeline recertification process. While this certification is now an annual requirement, the magnitude of this cleanup from last quarter is in all likelihood a one time event

Second, we had major shift in our technology in Q4 with the launch of 4G LTE. Given the AWN transaction, we changed our technology from LTE/CDMA to LTE/HSPA+. This caused device supply chain issues for us. Additionally this introduced some complexity in our sales channel as our sales associates now sell both 3G and 4G technologies while they work through a new process. We continue to work through these issues. While these caused some near term pain, they position us for a running start when AWN closes.

Closing out my comments on 2012, I would like to emphasize our strong performance in generating cash and deleveraging. We ended the year at the high end of our free cash flow guidance generating $33 million during the year and reducing our debt balances for the first time in three years and setting a trend that will continue. Let me now share my perspective about our business in 2013 and beyond.

Let's start with the AWN transaction and our wireless operations. The competition we face today in wireless will only intensify with the entry of Verizon Wireless quite possibly in the next few months. This will put pressure on the wireless retail metrics and we intend to work hard to earn and maintain our fair share in the market. That being said, this is where the beauty of the AWN transaction comes into play for us over the next four years.

With the one-time cash of $100 million dollars upon closing, and our estimated preferential distributions totaling $190 million over four years, AWN, provides tow major benefits. One, it provide a free cash flow, mitigating, roaming and CETC risks. Two, cash to delever.

We expect to continue our strong performance in the business and wholesale segments. We said we could grow top line and we did this in 2012. We expect to see steady and consistent growth in our top line revenues in this market segment as a result of several factors including one, our investments in sales with both an increased number of sales associates and the performance of our sales channel. We expect to see this performance strengthening over time, while we expand our channel lineup to indirect sales channels.

Two, our investment in network and products is showing rich dividends. In fact, with the closing of AWN, substantially all our capital expenditures will be directed towards wireline and broadband, representing an investment in our future growth. As Wayne will note later, this is not a result of increasing capital expenditures but a result of focused investment in broadband capabilities.

Three, we intend to accelerate our growth in the managed services space. Our investment in TekMate two years ago has helped us train our sales channel in selling IT managed services along with our core connectivity. Having a sales channel that works is most important and this gives us confidence to drive further growth in this growing sector.

Last and most important. Over time, you should expect to see a company with lower levels of debt and leverage. We have already started reducing our debt balances and you should expect to see a further significant reduction in the absolute level of debt balances by the end of 2013. We have a goal of total leverage of below 3.5 within a few years.

With that let me hand the call to Wayne to review the results of the quarter.

Wayne Graham

Thanks, Anand. While Anand spoke to our performance for the year, will spend time discussing the results for the quarter. First, the top line. Total revenues for the quarter was strong, at $95.1 million, up $7.6 million, or 8.7% on a year-over-year basis. Business and wholesale revenue increased 14%. We benefited from a nonrecurring equipment sale in the quarter of $1.4 million but even excluding that amount, the category performed exceptionally well and we believe it is a precursor for our performance in 2013.

Consumer revenue was up and we stabilize this revenue stream from its history of erosion, which is a significant accomplishment. Wireless revenue increased 16.2%. Strong revenue growth in roaming overcame somewhat disappointing retail service revenue, which was flat year-over-year. Access and CETC revenue was down $1.5 million consistent with our expectations.

Now on to metrics. The performance of our broadband products was strong. Connections across every category saw sequential growth greater than in the prior quarter. Similarly broadband ARPU saw growth across every category. Consumer access lines erosion was 2.9% compared to 2% last year. We are seeing an acceleration of line losses in this area. On the positive side, business access lines erosion was 0.6% were half the level we experienced last year. So we are seeing improvement.

Wireless connections declined approximately 6,000 or 4.9% sequentially. The lifeline certification process that Anand spoke about previously accounted for over 3,100 of the total erosion. Our 3G MiFi devices also declined by 500 connections as we tightened up our usage policies and as customers enabled the Wi-Fi feature on their phones. The rest of erosion was a result of our delayed launch of the iPhone 5 as we moved LTE/HSPA phones. Other carriers in Alaska launched this product in September but we did not get access to the device until December.

Now moving to adjusted EBITDA. For the quarter we were up $2.5 million, or 8.2% from the prior year. For the year, we landed at $121.8 million, which is greater than our guidance. Similarly, free cash flow was solid. For the quarter we were up $2.6 million, or 94% over the prior year, and for the year, we landed at $33 million at the high end of our guidance range.

Finally, our debt balances came down. This is the first year in three years that our debt balances had declined. Long term obligations declined by 2.5%. We stand at $536.5 million of debt net of cash and investment which is 4.4 times trailing EBITDA. Tomorrow we are playing off $12.9 million of debt related to our maturing 5.75% convertible notes. Our next maturing debt is not until October 2016, so we have flexibility on our balance sheet.

This would be time where we traditionally provide guidance for next year but we are finding that until we determine the closing date for the AWN transaction and understand when Verizon will launch services this year, its difficult to provide full year guidance. Until we can provide updated guidance, we can't offer our perspective on how you should think about our business in 2013, before we close AWN.

First, we expect to see continued growth in business and wholesale revenue, stability in consumer revenue and downward pressure in access and CETC as the impact of the FCC rule changes begin to take impact in 2013 which we have said would cost us $4 million to $5 million a year. Not knowing the timing of Verizon's entry into the market, our best thinking indicate that roaming revenues will remain flat and we will see pressure on our wireless service revenues. In total, we expect to see modest declines in overall revenues from 2012 levels.

Second, as we had planned we saw significant uptick in expenses in 2012 which, exclusive of the AWN transaction, saw our cost grow $22 million year-over-year. About a third of the increase was due to wireless COGS such as roaming and handsets, a third was due to higher labor costs associated with investment in sales, service and delivery, and process improvement and the remainder was caused by either one time benefits that we realized in 2011 for increases in various costs such as USS expense. While we expect the pressure to continue in wireless COGS until we close the AWN transaction, our other cost categories will see significantly reduced rates of growth in 2013. We will manage these costs closely throughout the year.

Third, this translates into pressure on our EBITDA in 2013 which is something that we have been reporting to you given Verizon's entry and the impact of the FCC rule changes.

Fourth, we expect our capital programs to be focused on business broadband and because we completed most of our LTE build in 2012, we expect capital spending to be lower year-over-year coming in about $45 million for the year.

Finally, although we are managing many different scenarios, we are trading free cash flow for 2013 to come in above $20 million.

Now lets talk about the impact of AWN transaction. Roaming, CETC and backhaul revenue will move to AWN. We will avoid certain wireless COGS and pay a wholesale charge to AWN. We will then begin to receive our preferential dividends at an annual rate of $50 million for the first full year. We will reconcile these moving parts and provide updated guidance following close.

Most importantly, upon closing of AWN, we will use $55 million of the $100 million upfront proceeds for immediate debt pay downs of our term loan facility. Between the free cash flows from AWN and operations, we expect to end 2013 with approximately $100 million lower debt balances. We see this translating directly into shareholder value.

With that I will now hand the call back to Anand.

Anand Vadapalli

Thank you, Wayne. 2013 will be a year with big moving parts. Given substantial shifts in both our top and bottom-line with the closing of AWN and the entry of a major new competitor. All that being said, there are two things this year that provide strength going forward

One, the about $100 million dollars reduction in debt balances that we expect. Two, our continued growth and strength in business broadband. I am confident about the opportunity in our market and our ability to perform to our plan. We have addressed our risks and opportunities and are heads down focused on performing to our business plan. We look forward to providing further updates to you at our upcoming calls.

Operator, please open the line for questions.

Question-and-Answer Session


Our first question is from the line of Frank Louthan with Raymond James. Please go ahead.

Frank Louthan - Raymond James

Great. Can you give us an update on some of the early results and you sort of see renewed focus on residential broadband? Can you give us an idea of what the rough break out, what percentage of your run gravity comes from the anchorage market? That would be great. Thanks.

Anand Vadapalli

Thanks, this is Anand. Thanks for the question. So, the consumer, as you have seen, Frank, has been stable. Managing that revenue stream for stability going forward is how we are looking at and that’s, I believe, how we can characterized it in the prepared remarks as well.

Our focus really is growing the business broadband segment where we have grown it really well in 2012 and we expect to grow it equally well in 2013 and going forward. With respect to the roaming revenues, we haven’t really broken it out by market. So I am not sure I can share that information at this time.

Wayne Graham

That’s a good question, Frank. It is something we haven’t disclosed in the past.

Frank Louthan - Raymond James

Okay, great. Can you give us a little bit more update then maybe on traction in the enterprise segment. Any deals between the end of the quarter, end of the fourth quarter now that you closed? Any color on what the pipeline looks like in that business?

Anand Vadapalli

Thank you, Frank. Thanks for the question. So lets just step back and look at our context, right. We are starting with, first of all, a relatively low market share with about 20%, as we have shared with you last year. When you look at Alaska, unlike markets in the lower 48, there is really only two facilities-based providers in the state that has reached the majority of businesses. We are one of those two. So really in a two player market, we certainly believe we much better than 20% share that we started off with.

Now you look at 2012, we have engaged our market and our customers in ways that we haven’t done before. With new sales teams, new products and new network and our growth has been disciplined. We have not gone and bought market share. We have sold on the basis of creating a real good value for our customers.

We have always said that own network has been a differentiator and it continued to be a differentiator. We just upgraded our network to a VPLS core last year. In fact, in a couple of months, we will be one of the few carriers in the country who will be certified with a Metro Ethernet Forum Network for our Ethernet network. For the large enterprise customers, that certainly continues to be a source of differentiation.

Yet there hasn’t been a silver bullet, right. There has been a lot of foundational work. We have invested in our sales team. We have invested in customer service. We have invested in products and network. The way I think about it, Frank, these investments are gifts that keep on giving. So I expect this to be a really solid traction in business revenues growth this year and going forward for the long-term. That is the basis of our plan.

Frank Louthan - Raymond James

Okay, thank you. But can you give us some color on what the pipeline looks like and any update on any deals that you may have closed since the quarter began?

Anand Vadapalli

We have had some good wins. I can't name customers, specific customer name for reasons of customer confidentiality and the pipeline looks very, very encouraging. As we look at pipeline, as we look at the deals we have closed, even since the start of this new year, we have nothing but confidence in our performance for the business in both of those segments.


Thank you. Our next questions is from the line of Barry Sine with Drexel Hamilton. Please go ahead.

Barry Sine - Drexel Hamilton

Good evening, gentlemen. Very nice quarter. Thank you. My question is on the sales force. Wayne mentioned some of the expense growth, about a third of that went to growing the sales force and then Anand you just mentioned in terms of new sales teams, products and network. Could you elaborate what you are doing with the sales force and the new approach is?

Anand Vadapalli

I am happy to. So the first is, really I think we mentioned this before, previously we really focused on the enterprise segment of the business market and we talked about that. Last year was the first year that we made our investments in going after the entire business community which includes the small and medium business sector. In Alaska, like most states in the country, the small and medium business sectors are the backbone of our economy and we have had to really go after that sector that we had not focused before.

So first of all, we stood up this new sales channel last year to go after this sector and I am really pleased with how they have performed. I can't, Barry, share with you the specific numbers of the sales people for reasons of confidentiality, but what I can tell you is that between 2011 and 2013, we have doubled the size of our sales team. We have seen the results in the market. We see a big opportunity for us.

On top of that, clearly we see an opportunity to increase, what I call the force multiplier, by growing active indirect sales channels and we are training those up as we speak. That, too will only take us further.

As I mentioned in my prepared remarks, in the last two years, the sales that we have done on IT managed services with our partners from TekMate, we really trained our sales team in how to sell IT services along with core connectivity. We are differentiating ourselves in the market there and that leads to pull through sales and lot of synergies in many different ways.

So, overall, both the number of sales people, expanded channels, better products and better backend process, we just see our sales performance improving everyday.

Barry Sine - Drexel Hamilton

Maybe you can continue on the same vein and talk about some of the products that you have launched on the business side and which ones do you see in the greatest traction way?

Anand Vadapalli

Sure, so last year, if you look at what we did, we started off really with upgrading our business and its portfolio. It is something that we had not done in several years. We introduced several small and medium bundles right at the end of the first quarter, early second quarter in 2012. Then, certainly we had the launch of the iPhone that was beneficial across the board initially.

Then we went on and we had upgrades to our Metro Ethernet product. We had a big pricing refresh on Metro Ethernet and we upgraded our VPLS core that gave us certain capabilities for the enterprise class customers.

Lastly, towards the end of third quarter, early fourth quarter, we launched our business voice product and now we are pulling all that together in to more bundled for business customers going into this year. So Ethernet as the platform for data growth is strong and we are continuing to enhance it. VoIP is really converting voice into another data application for us as we go forward and certainly the upgrades that we have done to our business and its portfolio are bearing rich dividends. So we are competing very, very well in the business side and when I throw in the IT services from TekMate, these are solid points of differentiators.

Barry Sine - Drexel Hamilton

Lastly, particularly on the SMB where you have reentered the market, can you talk about what type of competitive response if any? It is a duopoly market but what kind of a response have you seen from the competition in that market?

Anand Vadapalli

Certainly, we have seen our competitors respond without question. We have seen responses in terms of reduction-in prices. That has been the primary response. But we have had a long history of never being the lowest cost provider in the market. We have always sold on value and we still continue to be able to differentiate ourselves on that value that we see it for our customers. So I think we have held our own despite the response from our competitors.


At this time, there are no further questions in queue. I would like to turn the call over for closing remarks.

Anand Vadapalli

Thank you all for taking the time today and we look forward to you again soon.


Ladies and gentlemen, that does conclude our conference for today. If you would like to listen to a replay of today's conference please dial 303-590-3030 and enter the access code 4593495. You may also dial toll-free in the U.S. at 800-406-7325 and enter the access code of 4593495. We would like to thank you for your participation. You may now disconnect.

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