Alaska Communications Systems Group, Inc. (NASDAQ:ALSK) Q2 2019 Earnings Conference Call August 8, 2019 2:00 PM ET
Tiffany Smith - Manager, Board & IR
William Bishop - Interim CEO & COO
Laurie Butcher - SVP, Finance
Conference Call Participants
Barry Sine - Spartan Capital Securities
Good day, and welcome to the Alaska Communications Second Quarter 2019 Earnings Call. [Operator Instructions]. Today's conference is being recorded.
At this time, I'd like to turn the conference over to Ms. Tiffany Smith, Manager, Investor Relations. Please go ahead, ma'am.
Thank you. Welcome to the Alaska Communications Second Quarter 2019 Conference Call. I'm Tiffany Smith, Manager of Investor and Board Relations. With me today are Bill Bishop, Interim President and Chief Executive Officer; Laurie Butcher, Senior Vice President of Finance; and Lars Danner, Deputy General Counsel. 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 displayed on your screen. For others, you will find it on our investor website, www.alsk.com.
Now 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. You are cautioned not to put undue reliance on forward-looking statements as actual results could differ materially 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. These reconciliations are in the appendix to our presentation.
Following our remarks, we will open the line for questions. With that, I would like to turn the call over to Bill. Bill?
Thank you, Tiffany. Good day, and thank you for joining us. Let's turn to Slide 5. I'd like the opportunity to reintroduce myself. As a longtime customer-facing member of the executive team, the board has entrusted me to achieve our business plan and create our company as a more engaged partner with our customers. Under my leadership, our success has been, and will continue to be, from the strength of our team and our customer-centric philosophy. As a technology leader in connectivity, broadband and managed IT capabilities, we have been the first to market with many solutions. We pride ourselves in having a state-of-the-art, robust and reliable network across the state of Alaska and in our strategic markets. With fiber optic rings and extensions that span across Alaska and into the Pacific Northwest, we own, operate and manage over 130,000 fiber miles, ensuring a seamless network experience for all of our customers. With approximately 580 full-time employees across 19 states, we serve customers across 11 states, with 15 owned and managed cable landing stations, 870 fiber-lit buildings and 29 points of presence across 6 states. Many locations across Alaska cannot be served by fiber. To ensure that we meet our customers' needs, we have advanced our capabilities using our fixed wireless, our microwave and our satellite services.
Turning to Slide 6. Having led our revenue teams, I am intimately familiar with our customer base, and it is with laser focus that we continue to serve them. While Laurie will speak to our financial results, I will note that our performance for the quarter was within our expectations. In the first half of the year, we won new large customer contracts, which will translate to increased reoccurring revenue in the second half of 2019. And our solid sales and delivery funnels provide additional growth for the future. Business and Wholesale continues to be our main growth driver. The true indication of a job well done is when your customers come back for more.
In July, our team's strength was exemplified with the signing of an additional long-term contract with an existing carrier customer for another prefunded, high-capacity fiber and security network. This sale of network services enables revenue growth for this carrier as it serves its customers in addition to providing opportunities for our own future growth. This contract was the third phase of similar prefunded builds.
Additionally, progress contained on our multiyear 5G wireless backhaul build-out. We've continued to work closely with the customer, and we are on track to meet the milestones they are setting. We have also completed an upgrade on our AKORN fiber system earlier in 2019 and continue to upgrade our NorthStar fiber system and expect this to be completed Q1 of 2020. These are just a few examples of our initiatives to strengthen the backbone of our network, efficiently using our capital and create a foundry station for our future growth.
We do recognize the Alaska economy is facing challenges, our legislature and governor are locked in a budget process that has the potential to impact how Alaska businesses may spend their money. We've long been known for providing solutions that enable customers to get the highest value for their IT spend and now that is more important than ever. We will continue to monitor the state's fiscal status and analyze both the risk and the opportunities associated with them.
Let's turn to Slide 7. We continue our targeted focus in our Consumer business. We are progressing with our expansion into our multi-dwelling units. During the quarter, we signed a contract with the Army and Air Force Exchange Services, commonly known as AAFES. This is significant because it allows us access on multiple Army and Air Force bases to provide our Internet now product. Since we last reported, we are initiating services into 2 additional bases in Alaska. Our penetration rate is approximately 32%. And we expect our target -- we expect to reach our target of 6,000 locations enabled by the end of this year. Also in the second quarter, we continued our fixed wireless deployments to accelerate our growth in future rural areas as part of the FCC's Connect America program. We are enabling more locations each year and ramping up our sales efforts to increase this penetration. We are pleased to report that those efforts are showing success. And to date, we have over 500 new installations completed. We expect to see continued progress with these efforts.
We recognize that in our industry, there are areas of growth and areas of legacy declines. We are actively choosing to focus our business on the areas of growth revenues. Those revenues, combined with our stable high-cost support, made up 70% of our revenues this quarter. This is the trend that we expect to see increase in the future.
I look forward to working with our team. And I am confident in our business plan and our team's ability to meet our plan. With this, let me now hand the call to Laurie who will cover our financial results. Laurie?
Thank you, Bill. Turning to Slide 9, let me start with our year-over-year revenue performance for the quarter and year-to-date periods ended June 30, 2019. Total revenue was $57.4 million for the quarter and $114.3 million year-to-date, decreasing 3.7% and 1.1%, respectively, from prior year comparable period. The decline year-over-year is primarily attributable to lower regulatory revenue in 2019 related to the restructuring of the Alaska Universal Service program, offset by modest growth of 3.2% in Business and Wholesale revenue. Our typical growth in Business and Wholesale was negatively impacted in the quarter by a $2.1 million favorable adjustment to business broadband for the effect of Rural Health Care increases approved by the FCC and recorded in June of 2018 and lower equipment sales, which we know can be variable during the year. Business and Wholesale representing 64.5% of our total revenue, declined 1.2% for the quarter and grew 3.2% for the 6 months ended June 30, 2019, compared to the prior year.
Consumer revenue representing 16.3% of our total revenues, decreased in the second quarter 1.2% and 1.5% year-to-date. As Bill noted in his remarks, we're taking a focused approach with our consumer market, targeting the use of new technology and go-to-market strategies, with fixed wireless and multi-dwelling units. Regulatory revenue, representing 19.2% of our total revenue, declined 12.9% for the second quarter and 12.8% year-to-date. As a reminder, this decline was anticipated and reflects changes I noted earlier to the program under which we received state Universal Service Fund. We continue to expect similar declines in regulatory revenue for the remainder of the year, yet we expect these declines to be less pronounced in the future.
Turning to Slide 10. We shared this slide with you on our year-end earnings call. We've provided it here again as a reminder of revenue trends over the years and the anticipated shift in our growth and legacy revenues. Looking to the future, it's this trajectory of growth revenues and its increasing percentage of our overall revenues that will create the basis for top line growth and EBITDA expansion.
Turning to Slide 11. You can see the annual trends in our business. Our Business and Wholesale revenue shows year-over-year growth and is expected to continue to drive overall performance. Adjusted EBITDA was $13.9 million for the quarter and $29.1 million for the 6 months ended June 30, 2019, compared to $16.9 million and $31.3 million in the prior year period. The decrease in the quarter year-over-year reflects the impact of $2.4 million in labor increases in 2019, which are primarily the results of the reinstatement of both the furloughs and temporary wage reductions we imposed in the first quarter of 2018 in response to revenue pressures from the Rural Health Care Program. As Bill noted, our employees are the foundation of our business, and we believed it was imperative to restore wages and retain our talent.
Even with those labor increases in 2019, we are on track with our adjusted EBITDA expectation. Adjusted free cash flow was negatively -- was negative $3.1 million for the quarter and negative $100,000 for the 6 months ended June 30, 2019. Reflecting the impact noted in EBITDA above, increases in capital spending for our 5G wireless backhaul build and $1.6 million of severance costs for the departure of our former CEO. Although the severance expense was unanticipated and puts pressure on our free cash flow this quarter, with stronger EBITDA performance in the back half of the year and anticipated AMT tax credits, we remain comfortable with our guidance.
Turning to the balance sheet. With a net debt balance of $159 million and net leverage of 2.97x at June 30, 2019, we're a leader among our peers. This is a direct result of hard decisions we made several years ago such as reducing and then eliminating our dividends and focusing on bringing debt levels down. This is something that many of our peers are focusing on now. Also, as we mentioned on our last call, in the first quarter of this year, we renegotiated our debt instrument for more flexibility and more favorable terms. As a follow-up to that, in June, the company entered into an interest rate swap with our lenders, effectively fixing the interest payments on 75% of our debt at 6.17% for 3 years, providing protection from interest rate fluctuations. Today, we're sitting with a strong balance sheet, with $25.6 million in cash on June 30, 2019, and an undrawn capacity on both a $25 million delayed draw instrument and a $20 million revolver. That translates to over $70 million in liquidity.
Additionally in the second quarter, the Board directed management to repurchase up to 1 million shares of the company's outstanding stock through a program trading plan under the share repurchase authorization in place through December 31, 2019. To date, the company has repurchased over 500,000 shares.
Net capital spending for the quarter was $11.9 million and $20.4 million for the 6 months ended June 30, 2019, compared to $8.4 million and $17.1 million in the prior year comparable period. This is in line with our expectations and the additional capital we spoke of that has been allocated to our 5G wireless builds. As Bill noted in his remarks, in July, we signed an agreement with a carrier customer to build a fiber network in Alaska. This project is yet another exciting opportunity for us to expand our fiber footprint without the typical impacts to free cash flow. This project is being entirely prefunded by the customer as the fiber is constructed and the milestones are complete. Capital spend for this project is not included in our guidance, and will be reported separately in our adjusted free cash flow to clearly show the inflows and corresponding capital outlays. Like the project currently underway in Oregon, this project will result in a revenue stream from a long-term anchored tenant while additional capacity will be available for us to sell.
Turning to Slide 12. In summary, I'd like to remind you that operating results can vary by quarter as a result of many factors, which can include the timing of our sales delivery and associated revenue recognition and a higher capital spending due to seasonal work, among other things. The first half of the year is not necessarily indicative of annual performance, and we anticipate a strong back half of the year as we get the benefit from a variety of sales and installation initiatives. We have confidence in our business plan, and we reaffirm our guidance for 2019. We look forward to reporting our progress to guidance in future quarters.
And with that, let me hand the call back to Bill. Bill?
Thank you, Laurie. Turning to Slide 13. Our top priority is performing to our business plan as I am committed to meeting our 2019 guidance. Our market and technology dynamics, combined with our internal competencies, will enable our continued growth. We do this by leveraging our reliable network, our strategic customer relationships and our notable customer service. We continue to efficiently track our growth capital in areas that will grow the business today and will sustain us in the future. Our management team is focused on superior execution with an emphasis on achieving or exceeding our operational and financial goals. And we are working closely with the Board to draw the most value-creative capital allocation strategies. The Board and its management team remain committed to maximizing shareholder value and have taken several steps to do so, including rightsizing the Board and management team as well as implementing the authorized stock buyback plan.
In closing, we would like to thank Anand Vadapalli for his dedicated service to our company over the last 13 years. I look forward to providing updates on all fronts in the months and quarters ahead. Thank you for joining us today.
And with this, let me open the call for questions. Operator?
[Operator Instructions]. And we'll take our first question today from Barry Sine with Spartan Capital Securities.
The script was very helpful. If you look at the reported results for the first half of the year and compare that to the guidance, it's not quite clear how you get there but you've cleared up a lot of that in talking about some of these projects. I wanted to talk about the guidance you've given. You've reiterated the guidance, it implies roughly stable revenue, which is quite a good accomplishment compared to some of your peers in the industry. If we look at the business side of that and how that may drive the guidance numbers that you're talking about, you've talked about a number of major initiatives, you have the prefunded CapEx, you have the 5G build. On the other side, we have continued difficult Alaskan economy, if you can update us a bit on that. What are we seeing? I've read externally from faraway a bit about the budget process in Alaska, if you could give us a little color and that. And then secondly, the competitive environment. I know versus a lot of your peers, you have limited competition, but it is still a fairly large competitor in the market.
Yes. Thanks, Barry, for the question. Let me start with the state budget part of your question, and then I'll go on to the competition piece. Like I said in my opening remarks, it's the legislature in the state and the governor are in the process -- actually, hopefully in the process of finalizing what the new budget will look like. If you've read anything, you do know that it's important to the governor -- our governor, existing governor to balance the budget based on budget cuts. And because of some of those cuts and what we think our new budget will look like for the state, it may intake -- impact some of the Alaska businesses to invest and to spend money. Now we haven't seen any impact or much impact at this point. But what I would be comfortable saying is if the -- I think the uncertainty is -- or the uncertainty is driving a little bit of hesitation in the market and when we see that hesitation, it's usually from a project-based point of view. So our customers, if they could put off a project -- if they were willing to invest in this year and they could put it off to next year, they may do so. So that may impact some of our NRCs, our nonrecurring revenues. On the flip side, when we have had challenging budget times like this, we've had very little or minimal impact on our NRC side of the business, which is good for us. So that's from the steady budget point of view.
From the competitive point of view, we have one large competitor up here that we competed in the marketplace against for a very, very long time, multiple other smaller competitors in the rural areas. I wouldn't say a lot has changed on the competitive landscape, either from how our competitors are responding to us or how we are responding to our competitors. I think our results for the last 5 and -- 5 or -- 5 to 6 years, especially in the Business and Wholesale side, shows we continue to steal market share and continue to win as the market grows. And I would expect that in the future. Thanks for the question.
A similar question on the consumer part of revenue expectations. Again there, you've got drivers with the CAF II broadband market expansion, MDU activity. On the economic and competitive environment, or on the economy, I believe, correct me if I'm wrong, that one of the goals of the governor is to perhaps grow the annual dividend that Alaskans receive. So that may, I would think, have positive implications for the consumer part of the -- of your spending and then also if you are seeing any changes on the competitive environment, you have faced the same large competitor and consumer as well.
Yes. So nothing on the competitive landscape is really different than the past. We on -- in our consumer line of business, we have expected and we continue to expect our voice revenue in the Consumer line of business to decline. We've seen a decline in years past, and it will continue to decline. Where we focus our attention on a consumer is really where we see strategic growth areas. And as I identified in my remarks as the MDUs, especially on the military bases and also our market expansion through our fixed wireless technology. To your point on the dividend, certainly as a longtime Alaska resident, we certainly -- I would love to see our dividends continue to grow. I'm not sure how that would impact additional voice services or additional revenue services to the voice channel. Certainly, we will -- like I said, we'll continue to analyze that. And if we see opportunities, we will be ready to move forward with this. But I appreciate the questions.
You mentioned two additional military bases. Have you launched in those bases yet? And can you tell us what those bases are?
So we have launched into one, and we're in the process of turning the second military base on -- and again, these are additional to the military bases we reported on earlier. Both bases are in the interior of Alaska. I don't want to name the bases until we get them both launched and all services out at this point. But we are on track and actually ahead of schedule to have both of these bases launched.
Okay. And then turning to CapEx. You talked about the prefunded contract. There was a press release on that and then also a 5G wireless backhaul. I just want to confirm, those are two separate contract, two separate initiatives? And then on the prefunded, Laurie, you talked about how you would report that in the free cash flow table. So I'm assuming that there's been no -- there was no action in the first half of the year because I don't see anything indicated in the free cash flow table on that prefunded contract.
Barry, that's absolutely correct. And just to give you kind of a visual, if you go back to our year-end cash flow statements, free cash flow statement, you will see an example, and that was in a project that we had started earlier in Oregon last year. So you will see an example of exactly how those projects will be broken out. And you'll see that appear actually here next quarter for this one that we just signed in July. And to -- and kind of linking that for you, yes, the -- what we -- our 5G backhaul, we're calling as C-RAN project. Our C-RAN project is actually incorporated into our guidance number, which is why you see our guidance this year being well above our typical $35 million a year spend. We've announced earlier that we expected to spend $7 million to $8 million on C-RAN this year. Hence, our guidance bumped up to $40 million to $42 million, and we'll be reporting out against that as we get later in the year. But the special projects, which, yes, are very different, this prefunded project is not included in guidance and as I said, will be broken out separately for you in that free cash flow. And the reason we did that is really the guidance for capital and free cash flow shouldn't be impacted by those because, again, the customer gives us all of the money upfront.
And my last question revolves around the Schedule 7 in your earnings release. The last section there is on the regulatory revenue. Correct me if I'm wrong, I believe the high-cost support relates to the CAF II funding, and that number has been pretty stable, that should be locked in for several years. On the access revenue, that's where we saw a pretty significant decline and you cited the Alaska Universal Service program. On that push in the revenue, typically companies will have pretty good forward visibility on that because the regulations will be announced in advance. What do we know in terms of the regulatory picture in Alaska and the impact on that revenue line item and how that may change, not just in 2019? But do we have any visibility from the regulators in the state or at the federal level going forward?
Another great question, Barry. First of all, to answer your question, yes, the high-cost support line item is entirely CAF II, and you will see that number remain constant through 2025. That program actually sunsets at the end of that year, but as we have seen going from CAF I to CAF II, additional programs are typically spun. And I know in the Lower 48, they are already working on the equivalent of CAF III. From an access perspective, you're also absolutely right. The regulatory wheel, I think, for better or worse, turns slowly, so we typically have a lot of visibility into the future. As I mentioned in my prepared remarks, this 12.8% decline that we saw this year was absolutely anticipated, and it has been built into our budget. And it was really the direct result of one program sunsetting and another taking its place that is actually funding at about half the amount. As we said, we expect some of these programs to continue to decline but at a much slower pace than we're seeing this year. So if you look at a linear line of these revenues, we've had a gradual decline 2019, we expect this fairly steep one and then we expect that to level out to a slower decline out into the future.
[Operator Instructions]. And that will conclude today's question-and-answer session. I will now turn the conference over to management for any additional or closing remarks.
So thank you all for joining us on the call today. We always welcome the opportunity to talk with our shareholders. And if you are interested in meeting with us, whether by phone or in person on future roadshows, please reach out to Tiffany Smith in Investor Relations. Good day.
That does conclude today's conference call. Thank you for your participation. You may now disconnect.