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Executives

Michael Allen – Vice President, Investor Relations

Anand Vadapalli – President and CEO

Wayne Graham – Chief Financial Officer

Leonard Steinberg – General Counsel

Analysts

Frank Louthan – Raymond James

Julia Senior – Bank of America

Alaska Communications Systems Group, Inc. (ALSK) Q3 2012 Earnings Call November 1, 2012 5:00 PM ET

Operator

Good day ladies and gentlemen. Thank you for standing by. Welcome to the Alaska communications Systems third quarter earnings conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator instructions). As a reminder, this conference is being recorded today, Thursday, November 1st, 2012.

I’d now like to turn the call over to Leonard Steinberg, General Counsel. Please go ahead sir.

Leonard Steinberg

Good afternoon. And welcome to Alaska Communications third quarter 2012 conference call. I am Leonard Steinberg, General Counsel and with me today are Anand Vadapalli, President and Chief Executive Officer of Alaska Communications and Wayne Graham, Chief Financial Officer.

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, estimations of shareholder returns, or other descriptions of the company’s business plans, objectives, expectations, or intention.

You’re 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.

Important risk factors regarding our expected results such as Verizon’s entry into the Alaska market and FCC rule changes have substantial disclosures in our most recent SEC filings and in our Form 10-K and Form 10-Q. We would encourage investors to refer to these documents.

Any non-GAAP measurements referred to during the call have been reconciled to their nearest GAAP measure. You may find this reconciliation in today’s press release and our FCC filings on our investor’s website at www.alsk.com. Following our remarks we will open the line for questions.

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

Anand Vadapalli

Thank you Leonard and welcome to everyone on the call today. Over the last year, we’ve charted a new trajectory for Alaska communications and are performing on this plan to strengthen your company for the long term. First, we are 10 months into executing to a business plan, focused on increasing retail broadband revenues in a billion dollar and growing telecom market in Alaska, while strengthening our balance sheet through dealer reaching program. Second, we announced the AWN transaction, which positions us to provide the most expansive, fastest wireless services in Alaska and even more importantly, allows us to further accelerate dealer reaching.

I’m pleased to report solid progress on both fronts. Let me start with a business update. We’re adding new business customer relationships every day. The new small medium business team we created this year, combined with our enterprise sales team is ahead of their sales plan and we expect to close the year with about 25% more in monthly sales compared to last year. With the refresh of our home and business broadband products, more of our customers are moving into higher bandwidth products and we’re seeing sequential and year over increases in broadband output.

Broadband revenues as a percentage of retail revenues are now at 46%, up 10% over last year. Our wireless business continues to show strength with connections and our pool increasing. Importantly, we launched our 4G LTE network a few weeks ago with three devices and multicon. This is the most extensive deployment of 4G LTE in Alaska today.

Adjusted EBITDA performance was at record levels for the quarter, up 12% year-over-year. We knew we were making investments in our business in the first half of the year. We also shared with you that the elevated levels of device subsidies in the second quarter would be managed. We have and with our spending returning to more normal levels, we are now seeing the benefits on our bottom line. More importantly, we expect to maintain and build on this performance going into 2013 and beyond.

Leading onto our works and sales service I discussed previously, other drivers of our performance include a robust product funnel and road map. There are customers who continue to see value add products later this year and through the course of next year. We’re adding additional sales people for our business segment where we see continued opportunity to grow revenues and our continued investment in systems and process, both of which will further simplify how we conduct business and improve the speed and quality with which we deliver our services.

Moving on to AWN. First, as a reminder, AWN makes us stronger by allowing us to better compete with new entrants giving us the most expansive and advanced wireless network in the state and an accelerated path to deleveraging. In fact, we’ll use $65 million of the initial $100 million proceeds to pay down debt upon closing of the transaction. In the four months since we announced the deal, we’ve secured two important agreements and in the process moved the overall business forward for future success.

First, we’ve signed a three year extension to our collective bargaining agreement. In addition to securing an agreement from the IBEW to move forward with AWN, this also positions us well for the future. For new employees, this agreement allows us to introduce defined contribution plans and cost sharing for defined benefit plans. The agreement also allows us to pursue options to perform work at lower cost while providing certain job security protections for our valuable employees and implementing a new success share compensation model. This have substantial improvements in our labor relations model and reflect a shared commitment with the IBEW to secure our future.

Second, we now have an amended credit agreement in place with our lender group. This now brings me to the last part of my opening remarks. While we’ve made progress to position our business for growth and long term value creation, we’re also mindful that the telecom business continues to undergo rapid change. The traditional cash cow businesses such as voice are seeing an acceleration of erosion while the businesses with significant growth opportunities such as broadband data require increasing amounts of capital. We are experiencing these same trends. We compete with many companies for capital and the strongest companies are getting stronger by reducing their levels of debts and driving down their cost of capital.

As an example, some of the strongest companies in our sector have leverage ratios below three and a half times EBITDA. Our board has considered these industry trends. The merits of the AWN transaction, the strength of our business plan and determined that a well capitalized balance sheet with the lowest cost of capital, best positions us for success to drive long term value creation.

At the same time, it goes without saying that our lenders are equally keen in accelerated deleveraging on our part. Timing a dividend suspension now to accelerate deleveraging secure better terms for us as we negotiated our credit agreement. Consequently, our board has elected to suspend the common stock dividend. The $8 million of cash that was used to pay dividends will now be used to accelerate our debt pay down, with every dollar of deleveraging creating value for all shareholders.

With two AWN milestones achieved, our focus on executing to our plan and growing our business has never been stronger. We have one of the strongest brands in Alaska, with a reputation for reliability, customer service, trustworthiness and local community presence. These are the things that our customers value the most and this is why they buy from us.

With that, let me hand the call over to Wayne to review the results of the quarter. Wayne?

Wayne Graham

Thank you, Anand. As we discuss our quarterly results, I’ll first be focusing on schedule five for the recent press release. Total revenues for the quarter were strong at $96.8 million, up $6.5 million or 7.2% on a year-over-year basis. Our key areas of focus are similar strong performance. Total business in wholesale revenue increased to $26.5 million, compared to $25.3 million last year, representing 4.6% year-over-year growth.

The retail service revenue categories were strong, led by growth in retail service broadband revenue which was $8.6 million for the quarter, an increase of $26 million over last year or 7%. Wholesale revenue was $11.6 million, an increase over last year of $1 million or 9.3%.

Moving to wireless revenue which was $40.5 million, up $5.7 million or 16.5% year-over-year. As expected, roaming revenue led the way, increasing $5.4 million. Retail service revenue increased led by strength in broadband service revenue which grew $0.9 million and was partially offset by erosion in voice revenue which declined $0.6 million.

Consumer revenue is now experiencing solid performance from historical trends of decline and stands at $9.7 million. Consumer broadband retail service revenue was up $0.3 million year-over-year, which offset decline in voice and other revenue.

Access and CETC revenue was $20.1 million and as expected was down $0.4 million year-over-year. The decrease was caused by lower CETC and lower interest state carrier compensation, partially offset by higher interest state access revenue as a result of rule changes effective last year.

Turning to schedule 6 of the press release, you will find our operating metrics. We experienced strong performance in the quarter, led by an increase in wireless connection sequentially of 925 and 3479 year-over-year. Wireless broadband RPU was strong at $19.70, growing 5.1% sequentially and 17.1% year-over-year. However, erosion in voice revenue partially offset these increases, with overall retail wireless RPU increasing $0.53 sequentially.

On a sequential basis, business and consumer broadband connections excluding the impact of dial-up erosions, saw a slight uptick and stand at 19,063 and 38,491 respectively. Importantly, broadband RPU, whether from a business or consumer strengthened with business broadband RPU growing 2.3% sequentially and 7% year-over-year and consumer broadband RPU growing 2.3% sequentially and 12.3% year-over-year.

Now moving to schedule 4. Adjusted EBITDA for the quarter excluding $0.6 million of expenses associated with the AWN transaction stood at $36.6 million or $3.8 million higher on year-over-year basis. Adjusted EBITDA benefited from higher revenues and moderated growth in operating expenses in the third quarter.

Turning to schedule 1 to review our operating cost. After excluding the AWN cost, SG&A expense increase $0.7 million and was caused primarily by higher sales and service expenses. Cogs increased $1.8 million or 5.3%. The increase was due in part to higher roaming cogs in our wireless business.

Finally, free cash flow was strong and stood at $13.1 million, up 21.2% year-over-year. Strong free cash flow is translating into strong cash positions. We ended the quarter with over $25 million in cash, an increase of approximately $3 million from the previous quarter. this is a solid level of performance especially given AWN transaction expenses paid this year.

We paid down $9.3 million of debt on year-to-date basis and we continue to have access to $30 million under our revolving credit facility, representing 100% of available capacity.

Our guidance for the rest of the year is unchanged from previous guidance and is as follows. We expect revenues of between $355 million and $365 million. Adjusted ABITDA of approximately $120 million. CapEx of $54 million to $57 million and free cash flow which is adjusted EBITDA minus capital spending and cash interest expense of $28 million to $34 million. We continue to target free cash flow to delever. Please note that all guidance excludes costs associated with the AWN transaction.

Now let me hand the call back to Anand.

Anand Vadapalli

Thank you, Wayne. I’m very pleased with our performance this quarter, but also very mindful that we all have seen a substantial reduction in the value of our share price over the last year. Three things have caused a fundamental shift in our business. One, the future entry of a national competitor in the wireless market. Two, material changes by the FCC in the regulatory framework for our sector and three, having to deal with these two substantial external events while we had a balance sheet with high debt and historically we’re using most of our free cash to pay a dividend.

We’ve said we needed to go on the offense to address these issues and we could not cut our way to sustain our free cash flow. Our board has elected to preserve and build the long term value of the business. We must make deleveraging a priority, just as we made investing in the business a priority. We acknowledge the near term impact to our shareholders, but we believe that this course of actions strengthens us for the long term.

We are confident in our business plan and we are showing we can perform. Here is what I believe will come out of this, a stronger company. Alaska is a great place to do business. We have a stable economy and have not been subject to pressures felt by other parts of the country. Our market is large and is growing. Our brand is strong. We add customer relationships not because we are the lowest cost provider. Our customers value our reliability, our customer service, our trustworthiness and our local community presence. This is a testament to our employees who make all these real for our customers every single day. We generate strong cash flows. We are investing in our network, our products and our sales and service capabilities. These investments will sustain our momentum in the upcoming months and quarters to come.

AWN gives us a competitive framework for wireless given the rising future entry and allows to accelerate deleveraging. We remain on track to close the transaction by second quarter 2013. With our accelerated deleveraging plan, we expect to be one of the best cap lays telecom companies in Alaska. Every dollar of debt paid down is a dollar of value created for our shareholders. I look forward to reporting on our progress in future quarters.

Thank you for participating in the call today. Operator, please open the line for questions.

Question-and-Answer Session

Operator

Thank you sir. (Operator instructions). And our first question is from the line of Frank Louthan with Raymond James. Please go ahead sir.

Frank Louthan – Raymond James

Could you let us know specifically what concerned the banks over your lending agreements that an additional 1.7% of debt repayment per year was that important to them that you would take the step of going ahead and further cutting the dividend?

Anand Vadapalli

Frank, this is Anand. Thank you for the question. Let me take a first shot at that. Let’s go back a year and take a look at where we were that time. We had the business plan. We were looking at the entry of Verizon and rule changes from the FCC and we knew we had to reduce our debt. Now if I can go back to my prepared remarks, over the last year we’ve executed on the AWN transaction. We have three quarters of performance under our belt and we have seen companies in our sector strengthen their balance sheets by reducing their leverage down to three, three and a half our times level. So as we begun discussions with our lender group, rightfully so they were as focused as we were on deleveraging as fast as we could. And we had an opportunity to get favorable terms by making a decision now to accelerate deleveraging. So this certainly gave us the catalyst to make the decisions we did and the amortization rate that you see in there is a reflection of that which certainly starts at a certain rate in the first year, increases in the next couple of years and then stabilized thereafter. Certainly we think we’re creating value by developing on our business plan as we’ve done over the last few quarters and every dollar of deck that we pay down moves and affects value to our shareholders. So looking forward Frank to continue to deliver on the plan and delivering and hopefully I’ve answered your question.

Frank Louthan - Raymond James

Well, not really. A dollar debt going to shareholders that was truly your go too, so what-- so again what specifically has changed and all of a sudden 1.7% of your debt paid down per year is all of a sudden so important that-- something must have changed because you’ve had Linder Groups for a while and something-- this seems like a relatively small amount of additional repayment that’s kind of a pretty negative impact on your shareholders. So what specifically made them suddenly less willing to lend to you or is it going to net out in lower interest payments? How does this really benefit because again it was true a year ago?

Anand Vadapalli

Good follow up. Here is how I would take that, I would answer the question. I would rather look at the overall in terms of you’re making through this process. If you look at the debt payment this year, we’ve already paid down $10 million. We have our converges coming up from surety and our plans to pay them as scheduled, right? And then when the transaction closes, we’re using $65 million of the proceeds up front, of the $100 million up front to be level. So then in and of itself there’s fairly substantial deleveraging happening in short order.

And then what you see as the amortization grade, reflects an ongoing commitment that frankly it is definitely at a higher level than they would be at today, but that’s just continuing the trend that we’ve started with substantial one-time deleveraging happening here in short order. And then the quick amortization is a reflection of us finding the right balance between debt repayment and investing in the business. That was really important to use that we preserver the ability to invest in the business. We are, and thank to me, growing the business is the most important thing that we can do along with paying down the debt. And collectively in mind that’s what creates shareholder value.

Frank Louthan - Raymond James

Okay, again this was probably the case six months ago and a year ago but I’ll just let that go. Next question quickly then I’ll get off you launched LPE with the most extensive LP in the state. How are you defining the most extensive LPE in the state? And I guess specifically can you compare either your pop coverage or square miles or something number of market relative to AT&A and Verizon?

Anand Vadapalli

Well yes Frank. Again thanks for a great question let me respond to that first. If you look at our competition, Verizon is not in the market yet so it’s hard to say, define when they’ll be in the market. Though when I look at what’s going on with respect to their bill, I find it hard to believe that they’ll be in market before second quarter of next year. But that’s just me I don’t have any specific information from-- there is no specific announcement from Verizon.

With respect to AT&T, we saw some announcements come through for LTE in Alaska but beyond that, based on what we’ve seen, that’s likely just in the anchorage market. So when we look at what we have done with LTE, it’s in the major population centers in Alaska. And certainly, what we have now is just the first phase and we’ll continue to do more as we go into next year. I probably at this time once we are comfortable getting into a purple square mile coverage, but for sure we know we have far more extensive coverage in the market.

Frank Louthan - Raymond James

Thank you.

Operator

Thank you. (Operator instructions).

And our next question is from Julius Senior with Bank of America. Please go ahead.

Julia Senior – Bank of America

Hey guys thanks for taking a question. I guess just a couple. How are you thinking about target leverage? Is it the 3½ times is that we’re going at or is it something different? And I mean till it gets to that end, is there other things you need to do like cut CapEx flow where you otherwise would have been to kind of drive in that direction.

And obviously it’s a bit premature to ask but I will anyways. In the longer term, do you see this as a dividend-paying business? Is we can get to whatever your target leverage may be and then just separately, on the Wireline side it looks like active line declined it actually picked up in the same quarter. Please kind of talk about what might be driving that. Thanks.

Anand Vadapalli

Julia this is Anand thank you for the question. Let me take a first shot at it and I’ll see if Wayne wants to add anything beyond what I have said. So first, in terms of how we look at the business, we know Julia we are creating value everyday by growing our customer relationship, by growing retail revenues and by growing broadband service (and interest). And to our executing on that business plan and making sure that our investments in that plan are not compromised, that’s really important to us.

That being said, the other part of creating value is strengthening the balance sheet and deleveraging. We are not setting a specific target leverage ratio. Yes, we have a 3½ times covenant in the amendment clarity amendment, but that being said I would not plead that as a target that we’re shooting for. It’s a milestone, but that-- but to be honest when we get to those kinds of leverage levels, there are other levels that open up for us to create more value for all our shareholders. Our focus right now Julia is to get into our plan. We’re investing in the business and we’re growing it we’re taking care of our customers and I feel good about how we’re doing in the marketplace.

Wayne Graham

I could ask a question now (inaudible) series of questions one of them had to do with (just one erosion) (inaudible) we do see a bit of a pick-up and we’re addressing that in some product promotions here coming up. And what we’re seeing is just more erosion particularly in the (inaudible) part of the business. We’re offsetting that by really strong performance in broadband whether it’s connections in (inaudible) I think we’re really also like the fact that our turn in those poor metrics have improved as we move to the year.

Julia Senior – Bank of America

Okay great. I guess you sort of addressed the future CapEx but I guess is it safe to say that you will kind of continue with whatever plan of investment you already had?

Wayne Graham

Well, we’ve got a deal with what our close closing capital spending will be once we close the AWN transaction. But I think once we launched our long-term plan we’ve been pretty clear to everybody that we will see higher levels of capital spending and what we otherwise traditionally invested. So we don’t-- we’ll find a plan to reduce capital spending in our wireline business and particularly even after we close the AWN transaction.

Julia Senior – Bank of America

Okay great. Thanks guys.

Operator

Thank you. At this time I’d like to turn the call back to management for additional remarks.

Anand Vadapalli

No, I’d like to thank everyone for joining the call today, we appreciate it and look forward to speaking to you in the future.

Operator

Thank you sir. Ladies and gentlemen this concludes Alaska Communications Systems third quarter earnings conference call. If you’d like to listen to your replays to this conference, please dial 1-800-406-7325 or internationally at 303-590-3030 with access code 4568287 followed by the pound sign. ACT would like to thank you for your participation and you may now disconnect.

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