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As filed with the Securities and Exchange Commission on August 14, 2002.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-5890
GCI, INC.
(Exact name of registrant as specified in its charter)
STATE OF ALASKA 91-1820757
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2550 Denali Street
Suite 1000
Anchorage, Alaska 99503
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (907) 265-5600
Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (l) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
$180,000,000 9.75% Senior Notes due August 2007
1
INDEX
GCI, INC.
A WHOLLY OWNED SUBSIDIARY OF GENERAL COMMUNICATION, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2002
Page No.
--------
Cautionary Statement Regarding Forward-Looking Statements.................................................3
PART I. FINANCIAL INFORMATION
Item l. Consolidated Balance Sheets as of June 30, 2002
(unaudited) and December 31, 2001..................................................5
Consolidated Statements of Operations for the
three and six months ended June 30, 2002
(unaudited) and 2001 (unaudited)...................................................7
Consolidated Statements of Stockholder's Equity
for the six months ended June 30, 2002
(unaudited) and 2001 (unaudited)...................................................8
Consolidated Statements of Cash Flows for the six
months ended June 30, 2002 (unaudited)
and 2001 (unaudited)...............................................................9
Notes to Interim Condensed Consolidated Financial
Statements.........................................................................10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................................................18
Item 3. Quantitative and Qualitative Disclosures About
Market Risk...........................................................................37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.....................................................................37
Item 6. Exhibits and Reports on Form 8-K......................................................38
Other items are omitted, as they are not applicable.
SIGNATURES................................................................................................39
2
Cautionary Statement Regarding Forward-Looking Statements
You should carefully review the information contained in this Quarterly Report,
but should particularly consider any risk factors that we set forth in this
Quarterly Report and in other reports or documents that we file from time to
time with the Securities and Exchange Commission ("SEC"). In this Quarterly
Report, in addition to historical information, we state our future strategies,
plans, objectives or goals and our beliefs of future events and of our future
operating results, financial position and cash flows. In some cases, you can
identify those so-called "forward-looking statements" by words such as "may,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," "project," or "continue" or the negative of those words
and other comparable words. All forward-looking statements involve known and
unknown risks, uncertainties and other important factors that may cause our
actual results, performance, achievements, plans and objectives to differ
materially from any future results, performance, achievements, plans and
objectives expressed or implied by these forward-looking statements. In
evaluating those statements, you should specifically consider various factors,
including those outlined below. Those factors may cause our actual results to
differ materially from any of our forward-looking statements. For these
statements, we claim the protection of the safe harbor for forward-looking
statements provided by the Securities Reform Act. Such risks, uncertainties and
other factors include but are not limited to those identified below.
- - Material adverse changes in the economic conditions in the markets we serve
and in general economic conditions, including the continuing impact of the
current depressed telecommunications industry due to high levels of
competition in the long-distance market resulting in pressures to reduce
prices, an oversupply of long-haul capacity, excessive debt loads; several
high-profile company failures and potentially fraudulent accounting practices
by some companies;
- - The financial, credit and economic impacts of WorldCom's bankruptcy filing on
the industry in general and on us in particular;
- - The efficacy of the rules and regulations to be adopted by the Federal
Communications Commission ("FCC") and state public regulatory agencies to
implement the provisions of the 1996 Telecom Act; the outcome of litigation
relative thereto; and the impact of regulatory changes relating to access
reform;
- - Our responses to competitive products, services and pricing, including
pricing pressures, technological developments, alternative routing
developments, and the ability to offer combined service packages that include
local, cable and Internet services;
- - The extent and pace at which different competitive environments develop for
each segment of our business;
- - The extent and duration for which competitors from each segment of the
telecommunication industries are able to offer combined or full service
packages prior to our being able to do so;
- - The degree to which we experience material competitive impacts to our
traditional service offerings prior to achieving adequate local service
entry;
- - Competitor responses to our products and services and overall market
acceptance of such products and services;
- - The outcome of our negotiations with incumbent local exchange carriers
("ILECs") and state regulatory arbitrations and approvals with respect to
interconnection agreements;
- - Our ability to purchase network elements or wholesale services from ILECs at
a price sufficient to permit the profitable offering of local telephone
service at competitive rates;
- - Success and market acceptance for new initiatives, many of which are
untested;
- - The level and timing of the growth and profitability of new initiatives,
particularly local telephone services expansion, Internet (consumer and
business) services expansion and wireless services;
- - Start-up costs associated with entering new markets, including advertising
and promotional efforts;
- - Risks relating to the operations of new systems and technologies and
applications to support new initiatives;
- - Local conditions and obstacles;
3
- - The impact of oversupply of capacity resulting from excessive deployment of
network capacity;
- - Uncertainties inherent in new business strategies, new product lau nches and
development plans, including local telephone services, Internet services,
wireless services, digital video services, cable modem services, digital
subscriber line services, and transmission services and the offering of these
services in geographic areas with which we are unfamiliar;
- - The risks associated with technological requirements, technology substitution
and changes and other technological developments;
- - Development and financing of telecommunication, local telephone, wireless,
Internet and cable networks and services;
- - Future financial performance, including the availability, terms and
deployment of capital; the impact of regulatory and competitive developments
on capital outlays, and the ability to achieve cost savings and realize
productivity improvements and the consequences of increased leverage;
- - Availability of qualified personnel;
- - Changes in, or failure, or inability, to comply with, government regulations,
including, without limitation, regulations of the FCC, the Regulatory
Commission of Alaska, and adverse outcomes from regulatory proceedings;
- - Uncertainties in federal military spending levels and military base closures
in markets in which we operate;
- - The ongoing global and domestic trend towards consolidation in the
telecommunications industry, which trend may be the effect of making the
competitors larger and better financed and afford these competitors with
extensive resources and greater geographic reach, allowing them to compete
more effectively;
- - The effect on us of pricing pressures, new program offerings and market
consolidation in the markets served by our major customers, WorldCom and
Sprint; and
- - Other risks detailed from time to time in our periodic reports filed with the
SEC.
You should not place undue reliance on any such forward-looking statements.
Further, any forward-looking statement, and such risks, uncertainties and other
factors speak, only as of the date on which they were originally made and we
expressly disclaim any obligation or undertaking to disseminate any updates or
revisions to any forward-looking statement to reflect any change in our
expectations with regard to those statements or any other change in events,
conditions or circumstances on which any such statement is based, except as
required by law. New factors emerge from time to time, and it is not possible
for us to predict what factors will arise or when. In addition, we cannot assess
the impact of each factor on our business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statements.
4
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
ASSETS 2002 2001
- --------------------------------------------------------------------------- ---------------- ---------------
(Amounts in thousands)
Current assets:
Cash and cash equivalents $ 8,957 11,097
--------------- ----------------
Receivables:
Trade 66,184 58,895
Employee and other 2,754 2,036
--------------- ----------------
68,938 60,931
Less allowance for doubtful receivables 13,879 4,166
--------------- ----------------
Net receivables 55,059 56,765
--------------- ----------------
Deferred income taxes, net 5,137 4,690
Inventories 4,282 3,462
Prepaid and other current assets 2,711 3,061
Property held for sale 518 481
Notes receivable with related parties 171 182
--------------- ----------------
Total current assets 76,835 79,738
--------------- ----------------
Property and equipment in service, net of depreciation 399,418 395,887
Construction in progress 13,166 8,121
--------------- ----------------
Net property and equipment 412,584 404,008
--------------- ----------------
Cable certificates, net of amortization of $26,884,000 at June 30, 2002
and December 31, 2001 191,132 191,132
Goodwill, net of amortization of $7,200,000 at June 30, 2002 and December
31, 2001 41,191 40,940
Other intangible assets, net of amortization of $1,444,000 and $1,252,000
at June 30, 2002 and December 31, 2001, respectively 3,001 3,387
Deferred loan and senior notes costs, net of amortization of $6,696,000
and $5,568,000 at June 30, 2002 and December 31, 2001, respectively 6,533 7,630
Notes receivable with related parties 5,572 3,246
Other assets, at cost, net of amortization of $15,000 and $70,000 at June
30, 2002 and December 31, 2001, respectively 5,457 4,598
--------------- ----------------
Total other assets 252,886 250,933
--------------- ----------------
Total assets $ 742,305 734,679
=============== ================
See accompanying notes to interim condensed consolidated financial statements.
5 (Continued)
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Continued)
(Unaudited)
June 30, December 31,
LIABILITIES AND STOCKHOLDER'S EQUITY 2002 2001
- -------------------------------------------------------------------------- ---------------- ----------------
(Amounts in thousands)
Current liabilities:
Current maturities of obligations under long-term debt and capital
leases $ 38,161 7,346
Accounts payable 35,340 36,464
Deferred revenue 11,967 11,129
Accrued payroll and payroll related obligations 10,506 15,289
Accrued interest 8,245 8,049
Accrued liabilities 5,955 4,697
Due to related party 5,022 5,160
Subscriber deposits 1,323 1,121
---------------- ----------------
Total current liabilities 116,519 89,255
Long-term debt, excluding current maturities 324,125 346,000
Obligations under capital leases, excluding current maturities 44,588 44,933
Obligations under capital leases due to related party, excluding
current maturities 713 703
Deferred income taxes, net of deferred income tax benefit 26,503 25,069
Other liabilities 5,009 4,339
---------------- ----------------
Total liabilities 517,457 510,299
---------------- ----------------
Stockholder's equity:
Class A common stock. Authorized 10,000 shares; issued and outstanding 100
shares at June 30, 2002 and December 31, 2001 206,622 206,622
Paid-in capital 44,493 44,902
Retained deficit (26,043) (27,152)
Accumulated other comprehensive income (loss) (224) 8
---------------- ----------------
Total stockholder's equity 224,848 224,380
Commitments and contingencies
---------------- ----------------
Total liabilities and stockholder's equity $ 742,305 734,679
================ ================
See accompanying notes to interim condensed consolidated financial statements.
6
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
-------------- -------------- --------------- --------------
(Amounts in thousands)
Revenues $ 92,740 85,535 180,950 182,452
Cost of sales and services 30,861 33,831 62,098 75,917
Selling, general and administrative expenses 32,585 27,629 63,886 54,619
Bad debt expense 10,616 1,964 11,197 2,824
Depreciation and amortization expense 14,283 13,700 28,998 27,639
-------------- -------------- --------------- --------------
Operating income 4,395 8,411 14,771 21,453
-------------- -------------- --------------- --------------
Interest expense 6,236 8,074 12,827 16,957
Interest income 155 99 228 262
-------------- -------------- --------------- --------------
Interest expense, net 6,081 7,975 12,599 16,695
-------------- -------------- --------------- --------------
Net income (loss) before income taxes (1,686) 436 2,172 4,758
Income tax (expense) benefit 583 (270) (1,063) (2,169)
-------------- -------------- --------------- --------------
Net income (loss) $ (1,103) 166 1,109 2,589
============== ============== =============== ==============
See accompanying notes to interim condensed consolidated financial statements.
7
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
Shares of Accumulated
Class A Class A Other
(Unaudited) Common Common Paid-in Retained Comprehensive
(Amounts in thousands) Stock Stock Capital Deficit Income (Loss) Total
-----------------------------------------------------------------------------
Balances at December 31, 2000 100 $206,622 29,941 (31,741) --- 204,822
Net income --- --- --- 2,589 --- 2,589
Contribution from General Communication, Inc. --- --- 13,655 --- --- 13,655
-----------------------------------------------------------------------------
Balances at June 30, 2001 100 $206,622 43,596 (29,152) --- 221,066
=============================================================================
Balances at December 31, 2001 100 $206,622 44,902 (27,152) 8 224,380
Components of comprehensive income:
Net income --- --- --- 1,109 --- 1,109
Fair value of cash flow hedge, net of income tax
liability of $151 --- --- --- --- (232) (232)
-----------
Comprehensive income 877
Contribution to General Communication, Inc. --- --- (409) --- --- (409)
-----------------------------------------------------------------------------
Balances at June 30, 2002 100 $206,622 44,493 (26,043) (224) 224,848
=============================================================================
See accompanying notes to interim condensed consolidated financial statements
8
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
2002 2001
-------------- --------------
(Amounts in thousands)
Operating activities:
Net income $ 1,109 2,589
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 28,998 27,639
Amortization charged to selling, general and administrative --- 17
Non-cash cost of sale --- 10,877
Deferred income tax expense 1,158 2,028
Bad debt expense, net of write-offs 9,713 1,851
Deferred compensation and compensatory stock options 634 675
Write-off of capitalized interest --- 170
Other noncash income and expense items 18 54
Change in operating assets and liabilities (11,705) (227)
-------------- --------------
Net cash provided by operating activities 29,925 45,673
-------------- --------------
Investing activities:
Purchases of property and equipment (36,192) (28,443)
Advances and billings to Kanas Telecom, Inc. --- (5,632)
Payment of deposit --- (1,200)
Notes receivable issued to related parties (3,055) (304)
Payments received on notes receivable with related parties 858 754
Purchases of other assets (940) (895)
Cash received upon acquisition of Kanas Telecom, Inc. --- 228
-------------- --------------
Net cash used by investing activities (39,329) (35,492)
-------------- --------------
Financing activities:
Repayments of long-term borrowings and capital lease obligations (395) (12,595)
Long-term borrowings - bank debt 9,000 ---
Payment of debt issuance costs (250) (81)
Cash contribution from (to) General Communication, Inc. (1,091) 1,116
-------------- --------------
Net cash provided (used) by financing activities 7,264 (11,560)
-------------- --------------
Net decrease in cash and cash equivalents (2,140) (1,379)
Cash and cash equivalents at beginning of period 11,097 5,962
-------------- --------------
Cash and cash equivalents at end of period $ 8,957 4,583
============== ==============
See accompanying notes to interim condensed consolidated financial statements.
9
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
The accompanying unaudited interim condensed consolidated financial statements
include the accounts of GCI, Inc. and its subsidiaries and have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements. They should be read in conjunction
with our audited consolidated financial statements for the year ended December
31, 2001, filed as part of our annual report on Form 10-K. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. The results of operations
for the interim periods ended June 30, 2002 and 2001, are not necessarily
indicative of the results that may be expected for an entire year or any other
period.
(1) General
In the following discussion, GCI, Inc. and its direct and indirect
subsidiaries are referred to as "we," "us" and "our."
Basis of Presentation
We were incorporated in 1997 to effect the issuance of senior notes. As a
wholly owned subsidiary of General Communication, Inc. ("GCI"), we
received through our initial capitalization all ownership interests in
subsidiaries previously held by GCI.
(a) Business
We offer the following services:
- Long-distance telephone service between Anchorage, Fairbanks,
Juneau, and other communities in Alaska and the remaining United
States and foreign countries
- Cable television services throughout Alaska
- Facilities-based competitive local access services in Anchorage,
Fairbanks and Juneau, Alaska
- Internet access services
- Termination of traffic in Alaska for certain common carriers
- Private line and private network services
- Managed services to certain commercial customers
- Broadband services, including our SchoolAccess(TM) offering to
rural school districts and a similar offering to rural hospitals
and health clinics
- Sales and service of dedicated communications systems and related
equipment
- Lease and sales of capacity on two undersea fiber optic cables
used in the transmission of interstate and intrastate private
line, switched message long-distance and Internet services
between Alaska and the remaining United States and foreign
countries
(b) Principles of Consolidation
The interim condensed consolidated financial statements include the
accounts of GCI, Inc., GCI, Inc.'s wholly-owned subsidiary GCI
Holdings, Inc., GCI Holdings, Inc.'s wholly-owned subsidiaries GCI
Communication Corp., GCI Cable, Inc., and GCI Transport Co., Inc.,
GCI Holdings, Inc.'s 85% controlling interest in GCI Fiber
Communication Co., Inc., GCI Communication Corp.'s wholly-owned
subsidiary Potter View Development Co., Inc., GCI Cable, Inc.'s
wholly-owned subsidiary GCI American Cablesystems, Inc., GCI
American Cablesystems, Inc.'s wholly-owned subsidiary GCI
Cablesystems of Alaska, Inc., GCI Transport Co., Inc.'s
wholly-owned subsidiaries GCI Satellite Co., Inc., GCI Fiber Co.,
Inc. and Fiber Hold Co., Inc. and GCI Fiber Co., Inc.'s and Fiber
Hold Co., Inc.'s wholly-owned partnership Alaska United Fiber
System Partnership ("Alaska United"). All significant intercompany
transactions have been eliminated.
10 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
(c) Earnings Per Share and Common Stock
We are a wholly owned subsidiary of GCI and, accordingly, we are
not required to present earnings per share. Our common stock is not
publicly traded.
(d) Sale of Fiber Optic Cable System Capacity
During the first quarter of 2001 we completed a $19.5 million sale
of long-haul capacity in the Alaska United undersea fiber optic
cable system ("fiber system capacity sale") in a cash transaction.
The sale included both capacity within Alaska, and between Alaska
and the 48 contiguous states south of or below Alaska ("Lower 48").
We used the proceeds from the fiber system capacity sale to repay
$11.7 million of the Fiber Facility debt and to fund capital
expenditures and working capital.
The fiber system capacity sale contract gave the purchaser an
indefeasible right to use a certain amount of fiber system capacity
and expires on February 4, 2024. The term may be extended if the
actual useful life of the fiber system capacity extends beyond the
estimated useful life of twenty-five years. The fiber system
capacity sold is integral equipment because it is attached to real
estate. Because all of the benefits and risks of ownership have
been transferred to the purchaser upon full receipt of the purchase
price and other terms of the contract meet the requirements of
Statement of Financial Accounting Standard ("SFAS") No. 66,
"Accounting for Sales of Real Estate" we accounted for the fiber
system capacity sale as a sales-type lease. We recognized $19.5
million in revenue and $10.9 million in cost of sales from the
fiber system capacity sale during the first quarter of 2001.
The accounting for the sale of fiber system capacity is currently
evolving and accounting guidance may become available in the future
which could require us to change our policy. If we are required to
change our policy, it is likely the effect would be to recognize
the gain from future sales of fiber system capacity, if any, over
the term the capacity is provided.
(e) Concentrations of Credit Risk
Financial instruments that potentially subject us to concentrations
of credit risk are primarily cash and cash equivalents and accounts
receivable. Excess cash is invested in high quality short-term
liquid money instruments issued by highly rated financial
institutions. At June 30, 2002 and December 31, 2001, substantially
all of our cash and cash equivalents were invested in short-term
liquid money instruments.
We have two major customers, WorldCom, Inc. ("WorldCom") (see note
6) and Sprint Corporation. We may experience increased risk
associated with these customers' accounts receivable balances. Our
remaining customers are located primarily throughout Alaska.
Because of this geographic concentration, our growth and operations
depend upon economic conditions in Alaska. The economy of Alaska is
dependent upon the natural resources industries, and in particular
oil production, as well as tourism, government, and United States
military spending. Though limited to one geographical area and
except for WorldCom and Sprint Corporation, the concentration of
credit risk with respect to our receivables is minimized due to the
large number of customers, individually small balances, and short
payment terms.
(f) New Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 141, "Business Combinations." SFAS No. 141 requires
that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. Use of the
pooling-of-interests
11 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
method will be prohibited on a prospective basis only. Adoption of
SFAS No. 141 has not had a significant impact on our results of
operations, financial position or cash flows.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 142 provides accounting and reporting
standards for intangible assets acquired individually, with a group
of other assets, or as part of a business combination. This
statement addresses how acquired goodwill and other intangible
assets are recorded upon their acquisition as well as how they are
to be accounted for after they have been initially recognized in
the financial statements. Under this statement, goodwill and other
intangibles with indefinite useful lives, on a prospective basis,
will no longer be amortized, however will be tested for impairment
at least annually, based on a fair value comparison. Intangibles
that have finite useful lives will continue to be amortized over
their respective useful lives. This statement also requires
expanded disclosure for goodwill and other intangible assets.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 replaces
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of. However it retains the
fundamental provisions of SFAS No. 121 for recognition and
measurement of the impairment of long-lived assets to be held and
used and for measurement of long-lived assets to be disposed of by
sale. This statement applies to all long-lived assets, including
discontinued operations, and replaces the provisions of APB Opinion
No. 30, Reporting Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, for the disposal of segments
of a business. This statement requires that those long-lived assets
be measured at the lower of carrying amount or fair value less cost
to sell, whether reported in continuing operations or in
discontinued operations. Adoption of SFAS No. 144 has not had a
significant impact on our results of operations, financial position
or cash flows.
(g) Reclassifications
Reclassifications have been made to the 2001 financial statements
to make them comparable with the 2002 presentation.
(2) Consolidated Statements of Cash Flows Supplemental Disclosures
Changes in operating assets and liabilities consist of (amounts in
thousands):
Six month periods ended June 30, 2002 2001
------------- ------------
Increase in accounts receivables $ (7,819) (7,503)
(Increase) decrease in inventories (820) 981
Decrease in prepaid and other current assets 455 200
Increase (decrease) in accounts payable (1,124) 2,160
Increase (decrease) in deferred revenues (162) 899
Increase (decrease) in accrued payroll and payroll related obligations (4,783) 924
Increase in accrued interest 196 425
Increase in accrued liabilities 1,258 1,849
Increase (decrease) in subscriber deposits 202 (115)
Increase (decrease) in components of other long-term liabilities 892 (47)
------------- ------------
$ (11,705) (227)
============= ============
12 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
We paid interest totaling approximately $12,631,000 and $16,532,000
during the six months ended June 30, 2002 and 2001, respectively.
GCI, Inc., as a wholly owned subsidiary and member of the GCI controlled
group of corporations, files its income tax returns as part of the
consolidated group of corporations under GCI. Accordingly, the following
discussion of an income tax payment and refund reflects the consolidated
group's activity. We received an income tax refund of approximately
$95,000 and $0 during the six months ended June 30, 2002 and 2001,
respectively. We paid income taxes totaling approximately $0 and $61,000
during the six months ended June 30, 2002 and 2001, respectively.
(3) Intangible Assets
Effective with the adoption of SFAS No. 142, "Goodwill and Other
Intangible Assets" on January 1, 2002, goodwill and cable certificates
(certificates of convenience and public necessity) are no longer
amortized. The following pro forma financial information reflects net
income as if goodwill and cable certificates were not subject to
amortization for the three and six months ended June 30, 2001 (amounts in
thousands):
Three Months Ended Six Months Ended
June 30, 2001 June 30, 2001
----------------- -----------------
Net income, as reported $ 166 2,589
Add cable certificate amortization, net of
income taxes 430 1,406
Add goodwill amortization, net of income
taxes 124 348
----------------- -----------------
Adjusted net income $ 720 4,343
================= =================
Cable certificates are allocated to our cable services reportable
segment. Goodwill is primarily allocated to the cable services segment
and the remaining amount is not allocated to a reportable segment, but is
included in the All Other category in note 5.
Amortization expense for amortizable intangible assets for the three and
six months ended June 30, 2002 and 2001 follow:
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
---------- ----------- ---------- ----------
Amortization expense for intangible assets $ 181 1,805 387 3,554
========== =========== ========== ==========
13 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Amortization expense for amortizable intangible assets for each of the
five succeeding fiscal years is estimated to be (amounts in thousands):
Years ending
December 31,
2002 $ 760
2003 374
2004 229
2005 123
2006 119
No intangible assets have been impaired based upon impairment testing
performed as of January 1, 2002.
(4) Long-term Debt
Efforts to refinance our Senior Holdings Loan and Fiber Facility are
presently on hold due to the WorldCom bankruptcy and current financial
market conditions. We plan to aggressively pursue a refinancing of these
facilities when market conditions improve. Upon completion of such a
refinancing we expect to recognize $2.7 million to $2.9 million as an
infrequent loss attributed to remaining unamortized loan costs.
(5) Industry Segments Data
Our reportable segments are business units that offer different products.
The reportable segments are each managed separately and offer distinct
products with different production and delivery processes.
We have four reportable segments as follows:
Long-distance services. We offer a full range of common-carrier
long-distance services to commercial, government, other
telecommunications companies and residential customers, through our
networks of fiber optic cables, digital microwave, and fixed and
transportable satellite earth stations and our SchoolAccess(TM)
offering to rural school districts and a similar offering to rural
hospitals and health clinics.
Cable services. We provide cable television services to residential,
commercial and government users in the State of Alaska. Our cable
systems serve 33 communities and areas in Alaska, including the state's
three largest urban areas, Anchorage, Fairbanks and Juneau. We offer
digital cable television services in Anchorage, Fairbanks, Juneau and
Kenai and retail cable modem service (through our Internet services
segment) in Anchorage, Fairbanks, Juneau and several other communities
in Alaska. We plan to expand our product offerings as plant upgrades
are completed in other communities in Alaska.
Local access services. We offer facilities based competitive local
exchange services in Anchorage, Fairbanks and Juneau and plan to
provide similar competitive local exchange services in other locations
pending regulatory approval.
Internet services. We offer wholesale and retail Internet services. We
offer cable modem service in Anchorage, Fairbanks, Juneau and several
other communities in Alaska and plan to provide cable modem service in
other areas in 2002. Our undersea fiber optic cable allows us to offer
enhanced services with high-bandwidth requirements.
14 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Included in the "All Other" category in the tables that follow are our
managed services, product sales, cellular telephone services, and, during
the six months ended June 30, 2001, management services for Kanas
Telecom, Inc. ("Kanas"), a related party. None of these business units
has ever met the quantitative thresholds for determining reportable
segments. Also included in the All Other category are corporate related
expenses including management information systems, accounting, legal and
regulatory, human resources and other general and administrative
expenses. In 2001, the All Other category includes revenues and costs
associated with the sale of undersea fiber optic cable system capacity
(see note 1(d)).
We evaluate performance and allocate resources based on (1) earnings or
loss from operations before depreciation, amortization, net interest
expense and income taxes, and (2) operating income or loss. The
accounting policies of the reportable segments are the same as those
described in the summary of significant accounting policies in note 1.
Intersegment sales are recorded at cost plus an agreed upon intercompany
profit.
We earn all revenues through sales of services and products within the
United States of America. All of our long-lived assets are located within
the United States of America.
Summarized financial information for our reportable segments and for the
All Other category for the six months ended June 30, 2002 and 2001
follows (amounts in thousands):
Reportable Segments
--------------------------------------------------------
Long- Local Total
Distance Cable Access Internet Reportable All
Services Services Services Services Segments Other Total
------------------------------------------------------------------------------
2002
----
Revenues:
Intersegment $ 10,847 1,017 5,490 4,548 21,902 372 22,274
External 102,442 43,265 15,414 7,485 168,606 12,344 180,950
------------------------------------------------------------------------------
Total revenues $ 113,289 44,282 20,904 12,033 190,508 12,716 203,224
==============================================================================
Earnings (loss) from
operations before
depreciation,
amortization, net interest
expense and income taxes $ 43,212 20,351 2,127 (5,658) 60,032 (15,806) 44,226
==============================================================================
Operating income (loss) $ 29,825 12,085 459 (7,432) 34,937 (19,709) 15,228
==============================================================================
15 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Reportable Segments
--------------------------------------------------------
Long- Local Total
Distance Cable Access Internet Reportable All
Services Services Services Services Segments Other Total
------------------------------------------------------------------------------
2001
----
Revenues:
Intersegment $ 9,925 754 3,754 2,659 17,092 169 17,261
External 96,087 36,919 12,141 5,753 150,900 31,552 182,452
------------------------------------------------------------------------------
Total revenues $ 106,012 37,673 15,895 8,412 167,992 31,721 199,713
==============================================================================
Earnings (loss) from
operations before
depreciation,
amortization, net interest
expense and income taxes $ 40,368 16,989 2,448 (5,878) 53,927 (4,367) 49,560
==============================================================================
Operating income (loss) $ 28,827 6,964 786 (7,203) 29,374 (7,453) 21,921
==============================================================================
A reconciliation of reportable segment revenues to consolidated revenues
follows (amounts in thousands):
Six months ended June 30, 2002 2001
------------- --------------
Reportable segment revenues $ 190,508 167,992
Plus All Other revenues 12,716 31,721
Less intersegment revenues eliminated in consolidation (22,274) (17,261)
------------- --------------
Consolidated revenues $ 180,950 182,452
============= ==============
A reconciliation of reportable segment earnings from operations before
depreciation, amortization, net interest expense and income taxes to
consolidated net income before income taxes follows (amounts in
thousands):
Six months ended June 30, 2002 2001
-------------- --------------
Reportable segment earnings from operations before
depreciation, amortization, net interest expense and
income taxes $ 60,032 53,927
Less All Other loss from operations before depreciation,
amortization, net interest expense and income taxes (15,806) (4,367)
Less intersegment contribution eliminated in consolidation (457) (468)
-------------- --------------
Consolidated earnings from operations before
depreciation, amortization, net interest expense
and income taxes 43,769 49,092
Less depreciation and amortization expense 28,998 27,639
-------------- --------------
Consolidated operating income 14,771 21,453
Less interest expense, net 12,599 16,695
-------------- --------------
Consolidated net income before income taxes $ 2,712 4,758
============== ==============
16 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
A reconciliation of reportable segment operating income to consolidated
net income before income taxes follows (amounts in thousands):
Six months ended June 30, 2002 2001
-------------- -------------
Reportable segment operating income $ 34,937 29,374
Less All Other operating loss (19,709) (7,453)
Less intersegment contribution eliminated in consolidation (457) (468)
-------------- -------------
Consolidated operating income 14,771 21,453
Less interest expense, net 12,599 16,695
-------------- -------------
Consolidated net income before income taxes $ 2,172 4,758
============== =============
(6) WorldCom Chapter 11 Bankruptcy Filing
We provide long-distance and other services to WorldCom, a related party
and a major customer. We earned revenues from WorldCom, net of discounts,
totaling approximately $40.5 million for the six months ended June 30,
2002. As a percentage of total revenues, WorldCom revenues totaled 22.4%
for the six months ended June 30, 2002. On July 21, 2002 WorldCom and
substantially all of its active U.S. subsidiaries filed voluntary
petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code
in the United States Bankruptcy Court. Chapter 11 allows a company to
continue operating in the ordinary course of business in order to
maximize recovery for the company's creditors and shareholders. The
filings have enabled WorldCom to continue to conduct business while it
develops a reorganization plan. During the three and six months ended
June 30, 2002 we have recognized a $9.7 million bad debt reserve for
uncollected balances due from WorldCom as of June 30, 2002. We expect to
recognize during the third quarter of 2002 approximately $6.7 million in
additional bad debts due from WorldCom for the period from July 1, 2002
to July 21, 2002. We currently cannot predict the timing or amount that
WorldCom will pay on outstanding balances due us as of their bankruptcy
filing date of July 21, 2002.
(7) Commitments and Contingencies
Bid to Purchase Fiber Optic Cable System Assets
The assets of WCI Cable, Inc. and its subsidiaries ("WCIC"), a competing
fiber optic cable system connecting Alaska to the Lower 48 states, were
offered for sale following its bankruptcy filing and reorganization. We
were not the successful bidder and we expect to continue to pursue other
opportunities to secure facilities to supplement our existing backup
facilities.
Litigation and Disputes
We are routinely involved in various lawsuits, billing disputes, legal
proceedings and regulatory matters that have arisen in the normal course
of business. While the ultimate results of these items cannot be
predicted with certainty, we do not expect at this time the resolution of
them to have a material adverse effect on our financial position, results
of operations or our liquidity.
Internal Revenue Service Examination
Our U.S. income tax return for 1999 was selected for examination by the
Internal Revenue Service during 2001. The examination commenced during
the third quarter of 2001 and was completed during the second quarter of
2002 with no material adjustments required.
17
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
In the following discussion, GCI, Inc. and its direct and indirect subsidiaries
are referred to as "we," "us" and "our."
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an on-going basis, we evaluate our estimates and
judgments, including those related to unbilled revenues, allowance for doubtful
accounts, depreciation and amortization periods, intangible assets, income
taxes, and contingencies and litigation. We base our estimates and judgments on
historical experience and on various other factors that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. See also our Cautionary
Statement Regarding Forward-Looking Statements.
GCI, Inc. was incorporated in 1997 to effect the issuance of senior notes. GCI,
Inc., a wholly owned subsidiary of GCI, received through its initial
capitalization all ownership interests in subsidiaries previously held by GCI.
Shares of GCI's Class A common stock are traded on the Nasdaq National Market
tier of the Nasdaq Stock Market under the symbol GNCMA. Shares of GCI's Class B
common stock are traded on the Over-the-Counter market.
General Overview
We have experienced significant growth in recent years through strategic
acquisitions, deploying new business lines and expansion of our existing
businesses. We have historically met our cash needs for operations, regular
capital expenditures and maintenance capital expenditures through our cash flows
from operating activities. Cash requirements for significant acquisitions and
major capital expenditures have been provided largely through our financing
activities.
Long-Distance Services Overview
During the second quarter of 2002 long-distance services revenue represented
56.5% of consolidated revenues. Our provision of interstate and intrastate
long-distance services to residential, commercial and governmental customers and
to other common carriers (principally WorldCom, a related party, (see note 6 to
the Interim Condensed Consolidated Financial Statements for a discussion of
WorldCom's Chapter 11 bankruptcy filing) and Sprint), provision of private line
and leased dedicated capacity services and broadband services accounted for
97.5% of our total long-distance services revenues during the second quarter of
2002.
Factors that have the greatest impact on year-to-year changes in long-distance
services revenues include the rate per minute charged to customers, usage
volumes expressed as minutes of use, and the number of private line, leased
dedicated service and broadband products in use.
Long-distance services face significant competition from AT&T Alascom, Inc.,
long-distance resellers, and from local telephone companies that have entered
the long-distance market. We believe our approach to
18
developing, pricing, and providing long-distance services and bundling different
business segment services will continue to allow us to be competitive in
providing those services.
Our contract to provide interstate and intrastate long-distance services to
Sprint was replaced in March 2002 extending its term to March 2007 with two
one-year automatic extensions to March 2009. Beginning in April 2002 the new
contract reduced the rate to be charged by us for certain Sprint traffic over
the extended term of the contract.
Other common carrier traffic routed to us for termination in Alaska is largely
dependent on traffic routed to WorldCom and Sprint by their customers. Pricing
pressures, general economic deterioration, new program offerings, business
failures, and market consolidation continue to evolve in the markets served by
WorldCom and Sprint. If, as a result, their traffic is reduced, or if their
competitors' costs to terminate or originate traffic in Alaska are reduced, our
traffic will also likely be reduced, and our pricing may be reduced to respond
to competitive pressures. We are unable to predict the effect on us of such
changes, however given the materiality of other common carrier revenues to us, a
significant reduction in traffic or pricing could have a material adverse effect
on our financial position, results of operations and liquidity.
Cable Services Overview
During the second quarter of 2002, cable television revenues represented 23.6%
of consolidated revenues. The cable systems serve 33 communities and areas in
Alaska, including the state's three largest population centers, Anchorage,
Fairbanks and Juneau.
We generate cable services revenues from four primary sources: (1) digital and
analog programming services, including monthly basic or premium subscriptions
and pay-per-view movies or other one-time events, such as sporting events; (2)
equipment rentals or installation; (3) cable modem services (shared with our
Internet services segment); and (4) advertising sales. During the second quarter
of 2002 programming services generated 77.1% of total cable services revenues,
equipment rental and installation fees accounted for 9.6% of such revenues,
cable services' allocable share of cable modem services accounted for 9.0% of
such revenues, advertising sales accounted for 3.6% of such revenues, and other
services accounted for the remaining 0.7% of total cable services revenues.
The primary factors that contribute to year-to-year changes in cable services
revenues are average monthly subscription and pay-per-view rates, the mix among
basic, premium and pay-per-view services and digital and analog services, the
average number of cable television and cable modem subscribers during a given
reporting period, and revenues generated from new product offerings.
Cable services face competition from alternative methods of receiving and
distributing television signals and from other sources of news, information and
entertainment. We believe our cable television services will continue to be
competitive by providing, at reasonable prices, a greater variety of programming
and other communication services than are available off-air or through other
alternative delivery sources and upon superior technical performance and
responsive local customer service.
Local Access Services Overview
We generate local access services revenues from three primary sources: (1)
business and residential basic dial tone services; (2) business private line and
special access services; and (3) business and residential features and other
charges, including voice mail, caller ID, distinctive ring, inside wiring and
subscriber line charges. During the second quarter of 2002 local exchange
services revenues represented 8.8% of consolidated revenues.
The primary factors that contribute to year-to-year changes in local access
services revenues are the average number of business and residential subscribers
to our services during a given reporting period, the average
19
monthly rates charged for non-traffic sensitive services and the number and type
of additional premium features selected.
Our local access services segment faces significant competition in Anchorage,
Fairbanks, and Juneau from the ILEC Alaska Communications Systems, Inc. ("ACS")
and AT&T Alascom, Inc. We began marketing efforts in the Juneau market in the
fourth quarter of 2001 and began provisioning service in the first quarter of
2002. We believe our approach to developing, pricing, and providing local access
services and bundling different business segment services will allow us to be
competitive in providing those services.
Internet Services Overview
We generate Internet services revenues from three primary sources: (1) access
product services, including commercial, Internet service provider, and retail
dial-up access; (2) network management services; and (3) Internet services'
allocable share of cable modem services (a portion of cable modem revenue is
also recognized by our cable services segment). During the second quarter of
2002 Internet services segment revenues represented 4.2% of consolidated
revenues.
The primary factors that contribute to year-to-year changes in Internet services
revenues are the average number of subscribers to our services during a given
reporting period, the average monthly subscription rates, and the number and
type of additional premium features selected.
Marketing campaigns continue to be deployed targeting residential and commercial
customers featuring bundled Internet products. Our Internet offerings are
coupled with our long-distance and local access services offerings and provide
free basic Internet services or discounted premium Internet services if certain
long-distance or local access services plans are selected. Value-added premium
Internet features are available for additional charges.
We compete with a number of Internet service providers in our markets. We
believe our approach to developing, pricing, and providing Internet services
allows us to be competitive in providing those services.
All Other Services Overview
Revenues reported in the All Other category as described in note 5 in the
accompanying Notes to Interim Condensed Consolidated Financial Statements
include our managed services, product sales, cellular telephone services, and,
during the second quarter of 2001, management services for Kanas, a related
party.
Revenues included in the All Other category represented 6.9% of total revenues
in the second quarter of 2002 and include managed services revenues totaling
$5.5 million and product sales and cellular telephone services revenues totaling
$937,000.
20
RESULTS OF OPERATIONS
The following table sets forth selected Statement of Operations data as a
percentage of total revenues for the periods indicated (unaudited, underlying
data rounded to the nearest thousands):
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
Percent- Percent-
age Change(1) age Change(1)
2002 vs. 2002 vs.
2002 2001 2001 2002 2001 2001
---- ---- ---- ---- ---- ----
Statement of Operations Data:
Revenues
Long-distance services 56.5% 58.3% 5.1% 56.6% 52.7% 6.6%
Cable services 23.6% 22.1% 16.1% 23.9% 20.2% 17.2%
Local access services 8.8% 7.2% 31.1% 8.5% 6.7% 27.0%
Internet services 4.2% 3.7% 24.8% 4.2% 3.1% 30.1%
All Other services 6.9% 8.7% (14.2%) 6.8% 17.3% (60.9%)
-----------------------------------------------------------------------
Total revenues 100.0% 100.0% 8.4% 100.0% 100.0% (0.8%)
Cost of sales and services 33.3% 39.6% (8.8%) 34.3% 41.6% (18.2%)
Selling, general and administrative
expenses 35.1% 32.3% 17.9% 35.3% 29.9% 17.0%
Bad debt expense 11.5% 2.3% 440.5% 6.2% 1.6% 296.5%
Depreciation and amortization 15.4% 16.0% 4.3% 16.0% 15.1% 4.9%
-----------------------------------------------------------------------
Operating income 4.7% 9.8% (47.7%) 8.2% 11.8% (31.1%)
Net income (loss) before income
taxes (1.8%) 0.5% (486.7%) 1.2% 2.6% (54.4%)
Net income (loss) (1.2%) 0.2% (764.5%) 0.6% 1.4% (57.2%)
Other Operating Data:
Long-distance services operating income (2) 22.9% 32.9% (26.9%) 29.1% 30.3% 2.3%
Cable services operating income (3) 29.1% 22.7% 25.5% 27.9% 23.0% 42.3%
Local access services operating income (4) 5.2% 23.6% (82.2%) 3.0% 22.5% (83.2%)
Internet services operating loss (5) (92.2%) (94.6%) (59.6%) (99.3%) (101.5%) (27.3%)
- --------------------------
1 Percentage change in underlying data.
2 Computed as a percentage of total external long-distance services revenues.
3 Computed as a percentage of total external cable services revenues.
4 Computed as a percentage of total external local access services revenues.
5 Computed as a percentage of total external Internet services revenues.
- --------------------------
21
Three Months Ended June 30, 2002 ("2002") Compared To Three Months Ended June
30, 2001 ("2001").
Revenues
Total revenues increased 8.4% from $85.5 million in 2001 to $92.7 million in
2002.
Long-distance services revenues from residential, commercial, governmental, and
other common carrier customers increased 5.1% to $52.4 million in 2002. The
increase was largely due to the following:
- An increase of 23.1% in message telephone service revenues from other
common carriers (principally WorldCom and Sprint) to $23.6 million in
2002,
- An increase in 2002 of 20.6% to $4.6 million in revenues from our
packaged telecommunications offering to rural hospitals and health
clinics and our SchoolAccess(TM) offering to rural school districts.
The increase is primarily due to an increase in circuits and services
sold to rural hospitals and health clinics and the provision of
SchoolAccess(TM) services to an additional nine school districts
located in Arizona and New Mexico beginning in July 2001,
- Additional revenues resulting from an increase of 13.5% in total
minutes of use to 296.6 million minutes primarily due to a 25.1%
increase in wholesale minutes carried for other common carriers to
217.7 million minutes. After excluding certain low-margin wholesale
minutes no longer carried for other common carriers, comparable total
minutes over the prior year increased 18.1% and wholesale minutes
carried for other common carriers increased 32.8% over the prior year,
and
- Additional revenues resulting from an increase of 2.4% in the number of
active residential, small business and commercial customers billed to
90,000 at June 30, 2002.
Long-distance services revenue increases described above were partially offset
by a 3.6% decrease in our total average rate per minute to $0.112 per minute in
2002 due to the following:
- A 1.7% decrease in the average rate per minute on minutes carried for
other common carriers due to a reduced rate charged by us for certain
Sprint traffic due to a new contract commencing April 2002. After
excluding certain 2001 low-margin wholesale minutes not carried in 2002
for other common carriers, the comparable average rate per minute
decreased 6.4% from the prior year, and
- Reduced revenues resulting from our promotion of and customers'
enrollment in calling plans offering a certain number of minutes for a
flat monthly fee.
Cable services revenues increased 16.1% to $21.9 million in 2001. Programming
services revenues increased 11.8% to $16.9 million in 2002 and average gross
revenue per average basic subscriber per month increased $3.51 or 6.7% in 2002
resulting from the following:
- Basic subscribers served increased approximately 12,100 to
approximately 135,100 at June 30, 2002 as compared to June 30, 2001
(the 2002 increase includes approximately 7,000 basic subscribers
acquired from Rogers American Cablesystems, Inc.
("Rogers") on November 19, 2001),
- New facility construction efforts in 2002 and the acquisition of Rogers
subscribers resulted in approximately 15,700 additional homes passed, a
8.8% increase from 2001, and
- Digital subscriber counts increased 45.1% to approximately 26,400 at
June 30, 2002 as compared to June 30, 2001.
The cable services segment's share of cable modem revenue (offered through our
Internet services segment) increased $768,000 to $2.0 million in 2002 due to an
increased number of cable modems deployed.
Local access services revenues increased 31.1% in 2002 to $8.1 million primarily
due to growth in the average number of customers served. At June 30, 2002
approximately 95,800 lines were in service as
22
compared to approximately 69,000 lines in service at June 30, 2001. At June 30,
2002 approximately 1,850 additional lines were awaiting connection.
Internet services revenues increased 24.8% to $3.9 million in 2002 primarily due
to growth in the average number of customers served and the number of cable
modems deployed. We had approximately 71,400 active residential, commercial and
small business retail dial-up Internet subscribers at June 30, 2002 as compared
to approximately 65,500 at June 30, 2001. We had approximately 31,300 active
residential, commercial and small business retail cable modem subscribers at
June 30, 2002 as compared to approximately 19,600 at June 30, 2001.
Approximately 850 cable modem subscribers were added with the Rogers acquisition
on November 19, 2001.
The 14.2% decrease in All Other revenues to $6.4 million in 2002 is primarily
due to a $764,000 decrease in product sales due to non-recurring purchases by a
customer in 2001.
Cost of Sales and Service
Total cost of sales and services decreased 8.8% to $30.9 million in 2002. As a
percentage of total revenues, total cost of sales and services decreased from
39.6% in 2001 to 33.3% in 2002.
Long-distance services cost of sales and services decreased 20.0% to $14.9
million in 2002. Long-distance services cost of sales as a percentage of
long-distance services revenues decreased from 37.4% in 2001 to 28.5% in 2002
primarily due to the following:
- Reductions in access costs due to distribution and termination of our
traffic on our own local services network instead of paying other
carriers to distribute and terminate our traffic. The statewide average
cost savings is approximately $.038 and $.078 per minute for interstate
and intrastate traffic, respectively. We expect cost savings to
continue to occur as long-distance traffic originated, carried, and
terminated on our own facilities grows,
- The FCC Multi-Association Group reform order reducing access rates paid
by interexchange carriers to local exchange carriers ("LECs"), and
- In the course of business we estimate unbilled long-distance cost of
sales based upon minutes of use processed through our network and
established rates. Such estimates are revised when subsequent billings
are received, when tariffed billing periods lapse, or when disputed
charges are resolved. In 2002 we had favorable adjustments of $1.8
million.
Partially offsetting the 2002 decrease in long-distance services cost of sales
as a percentage of long-distance services revenues is a decrease in the average
rate per minute billed to customers as previously described.
Cable services cost of sales and services increased 19.1% to $6.0 million in
2002. Cable services cost of sales and services as a percentage of cable
revenues, which is less as a percentage of revenues than are long-distance,
local access and Internet services cost of sales and services, increased from
26.8% in 2001 to 27.5% in 2002. Cable services rate increases did not keep pace
with programming cost increases in 2002. Programming costs increased for most of
our cable services offerings, and we incurred additional costs on new
programming introduced in 2001 and 2002.
Local access services cost of sales and services increased 40.8% to $4.9 million
in 2002. Local access services cost of sales and services as a percentage of
local access services revenues increased from 56.6% in 2001 to 60.8% in 2002,
primarily due to the following:
- Decreased network access services revenues from other carriers as the
number of customers purchasing both long-distance and local access
services from us increases,
- An increase in the Anchorage loop lease rates paid to ACS as described
below,
23
- The effect of offering one to two months of free service to significant
numbers of new local access services customers acquired in 2002 while
continuing to incur cost of sales for such new customers,
- The FCC Multi-Association Group reform order reducing the access rates
paid by interexchange carriers to LECs, and
- The lease of wholesale circuits from the ILEC in Fairbanks and Juneau
pending completion of our own facilities enabling service transition to
unbundled network elements ("UNE") facilities and pricing.
The increases in local access services cost of sales as a percentage of local
access services revenues described above are partially offset by further
economies of scale and more efficient network utilization as the number of local
access services subscribers and resulting revenues increase.
ACS requested and received permission for a 7.7% increase in the UNE loop rate
to $14.92 and a 24% increase in their retail residential rates, both effective
in November 2001. The wholesale service rate we pay is tied to the retail
residential rate and increased approximately $2.25 per line. Additionally, the
cost of residential features increased 24% to approximately $1.35 per line. We
estimate that the increased rates will result in a 3.0% to 4.0% increase in our
local access services cost of sales as a percentage of local access services
revenue for the year ended December 31, 2002.
Internet services cost of sales and services decreased 8.5% to $1.2 million in
2002, and as a percentage of Internet services revenues, totaled 29.4% and 40.1%
in 2002 and 2001, respectively. The decrease as a percentage of Internet
services revenues is primarily due to a $1.4 million increase in Internet's
portion of cable modem revenue that generally has higher margins than do other
Internet services products. As Internet services revenues increase, economies of
scale and more efficient network utilization continue to result in reduced cost
of sales and services as a percentage of revenues.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 17.9% to $32.6 million in
2002 and, as a percentage of total revenues, increased to 35.1% in 2002 from
32.3% in 2001. The 2002 increase is primarily due to increased labor and health
insurance costs, incremental new costs to operate GCI Fiber Communication Co.,
Inc. ("GFCC") and Rogers, and costs incurred for our unsuccessful bid to
purchase certain of the assets of WCIC.
Marketing and advertising expenses as a percentage of total revenues decreased
from 2.7% in 2001 to 2.6% in 2002.
Bad Debt Expense
Bad debt expense increased 440.5% to $10.6 million in 2002 and, as a percentage
of total revenues, increased to 11.5% in 2002 from 2.3% in 2001. The 2002
increase is primarily due to the provision of a $9.7 million bad debt reserve
for uncollected accounts from WorldCom ("WorldCom reserve") resulting from
substantially all of its active U.S. subsidiaries filing voluntary petitions for
reorganization under Chapter 11 of the U.S. Bankruptcy Code in the United States
Bankruptcy Court for the Southern District of New York on July 21, 2002.
The WorldCom reserve consists of all unpaid billings for services rendered prior
to June 30, 2002 that were due from WorldCom at June 30, 2002 which have not
been subsequently paid through the date of this report. An additional estimated
$6.7 million is expected to be added to the WorldCom reserve in the third
quarter of 2002 attributed to July 2002 pre-petition services and associated
billings that are not expected to have been paid at the end of the third
quarter. Any payments received on amounts included in the WorldCom reserve will
reduce the reserve and bad debt expense in the period of receipt.
24
Depreciation and Amortization
Depreciation and amortization expense increased 4.3% to $14.3 million in 2002.
The increase is primarily attributable to an increase in depreciation expense on
our $68.0 million investment in equipment and facilities placed into service
during 2001 for which a full year of depreciation will be recorded during the
year ended December 31, 2002, and the $31.1 million investment in equipment and
facilities placed into service during the six months ended June 30, 2002 for
which a partial year of depreciation will be recorded during the year ended
December 31, 2002.
Partially offsetting the depreciation expense increases described above is the
discontinued amortization of Goodwill and Cable Certificates upon the adoption
of SFAS 142, "Goodwill and Other Intangible Assets" resulting in a decrease in
2002 amortization expense of approximately $1.6 million as compared to 2001.
Interest Expense, Net
Interest expense, net of interest income, decreased 23.8% to $6.1 million in
2002. This decrease resulted primarily from decreased interest rates in 2002 on
our variable rate debt and a $826,000 net interest benefit earned in 2002 from
our interest rate swap agreements. Partially offsetting these decreases was
additional interest expense in 2002 resulting from an increase in average
outstanding indebtedness.
Income Tax (Expense) Benefit
GCI, Inc., as a wholly owned subsidiary and member of the GCI controlled group
of corporations, files its income tax returns as part of the consolidated group
of corporations under GCI. Accordingly, the following discussion of income tax
(expense) benefit reflect the consolidated group's activity and balances.
Income tax (expense) benefit was $583,000 in 2002 and ($270,000) in 2001. The
change was due to our net loss before income taxes in 2002 as compared to net
income before income taxes in 2001, primarily due to the effect of the $9.7
million WorldCom reserve as previously described. Our effective income tax rate
decreased from 61.9% in 2001 to 34.6% in 2002 due to the effect of items that
are nondeductible for income tax purposes.
Six Months Ended June 30, 2002 ("2002") Compared To Six Months Ended June 30,
2001 ("2001").
Revenues
Total revenues decreased 0.8% from $182.5 million in 2001 to $181.0 million in
2002. Excluding the fiber optic cable system capacity sale of $19.5 million in
2001 as described in note 1(d) in the accompanying Notes to Interim Condensed
Consolidated Financial Statements, total revenues increased 11.1% in 2002.
Long-distance services revenues from residential, commercial, governmental, and
other common carrier customers increased 6.6% to $102.4 million in 2002. The
increase resulted primarily from:
- An increase of 21.1% in private line and private network transmission
services revenues to $18.0 million in 2002 due to an increased number
of leased circuits in service,
- An increase of 19.6% in message telephone service revenues from other
common carriers (principally WorldCom and Sprint) to $44.5 million in
2002,
- An increase in 2002 of 40.2% to $9.0 million in revenues from our
packaged telecommunications offering to rural hospitals and health
clinics and our SchoolAccess(TM) offering to rural school districts.
The increase is primarily due to an increase in circuits and services
sold to rural hospitals and health clinics and the provision of
SchoolAccess(TM) services to an additional nine school districts
located in Arizona and New Mexico beginning in July 2001, and
- Additional revenues resulting from an increase of 12.0% in total
minutes of use to 565.0 million minutes primarily due to a 21.7%
increase in wholesale minutes carried for other common carriers to
405.4 million minutes. After excluding certain low-margin wholesale
minutes no longer carried for
25
other common carriers, comparable total minutes over the prior year
increased 16.3% and wholesale minutes carried for other common carriers
increased 28.9% over the prior year.
Long-distance services revenue increases described above were partially offset
by a 2.7% decrease in our total average rate per minute to $0.114 per minute in
2002 due to the following:
- A 1.8% decrease in the average rate per minute on minutes carried for
other common carriers due to a reduced rate charged by us for certain
WorldCom and Sprint traffic due to a WorldCom contract amendment
commencing March 2001 and a new Sprint contract commencing April 2002.
After excluding certain 2001 low-margin wholesale minutes not carried
in 2002 for other common carriers, the comparable average rate per
minute decreased 6.1% from the prior year, and
- Reduced revenues resulting from our promotion of and customers'
enrollment in calling plans offering a certain number of minutes for a
flat monthly fee.
Cable services revenues increased 17.2% to $43.3 million in 2002. Programming
services revenues increased 12.7% to $33.5 million in 2002 and average gross
revenue per average basic subscriber per month increased $3.03 or 5.8% in 2002
resulting from the following:
- Basic subscribers served increased approximately 12,100 to
approximately 135,100 at June 30, 2002 as compared to June 30, 2001
(the 2002 increase includes approximately 7,000 basic subscribers
acquired from Rogers on November 19, 2001),
- New facility construction efforts in 2002 and the acquisition of Rogers
subscribers resulted in approximately 15,700 additional homes passed, a
8.8% increase from 2001, and
- Digital subscriber counts increased 45.1% to approximately 26,400 at
June 30, 2002 as compared to June 30, 2001.
The cable services segment's share of cable modem revenue (offered through our
Internet services segment) increased $1.5 million to $3.6 million in 2002 due to
an increased number of cable modems deployed.
Local access services revenues increased 27.0% in 2002 to $15.4 million
primarily due to growth in the average number of customers served. At June 30,
2002 approximately 95,800 lines were in service as compared to approximately
69,000 lines in service at June 30, 2001. At June 30, 2002 approximately 1,850
additional lines were awaiting connection.
Internet services revenues increased 30.1% to $7.5 million in 2002 primarily due
to growth in the average number of customers served and the number of cable
modems deployed. We had approximately 71,400 active residential, commercial and
small business retail dial-up Internet subscribers at June 30, 2002 as compared
to approximately 65,500 at June 30, 2001. We had approximately 31,300 active
residential, commercial and small business retail cable modem subscribers at
June 30, 2002 as compared to approximately 19,600 at June 30, 2001.
Approximately 850 cable modem subscribers were added with the Rogers acquisition
on November 19, 2001.
The 60.9% decrease in All Other revenues to $12.3 million in 2002 is primarily
due to the $19.5 million fiber system capacity sale in 2001 as previously
described, partially offset by an increase in managed services revenue of
$673,000 to $10.2 million in 2002 primarily due to increased contract rates and
services with one customer.
Cost of Sales and Service
Total cost of sales and services decreased 18.2% to $62.1 million in 2002. As a
percentage of total revenues, total cost of sales and services decreased from
41.6% in 2001 to 34.3% in 2002. Excluding the 2001 fiber
26
system capacity sale, total cost of sales and services as a percentage of total
revenues decreased from 39.9% in 2001 to 34.3% in 2002.
Long-distance services cost of sales and services decreased 16.0% to $30.9
million in 2002. Long-distance services cost of sales as a percentage of
long-distance services revenues decreased from 38.3% in 2001 to 30.2% in 2002
primarily due to the following:
- Reductions in access costs due to distribution and termination of our
traffic on our own local services network instead of paying other
carriers to distribute and terminate our traffic. The statewide average
cost savings is approximately $.038 and $.078 per minute for interstate
and intrastate traffic, respectively. We expect cost savings to
continue to occur as long-distance traffic originated, carried, and
terminated on our own facilities grows,
- The FCC Multi-Association Group reform order reducing the access rates
paid by interexchange carriers to LECs, and
- In the course of business we estimate unbilled long-distance cost of
sales based upon minutes of use processed through our network and
established rates. Such estimates are revised when subsequent billings
are received, when tariffed billing periods lapse, or when disputed
charges are resolved. In 2002 we had favorable adjustments of $2.5
million.
Partially offsetting the 2002 decrease in long-distance services cost of sales
as a percentage of long-distance services revenues is a decrease in the average
rate per minute billed to customers as previously described.
Cable services cost of sales and services increased 19.9% to $12.0 million in
2002. Cable services cost of sales and services as a percentage of cable
revenues, which is less as a percentage of revenues than are long-distance,
local access and Internet services cost of sales and services, increased from
27.1% in 2001 to 27.7% in 2002. Cable services rate increases did not keep pace
with programming cost increases in 2002. Programming costs increased for most of
our cable services offerings, and we incurred additional costs on new
programming introduced in 2001 and 2002.
Local access services cost of sales and services increased 45.2% to $9.6 million
in 2002. Local access services cost of sales and services as a percentage of
local access services revenues increased from 54.7% in 2001 to 62.5% in 2002,
primarily due to the following:
- Decreased network access services revenues from other carriers as the
number of customers purchasing both long-distance and local access
services from us increases,
- An increase in the Anchorage loop lease rates paid to ACS as described
below,
- The effect of offering one to two months of free service to significant
numbers of new local access services customers acquired in 2002 while
continuing to incur cost of sales for such new customers,
- The FCC Multi-Association Group reform order reducing the access rates
paid by interexchange carriers to LECs, and
- The lease of wholesale circuits from the ILEC in Fairbanks and Juneau
pending completion of our facilities enabling service transition to UNE
facilities and pricing.
The increases in local access services cost of sales as a percentage of local
access services revenues described above are partially offset by further
economies of scale and more efficient network utilization as the number of local
access services subscribers and resulting revenues increase.
ACS requested and received permission for a 7.7% increase in the UNE loop rate
to $14.92 and a 24% increase in their retail residential rates, both effective
in November 2001. The wholesale service rate we pay is tied to the retail
residential rate and increased approximately $2.25 per line. Additionally, the
cost of residential features increased 24% to approximately $1.35 per line. We
estimate that the increased rates will
27
result in a 3.0% to 4.0% increase in our local access services cost of sales as
a percentage of local access services revenue for the year ended December 31,
2002.
Internet services cost of sales and services decreased 3.1% to $2.3 million in
2002, and as a percentage of Internet services revenues, totaled 31.3% and 42.1%
in 2002 and 2001, respectively. The decrease as a percentage of Internet
services revenues is primarily due to a $2.7 million increase in Internet's
portion of cable modem revenue that generally has higher margins than do other
Internet services products. As Internet services revenues increase, economies of
scale and more efficient network utilization continue to result in reduced
Internet cost of sales and services as a percentage of revenues.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 17.0% to $63.9 million in
2002 and, as a percentage of total revenues, increased to 35.3% in 2002 from
29.9% in 2001. Excluding the fiber system capacity sale in 2001, selling,
general and administrative expenses, as a percentage of total revenues,
increased from 32.7% in 2001 to 35.3% in 2002. The 2002 increase in selling,
general and administrative expenses is primarily due to increased labor and
health insurance costs, incremental new costs to operate GFCC and Rogers, and
costs incurred for our unsuccessful bid to purchase certain of the assets of
WCIC, partially offset by a decreased accrual for company-wide success sharing
bonus costs.
Marketing and advertising expenses as a percentage of total revenues increased
from 3.1% in 2001 to 3.4% in 2002. Excluding revenues from the fiber system
capacity sale in 2001, marketing and advertising expenses as a percentage of
total revenues were 3.5% in 2001.
Bad Debt Expense
Bad debt expense increased 296.5% to $11.2 million in 2002 and, as a percentage
of total revenues, increased to 6.2% in 2002 from 1.6% in 2001. Excluding
revenues from the fiber system capacity sale in 2001, bad debt expense as a
percentage of total revenues was 1.7% in 2001. The increase in bad debt expense
in 2002 is primarily due to the $9.7 million WorldCom reserve as previously
described.
The WorldCom reserve consists of all unpaid billings for services rendered prior
to June 30, 2002 that were due from WorldCom at June 30, 2002 which have not
been subsequently paid through the date of this report. An additional estimated
$6.7 million is expected to be added to the WorldCom reserve in the third
quarter of 2002 attributed to July 2002 pre-petition services and associated
billings that are not expected to have been paid at the end of the third
quarter. Any payments received on amounts included in the WorldCom reserve will
reduce the reserve and bad debt expense in the period of receipt.
Depreciation and Amortization
Depreciation and amortization expense increased 4.9% to $29.0 million in 2002.
The increase is primarily attributable to an increase in depreciation expense on
our $68.0 million investment in equipment and facilities placed into service
during 2001 for which a full year of depreciation will be recorded during the
year ended December 31, 2002, and the $31.1 million investment in equipment and
facilities placed into service during 2002 for which a partial year of
depreciation will be recorded during the year ended December 31, 2002.
Partially offsetting the depreciation expense increases described above is the
discontinuation of amortization of Goodwill and Cable Certificates upon the
adoption of SFAS 142, "Goodwill and Other Intangible Assets" resulting in a
decrease in 2002 amortization expense of approximately $3.2 million as compared
to 2001.
Interest Expense, Net
Interest expense, net of interest income, decreased 24.5% to $12.6 million in
2002. This decrease resulted primarily from decreased interest rates in 2002 on
our variable rate debt and a $1.3 million net interest
28
benefit earned in 2002 from our interest rate swap agreements. In 2001 we earned
a $285,000 interest benefit from our interest rate swap agreement. Partially
offsetting these decreases was additional interest expense in 2002 resulting
from an increase in average outstanding indebtedness.
Income Tax Expense
GCI, Inc., as a wholly owned subsidiary and member of the GCI controlled group
of corporations, files its income tax returns as part of the consolidated group
of corporations under GCI. Accordingly, the following discussions of income tax
expense and net operating loss carryforwards reflect the consolidated group's
activity and balances.
Income tax expense was $1.1 million in 2002 and $2.2 million in 2001. The
decrease was due to reduced net income before income taxes in 2002 as compared
to 2001, primarily due to the effect of the $9.7 million WorldCom reserve as
previously described. Our effective income tax rate increased from 45.6% in 2001
to 48.9% in 2002 due to the effect of items that are nondeductible for income
tax purposes.
At June 30, 2002, we have (1) tax net operating loss carryforwards of
approximately $174.1 million that will begin expiring in 2007 if not utilized,
and (2) alternative minimum tax credit carryforwards of approximately $1.9
million available to offset regular income taxes payable in future years. Our
utilization of remaining net operating loss carryforwards is subject to certain
limitations pursuant to Internal Revenue Code section 382.
Tax benefits associated with recorded deferred tax assets are considered to be
more likely than not realizable through future reversals of existing taxable
temporary differences and future taxable income exclusive of reversing temporary
differences and carryforwards. The amount of deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income during the carryforward period are reduced. We estimate that our
effective income tax rate for financial statement purposes will be 40% to 45% in
2002.
The Job Creation and Worker Assistance Act of 2002 was signed into law on March
9, 2002 and contains several provisions that are effective for tax years ending
in 2001, one of which relates to net operating losses. The Act amends Internal
Revenue Code ("IRC") Section 172(b)(1) to provide, generally, that a net
operating loss for a tax year ending in 2001 or 2002 can be carried back five
years, rather than the two-year carryback generally allowed by section
172(b)(1)(A). The Act also amends IRC Section 56(d)(1) to allow alternative
minimum tax net operating losses carried forward into tax years ending in 2001
or 2002 to be used without regard to the 90 percent alternative minimum taxable
income limitation that generally applies. In addition, alternative minimum tax
net operating losses generated in 2001 or 2002 and carried back to an earlier
year under IRC Section 172 are not subject to the 90 percent alternative minimum
taxable income limitation. SFAS No. 109 states that a change in tax law or rates
that affects deferred income taxes is recorded in the statement of operations in
the year of enactment.
Our U.S. income tax return for 1999 was selected for examination by the Internal
Revenue Service during 2001. The examination commenced during the third quarter
of 2001 and was completed during the second quarter of 2002 with no material
adjustments required.
29
FLUCTUATIONS IN QUARTERLY RESULTS OF OPERATIONS
The following chart provides selected unaudited statement of operations data
from our quarterly results of operations during 2002 and 2001:
(Amounts in thousands)
-------------------------------------------------------------
First Second Third Fourth Total
Quarter Quarter Quarter Quarter Year
-------------------------------------------------------------
2002
Revenues:
Long-distance services $ 50,068 52,375 102,443
Cable services $ 21,346 21,919 43,265
Local access services $ 7,308 8,106 15,414
Internet services $ 3,573 3,912 7,485
All Other services $ 5,915 6,428 12,343
-------------------------------------------------------------
Total revenues $ 88,210 92,740 180,950
Operating income (1) $ 10,376 4,395 14,771
Net income (loss) before income taxes (1) $ 3,858 (1,686) 2,172
Net income (loss) (1) $ 2,212 (1,103) 1,109
2001
Revenues:
Long-distance services $ 46,236 49,851 53,892 50,715 200,694
Cable services $ 18,046 18,873 19,113 20,522 76,554
Local access services $ 5,958 6,183 6,397 6,691 25,229
Internet services $ 2,619 3,134 3,019 3,224 11,996
All Other services (2) $ 24,058 7,494 5,598 5,635 42,785
-------------------------------------------------------------
Total revenues $ 96,917 85,535 88,019 86,787 357,258
Operating income (2) $ 13,042 8,411 10,192 7,928 39,573
Net income before income taxes $ 4,322 436 2,717 1,184 8,659
Net income $ 2,423 166 1,527 473 4,589
--------------
1 The second quarter of 2002 includes provision of the $9.7 million
WorldCom reserve as previously described.
2 The first quarter of 2001 includes $19.5 million of revenue and $7.3
million of operating income (after deducting direct operating costs)
from the sale of long-haul capacity in the Alaska United undersea fiber
optic cable system.
--------------
Revenues
Total revenues for the quarter ended June 30, 2002 ("second quarter") were $92.7
million, representing a 5.1% increase from $88.2 million for the quarter ended
March 31, 2002 ("first quarter"). The second quarter increase resulted primarily
from a 4.6% increase in long-distance services revenues to $52.4 million
resulting from the following:
- Revenues from other common carriers increased 13.2% to $23.6 million,
primarily due to a 16.1% increase in minutes carried to 217.7 million
minutes, partially offset by a 2.5% decrease in the average rate per
minute on minutes carried for other common carriers, and
- An increase of 3.3% in private line and private network transmission
services revenues to $9.1 million in second quarter due to an increased
number of leased circuits in service.
The increase in long-distance services revenue described above is partially
offset by a decrease in the long-distance services average rate per minute from
$0.115 in the first quarter to $0.112 in the second quarter.
30
Cost of Sales and Services
Cost of sales and services decreased from $31.2 million in the first quarter to
$30.9 million in the second quarter. As a percentage of revenues, first and
second quarter cost of sales and services totaled 35.4% and 33.3%, respectively.
The second quarter decrease as a percentage of revenues primarily results from
the following:
- Reductions in access costs due to distribution and termination of
traffic on our own long-distance and local services networks instead of
paying other carriers to distribute and terminate our traffic. We
expect cost savings to continue as traffic carried on our own
facilities grows, and
- In the course of business we estimate unbilled long-distance cost of
sales based upon minutes of use processed through our network and
established rates. Such estimates are revised when subsequent billings
are received, when tariffed billing periods lapse, or when disputed
charges are resolved. We had favorable adjustments of $663,000 and $1.8
million in first and second quarter, respectively.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 4.1% to $32.6 million in
the second quarter as compared to the first quarter. As a percentage of
revenues, second quarter selling, general and administrative expenses were 35.1%
as compared to 35.5% for the first quarter. The second quarter increase in
selling, general and administrative expenses is primarily due to increased labor
and health insurance costs and costs incurred for our unsuccessful bid to
purchase certain of the assets of WCIC. The second quarter decrease in selling,
general and administrative expenses as a percentage of revenues is due to
increased revenues in the second quarter without a comparable increase in
expenses.
Bad Debt Expense
Bad debt expense increased $10.0 million to $10.6 million in the second quarter
as compared to the first quarter. As a percentage of revenues, second quarter
bad debt expense was 11.5% as compared to 0.7% for the first quarter. The second
quarter bad debt expense increase is primarily due to the $9.7 million WorldCom
reserve as previously described.
Net Income (Loss)
We reported net loss of ($1.1) million for the second quarter as compared to net
income of $2.2 million for the first quarter. The decrease is primarily due to
the effect of the $9.7 million WorldCom reserve as previously described,
partially offset by increased revenues and decreased cost of sales, net interest
expense and income tax expense.
Liquidity and Capital Resources
Cash flows from operating activities totaled $29.2 million for the six months
ended June 30, 2002 ("2002") as compared to $45.7 million for the six months
ended June 30, 2001 ("2001"), net of changes in the components of working
capital. The decrease in 2002 is primarily due to the effect of the 2001 fiber
system capacity sale partially offset by increased cash flow in 2002 from
substantially all segments. Uses of cash during 2002 include $36.2 million of
expenditures for property and equipment, including construction in progress,
payment of $3.1 million in notes receivable issued to related parties, and a
$1.1 million contribution to GCI. Other sources of cash in 2002 include $9.0
million in long-term borrowings and receipt of $858,000 in repayments of notes
receivable issued to related parties.
Trade receivables increased $7.3 million from December 31, 2001 to June 30, 2002
primarily due to an increase in balances due from WorldCom preceding their
filing for Chapter 11 bankruptcy reorganization.
Working capital deficit totaled $39.7 million at June 30, 2002, a $30.2 million
increase in working capital deficit as compared to a deficit of $9.5 million as
of December 31, 2001. The deficit increase is primarily
31
attributed to classification of $38.2 million of our senior credit facilities
scheduled principal reductions through June 30, 2003 to current maturities of
long-term debt, as described further below.
We borrowed an additional $9.0 million on our Senior Holdings Loan credit
facilities in 2002, and are scheduled to make $575,000, $10.0 million, $10.0
million, and $10.0 million principal payments on those facilities in the third
quarter of 2002, fourth quarter of 2002, first quarter of 2003, and second
quarter of 2003, respectively. Efforts to refinance the Senior Holdings Loan and
the Fiber Facility are continuing. If we were to complete a refinancing and
accept an early adoption of SFAS No. 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" in
2002 we expect to recognize $2.7 million to $2.9 million as an infrequent loss
attributed to remaining unamortized loan costs.
We are scheduled to make $3.0 million and $3.0 million principal payments on our
Fiber Facility in the first and second quarters of 2003, respectively.
We were not the successful bidder for certain of the assets of WCIC, as
described in note 7 to the Interim Condensed Consolidated Financial Statements,
therefore the December 17, 2001 amendment to the Senior Holdings Loan will not
become effective. Loan fees associated with this amendment were charged to
expense.
We were in compliance with all loan covenants at June 30, 2002.
Our semi-annual Senior Notes interest payment of $8.8 million was due August 1,
2002 and was paid in full at that time out of existing cash balances.
Our expenditures for property and equipment, including construction in progress,
totaled $36.2 million and $28.4 million during 2002 and 2001, respectively. We
expect our 2002 expenditures for property and equipment, including construction
in progress, for our core operations to total $60 million - $65 million. Planned
capital expenditures over the next five years include those necessary for
continued expansion of our long-distance, local exchange and Internet
facilities, supplementation of our existing network backup facilities,
continuing development of our Personal Communication Services, or PCS, network,
cable telephony, and upgrades to our cable television plant.
The long-distance, local access, cable, Internet and wireless services
industries are experiencing increasing competition and continuing technological
changes. Our future results of operations will be affected by our ability to
react to changes in the competitive environment and by our ability to fund and
implement new or enhanced technologies. We are unable to determine how
competition and technological changes will affect our ability to obtain
financing.
The telecommunications industry in general is depressed due to high levels of
competition in the long-distance market resulting in pressures to reduce prices,
an oversupply of long-haul capacity, excessive debt loads, several high-profile
company failures and potentially fraudulent accounting practices by some
companies. Our ability to refinance existing debt in the near term and to obtain
new debt under acceptable terms and conditions in the longer-term may be
diminished as a result.
The financial, credit and economic impacts of WorldCom's bankruptcy filing on
the industry in general and on us in particular are not yet fully understood and
are not predictable. We currently cannot predict the timing or amount that
WorldCom will pay on outstanding balances due us as of their bankruptcy filing
date of July 21, 2002. We expect such unpaid balances to total approximately
$16.4 million for services rendered prior to their filing date. We believe that
services provided to WorldCom subsequent to their bankruptcy
32
filing date will be paid currently, consistent with our status in WorldCom's
filing as a key service provider or utility to WorldCom's global network.
A conversion of WorldCom's bankruptcy petition to Chapter 7, an unfavorable
classification of our service provider status for post July 21, 2002 services,
unfavorable reauthorization of our pre-filing contracts and agreements with
WorldCom, or a migration of WorldCom's traffic off our network without it being
replaced by other common carriers that interconnect with our network, could have
a materially adverse impact on our financial position, results of operations and
liquidity.
We believe that we will be able to meet our current and long-term liquidity and
capital requirements and fixed charges through our cash flows from operating
activities, existing cash, cash equivalents, short-term investments, credit
facilities, and other external financing and equity sources. Should cash flows
be insufficient to support additional borrowings and principal payments
scheduled under our existing credit facilities or should we be unable to
refinance our existing debt in 2002, capital expenditures will likely be
reduced. If we are unable to timely make our scheduled principal payments and
our lenders then elect to accelerate the repayment terms, we would not have the
liquidity to repay the debt.
New Accounting Standards
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 provides accounting and reporting standards for costs
associated with the retirement of long-lived assets. This statement requires
entities to record the fair value of a liability for an asset retirement
obligation in the period in which it is incurred. When the liability is
initially recorded, the entity capitalizes a cost by increasing the carrying
amount of the related long-lived asset. Over time, the liability is accreted to
its present value each period, and the capitalized cost is depreciated over the
useful life of the related asset. Upon settlement of the liability, an entity
either settles the obligation for its recorded amount or incurs a gain or loss
upon settlement. We will be required to adopt this statement no later than
January 1, 2003 and do not expect this statement to have a material effect on
our results of operations, financial position and cash flows.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
The following summarizes the effects of SFAS No. 145:
- SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt",
which required all gains and losses from extinguishment of debt to be
aggregated and, if material, classified as an extraordinary item, net
of related income tax effect is rescinded. Upon adoption of SFAS No.
145, companies will be required to apply the criteria in Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" ("Opinion No. 30"), in determining the classification of
gains and losses resulting from the extinguishment of debt,
- SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements", amended SFAS No. 4 and is no longer necessary since SFAS
No. 4 has been rescinded,
- SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers", was
issued to establish accounting requirements for the effects of the
transition to the provisions of the Motor Carrier Act of 1980. Those
transitions are completed and, therefore, SFAS No. 44 is no longer
needed, and
- SFAS No. 13, "Accounting for Leases", is amended to require that
certain lease modifications that have economic effects similar to
sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions.
SFAS No. 145 will be effective for fiscal years beginning after May 15, 2002,
with early adoption of the provisions related to the rescission of Statement No.
4 encouraged. Upon adoption, enterprises must reclassify prior period items that
do not meet the extraordinary item classification criteria in Opinion No. 30.
33
We are currently assessing the impact of this statement on our results of
operations, financial position and cash flows.
In July 2002, the FASB issued SFAS No 146, "Accounting for Costs Associated with
Exit or Disposal Activities". Upon adoption of SFAS 146, enterprises may only
record exit or disposal costs when they are incurred and can be measured at fair
value. The recorded liability will be subsequently adjusted for changes in
estimated cash flows. SFAS 146 revises accounting for specified employee and
contract terminations that are part of restructuring activities. We will be
required to adopt this statement no later than January 1, 2003 and do not expect
this statement to have a material effect on our results of operations, financial
position and cash flows.
Critical Accounting Policies
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our interim
condensed consolidated financial statements.
- We recognize unbilled revenues based upon minutes of use carried and
established rates, net of credits and adjustments.
- We estimate unbilled long-distance cost of sales based upon minutes of
use carried through our network and established rates. Such estimates
are revised when subsequent billings are received, when tariffed
billing periods lapse, or when disputed charges are resolved.
- We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required
payments. We base our estimates on the aging of our accounts receivable
balances and our historical write-off experience, net of recoveries. If
the financial condition of our customers were to deteriorate, resulting
in an impairment of their ability to make payments, additional
allowances may be required.
- When recording depreciation expense associated with our telephony and
cable television distribution systems, we use estimated useful lives.
Because of changes in technology and industry conditions, we
periodically evaluate the useful lives of our telephony and cable
television distribution systems. These evaluations could result in a
change in useful lives in future periods.
- When recording amortization expense on intangible assets, we use
estimated useful lives. We periodically evaluate the useful lives of
our intangible assets. These evaluations could result in a change in
useful lives in future periods. Additionally, we periodically review
the valuation of our intangible assets. These reviews could result in
write-down of the value of intangible assets.
- We record a valuation allowance to reduce our deferred tax assets to
the amount that we believe is more likely than not to be realized.
While we have considered future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for the
valuation allowance, in the event we were to determine that we would
not be able to realize all or part of our net deferred tax assets in
the future, an adjustment to the deferred tax assets would be charged
to income in the period such determination was made.
- We have recorded revenues in the first quarter of 2001 associated with
a cash sale of indefeasible rights to use certain amounts of our fiber
system capacity. The fiber system capacity sold was treated as integral
equipment because it is attached to real estate. Because all of the
benefits and risks of ownership were transferred to the purchaser upon
full receipt of the purchase price and other terms of the contract meet
the requirements of SFAS No. 66, "Accounting for Sales of Real Estate,"
we accounted for the fiber system capacity sale as a sales-type lease.
The accounting for the sale of fiber system capacity is currently
evolving and accounting guidance may become available in the future
which could require us to change our policy. If we are required to
change our policy, it is likely the effect would be to recognize the
gain from future sales of fiber system capacity, if any, over the term
the capacity is provided.
- Potential refundable amounts attributed to ILEC excess earnings are
accounted for as gain contingencies since we cannot estimate future
refundable amounts nor do we know if or when we
34
will receive such refunds in the future. Such refunds are not recorded
until realization is a certainty upon receipt.
Geographic Concentration and the Alaska Economy
We offer voice and data telecommunication and video services to customers
primarily throughout Alaska. Because of this geographic concentration, growth of
our business and of our operations depends upon economic conditions in Alaska.
The economy of Alaska is dependent upon the natural resource industries, and in
particular oil production, as well as investment earnings, tourism, government,
and United States military spending. Any deterioration in these markets could
have an adverse impact on us. In fiscal 2001 Alaska's oil revenues and federal
funding supplied 61% and 33%, respectively, of the state's total revenues.
Investment losses negatively affected the state's total revenues in fiscal 2001
due to a decline in the value of its stock market investments. Investment losses
of approximately $615.2 million reduced the state's total revenues to
approximately $3.8 billion. All of the federal funding is dedicated for specific
purposes, leaving oil revenues as the primary funding source of general
operating expenditures. In fiscal 2002 state economists forecast that Alaska's
federal funding, oil revenues, and investment earnings will supply 42%, 33% and
10%, respectively, of the state's total projected revenues.
The volume of oil transported by the TransAlaska Oil Pipeline System over the
past 20 years has been as high as 2.0 million barrels per day in fiscal 1988.
Production has been declining over the last several years with an average of
0.991 million barrels produced per day in fiscal 2001. The state forecasts the
production of 1.011 million barrels per day in fiscal 2002, and a production
rate slightly above 1.0 million barrels per day through fiscal 2009. The state
attributes the production rate increase to future development of recent
discoveries in the National Petroleum Reserve Alaska, further development of
heavy oil in both the Kuparuk and Prudhoe Bay fields, and additional satellite
field development.
Market prices for North Slope oil averaged $27.85 in fiscal 2001 and are
forecasted to average $21.50 in fiscal 2002. State economists forecast the
average price of North Slope oil to decline to $20.50 in fiscal 2003. The
closing price per barrel was $25.49 on August 2, 2002. The production policy of
the Organization of Petroleum Exporting Countries and its ability to continue to
act in concert represents a key uncertainty in the state's revenue forecast.
The State of Alaska maintains the Constitutional Budget Reserve Fund that is
intended to fund budgetary shortfalls. If the state's current projections are
realized, the Constitutional Budget Reserve Fund will be depleted in 2004. If
the fund is depleted, aggressive state action will be necessary to increase
revenues and reduce spending in order to balance the budget. The governor of the
State of Alaska and the Alaska legislature continue to pursue cost cutting and
revenue enhancing measures.
In 2002 the Alaska Legislature passed and the Governor signed legislation that,
among other things, increased certain alcohol beverage taxes, increased the
state minimum wage to $7.15 per hour (adjusted for inflation in future years),
and extended the termination date of the RCA one year to June 30, 2003.
Tourism, air cargo, and service sectors have helped offset the prevailing
pattern of oil industry downsizing that has occurred during much of the last
several years. Funds from federal sources totaling $2.1 billion are expected to
be distributed to the State of Alaska for highways and other federally supported
projects in fiscal 2002.
Should new oil discoveries or developments not materialize or the price of oil
become depressed, the long term trend of continued decline in oil production
from the Prudhoe Bay area is inevitable with a corresponding adverse impact on
the economy of the state, in general, and on demand for telecommunications and
cable television services, and, therefore, on us, in particular. In the past
year, there has been a renewed effort to allow exploration and development in
the Arctic National Wildlife Refuge
35
("ANWR"). The U.S. Department of Energy estimates it could take seven to twelve
years to begin oil field production after approval of ANWR exploration.
Deployment of a natural gas pipeline from the State of Alaska's North Slope to
the Lower 48 states has been proposed to supplement natural gas supplies. A
competing natural gas pipeline through Canada has also been proposed. The
economic viability of a natural gas pipeline depends upon the price of and
demand for natural gas. Either project could have a positive impact on the State
of Alaska's revenues and the Alaska economy. According to their public comments,
neither Exxon Mobil, BP nor Phillips Petroleum, Alaska's large natural gas
owners, believe either natural gas pipeline makes financial sense based upon
their preliminary analysis, though Phillips Petroleum says it will move forward
with permitting of the project if certain federal income tax incentives are
included. The governor of the State of Alaska and certain natural gas
transportation companies continue to support a natural gas pipeline from
Alaska's North Slope by trying to reduce the project's costs and by advocating
for federal tax incentives to further reduce the project's costs. In April 2002
the U.S. Senate passed an energy bill mandating the following:
- A North Slope natural gas pipeline will follow the Alaska Highway
route,
- Gas producers will be allowed to take a credit on their federal income
taxes if prices fall,
- Alaskans along the pipeline route will have access to the gas, and
- Future gas discoveries will be allowed to move through the pipeline.
We have, since our entry into the telecommunication marketplace, aggressively
marketed our services to seek a larger share of the available market. The
customer base in Alaska is limited, however, with a population of approximately
627,000 people. The State of Alaska's population is distributed as follows:
- 42% are located in the Municipality of Anchorage,
- 13% are located in the Fairbanks North Star Borough, and
- 5% are located in the City and Borough of Juneau.
The remaining population is spread out over the vast reaches of Alaska. No
assurance can be given that the driving forces in the Alaska economy, and in
particular, oil production, will continue at appropriate levels to provide an
environment for expanded economic activity.
No assurance can be given that oil companies doing business in Alaska will be
successful in discovering new fields or further developing existing fields which
are economic to develop and produce oil with access to the pipeline or other
means of transport to market, even with a reduced level of royalties. We are not
able to predict the effect of changes in the price and production volumes of
North Slope oil on Alaska's economy or on us.
Seasonality
Long-distance revenues (primarily those derived from our other common carrier
customers) have historically been highest in the summer months because of
temporary population increases attributable to tourism and increased seasonal
economic activity such as construction, commercial fishing, and oil and gas
activities. Cable television revenues, on the other hand, are higher in the
winter months because consumers spend more time at home and tend to watch more
television during these months. Local access and Internet services are not
expected to exhibit significant seasonality. Our ability to implement
construction projects is also hampered during the winter months because of cold
temperatures, snow and short daylight hours.
36
PART I.
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various types of market risk in the normal course of business,
including the impact of interest rate changes. We do not hold derivatives for
trading purposes.
Our Senior Holdings Loan agreement carries interest rate risk. Amounts borrowed
under this agreement bear interest at either Libor plus 1.0% to 2.5%, depending
on the leverage ratio of Holdings and certain of its subsidiaries, or at the
greater of the prime rate or the federal funds effective rate (as defined) plus
0.05%, in each case plus an additional 0.0% to 1.375%, depending on the leverage
ratio of Holdings and certain of its subsidiaries. Should the Libor rate, the
lenders' base rate or the leverage ratios change, our interest expense will
increase or decrease accordingly. On September 21, 2001, we entered into an
interest rate swap agreement to convert $25 million of this variable interest
rate debt to 3.98% fixed rate debt plus applicable margin. As of June 30, 2002,
we have borrowed $120.7 million of which $95.7 million is subject to interest
rate risk. On this amount, a 1% increase in the interest rate would cost us
$957,000 in additional gross interest cost on an annualized basis.
On January 3, 2001 we entered into an interest rate swap agreement to convert
$50 million in 9.75% fixed rate debt to a variable interest rate equal to the 90
day Libor rate plus 334 basis points. The swap agreement carries interest rate
risk. Should the Libor rate change, our interest expense will increase or
decrease accordingly. A 1% change in the variable interest rate will change the
annualized benefit of the swap by $500,000. As of June 30, 2002, the interest
rate spread between the fixed and swapped variable rate is 4.50%, an annualized
reduction in interest expense of approximately $2,250,000. This interest rate
swap agreement was called at no cost and terminated on August 1, 2002.
Our Fiber Facility carries interest rate risk. Amounts borrowed under this
Agreement bear interest at either Libor plus 2.5%-2.75%, or at our choice, the
lender's prime rate plus 1.25%-1.5%. Should the Libor rate, the lenders' base
rate or the leverage ratios change, our interest expense will increase or
decrease accordingly. As of June 30, 2002, we have borrowed $60.0 million
subject to interest rate risk. On this amount, a 1% increase in the interest
rate would cost us $600,000 in additional gross interest cost on an annualized
basis.
Our Satellite Transponder Capital Lease carries interest rate risk. Amounts
borrowed under this Agreement bear interest at Libor plus 3.25%. Should the
Libor rate change, our interest expense will increase or decrease accordingly.
As of June 30, 2002, we have borrowed $45.9 million subject to interest rate
risk. On this amount, a 1% increase in the interest rate would cost us $459,000
in additional gross interest cost on an annualized basis.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information regarding pending legal proceedings to which we are a party is
included in note 7 to the Interim Condensed Consolidated Financial Statements
and is incorporated herein by reference.
37
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 10.100 - Contract for Alaska Access Services between
Sprint Communications Company L.P. and General Communication,
Inc. and its wholly owned subsidiary GCI Communication Corp.
dated March 12, 2002 (certain information has been redacted from
this document which we desire to keep undisclosed)
Exhibit 99.36 - Certifications Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
(b) Reports on Form 8-K filed during the quarter ended
June 30, 2002 - None
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GCI, INC.
Signature Title Date
- -------------------------------------- ---------------------------------------- ----------------------
/s/ Ronald A. Duncan President and Director August 9, 2002
- -------------------------------------- (Principal Executive Officer) ----------------------
Ronald A. Duncan
/s/ G. Wilson Hughes Vice President and Director August 9, 2002
- -------------------------------------- ----------------------
G. Wilson Hughes
/s/ John M. Lowber Secretary, Treasurer and Director August 9, 2002
- -------------------------------------- (Principal Financial and Accounting ----------------------
John M. Lowber Officer)
39