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Alaska Communications Systems Group Inc. (NASDAQ:ALSK)

Q4 2008 Earnings Call

March 5, 2009 5:00 pm ET

Executives

David Wilson – Chief Financial Officer

Liane J. Pelletier – President, Chief Executive Officer & Chairman

Leonard A. Steinberg – General Counsel

Analysts

[Steven Douglas] - Bank of America-Merrill Lynch

Frank Louthan - Raymond James

David Coleman - RBC Capital Markets

Christopher King - Stifel Nicolaus & Company, Inc.

Operator

Good afternoon ladies and gentlemen. Thank you for standing by. Welcome to the Alaska Communications Systems fourth quarter 2008 conference call. (Operator Instructions) This conference is being recorded today Thursday, March 5 of 2009.

At this time I’d like to turn the conference over to Mr. David Wilson, Chief Financial Officer. Please go ahead sir.

David Wilson

Thank you. Good afternoon and welcome to the Alaska Communications Systems fourth quarter and year end 2008 conference call. With me today are Liane Pelletier, President, CEO and Chairman of ACS and Leonard Steinberg, General Counsel.

During this call the company’s participants will make forward-looking statements as defined under U.S. Securities law. 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 measure referred to during this call has been reconciled to the nearest GAAP measure. You may find these reconciliations today’s press release, in our SEC filings on our Investor website at www.alsk.com.

We will begin with Liane discussing our enterprise and wireless business. Then I will review the details of our operating and financial performance. Liane will then open the call for questions. With that I’d like to turn the call over to Liane. Liane.

Liane J. Pelletier

Thank you David. Welcome and thank you all for participating today. We’ve closed 2008 with revenues and EBITDA meeting guidance that we shared at this time last year and we closed the year with the expected shifts in the business taking a firm hold.

Enterprise and wireless comprised 46% of total revenues, showing that the ACS transformation is well underway. The transformation positions ACS with differentiated solutions in the higher demand and higher quality segments in the telecom space. With many enterprise assets established, ACS can present a competitive alternative to the sophisticated buyers who need in-state and out-of-state data network solutions.

In the enterprise segment we reached several key milestones since our last call; successful testing of the AKORN cable which will be ready for turn up by the end of this month; capacity upgrade of the Crest Northstar cable to OC-192 increments that means these two fibers can be operated as a [ring] providing the most reliable transport to and from Alaska; integration of the Crest operation into ACS; development of the second Anchorage to Fairbanks fiber; and booked revenues sufficient to cover the cash carry cost of AKORN and Northstar.

Further in this quarter and not yet reflected in enterprise revenues are new contracts from two lower 48 carriers that wanted [node] in Alaska to connect their national accounts MPLS networks to the same technology in Alaska.

In the wireless segment a major goal is to drive data revenues. On that front our progress is good. The Blackberry launch has been well received by the market and our existing customer base. Existing customers are upgrading at a very healthy rate and that brings a meaningful ARPU lift for us. Laptop aircards were again close to 20% of total activations. And texting devices like the LG 260 and the Kyocera Lingo loved by teens were among the most popular sales in the quarter.

These together contributed to a 22% sequential gain in data ARPU, $6.10 at the end of the year.

While we enjoyed [concernible] success in driving data adoption and revenues, a dip in retail demand hit us starting in November. So while we had an improvement in churn in Q4 versus Q3, we ultimately saw a decline of about 700 subscribers. Lower churn was not able to mitigate the slowdown in gross adds.

And our experience so far this year followed some of the same things, but with more non-pay as a reason for disconnection. And this of course is a result of the softening economy. So metrics are softer than we would like but we are focused on making the most of good quality growth and our plans are going to keep us on that course. We are relentless about defending our network quality as measured by independent drive tests, and we continue to allocate a significant portion of our CapEx to extend and enhance our 3d EVDO Rev A footprint which will support the growth of mobile data on the ACS network.

The pursuit of high quality growth and revenue has been a hallmark for the ACS team over the last five years. Our pursuit of process improvement and cost containment has also been a hallmark. By persistently adhering to these strategies, we’ve grown revenues each year while reducing headcount.

In the most recent quarter as the latest example, we gained meaningful operating leverage by absorbing 14 employees associated with the Crest operation while also reducing overall headcount by 20.

I’ll now ask David to present fourth quarter operating and financial results, as well as review our liquidity position. David.

David Wilson

Thank you Liane. I’ll start with the quarterly operating details for wireless. While churn improved sequentially by 10 basis points to 1.8% our business is experiencing the impacts to this economy with gross adds for the quarter falling by 29% sequentially and 18% annually, leading to a net subscriber loss of 700. As Liane noted, the impact of soft demand has been offset in part by our ability to continue to attract high quality subscribers to our network, with the ARPU of activations outstripping that of deactivations by over 3%.

On to wire line, with performance consistent with the prior quarter the local retail lines declining 6% on a trailing 12 month basis, with losses again concentrated in consumer segments, the DSL subscribers remaining flat at 47,600.

Now I’ll review fourth quarter financial results. Total revenues for the quarter were $97.1 million, down from $99.1 million in the prior year which benefited from $4.9 million in out-of-period network access revenue. The mix of revenue continued to sweeten with wireless and enterprise accounting for 48% of the total, up from 43% in the prior period.

Wireless revenue was $35.4 million, was in line with prior year revenue of $35.1 million, with a 3.4% increase in average subscribers offset by a 4.9% decline in ARPU. Data ARPU is an ever more important revenue component, increasing by $2.84 or 87% over the prior period to $6.10, mitigating in part a $4.85 decline in voice ARPU driven by proactive measures taken to match ACS voice plans to those of AT&T. Foreign roaming revenue of $3.9 million was in line with the prior year total of $4 million.

Wire line revenue decreased by $2.3 million to $61.8 million with gains in enterprise offsetting in part high levels of out-of-period network access revenue in the prior year. Enterprise revenue was up $3.3 million or 42% to $11.1 million with revenue from the acquired Crest book of business accounting for $1.8 million of the gain.

In line with our expectations, we ended the year with booked business more than covering the incremental operating and financing costs of our AKORN build and Crest buy. Retail revenue of $23.6 million was broadly in line with the prior year totals of $24 million, with gains in Internet and business [inaudible] sales offsetting structural pressure on consumer voice services.

Wholesale revenues declined 16% to $4.7 million as lines moved off net. Access revenue declined $4.3 million or 16.1% with the prior year benefiting from $4.9 million and out-of-period revenue compared to a current year benefit of only $300 thousand.

On to EBITDA. EBITDA was $30.8 million in the quarter before $1.4 million in start up costs for enterprise business. This is down $3.2 million from last year with $4.3 million in declines from network access revenue offset by gains in enterprise. Wireless EBITDA margins were 41.7% up from 41.3% in the prior year with tight expense management in the quarter and a lower level of gross adds offset the impact of re-pricing voice plans to national rates.

Wire line EBITDA margin was 23.8% compared to 30.5%. Primary drivers of the change include $1.4 million in start up costs relating to our AKORN build and lower network access revenue. Net loss before tax was $32 million compared to net income in the prior period of $8.9 million. The decline reflects an impairment charge for wire line goodwill of $29.6 million driven by adverse equity market conditions, lower out-of-period network access revenue, start up costs for the enterprise business, increased stock-based compensation expense, higher known cash depreciation expense, and interest expense from the April 2008 issuance of $125 million convertible note.

Cash from operations was $26.4 million, in line with $26.6 million in the prior year. Major uses of cash during the quarter included $60.7 million to acquire Crest, $20.7 million in capital expenditures including $9.4 million for AKORN build, and $9.4 million in dividends.

And now the 2009 financial guidance. Revenues and EBITDA for the full year 2009 are expected to exceed 2008 levels. Revenue expectations are based on the continued adoption of FAS 71, accounting for the effects of certain types of regulations. Should we roll off of FAS 71 part way through the year, certain inter-company revenues would be completely eliminated on consolidation, which would reduce reported revenues but have no impact on EBITDA or cash flow.

Net cash interest expense is expected to be approximately $36 million. ACS expects maintenance capital expenditures to be in line with 2008 levels, around $40 million with growth CapEx limited to $60 million to complete AKORN, the upgrade of Crest to OC-192 increments, and our geographically diverse fiber between Anchorage and Fairbanks. Our CapEx guidance excludes [inaudible].

Our dividend payout ratio is expected to be below our long term payout target of 70, 75%. Our dividend payout ratio is pro forma for working capital movement and residual growth CapEx investments.

ACS expects to incur certain costs during 2008 which are outside of our guidance. These include depreciation expense of approximately $80 million; stock-based compensation expense of approximately $7 million; and non-cash interest expense of $9 million. Non-cash interest expense reflects the adoption of ACP 14-1, effective January 1, 2009.

Before handing the call back to Liane, let me reaffirm how ACS is positioned from a balance sheet perspective in light of the choppy financial market. First we have no need to access the capital market. We exited the fourth quarter with over $40 million of liquidity available through cash on hand and our revolver, providing more than enough liquidity to fund the $60 million needed for the final month of payments for AKORN and completing our in-state fiber build.

We have significant run way with our debt maturities with no scheduled principal repayments due until February, 2012.

Second, we exited the year with close to a full turn of EBITDA headroom versus our tightest covenant. Third, we have benefited from bonus depreciation available under the Economic Stimulus Act of 2008 and now do not expect to pay full cash taxes until 2015.

In summary, we remain well positioned from a liquidity standpoint. We expect to accumulate cash as we leverage our fiber investments, generate returns from enterprise customers, and as our cash outflows to investments decline sharply with our recurring maintenance CapEx program potentially covering future needs. And as we accumulate cash, de-leveraging will be an increasingly important priority.

Now back to Liane for closing remarks.

Liane J. Pelletier

Thank you David. In wrapping, we manage the business for the long run and we’re staying focused on those things we can control. We’re clearly taken aback by the market performance of all high yielding stocks of the past few weeks, and we’re digesting how to best reward our shareholders. I can reiterate that the cash flow supporting the dividend of $0.86 is secure and that the dividend will be maintained at this level as long as it continues to maximize shareholder value.

One final note I’d like to share that David Wilson will be presenting at Raymond James 30th Annual Institutional Conference in Orlando on March 11.

Operator, let’s open the call for questions right now.

Question-and-Answer Session

Operator

Thank you ma’am. (Operator Instructions) Your first question comes from [Steven Douglas] - Bank of America-Merrill Lynch.

Steven Douglas - Bank of America-Merrill Lynch

Number one, can you just remind us what the internal criteria that you guys go through when you’re looking at dividends and whether or not to grow it? And number two, I guess do you have the number for foreign roaming revenue in the quarter and what is your outlook for cruise ship volumes given the current unemployment?

David Wilson

I’ll take the foreign roaming one quickly. We did $3.9 million of roaming revenue in the quarter. With regards to cruise ship volumes, watching it closely. The good news on that front is while consumer spending may be soft as a cruise ship typically priced to fill, so you’re certainly seeing deep discounts in terms of the costs coming from Alaska this year versus last year.

In terms of the dividend increase clearly it’s a long term commitment that you make. As we look at how markets are currently trading, there’s certainly more thought that needs to occur in terms of understanding whether a dividend increase is the most appropriate way to reward shareholders. So we’re certainly watching the markets closely, so a combination of markets – shareholders being rewarded for the increase and also just long term prospects, too.

Operator

Your next question comes from Frank Louthan - Raymond James.

Frank Louthan - Raymond James

Can you give us an idea of what the value is of those two contracts that you got from the lower 48 carriers? Sort of a ballpark on an annual basis. And then what can you expect on the gross add front? How are you going to try and reverse that trend? And should we be modeling a little bit more handset subsidy or some re-pricing action? How should we think about that? And can you walk us through the cash interest expense and why that’s increasing over year-over-year? Thanks.

Liane J. Pelletier

Frank, I’ll start with the first couple and then maybe David can pick up with the cash interest comments. It’s not smart for us to report the revenue values for those nodes. I think I can just help remind folks about the strategic of it is to carriers who serve accounts in the lower 48 on an MPLS footprint and to be able to connect that seamlessly throughout all locations including those in Alaska is the strategic rationale for placing them here. We’re excited to be able to do that and to leverage the in-state data networks we have. But it’s just not prudent for me to comment and give you something that’s forecasting and I hope you understand that for your model’s sake.

Frank Louthan - Raymond James

Were these existing contracts or it this sort of net new demand that you’re picking up?

Liane J. Pelletier

It’s net new demand. Did you hear me?

Frank Louthan - Raymond James

Yes. Thank you.

Liane J. Pelletier

On the gross add front you can imagine we are extremely focused on the right formulation for that and again for probably smart, competitive reasons I’m not going to lay out what our play book is, but you can count on us to do a couple things. We are going to manage this like owners as we are and keep our high credit standards in place because I don’t want us to sort of live through a bubble where things happen to us afterwards.

But there’s still a lot of good data demand out there and we are recognized as the network provider in the state that can deliver that high value. Different segments have different plays and we’re going to be moving through that and examining all the dials that you mentioned and others to try to tap into what gross adds are out there. So maybe there’s some follow up questions. I think you can count on us sort of looking at all those dials, but we’re not going to do it in pushing ourselves into a situation where we’re not really serving creditworthy customers because that’s not a good place for any carrier to be over the long haul.

There are some news items that you probably track in the states. There have been some cutbacks on employment in some of the more material firms in the states. Some of the governments, local and state, are putting hiring freezes on. I think everybody’s trying to stay very optimistic. It’s a great state in which to operate. There’s a lot of really strong fundamentals and projects that we know are going to take place but it’s not a normal year and we’re going to be finding new ways I think to go capture the right demand for ACS.

David Wilson

And in terms of cash interest, Frank, a couple of things are in play. Firstly there was the convertibles in place for the full 12 months as opposed to close to 9 months last year. And secondly in terms of cash interest, we had significant cash on hand to (a) fund AKORN; (b) fund the acquisition of Crest; and (c) we had the proceeds from the convertible sitting in a restricted account where we actually gained from the interest for a period of last year, too. So it’s two things, lower cash interest and the convertible being placed at the full year.

Operator

Your next question comes from David Coleman - RBC Capital Markets.

David Coleman - RBC Capital Markets

Just going back to the earlier question on the gross add, was the weakness during the quarter was that on the post-pay or prepay side or was there really any difference between the two?

Liane J. Pelletier

I can take that. It was on the post-paid side and we had some gross on the prepaid side. And you know we had I think what a lot of the retailers saw in starting in November a very different performance in terms of traffic into the stores and so it’s just really important to sort of reiterate, it really was a gross demand issue as opposed to a churn issue. And we’re trying to again find that path for the demand that’s available in the market and apply the ACS capabilities into it. And it’s going to probably continue to be a data rich user base that we’re going to try to go pursue. But the issue was greater more on the post-paid. We saw some lift on prepaid.

David Coleman - RBC Capital Markets

When you underwrote the AKORN project and sort of the criteria before revisiting the dividend that you want to build a book of business on that network before, you know, revisiting the dividend. Obviously the market is rewarding high dividend or dividend paying stocks differently now than in the past. Sort of ignoring that, can you talk about the book of business on the AKORN? Where it is versus your expectations when you underwrote that project and if you’re seeing strength among carriers for enterprises or weakness among the two?

David Wilson

Sure. I’ll take that Dave. So in terms of where we are, pretty much on track for the full year, albeit there were certain things that were delayed earlier in the year. So I think we look at it from a budget standpoint, maybe change it in terms of mix but that’s part of the reason we recovered in terms of hitting the high end of the revised guidance was the nice pick up in terms of enterprise in Q3. So pretty much in line for the full year. In terms of demand, I think the key issue is just the sales cycles involved. So again we’re very active, we’re very engaged. We’re pleased with the announcement that we’ve made today, but as you build up a book of business timing is uncertain. So you know we just need to think through and we need to be cautious this year because there are many things that are outside of our control.

David Coleman - RBC Capital Markets

Liane you mentioned one of the priorities for 2009 being de-leveraging the balance sheet. Can you talk about your thoughts on buying back the converts at the currently I guess depressed levels? And just wondering if you’re able to tender for them or buy them back under your current back agreements.

David Wilson

Yes, so as we get through the completion of AKORN which will happen sort of semi-final payments will be done by the end of – [inaudible] the second quarter of this year and then as we look at the excess cash given we’re not paying out 100%, de-leveraging will be a focus. And clearly when we look at the opportunity to buy down the convertibles which I think as of yesterday we’re trading about $0.65 on the dollar, it’s a pretty tangible and meaningful opportunity for shareholders to clear that debt off given it’s probably yielding about 80% through maturity. So yes, that’s an increasingly important focus and a good opportunity for us.

In terms of restrictions, we have [RP] basket with our term loans. We have the ability to use our excess cash generated to buy down debt.

Operator

Your next question comes from Christopher King - Stifel Nicolaus & Company, Inc.

Christopher King - Stifel Nicolaus & Company, Inc.

First of all, just in terms of running through your guidance for 2009, just trying to back in what that would imply for wire line margins going into 2009 which did bounce around a little bit I guess during 2008. Just was wondering if you could provide any color for us there in terms of what your assumptions may or may not be for wire line margins.

And then secondly, just was curious with respect to our hearing that there may be some movement in Washington on the tribal lands issue related to your CETC revenue. Just was wondering if you were hearing the same things or whether you could comment on anything that’s taken place in Washington on that front.

David Wilson

Yes. So Chris in terms of wire line margins, you should definitely expect them to bounce back from the level in Q4, still carrying a lot of start up costs there. So as we continue to build our enterprise line of business that will help offset some of the structural pressure. So expect wire line EBITDA margins to be in the mid-20s. I think that’s a good way of thinking about that. And I think Leonard’s well placed to address your question regarding tribal lands.

Leonard A. Steinberg

Just real quickly, we’ve also heard some rumors that there’s some action regarding the tribal lands exception and we’re obviously very interested in that, but to our knowledge nothing has yet been announced.

Operator

And at this time we have no further questions in queue. I’d like to turn it back to Ms. Pelletier for any closing remarks.

Liane J. Pelletier

Well, that was short and sweet. Thank you for joining us today and we thank you for your support of ACS and we look forward to communicating with you on our next quarter call.

Operator

Thank you ladies and gentlemen. That does conclude our conference for today. Thank you very much for your participation and for using ACT Teleconference. You may now disconnect.

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Source: Alaska Communications Systems Group Inc. Q4 2008 Earnings Call Transcript

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