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Alaska Communications Systems Group Inc. (NASDAQ:ALSK)

Q1 2010 Earnings Call

April 29, 2010 5:00 pm ET

Executives

Melissa Fouts – Investor Relations

Liane Pelletier – President, Chief Executive Officer, Chairman

David Wilson – Chief Financial Officer

Anand Vadapalli – Chief Operating Officer

Leonard Steinberg – General Counsel

Analysts

David Barden - BofA Merrill Lynch

David Coleman - RBC Capital Markets

Jason Fraser - Raymond James

Operator

Good afternoon ladies and gentlemen. Thank you for standing by. Welcome to the Alaska Communications Systems first quarter earnings conference call. (Operator Instructions) This conference is being recorded today, Thursday, April 29, 2010.

I would now like to turn the conference over to Miss Melissa Fouts. Please go ahead, ma’am.

Melissa Fouts

Good afternoon and welcome to the Alaska Communications Systems first quarter conference call. With me today are Liane Pelletier, President, Chief Executive Officer and Chairman of ACS; David Wilson, Chief Financial Officer; Anand Vadapalli, Chief Operating Officer; 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 of 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 the nearest GAAP measure. You may find these reconciliations, today’s press release and our SEC filings on our investor website at www.alsk.com.

We will begin the call with Liane providing an overview of our results and strategies. Anand will discuss our operational imperatives and David will review our preliminary Q1 metric and financial performance. With that, I would like to turn the call over to Liane. Liane?

Liane Pelletier

Thank you Melissa. Our strategy and our first quarter results are all about capturing data users. Capturing these users is reflected in our marketing, our network enhancements, our product roadmap and our execution across all customer touchpoints. This strategy requires disciplined marketing and market research. We’re honing our skills and knowledge every day in these areas.

Revenue and EBITDA came roughly in line with what we had planned for the quarter. These numbers are preliminary, though, and David will provide the commentary on this and in the press release today. In wireless, you’ll see growth in data revenue, data ARPU and data users. In late January, we launched the HTC Hero, the first of many Android devices we’ll bring to market this year. Pick up from our customers clearly showed that they were eager to pair an app centric device with the state’s fastest and most extensive data network.

Smartphones comprised 27% of device sales in the quarter, up from 12% last year. Data devices are held by 21% of the base, up from 10% last year. Data ARPU grew by 28% to $9.34 and we see lots of headroom in that metric. Data revenues accounted for 18% of total wireless service revenue in the quarter, up from 13% a year ago. And while we now have the Android, of course the wait and appeal of the iPhone hasn’t totally diminished in Alaska or elsewhere, so while they have been muted, ACS departures to the iPhone continue. Although our headline churn rate in Q1 was high, we did achieve lower churn in our highest value and largest retail postpaid customer segment.

In enterprise, data revenues grew 19% annually as we continue to make steady progress across a wide range of customers with our advanced data product line. We are generating with each sale higher value than before and are serving a growing number of customer locations outside of Alaska. As always, process improvement and margin management are priorities, and they were during this quarter. The team has delivered for the same operating expense level, higher quality revenues this year than last.

Anand will now share the operating framework that delivered the strategy and the financial results that we guided on our last call for the full year 2010. Anand?

Anand Vadapalli

Thank you Liane. Our focus centers on driving share gains in the fast growing data market, extracting operating efficiencies and enhancing brand strength while moving the wireless business again into a situation of net adds. It’s clearly a goal for 2010. I’m pleased with our performance and driving quality wireless revenue.

In the past year, we doubled the penetration of data centric devices in our base, contributing to a 28% year-over-year increase in data ARPU. Over the last six months, we’ve seen a 50% increase in 3G data sessions. Customers who use heavy data services are more engaged with the product and network, and we are seeing a beneficial impact on retention among data users. At the same time as these users continue to use heavy amounts of data, our network provides the best data experience in the state. We have allocated a significant portion of our 2010 capital budget to expand and deepen our 3G coverage to keep our data users happy. We will increase our e-video sites by close to 50% this year, and we will complete the vast majority of this work by Q3.

We are leveraging both the quality of our network and demonstrating our focus on customer value as we get ready to launch a series of innovative wireless products in our 2010 roadmap, creating secure relationships with our customers. In a nutshell, our game plan for wireless centers on quality growth and we see interesting ways to pursue that in our market. More to share in the upcoming quarters.

In the enterprise segment, we remain focused on disciplined channel execution supported by the development of innovative solutions and new products. Enterprise data revenues were up 19% from last year, up 6% sequentially and our sales funnel remains strong. The carrier voice segment, subject to volatility from share shifts and commodity pricing maneuvers, is now just 14% of enterprise revenues. On the last call, I reported the hire of a new sales leader for enterprise. I’m pleased to see execution getting stronger every day, which is really the key to sustainable performance. I expect to see the impact from this discipline in the months to come, and I’ll look forward to sharing our results with you.

[Profit] execution relies on our capability to secure the best wireless and wired line data networks in the state for some unique customer solutions. This advantage will be leveraged in the coming months.

I’m pleased with wins from competition in Q1, including a major school district. We’re also deepening our relationships with existing customers. As one example, a customer has expanded operations to the lower 48 and asked ACS to provide end to end solutions for all locations. This is exactly what our capabilities are built to do for [satisfied] customers.

As I have reviewed the [inaudible] price metrics from Q1 and the funnel for Q2 and beyond, I’m pleased with where we are. We have the funnel size I want to see and we continue to hold our own for the loss ratio.

Market awareness about ACS capabilities is growing every day, and the ACS team is getting better at shaping solutions for our customers. This is what makes wireless and funnel size strengthen over time.

Finally, we continue to drive transformation of our operations, shifting our cost structure as the lines of business shift. David will now share more on our results to manage margin from the top line down with a review of Q1 performance. David?

David Wilson

Thank you Anand. Before I begin to review our first quarter performance, I’d first like to remind you that the financial results presented today are preliminary. The open items that exist is tendered on a notice to propose adjustments issued by the IRS on April 19, impacting the 2006, 2007 and 2008 taxable years of Crest Communications Corporation, a company we acquired in October, 2008. The stock purchase agreement underlying this acquisition provides us with indemnification rights from the selling stockholder, Crest. We are in the process of evaluating what impact, if any, this issue could have on our first quarter 2010 results.

I’ll now review our financial performance in the quarter, where revenue came in late versus consensus expectations while strong margin management drove an EBITDA beat. While headline revenues of $82.6 million were down from $86.2 in the prior year, important shifts in the mix of revenue continues, with strong growth in data upsetting declines in legacy fixed and wireless voice services. These shifts in revenue are consistent with our strategy of maximizing opportunities and returns in an increasingly data centric world.

Our focus on growing data revenue is complemented by a business transformation agenda that is securing productivity gains from our process improvement initiatives and aggressively allocating resource to growing business segments while minding costs [inaudible]. Success in this area is clearly evidenced in our first quarter results for wireline, where strong data growth and disciplined margin management more than offset structural pressures in legacy voice, driving margin expansion to 30.9% from 30.1% and an increase in absolute EBITDA.

Our enterprise business has modernized our wireline assets and is centered on building share in a data market characterized by outstanding growth fundamentals.

Government enterprise grew by 6% year-over-year to $11.7 million, but enterprise data revenue grew by 19% year-over-year, and data now represents 86% of total enterprise revenue, up from 77% in the prior year. While gains in enterprise only partially offset $1.5 million in annual declines in our legacy wireline business, disciplined expense management maintained wireline EBITDA of $15.5 million for the quarter, at a modestly higher level than the prior year.

In the wireless segment, disciplined execution translated into growth in data, ARPU and EBITDA margins, staying at an industry leading level of 44.3%. As we sold more subsidy rich Android devices into our base and spent more on advertising, we absorbed these increases with other reductions so that total wireline costs were flat with last year. While its revenue year-over-year comparisons are challenging, given the benefit in 2009 from 1.4 million and add a third CTC. Adjusting for this, wireless revenues declined by $1.3 million to $32.5 million.

Looking at the sources of wireless revenue, data grew with a 28% increase in postpaid data ARPU, driving a $600,000 gain, while a 3.4% decline in voice ARPU contributed to a $2.1 million decline in subscriber voice revenues. Voice ARPU was affected by a decision in January of this year to quickly match AT&T’s $69.99 nationwide unlimited voice plan so we would not suffer competitive disadvantage.

As highlighted earlier, this quarter’s wireless subscriber performance was heavily impacted by ACS disconnects of non-paying users who get subsidized service from a low income program in which ACS is required to participate as part of it’s CTC designation. Late in the first quarter we rolled out a new CRM, we reviewed all customization processes and requirements in standardized correction standards for this segment customers, resulting in 4.5 thousand ACS initiated disconnects, 65% of the quarterly decline.

ACS initiated disconnects aside, we saw stronger attention in the remaining postpaid subscriber base with monthly churn improved sequentially by 20 basis points to 2%. A high tech rate of Android parent devices among our embedded base was an important contributing factor to this improved performance.

And now for 2010 financial guidance. As previously reported, ACS expects its dividend payout ratio to be below the 70 to 75% target set by the board; revenue to be stable and in line with 2009 levels; EBITDA to modestly exceed 2009 levels; CapEx to be approximately $36 million, and to pay $29 million in cash interest.

Finally, a quick recap of the capital markets while the debt markets remain robust and risk bases continue to tighten. With our term loan debt maturity 21 months from now, we are focused on executing a refi deal ahead of the 2011 maturity of our revolver. In the intervening time, we continue to save close to $1 million in cash interest for each month that we wait.

We also can see the benefit from the expiration of our other money interest rate swap, the most recent of which occurred on March 31 of this year, saving $4 million per annum, enabling us to absorb the widened refi credit spreads necessary to maintain cash interest at over low 2009 levels.

Now back to Liane.

Liane Pelletier

Thank you David. We’re growing the business in smart, sustainable ways. We have built a strong data network for our wired and wireless needs, vertically integrating across the networks and we’ve connected them to the lower 48. We believe our focus really makes us unique in Alaska and positions us to capture quality revenue and quality margin over the long haul. This strategy supports our plans for 2010 and beyond, and it clearly shows we’ve already aligned ACS with the national focus on broadband.

I’d like to mention that David Wilson and I will be at the J. P. Morgan 38th Annual Tech, Media and Telecom Conference in Boston on May 17, and David will be at the RBC Tech, Media and Communications Conference on June 9.

Operator, would you please open the call for questions now?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Barden - BofA Merrill Lynch.

David Barden - BofA Merrill Lynch

If I could just maybe two. David, maybe could you kind of elaborate a little bit more on what the cost actions were that you took in the quarter that were able to offset some of the revenue pressures, especially in the wireless business this quarter? And kind of what incremental actions you think might be necessary over the course of the year and how easy they are to achieve? I guess the second question would be, obviously you mentioned, Liane, the iPhones impact on wireless subscriber growth, x-ing out the proactive disconnects. You know obviously we’re expecting a refresh this summer, potentially an incremental unit of price compression for legacy iPhone devices, you know, what did you learn last year about the device and its impact on your business that kind of gives you the comfort to talk about the prospect of turning subscriber growth positive this year?

David Wilson

Sure. So, David, I’ll start with the first part which sort of centers on the success we’ve had in terms of money management and cost control. So you know in essence, David, no stone is left unturned and what you see is really a continuation of what you’ve seen for a number of quarters now, basically insuring that we mine costs out of shrinking parts of the business as ingrained in terms of how we operate. A few things that were maybe new this quarter improved set of controls, coming out of the recently executed CBA which enables us to actually have more front line employees or a high proportion actually facing the customer. We continue to see benefits from our process to group initiatives. Again, that’s a long term trend that we’ve enjoyed.

And in terms of other areas, network rationalization, so heavily engaged in terms of making sure that we groom wherever possible in terms of third party networks, and the investments that we’ve done in terms of the build out have enabled us to carry more of our own traffic has served us well, too. So it’s a whole range of issues. We’re also looking at areas of the business that just don’t make sense anymore. So one example would be getting out of the pay phone business, which we’ve done recently. So we’re again moving out of shrinking areas so we have resources to invest in growing areas.

Liane Pelletier

Okay, David, well let me grab this commentary about the iPhone. And you know a year ago, David, we had a large elephant in Alaska with its unbelievable advertising spend plus an iconic device and this year we feel we’re a little bit differently positioned. We know, and I think we’ve given you a few dimensions of color around what introducing Android has meant. Not the entire world goes to the Apple products and we found large reception for Android base. We do plan to have more of those between now and year end. So that’s one element.

Number two, we didn’t put our Android on the shelf like other devices and simply say come along and buy a voice plan, buy a data plan, and sort of do things a la carte. We created a total customer experience called Android Life. It is a sweet price point, $99, unlimited voice and data, plus some other goodies that are different and unique to ACS. Exclusive event invitations and other gifts that happen during your customer experience with ACS. And we know that that’s not happening with the other area and the price point is probably a sweeter price point than what you buy with the Apple product on AT&T’s network.

We know that our network is more than holding its own. We have experienced 350% 3G session increases and we have a network that responds well with Android in data consumption. We’re putting 50% more EVDO sites in between Q2 and Q3 this year, so even where we’re not, we’re ramping the capacity for 3G performance.

And finally, there’s an element of a brand. I think we shared on our last call that we’ve gone to market and we’ve learned a lot about the advantages of ACS that we’ve not yet played out in the market. We’ve also learned about weaknesses of the competition, and we hope that what we end up doing, which is both art and science and our brand work between now and year end, is in fact going to make that stand out in the local community.

Part of that, of course, is the fact that we are local and as opposed to a national player, who has limitations on what they might choose to do just for Alaskans, we do think just for Alaskans and we sort of are known as the community centered provider to big data users in Alaska. So without going into too much that would probably be competitively inappropriate, I think those are some of the areas that I can say we’ve learned from and that we’ve actioned to get ready for more Apple products in the market.

Operator

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

David Coleman - RBC Capital Markets

Just following up on that question, looking at I guess the handset prices for your Blackberrys between March and April it looks like you marked down a few of those quite a bit. I’m just wondering how much that plays into your strategy to improve the gross subscriber additions. And then just going back to the first quarter, the 4,500 customers that were non-pays, is there any kind of revenue recognition from earlier periods that would need to be reversed? Then a final question just on the Acorn and Northstar networks, I was wondering if you could talk about order volumes or bookings in the first quarter on those networks and how that’s been trending versus earlier quarters.

Liane Pelletier

Thanks Dave. I’ll start then I think maybe David Wilson will cover the non-pays and Anand do you want to talk about the cable biz?

Anand Vadapalli

Sure.

Liane Pelletier

Okay. So what you may have seen on our website for example is a very tactical move. It’s not some long-term, full baked strategy. So when we have various devices that we want to clear from inventories for example, we and others tend to do that special targeted pricing. And so I don’t think you should read anything big into that in terms of a long-term Blackberry price strategy.

To the non-pays, David?

David Wilson

So in terms of non-pay disconnects, David, satisfied that the procedures we had in place met the requirements of USAC, which is a major source of those funds. And really what we’ve done recently is align the early customer life experience with early payment patterns, so we’re probably being a little bit more aggressive in terms of early disconnects and flushing that through the base was really the driver of the one time pick up in discos.

And then Anand in terms of the enterprise revenue?

Anand Vadapalli

Well, Dave, enterprise revenue truly, I mean I see this answered in two parts. We’ve enjoyed significant growth in enterprise data. It’s 19% year-over-year and 6% sequentially, so that should mean a significant increase in the traffic that we’ve carried on the submarine cable systems that she talked about. To some degree, this growth has been muted by compression in the cable voice segment, but that piece of the enterprise revenue is now only 14%, so we expect this to be less impactful on future results.

Now as order volumes and looking ahead, our core business metrics on the enterprise side actually remain very strong. Funnel is strong and we continue to carry forward a number of live opportunities. We’ve had now a good tenure in the market, a year since both of those assets went live in the market for us and that’s helping grow awareness for ACS. And that’s helping us in two ways. That’s helping us close deals and its helping us add deals to the top of the funnel. Clearly you know with that, and the sales leadership driving better execution, we expect to see strong growth and accelerating growth on the enterprise side.

David Coleman - RBC Capital Markets

This might be difficult to answer, but I’m assuming it would take, you know, two, three, four quarters for your enterprise sales force to get up to speed. At what point, now that you’ve been selling into this network for about a year now, at what point do we sort of reach a steady state where it’s a more predictable level of enterprise data sales growth?

Anand Vadapalli

So we’ve had a fair focus on getting the sales force and their performance lined up for quite some time now, including even before the cable systems went into place. That’s something that we’ve had in place. And some of the growth that we’ve seen is as a result of that. The most recent leadership arrival that we announced only helps accelerate that trend and I certainly expect to see good results here in very short order.

David, do you want to add anything more?

David Wilson

Yes. What I would say is we’re still a small share player and we’re bringing a brand new solution to the market and we think a better solution to the market. And I think data continues to grow from a dollar standpoint and we will grow with the market and we’ll grow by taking share. So again, as Anand said, I expect to see good, strong, accelerated growth between now and the end of the year.

Operator

Your next question comes from Jason Fraser - Raymond James.

Jason Fraser - Raymond James

You mentioned you’re seeing a strong response on HTC Hero. I was wondering if you could talk about the pouring ratio with AT&T before and after the Hero launch just qualitatively or quantitatively would be great. And number two, you mentioned just the roll out of additional 3G EVDO sites. I was wondering if you could also give us an update on your thoughts for LTE deployment. And lastly if we could get the roaming revenue for Q1, that would be great.

Liane Pelletier

Jason, I’ll start. With HTC Hero, I think one of the competitive dynamics we’ve shown you in the past is that when we have losses of customers it is to AT&T and it is because of the iPhone. And that dynamic itself has not changed. We’re slightly down from Q4 sequential and we attribute that to the strength of the Hero in terms of absolute number of exits from ACS to AT&T. Does that help?

Jason Fraser - Raymond James

It does.

Liane Pelletier

Yes. And on LTE we intend to continue what we started years ago, which is build networks and serve needs for broadband. And so LTE is definitely on our strategic roadmap as a [foot] follower. I think one of the things that’s going to really help ACS and is helping us already is the vertical integration we have. We have the far majority of our wireless footprint inside a footprint that we can also self serve from a wireline standpoint inside Alaska and then vertically integrated all to the content point in the Seattle area is also very helpful.

David Wilson

Then roaming revenue I think comparable to last, so right around $4 million.

Operator

Your next question comes from David Barden – BofA Merrill Lynch.

David Barden – BofA Merrill Lynch

So just going back to the dividend side again, you guys have kind of looking back over the last year, worked very hard to kind of get the cash flow situation steadied, get focused on the de-leveraging side of the equation; your dividend payout ratio fell kind of below the long-term target that historically, in better credit times, had seen your stock price up in the mid to high teens at one point. So I realize that there’s obviously a focus on leverage and its still very important to kind of have that longer term vision, but you know the credit markets are monumentally better than they were and I guess could you kind of tee up the criteria or the situation where you guys would feel comfortable kind of moving back into that targeted payout ratio. Is it still that February kind of timetable? It’s always going to be February and we have to wait until February ’11 to find out, or is there any possibility that the environment could change enough that 2010 could be that year?

David Wilson

We said in our prepared remarks that we’re looking to execute a refi deal ahead of February next year which is when our existing revolver expires. When you actually look at cash interest, we’re currently paying today quite a lot of cash interest rather than money swaps, and so we moved down from close to sort of $36 million in cash interest was the amount we paid in 2009, guidance this year $29 million. And we still have more swaps to roll off. But what you’re going to see is by the time we execute the refi deal based on the most recent read we had from our relationship banks, expect to see that cash interest maybe close to $32 million than the $29 we’re guiding to this year.

So the swaps allow us to absorb some of the widened credit spreads, but the underlying cost of that is actually higher. We’re just going to be able to absorb it because these swaps are going to roll off. So you will see a slight uptick in terms of cash interest, and that pushes the payout ratio more in line to the 70, 75%.

Jason Fraser - Raymond James

So we’re getting there the wrong way.

David Wilson

We’re going to be able to absorb widened credit spreads and still be there is another way of saying that point.

Operator

At this time I would like to turn the conference back to Miss Pelletier. Please continue with any closing remarks.

Liane Pelletier

Thank you all for joining us today. We appreciate your interest in ACS and we look forward to speaking with you next quarter.

Operator

Ladies and gentlemen, this concludes the Alaska Communications Systems first quarter earnings conference call. Thank you for using ACT Conferencing. You may now disconnect.

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