Alaska Communications Systems Group, Inc. Q2 2008 Earnings Call Transcript

Sep.21.08 | About: Alaska Communications (ALSK)

Alaska Communications Systems Group, Inc. (NASDAQ:ALSK)

Q2 2008 Earnings Call

August 5, 2008  5:00 pm ET

Executives

Paula Dobbyn – Director of Corporate Communications

Liane Pelletier – President, Chief Executive Officer and Chairman

David Wilson – Chief Financial Officer

Leonard Steinberg – General Counsel

Analysts

David Barden – Banc of America Securities

Frank Louthan – Raymond James

David Coleman – RBC Capital Markets

Christopher King – Stifel Nicolaus and Company, Inc.

Operator

Welcome to the Alaska Communications Systems second quarter 2008 conference call. (Operator Instructions) I would now like to turn the conference over to Paula Dobbyn, Director of Corporate Communications for Alaska Communications Systems.

Paula Dobbyn

With me today are Liane Pelletier, President, Chief Executive Officer and Chairman of ACS; David Wilson, Chief Financial 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 fact and may include financial projections, estimates of shareholder returns or other descriptions of the company’s plans, objectives, expectations or intentions. You are cautioned not to put undue reliance on forward-looking statements as actual results could differ materially from expectations as a result of a variety of factors, many of which are outside the company’s control. We discuss these factors in our SEC filings.

Lastly any non-GAAP measurements referred to during this call have been reconciled to their nearest GAAP measure. You may find these reconciliations in today’s press release and our SEC filings on our investor website at www.alsk.com. We will begin the call with Liane discussing the company’s progress towards its strategic transformation, then David will review the details of our operating and financial performance and guidance for the year. Liane will then open the call for questions. With that I would like to turn the call over to Liane. Liane.

Liane Pelletier

Thank you Paula. Welcome and thank you all for participating today. We’ve had a lot going on since the last call. There is much to share regarding the market, the company’s growth in wireless and the company’s progress for building a differentiated quality wireline operation for enterprise customers.

We want to share insights into the components of the financial results we’ve posted today and the adjustments we’re making to recurring revenue and EBITDA guidance of approximately 1% each. First Alaska economic indicators still show it to be largely counter-cyclical to the rest of the U.S. Specifically housing, employment and investment in the state’s energy resources show continued strength.

And disposable income promises to be boosted by one perhaps two checks to be distributed to every Alaskan citizen by year end that result from the state’s record permanent fund earnings and the state’s record budget surplus attributed to higher oil royalties. And significant activities continue on the gas pipeline development front.

Next the company’s results. Q2 ’08 revenues are flat to Q2 ’07 revenues as the much discussed transition and mixed shift of the business takes hold. Growth in the strategic high value retail parts of the business added about 10% to the top line or $4 million, but nearly all of that was eroded by revenue declines in wholesale, local and network access. Q2 ’08 recurring EBITDA reached $31 million versus $33.6 million last year with decline attributable to favorable access settlements in the prior period and a reset to wireless pricing in the current period.

Onto two strategic segments where ACS allocates its resources, wireless and enterprise. They are where demand is growing and where we can create value for customers and where we can create value for shareholders. Wireless is now 37% of company revenues and 47% of company EBITDA. Wireless has gone through a momentous shift this year. The company simultaneously repositioned its operations for long term competitiveness with the entry of a national brand, completed migration from PDMA to all CDMA and just recently upgraded to EBDO Rev A.

As evidenced by our Q2 operating metrics, execution was solid. Wireless growth ads were higher in Q2 than in any of the prior six quarters and churn among our post paid subscribers 94% of all subscribers, improved to 1.5% monthly levels. ACS grew most in the high quality subscriber segment with unlimited voice calling plans and data cards accounting for 30% of gross adds in Q2. Over one third of our customer base now uses 3D devices.

ACS messaging in the market is all about wireless data and wireless internet usage has grown over 50% in the last four months. We’ve also been positioning for success in the enterprise segment. Enterprise revenues are up 44% this quarter over a year ago and the sales funnel is very strong. We have hired new and trained existing employees to serve enterprise customers. We continue to re-purpose our local plants for data.

We’ve added over 100 new fiber entrance facilities to buildings in the metro areas. We’ve upgraded and extended our differentiated metro Ethernet and MPLS networks. We will execute a contract this week for a second knock in the lower 48 to provide world class management network services and customer interfaces with the turn up of AKORN.

The AKORN cable build is on schedule and ACS obtained final regulatory approval last week for the acquisition of Crest. These are just a few of the transformative actions taking place, making what was once a collection of local telephone assets into a 21st century network built to serve enterprise customers who need security, flexibility, convergence and speed.

While making these bold investments to reposition the firm, we keep a relentless focus on cost management. We continue to accomplish more with less. Headcount is down year-over-year even as we rebuild the company for the long term. Our culture of cost improvements continues with the results driving better customer experience and better operating efficiency.

Finally, I want to comment on the change to guidance. We are lowering revenue guidance by $5 million and recurring EBITDA guidance by $2 million. There are three drivers for this. One, we proactively introduced lower national prices to our wireless customers, which resulted in a one time reset to the wireless business. And customer conversion occurred much faster than planned. But operating root results prove it was the right call.

With the reset behind us we have the right programs in place to continue high quality growth. Two, our enterprise segment predicts some customer sales may shift into next year making it difficult to hit the high end of original guidance. Our conservative nature is coming true with this change.

And three, there is some uncertainty around CETC. I’ll now hand the call over to David who will provide additional details about our operating and financial performance. David.

David Wilson – Chief Financial Officer

Thank you Liane. I will start with wireless and the key operating metrics of net ads, churn and ARPU. In net ads we saw the expected rebound coming from the wireless initiatives put in motion earlier this year; specifically, a proactive repricing at national levels, introducing new feature and data bundles and delivering differentiated customer service.

We generated 3,600 net ads in the quarter for a 2.5% sequential increase in subscribers. Regarding churn, the turndown of the TDA network is complete and churn in the strategically important post paid wireless segment improved by 30 basis points to 1.5%.

On to ARPU. Data ARPU increased 22% sequentially helping to mitigate some of the voice ARPU declines caused by the reset national crisis. Overall, ARPU declines to $60.80 from $61.62 that’s cut to quickly converted plans. As of today, 69% of consumers and 43% of business subscribers have transitioned to our new nationally based price plans.

Now on to wirelines. Local retail lines declined 5.9% on a treading 12 month basis, primarily in the consumer segment. We estimate that over half of that decline is attributable to core customers. DSL subscribers remain flat at approximately 48,000 but the base for our $0.78 increase in ARPU is 51% of more consumers buying higher speeds.

Consumer DSL penetration among retail lines is now at 48% and business DSL sales were again strong given ACS’s differentiated symmetrical high speed offering.

I’ll now review the second quarter financial results. In comparing this year to last, it is important to remember that last year the company benefited from a network access supplement of $2.5 million and this year we converted the wireless states to lower national price points, impacting revenue and EBITDA about $1.3 year-over-year. Outside of these two discreet factors that affected the year-over-year comparison the business continues to grow. Total revenues for the quarter were $94.4 million in line with prior year revenues of $94.5 million.

Wireless revenue was $35.3 million up 4.9% of the prior year revenue of $33.6 million. Wireless revenue benefits from a 6.4% increase in average retail subscribers, a 61% increase in better options, a 22% increase in fund roving to $5.5 million and a 10% increase in CETC revenues to $4.6 million. But again some of the growth was muted by lower voice offerings.

Wireline revenues decreased by $1.8 million to $59.1 million. Retail revenue of $23.9 million was broadly in line with year ago levels. Also revenue declined 15% to $5.1 million as line use off net. Access revenue was 13% or $3.2 million lower given we did not have an out of period settlement this year. Enterprise revenue was up 44% or $2.6 million to $8.5 million. We are very satisfied with our progress here and as you recall a key measure of our success is the new revenue generated in this segment.

At the end of Q2 we achieved over two-thirds of our $9 million contribution target which was set to support the cash counting costs of our long haul fiber investments. On to EBITDA. ACS recorded $31 million in the quarter before the $600,000 start up costs for the enterprise segment.

$31 million with $6.2 million left from the prior year of $33.6 million. Here are the components. While this EBITDA margin with 43.3% compared to 47.1% the match to national voice plans, ahead of about 200 basis points EBITDA margin and the investments in customer conversion are behind us and we anticipate higher growth going forward.

While an EBITDA margin was 27% compared to 29.2% compare the differences explained by the one time network access settlement in 2007. Net income before tax was $1.7 million compared to $6.3 million. Net income after tax was $900,000 compared to $6.2 million. The decline reflects one time network access settlement in 2007, start up costs of the enterprise business, higher non-cash depreciation and asset disposal expenses put tax expense this year but not last, and interest expense in April of an additional $125 million convertible note.

Cash from operations was $14.9 million compared to $19 million in the prior year. Major uses of cash during the quarter include $47.2 million in capital expenditures, including $35 million for AKORN build and $9.3 million in dividends.

And now to our financial guidance. Revenues are expected to be in the range of $380 to $390 million versus prior guidance of $385 million to $395 million. EBITDA including start up costs is expected in the range of $128 million to $132 million versus our prior guidance of $130 to $134 million. Start up costs for our fiber investment are now expected to be $4 million versus prior guidance of $6 million. Capex remains unchanged, $42 million for maintenance Capex and $82 million for AKORN, as does net cash interest expense at $33 million.

The changes in 2008 revenue and EBITDA guidance are driven by the reset to wireless, substantially now behind us, the longer enterprise sales cycle, a tiny matter only and lowered expectations for CETC. Now back to Liane for closing remarks.

Liane Pelletier

Thank you David. To summarize, we’re confident our strategy for the long term is there and our ability to execute this exciting transformation is also there. We believe the company can operate the state’s best wireless network for demanding users of mobile, data and voice and the state’s best wireline network for demanding enterprise customers.

We anticipate enterprise success to accelerate as long sales cycle concludes and we grow from a very small position today. We also anticipate renewed growth in wireless, given the state’s first appointment in EBDO Rev A and our programs of conversion behind us.

Before closing prepared remarks, I want to share the news of the change on our board. We welcome Peter Ley as new director. Peter is currently CFO of Connexion Technologies and was previously a managing director in investment banking at Bank of America. Peter replaces Patrick

Pichette who resigned his board seat as he was named the new CFO at Google.

I’m delighted to welcome Peter and I think Patrick for his outstanding service and contributions to ACS. And finally David and I will be scheduling a time in September to meet with investors. If you’d like to meet with us, please contact our investor line at 907-564-7556 or email us at investors@acsalaska.com. With that, I’d like to open the call to questions. Michael.

Question-and-Answer Session

Operator

Thank you Liane. (Operator Instructions) Your first question comes from David Barden – Banc of America Securities.

David Barden – Banc of America Securities

Good evening. Thanks for taking a question. I’ve got a bunch frankly and I’ll try to keep them down. But the first one is David, with respect to the guidance, if I’m not mistaken I look on Bloomberg, basically with this number this quarter you basically came short of consensus expectations by about $2 million. You’ve taken the guidance down by $2 million. So basically are you saying that street models more or less are fine for the back part of the year?

David Wilson

I think when you look at consensus, David, for the entire year it’s not entirely clear to me whether everybody has factored in the start up costs for our AKORN investment, so I think we struggled to a degree to understand exactly what is in and what is out of certain people’s models.

But in terms of the guidance we presented it’s obvious we’re very comfortable with the $128, $132 million range for recurring EBITDA and the $4 million start up costs. So I don’t at my fingertips have an adjusted consensus view for the entire year, but again we’ve provided guidance that we’re comfortable with and in our minds that’s a fair representation of what we think this company can do this year.

David Barden – Banc of America Securities

And I guess when I’m looking at my numbers, I mean you guys beat lines, beat wireless ads, beat churn and beat the wireless number I have after adjusting the stuff you talked about last quarter. And the number that stands out this quarter is network access. It was 24 in the first quarter of ’07, 25, 26, 27, 26, and now it’s 22. And I know there’s this year-over-year delta but it seems like it really went diverged from trends, even figuring that a year ago there was a $2.5 million positive. What happened in access this quarter?

David Wilson

Yes. You’re right. In terms of major delta it is on the access line. We will try to be as explicit as we can be and certainly when you look better at our Q4 release that occurred in mid-March we definitely talked about an extra $10 million in network access that we benefited from in 2007 that was above run rate. And we’ve also talked in the past about the 2006 numbers being about $6 million higher than run rate.

And this quarter there were no major one time benefits network access revenues. They do occasionally happen. I think we’ve had a good run of them through a lot of hard work, but in terms of major benefits on a go forward basis I think less opportunity on a go forward basis than we certainly enjoyed in the past.

David Barden – Banc of America Securities

And the guidance doesn’t assume any change in that one timer aspect of it?

David Wilson

No it does not.

David Barden – Banc of America Securities

And then the – everything in AKORN and Crest is still on track for launch in the first quarter at, you know, some kind of coverage of the run rate expenses and that’s all kind of incremental too to the picture in ’09?

David Wilson

Correct. Yes. We’re delighted with the book of business we’re building up as Liane spoke to earlier in terms of the sales funnel and we’re looking forward to sharing more color as in when we turn AKORN up early in 2009.

David Barden – Banc of America Securities

All right. And I guess my last one guys if you – you kept saying something about uncertainty on CETC cap. Last quarter there didn’t seem to be very much uncertainty about your understanding with respect to the waiver that Alaskan tribal lands would receive from any applications of the cap. Could you be more clear what specifically you mean about the uncertainty?

Liane Pelletier

You’re exactly right. Last fall we shared that there was an expectation that there would be an Alaska carve out and it was intended to continue to give Alaska tribal lands support for all wireless users. The language from the FCC is not in line with that intention and we are in the process of securing some clarity from the FCC on why the language doesn’t seem like it was in line with the intent.

And if I’m clear about timing I think that we had – when was that issued?

David Wilson

I think about a couple of days before we had our call.

Liane Pelletier

Yes. And so we were still digesting it. But nonetheless you’re right. We have a different expectation, I think, as some of our supporters in Washington do as well about what the Alaska carve out means and it doesn’t seem like it’s fully reflected in the FCC language so far. And so that’s our – that’s what we’re referring to there.

David Barden – Banc of America Securities

And is the worse case financial impact in the guidance numbers you have now or no?

David Wilson

Yes. We’ve factored in the guidance number that we wouldn’t receive benefits from the Alaska carve out.

Operator

Your next question comes from Frank Louthan – Raymond James.

Frank Louthan – Raymond James

On the enterprise side I just wanted to get a little more take there. Is that – are we seeing some more competition? Is that maybe what’s driving the sales cycle a little longer? Or is it something – I wouldn’t think it’s as much the economy given Alaska is sort of counter cyclical there but maybe something – some delays coming from some of the lower 48 states base customers. And then with the Rev A rollout do you think you’ll be expanding your roaming agreement with Verizon or any other CDMA carriers on that? And how much could that improve the ARPU if you were to expand that agreement?

Liane Pelletier

The first point, the enterprise sales cycle is extended and there’s a whole range of accounts that we intend to serve and we’re actively selling into commercial, civilian, federal, military federal, and some of the very larger federal ones those contracting vehicles actually have shifted many, many quarters so we were conservative in laying out our year. But even some of those procurement cycles are pushed out.

So it’s not a function of the economy. It’s not a function of having lost against the proposals that we’ve submitted into our target accounts. It really is a timeline matter on the part of the customers. We’re not new at this overall as a management team, so we thought we’d have a conservative outline in our forecast. But our conservative nature’s coming out as we adjust the annual EBITDA guidance for the year.

On Rev A we’re happy to have that in the Alaska network but it truly becomes meaningful as it extends into the lower 49. And we already have it up in a roaming relationship in Canada and we intend to have it up in our roaming relationship in the lower 49 by year end.

Frank Louthan – Raymond James

Can you give us an idea? You said that headcount was down. Can you give us an idea of that? Do you have more – is there more cost cutting that you’re going to be looking to do that would be headcount related or are there other measures?

Liane Pelletier

Frank we’re not positioning for any major headcount reductions. We enjoy a gradual shifting in our workforce and we’re constantly applying process improvement to see if we can change the way we work and not replace people who are retiring, for example. I think we’re down about 2% in terms of total amount. But I think you also heard in the prepared remarks that we’re investing in new skill sets that are going to help us in the enterprise.

So it’s quite a mixed shift that’s going on inside the firm but we don’t have a big headcount program coming up. It’s very gradual and organic, if you will. And we apply process improvement every time we see some reductions happening in our staff.

Frank Louthan – Raymond James

Okay. I’ll just clarify one thing. Your $128 million guidance for lowered EBITDA does that include or exclude the start up costs and where are you on the start up costs, the year-to-date?

David Wilson

So it’s the full start up cost, Frank, so you’d need to take the $4 million off that range number. In terms of where we are so far I think we’ve spent about $800,000 in the first six months. So a little bit back end loaded.

Operator

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

David Coleman – RBC Capital Markets

Just a question on the network access piece, the $21.6 million reported in Q2 is that, I guess, a good base number to estimate future network access revenue since it’s not going to include any kind of one time settlement?

David Wilson

Yes that’s a good base number to think about, Dave. I mean it’s not uncommon that certain favorable circumstances will occur but again at a much slower rate than we’ve enjoyed previously. But in terms of just, say, pure number that’s a good number to work from.

David Coleman – RBC Capital Markets

And then on the wireless ARPU, that was a little lower than we were anticipating. I imagine that didn’t fully take into account the pricing reduction to match AT&T’s, or I guess a national plan reduction. How much of the base would you say is sort of moved over to the new pricing plans? And how much further lower could ARPU go?

Liane Pelletier

We shared that 69% of consumers and 43% of businesses have already taken advantage of the new national price plans and it’s faster than a pro rata plan would have suggested, given when we started consumers and then we feathered in businesses after that. But it is happening in a way you would expect. Those who have the most value to procure are taking advantage of it first. And so the biggest chunk of ARPU hit has already been accomplished. It’s actually $1.3 million year-over-year affect when you look at Q2 ’08 versus Q2 ’07.

David Coleman – RBC Capital Markets

As far as your price inverse competition, would you say it’s more or less in line at a premium discount to the competitor’s pricing for wireless?

Liane Pelletier

Very much in line, Dave.

David Coleman – RBC Capital Markets

The DSL net ads look very weak. I was just wondering what’s going on in that segment at the business?

Liane Pelletier

The market in Alaska was flat overall when you kind of look at the two players who get to release numbers. It’s definitely not a product we promoted to consumers. Our strength in sales was more relative on the business side where we have some metric products.

But you could tell from what we do with our base management is we continue to move people up to higher speed products and so we did see about a 2.6% increase in sequential ARPU for DSL. So that’s sort of where we’ve been allocating our marketing resources, is really in base management.

David Wilson

So just to give you a sense, Dave, on a reported base about 150,000 subscribers it was up about 300, so 2% for the entire market. So again very flat [mark] as a whole.

Operator

Your next question comes from Christopher King – Stifel Nicolaus and Company, Inc.

Christopher King – Stifel Nicolaus and Company, Inc.

Most of my questions have been answered. Just wanted to get one more quick one on wireless, specifically with respect to EBITDA margin and despite the weakness in ARPU’s your margins actually appear to have held up pretty well, certainly versus the last several quarters. I was just wondering if we should expect to see a bit of a ramp up in wireless margins going into the second half now that those pricing plans are in place and certainly given the seasonal strength that you guys see in wireless in the third quarter?

David Wilson

Yes. So in terms of margin, I think we’ve definitely settled down at a reasonable rate in terms of low 40% and a lot of it, I think, in terms of contribution is going to come from scale. So certainly looking at our abilities to drive that and increase the subscriber base, we see as a key growth opportunity there.

We’ll certainly review at cost cutting efficiencies, network efficiencies as and when we can and – but I think from a growth standpoint I think it’s more going to be a scaled pace than an increased margin pace. I think if you look at our EBITDA margins they’re not dissimilar, for example, to the margins endured by AT&T.

Christopher King – Stifel Nicolaus and Company, Inc.

And then just a follow up on the CETC question, I just was wondering if you could clarify a bit what exactly the difference is with the language in the actual FCC order versus what was originally expected? Does it solely relate to the tribal land issue or is there something else that we should be paying attention to there?

Leonard Steinberg

The issue is that there was the exception that was created in the FCC’s order. The intent of the exception for Alaska native regions and tribal lands was to provide increased funding over and support over what is provided by the cap, but at one read it appears as if the FCC may have included language that imposes a primary line restriction which eliminates support for, for example, for family plans if you opt for the exception.

The consequence of that as most folks have looked at it is that carriers would receive less support under the exception than they do as remaining cap. That is just one read and that is why we believe there is an ambiguity and we’re trying to obtain clarification from the FCC. Clearly that is not consistent with the intent of creating an exception from the capped policy. We’re cautiously optimistic that the FCC will agree that that doesn’t implement their intent but we’re still waiting to hear clarification from them.

Operator

At this time we’ll turn the conference back to Liane Pelletier for closing comments.

Liane Pelletier

Thank you, Michael, and thank you all for joining us today. We look forward to sharing our results with you on the call next quarter.

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