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Alaska Communications Systems Group Inc. (NASDAQ:ALSK)

Deutsche Bank Securities 21st Annual Leveraged Finance Conference

October 1, 2013 4:00 PM ET

Executives

Anand Vadapalli - President and CEO

Wayne Graham - Chief Financial Officer

Analysts

Unidentified Analyst

Good afternoon, everyone. Welcome to the Alaska Communications System presentation. My name is (inaudible). I work in the TMC Group at Deutsche Bank. It is my pleasure to introduce the ACS management team today. We have Anand Vadapalli, President and CEO; and Wayne Graham, our CFO. And with that, I will pass it to Anand.

Anand Vadapalli

Thank you. Good afternoon. My name is Anand Vadapalli and I serve as the President and CEO of Alaska Communications. Thank you for joining us today. I wasn't sure if this room was open given all the festivities going on in the main ball room there with a lot of speakers and I was actually waiting outside and ended up coming a few minutes late.

Well, as a reminder, I would like to reference our Safe Harbor statement as noted on page two of this deck before I begin my presentation. I’ll pause here for a second.

All right. Moving on to slide three, this is an overview of Q2 2013, the most recent public information that’s available on our performance. There are several metrics on this slide and I would like to focus on a few.

One, the network and people section which is there in the bottom right hand corner there and we will talk more about this. We see our network and our customer service that’s’ delivered by our people as something that’s crucial and a point of differentiation for us in our growth plan.

And, I will go to the top right hand corner which is the financial metrics and the important thing there I would like to point out is the broadband growth. In the first six months of this year, we accomplished about 20% growth in broadband revenues, compared to about 11% that we did for full year 2012. So we are pleased that we are able to accelerate growth in broadband which is also central to our plan.

Now as I’ll note in our upcoming slides, with the closing of the Alaska Wireless Network or AWN transaction our revenue profile for wireless has changed, in particular as it pertains to roaming revenues, which are now part of the Alaska Wireless Network entity. So, some of the revenue mix elements that you see here will be different for us going forward.

Slide four, on this slide I would like to focus on the right side which talks about our view, our perspective of how we think about the rest of 2013. I will talk more about it but we are confident about the market opportunity for broadband in Alaska.

Our performance so far reflects our ability to seize this opportunity and our actions on a go-forward basis are targeted at this segment of growing broadband revenues. In particular, we have been talking about our investment in a fiber-to-the-node program.

We have indicated that this year we expect to invest about $10 to $15 million in this program as part of our CapEx for the year targeted primarily at business communities in Anchorage. We expect to see some benefit for the consumer segment but the investment is directed towards the business segment in the market.

I would like to dwell a little bit on LEAN as a process improvement program that we have initiated. I will cover more that later. This is central to how we do business and central to how we intend to provide quality customer service as source of differentiation while at the same time manage our cost structures.

In particular I would like to draw your attention to a recent announcement we made about an addition to our leadership team. We announced recently that we hired a new leader to lead our managed services area. We see that as an opportunity for growth again in the business segment. We view that as a logical adjacency for what we already do in broadband and this new leader will bring a lot of focus to what we already do in this area and drive more growth.

Additionally, our Board recently approved issuing up to 10% of our outstanding stock to buyback our convertible notes. I viewed about 40% of the way into this repurchase program and that’s the last bullet point on that box there. And as I noted in my investor letter from August of this year, our focus is on growing broadband revenues and paying down debt and we are committed to that approach.

Slide five will serve as a reminder and a refresher of our recently closed Alaska Wireless Network or AWN transaction. The right side of the screen there, gives you a brief overview of how the structure works.

In June of 2012, Alaska Communications and GCI announced that we were going to combine our two wireless networks into one entity called the Alaska Wireless Network. Alaska Wireless Network will operate the largest wireless network in the state of Alaska while the two retail parents Alaska Communications and GCI will continue to sell wireless services on an independent basis in our respective retail channels. That at a very high level is the structure of AWN.

Briefly, how does AWN make money, in four ways, one, from the wholesale revenues it gets from its two retail parents, Alaska Communications and GCI, that’s one. Two, roaming revenues, effective the close of this transaction in July of 2013, roaming revenues moved to AWN.

Three, as of the date of closing the transaction both Alaska Communications and GCI moved their backhaul revenues to AWN and those revenues are -- will continue to grow over time, that’s the third source of revenue. I would point out that as it pertains to backhaul, while we move our backhaul revenues on the day of close to AWN, it does not preclude Alaska Communications from competing for new back revenue in the future.

And fourth, both Alaska Communications and GCI will collect and pass through 100% of the CETC receipts to AWN. So those are the four ways that AWN makes money.

At transaction closed, we received $100 million in cash that was July 22, 2013. We used $65 of that to pay down debt. Some additional monies went towards transaction expenses and there is some cash that’s stuck on our balance sheet right now.

On -- so clearly AWN upon close created a significant amount of value for Alaska Communications. On an ongoing basis, Alaska Wireless Network or AWN will return free cash flow to Alaska Communications. In years one and two, we are eligible to receive up to $100 million in preferred distributions, $50 million each in years one and two. In years three and four, we are eligible to receive $90 million in total preferred distribution at $45 million a year. And post year four i.e. year five onwards, we will receive distributions proportional to our one-third interest in AWN.

Essentially what AWN has done for us is it has mitigated some of the external risks in the wireless market which is primarily the entry of a new competitor in the market, a national competitor and two, it’s given us predictability of cash flow from the wireless business.

Giving us runway to continue to grow and solidify our gains in the wireline broadband business where we have done well and we have anticipate to continue to do well in that area and this structure gives us the runway to clearly solidify the gains that we have seen there.

Slide seven is a very high level representation of how we intend to grow our value. It’s fairly straightforward and if I start from the right side of the slide and move my way back to the left, there are two levers, grow free cash flow, pay down debt, relatively simple.

And for us growing top line by growing broadband revenues is an extremely important part of how we intend to grow free cash flow. And we intend to improve EBITDA by our focus on LEAN and process improvements, manage our cost structures as we grow revenues.

Top line growth is something that we believe is extremely important, something that we’ve demonstrated and something that we believe sets this apart from other companies in our sector.

And moving to the left corner of this slide, how do we grow revenues, our network has been and will continue to be a source of differentiation. This investment in the fiber-to-the-node program will extend Ethernet down to the edge into the customer location.

Managed service is an important part of our growth. If you recall about three years ago we made an investment in a local IT firm and we’ve continued to provide managed services. And now with the addition of this leader, we expect to see more growth.

Customer experience and customer service, we believe, is a source of differentiation for us long term. And we’re investing in that. We measure customer experience using net promoter score and we manage operational improvements to drive improvements in the NPS score.

In terms of enhancing EBITDA which is managing cost structures, we intend to do it the right way. And the right way for us is by eliminating waste and that’s the key principle of LEAN. Anything that does not add value to a customer, we take out to our business and simplify how we do business that’s LEAN and that’s how we intend to manage our cost structures on a go forward basis.

Slide 8. Our assessment of our market starts with an assessment of where we are in Alaska. Alaska is our primary market. The majority of our revenues come from Alaska. We are a strong and stable economy. You can see that our GDP per capita is amongst one of the highest in the country.

We’ve had traditionally a pretty stable economy and lower unemployment rates, especially over the last several years as the rest of the country has seen the downturn. We’re fuelled -- our state economy is fuelled by few different drivers, one is natural resources. Oil is a big driver of the economy as is mining, natural gas et cetera.

Two, federal and state spending military and civilian on the federal side, several basis in Alaska. That’s the driver in the economy. Three, tourism and everything else falls into the third bucket. So we see stability in our economy and certainly that contributes over the long term. We’ve said that we assess our retail telecom market to be about a billion dollars and growing.

This is wire line and wireless, voice and broadband, consumer and business across all those we assess it to be about a billion dollars and growing. This does not include consumer video we do not play in that space. We assess our market share to be about 20% and people ask me what’s different why are you growing.

The way I think about our market is not as if the market itself is dramatically different than in the lower 48. Homes and business in Alaska consuming broadband and increasing the consumption pretty much at the same rates that you have seen in the lower 48 what is different is the competitive dynamic.

Our previous focus meant that we underserved certain segments particularly small medium business. And we are underrepresented and underindexed in certain segments and that gives us the opportunity to grow.

As I noted before, the strength of our network is the underpinning of our growth. We’ve always had an extremely strong long haul network. We were the first to introduce Ethernet and MPLS into the state. We were the first to introduce VPLS into the state last year and this year we are the first in the state and only the third carrier in the world to be certified carrier Ethernet 2.0 compliant.

What that means is a network of a certain reliability and quality characteristics for our business customers that they can’t get from anyone else. Also now with the extension of our access network with this fiber-to-the-network belt that we’ve underweighed. We will extend the same quality and reliability down to the edge, down to the customer.

Now as we’ve received several questions about fiber-to-the-node program in terms of the network enablement and sales penetration. We are early on in the program and we expect to share more of that over the upcoming quarters.

Our focus on business is represented by the wide range of products that we have for business customers on Slide 11, all the way from IT infrastructure solutions to traditional voice. In terms of the quality of the core network, we have this advantage.

We recently launched hosted voice services that’s been a hot seller for us and has given us an opportunity to upsell our customers and convert many customers over to broadband. The IT and managed service solutions give us additional opportunities to enter into a new relationship and upsell and cross sell other services. And with the addition of this new leader in the managed services area, we expect to see a continued growth. We’ve done well and we expect to do well.

Consumers on slide 12 is an area of opportunistic growth is how I characterize it. You’ll note in our results that consumer broadband actually has been doing well. We’ve been adding subscribers and we’ve been adding revenue.

We see an opportunity there as we do fiber-to-the-node for businesses. We’ll certainly pass some residential neighborhoods. And we’ll improve speeds and we’ll sell more.

We’ve been often asked so why are you adding connections in the consumer broadband area. Why are you gaining revenues. It’s not many telecoms are doing that. Well, one of the main reasons is us is the only market where the cable company actually has data caps on wire line broadband on their cable modem service.

So on one hand, we can talk about as our cable company competitor does of a low price for a high speed wherein you put a 10 gig cap on the service that’s two movies. One Saturday evening and you reach your data cap and we are able to take advantage of that. It’s still opportunistic but look it’s a market segment that’s holding its own and we like it.

I have already talked about the Alaska wireless network and what it does for us. What are the points of differentiation for us in wireless in the face of competition that we already have and in the face of competition that’s coming in?

One, AWN offers the most extensive coverage in the State of Alaska. We believe that this coverage will never be matched by national players. The national players will never go into some of the rural communities that are so important to us in our state. So coverage is absolutely a factor.

Increasingly, we’re getting better devices. In fact, just today we launched the iPhone 5S and 5C in our market. So we’re able to compete with the latest devices. We expect AWN to provide competitive plans. We expect to bundle wireless with our wire line services to create compelling offers for our customers to differentiate ourselves from both in state and national competitors.

I have touched on elements of slide 14 previously. And this is -- even though it’s one of the last slides, it’s an important slide. This is -- these two are central keys to our business plan. One, continuous process improvement through LEAN.

LEAN is a bottom set approach. It’s a way of life. It’s the culture. We’ve started that journey towards the late part of last year, early this year. We’ve had some really good success this year particularly in areas like supply chain management.

We’ve shown solid results. And this has driven up employee engagement in their work that’s huge for us. Talked about customer service this we view as a sustainable source of differentiation over the long term. We’ve invested in it. We’ll continue to focus on it.

And NPS and customer service for us, these are not just feel good things. There is enough body of research that shows that NPS scores, an improvement in NPS scores is typed to gain in market share. And we believe in that and we are following through on that in terms of how we work customer service and customer experience in the company.

This gets me to my concluding slide which is a summary of what I’ve just covered with you. Fairly simple principles to our business plan, grow broadband revenues and hence EBITDA, improve cash flow and pay down debt. And these are not just words, we have results behind each one of these.

Over the last two years, we have changed our company into one that’s growing top line revenues. We have changed our company by paying down debt and strengthening our balance sheet. We’ve shown we can do that.

A year and a half ago, now almost two years ago when we launched our business plan, which by the way talked about exactly these same principles, the reaction was well show me. A year and half a later, here we are and we are glad to show you those results.

So with that, I’ll conclude my presentation. And we have about 10 minutes for Q&A. Thank you.

Question-and-Answer Session

Unidentified Analyst

(Inaudible)

Anand Vadapalli

Yes. Thank you for the question. We have set a long-term leverage target of 3.5 times. And we’ve been asked about the number. And the reason we picked 3.5 for now is the conditions in our term-loan agreement allow the board flexibility to reconsider a dividend policy only when our leverage is at or below 3.5.

So 3.5 to us at this time sounded as good a target as any. Is that a long-term target, should be lower? I don’t know. Let us get to 3.5 and if we continue to grow our top line as we have and which is our plan to do so. And we get to 3.5 leverage which is our plan to do so, we believe that we will create significant value for all our stakeholders and the optionality for creating more value we believe gets stronger.

So it’s a number that’s out there. And once we get there, we’ll take an assessment of where we are and decide what we do after that.

Unidentified Analyst

Okay.

Anand Vadapalli

Thank you.

Unidentified Analyst

(Inaudible)

Anand Vadapalli

The question was if we had any plans, long-term plans to get into consumer video. The answer to that right now is no. Our focus is on the business customer base. We believe we have a lot more growth to achieve that. We stood up and dramatically enhanced our business sales team, the number of feet on the ground over the last 18 months.

We believe that there is a lot more potential for the sales team to do more. In fact, one of our constraints right now is just catching up with what the sales team is doing in the back office.

So we-we believe that there is lot more growth to be achieved in the business segment. And this new addition of a leader, which is a big investment for us for managed service, underlines that commitment in that segment. So more than the dollars, I don’t want management’s attention distracted. They are doing few things well. I’d rather do a few things well.

Unidentified Analyst

(Inaudible)

Anand Vadapalli

Yes. And so the question was, if I could speak to the Verizon Wireless rollout. Verizon acquired the 700 megahertz spectrum, 4G spectrum in the third quarter of 2010. They had an obligation under the spectrum acquisition to cover about 45% of Alaska by July 2013.

Based on the build out that they have done in the state, they have probably met that threshold. It’s a 4G data network only. They’ve done that up couple of months ago. There is no voice on that network obviously. So voice network or voice services for Verizon customers coming into Alaska, they continue to roam on the AWN network

We -- we do not know when Verizon will be in the retail market. It appears to be delayed compared to what we thought -- where we thought they would be. But we -- that’s just our point of view. We have no visibility into when they plan to be in the -- in the retail market.

Unidentified Analyst

You bet.

Unidentified Analyst

(Inaudible)

Anand Vadapalli

So may I repeat the question, the tackle plan for AWN and is there a put call facility for us five years down the road. So, some time in the future. So AWN has not yet released their guidance and that would be part of how AWN and GCI, will talk about it.

One thing that we encourage our investor’s to remember is that this deal closed only about two and a half months ago. And there is a lot about the business, particularly about the roaming, our roaming business and our backhaul business that AWN had no visibility into before the deal closed.

So the next year or two is going to be a certain level of enhance spending as AWN built its network out. But at the same time please also keep in mind that this inauguration of the two networks happening and there is the rationalization that’s happening between the two networks. So the synergies will also start coming in over the next couple of years.

So from the AWN perspective, we’ll have to wait for AWN and GCI to provide that guidance but it will certainly take them a little bit of time to get their hands around the business and provide that.

To your second part about any put call options in the future, we haven’t made any public disclosures about that at this time.

There is time for one more question, if there is any. Thank you all for your time. Appreciate it.

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