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Executives

Melissa Fouts -- Director, Internal Reporting

Liane Pelletier -- Chairman, President and CEO

David Wilson -- SVP, Treasurer and CFO

Analysts

David Barden – Banc of America Securities

Jason Frazier – Raymond James

Dave Coleman – RBC Capital Markets

Alaska Communications Systems Group, Inc. (ALSK) Q3 2008 Earnings Call Transcript October 30, 2008 5:00 PM ET

Operator

Good afternoon ladies and gentlemen. Thank you for standing by. Welcome to the Alaska Communications Systems Third Quarter 2008 Conference Call. During today’s presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for questions.

(Operator instructions)

This conference call is being recorded today Thursday, October 30th of 2008. I would now like to turn the conference over to Melissa Fouts with Alaska Communications Systems. Please go ahead ma’am.

Melissa Fouts

Good afternoon and welcome to the Alaska Communications Systems third quarter 2008 conference call. With me today are Liane Pelletier, President, Chief Executive Officer, and Chairman of ACS, David Wilson, Chief Financial Officer, Anand Vadapalli, Senior Vice President for Network and Information Technology, and Leonard Steinberg, General Counsel.

During this call, company participants will make forward-looking statements as defined under U.S. Securities 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 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. We discuss these factors in our SEC filings.

Lastly, any non-GAAP measurements referred to during this call have been reconciled to their nearest GAAP measure. You may find these reconciliations in today’s press release and our SEC filings on our investor website at www.alsk.com. We will begin the call with Liane discussing the Alaskan economy and our enterprising wireless businesses. Then, David will review the details of our operating and financial performance and will discuss the company’s position vis-a-vis the capital markets. Liane, will then open the call for questions.

With that, I would like to turn the call over to Liane. Liane?

Liane Pelletier

Thank you, Melissa. Welcome and thank you all for participating today. It’s an understatement to say that financial markets and many economies around the world have been hit hard with our second quarter earnings call but Alaska had been somewhat sheltered and should weather the impacts better than most states. For example in housing, Alaska lenders did not proudly participate in subprime lending practices and their current housing market logistics indicates a stable outlook with single-family home medium prices up slightly from the prior year and the annual foreclosure rate of less than 1%, the second lowest in the nation.

In the private sector, oil and gas dominates all other industries and contribute to full third of the state growth products. Even though the price of oil had recently dropped, it remains at historic high and investment continues to grow. With energy independence and diversification on the national agenda, decision makers understand that Alaska can play a part in delivering on that policy. And as discussed in our prior calls, significant start up efforts are under way in Alaska that will hopefully concluded the construction of a $30 billion GAAP pipeline.

Alaska’s state budget remains at surplus even at today’s lower prices, and that’s relevant because oil royalties contribute nearly 90% of the state’s revenues. As for employment, Alaska is enjoying its 21st consecutive year of statewide job growth and range from the top cortile [ph] of phase in terms of year-over-year job growth. As for income and spending, Alaska insists benefited from record permanent fund dividends and a separate energy rebate valued together at $3,300 per residence or $2 billion overall.

Against this economic backdrop, we continue to transform ACS to capitalize on telecommunications growth opportunities. And in our assessment, both strategic growth areas are wireless and enterprise data. For the past quarter, ACS grew revenues overall with wireless and enterprising accounting for 48% of the totals. We set ambitious goals for the enterprise segment and we’re on tract to meet them all.

First, the commercial launch of AKORN, the new ACS submarine fiber optic cable to the lower 48. The project is on track, both schedule and budget; second, the closed of the Crest acquisition. We closed the transaction earlier today and we are moving promptly into merger integration; third, generating contribution dollars from growth in the enterprise segment sufficient to cover the $9 million of incremental operating and finance carry-cost of the AKORN and Crest investments. Enterprise revenues grew 13% sequentially and 37% annually. And with that, we have ended the quarter substantially covering the $9 million target.

We’ve also set ambitious goals for the wireless business and we’re on track there too. During the quarter, we completed our upgrade to EV-DO Rev A technology keeping ACS in a position of delivering the fastest data seed in Alaska. Much discussed all year, we proactively lowered prices to match AT&T and then proactively converted our customer base so we could neutralize much of AT&T impact in the Alaska market as we exited the third quarter and the impact of re-pricing is substantially behind us.

In the quarter, we again brought the mostly highly valued subscribers into the fold with unlimited voice and data card users comprising over 30% of total gross assets. Our postpaid customer mix is also best-in-class at 93%, and we were finally able to include BlackBerry in the ACS lineup launching this dominant product through our channels starting in mid September, and we look forward to the ARPU benefits flowing into ACS results over time.

In summary, we’re executing well to meet the commitment we set for ourselves in the enterprise and wireless growth segments. And while Alaska will no doubt feel some effects from the world’s financial and economic turbulence, the state is comparatively well-positioned and the ACS network is well suited to serve the state’s future telecommunication needs.

I will now ask David to present third quarter operating and financial results as well as a review of the health of our balance sheet.

David Wilson

Thank you, Liane. I will start with the quarterly operating details for wireless. Demands for our wireless products remain grows up from the quarter with gross at 60% higher than prior year as we continue to attract the highest quality subscribers in the market with over 30% signing up for data card or unlimited voice services. While demands for our services remain strong, net addition where impacted by higher [ph] churn, which increased 30 basis points sequentially to 1.9% driven in part by major deployment, accounting for almost half of the increase and the launch of the 3G iPhones, in line with natural carriers who experienced an increased insurance following its introduction to the market.

Wireless retention has been and will be a major part of ACS and a comprehensive set of retention programs are intended to (inaudible) drivers in Alaska. Wireless ARPU increased sequentially to $61.07 from $60.80. The impact to the price matching strategy is largely behind us and is reflected in our third quarter operation. Looking at the components of ARPU, data ARPU was $5.02 up 9% sequentially and 65% annually, while voice was $45.72 in line with the prior quarter and down 9% versus the prior year.

Now on to wireline. Local retail lines declined 6% on a treading 12-month basis primarily in the consumer segments. While DSL subscribers declined moderately by 300,000 to 47,600. Wireline performance was impacted by mostly deployment in September adding 20 basis points to our treading 12-month rate of retail lineup and offsetting DSL gains in other markets.

Now, we’ll review the third quarter financial results. Total revenues for the quarter, were $101.3 million up from $100.6 million in the prior year obtained in wireless enterprise offsetting declines in retail wirelines and as such [ph]. As Liane noted, wireless enterprise revenue, now account for 48% of total revenue. Wireless revenue was $39.2 million, up 5.6% of the prior year revenue of $37.2 million. Wireless revenue benefited from a 6.3% annual increase in average retail subscriber, at 65% increase in data ARPU, at 16% increased in foreign roaming of $7.3 million, which collectively more than offset the re-pricing of voice plans financial rights. Wireline revenue increased moderately by $1.3 million to $62.1 million. Retail revenue was $23.6 million declined 5% from the prior year which declined primarily attributable to low-recurring CPE sales. Wholesale revenue declined 12.5% to $5.2 million as line use off net. Access revenue declined $1.9 million with 7.4% for the prior year benefiting from $3.3 million out of period revenue compared to a current year benefits of only $1.4 million. Enterprise revenue was up $2.6 million or 37% to $9.6 million. We are pleased with the results from this segment and we exit of the quarter with business that’s substantially covered the incremental operating and financing costs for AKORN bills and our Crest stocks.

On to EBITDA. The EBITDA was $35.3 million for the quarter, the full [ph] $1.4 million in start-up costs for enterprise business. This is down $2 million from last year, with the decline solely attributable to lower access revenue. Wireless EBITDA margin was 42.8%, compared to 47.4% in the prior year. The low margin is attributed primarily to re-pricing our wireless international rates, increased subsidies for handsets resulting from higher sales volume, an increased expense for back call associated with our expanded wireless footprints. Wireline EBITDA margin was 27.7%, compared to 31.1%. Primary driver to the change include $1.4 million in start-up costs related to our AKORN build, and lower network access revenue for data period settlement of $1.9 million lower from last year.

Net income before tax was $3.8 million, compared to $10.5 million. Net income after tax is $2 million, compared to $10.3 million. The declines reflect start-up costs for the enterprise business, the increases stock base compensation expense, higher non-cash depreciation expense, interest expense from our April 2008 issuance of $125 million convertible notes, and book tax expense this year but not less.

Cash from operations were $28.4 million, compared to $31.3 million in the prior year. Major uses of cash during the quarter include $28.6 million in capital expenditures, including $15.4 million for AKORN build and $9.4 million in dividends.

And now, for our financial guidance where we are reaffirming guidance revenues, which was expected to be in the range of $380 million to $390 million. EBITDA which is expected to be in the range of $128 million to $132 million, including $4 million in start-up costs for our long whole fiber investments. Net cash interest expense of $33 million, and maintenance CapEx of $42 million.

We are increasing our growth CapEx guidance and there are three drivers. One, the AKORN the final milestone in voice was originally expected in Q1 2009 but now expected in Q4 2008, increasing our guidance for the year from $82 million to $92 million. The actual milestone payments will be made in Q1 2009, so this change in the guidance will have no impact to tax growth. Two, ACS agreed to purchase earlier this year $2.6 million in wireless spectrum to (inaudible) the company’s future migration to LTE. The purchase is not expected to close in Q4 2008 rather in early 2009 entry. We will invest $2 million in CapEx in Q4 2008 to second geographically divert fiber out to Anchorage to Fairbanks. It will be operated in the range with the existing Anchorage to Fairbanks fiber and our strategy is to secure this half comes to the fraction of the cost of the new bill.

Before handing the call back to Liane, I’ll review how ACS is positioned from the balance sheet perspective and in light of the tumultuous financial markets. First we have no need to access the capital markets. Closing our $125 million convertible operating in April this year provided that with the necessary funding to complete the AKORN build and to acquire Crest.

We acted the third quarter with total cash deposit of $83.6 million and will full access to $45 million revolver providing more than enough liquidity to complete our long-haul fiber investments. We are well-positioned with regards to debt maturities with no scheduled principal repayments due until February 2012.

Second, we are protected from the impact of widening (inaudible) spread from LIBOR with interest rates to up to the fix rate inflates for 100% of our back term log.

Third, we are well-positioned to debate [ph] our debt covenant with over a full turn of EBITDA headroom [ph] both as our tightened covenant.

Finally, our bank (inaudible) is limited, our revolver and our interest rate and other financial derivatives are backed by J.P. Morgan, Bank of America, CIBC, and Barclay. In summary, we are very well-positioned in this current time and are able to focus our energies on operating our business for maximum returns.

Now back to Liane for closing remarks.

Liane Pelletier

Thank you, David. To summarize, in this quarter, we continue to execute well, deliver on our commitments and generate growth especially in the most strategic areas of enterprise and wireless. We look forward to sharing progress on the fourth quarter call and to provide further insight into an update on the Alaska economy. While there’s likely to be much change to absorb nationally and locally between now and then, we will keep ourselves focused on execution. That’s the only way to continue the track record that this team has established.

And to that point, I’d like to share the addition of three new vice presidents to the leadership team at ACS, each bringing expertise, energy and track records of their own. They are Russell Girten, to drive information technology and process transformation; Mike Todd, to drive engineering; and Donn Wilmott, to drive business sales and service; and I’d like to thank David Eisenberg, who contributed to the company’s transformation over the last five years and as a member of the Senior Executive team and who will retire from ACS at the end of this month.

With that, I’d like to open up the call for questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of David Barden with Banc of America Securities. Please go ahead.

David Barden – Banc of America Securities

Hey, guys. Thanks for taking the question. I got a couple if I could. First, maybe Liane, it would – obviously, these are different times than we’ve been in before. It might be helpful for people to hear what your commitment level is at this juncture still to the dividend payout ratio and the maintenance of that policy as a go-forward strategic comparative for the business. Second, if you guys could talk a little bit about one of the aspects of dividend setting in the go-forward ’09 period will be very much centered on the AKORN and Crest projects. How do you think one should think about those businesses given the economic situation and have your expectations with respect to the market opportunity, maybe, come in a bit in the context of what you’re seeing going on around us today? And then the last, if I could. David, can you just go back and just revisit some of those numbers that you gave about what you think the impact this quarter was from the deployments that happened? Thank you very much.

Liane Pelletier

Thanks, David. I will take those in the order you shared them. So I hope you were as pleased to hear as we were to report our track record of execution. We’ve laid out commitments and every one of those we feel great about having delivered on. In all of those work very commonly communicated as prerequisite for our change in dividends looking forward, every board, and ours is no different, has the responsibility to consider total market condition as they undertake their annual review of the dividend. I, and I think everyone on this call, is in no position to predict what’s going to happen over the next couple of months as we take that all in, but I have no announcement about our change in our dividend payout ratio; but every board’s duty is to look at those things that can be controlled, those things in the company’s hands and I feel great about what we’ve been delivering, as well as the things that we can’t control. And again, it’s not helpful for me to forecast what that combination might look like, but I have no announcement today on anything to that but just know that we’re all going to stay tuned in this crazy environment.

I’m going to pick up the next one as well, which is our enterprise business. It’s absolutely something that we also feel good about. We obviously posted night sequential and annual growth in exactly the customer segments that take good use of the assets. It’s not only the wet assets at AKORN and Crest but the entire portfolio of reformed local plans that we’ve made more useful to data users in the business phase. We know that the stuff that we built is very appealing to those customers. And in fact, because of the way we built those data network capabilities, the customers we’re meeting with are finding that they can get even more value for the same dollars because they are moving off of legacy technologies, sometimes point-to-point technologies, etc. So I have nothing to share today that gives us any pause about the expectations of growth we see in the enterprise phase and we’re happy with the picture we see.

At this point, I’ll hand it off to the military side.

David Wilson

Sure. So, David, in terms of deployment, they came late in the quarter. And wireless, we think, on the low end; probably got 700 wireless losses due to VAT; and then for DSL, certainly offset any gains we had elsewhere, so 400 or more DSL losses attributable to that. Just to give you a magnitude, it’s about 4,000 troops who left the state and often has families have moved with them too; so for the market outside, that has a significant impact.

David Barden – Banc of America Securities

And thanks for those comments, guys. Liane, if I could just follow up on that, obviously, anything can happen, comment on the dividends. If things didn’t change from the way they are today, what would you recommend to the board to do?

Liane Pelletier

I don’t even have a crystal ball, David. I feel like everyday is another turn on the rollercoaster, so I don’t feel like I’ve seen enough recent history that gives me a sense that we are in a stable environment so I don’t know how else to respond to that. It does feel like a rollercoaster even from here.

David Barden – Banc of America Securities

Okay. Thanks, guys.

Operator

Thank you. Our next question comes from the line of Jason Frazier with Raymond James. Please go ahead.

Jason Frazier – Raymond James

Hi, good afternoon. Just one real quick question here. This is regarding the Rev A deployment. What kind of take rate have you been seeing on the wireless AirCards, specifically after the deployment and the percentage terms of the grade if you could? Thanks.

Liane Pelletier

Thanks for the question. It’s about – we described our growth ad lift year-over-year was about some 16% and about 20% – I’m sorry.

David Wilson

Do you think that that would’ve been data products?

Liana Pelletier

Right.

Jason Frazier – Raymond James

Okay. And then just after the Rev A. Just the difference before and after on the data cards; that’ll be great.

Liane Pelletier

I’m so sorry, I didn’t understand. The –?

Jason Frazier – Raymond James

The data cards. Yes, I’m after the deployment on Rev A. Just the data cards.

Liane Pelletier

We actually had strength in the data card on Rev 0 sales.

Jason Frazier – Raymond James

Okay.

Liane Pelletier

And then as we moved the cell technology to Rev A, we changed out the device type to move to Rev A and it was equally strong; so I would say that the before and after was that of remarkable difference. It’s a really strong selling product for the company overall.

Jason Frazier – Raymond James

All right, great. Thank you.

Liane Pelletier

Thanks.

Operator

Thank you. (Operator instructions) And our next question comes from the line of Dave Coleman with RBC Capital Markets. Please go ahead.

Dave Coleman – RBC Capital Markets

Thank you. Just a couple of questions. I just want to confirm that in the third quarter, I believe you said there were about $1.4 million of one-time settlement revenues in the network access piece. Is that correct?

David Wilson

That’s correct, yes, Dave.

Dave Coleman – RBC Capital Markets

Okay. And then I know you just launched the, I think, two Blackberry handsets late in the third quarter. Can you talk about ARPU trends among Blackberry subscribers in the percentage of handsets sold, I guess, sans those have been introduced that are Blackberries?

Liane Pelletier

Yes, I’ll be happy to give you a little bit of color about it going to the last two weeks of the quarter that we launched the curve in deferral. We love the ARPU effect of those because as you know, there – our pricing finance are, just like you, you would see in the lower 48; so it’s a nice, healthy voice and then the 40 or 45 on the data ARPU side. We’re not going to probably be reporting percent of sales under the Blackberry piece, but we’ll show more over time and we’re excited to have it in the market.

David Wilson

I think it’s fair to say that obviously, given that it came in very late in the quarter with the ARPU benefits had come; and again, it’s an important part of the components as they dropped to. That’s what they’ve been doing below 48 and at a level significantly higher than ours, so it’s a big opportunity for us to continue to drive. If they drop, they drop.

Dave Coleman – RBC Capital Markets

You have a push towards selling more towards enterprises. Is there a way to leverage the Blackberry product with the growth in the enterprise business?

Liane Pelletier

You bet.

Dave Coleman – RBC Capital Markets

Okay. And then two final questions. Completed the Crest acquisition, are there any synergies, expense energies with that acquisition? And then anything you can share as far as inter-carrier compensation in the reform proposals for DC?

David Wilson

In terms of expense energies, that is when we talked about the $9 million cash carried cap. There was $1 million cap synergy factored into that; very obtainable, straightforward, no risk in terms of obtaining that, and that was really just running it in conjunction with AKORN. So, again, that factored in and that’s in effect an immediate benefit if we just have left cost to pick up on AKORN side as it turns out. I’ve landed concern to give you thought unless you have anything more effect on the inter-carrier comp that landed to definitely address any question that you have.

Leonard Steinberg

Just on your current costs we’ve all been watching. As you know, Chairman Martin’s proposal is not public. And in fact, the other four SEC commissioners have only had it for a few weeks themselves. We understand that if it remains fluid, and it’s still being modified before next week’s meeting and we’re watching it very carefully and we’ve got some early indications that it may include some provisions that are helpful and some that are not, but we’ll just have to wait and see, as well as everybody else in the country as what this final order is.

Dave Coleman – RBC Capital Markets

Just a follow up on that. Can you say how much terminating access revenue, either as a dollar amount or percentage in total revenue that you recognize in the third quarter?

David Wilson

Yes. I think there’s an important distinction, Dave, and we already returned base as opposed to price cap; so we recover on that basis, so I think everything seems to be currently would be more impactful to people with a price cap as opposed to rate of returns.

Dave Coleman – RBC Capital Markets

That’s right. All right, great. Thank you very much.

Operator

Thank you. (Operator instructions) One moment please. And we do have a follow-up coming from the line of David Barden with the Banc of America Securities. Please go ahead.

David Barden – Banc of America Securities

Hey, guys. Sorry, couldn’t let you off that easy as long as there is an opening. Just the last piece, obviously, the thing we’ve been talking a lot about this week has been expectations for next week and what the FCC might do or not do. Could you lay out how you think the basic understanding is in the market today about access rate reform and CETC reform might conceivably impact the ACS? Appreciate it. Thank you.

Liane Pelletier

Hey, Dave. Let me take a shot at that and I invite my colleagues to add any additional color. There definitely is a lot of speculation, I guess, I would say. We don’t know what the commission’s going to be looking at in total until the fourth, so we remain on the sidelines. We definitely have a few things we can say to remain focused about our company. Number one, we are different than many of our peers in terms of percent of revenue, percent of EBITDA associated with that thing called network access, and the subsidy dollars that are most commonly discussed on the wireline side; and number two, Alaska as a market is different and I think it is well understood by industry experts in terms of the operating costs of running telecommunications network here and frankly, in Hawaii, etc. In fact, we saw that curve out for tribal lands across the country, affect how people recently put in new frameworks for CETC and that’s for us on the wireline’s side are saying, “I have no reason to believe that those curve outs will be unwound, but I would be sitting there like everyone else on the fort just to see what happens in that overall review by the commission;” but I think there are a couple of things in there to help remind everybody about how ACS is quite a bit different than some of the peers.

David Barden – Banc of America Securities

Great, thanks guys.

Operator

Thank you. And there are no further questions. Ms. Pelletier, I’ll turn it back to you for closing comments.

Liane Pelletier

Well, thank you very much for your brief attention today. We very much look forward to a stabilizing world and we’re going to stay focused on executing, and we look forward to sharing our results with you on the fourth quarter call. Have a good day.

Operator

Thank you. Ladies and gentlemen that will conclude today’s teleconference. We do thank you again for your participation. And at this time, you may disconnect. Have a nice day.

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