ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS AND ANALYSTS’ REPORTS
This Form 10-Q and our future filings on Forms 10-K, 10-Q and 8-K and the documents incorporated therein by reference include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934 (“Exchange Act”), as amended. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements. All statements other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws, including statements about anticipated future operating and financial performance, financial position and liquidity, growth opportunities and growth rates, pricing plans, acquisition and divestiture opportunities, business prospects, strategic alternatives, business strategies, regulatory and competitive outlook, investment and expenditure plans, financing needs and availability and other similar forecasts and statements of expectation and statements of assumptions underlying any of the foregoing. Words such as “anticipates”, “believes”, “could”, “estimates”, “expects”, “intends”, “may”, “plans”, “projects”, “seeks”, “should” and variations of these words and similar expressions are intended to identify these forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. Forward-looking statements by us are based on estimates, projections, beliefs and assumptions of management and are not guarantees of future performance. Such forward-looking statements may be contained in this Form 10-Q under Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere. Actual future performance, outcomes, and results may differ materially from those expressed in forward-looking statements made by us as a result of a number of important factors. Examples of these factors include (without limitation):
|
|
•
|
Governmental and public policy changes and investigations, including on-going changes in our revenues, or obligations for current and prior periods related to these programs, resulting from regulatory actions affecting inter-carrier compensation, and on-going support for federal and state programs such as Essential Network Support obligations and the rural health care universal service support mechanism such as ascertainment of the “urban rate” and “rural rate” used to determine federal support payments for services we provide to the majority of our rural health care customers for current and prior periods, as well as our ability to comply with the regulatory requirements to contribute to the Universal Service Fund and receive support payments from that fund
|
|
|
•
|
our size, because we are a smaller sized competitor in the markets we serve and we compete against large competitors with substantially greater resources
|
|
|
•
|
our ability to continue to develop attractive, integrated products and services to evolving industry standards, and meet the pressure from competition to offer these services at lower prices
|
|
|
•
|
unforeseen challenges when entering new markets
|
|
|
•
|
our business and operations could be negatively affected as a result of the actions of activist stockholders, which could cause us to incur significant expense, hinder execution of our business strategy and impact our stock price
|
|
|
•
|
the Alaskan economy, which has been impacted by continued low crude oil prices which are creating a significant impact on both the level of spending by the State of Alaska and the level of investment in resource development projects by natural resource exploration and development companies in Alaska. That reduced spending may impact the economy in the markets we serve and impact our future financial performance
|
|
|
•
|
the ability to attract, recruit, retain and develop the workforce necessary for implementing our business plan
|
|
|
•
|
disruptions or failures in the physical infrastructure or operating systems that support our businesses and customers, or cyber-attacks or security breaches of the physical infrastructure, operating systems or devices that our customers use to access our products and services
|
|
|
•
|
our ability to keep pace with rapid technological developments and changing standards in the telecommunications industry, including on-going capital expenditures needed to upgrade our network to industry competitive speeds, particularly in light of expected 5G deployments by mobile wireless carriers
|
|
|
•
|
our ability to maintain our cost structure as a focused broadband and managed information technology (“IT”) services company. Maintaining our cost structure is key to generating cash flow from operating activities. If we fail to effectively manage our costs, our financial condition will be impacted
|
|
|
•
|
unanticipated damage to one or more of our undersea fiber optic cables resulting from construction or digging mishaps, fishing boats or other reasons
|
|
|
•
|
structural declines for voice and other legacy services within the telecommunications industry
|
|
|
•
|
a maintenance or other failure of our network or data centers
|
|
|
•
|
a failure of information technology systems
|
|
|
•
|
our ability to invest sufficiently in our underlying physical infrastructure, including buildings, fleet and related equipment
|
|
|
•
|
a third-party claim that the Company is infringing upon their intellectual property, resulting in litigation or licensing expenses, or the loss of our ability to sell or support certain products
|
|
|
•
|
unanticipated costs required to fund our post-retirement benefit plans, or contingent liabilities associated with our participation in a multi-employer pension plan
|
|
|
•
|
the success or failure of any future acquisitions or other major transactions
|
|
|
•
|
geologic or other natural disturbances relevant to the location of our operations
|
|
|
•
|
our ability to meet the terms of our financing agreements and to draw down additional funds under the facility to meet our liquidity needs
|
|
|
•
|
the cost and availability of future financing, at the terms, and subject to the conditions necessary, to support our business and pursue growth opportunities; our debt could also have negative consequences for our business; for example, it could increase our vulnerability to general adverse economic and industry conditions, or limit our flexibility in planning for, or reacting to, changes in our business and the telecommunications industry; in addition, our ability to borrow funds in the future will depend in part on the satisfaction of the covenants in our credit facilities; if we are unable to satisfy the financial covenants contained in those agreements, or are unable to generate cash sufficient to make required debt payments, the lenders and other parties to those arrangements could accelerate the maturity of some or all of our outstanding indebtedness
|
|
|
•
|
our success in providing broadband solutions to the North Slope and western Alaska
|
|
|
•
|
our ability to repurchase shares of our Common Stock under our repurchase program
|
|
|
•
|
the success of the Company’s expansion into managed IT services, including the execution of those services for customers
|
|
|
•
|
our internal control over financial reporting may not be effective, which could cause our financial reporting to be unreliable
|
|
|
•
|
the matters described under Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2018.
|
In light of these risks, uncertainties and assumptions, you should not place undue reliance on any forward-looking statements. Additional risks that we may currently deem immaterial or that are not currently known to us could also cause the forward-looking events discussed in this Form 10-Q or our other reports not to occur as described. Except as otherwise required by applicable securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason after the date of this Form 10-Q.
Investors should also be aware that while we do, at various times, communicate with securities analysts, it is against our policy to disclose to them any material non-public information or other confidential information. Accordingly, investors should not assume that we agree with any statement or report issued by an analyst irrespective of the content of the statement or report. To the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.
OVERVIEW
We are a fiber broadband and managed IT services provider, offering technology and service enabled customer solutions to business and wholesale customers in and out of Alaska. We also provide telecommunication services to consumers in the most populated communities throughout the state. Our facilities based communications network extends through the economically significant portions of Alaska and connects to the contiguous states via our two diverse undersea fiber optic cable systems. Our network is among the most expansive in Alaska and forms the foundation of service to our customers. We operate in a largely two-player terrestrial wireline market and we estimate our market share to be less than 25% statewide. However, we sponsored a third-party market study in the fourth quarter of 2018 which suggests that our market share in “near net”, that is, within one mile of our fiber footprint, may be closer to 40%. This is consistent with our hypothesis that from a revenue performance perspective, relative to our largest competitor we are gaining market share in the markets we are serving.
The sections that follow provide information about important aspects of our operations and investments and include discussions of our results of operations, financial condition and sources and uses of cash. In addition, we have highlighted key trends and uncertainties to the extent practicable. The content and organization of the financial and non-financial data presented in these sections are consistent with information we use in evaluating our own performance and allocating our resources.
The Alaska Economy
We operate in a geographically diverse state with unique characteristics. We monitor the state of the economy and, in doing so, we compare Alaska economic activity with broader economic conditions. In general, we believe that the Alaska telecommunications market, as well as general economic activity in Alaska, is affected by certain economic factors, which include:
|
|
●
|
investment activity in the oil and gas markets and the price of crude oil
|
|
|
●
|
tourism levels
|
|
|
●
|
governmental spending and activity of military personnel
|
|
|
●
|
the price trends of bandwidth
|
|
|
●
|
the growth in demand for bandwidth
|
|
|
●
|
decline in demand for voice and other legacy services
|
|
|
●
|
local customer preferences
|
|
|
●
|
unemployment levels
|
|
|
●
|
housing activity and development patterns
|
The population of Alaska, which declined marginally in 2018, is approximately 740,000 with Anchorage, Fairbanks and Juneau serving as the primary population and economic centers in the state.
It is estimated that one-third of Alaska’s economy is dependent on federal spending, one-third on natural resources, in particular the production of crude oil, and the remaining one-third on drivers such as tourism, mining, timber, seafood, international air cargo and miscellaneous support services.
Alaska’s economy is dependent on investment by oil companies, and state tax revenues correlate with the price of oil as the State assesses a tax based on the retail price of oil that transits the pipeline from the North Slope. The price of crude oil dropped substantially during 2014 through 2016, and increased marginally in 2017 and 2018. The decline in the price of crude oil has impacted the state in two ways:
|
|
1.
|
Resource based companies reduced their level of spending in the state, and in particular the North Slope, through reducing their operating costs.
|
|
|
2.
|
The State of Alaska budget represents approximately 15% of the states total economy. The state’s budget deficit has been reduced from $3.7 billion in 2015 to $0.7 billion in 2019 (as enacted) primarily through spending reductions and utilization of interest earned on the state’s permanent fund. Reduced spending by the state has had a dampening effect on overall economic activity in the state.
|
Economists anticipate that slowly increasing oil prices and growing industry optimism bode well for continued new development and increased activity on the North Slope in 2019, supporting an increase in the volume of oil moving through the pipeline and the generation of revenue for the state government.
Economists believe the Alaskan economy entered a moderate recession beginning in the second half of 2015, which they currently expect to end during 2019. Employment levels in the state declined approximately 0.3% in 2018 (compared with a 1.3% decline in 2017) driven by declines in the oil and gas industry, construction, and Federal and state government, offset by increases in health care and local government. The negative effects of the recession have been mitigated by diversity in the Alaskan economy, including growth in the health care and tourism industries. However, economists believe that, without a long-term solution to the state budget deficit, a full economic recovery may remain elusive.
Our objective is to continue generating sector leading revenue growth in the broadband market through investments in sales, service, marketing and product development while expanding our broadband network capabilities through higher efficiencies, automation, new technology and expanded service areas. We also intend to continue our growth in the managed IT services market by providing these services to our broadband customers, and leveraging our position as the premier Cloud Enabler for business in the state of Alaska. We also seek to continuously improve our customer service, and utilize the Net Promoter Score (“NPS”) framework to track the feedback of our customers for virtually all customer interactions. We believe that higher NPS scores will allow us to increasingly provide a differentiated service experience for our customers, which will support our growth. We are focused on expanding our margins, and we utilize the LEAN framework to eliminate waste and simplify how we do business.
Regulatory Update
The items reported under Part I, Item 1. Business – Regulation in our Annual Report on Form 10-K for the year ended December 31, 2018, are updated as follows. This section should be read in conjunction with the corresponding items previously disclosed in our Annual Report.
US Federal Regulatory Matters
Rural Health Care Support Program
As described in our most recent Form 10-K, in November 2018, USAC approved the rural rates for the services we provide to our rural healthcare customers for Funding Year 2018, which began on July 1, 2018 and ends on June 30, 2019.
We are also working to reduce the level of regulatory and business uncertainty associated with our rural healthcare business in two additional ways. First, in November 2018, we requested FCC approval for rural rates for Funding Year 2019, which will begin July 1, 2019, in order to shorten the USAC funding request approval process and bring greater certainty to the competitive bidding process for rural healthcare provider services that began in January 2019. Second, we continue to advocate for the FCC expeditiously to adopt rules to reform and modernize the Rural Health Care Telecommunications Program, on which the majority of healthcare providers in Alaska rely, in the proceeding that began in December 2017. In December 2018, FCC Chairman Pai committed in a letter to Alaska Senator Dan Sullivan to move forward with an order adopting new rules for the Rural Health Care Program in 2019, with a target of doing so in the first half of the year. If the FCC meets that timeline, it is possible that new rules would be in place to govern the bidding and funding commitment process for Funding Year 2020, which will begin July 1, 2020.
At this time, it is impossible to predict the outcome of that rulemaking process or the impact the new rules may have. We are continuing to evaluate the impact of the funding cap constraints, ongoing uncertainty and unpredictability in the Rural Health Care Universal Service Support Mechanism, and the potential impact of future rule changes on our rural health care customers and revenues in light of these developments.
CAF Phase II
CAF Phase II supplanted the CAF Phase I frozen support mechanism and requires recipients to provide broadband service to unserved locations throughout the designated coverage area by the end of a specified build-out period, as well as to meet interim milestone build-out obligations.
On October 31, 2016, the FCC released its order adopting CAF Phase II (“CAF II”) for price cap carriers in Alaska. Alaska Communications is the only price cap carrier in Alaska and, under the CAF II order, we will receive approximately $19.7 million annually (the same amount we received as CAF I high cost frozen support) for the ten-year period starting January 1, 2016 and continuing through December 31, 2025. To receive this support, we committed to provide voice and broadband Internet access service to 31,571 locations in census blocks that are unserved or only partially served by any unsubsidized competitor. These will include approximately 26,000 locations that did not previously have access to broadband Internet access service.
On December 28, 2017, Alaska Communications filed a notice with the FCC proposing to serve 4,762 unique geocoded locations (encompassing 6,056 unserved customer locations because some are in multi-unit buildings) in partially-served census blocks to partially fulfill this requirement. On March 27, 2018, GCI filed a challenge at the FCC, asserting that GCI serves 3,099 of these locations, and we filed a response, disputing that assertion. On September 28, 2018, the FCC granted our request with respect to 1,713 unique geocoded locations, which will assist us in meeting our CAF Phase II deployment obligation.
In addition, on June 21, 2018, we filed a supplemental notice with the FCC proposing to serve an additional 3,252 unique geocoded locations (encompassing 4,691 unserved customer locations) in partially-served census blocks, again to partially fulfill our CAF Phase II deployment obligation. On September 4, 2018, GCI filed a challenge at the FCC, asserting that it serves 2,604 of those 3,253 locations. On March 5, 2019, the FCC found that 647 of the 3,252 proposed locations are eligible for CAF Phase II, and granted our request to include 14 additional unserved census blocks as eligible for CAF Phase II broadband deployment. On May 6, 2019, as required under the FCC’s original October 31, 2016 CAF II Order, we filed a proposed confidential deployment plan identifying the 31,571 eligible customer locations where, subject to technological advances, deployment challenges, and market conditions, we propose to offer voice and broadband Internet access services by December 31, 2025. If however, our expectations concerning these factors do not emerge as planned over that time period, it may be more difficult and costly to meet our CAF Phase II deployment obligations.
On April 26, 2018, the FCC released an Order denying our request to modify the conditions on our use of CAF Phase II high cost support. The CAF locations may include up to 2,714 unserved locations in census blocks deemed “low-cost” by the FCC, so long as we certify that the capital expenditure to serve each such location was at least $5,000.00. The FCC denied our request to reduce that minimum capital expenditure requirement to $2,577.79. As a result of this denial, we may find it more difficult to identify eligible service locations to meet our CAF Phase II deployment requirement.
We are continuing to work toward meeting our CAF Phase II obligations in a capital-efficient manner, including the potential to deliver broadband Internet access services meeting CAF Phase II requirements using our fixed wireless platform.
Satellite Services
On February 16, 2018, the FCC granted our application for a license to operate a network of C-band satellite earth stations to be used to serve our customers that cannot be reached by terrestrial middle mile facilities. Under that license, we are authorized to use up to 72 MHz of C-band spectrum on Eutelsat’s satellite, E115WB, for a term of 15 years. In June 2018, the FCC granted our application to expand that network to include new customer sites, and we have since requested authority to double the amount of spectrum we are authorized to use, up to 144 MHz, and serve additional sites. We expect this arrangement to provide us with greater predictability and stability in the availability and cost of long-haul transport connectivity to our customers that must be served by satellite. Since that time, we have continued to expand our C-band network.
Our C-band satellite earth stations use the 3.7 - 4.2 GHz band to receive downlink transmissions from geostationary satellites. On April 19, 2018, the Wireless Telecommunications, International, and Public Safety Bureaus of the FCC announced an immediate, temporary freeze on the filing of new or modification applications for fixed-satellite service earth station licenses, receive-only earth station registrations, and fixed microwave licenses in the 3.7 - 4.2 GHz portion of the C-band spectrum, in order to preserve the current landscape of authorized operations in that band while the Commission continues to examine opportunities to permit expanded terrestrial use of that band for mobile broadband and additional fixed services. On July 13, 2018, the FCC issued a Notice of Proposed Rulemaking seeking comment on options for expanding terrestrial use of the 3.7 - 4.2 GHz band for “5G” services. In response, we have filed comments and reply comments advocating for continued access to this spectrum for satellite downlink operations in Alaska. We are unable to predict the outcome of this proceeding. If the FCC adopts rules that limit our ability to register additional satellite earth stations in this band, or expands terrestrial transmissions in the 3.7 - 4.2 GHz band, it may become more difficult or costly for us to use this band, or necessitate relocation of our services to alternative spectrum bands.
In October 2018, the FCC also opened a proceeding to examine possible new terrestrial uses of the 6 GHz band, including the 5.925-6.425 GHz spectrum used for C-band satellite uplink transmissions originating from terrestrial earth stations to geostationary satellites in orbit. Because C-band earth stations are transmitting in that band, not receiving, we expect any increase in terrestrial use of the 6 GHz band to have a less severe impact on our satellite C-band network than would use of the 3.7 - 4.2 GHz receive band. Nevertheless, we are unable at this time to predict the outcome of these proceedings, or to assess any potential future impact on our C-band satellite services.
State of Alaska Regulatory Matters
Alaska Universal Service Fund
The Alaska Universal Service Fund (“AUSF”) complements the federal Universal Service Fund, but is focused on obligations to meet intrastate service obligations. The RCA has opened an “information docket” to evaluate and scope a comprehensive AUSF reform rulemaking that might include consideration of the Fund’s continued need. The RCA also opened a rulemaking to review the regulations specific to AUSF shortfalls. A final decision in that matter was issued in late December, 2017. These rules were transmitted to the Lt. Governor for signature and became effective April, 2018. They eliminate the hierarchy of shortfall payments except for Lifeline and administrative operating expenses.
In January, 2018, the RCA opened a rulemaking to repeal the AUSF effective July 31, 2019, and sought comments and reply comments. The Alaska Telephone Association and its members filed a plan to cap the fund and distributions. AT&T, GCI, and Alaska Communications also filed comments and reply comments. A hearing was scheduled in April. A final order was issued by the RCA on October 24, 2018 with changes to the distribution to be effective January 1, 2019.
Prior to changes to the AUSF distribution, AUSF supported a portion of certain higher cost carriers’ switching costs, the costs of Lifeline service (which supports rates of low-income customers), the Carrier of Last Resort (“COLR”), Carrier Common Line (“CCL”) support program and other costs associated with regulated service. These funding mechanisms have been eliminated and replaced with a new funding mechanism called Essential Network Support (“ENS”). In addition, the AUSF surcharge has been capped at 10%.
In response to the FCC’s order eliminating Lifeline qualifying programs approved by state regulatory commissions, the Alaskan telecommunications industry has proposed a waiver of the state qualifying programs to align the state and federal qualifying programs. The RCA granted that waiver prior to December 2, 2016 when the new rules went into effect. In August 2017, the RCA opened a docket, R-17-002, on Lifeline to align the programs with the federal rules and revise the certification and verification procedures to reflect revised federal procedures. Lifeline service providers have been operating under an RCA order that aligns some issues and companies made tariff filings to align their procedures. This rulemaking is somewhat ministerial in nature but may become moot depending on the outcomes of the AUSF docket R-18-001. Comments were submitted in September 2017. The regulation docket has a final decision deadline of August 25, 2019.
Other State Regulatory Matters
The RCA opened three dockets on July 27, 2016 to investigate the continued need for COLR funding in competitive areas. Two of the dockets investigating the continued need for COLR funding affect the Fairbanks and Juneau markets. On May 24, 2017, the RCA issued an order approving the 2016 COLR filing for ACSF but denying the 2016 COLR filing for ACSAK and terminating its COLR status and related support. ACSAK petitioned for reconsideration which was denied, and on July 14, 2017, ACSAK filed a notice of appeal in the Anchorage Superior Court. ACSAK filed its appellant brief on March 1, 2018 simultaneously with MTA. COLR support continued during the appeal.
Oral arguments were held on the COLR matter in January 2019, after which the RCA and ACSAK entered a settlement which allowed ACSAK to retain all COLR amounts paid during the pendency of the Superior Court action.
Business Plan Core Principles
Our results of operations, financial position and sources and uses of cash in the current and future periods reflect our focus on being the most successful broadband solutions company in Alaska by delivering the best customer experience in the markets we choose to serve. To do this we will continue to:
|
|
●
|
Create a Workplace That Develops Ou
r People and Celebrates Success
We believe an engaged workforce is critical to our success. We are deeply committed to the development of our people and creating opportunities for them.
|
|
|
●
|
Create a Consistent
Customer Experience Every Time
We strive to deliver service as promised to our customers, and make it right if our customers are not satisfied with what we delivered. We track virtually every customer interaction and we utilize the Net Promoter Score framework for assessing the satisfaction of our customers.
|
|
|
●
|
Develop Our Network Focusing on Efficient Delivery and Management
We are moving toward higher efficiencies and improved customer experience through automation, new technology and expanded geographic service areas. Our network architecture is a simpler mix of our fiber backbone, supported with fixed wireless (“FiWi”), WiFi and satellite.
|
|
|
●
|
Relentlessly Simplify
and Transform
How We Do Business
We believe we must reduce waste, which is defined as any activity that does not add value to its intended customer. Doing so improves the experience we deliver to our customers. We make investments in technology and process improvement, utilize the LEAN framework, and expect these efforts to meaningfully impact our financial performance in the long-term.
|
|
|
●
|
Offer Broadband
and Managed IT
Solution
s
that Create Market Differentiation
We are building on strength in designing and providing new products and solutions to our customers.
|
We believe we can create value for our shareholders by:
|
|
●
|
Driving revenue growth through increasing business broadband and managed IT service revenues,
|
|
|
●
|
Generating Adjusted EBITDA and Adjusted Free Cash Flow growth through margin management, and
|
|
|
●
|
Careful allocation of capital, including selectively investing success based capital into opportunities that generate appropriate returns on investments.
|
2019 Operating Initiatives
|
|
●
|
Continue our focus on robust broadband growth as the foundation of our other initiatives.
|
|
|
●
|
Ignite success in the Consumer customer market, including the Mass Market group, through the expansion and enhancement of our products, services and the supporting infrastructure.
|
|
|
●
|
Continue to strengthen our Enterprise and Carrier customer group, which is the primary driver of our Business and Wholesale group, through increased focus on specific products and services.
|
|
|
●
|
Improve market penetration of our MIT products and services.
|
|
|
●
|
Build on our work in 2018 in the areas of network modernization through SD-WAN, Fixed Wireless Access, fiber fed Multi-Dwelling Units, Optical Transport Network modernization, and adding product capabilities that leverage our network.
|
|
|
●
|
Effectively manage operating expenses and capital spending to improve our margin profile over the long term.
|
|
|
●
|
Continue to meet our CAF II deployment obligations.
|
|
|
●
|
Successful implementation of an IT project targeted at replacing several of our legacy IT systems.
|
|
|
●
|
Continued emphasis on employee engagement and effective communication.
|
|
|
●
|
Evaluate strategic opportunities in and out of Alaska that address scale and geographic diversification and reduce the risk of investments made in our company.
|
Revenue Sources by Customer Group
We operate our business under a single reportable segment. We manage our revenues based on the sale of services and products to the three customer categories listed below. Revenue in the following management’s discussion and analysis is presented by customer and product category, combining revenue accounted for under ASC 606 and other guidance.
|
|
●
|
Business and Wholesale (broadband, voice and managed IT services)
|
|
|
●
|
Consumer (broadband and voice services)
|
|
|
●
|
Regulatory (
access services, high cost support and carrier termination
)
|
Business and Wholesale
Providing services to Business and Wholesale customers provides the majority of our revenues and is expected to continue being the primary driver of our growth over the next few years. Our business customers include large enterprises in the oil and gas, healthcare, education, Alaska Native Corporations, financial industries, Federal, state and local governments, and small and medium business. We were the first Alaska-based carrier to be Carrier Ethernet 2.0 Certified and are currently the only Alaska-based carrier certified for multipoint-to-multipoint services. This certification means that we meet international standards for the quality of our broadband services. We also offer IP based voice including the largest SIP implementations in the state of Alaska, and are the first Microsoft Express Route provider in the state. We believe our network differentiates us in the markets we serve, because we prefer not to compete on price; but on the quality, reliability, customer service and the overall value of our solutions. Accordingly, we have significant capacity to “sell into” the network we operate and do so at what we believe are attractive incremental gross margins.
Business services have experienced significant growth and we believe the incremental economics of business services are attractive. Given the demand from our customers for more bandwidth and services, we expect revenue growth from these customers to continue for the foreseeable future. We provide services such as voice and broadband, managed IT services including remote network monitoring and support, managed IT security and IT professional services, and long distance services primarily over our own terrestrial network. We are continuing our efforts to position the Company as the premier Cloud Enabler for business in the state of Alaska.
Our wholesale customers are primarily in-state, national and international telecommunications carriers who rely on us to provide connectivity for broadband and other needs to access their customers over our Alaskan network. The wholesale market is characterized by larger transactions that can create variability in our operating performance. We have a dedicated sales team that sells into this customer segment, and we expect wholesale revenue to grow for the foreseeable future.
Consumer
We also provide broadband, voice and IT services to residential customers, including residential homes and multi-dwelling units. Given that our primary competitor has extensive quad play capabilities (video, voice, wireless and broadband) we target how and where we offer products and services to this customer group in order to maintain our returns. Our focus is to leverage the capabilities of our existing network and sell customers our highest available bandwidth. Our primary competitive advantage is that we offer reliable internet service without data caps, while our competitor, with certain exceptions, charges customers or throttles customers’ speeds for exceeding given levels of data usage. We experienced consistent growth in consumer broadband revenues in 2018. More recently, we expanded product and service offerings to this customer group and have implemented fiber fed WiFi and certain fixed wireless technology solutions for providing broadband, all of which have provided a basis for continued growth in this market in 2019.
Regulatory
Regulatory revenue is generated from three primary sources: (i) access charges, which include interstate and intrastate switched access and special access charges, and cellular access; (ii) surcharges billed to the end user (pass-through and non-pass-through); and (iii) federal and state support. We provide voice and broadband origination and termination services to interstate and intrastate carriers. While we are compensated for these services, these revenue streams have been in decline and we expect them to continue to decline, although at a relatively predictable rate. In addition, as regulators have reformed traditional access charges, they have simultaneously implemented new end user surcharges that contribute to our revenue.
The following table summarizes our primary sources of regulatory revenue and their contribution to total revenue in 2018 (dollars in thousands).
|
Source
|
Description
|
|
2018 Revenue
|
|
|
As a % of
Regulatory
Revenue
|
|
|
As a % of
Total
Revenue
|
|
|
Access Charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interstate and intrastate switched access are services based primarily on originating and terminating access minutes from other carriers. Special access is primarily access to dedicated circuits sold to wholesale customers, substantially all of which is generated from interstate services. Cellular access is the transport of local network services between switches for cellular companies based on individually negotiated contracts. Access revenue has declined at an average of approximately 9% annually over the past three years.
|
|
$
|
4,548
|
|
|
|
9.0
|
%
|
|
|
2.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Access Charges
|
|
$
|
4,548
|
|
|
|
9.0
|
%
|
|
|
2.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Surcharges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pass-Through
|
We assess our customers for surcharges, typically on a monthly basis, as required by various state and federal regulatory agencies, and remit these surcharges to these agencies. These pass-through surcharges include Federal Universal Access and State Universal Access. These surcharges vary from year to year, and are primarily recognized as revenue, and the subsequent remittance to the state or federal agency as a cost of sale and service. The rates imposed by the regulators continue to increase. However, because the charges are only assessed on a portion of our services, and that portion continues to decline, we expect these revenue streams to decline over time as the revenue base declines.
|
|
$
|
7,874
|
|
|
|
15.6
|
%
|
|
|
3.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
Other non-pass-through surcharges are collected from our customers as authorized by the regulatory body. The amount charged is based on the type of line: single line business, multi-line business, consumer or lifeline. The rates are established based on federal or state orders. These charges are recorded as revenue and do not have a direct associated cost. Rather, they represent a revenue recovery mechanism established by the FCC or the Regulatory Commission of Alaska.
|
|
$
|
11,560
|
|
|
|
22.8
|
%
|
|
|
5.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Surcharges
|
|
$
|
19,434
|
|
|
|
38.4
|
%
|
|
|
8.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal and State Support
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAF II
|
In 2016, the FCC released the CAF Phase II order specific to Alaska Communications which transitioned from CAF Phase I frozen support to CAF Phase II. Funding under the new program generally requires the Company to provide broadband service to unserved locations throughout the designated coverage area by the end of a specified build-out period, and meet interim milestone build-out obligations. CAF II revenues are expected to be relatively stable through 2026.
|
|
$
|
19,694
|
|
|
|
39.0
|
%
|
|
|
8.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COLR and CCL
|
The Company is designated by the State of Alaska as a COLR in five of the six study areas. In addition to COLR, the Company receives CCL support. We do not receive COLR or CCL funding for the ACS of Anchorage study area. As a COLR we are required to provide services essential for retail and carrier-to-carrier telecommunication throughout the applicable coverage area.
|
|
$
|
6,896
|
|
|
|
13.6
|
%
|
|
|
2.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Federal and State Support
|
|
$
|
26,590
|
|
|
|
52.6
|
%
|
|
|
11.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Regulatory Revenue
|
|
$
|
50,572
|
|
|
|
|
|
|
|
21.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$
|
232,468
|
|
|
|
|
|
|
|
|
|
Executive Summary
Operating
Revenues
Total revenue of $56.9 million increased $0.9 million, or 1.7%, in the first quarter of 2019 compared with the first quarter of 2018. This growth reflects a $2.3 million increase in total broadband revenue partially, offset by a $1.6 million decrease in regulatory access revenue. Rural health care revenue was $4.1 million in 2019 compared with $3.5 million in 2018. Results in 2018 reflect the impact of the funding cap for the rural health care program announced in March 2018 which was subsequently increased in June 2018
Operating Income
Operating income of $5.9 million in the first quarter of 2019 increased $0.6 million, or 11.3%, compared with the first quarter of 2018 due to revenue growth, partially offset by marginally higher operating expenses. These items are discussed in more detail below.
Operatin
g Metrics
Business broadband average monthly revenue per user (“ARPU”) of $334.94 in the first quarter of 2019 increased from $297.38 in the first quarter of 2018 due primarily to price reductions associated with the funding shortfalls in the rural health care program announced in March 2018. The funding cap was subsequently increased in June 2018. Business broadband connections of 15,126 at March 31, 2019 declined marginally from connections of 15,306 at March 31, 2018. We count connections on a unitary basis regardless of the size of the bandwidth. For example, a customer that has a 10MB connection is counted as one connection as is a customer with a 1MB connection. While we present metrics related to Business connections, we note that we manage Business and wholesale in terms of new Monthly Recurring Charges (“MRC”) sold. Achievement of sales performance in terms of MRC is the primary operating metric used by management to measure market performance. For competitive reasons, we do not disclose our sales or performance in MRC.
Consumer broadband connections of 32,840 at March 31, 2019 declined from 33,675 at March 31, 2018, and consumer broadband ARPU of $65.39 in the first quarter of 2019 increased from $63.77 in the first quarter of 2018. However, connections of 10 Mbps or higher increased to 22,285 at March 31, 2019 compared to 22,220 at March 31, 2018 reflecting our focus on offering higher speed connections.
The table below provides certain key operating metrics as of or for the periods indicated.
|
|
|
|
|
March 31,
|
|
|
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Voice:
|
|
|
|
|
|
|
|
|
|
|
|
At quarter end:
|
|
|
|
|
|
|
|
|
|
Business access lines
|
|
|
68,788
|
|
|
|
71,002
|
|
|
Consumer access lines
|
|
|
25,156
|
|
|
|
28,221
|
|
|
Quarter:
|
|
|
|
|
|
|
|
|
|
|
ARPU - business
|
|
$
|
25.21
|
|
|
$
|
24.76
|
|
|
ARPU - consumer
|
|
$
|
33.77
|
|
|
$
|
31.57
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Broadband:
|
|
|
|
|
|
|
|
|
|
|
At quarter end:
|
|
|
|
|
|
|
|
|
|
Business connections
|
|
|
15,126
|
|
|
|
15,306
|
|
|
Consumer connections
|
|
|
32,840
|
|
|
|
33,675
|
|
|
Quarter:
|
|
|
|
|
|
|
|
|
|
|
ARPU - business
|
|
$
|
334.94
|
|
|
$
|
297.38
|
|
|
ARPU - consumer
|
|
$
|
65.39
|
|
|
$
|
63.77
|
|
Liquidity
We generated cash from operating activities of $15.5 million in the first quarter of 2019 compared with $13.4 million in the first quarter of 2018. This improvement reflects lower accounts receivable, partially as a result of cash receipts from the rural health care program, offset by increases in materials and supplies due to timing of construction projects.
In the first quarters of 2019 and 2018, we invested a total of $10.0 million and $10.4 million, respectively, in capital, including capitalized interest and net of the settlement of items accrued in previous periods.
Net debt (defined as total debt excluding debt issuance costs, less cash and cash equivalents) at March 31, 2019 was $159.9 million compared with $161.2 million at December 31, 2018. The decrease reflects cash generated from operating activities during in the first quarter and net cash proceeds from the refinancing transaction, largely offset by capital spending and the increased principal balance of the 2019 Senior Credit Facility.
As described above, on January 15, 2019, the Company entered into an amended and restated credit facility which provides for a reduction in interest rates, extension of principal payment terms, increased borrowing capacity and resetting and widening of key covenant thresholds.
RESULTS OF OPERATIONS
The following table summarizes our results of operations for the three-month periods ended March 31, 2019 and 2018. Revenue and the associated analysis is presented by customer and product category, combining revenue accounted for under ASC 606 and other guidance.
Three Months Ended March 31, 2019 Compared to Three Months Ended March 31, 2018
|
|
|
Three Months ended March 31,
|
|
|
(in thousands)
|
|
2019
|
|
|
2018
|
|
|
Change
|
|
|
% Change
|
|
|
Operating revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business and wholesale revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business broadband
|
|
$
|
15,267
|
|
|
$
|
13,659
|
|
|
$
|
1,608
|
|
|
|
11.8
|
%
|
|
Business voice and other
|
|
|
7,001
|
|
|
|
6,851
|
|
|
|
150
|
|
|
|
2.2
|
%
|
|
Managed IT services
|
|
|
1,659
|
|
|
|
1,265
|
|
|
|
394
|
|
|
|
31.1
|
%
|
|
Equipment sales and installations
|
|
|
880
|
|
|
|
922
|
|
|
|
(42
|
)
|
|
|
-4.6
|
%
|
|
Wholesale broadband
|
|
|
10,262
|
|
|
|
9,578
|
|
|
|
684
|
|
|
|
7.1
|
%
|
|
Wholesale voice and other
|
|
|
1,426
|
|
|
|
1,488
|
|
|
|
(62
|
)
|
|
|
-4.2
|
%
|
|
Total business and wholesale revenue
|
|
|
36,495
|
|
|
|
33,763
|
|
|
|
2,732
|
|
|
|
8.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Broadband
|
|
|
6,468
|
|
|
|
6,492
|
|
|
|
(24
|
)
|
|
|
-0.4
|
%
|
|
Voice and other
|
|
|
2,733
|
|
|
|
2,877
|
|
|
|
(144
|
)
|
|
|
-5.0
|
%
|
|
Total consumer revenue
|
|
|
9,201
|
|
|
|
9,369
|
|
|
|
(168
|
)
|
|
|
-1.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total business, wholesale and consumer revenue
|
|
|
45,696
|
|
|
|
43,132
|
|
|
|
2,564
|
|
|
|
5.9
|
%
|
|
Growth in broadband revenue
|
|
|
7.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regulatory revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Access
|
|
|
6,289
|
|
|
|
7,917
|
|
|
|
(1,628
|
)
|
|
|
-20.6
|
%
|
|
High cost support
|
|
|
4,924
|
|
|
|
4,923
|
|
|
|
1
|
|
|
|
0.0
|
%
|
|
Total regulatory revenue
|
|
|
11,213
|
|
|
|
12,840
|
|
|
|
(1,627
|
)
|
|
|
-12.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
$
|
56,909
|
|
|
$
|
55,972
|
|
|
$
|
937
|
|
|
|
1.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services and sales (excluding depreciation and amortization)
|
|
|
25,627
|
|
|
|
25,833
|
|
|
|
(206
|
)
|
|
|
-0.8
|
%
|
|
Selling, general and administrative
|
|
|
16,656
|
|
|
|
16,012
|
|
|
|
644
|
|
|
|
4.0
|
%
|
|
Depreciation and amortization
|
|
|
8,679
|
|
|
|
8,787
|
|
|
|
(108
|
)
|
|
|
-1.2
|
%
|
|
Gain on disposal of assets, net
|
|
|
(2
|
)
|
|
|
(3
|
)
|
|
|
1
|
|
|
|
-33.3
|
%
|
|
Total operating expenses
|
|
|
50,960
|
|
|
|
50,629
|
|
|
|
331
|
|
|
|
0.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
5,949
|
|
|
|
5,343
|
|
|
|
606
|
|
|
|
11.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income and (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(3,056
|
)
|
|
|
(3,504
|
)
|
|
|
448
|
|
|
|
-12.8
|
%
|
|
Loss on extinguishment of debt
|
|
|
(2,799
|
)
|
|
|
-
|
|
|
|
(2,799
|
)
|
|
|
NM
|
|
|
Interest income
|
|
|
75
|
|
|
|
14
|
|
|
|
61
|
|
|
|
NM
|
|
|
Other income, net
|
|
|
122
|
|
|
|
104
|
|
|
|
18
|
|
|
|
17.3
|
%
|
|
Total other income and (expense)
|
|
|
(5,658
|
)
|
|
|
(3,386
|
)
|
|
|
(2,272
|
)
|
|
|
67.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax (expense) benefit
|
|
|
291
|
|
|
|
1,957
|
|
|
|
(1,666
|
)
|
|
|
-85.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax (expense) benefit
|
|
|
(98
|
)
|
|
|
112
|
|
|
|
(210
|
)
|
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
193
|
|
|
|
2,069
|
|
|
|
(1,876
|
)
|
|
|
-90.7
|
%
|
|
Less net loss attributable to noncontrolling interest
|
|
|
(34
|
)
|
|
|
(32
|
)
|
|
|
(2
|
)
|
|
|
6.3
|
%
|
|
Net income attributable to Alaska Communications
|
|
$
|
227
|
|
|
$
|
2,101
|
|
|
$
|
(1,874
|
)
|
|
|
-89.2
|
%
|
Operating Revenue
Business and Wholesale
Business and wholesale revenue of $36.5 million increased $2.7 million, or 8.1%, in the first quarter of 2019 from $33.8 million in the first quarter of 2018. Business broadband revenue increased $1.6 million due primarily to an increase in ARPU from $297.38 in 2018 to $334.94 in 2019. ARPU in the first quarter of 2018 reflected price reductions associated with the announced funding shortfalls in the rural health care program. The funding cap was subsequently increased in June 2018. Rural health care revenue was $4.1 million in 2019 compared with $3.5 million in 2018. Connections were down marginally year over year. Wholesale broadband revenue increased $0.7 million, Managed IT services increased $0.4 million and voice and other revenue increased $0.1 million. These increases were partially offset by a marginal decline in equipment sales and installations. While connections and ARPU serve as data points to support the analysis of period-over-period changes in revenue, they are not critical indicators utilized by the Company to manage the Business and Wholesale customer group.
Business and wholesale revenue includes the amortization of deferred revenue for the three-month periods ended March 31, 2019 and 2018 as follows:
|
|
|
Three Months Ended
|
|
|
|
|
March 31,
|
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
GCI capacity revenue
|
|
$
|
511
|
|
|
$
|
511
|
|
|
Other deferred capacity revenue
|
|
|
615
|
|
|
|
436
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred capacity revenue
|
|
|
1,126
|
|
|
|
947
|
|
|
|
|
|
|
|
|
|
|
|
|
Other deferred revenue
|
|
|
899
|
|
|
|
752
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,025
|
|
|
$
|
1,699
|
|
Consumer
Consumer revenue of $9.2 million in the first quarter of 2019 was down marginally from $9.4 million in the first quarter of 2018. Broadband revenue was unchanged year over year as lower connections were offset by an increase in ARPU to $65.39 from $63.77. Voice and other revenue decreased $0.1 million due to 3,065 fewer connections, partially offset by an increase in ARPU to $33.77 from $31.57 in the prior year.
Regulatory
Regulatory revenue of $11.2 million decreased $1.6 million year over year due primarily to lower access charges resulting from reduced funding from the Alaska Universal Service Fund, which supports the Company’s obligations to meet its intrastate service obligations, and reduced ENS funding.
Operating Expenses
Cost of Services and Sales
(excluding depreciation and amortization
)
Cost of services and sales (excluding depreciation and amortization) of $25.6 million decreased $0.2 million, or 0.8%, in the first quarter of 2019 from $25.8 million in the first quarter of 2018. A $0.9 million decrease in access charges and $0.5 million decrease in circuit installation costs were partially offset by increases in labor, permitting and other costs totaling $1.2 million.
Selling, General and Administrative
Selling, general and administrative expenses of $16.7 million increased $0.7 million, or 4.0%, in the first quarter of 2019 from $16.0 million in the first quarter of 2018. This increase reflects a $1.9 million increase in labor costs offset by a $1.2 million reduction in the provision for doubtful accounts receivable.
Depreciation and Amortization
Depreciation and amortization expense of $8.7 million decreased $0.1 million, or 1.2%, in the first quarter of 2019 from $8.8 million in the first quarter of 2018. This decrease was due primarily to certain assets reaching the end of their depreciable life.
Other
Income
and Expense
Interest expense of $3.1 million in the first quarter of 2019 declined from $3.5 million in the first quarter of 2018 due to a lower average interest rate and borrowing levels. The loss on extinguishment of debt of $2.8 million in the first quarter of 2019 was associated with the settlement of the 2017 Senior Credit Facility in the first quarter.
Income Taxes
Income tax expense and the effective tax rate in the first quarter of 2019 were $0.1 million and 33.7%, respectively. The income tax benefit in the first quarter of 2018 of $0.1 million reflects a $0.7 million benefit recorded to correct an overstatement of the income tax provision in 2017. Excluding this out-of-period adjustment, the income tax provision was $0.6 million and the effective tax rate was 30.2% in the first quarter of 2018.
Net Loss Attributable to Noncontrolling Interest
The net loss attributable to the noncontrolling interest of the AQ-JV was $34 thousand and $32 thousand in the first quarter of 2019 and 2018, respectively.
Net
Income Attributable to Alaska Communications
Net income attributable to Alaska Communications of $0.2 million in the first quarter of 2019 compares with $2.1 million in the same period of 2018. The year over year results reflect the revenue and expense items discussed above.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
We satisfied our cash requirements for operations and capital expenditures in the first quarter of 2019 through internally generated funds and cash on hand. At March 31, 2019, we had $22.8 million of cash and cash equivalents, $1.6 million of restricted cash and $20.0 million available under our revolving credit facility.
On January 15, 2019, we completed a refinancing transaction. See the discussion under “Liquidity and Capital Resources” below.
Our major sources and uses of funds in the three months ended March 31, 2019 and 2018 were as follows:
|
|
|
Three Months Ended
|
|
|
|
|
March 31,
|
|
|
(in thousands)
|
|
2019
|
|
|
2018
|
|
|
Net cash provided by operating activities
|
|
$
|
15,475
|
|
|
$
|
13,421
|
|
|
Capital expenditures
|
|
$
|
(8,563
|
)
|
|
$
|
(8,680
|
)
|
|
Change in unsettled capital expenditures
|
|
$
|
(1,121
|
)
|
|
$
|
(1,272
|
)
|
|
Repayments of long-term debt
|
|
$
|
(171,758
|
)
|
|
$
|
(8,807
|
)
|
|
Proceeds from the issuance of long-term debt
|
|
$
|
180,000
|
|
|
$
|
7,000
|
|
|
Debt issuance costs and discounts
|
|
$
|
(2,659
|
)
|
|
$
|
-
|
|
|
Cash paid for debt extinguishment
|
|
$
|
(1,222
|
)
|
|
$
|
-
|
|
|
Interest paid
(1)
|
|
$
|
(3,075
|
)
|
|
$
|
(3,441
|
)
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Included in net cash provided by operating activities.
|
|
|
|
|
|
|
|
|
Cash Flows from Operating Activities
Cash provided by operating activities of $15.5 million in the first quarter of 2019 reflects net income excluding non-cash items (defined as cash provided by operating activities excluding changes in operating assets and liabilities) of $11.4 million, a $6.5 million decrease in account receivable primarily reflecting cash receipts, partially offset by a $1.6 million increase in materials and supplies due to timing of construction projects.
Cash provided by operating activities of $13.4 million in the first quarter of 2018 reflects net income excluding non-cash items of $11.0 million and a $3.0 million decrease in accounts receivable, materials and supplies, and other current assets, partially offset by a $1.1 million decrease in accounts payable and other current liabilities. The decrease in accounts receivable, materials and supplies, and other current assets reflects cash receipts on accounts receivable and utilization of materials and supplies in capital projects, offset by increases in accounts receivable associated with rural health care customers. The decrease in accounts payable and other current liabilities includes the effect of cash interest payments totaling $3.4 million.
Cash Flows from Investing Activities
Cash used by investing activities of $10.0 million in the first quarter of 2019 consisted of expenditures on capital. Of $8.6 million incurred in 2019, $5.1 million was success based versus maintenance.
Cash used by investing activities of $10.4 million in the first quarter of 2018 consisted of expenditures on capital. Of $8.7 incurred in 2018, $5.9 was success based versus maintenance.
Our networks require the timely maintenance of plant and infrastructure. Future capital requirements may change due to impacts of regulatory decisions that affect our ability to recover our investments, changes in technology, the effects of competition, changes in our business strategy, and our decision to pursue specific acquisition and investment opportunities. Capital spending is typically higher during the second and third quarters. We intend to fund future capital expenditures with cash on hand and net cash generated from operations.
Cash Flows from Financing Activities
Cash provided by financing activities was $4.1 million in the first quarter of 2019. Proceeds from the issuance of long-term debt of $180.0 million consisted of Term A Facility of the 2019 Senior Credit Facility. Repayments of long-term debt of $171.8 million consisted of settlement of the 2017 Senior Credit Facility. Debt discount, issuance and extinguishment payments totaling $3.9 million were associated with the refinancing transaction.
Cash used by financing activities were $2.2 million in the first quarter of 2018. Repayments of long-term debt of $8.8 million included scheduled principal payments on the term loan components of our 2017 Senior Credit Facility of $1.7 million and repayment of draws totaling $7.0 million on the revolving credit facility. Proceeds from the issuance of long-term debt of $7.0 million consisted of draws on the revolving credit facility.
Liquidity and Capital Resources
Consistent with our history, our current and long-term liquidity could be impacted by a number of challenges, including, but not limited to: (i) potential future reductions in our revenues resulting from governmental and public policy changes, including regulatory actions affecting inter-carrier compensation, changes in revenue from Universal Service Funds, and the timing of Rural Health Care Program funding receipts; (ii) servicing our debt and funding principal payments; (iii) the funding of other obligations, including our pension plans and lease commitments; (iv) competitive pressures in the markets we serve; (v) the capital intensive nature of our industry; (vi) our ability to respond to and fund the rapid technological changes inherent to our industry, including new products; and (vii) our ability to obtain adequate financing to support our business and pursue growth opportunities.
We are responding to these challenges by (i) driving top line growth in broadband service revenues outside the rural health care market with a focus on business and wholesale customers; (ii) managing our cost structure to deliver consistent Adjusted EBITDA and Adjusted Free Cash flow performance; and (iii) holding capital spending to approximately $35 million annually.
On January 15, 2019, we entered into the 2019 Senior Credit Facility, consisting of an Initial Term A Facility in the amount of $180 million, a Revolving Facility in an amount not to exceed $20 million and a Delayed-Draw Term A Facility in an amount not to exceed $25 million. The 2019 Senior Credit Facility also provides for Incremental Term A Loans up to an aggregate principal amount of the greater of $60 million and trailing twelve month EBITDA, as defined. On January 15, 2019, proceeds from the Initial Term A Facility of $180 million were used to repay in full the outstanding principal balance of the Term A-1 Facility and Term A-2 Facility under the Company’s 2017 Senior Credit Facility totaling $171.8 million, plus accrued and unpaid interest, pay fees and expenses associated with the Agreement and for general corporate purposes.
Principal payments on the Initial Term A Facility, Delayed-Draw A Facility and any amounts outstanding under the Incremental Term A Loans are due commencing in the third quarter of 2019 as follows: the third quarter of 2019 through the second quarter of 2020 – 0.625% per quarter; the third quarter of 2020 through the second quarter of 2022 – 1.25% per quarter; the third quarter of 2022 through the second quarter of 2023 – 1.875% per quarter; and the third quarter of 2023 through the fourth quarter of 2023 – 2.5% per quarter. The remaining outstanding principal balance, including any amounts outstanding under the Revolving Facility, is due on January 15, 2024.
The obligations under the 2019 Senior Credit Facility are secured by substantially all of the personal property and real property of the Company, subject to certain agreed exceptions. The 2019 Senior Credit Facility provides for events of default customary for credit facilities of this type, including non-payment defaults on other debt, misrepresentation, breach of covenants, representations and warranties, change of control, and insolvency and bankruptcy. The 2019 Senior Credit Facility contains customary representations, warranties and covenants, including covenants limiting the incurrence of debt, the payment of dividends and repurchase of the Company’s common stock.
Financial covenants as defined in the Agreement are summarized below.
Maximum Net Total Leverage Ratio
: The ratio of our (a) total debt, less unrestricted cash and cash equivalents held in pledged accounts, less cash drawn under the Delayed-Draw Term A Facility held for specified capital projects to (b) Consolidated EBITDA (as defined more specifically below) for the consecutive four fiscal quarters ending as of the calculation date. The maximum allowable net total leverage ratio is provided in the table below.
|
Period
|
|
Ratio
|
|
|
|
|
|
|
|
|
January 15, 2019 through March 30, 2020
|
|
|
3.50 to 1.00
|
|
|
March 31, 2020 through September 29, 2020
|
|
|
3.35 to 1.00
|
|
|
September 30, 2020 through June 29, 2021
|
|
|
3.25 to 1.00
|
|
|
June 30, 2021 through June 29, 2022
|
|
|
3.00 to 1.00
|
|
|
June 30, 2022 and thereafter
|
|
|
2.50 to 1.00
|
|
The actual net total leverage ratio was 2.78 at March 31, 2019.
Fixed Charge Coverage Ratio:
The ratio of our (a) Consolidated EBITDA for the applicable period (as defined below) to (b) (i) the sum of, for the same period, consolidated interest expense, capital expenditures (with certain exceptions), long term indebtedness (with certain exceptions) required to be paid, capital lease obligations required to be paid, restricted payments, cash payments for income taxes, (ii) minus, for the same period, specified capital expenditures. The applicable periods for purposes of calculating this ratio are the fiscal quarter ending March 31, 2019; the two consecutive fiscal quarters ending June 30, 2019; the three consecutive fiscal quarters ending September 30, 2019; and the four consecutive fiscal quarters ending December 31, 2019 and thereafter. The minimum fixed charge coverage ratio is 1.10 to 1.00. The actual fixed charge coverage ratio was 1.28 at March 31, 2019.
Consolidated EBITDA
, as defined in the 2019 Senior Credit Facility, is not a GAAP measure and is defined as consolidated net income attributable to Alaska Communications, plus (to the extent deducted in calculating net income) the sum of:
|
|
●
|
cash and non-cash interest expense;
|
|
|
●
|
depreciation and amortization expense;
|
|
|
●
|
other non-cash charges and expenses, including equity-based compensation expense;
|
|
|
●
|
the write down or write off on any assets, other than accounts receivable;
|
|
|
●
|
subject to limitation, fees, premiums, penalty payments and out-of-pocket transaction costs incurred in connection with the 2019 refinancing transactions;
|
|
|
●
|
non-cash cost of goods sold associated with certain projects;
|
|
|
●
|
subject to limitation, unusual, non-recurring losses, charges and expenses;
|
|
|
●
|
one-time costs associated with permitted acquisitions;
|
|
|
●
|
cost savings from synergies in connection with permitted acquisitions or dispositions;
|
|
|
●
|
certain costs required to be expensed in connection permitted acquisitions; and
|
|
|
●
|
investment losses of unconsolidated entities.
|
minus (to the extent included in calculating net income) the sum of:
|
|
●
|
unusual, non-recurring gains on permitted sales or dispositions of assets and casualty events;
|
|
|
●
|
cash and non-cash interest income;
|
|
|
●
|
other unusual nonrecurring items;
|
|
|
●
|
the write up of any asset;
|
|
|
●
|
patronage refunds or similar distributions from any lender;
|
|
|
●
|
deferred revenue associated with certain projects; and
|
|
|
●
|
investment income of unconsolidated entities.
|
The Initial Term A Facility, Revolving Facility, Delayed-Draw Facility and Incremental Term A Loans bear interest at LIBOR plus 4.5% per annum.
The weighted interest rate on the 2019 Senior Credit Facility was 6.49% at March, 2019.
As required under the terms of the 2019 Senior Credit Facility and as a component of its cash flow hedging strategy, the Company has entered into an interest rate hedge sufficient to effectively fix or limit the interest rate on borrowings under the 2019 Senior Credit Facility of $90.0 million through June 28, 2019 and will obtain another hedging instrument to be effective subsequent to that date.
All terms are defined in the Agreement. See the “First Amended and Restated Credit Agreement, dated as of January 15, 2019, by and among Alaska Communications, as the borrower, the Company and certain of its direct and indirect subsidiaries, as guarantors, ING Capital LLC, as administrative agent, and the lenders party thereto,” filed as Exhibit 10.1 to the Current Report on Form 8-K filed on January 22, 2019.
As of March 31, 2019, USAC had issued funding commitment letters for all of the Company’s rural health care customer applications for Funding Year 2018 (July 1, 2018 through June 30, 2019). As of the date of this report, the Company’s cost-based rural rates for Funding Year 2019 (July 1, 2019 through June 30, 2020) had not been approved by the FCC. Our accounts receivable balance for rural health care customers, net of amounts reserved, was $5.2 million at March 31, 2019 and $8.1 million at December 31, 2018.
We believe that we will have sufficient cash on hand, cash provided by operations and availability under our 2019 Senior Credit Facility to service our debt and fund our operations, capital expenditures and other obligations over the next twelve months. However, our ability to make such an assessment is dependent upon our future financial performance, which is subject to future economic conditions and to financial, business, regulatory, competitive entry and many other factors, many of which are beyond our control and could impact us during the time period of this assessment. See Item 1A. Risk Factors in Amendment No. 1 on Form 10-K for the year ended December 31, 2018 for further information regarding these risks.
OUTLOOK
We expect to see continued strength in business and wholesale revenues, led by broadband revenue and managed IT services, focused on the larger enterprise and carrier customer segments. These revenue increases are driven by continued demand for broadband as businesses migrate their IT infrastructure to the cloud, deployment of small cell networks, expansion into managed IT services, investments by Federal agencies in long haul broadband infrastructure and continued progress in serving new school districts. We expect the rural health care segment to begin to stabilize in 2019 as a result of program funding increases announced by the FCC in 2018. However, the pricing methodology for funding year 2019 and beyond is uncertain. We expect to see solid performance from our carrier and federal customers as well as opportunities in markets enabled by the North Slope networks. Driven by our network investments in fiber fed WiFi and fixed wireless, we expect to become more competitive serving small business and residential customers, while we focus on improving profitability by enhancing our online and self-serve capabilities. Growth in these areas is expected to be somewhat offset by continued pressure in the rural health care program.
Additionally, we are focused on continued implementation of the CAF II program and expect to meet our obligations for 2019 by providing broadband coverage to an additional 10%, or approximately 3,200, of our target locations by the end of the year.
We also expect continued attention by our Board of Directors on the evaluation of value creating strategic opportunities that address our scale and geographic concentration issues.
LEGAL
We are involved in various claims, legal actions, personnel matters and regulatory proceedings arising in the ordinary course of business and as of March 31, 2019, we have recorded litigation accruals of $1.1 million against certain of those claims and legal actions. Estimates involved in developing these litigation accruals could change as these claims, legal actions and regulatory proceedings progress. See also Part II, Item 1. Legal Proceedings.
E
MPLOYEES
As of March 31, 2019, we employed 575 regular full-time employees, 8 regular part-time employees and 4 temporary employees, compared with 584, 8 and 4, respectively at December 31, 2018. Approximately 53% of our employees are represented by the IBEW. Our Master Collective Bargaining Agreement (“CBA”) with the IBEW, which is effective through December 31, 2023, governs the terms and conditions of employment for all IBEW represented employees working for us in the state of Alaska. Management considers employee relations to be generally good.
CRITICAL ACCOUNTING POLICIES AND ACCOUNTING ESTIMATES
We have identified certain policies and estimates as critical to our business operations and the understanding of our past or present results of operations. For additional discussion on the application of significant accounting policies, see “Critical Accounting Policies and Estimates” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2018. These policies and estimates are considered critical because they had a material impact, or have the potential to have a material impact, on our financial statements and because they require significant judgments, assumptions or estimates.
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Among the significant estimates affecting the financial statements are those related to the realizable value of accounts receivable and long-lived assets, the value of derivative instruments, deferred capacity revenue, legal contingencies, stock-based compensation and income taxes. As future events and their effects cannot be determined with precision, actual results may differ significantly from those estimates. Changes in those estimates will be reflected in the financial statements of future periods.
New Accounting Pronouncements
See Note 1 “
Summary of Significant Accounting Polices
” to the condensed consolidated financial statements for a description of recently adopted accounting pronouncements and recently issued pronouncements not yet adopted.