Alaska Communications Systems Group, Inc.

Leonard Steinberg - Vice President, General Counsel, Corporate Secretary and Chief Ethics Officer Anand Vadapalli - President and Chief Executive Officer Wayne Graham - Chief Financial Officer Laurie Butcher - Vice President, Finance

Jason Bernstein - Odeon Capital Group

Good day and welcome to the Alaska Communications third quarter 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'll be using a slide deck that we would 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 third quarter 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.

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. Additionally, any non-GAAP measurements referred to during this call have been reconciled to their nearest GAAP measure.

You can find these reconciliations in our earnings call press release. Following our remarks, we will open the line up for questions.

With that, I'd like to turn the call over to Anand. Anand?

Thank you, Leonard. Good afternoon and thank you for joining us today.

Starting with Slide 5, we've had another quarter of stellar results and our prospects for continued performance are brighter than ever. Before I spend time discussing the quarter, I'd like to highlight important foundations for our success.

To understand our prospects you must first start with our exceptional market opportunity. We believe it's unique in our sector.

First, between telecom and IT services, we have a $1.9 billion opportunity and we are one of two facilities based statewide broadband providers. While we are one of several IT services providers in a highly fragmented market, our strength in the broadband space creates exceptional market opportunity.

This market dynamic in broadband and IT allows us to gain share every single day. We combine market opportunity with a sustainable competitive advantage that translates into new customers.

We win for three reasons: first, the quality and responsiveness of our team in listening to our customers and constructing solutions that meet their needs, without exception, the professionalism of our team swings the balance in our favor; second, the quality of our broadband network in providing secure and reliable solutions; and third, our ability to provide managed IT solutions that add great value on top of broadband. As we sell into our network, our broadband sales have high incremental margins.

The investments we make in our network and systems are targeted to have returns on invested capital of higher than 20%. Combined with topline growth, this sets the course for expanding margins.

Moving on to Slide 6. The bottomline is that this is a team that has delivered consistently over the last three years.

We've done what we said we will do. We have some of the best topline growth in our sector.

We had expanding margins. And we have a stellar track record of paying down debt.

Moving to Slide 7. I am pleased to report another quarter of strong operating and financial performance.

Our wireline revenue growth at 6.7% is unprecedented in our sector, driven by growth in broadband revenues at over 10%. More importantly, we are growing margins, as we said we would.

The charts on this slide reflect what makes us so unique amongst leading telecom providers in our sector. Our results are not just from one quarter.

We've been outperforming our sector in topline growth for sometime now, and look forward to continued success in this area. With this wind on our back, we are pleased to increase 2014 guidance for both revenue and adjusted EBITDA.

Wayne will cover this in a few minute. Slide 8, highlight some of the operational strides we've made and provides color into how we run our business.

We are making conscious choices of how we compete in the market in a manner that grows margins without compromising market positioning. An example of this has to do with how we expand our network.

Our focus is business and we are laying fiber into many new locations. As part of our contract with the Anchorage School District, we have fiber into 92 schools.

Almost two-thirds of these schools are now migrated to our new VPLS network, with more coming online over the next few months. Combined with fiber upgrades in parts of our metro network, we have now deployed over 120 route miles of new fiber and conduit in Anchorage.

The marginal cost of deploying higher speeds in the largest market in Alaska comes down significantly as a result of this program. TekMate, our IT services company is doing very well in the market and exceeding expectations every single month.

In our build programs, as we pass neighborhoods, our consumer customers will also benefit from higher bandwidth speeds. So recently, we made the choice to stop selling less than 10 megabits per second home internet services and focused on high ARPU high bandwidth services up to 50 megabits per second.

This choice allows us to compete well in the market, while improving our overall margins. We believe strongly that process improvement and IT technology investments are mechanisms to improve efficiencies and customer service.

We recently deployed a field operations workforce management system that now allows us to better serve customers, while we improve utilization of our skilled employees. Our ongoing focus on lean process improvement combined with a strong emphasis on customer service and feedback will drive further improvements for us as we move forward.

On Slide 9, I'll highlight some recent customer wins that demonstrate the success we see in our market, and gives me confidence about our future growth. First, I want to take some time to discuss the State of Alaska opportunity.

For over a decade we've had little to no business in serving one of the largest consumers of technology in Alaska, the state government. Almost two years ago, we took active steps by assigning sales resources to begin a conscious effort to demonstrate our value to the state.

Over the course of several small opportunities, we demonstrated not only our capabilities, but also the value to the state in injecting competition into their vendor mix. Earlier this summer, the state issued an RFP for its core telecom services.

I am delighted to share with you that we've been awarded the contract for statewide core broadband services, initially valued at approximately $2.5 million over the contract term of five years. We were focused on winning the broadband portion of the RFP and we did it.

So how should we think about this opportunity? First, the core contract represents only a small portion of the telecom and IT spend by the state.

If you were to look at the state check book for 2013, the state spent over $60 million during the year on telecom and IT vendors, with the core contract representing a small fraction of this total spend. This opportunity gives us a seat at the table.

Our technical solution allows the state to rapidly grow their capacity, as it needs to evolve. Our market-based pricing gives the state an incentive to consume the bandwidth they really need.

By providing us with a platform to demonstrate value, this opportunity is the foundation for material additional revenues for years to come. Why do I believe we'll do well overtime with the state?

For all the same reasons we won now. The quality of the team assigned to this opportunity, the strength of our network and solutions we offer to the state.

And of course, the value we create by bringing real competition for the state's business. I have noted two other opportunities on this Slide, both a reflection of the responsiveness and quality of our teams and the strength of our network.

There are other opportunities that we have secured in the recent past and more in the funnel. As I noted earlier on the call, the quality, professionalism and responsiveness of our team combined with the reliability and security of our network and IT capabilities will be the reasons we will continue to win in the marketplace.

After Wayne walks through the numbers for the quarter, I'll provide my perspective on a long-term directional view of our revenue and margin profile. With that, let me turn the call over to Wayne.

Wayne?

Thanks, Anand. Turning to Slide 11.

We're pleased to report very strong financial performance for the quarter. Focusing on the left-hand side of the slide, you can see the total service and other revenue grew 6.7%.

Business and wholesale, which makes up 52.4% of these total revenues, grew 11.6%, with the impact of TekMate comprising 4% of that growth. Consumer revenue grew 2.1%.

And other revenue, which includes equipment sales also showed solid performance, up 1.4%. On the right-hand side of the slide, you can year-to-date numbers, which are equally strong.

Our revenue performance continues and our focus on broadband drives this growth. As you can see on Slide 12, we are doing exceptionally well.

Business and wholesale broadband revenue grew 8.8% for the quarter and 10.7% on a year-to-date basis. Consumer broadband grew 13.2% for the quarter and 12.2% on a year-to-date basis.

Turning the page to Slide 13. We provide more color on underlying drivers to our broadband performance.

As a reminder, the method we use to track broadband connections can cause variability in our result. We count connections on the unitary basis.

If we sell 10 megs of data, it's one connection. If we sell one gig of data, it's one connection.

As you can see on the slide, business broadband connections grew 0.6% sequentially and ARPU declined slightly. About half the ARPU decline was due to a higher level of customer credit activity in the quarter, and the rest was a mix issue based on the type of new sales that we delivered.

Because we have some large sales in the delivery pipeline, we expect good performance in this area going forward. On the consumer side, ARPU grew sequentially and connections declined slightly.

Consumer connection decline was expected and reflects our intentional decision to turn down some of our slower speed lower margin offerings, while turning up higher margin bandwidth product by 50 megabit service. We expect to see continued erosion in consumer broadband connections, but higher ARPU.

We expect the impact to our margins will be positive. Which leads us to Slide 14.

Expanding EBITDA margins is very important to us, and while we'll have some variability quarter-to-quarter, we're focusing on the long-term trend and we're committed to stringent cost management to continue to drive margins in the right direction. You can see solid success in this area.

Moving to Slide 15. With our financial momentum, we are updating our guidance.

We're pleased to announce we are raising guidance for total revenue to $315 million from $310 million and raising adjusted EBITDA to $92 million from $90 million. We are reaffirming our guidance on free cash flow and capital expenditures.

And although we don't typically provide guidance on net debt, based on these results, our leverage ratio should be around 4.4x by the end of the year. With that, let me hand the call back to Anand.

Anand?

Thank you, Wayne. Let's turn to Slide 16.

We had a great quarter. Our results show strong topline growth and continued market share gain.

The market dynamic in Alaska creates additional opportunities for growth. Our work in process improvement and IT systems will drive efficiencies and margin expansion.

Our investments in network generate high incremental return and we remain committed to dedicating free cash flow to debt reductions. What this all mean?

Bottomline, we expect our business and wholesale revenues to grow 50% over the next five years. We expect margins to improve and adjusted EBITDA to continue its upward trajectory.

With this growth and deleveraging, we will continue to drive significant shareholder value. We are moving forward with focus.

We have the right market. We have the right operating model.

This will create shareholder values. Thank you for joining us today.

With that, let me open up the call for questions. Operator?

Just had a quick follow-up on to the State of Alaska contract. Can you go into, I think you've quoted a number, but I wanted to get an idea of what the sort of aggregate total could be over the next five years?

And Wayne, there was a paydown, I just want to confirm that was to the $5 million of term loan in the quarter. Is that correct?

Yes, Jason, paydowns were towards the term loan.

So as I've noted, the initial contract that we have is valued at $2.5 million over the next five years. This is a core contract.

That being said, the state is the largest consumer of technology in Alaska. And in fact, if you look at the spend that the state have in 2013, it was north of $60 million overall and the core contract represented only a small fraction of that total spend.

So what this opportunity does for us, is that gives us seat at the table. Now, we expect the solution will be deployed in the first half of 2015, and the design of product solution allows the state to quickly expand the higher capacity as their needs grow.

Now, with the benefits of competition the state is also getting market-based pricing for its bandwidth, and this will in our mind, stimulate demand. And as the state looks to drive further efficiencies in how they conduct their business, technology is going to be a big area of focus for them.

We've invested two years in getting to this point. And I fully expect that our return on this investment will be excellent over the upcoming years.

This is [ph] Thomas. I'm calling from Debtwire.

I just had a quick question about how Verizon's expansion into Alaska is going to impact AWNs revenue for the rest of the year.

So Verizon, as I think you've noted before launched their retail operations in late September of this year. Their network has been up and running for over a year.

And as far as its impact on AWN, I think we saw earlier as reported by GCI that certainly roaming revenues have been pretty strong. So in terms of impacts on the retail side, again Verizon so far has had somewhat of a limited launch with two or three source and also they're launched only on Voice-over-LTE, which limits the number of devices that they can offer in the market as well.

So from our perspective, we are competing effectively in the retail market. There is a good network that AWN provides.

And we are looking forward to compete there.

And one more thing before you go, how do you plan on bringing leverage down to 4.4x or have it at 4.7x right now?

It's continued, if you take our guidance for the year, full year guidance as opposed to a trailing-12 months, the number we're forecasting as a net debt basis by the end of the year should get you pretty close to 4.4x.

So forward guidance only?

Yes.

I was just wondering, I know you have a principal debt payment due in 2016 for about [ph] $327 million, I was just wondering how you plan on addressing that?

So we're going to be opportunistic. Our focus this year is beating our numbers.

And we've done that in terms of updating guidance. We're talking to people about what our options are.

Based upon our performance, we think have quite a few options. So our desire here is to close out the year.

And then we expect to be in the market, to have everything stays solid with the market sometime in the first half of next year.

Well, thank you all for joining us today. We look forward to talking to you again in the upcoming quarter call.

Thank you, all.