Alaska Communications Systems Group, Inc.
Q4 2007 Earnings Call Transcript

Published: 24 Mar 2008

[Operator:]

Ladies and gentlemen thank you for standing by and welcome to the Alaska Communications System fourth quarter 2007 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) This conference is being recorded today, Monday, March 17, 2008. Now, I’d like to turn the conference over to Ms. Mary Gasperlin. Please go ahead ma’am.

[Mary Gasperlin:]

Good afternoon and welcome to the Alaska Communications System’s fourth quarter and year end 2007 conference call. With me today are Liane Pelletier, President, Chief Executive Officer and Chair 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 US securities laws. Forward-looking statements are statements that are not historical facts and may include financial projections and estimates 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. We expect to file our most recent 10K for the year ended December 31, 2007 later this week. You are strongly encouraged to carefully review the 10K; it will contain a comprehensive restatement of 2006 and 2007 financial results and other useful information. An 8K containing our earnings press release was filed prematurely by Business Wire before trading markets closed. Our earnings press release was issued subsequent to market close. These materials contain no differences in information. 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. Then David will review our quarterly and annual operational and financial performance after which Liane will close with a summary and then open the call for questions. With that, I’d like to turn the call over to Liane.

[Liane J. Pelletier:]

Welcome and thank you all for participating on the call today. First, let me say I am disappointed we weren’t able to bring you our results last month. As you know from our last release we’ve been working through some accounting issues. The effect of the accounting changes was to increase our 2007 EBITDA performance by nearly $6 million and to increase non-cash depreciation by $5 million. While I’ll let David Wilson walk you through those details I want to assure you that the issues were isolated and a function of very complex outward models, that our internal controls have been strengthened and that we don’t intend for this to ever happen again. Now, let me share the results of our 2007 performance. We closed 2007 with another year of superb execution with growth in top line, bottom line and cash from operations each exceeding 10%. Of particular importance, wireless revenues grew 19% and enterprise wireline revenues grew 45%. As you know we anticipate a substantial ROI in the enterprise segment as we bundle our differentiated long haul fiber to the lower 48 with our metro Ethernet, our MPLS and our instate fiber transport system for sophisticated users. We also anticipate a continued high ROI in the wireless segment even as we face a changed brand. The company’s wireless business model builds on fast network performance with additional differentiators. Specifically, having earned the reputation of best network, the company has turned to earning the reputation of best plans and best service. We intend to enhance an already loyal customer base by proactively serving it in many new ways. Our strategies, operating priorities and budgets for the year contemplate investing for success in the enterprise and wireless segments as these two segments drive the greatest return to shareholders. Let me turn the call over to David Wilson for our operational financial review of the fourth quarter and year 2007. David First I will review the operational details of our retail portfolios in 2007 starting with wireless where we gained 13,500 retail subscribes in the year and nearly 3,000 in the quarter. Notable is that retail wireless retention improved by 20 basis points both annually and sequentially with average monthly churn 1.5% for the quarter. Total retail ARPU for the quarter was up $3.78 or 6.3%, year-over-year to $64.20. The ongoing migration of high value and high use subscribers to the best network in the state coupled with data ARPU of $3.31 were the key drivers of the retail ARPU expansion. On to wireline, where local retail lines declined 1.5% during the quarter as more consumers cut the cord, our local line mix shifted towards business with a higher value business lines now accounting for more than 50% of our retail lines. Our DSL customers grew by nearly 1,300 or 2.7% during the quarter to 47,500 as DSL penetration of retail lines expanded to 25.6% and the mix within the DSL continues to swing towards higher speeds. Before providing the financial review I will provide a quick overview of the accounting issues we’ve been dealing with in the past month. Firstly, the need to restate depreciation expense for 2006 and the first three quarters of 2007. This issue centers on a rare set of facts and circumstances that are applicable to ACS and which require complex accounting treatments under FAS 71 accounting for the effects of certain types of regulations. Due to our unique set of circumstances we were forced to develop our own software to address the accounting implications, with a programmatic error within this software that caused the issue. Secondly, the increase in EBITDA from $132 million expectations we shared on February 22 and $138 million we reported today. The major driver of this change was a $4.5 million increase in network access revenue and the corresponding decrease in network access reserves. The reserve release is attributable to a change in estimates following management’s review of assumptions used in our network access revenue reserving process. Both of these issues we have implemented additional controls and procedures to prevent repetition. Additional details on these issues together with certain other immaterial adjustments that are common during a restatement process are included in our Form 10K which we expect to file with the SEC later this week. Now, I’ll review the fourth quarter 2007 financial results compared to the fourth quarter 2006. Revenue were $99.1 million up 7.9% from fourth quarter 2006 revenues of $91.9 million. Wireless revenue was up 7.6% over the year ago period. Wireline revenue was up 8.1% from the fourth quarter 2006. As set out in schedule four of the release, we’ve improved visibility into the revenue drivers of retail, wholesale, access and enterprise. The components of each of these segments will be described in our 10K. Fourth quarter retail wireline revenue was up 1.4% from the prior year due in large part to a higher number of DSL subscribers. On to wholesale where wholesale wireline revenue declined by 20.9% versus the prior year to $5.6 million consistent with a 29.7% reduction in CETC lines offset in part by 17% increase in CETC ARPU. Access revenue gained 12.1% to $26.6 million benefitting from periodic carrier settlements and the release of additional access revenue reserves. Four quarter enterprise revenue was up 64% and 12.7% sequentially to $7.9 million benefitting from carrier and commercial wins demonstrating success out of the Q1 2009 launch of Alaska Oregon network also as AKORN. On to EBITDA, which was $34 million in the fourth quarter up 7.9% from $31.5 million in the prior year. 2007 wireless EBTIDA performance was strong from ongoing operations yet was also affected by non-recurring expenses of $700,000 while 2006 wireless benefited from $2.4 million from out of period CETC. These two factors resulted in an EBITDA margin of 41.3% in Q4 2007 versus 50.1% in Q4 2006. Normalizing for these items wireless EBITDA margin was comparable to the prior year. Wireline EBITDA increased 28.4% over the prior year quarter to $19.6 million with gains in enterprise and access out pacing CETC losses. Net income for the quarter was up $120.4 million or $2.71 per diluted share compared to $4.2 million or $0.10 per diluted share in 2006. Net income benefitted from a one-time non-cash income tax benefitted of $111.2 million arising from the release of the company’s valuation reserve for its deferred tax assets. Absent this non-recurring tax benefit earnings per diluted share would have been $0.20 compared to a year ago net income of $0.10 per share. Cash flow from operations of $26.6 million were in line with 2006 which benefitted from out-of-period CETC funding. Major investments in uses for cash during the quarter included $21.4 million in capital expenditures comprising of $11.8 million in maintenance cap ex and $9.6 million in growth cap ex and $9.2 million in dividend payments. For the full year 2007 revenues of $385.8 million and EBITDA of $138.1 million both increased by more than 10% from 2006 levels. Cash from operations increased 14.3% to $104.9 million from $91.8 million. Investments in construction in capital expenditures total $60.9 million comprising maintenance cap ex of $39.3 million and investments in growth cap ex of $21.6 million. Now, for 2008 financial guidance. Revenues for the full year 2008 are expected to be in the range of $385 million to $395 million and EBITDA in the range of $130 to $134 million excluding $6 million in startup cost related to the enterprise segment. Specifically, cost for lower 48 network operation centers to compliment the Alaska center and business startup costs such as hiring staff located near our enterprise customers in the lower 48. Net cash interest expense is expected to be approximately $30 million. ACS expects maintenance cap ex of $42 million. The investment in our fiber facility of $82 million. Our cap ex guidance excludes capitalized interest. At the midpoint of EBITDA guidance and inclusive of $6 million in startup costs for AKORN distributable cash flow of $54 million, funding a dividend of $37 million on 43 million shares at $0.86 per share and retained cash of $17 million. Our payout ratio is projected to be 69% again, based on the midpoint of 2008 EBITDA guidance and pro forma for working capital movements in line with our policy to payout 70 to 75% over the long term. ACS expects to incur certain costs during 2008 which were outside of key guidance metrics. These include depreciation expense of approximately $70 million, stock-based compensation expense of approximately $7 million and non-cash tax expense of approximately $8 million. In order to gage our 2008 EBITDA target, 2007 should be normalized for network access revenues that management estimates was $10 million higher than long term trend driver by favorable carrier and other regulatory settlements and $700,000 in out-of-period CETC revenue received in the first quarter. These factors put 2007 EBITDA at $127.4 million. Based on the midpoint of our 2008 guidance and pro forma to the startup costs of our AKORN investment, guidance represents a 3.6% increase over normalized 2007 in line with our long term growth expectations of 3 to 4%. We expect solid growth for the year. Year-over-year comparisons for the first quarter may differ from your expectations. First quarter 2007 benefitted from $1.4 million in network reserves true up and $700,000 in out-of-period CETC neither of which will repeat in 2008. First quarter 2008 costs include the final portion to covert TDMA users to CDMA where we’ll turn down approximately 2,300 subscribers. The quarter also absorbed the front loading of new wireless program costs and costs associated with our accounting review. Before handing the call back to Liane I’ll provide a quick update on the timing and funding strategy for our fiber build. We continue to plan to fund the investment through a combination of cash on hand, cash generated from the build period and incremental debt. We continue to expect the fiber system to be operational early Q1 2009. [Inaudible] investments of approximately $105 million, $13 million was settled in 2007 leaving a residual $92 million to be funded by the end of February, 2009. At year end we had $36 million in unrestricted cash and short term investments, full access to our $45 million revolver and net debt leverage ratio of only 2.9 times and a dividend payout ratio of just under 70%. The total investment of $105 million represents an increase from the $95 million shared in our third quarter call and is primarily attributable to a more protected and therefore costlier landing of the cable of the Oregon cost, high structural network costs due to the demands placed on the Alaskan construction industry, a change in the Anchorage cable landing site, due to changed airport plans and now including all program management, internal labor and overhead costs. The total annual cash costs are expected to be approximately $12 million covering both operating and debt service costs. Now, back to Liane for closing remarks.

[Liane J. Pelletier:]

In closing, we posted strong results in 2007 and the same team is focused on delivery in 2008. Our game plan is to pursue high ROI in the enterprise and wireless market. It will be a very dynamic year for the ACS team and we feel we’ve been preparing for this transformational year for quite some time. Our priorities for 2008 are clear, we will continue to grow wireless by providing the best customer experience. We know we hold the reputation for best network. Customer research, a study of best practices and smart strategy will guide us to win the reputation for best plans and best services and through them we aim to win more high value subscribers, greater ARPU and higher retention in 2008 and beyond. We will build and enterprise customer base that values an end-to-end Ethernet NPOS and diverse fiber path to and from the lower 48. And, as always, we will continue to leverage our resources through process improvements. As we look to the future, ample opportunities exist to continue to extract efficiencies in the way we operate to both improve the customer experience and accommodate the demands of growth. That closes our prepared remarks so now I’d like to open the call for questions.

[Operator:]

(Operator Instructions) Our first question comes from the line of Dave Coleman with RBC Capital Markets. Please go ahead.

[David Coleman:]

Just a question on your guidance, if I look at the 4Q revenues of $99 million and I annualize that for 2008 and get towards the high end of your 2008 revenue guidance, I’m just wondering if there’s a reason being more conservative or if I’m miscalculating there? Second question, just on the I guess you call it AKORN network, wondering if you could quantify the committed or anticipated book of business for that long haul fiber network? If it’s not possible to quantify it, if you could speak about interest from carriers and enterprises, how that’s changed since announcing the build out? Then final question, Dave you mentioned that you have the credit facility now that’s fully available, what’s the maturity date on that facility?

[David Wilson:]

Let me start off Dave in terms of the first question which was if I look at four times Q4 revenue, how does that compare to guidance? I think we’re pretty clear in our prepared remarks that we did benefit from a higher than normal network access revenue. It’s probably about $3 million or so in the fourth quarter so if you were to normalize Q4 and take out that $3 million and you would then times that number by four I think you get close to our base end of our guidance for the year.

[David Coleman:]

Okay. So think about that more like a $95 to $96 million?

[David Wilson:]

Yeah, I think that’s a fair way to think about it. Then, in terms of the maturity, let me just answer that one quickly, the facility was a seven year facility we entered into it in February, 2005 so we have until 2012 [inaudible], for the revolver.

[Liane J. Pelletier:]

On AKORN, we are very happy with the dialogue we are having with the customers we are presenting that end-to-end solution. And, as you heard in the remarks, its statewide facilities, Ethernet NPOS, the diverse path and a lower 48 knock which is receiving a lot of interest from our customers. That’s probably all that’s prudent to share on this call.

[Operator:]

Our next question comes from the line of Jonathan Chaplin with JP Morgan. Please go ahead.

[Jonathan Chaplin:]

Just two quick follow ups, I’m wondering – you guys won a big contract in the third quarter, a big enterprise contract, I think it was worth $6 million a year. I’m wondering if you’ve signed any incremental contracts in the fourth quarter that you’re able to speak to? And, I’m not quite sure I got the comment on the bank facility correct. If the bank facility is secured, if you guys have actually drawn down on that, I know in the past that was one of the thresholds you were looking to get past before you’d consider increasing the dividend again. So, if that sort of funding is now absolutely secured, I’m wondering what else prevents you from raising the dividend? Then finally, on the fiber investment, it sounds like the investment is going to be about $10 million greater than you initially anticipated. I’m wondering if you could talk about how this has impacted your expected returns from the investment? On the other side of the investment, now that you’re a number of months into this process, what are the perspective revenues and EBTIDAs on the investment look like?

[David Wilson:]

Let me just clear off the facility first Jonathan and I think Liane will pick up the other two questions. In terms of the $45 million we referred to as part of the prepared remarks, that simply refers to the revolver, that revolver capacity has been there since February of 05. And, in terms of the remarks we had in the last call, we talked about securing $30 to $40 million of incremental debt and we’re prepared to do that but that is not yet in place.

[Liane J. Pelletier:]

Jonathan let me pick up on the other ones, you’re right the Q3 enterprise account we won was of the value you talked about and yes we’ve continued to add to that with [inaudible] in the fourth quarter. I guess one of the quickest ways to take a peek at that is schedule four behind the press release talked about the new view and you can see enterprise revenues as a line item there just looking at the Q4 over Q4 sort of numbers. In terms of the nature of building one of these complex systems, these are obviously relatively unanticipated changes and I’ll put a little more color on them. We had a focus on leaving Alaska in a very diverse way so that customers could feel good about putting some or all of their traffic on the AKORN system. The airport trumped our landing station and had us move another place which caused us to incur some incremental one-time build costs there. Similarly, the Oregon cost we have decided for security reasons of the asset to put it not necessarily deeper because we always intended to do deep burial but, further out on the shelf and that only comes about when you do more boring and more work with the local fishing community, etcetera. So, those are very legitimate, we have construction costs of the [inaudible] going on in Alaska and it’s a very hot market right now, the construction community gets to call their rates so that moved up slightly. The whole message behind this though is that the IRR on the project is still very well north of 20% so you should feel fine about that. As it relates to kind of giving an outside view of what revenues and EBITDA is, it doesn’t serve us well to give those very detailed contract schedule wins and I think as we’ve also shared in the past, we want to get the financing in place and the numbers to cover the carry cost for the cable before we work with the board on dividend decisions. We’re very pleased with the progress we’ve had so far both in constructing it on schedule and in the feedback we’re getting from accounts who are very interested in the full product placement this represents.

[Operator:]

(Operator Instructions) Our next question comes from the line of Chris King with Stifel Nicolaus. Please go ahead.

[Christopher C. King:]

Two quick questions for you, first of all which is nothing more than a bit of a housekeeping issue at this point, we’ve seen a nice increase in interexchange revenues in the second half of the year. I was just wondering how much of that could be contributed to the new enterprise contract that was signed in the third quarter? Second question would be with respect to your views on the macro economic outlook, how impacted is your business plan for AKORN based on a macroeconomic environment specifically in Alaska? We’re obviously seeing a worsening economic outlooks from everybody here over the last several weeks but on the flip side of that you guys are obviously much more pleased with the $100 barrel of oil prices than we are in the lower 48. So, I just wanted to get your sense in terms of the puts and takes of the macroeconomic landscape in Alaska and how you guys think about that vis-à-vis AKORN.

[Liane J. Pelletier:]

Why don’t I take it and then send it back for David to discuss the LD revenue piece. You’re absolutely right to observe that there’s something counter cyclical about the Alaska economy although we don’t want to be too naïve about the negative sentiment that we understand is happening nationwide. But, there’s a couple of factors that I think might be relevant for those who don’t study the particulars in Alaska. Yesterday, our state announced that we have a record revenues at the state level of $8.5 billion, it is clearly influenced by the taxes that are collected from the oil producers. So, as we might have shared in the past, every dollar increase in the price of a barrel of oil is well over $100 million infusion into the state coffers and that does come back out and effect here. Relative to some of the other metrics we can compare to the rest of the US, we’re number 42 among 50 states in mortgage defaults. Alaska didn’t experience the housing bubble nor are we experiencing some of the mortgage default crisis that are hitting some of the states in the lower 48. We do see tremendous continued strength in AKORN from the enterprise users and fundamentally Chris it is because businesses years ago changed how they do business. They are much more globally driven, they have operations throughout the world and that just means that there’s a growing appetite for bandwidth connections among their work locations, their vendors and suppliers, etcetera. So, we really see that $200 million market that was under pinning the AKORN investment as solid and in fact, many of the kinds of users only increasing their appetite for bandwidth connections.

[David Wilson:]

Chris, in terms of the interexchange revenue, it’s a highly seasonal segment for us. We tend to see a big uptick in the second and third quarter. I presume you’re looking at year-over-year growth of about $1.8 million from $4.2 to $6 million. That gain, essentially all of it is attributable to success in the enterprise segment.

[Operator:]

(Operator Instructions) Our next question comes from the line of David Janazzo with Merrill Lynch. Please go ahead.

[David Janazzo:]

Can you describe the wireless environment these days with AT&T taking over Dobson?

[Liane J. Pelletier:]

It’s a brand change, we knew it was coming and in fact, they spent time talking to the market all fourth quarter. I think the effects of that you should see in our Q4 numbers, we had terrific retention rates churn of 1.5 which is coming down from what we had of 1.7 and very strong ARPU, 64. So while we have just put, as David said in his remarks, our customer conversion headaches behind us, we just shut off 2,300 TDMA analog subscribers, I’m so happy to celebrate that, AT&T has now the start of that whole process in front of them as does the other competitors as a matter of fact. So, the influence of a new brand in the market, we’re doing well in the face of it and they will have to go through a lot of customer conversion pain and agony as we celebrate having that behind us.

[Operator:]

(Operator Instructions) We have no further questions so I would like to turn it back over to Liane.

[Liane J. Pelletier:]

Thank you all for dialing in today. We look forward to having you join us on the first quarter earnings call. Take care.

[Operator:]

Ladies and gentlemen that does conclude our conference for today. Thank you for your participation and for using AT&T. You may now disconnect.