ATN International Inc (ATNI) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Atlantic Tele-Network Q3 earnings conference call and webcast. At this time all participants are in a listen-only mode. Later we'll conduct a question and answer session and instructions will be given at that time. (Operator Instructions). As a reminder, this conference call is being recorded.

I would like to introduce your host for today's conference, Mr. Justin Benincasa, Chief Financial Officer. Sir, you may begin.

Thank you, Operator. Good morning, everyone. Thank you for joining us on our quarterly investor call as we review our third quarter results. With me here is Michael Prior, ATN's President and Chief Executive Officer. During the call I'll be covering the relevant financial information and operational data and Michael will be providing an update on business activities.

Before I turn the call over to Michael, I would like to point out that statements in this call and in our press release contain forward-look statements concerning our goals, beliefs, expectations, strategies, objectives, plans, future operating results and underlying assumptions, and are subject to risks and uncertainties that could cause actual results to differ materially from those described.

Also in an effort to provide useful information to investors, our comments today include non-GAAP financial measures. For details of these measures and reconciliation to comparable GAAP measures, please refer to our earnings release on our web site at www.ATNI.com, or to the 8-K filing provided to the SEC.

With that said, I'll first turn the call over to Michael for his comments on the quarter before I provide additional financial and operating details. So I hand it over to Michael.

All right, thank you, Justin. Good morning, everybody. I'm going to give you some overall thoughts on the quarter and then I'm going to get into some details, some update on the transition of the retail wireless assets. I'm also going to spend a fair amount of time on the market dynamics. It's clear that we probably didn't do a good enough job in the last quarter in orienting investors and analysts towards what our expectations were in this quarter, particularly with the sub movements and the expenditures. So I think we'll try to take some extra time today to walk people through those dynamics and make sure we're all speaking the same language. Then I will also cover some of the overlap on the transition expense. That's always a question. Then we'll turn to some other business highlights and developments.

Starting out with the overall view of the quarter, in the third quarter of 2010, I think we saw, again, a major impact on both revenue and, of course, expense of the addition of the Alltel assets and the process of transitioning those operations out of a much larger entity and into our organization. Our approach to the transition continues to be a conservative one and continues to be the one we set out before. Which is we're concentrating on exiting the process in the second quarter of 2011 on time and with a platform of subscribers that we can sustain and grow on a profitable basis and ensure becomes a substantial contributor to overall cash flows. As we have noted in previous quarters, that approach requires us to run a great deal of duplicate and extraordinary expense in the interim. Which clearly makes for some ugly margins. But we're convinced that the actions we're taking and have taken are the best bet for ensuring much better returns down the line.

On that note, let me give you an update on the transition itself. We are continuing to make good progress on two of our most important transition items, systems and network. We have begun internal testing of some transitioning elements and processes. We have also begun to rehome portions enforcement to the network. Rehoming is essentially repointing cell sites to different remote and core switch elements. We have much more to do still, and we have also designed and devoted substantial resources to a rigorous and detailed testing program. This is key to minimizing the risk of any negative impacts on customers when we actually do the changeover. This program will continue over the next quarter with the major transition events beginning in the first quarter 2011.

Our operational headquarters in Little Rock continue to grow. We expect to end to year with over 200 employees on site.

Let me get into the market dynamics, which hopefully will clarify some of the uncertainty. As we talked about before, part of our transition plan is the need to transition the subscriber base and related sales practices to a format that we think we can sustain profitably. These actions are reflected in the relatively high level of net subscriber losses. We're also dealing with, as I'll get into, some of the attributes and practices of the assets, past practices and current attributes to the assets we acquired. And I'll get into that, as well.

So, first, if we look at the gross subscriber addition side of it, we've curtailed several sales channels that brought in a lot of gross adds, but these gross adds were not valuable, were not sensible gross adds. They were gross adds that were costing us money because of the low quality, very high churn attributes of those subscribers. Second, also on the gross add side, we've reassessed and rolled back some of the more aggressive pricing plans for data services, which we did not believe were economically sustainable long-term. Third, on the disconnect side of the subscriber equation, we experienced higher involuntary disconnects because of the sales practices of the trust ownership, such as lowering credit thresholds for postpaid subscribers and rewarding aggressive selling to questionable segments. Fourth, also on the disconnect side, we experienced higher voluntary disconnects, which was expected because it was driven largely by the unusually high number of customer contracts that expired in the quarter. That will continue, to some extent, going forward. This is a very important category for all wireless operators. Customers falling off contract obviously presents a higher churn potential. It was made much larger by the practice deployed in 2009 of greatly expanding the equipment subsidies for one-year contracts, which created a larger than normal bubble in 2010 and into 2011.

Fifth, we also experienced higher voluntary disconnects as we began the separation and reoptimization of our network. This separation from the larger seamless Alltel network requires us to groom network hand-offs that were formerly invisible to Alltel customers. We expect the separation to be complete in the first quarter next year, but our optimization efforts will continue throughout 2011. In addition to the effect on subscriber levels and churn, these factors are also reflected to varying degrees in the current very low margins of the US wireless business, particularly the retail margins, despite robust revenue levels. For example, the network separation I just described has also created roaming expense challenges which is reflected in our margin. As we have observed all along, the geographic composition of our footprint creates inherently higher roaming expense. However, we don't think it's permanent at this level. We're taking a number of actions in various different areas to address that issue over time. But it won't happen overnight.

Another example is the costs required to deal with the contract expiration bubble I just mentioned. Sales and marketing expense, which includes handset and other equipment subsidies, was very high, as many people have noticed in the quarter. That's partly because we're being aggressive with our retention efforts aimed at recontracting the large volume of customers with expiring contracts. Our current subsidies and sales focus is aimed at returning to what's the normal practice of all the carriers on two-year contracts. Reversing that practice requires an extraordinary amount of handset subsidies without directly growing the base. But we're confident it is money well spent, and we also should note we expect this level of spending, which is included in this line item, to peak in the fourth quarter.

Another dynamic that's important to understand, and that I referenced in our earnings release, is that during the transition period, we're using systems that are not operated by us. Therefore, our ability to modify and enhance our service offerings and value proposition is quite constrained. It's likely to remain that way until the middle of 2011 when we are fully operational on our own systems. We also noted our expectation that prepaid subscriber losses will continue and, indeed, might accelerate. That's due to some changes in our distribution channels including the loss of our largest indirect distribution channel because of the shifting Alltel footprint. We have plans and efforts underway to offset all or part of that loss, but it's important to understand we do not expect the impact of those efforts to be evident until later in 2011. That will affect prepaid gross adds, first and foremost, and then from that, because of losing a channel for replenishment, it will also affect prepaid churn or disconnects from that point on.

Transition expense, let me move now to that. This is the overlapping transition expenses that we have talked much about in previous calls. That's also a major driver in the thin margins. First, those expenses are large. They are very large. In some cases, they are fully duplicative of our own internal expenses for a period of time. Second, that duplication will get bigger before it gets smaller. We expect to have heavy overlap in costs until the mid second quarter of 2011. That's why we reiterated in our release that we expect margins to remain quite thin until then. There may be some offset, of course, to this due to the improvement in other costs over the next two or three quaters, but the transition expenses are not expected to improve on their own. As we have noted previously, the overlap is still expected to be heaviest in the late first and early second quarter of 2011.

So to summarize on the retail wireless and the transition, while none of these major developments or attributes of our new US wireless assets was unexpected, there, of course, have been a number of smaller negative and positive discoveries versus our expectations. And as we said, we did spend a little more aggressively on sales and marketing in the third quarter than we initially expected. Overall, we continue to be very happy with the direction of this all important transition and integration work. We're confident we will have a very strong and profitable platform brand value proposition, as well, when we emerge from this process.

On the other side of US wireless and the wholesale business, we did have a bit of a disappointment in the quarter because of the failure of our legacy US wholesale business to show better growth. The quality of the execution was fine. Traffic volumes continued to grow despite a much reduced build plan, but the aggregate volume growth on a year-on-year basis was still not enough to overcome price declines. Keep in mind, as well, that we expect to have a significant net drop in wireless wholesale revenue in the first half of 2011 due to previously discussed overlaps with the Alltel property sold to AT&T. At the same time, we expect free cash flow of this business to continue to expand as we have reduced our rate of new builds.

In other areas, other business highlights for the quarter, during the second quarter we were pleased to have a number of key market launches in the island markets. We launched our 4G WiMAX and mobile 3G business in the Virgin Islands and met with very strong demand, particularly for the WiMAX high speed data service. And we launched our 3G mobile services in Turks and Caicos earlier in the quarter and also experienced strong demand. Together we added around 2,000 subscribers in these relatively small markets for the quarter. In Guyana, the submarine cable launch in July that we spoke about last quarter has also led to a rapid increase of high-speed data subscribers. Even as we have dramatically increased throughput and reliability to all existing customers. I think that improvement in the customer experience will have greater benefits down the line for us. We're also pleased to see continued strength in our wireless offering in Guyana with subscribers and revenue increasing at a steady pace.

So to sum up, the level of expanse in our US wireless business was significantly higher than normal levels in the industry, quite obviously. That's because in large part, as I went through in detail, we were very aggressive on sales and marketing spending, and we also had some unexpected charges and catch-ups through the transition services arrangement. Justin will note a few items there. In addition, we have the roaming expense issue, which we'll continue to work through and continue to improve. Directionally, though, the revenues and thin margins that resulted from transition expense overlap and remediating certain unprofitable sales practices, as well as, of course, managing the negative impact of those practices in the subscriber movement, are in line with our overall expectations. The good news is we believe we are still on track to see retail margins in the 20% to 30% range we talked about post transition. And we're building a sustainable customer base that will support long-term profitable growth and generate significant positive cash flow.

With that, I will turn it over to Justin to give you more on the financials.

Great. Thank you, Michael. Our operating revenues for the quarter totaled $205 million, which was an increase of $138.9 million over the same quarter in 2009. This increase was primarily the result of the Alltel acquisition which generated $129.7 million of the service revenues and $10.5 million of equipment and other revenue. Our total wireless revenues for the quarter were $173 million or 84% of total revenues. And our US wireless segment revenues were $158.8 million, or 77% of total revenues this quarter.

Operating expenses for the quarter totaled $191.1 million and adjusted EBITDA was $37.8 million. Included within the $37.8 million was non-cash stock-based compensation expenses of $556,000. Operating expenses of our US wireless segment accounted for $155.5 million of the $191.1 million and $31 million of the adjusted EBITDA total. As Michael pointed out earlier in his comments, transitional and duplicate expenses did greatly impact the segment's operating expenses this quarter. One item we pointed out in the press release was that approximately $10 million of sales and marketing costs primarily consisting of equipment subsidies and commissions related to moving customers back onto two-year contracts, as Michael covered in some detail.

Reported net income for the quarter was $6.4 million, giving us earnings per share of $0.41. Our effective tax rate was 45% this quarter, reflecting our current mix of taxable income and losses within the various tax jurisdictions we operate.

Turning to the balance sheet, as of September 30, we had cash balances of approximately $62 million and total debt outstanding of $267 million. As we previously disclosed, we closed an additional $75 million expansion of our credit facility at the end of September. This expanded our revolver facility by $25 million to a total of $100 million, which was undrawn at the end of the quarter and included an additional term loan of $50 million. Capital expenditures totaled approximately $39.6 million for the quarter and $91.6 million year to date. For the quarter capital expenditures included $28.8 million in our US wireless business of which almost $19 million was transition related expenses including IT back office, billing and point of sale systems, cell site rehoming and core network equipment. In addition, we incurred an additional $4 million on the undersea cable in Guyana as we wrapped up that project, and $2.3 million on the wireless network buildout in the US Virgin Islands.

Looking ahead to the remainder of 2010, we still anticipate total year capital expenditures to be in the range of $130 million to $140 million. This includes our current estimates for Alltell's capital expenditures plans of $70 million to $80 million. I would like to also offer some additional operating data for the quarter. MOUs in our legacy wholesale markets were $206 million, which is up 15% from Q2 and up slightly from Q3 of 2009. Data traffic was up 38% from Q2 and 114% from the same period last year. We also added a total of 21 base stations in these markets year to date for a total of 601 base stations. In international wireless, we ended the quarter with 293 subscribers in Guyana and 24,000 subscribers in the Islands, up from 277 a year ago in Guyana and up 17% from 20,500 in the Islands.

And with that, I would like to turn the call back to the Operator, please, to take questions.

Thank you. (Operator Instructions). Our first question comes from Rick Prentiss of Raymond James.

Good morning, guys. A couple questions focused on the Alltell side of things. First, as you look at the reporting that you do, the ARPU that you reported was a blended ARPU. Would you be able to share with us the mix on what prepaid ARPU was and postpaid ARPU?

Going forward, we've been talking more about that, Rick, and I think we will start to break that out. One of the things we've been talking about internally is with data, and some of it's arbitrary. So we're just trying to get, as we migrate systems, to try and make sure data comes over correctly, and in the same manner we want to report it. But I think we could probably take that into consideration on the prepaid and post going forward.

I think that will be important because obviously I think the discussion is that we should expect to see accelerated losses, I think I heard, on the prepaid side. So it will just help us understand what the revenue impact is going to be if these truly are low value, low end type customers, how much revenue are you really losing on that side. Also just a cosmetic one on the ARPU, and I think Alltel used to do this previously anyway. It included roaming up into the revenue into the ARPU calculation. I think it helps us also understand what's the real local bill that somebody is paying. So maybe as you look at breaking out pre and postpaid, also breaking out real retail, if you will, instead of retail plus wholesale ARPU would help.

Fair request.

Then moving to the more salient point probably on the gross add side and the disconnects, I understand changing distribution channels so we're going to see a hit to gross add prepaids because you're not going to be bringing as much in until you replace that channel. But on the postpaid side, are you feeling any impact on the ability to add customers or can you give us any color on what the gross adds were on the postpaid side and what you think might be happening going forward on the postpaid gross adds?

I don't think we feel we're at the top of our game on that. And I don't think it's because we don't have a lot of excellent people and employees working on it. I just think that we have, as I noted, a pretty limited tool box in the interim. A lot of the things you do to stay competitive and acquire new customers revolve around new service offerings and tweaks and modifications to that, and what you emphasize. To that extent, we're slightly hamstrung. We certainly expect to do better over time, particularly post transition, on that. So, no, I don't think we're at the top of our game there, at least in terms of results. Did that answer your question?

A little bit. I'm just trying to think, you also mentioned that you reassessed an aggressive data service plan. I assume that was on the postpaid side. Maybe just a little more details on what you meant by that.

That's right. I think there was some pricing on unlimited data plans and other data plans that did not make a lot of sense to us. As we're, again, involved in the transition and understanding the customer base, sifting through the information and figuring out where we want to go to with pricing on that, there's the fix the known problems first, steady it, assess, and then make a movement. So we're not in the "make big movement, launch new initiative" process right now, and again we'll be somewhat constrained on that. But that's part of it. Then the postpaid, the other thing, Rick, that I probably should have mentioned first is some of the postpaid gross adds, a good portion was that we had these indirect channels that were putting a lot of low quality postpaid subscribers on. That was a postpaid issue and not a prepaid issue. And we ceased that during the end of the quarter, I believe it was. We could see a negative on that , but on the flip side we'll see a positive. We expect to see postpaid in churn improve over time as we get that type of add out of the system.

Okay. You mentioned that there was a large chunk that were under one-year contracts. I think, did I hear correctly there's still a bubble to come then as far as in fourth quarter?

That's right. Unfortunately for us, this was a practice the trust ownership instituted, marketed very heavily beginning in May of '09. Up until when we took over ownership and we stopped it immediately. Now that would tend to say it will go all the way through April, but it won't go through at the same level because we've been aggressive in trying to turn it over. And you also expect in the fourth quarter a fairly high degree of that. It will be with us through the entire transition period, but it's to a lesser degree.

Post quarter.

Yes, that's right.

Okay. Thank you.

Our next question comes from Barry McCarver of Stephens.

Good morning, guys. So continuing that question about that bubble moving into the 4Q, can you give us an idea of what churn might have looked like in October , given the last 3Q?

No, we're not going to give inter quarter numbers. But I think none of those factors we discussed are gone at the end of September. So we will be dealing with that as we go through the fourth quarter, as well.

Okay. Then to make sure I understand your comments on the expense side, I think we understand the duplicate expense numbers. But in terms of specifically the additional marketing and customer service expenses that you point out in the press release, are those expected to continue at the same high level moving into 4Q as well?

Yes. I think that's a safe assumption.

And that's partly because of the nature of fourth quarter for all the carriers. You tend to have the highest level of that expense in the fourth quarter any way, it's the prime selling season.

And that goes hand in hand with what we were just talking about and working through those subscribers on the one-year contracts trying to move them over to two.

Okay. Then I know it's probably a long shot, this question, but can you give us an idea of the dollar amount of the duplicate costs you're running in the third quarter?

I think we'd rather not just because there's an awful lot of give and take in those balances. It gets a little bit where if we start giving that, it gets run rated and stuff, because there are stuff that's coming in there. Some things come positive. One element we haven't really fully -- on the positive side is USF ETC. We haven't received that yet so that would be on the positive side. So we get hesitant to give too much of that.

But the transition expense -- another way to answer that -- that is why we tried to give where we expect margins, admittedly the range is broad, but where we expect the margins to be post transition. And the single biggest change in margins is absolutely the overlapping transition expense.

Right. So still real comfortable with the 20% to 30% once we get April of next year?

Yes.

Okay. Thank you.

Thank you. (Operator Instructions). Our next question comes from Chris King of Stifel Nicolaus.

Good morning. Thank you for taking the question. Just wanted to drill down a little bit from a competitive standpoint, particularly regarding the voluntary disconnects on the post pay side of the Alltel business. Was wondering if you have seeing any increase in competitive activity either from Verizon or any of the other national carriers once you guys took over? Have they put their foot to the pedal in any kind of meaningful way that you can see at this point?

No. I don't think so. Verizon is our main competitor. And of course they are a formidable competitor, they are very strong. But I think one of the things that makes them strong at the size they are is they have a very overall national view to a lot of what they do. We haven't seen anything at a high level directed. We don't think that's a major part of the dynamic. But the competition is strong. They are a strong competitor, there's no doubt.

To follow up on that, I don't know if you have drilled down into this level of detail yet, but do you guys have a sense as to the percentage of customers that have smartphones or integrated their devices in your base right now, at least on the postpaid side of things? And is that any more or less than it is for Verizon Wireless at the national level?

I'm not sure what it is on the national level but about 30% of our overall base is smartphones. Although I will say we're adding the percentage on our upgrades in gross adds is greater than that, so it's increasing.

Okay. Thank you very much.

Thank you. Our next question comes from Hamed Khorsand of BWS Financial.

Good morning. I want to first start off with a simple question. Could you provide us with access lines in Guyana.

There's 149,000.

So unchanged. What was the Sovernet's business lines?

Hang on one second. I'll get that for you. 49,000.

Okay. My main question is that on the Commnet side of the business, you're growing the base stations, but it seems like there's a continuous decline in pricing. You were talking about more declines to come in the first half of 2011. How much more can it decline from here?

We don't have a complete control or crystal ball on that, but I would say we have within relatively recent period have had price declines and cut prices for all the major carriers now. The last one happening in this most recent quarter.

Okay. You're also suggesting that there's another price cut to come in Q1 though. If I'm doing simple math I'm running at --

No, I think you're misreading. What we suggested that's coming in Q1 is we've been talking about for almost a year now that at some point we're going to lose a fair amount of volume, a fair amount of traffic because of the AT&T acquisition of some of the Alltel assets. We originally thought that would impact us in third, fourth quarter 2010 and now we're saying we expect that impact to be mainly in the first and second quarter of 2011 starting in the first quarter. Is that what you're referring?

Yes, that helps. Then on the US retail business, it seems like EBITDA margins right now are running negative.

No. They are not negative. We don't break it out because it's a combined business, but they are not running negative.

Given the cost structure of the business, would margins continue to be at these levels or can we expect expenses to increase before we start to peak out in Q2 of next year?

We don't expect a major improvement in the margins in the fourth quarter. And depending on the selling activities, they could tighten. We do think some of the, at least on the selling expense, some of these things will start to improve in 2011 with no -- the real major improvement, again, is post transition in April.

Okay. And last question is you guys have been talking all morning about involuntary disconnections? But how about voluntary? Are you done with those, the voluntary disconnects?

You'd have to ask our customers. I'd love to say we're done with them. I didn't mean to be too facetious. But if we're done with the higher level, I think that, yes, we would expect that the voluntary disconnects will tend to improve over time. We're sorting through some of these edge issues I described. They are probably the biggest contribution to that.

Okay. Thank you.

Thank you. We have a followup question from Mr. Rick Prentiss from Raymond James.

I wanted to drill down a little further, if we could. On the $10 million item on the sales and marketing side, should we look at that as being primarily subsidies on handsets to get people to extend their contracts? And if so, just some quickie math, $10 million, say, $200, is that 50,000 subs you touched with that? Or how should we think about that $10 million?

It's primarily subsidies, but it also includes sales commissions too.

Another way to think of it is it's more than half, but it's not 90% or above of that number.

There were some other items in that $10 million outside of just the subsidies, but the majority of it was the subsidies and sales commissions

I'm just trying to think of how much you're having the subs. Obviously you don't have an iPhone so you're not having to eat all that kind of subsidy. But is it reasonable to think you're having to jack the subsidies up? Do you plan on maybe reporting a CPGA number, cost per gross adds, so we can get a sense of what it's costing?

I think it's safe to say our subsidies were probably a little bit higher than what you might expect otherwise. I don't know on the CPGA. We're thinking through that right now, as well. There's a lot of moving parts on it. That's why we're trying to be smart about what we give.

Which again, when Justin says that, we are getting in the transition period, we get a lot of our data from a unit that we don't control and you can't necessarily slice and dice and have the comfort level in all the little smaller components of data that you would if it's your own systems and people.

I understand, while you're asking for data. Also, any sense about how much universal service fund revenues you're collecting?

You're talking about the reimbursement?

Yes. Not from the customer but reimbursement revenue back to the Company from the USF fund.

Zero right now.

Really?

Yes.

But we do expect to have that kicked back in coming quarters perhaps starting in the fourth quarter.

I would assume the trust is collecting some of that because once you get to ETC status you would think it comes in.

You have to reapply. I'm probably not the person to ask, but you have to reapply. So it was in the trust, but we're in the process of reapplying and getting it approved and getting it going again.

You have to reapply state by state, I assume?

Correct.

Then data. 30% of smartphones in your base, assume postpaid base. That's a pretty impressive number, actually. Have you had a chance -- I know I'm slicing it many ways you probably don't know the answers to -- but do you know what data ARPU is on a postpaid basis?

We haven't given it. The reason for that, Rick, it goes back to what I was saying before. Data revenues, it's an allocation. So it's somewhat arbitrary. I think we feel until we move all that stuff over to our systems and reinput those allocations, we're hesitant to give it because then we have to, once we get it on to our own system --

We can't control the fluctuations.

Okay. Then final question. You had mentioned on the expansion on the financing availability that one of the items might be growth initiatives. What are your thoughts as far as which segment of the businesses might get growth initiatives?

Some of that is certainly would be what we talked about before on the retail wireless platform in terms of rounding out the footprint. So in terms of organic growth initiatives, that's one of them. That's probably the biggest one. We also have, some of the other things we've been doing offshore including in Guyana, there's a lot of pent-up demand, which we saw realized on the data side. We'll have to expand the access network to continue to tap that demand.

Any thoughts on the other side of the coin, that given some of the disparate footprint of maybe in the future after you get it all inhouse from the trust, maybe there's some market that might make sense selling?

Like any company, I think we look at all those strategic alternatives. We don't foreclose anything. I think we like the scale we have right now, I would tend to say. I think we're tending to look more towards growth than contraction. But you never say never. You listen to ideas.

Might as well throw one more about towers. How many towers do you own and is there any thought you might monetize those?

It's one of the things we're looking at.

We own a little over 225 towers, I believe. That's my understanding. There's more in there, but some of it is the American Tower stuff that they own.

So is 225 the ones you own, you think?

Yes, 225 is what we own.

Okay. Thanks.

Thank you. I'm showing no further questions. I'd like to turn the call back over to management for closing remarks.

That's all we have, everyone. Thank you for joining us. We'll see you in another quarter

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all now disconnect. Thank you and have a nice day.