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Alltel Corporation (NYSE:AT)

Q3 2006 Earnings Call

October 27, 2006 8:30 am ET

Executives

John Ebner - Senior Vice President, Investor Relations and Treasury

Scott T. Ford - President, Chief Executive Officer, Director

Kevin L. Beebe - Group President, Operations

Sharilyn S. Gasaway - Chief Financial Officer, Executive Vice President

Analysts

Michael Rollins - Citigroup

David Barden - Banc of America Securities

Simon Flannery - Morgan Stanley

Thomas Lee - JP Morgan

Tom Seitz - Lehman Brothers

David Janazzo - Merrill Lynch

Chris Larsen - Credit Suisse

Phil Cusick - Bear Stearns

Jonathan Atkins - RBC Capital Markets

Presentation

Operator

Good morning. My name is Beverly, and I will be your conference operator today. At this time, I would like to welcome everyone to the Alltel third quarter earnings release. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session.

(Operator Instructions)

Mr. Ebner, you may begin your conference.

John Ebner

Thank you. Good morning, everyone. Welcome to Alltel's third quarter 2006 conference call. My name is John Ebner, and I lead the Treasury Investor Relations team for Alltel. Thanks for participating in this discussion of our third quarter results.

Today’s conference call was preceded by our third quarter 2006 earnings release. This press release has been distributed on the newswire and is available from our website at www.alltel.com. Today’s conference call should be considered together with our press release and related financial information.

Today’s discussion includes statements about expected future events and future financial results that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to uncertainties that could cause actual future events or results to differ materially from those expressed in such statements.

Other factors that could cause actual results of Alltel to differ materially, many of which are beyond the control of Alltel, include but are not limited to, the items listed in the Safe Harbor statement contained in our third quarter 2006 earnings press release.

Additionally, today’s discussion will include certain non-GAAP financial measures. Again, we refer you to the investor relations section of our website, where we have posted our earnings release and supplemental materials which contain information regarding these non-GAAP financial measures, including a reconciliation of each such measure to the most directly comparable GAAP measure.

Note that a live webcast of this call is available on our website. To access the call, go to the investor relations section and click on the live webcast link.

As a reminder, after the spin-off of our wireline business, we are reporting our financial results as a single segment, inclusive of the wireless business, the retained communication support business, and corporate expenses. This new, single segment reporting drives changes in our reported CPGA and cash costs per unit statistic. These statistics are adjusted retrospectively in the material provided in today’s information, offering apples-to-apples comparisons.

Also, please note that this third quarter is the first quarter that the revenue and its underlying expense related to providing long-haul transport services to Windstream, is included in our results. It is accounted for prospectively and is not reflected in our restated financials or pro formas. This impacts year-over-year comparisons related to such items as revenue, ARPU, cash costs per unit, OBITDA, and reported margins.

Additionally, we have also provided pro forma results that reflect the wireline spin-off and the Western Wireless merger as if they were completed on January 1, 2005. These pro forma financials are included in supplemental materials provided in the earnings release.

Participating in our earnings discussion this morning are: Scott Ford, Alltel President and Chief Executive Officer; Kevin Beebe, Alltel Group President, Operations; and Sharilyn Gasaway, Alltel's Executive Vice President and Chief Financial Officer.

At the end of the call, we will take a few questions. With that, here is Scott Ford.

Scott T. Ford

Thank you, John. Good morning, everybody. For the third quarter of 2006, Alltel earned $1.04 of fully diluted earnings per share on a GAAP basis, which includes one-time expenses and income from the discontinued operations of Windstream, and several other items which are disclosed in our supplemental material.

From current businesses, we earned fully diluted earnings per share of $0.60 for the quarter, an 11% increase year over year. This quarter, we generated $214 million of equity free cash flow, also an increase of 11% year over year, on growth in total revenues of 12%.

Customer growth obtained during the first three quarters of the year has been beyond our plan. Year-to-date and pro forma for the acquisition of Western Wireless, gross adds increased 154,000, or 7%, and net adds increased 134,000, or 48% year over year. During the quarter, gross and net adds were up year over year 8% and 250% respectively.

This growth, and the associated sales and retention expense, coupled with flattening ARPU, impacts our margins. That said, our 37.2% third quarter OBITDA margin remains one of the best in the industry, and we are confident that the choices we are making strike the right balance between customer growth and long-term profitability.

Kevin and Sharilyn are going to discuss each one of these items in detail in just a few moments.

From a strategic perspective, in the third quarter, we completed the spin-off of Windstream and a $1 billion debt tender. On October 3rd, we expanded our business by acquiring Midwest Wireless, adding 450,000 customers in Iowa, Wisconsin, and Minnesota. Adjusted for the Midwest Wireless acquisition, we ended the quarter with net debt of approximately $900 million, and one of the strongest balance sheets in the industry, and the strongest one in our history.

During the quarter, we also acquired roughly 12.8 million shares, at a cost of $709 million, almost 25% of our $3 billion share repurchase authorization. If, as we expect, we maintain that same pace in the fourth quarter, we would acquire nearly 16 million additional shares, and will have acquired almost 7.5% of our total shares outstanding by year-end through this new program.

Before I turn the call over to Kevin, I would again like to thank the entire Alltel team for its tremendous efforts over the past several quarters. A series of very demanding transactions have been executed seamlessly by a truly exceptional group of people. We still have a tremendous amount of work to do, but the results of these efforts have created options for our shareholders and our employees, and have aligned our daily efforts more directly on our wireless customers’ needs.

We will turn the call over now to Kevin, and then Sharilyn will take you through the financials, and then we will answer a few questions at the end of the call. Kevin.

Kevin L. Beebe

Thanks, Scott, and good morning, everyone. Wireless gross customer additions were 829,000 for the quarter. That is up 14% year over year on an as-reported basis, and 8% pro forma for the former Western Wireless.

Our My Circle service offering, which gives customers the ability to make an unlimited number of calls to the 10 phone numbers they call the most, regardless of network, has been very well-received in the marketplace and helped us achieve net additions of 101,000 for the quarter. That is more than three times last year’s pro forma number.

Post-paid net additions were 75,000 in the quarter, and pre-paid net was 26,000. Our post-paid churn was 1.67%. Our total churn was 2.18% during the quarter. This is the third consecutive quarter that both those metrics have improved year over year.

Our post-paid churn has accelerated its year-over-year improvement each quarter this year, and was down 25 basis points from last year’s third quarter.

Costs per gross add of $337 was 7% lower sequentially. That was due to a few things -- reduced advertising spend, a sequential increase in gross adds, and changes in our commission structure.

Average revenue per customer of $53.76 in the quarter now includes revenues associated with our wholesale transport business. As we covered during our February analyst day, we predicted that our year-over-year retail revenue per unit growth comparisons would level out, and they are in fact down slightly this quarter to $47.66, driven by a decrease in voice ARPU that was somewhat offset by continued growth in data and EPC revenues.

In fact, data revenue per customer was $3.74. That is an increase of 72% year over year, and 15% sequentially, and it is now almost 8% of our retail revenue per unit. ETC revenue was up 34% year over year on a pro-forma basis.

Cash costs per customer, excluding selling and marketing expenses, were $25.37. That is an increase of less than 3% year over year. That increase was largely due to the initial recognition in our financial statements of the costs associated with the new transport revenue received from Windstream.

Turning to our wireless wholesale business, as we discussed last quarter, a combination of moving Sprint and Cingular minutes to lower rates in exchange for long-term agreements, the migration of traffic in the former Western Wireless markets to our agreements and rates, and reduced volumes from Verizon due to some over-build activity in the first-half of this year, resulted in a pro forma year-over-year revenue decrease of 11%.

Before I turn the call over to Sharilyn, I would like to make a few comments about the fourth quarter.

As Scott mentioned, our increase in market share this year has been the highlight of a very busy three quarters. As we begin the most competitive quarter of any year, we plan to continue growing share at the rate we have experienced to date, as long as we believe the long-term benefit outweighs the short-term costs. In other words, quality customer growth that generates solid future value is still our focus.

With that, I would like to turn the call over to Sharilyn who will discuss our financial results. Sharilyn.

Sharilyn S. Gasaway

Thank you, Kevin, and good morning, everyone. In the third quarter, we achieved $1.04 of fully diluted earnings per share on a GAAP basis, which includes $172 million in net income, primarily related to the following significant items, excluded from current businesses:

  • $237 million of income from discontinued operations, primarily related to the gain on the spin-off of the Wireline business and 17 days of income from its operations prior to its divestiture;
  • We also had $51 million of charges associated with both the exchange of debt related to the spin-off of the Wireline business, and a subsequent $1 billion debt tender; and
  • $39 million of wireless amortization expense related to intangible assets recorded in connection with previous wireless acquisitions.

Excluding these items, we achieved $0.60 of fully diluted earnings per share from current businesses on a 387 million share count. Please keep in mind, as Kevin previously mentioned, service revenue, which includes the traditional wireless retail and wireless wholesale roaming revenues, now also includes low margin transport revenue from leasing our fiber backbone to third parties, primarily Windstream.

Product sales now include the traditional equipment sales to end-user wireless customers, as well as equipment sales to Asia.

Also, as mentioned at the beginning of the call, corporate expenses are no longer detailed separately in our financial statements but are included in our single segment results. The inclusion of costs associated with transport revenue and corporate expenses has the effect of increasing our reported cash costs per unit.

The inclusion of revenues and the related margin from the sale of equipment to handsets also has the effect of decreasing our reported cost per gross add. The financial highlights, as well as the supplemental financial information, reflect these changes, which have been driven by the Wireline spin-off to our reported statistic and financial results.

For the quarter, Alltel generated $1.8 billion of service revenue, an increase of $93 million or 5% year over year on a pro forma basis. Retail revenue growth of 6% was driven by our continued focus on quality customer adds and increases in data and ETC revenues. For the quarter, we received approximately $68 million in ETC revenues.

OBITDA of $669 million was up 6% year over year for a 37.2% service margin.

Below the line other income was up $16 million sequentially, primarily due to an increase in interest income as our average cash balance was higher this quarter than it was in the second quarter.

Interest expense decreased $23 million sequentially, a result of the decrease in our average debt balance for the quarter. Also, our tax rate increased to 39.4% this quarter, bringing our annual effective rate to just over 38%.

Capital expenditures for the third quarter totaled $284 million, and we generated $214 million of equity-free cash flow, an increase of 11% year over year.

Our debt balance at the end of the quarter was $2.9 billion, which was impacted during the quarter by the $4.2 billion de-leveraging from our Wireline spin-off and the $1 billion debt tender. Our cash balance at the end of the quarter was $3.1 billion, which included the $2.3 billion dividend received from Windstream and the use of $709 million to repurchase approximately 12.8 million of our shares during the quarter.

On October 3rd, we completed the purchase of Midwest Wireless for $1.1 billion. Following this acquisition, our net balance was approximately $900 million.

Finally, turning to the fourth quarter, I would like to remind you that our results will be impacted by the inclusion of Midwest Wireless in our operations. In addition, the quarter will be affected by the traditional seasonality and higher relative volatility in sales, marketing and retention costs and, not unlike the third quarter, decisions that we make around our roaming relationship.

With that, we will now take a few of your questions. Operator, please review the instructions and open the call to questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Michael Rollins of Citigroup.

Michael Rollins - Citigroup

Good morning. Just a couple of questions. First, I am wondering if you can give us an update on where you are with the cost-cutting with the completed Western deal, and what might be on the horizon with respect to the magnitude of cost-cutting over the next 12 months?

Just on the ARPU side, do you think that ARPU can return back to growth as you move through some of the acquisitions and get that digested? What are the levers that you expect to be pulling on this ARPU side over the next few quarters, especially with the early indications that you gave us last quarter on the encouragement from the new rate plans? Thank you.

Kevin L. Beebe

I am going to try to take both of those, if I can. On Western, we integrated or transitioned to our systems back in March of this year, so that is all done. In terms of any other major kind of work that would have an impact on cash costs, we really do not have any plan other than just running the business. We are very pleased with what we have been able to do in those markets.

Keep in mind on that cash costs per customer, as I mentioned, it would have been flat had it not been for the inclusion of the expenses associated with our transport business. That, of course, is the services that we are selling, mostly to Windstream, so we feel really good about cash costs per customer, excluding selling and marketing expenses.

On average revenue per customer, as we talked about earlier this year in February, we thought that our year-over-year comparisons would be difficult, and certainly as you well know, the last few years, probably the last 12 to 18 months, I guess, to be more specific, the industry has trended downward on overall ARPU, or retail ARPU. We were pretty much flat, down less than 1%. My Circle certainly has been contributing in terms of the retail recurring side of our revenue streams, but the comparisons that are difficult for us year-over-year are really with some nice growth in ETC last year and some nice growth at wholesale.

We also had that wholesale mix change that all three of us I think alluded to that is beginning to impact our numbers, that we at least attempted to share information with people on earlier this year, when we signed the Sprint deal.

I hope that helps.

Michael Rollins - Citigroup

It does. If I could just sneak in one last question, are you still maintaining your second-half ’06 OBITDA guidance? Thank you.

Sharilyn S. Gasaway

Michael, with regard to our second-half guidance, I think that we are not going to comment on guidance quarterly. It is not our practice. We are not really making any comments.

But a few things to consider, that we have mentioned. First, Midwest Wireless is going to be included in our results for Q4, so you guys think about that. Sales and retention efforts have continued to exceed our plan and, given their traditional seasonality and volatility in the fourth quarter, this may continue. We will continue to focus on the quality customer growth while managing our costs, as well as the roaming relationships for the long-term.

Operator

Your next question comes from the line of David Barden of Banc of America Securities.

David Barden - Banc of America Securities

Thank you. Just one question on the balance sheet. Again, just as you look into next year, just kind of refreshing our thinking with the net set number of account sales of $1 billion, is it the game plan to unleash the power of the balance sheet for the benefit of the equity holders gradually over time and let it build as a growth contributor to the EPS line, or is there a thinking that there might be more of a big bang event to try to really extract the value sooner, rather than later, of bringing it to front-end load the benefits with stock holders?

The second question I would have would be just on the sales and retention, Sharilyn, being above plans. I guess we have had Verizon and Cingular back off of some of their handset plans, which you guys cited was one of the reasons for some margin pressure last quarter. What is the cause around the sales and retention being, or necessitating it being higher than was originally expected? Thank you.

Scott T. Ford

Kevin, do you want to take the second one first, and then I will take the first one?

Kevin L. Beebe

In fact, we have just seen the opposite recently. Only one of those competitors just hit the streets with a $49 Razor, so we are proud of the way we have been able to maintain that. Gross was up nicely in the quarter, which we feel a good amount of that -- of course, with the sales expense comes the retention expense as well.

Scott T. Ford

If you go back and look at the balance sheet, the one thing I want to make sure that I tap down is that we do not have a plan at this moment in time to deal with the balance sheet, other than in the ordinary course of business. This is the season where we have multiple board meetings back to back, just because we have the normal quarterly meetings and then we have an off-site that we do every September, where we kind of look at everything, soup to nuts.

We spent 2006, the first part of it, trying to get the Windstream transaction executed. We then said when we get that executed, we will then step back and, in the fullness of time, bring our board up to date on all of their options, and we will select a path that is best for our shareholders in the long-term.

One of the things we will look at in that context is what do we want to do with the balance sheet, what are the options available to us with the balance sheet. We will consider, should we use it incrementally over time, should we use it in a more dramatic one-time fashion, as you said, or should we look at doing none of the above and do something else?

All of that is currently being thought about. Any more details on that in this point in time would be premature.

David Barden - Banc of America Securities

Thanks a lot.

Scott T. Ford

But it is a great question. It obviously holds an enormous amount of potential value for our shareholders, and we are working on it, top of mind, every day, so that you know where we are on that.

David Barden - Banc of America Securities

Thank you.

Operator

Your next question comes from the line of Simon Flannery of Morgan Stanley.

Simon Flannery - Morgan Stanley

Thank you. Good morning. First, a clarification. I think, Sharilyn, you mentioned decisions we might make on roaming relationships. I just wanted to understand a little bit more about what contracts you might be reviewing.

Secondly, could you just update us on the GSM versus CDMA, where you are in terms of building in a GSM footprint and how you think about the role of GSM and the legacy Alltel properties over the next few years? Thank you.

Scott T. Ford

On the roaming question, as you can imagine, that is a particularly delicate issue with the individual businesses we have to negotiate with from time to time. Shedding light on that in this context and in discussions like this is probably not what we want to get into.

We did make some trade-offs in the third quarter that did impact the third quarter. We are likely going to make some trade-offs in the fourth quarter, all of which are in contrast to what we would have called a plan six months ago, but we are working through that in a judicious way that is best for our shareholders over the long-term, and it is small stuff in the interim.

Kevin L. Beebe

Simon, on GSM and CDMA, we are very close to finalizing some heritage Alltel markets to add GSM service to. We have had a good working relationship with Cingular on that, so look for that expansion to happen. I think we are right on track with where we thought we would be earlier this year in terms of markets and getting those underway.

Again, if you recall, in February, I think I said on the stage, do not plan for any impact on revenues until probably ’07.

Simon Flannery - Morgan Stanley

Is that really going to be more wholesale, or do you think you might get into the GSM retail business?

Kevin L. Beebe

Right now, our plans are just wholesale.

Simon Flannery - Morgan Stanley

Thank you.

Operator

Your next question comes from the line of Thomas Lee of JP Morgan.

Thomas Lee - JP Morgan

Good morning. I have a housekeeping question, and then just more of a strategic question, Scott, that I was hoping you could answer.

On the housekeeping question, I think Midwest obviously is going to be an important acquisition in terms of contributing additional EBITDA, and one reason why you could see an absolute improvement in EBITDA in fourth quarter versus third, so I just want to make sure I have the numbers right. If you could just give me the date of close for Midwest, and then an approximate number of subscribers, or what you previously said would be the approximate number of subs.

Of course, if you are willing to tell us what the EBITDA for the quarter would be for Midwest.

Then, the strategic question, which I want to really direct at Scott, is wireless is still -- it still seems like a high-single-digit growth revenue business today, as just providing traditional mobile telephony. I just want to get a sense from you that as you consider your strategic rural footprint, operating the largest network, when you start thinking about the next two years, what are the ways that you feel you can generate, or continue to grow organic revenues? Is it going to be through the rollout of additional services? Is it strategic fill-in acquisitions, which you guys have been doing accretively? Or is it by shifting customer mix, and again, through these My Circle plans?

I am real curious to see if you still see if it is possible to grow at the industry rate as Alltel, given your sizable market position today in your rural market. Thank you.

Sharilyn S. Gasaway

I will take the first one. On Midwest, we did close that on October 3rd, so basically right at the beginning of the fourth quarter. They have about 450,000 subscribers, and we did publicly disclose that their business would contribute about $25 million of EBITDA in the fourth quarter, and then of course, there will be some synergies associated with some pieces of their business, such as handsets, et cetera. Hopefully, that will help you in your modeling.

Thomas Lee - JP Morgan

If that is the case, it is still possible for you to make the low-end of your original guidance.

Scott T. Ford

Let me answer your second question. The second question has to do with the factors in the industry that relate to growth over the next two or three years, if I could make a synopsis of that.

We have all the issues that everybody else has. We like the business right now. We are executing very well, particularly in second- and third-tier markets. We are actually getting better in the primary markets, although as we have never run from, that is the ground war. In those markets, there are two kinds of wireless businesses starting to shake it up.

There are Verizon and Cingular, and then there are others. We are the other in the major metro markets, and you can see that in the revenue growth and in the profit growth and the customer activity that is taking place in that.

But as most of our markets are outside of those and on the whole, we have been able to balance a very nice increase in revenue and a nice increase in growth, and we have a balance sheet that allows us to amplify the benefits of the impacts of those things as they come through the income statement and the cash flow statement on a per share basis over the next several years.

If you look at in whole, as an investment, we have been very pleased with our track record of driving for our shareholders over a ten-year basis, over a five-year basis, always at least a third of that value creation is in how you manage the balance sheet and when you manage the balance sheet, as opposed to the operations alone. We think that will be true over the next two or three years, at least as much as it has been true over the last two or three years.

Thomas Lee - JP Morgan

Great. Just so I can follow-up with that thought, when we start thinking about the performance of your portfolio of assets, as you said it, when you think about footprints geographically, obviously it is like 90% non-metro. Do you see an expansion in that market opportunity that is different than metro? Do you see an opportunity to become more of a wireless -- does wireless become a lot more of a wireless substitution business in those markets, or is there a better broadband opportunity in those markets for wireless?

By the way, Sharilyn, just as a housekeeping, are you going to implement roaming changes in Q4 with Midwest, or is it after Q4?

Kevin L. Beebe

With Midwest, we are reviewing all of that right now. We are not sure we have any to implement.

I would tell you on the rural markets, my view on that would be, or less urban, as you said, certainly I think there are a couple of upsides there. One is penetration is lower on average than -- the overall market penetration is lower still in those markets than it is in the major metro, so there is some upside there.

I think in terms of a wireless alternative, or a substitution effect for Wireline, I think there are some real possibilities there as well in terms of taking share. I do not know that is going to be different than the major metros. I do not think there is anything within the customer base make-up that would suggest it is going to be different. I think our share will be different in those markets than it would be in major metros. I hope that helps.

Thomas Lee - JP Morgan

That is very helpful. Thank you.

Operator

Your next question comes from the line of Tom Seitz of Lehman Brothers.

Tom Seitz - Lehman Brothers

Thank you. I have one for Kevin and one for Scott. First, Kevin, could you talk a bit about the former western markets? When they were acquired, they looked a fair bit like the former Century Tel markets, roughly the same number of pops and penetration. Back in 2004 and 2005, as you moved in with the Alltel brand, there seemed to be an obvious lift in high quality net adds that I think you guys attributed in large part to the Century Tel markets.

It does not appear like we are getting the same lift from these properties. From a customer acquisition standpoint, are these properties meeting your expectations and there is just other stuff going on in other markets? Could you just generally comment about that?

Kevin L. Beebe

Let me take that, and he can -- your second question. I know you won’t have another one you want to get to, but we have been real pleased with the up-tick in the former Western Wireless markets. I think the percent of sales on national plans -- hey, keep one thing in mind; earlier this year, we decided to exit one of the rate plans that Western offered, that we have not disclosed, nor I do not think they ever disclosed, the percent of their base or the percent of their gross that was the result of that.

It was a spending limit kind of plan, sort of a crossover, pre-/post-paid kind of plan. They never disclosed, nor did we disclose, so keep that in mind.

We are working through that transition still in terms of the selling activity. Very pleased with the quality of the sale though, and the way our team in those markets has grabbed a hold of the things that we offer.

Tom Seitz - Lehman Brothers

Great, thanks. Scott, just at a high level, could you talk about when you are thinking about the balance sheet, how big of an issue, even though it is some time away, are you viewing the potential 700-meg auction down the road, both in terms of potentially acquiring some of that stuff yourself, or even in terms of MNA activity that you might consider, given that several potential targets are essentially just growing EBITDA from roaming which, given the 700 auction, may not be a long-term growth source of EBITDA?

Scott T. Ford

Several interesting questions and insights I think in that topic, on that topic as a whole. First of all, let’s say this -- we think 700 megahertz is real spectrum, and something that you can deploy and spectrum that you can use and efficiently deliver service to customers in these markets that we serve and just about any other market in the country where that spectrum is available.

We think that is worth a serious study over the next year as we go into -- I guess we are what now, maybe 15 months away from that auction, plus or minus? That has always been a -- we have viewed that as a watershed moment for a long time and we continue to view it that way, and we continue to think through our options with that aspect on the horizon as one of the issues that we have to sort through.

As you go into what does it mean about MNA and valuations, clearly the valuation gap, we have had a nice run this year, not near the run that everybody else in the telecom world has had on a percentage basis, but we have had a nice run, but we would rather buy our stock at these levels, as you have seen us do in the third quarter and we have talked about our plans in the fourth quarter, than we would rather than buy other assets that are not compelling at the valuations that they trade at. While trying to be complimentary of everybody and their business, we have made it very clear, we think, each of the quarters that we have talked, going back to the February call, that we are perfectly content just buying our own stock, given the relative valuations of the businesses that are out there.

We will just leave it at that and not speculate too much about what spectrum means on anybody else’s business.

Tom Seitz - Lehman Brothers

Perfect. Thank you very much.

Scott T. Ford

I am trying to get better about those kind of comments.

Operator

Our next question comes from the line of David Janazzo of Merrill Lynch.

David Janazzo - Merrill Lynch

Good morning. The ETC revenues seem to be increasing modestly. What is driving the changes, and are you perceiving the possibility of any regulatory changes in the future?

Sharilyn S. Gasaway

From a trend standpoint, we did see just a slight up-tick this quarter. From time to time, David, we will have some kind of [true ups]. There was probably $3 million to $5 million of that. So we could actually return in the fourth quarter down to the $60 million to $65 million range. Kevin can address any changes expected.

Kevin L. Beebe

Again, a combination of activities at the federal and state level. At the federal level, certainly the FCC seems to be focused on some other things right now, first and foremost seems to be the AT&T-BellSouth transaction. I have not heard anything really new out of the FCC relative to their thoughts on ETC.

At the state level, we continue to, as you know, we continue to work every day with state regulators in the various jurisdictions where we get ETC dollars, as well as continuing to work in other states where we think we should be in a good position to receive a similar kind of subsidy.

I do want to emphasize that the partnerships that have developed have been wonderful. We have targeted build-outs. Our engineering team has worked closely with the group of people that we have here that works with the regulators in each one of those states to make sure that our build-outs cover the rural areas that regulators believe should be tied to ETC revenues. That kind of partnership that has developed at the state level with state regulators and our team has been real good.

I think that is the reason for the subsidies, and I think the reason that subsidies obviously should continue. We are spending money wisely and helping rural parts of states to provide wireless service where we probably wouldn’t, quite frankly.

Scott T. Ford

That is a key contributor back to the question, and I do not remember if it was Tom or Simon, asked a minute ago about rural development. If you look at the history of the Wireline business, which is maybe less applicable than any time in its history as an analogy, but if you look at the development of the wireline business, without federal and state subsidies, the rural parts of the United States would have never seen telecommunication services, and there are big parts of several of the states we serve that it is just un-economical to build cell site coverage into without some form of subsidy. We pay in, as a wireless industry, $3, basically 30% of all U.S. [inaudible], and we only take one-third of that back out to build cell sites for our customers that are paying that fee. The rest of it goes to wireline rural incumbents.

The more money that is available on an ETC basis, the more cell sites get built, the more revenue, the higher penetration you are going to see, the more revenue that comes back off of that, and so it is a virtual cycle, but managing the politics of it is a tough aspect of the daily work.

David Janazzo - Merrill Lynch

Thank you.

Operator

Your next question comes from the line of Chris Larsen of Credit Suisse.

Chris Larsen - Credit Suisse

A question on Verizon’s over-build. I think you said in the last quarter that Verizon, or maybe I misheard you, had stopped their over-build in the first quarter. I wanted to get a sense if that was still the case, or if they had continued their over-build-out, and are they continuing it at 1900? Maybe a sense, if you can, for how much traffic was lost.

Then, at what point do we anniversary their minutes coming off and some of the price reductions, so we will actually see the natural growth in minutes, roaming minutes, show up in the roaming revenues?

Kevin L. Beebe

No additional over-builds really since the first-half of the year from Verizon, so that has been hopefully all behind us. In terms of the comparisons, are you speaking to Western and the price adjustment there?

Chris Larsen - Credit Suisse

Yes, I’m sorry, yes, and I think you also locked in some longer-term price agreements with Sprint and Cingular.

Kevin L. Beebe

We did. The Sprint/Cingular agreements were not effective until July 1st of this year, so very recently, beginning of the third quarter. The step-down at Verizon within the former Western markets really happened in the fourth quarter of last year, so the fourth quarter should be apples-to-apples comparison, if you will.

Chris Larsen - Credit Suisse

Thank you.

Operator

Your next question comes from the line of Phil Cusick of Bear Stearns.

Phil Cusick - Bear Stearns

Thanks for taking my question. I wonder if you could talk a little about the industry. It seems like Sprint has been spinning off some pretty good customers, with a push-to-talk focus. Cingular, Verizon have been picking up a lot of those. I wonder if you could help us think about what you feel like you have been taking from that direction, and as we go forward and Sprint gets more aggressive, you mentioned the $50 Razor, do you think that the fourth quarter this year could be a little more aggressive than typical? Or is it just a standard fourth quarter? Then I would like to follow-up on cap-ex, if I can.

Kevin L. Beebe

Why don’t I take the first part. I think we have, as you have said, based on the results yesterday, and Verizon has not reported yet, but Cingular did. They had a killer quarter -- Cingular, that is.

Obviously, all grabbing share. We all seem to be taking some share from Sprint. Mostly true for us, I think, in the ex-Sprint affiliate markets where we have a lot of -- we go toe-to-toe with the existing affiliates, or ex-affiliates. I am not sure how to talk about them anymore. I am not trying to be cute, I am just not sure. So I feel good about that.

On touch-to-talk service, I think I mentioned this maybe on the second quarter call, but for the first time, really, since we have launched our touch-to-talk, we are getting much further down the path on our proposal activity with the business customer than we ever have in the beginning to pick up some good share there.

Fourth quarter, tough to tell, but the early indications -- of course, the Razor is, believe it or not, getting close to end of life, so I think we will all be focused on that as we end the quarter in our promotional schemes. We are expecting a difficult fourth quarter.

The good news about all of that, being a glass-half-full kind of guy, the good news about all of that is it is all about the phones, and there has been pretty rational pricing on services, knock on wood. If it is just about the phones, the electronic device itself, and we all go after that rather aggressively, that is a one-time expense in cost which does not necessarily have a long-term impact on the value of the business.

Phil Cusick - Bear Stearns

So as we have talked about before, it sounds like you guys are willing to compete as long as it is a subsidy issue, not a long-term, taking a hit on the contracts.

Kevin L. Beebe

Yes, that is what I attempted, at least, to allude to in the last part of my prepared remarks. We are seeing good quality growth, which means post-pay at good average revenues, and as long as we can continue to do that, I think we should. That has a short-term impact on our earnings and our EBITDA that I know most -- I know all of you have noticed, but we think that is the right balance right now.

Phil Cusick - Bear Stearns

It has been successful so far. In terms of cap-ex, it seems like you are pretty far below your guidance run-rate. Is there some sort of GSM ramp-up that might happen in the fourth quarter, or just a bit of a budget flush, or do you think you come in substantially below?

Sharilyn S. Gasaway

Again, we are not going to give you specific guidance, or comment on the guidance, but we can tell you that we do plan to have a lot of activity between now and the end of the year. We expect to activate a number of sites with EV-DO in the fourth quarter, and expect to have about 50% of our cell sites covered by year-end with that. So I think there is going to be quite a bit of activity in the fourth quarter.

Kevin L. Beebe

It is mostly DO. There will be some GSM build, but most of that pop in cap-ex will be DO.

Phil Cusick - Bear Stearns

For GSM, should we look for any revenue before, say, the second-half of ’07?

Kevin L. Beebe

I do not think so. I think the first part of the second quarter if we are lucky, but not before the -- not a lot.

Phil Cusick - Bear Stearns

That helps a lot. Thank you.

John Ebner

Operator, we have time for one more call.

Operator

Your final question comes from the line of Jonathan Atkins of RBC Capital Markets.

Jonathan Atkins - RBC Capital Markets

Yes, a follow-on to one of the earlier questions. I was wondering if you could comment on the potential for new competition in your footprint as a result of the spectrum auctions, either over-build by one of the national carriers or perhaps a regional carrier that acquired spectrum within your footprint.

Scott T. Ford

You never know. At this point, we have six or eight competitors in most of our markets, and we have two or three competitors at least in almost all of them. The huge difference, the differentiator and the reason we do so well, and Kevin and I have both alluded to the difference between a major metro market and the rest of America, is that is really where you see the benefit of 850. When people have to build less dense areas in 1900 or 1700 or 2000 spectrum with dual bands talking back and forth, the economics of that network build are nowhere near as attractive for them as an operator as they are in a dense, metro, urban environment. I believe that you will continue to see a difference in that.

Someone asked a question earlier about the 700 megahertz auctions next year. That might actually have an impact over the next two to three years on the business. I do not think the spectrum auctions that we just saw are going to be even material difference makers in most of our markets.

Thank you all for the call. We appreciate your time.

John Ebner

Thank you for joining us this morning. We appreciate your interest and support. If you have additional questions, please contact our IR department at 501-905-8991. Tim Hicks, our Director of Investor Relations, and I will be available at that number. Thank you.

Operator

Ladies and gentlemen, that has concluded today’s conference call. You may now disconnect.

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Source: Alltel Q3 2006 Earnings Call Transcript
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