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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(X) ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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)
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
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
Indicate by check mark whether the registrant (1) 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, and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No .
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION J(1)(a) AND
(b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE
FORMAT.
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GCI, INC.
A WHOLLY-OWNED SUBSIDIARY OF GENERAL COMMUNICATION, INC.
2002 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
----
Glossary............................................................................................................3
Cautionary Statement Regarding Forward-Looking Statements..........................................................10
Part I.............................................................................................................12
Item 1. Business...............................................................................................12
Item 2. Properties.............................................................................................63
Item 3. Legal Proceedings......................................................................................65
Item 4. Submissions of Matters to a Vote of Security Holders....................................................66
Part II............................................................................................................66
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters..............................66
Item 6. Selected Financial Data................................................................................67
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................68
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................................93
Item 8. Consolidated Financial Statements and Supplementary Data...............................................93
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure...................93
Part III...........................................................................................................93
Items 10, 11, 12 and 13 are omitted per General Instruction J(1)(a) and (b) of Form 10-K........................93
Item 14. Controls and Procedures...............................................................................94
Part IV............................................................................................................95
Item 15. Exhibits, Consolidated Financial Statement Schedules, and Reports on Form 8-K.........................95
Item 15(b). Exhibits..........................................................................................133
Independent Auditors' Report...................................................................................138
Schedule VIII..................................................................................................139
Signatures........................................................................................................140
Certifications....................................................................................................141
This Annual Report on Form 10-K is for the year ending December 31, 2002. This
Annual Report modifies and supersedes documents filed prior to this Annual
Report. The Securities and Exchange Commission ("SEC") allows us to "incorporate
by reference" information that we file with them, which means that we can
disclose important information to you by referring you directly to those
documents. Information incorporated by reference is considered to be part of
this Annual Report. In addition, information that we file with the SEC in the
future will automatically update and supersede information contained in this
Annual Report.
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Glossary
Access Charges -- Expenses incurred by an IXC and paid to LECs for accessing the
local networks of the LECs in order to originate and terminate long-distance
calls and provide the customer connection for private line services.
ACS -- Alaska Communications Systems, Inc., previously ALEC Holdings, Inc. --
ACS, one of our competitors, includes acquired properties from Century Telephone
Enterprises, Inc. and the Anchorage Telephone Utility ("ATU"). ATU provided
local telephone and long distance services primarily in Anchorage and cellular
telephone services in Anchorage and other Alaska markets.
Alaska United -- Alaska United Fiber System Partnership -- an Alaska partnership
wholly owned by The Company. Alaska United was organized to construct and
operate a new fiber optic cable connecting various locations in Alaska and the
Lower 49 states and foreign countries through Seattle, Washington.
AT&T -- AT&T Corp. -- Acquired Tele-Communications, Inc. ("TCI") in a 1999
merger; one of our competitors.
AT&T Alascom -- Alascom, Inc. -- a wholly owned subsidiary of AT&T and one of
our competitors.
Basic Service -- The basic service tier includes, at a minimum, signals of local
television broadcast stations, any public, educational, and governmental
programming required by the franchise to be carried on the basic tier, and any
additional video programming service added to the basic tier by the cable
operator.
BOC -- Bell System Operating Company -- A LEC owned by any of the remaining
Regional Bell Operating Companies, which are holding companies established
following the AT&T Divestiture Decree to serve as parent companies for the BOCs.
Backbone -- A centralized high-speed network that interconnects smaller,
independent networks.
Bandwidth -- The number of bits of data that can move through a communications
medium in a given amount of time.
Broadband -- A high-capacity communications circuit/path, usually implying
speeds of 256 kbps or better.
CAP -- Competitive Access Provider -- A company that provides its customers with
an alternative to the LEC for local transport of private line and special access
telecommunications services.
Central Offices -- The switching centers or central switching facilities of the
LECs.
CLEC -- Competitive Local Exchange Carrier. -- A company that provides its
customers with an alternative to the ILEC for local transport of
telecommunications services, as allowed under the 1996 Telecom Act.
Co-Carrier Status -- A regulatory scheme under which the incumbent LEC is
required to integrate new, competing providers of local exchange service, into
the systems of traffic exchange, inter-carrier compensation, and other
inter-carrier relationships that already exist among LECs in most jurisdictions.
Collocation -- The ability of a CAP or CLEC to connect its network to the LEC's
central offices. Physical collocation occurs when a connecting carrier places
its network connection equipment inside the LEC's central offices. Virtual
collocation is an alternative to physical collocation pursuant to which the LEC
permits a CAP or CLEC to connect its network to the LEC's central offices on
comparable terms, even though the CAP's or CLEC's network connection equipment
is not physically located inside the central offices.
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The Company - GCI, Inc. and its direct and indirect subsidiaries, also referred
to as "we," "us" and "our."
Compression / Decompression -- A method of encoding/decoding signals that allows
transmission (or storage) of more information than the medium would otherwise be
able to support. Both compression and decompression require processing capacity,
but with many products, the time is not noticeable.
DAMA -- Demand Assigned Multiple Access -- The Company's digital satellite earth
station technology that allows calls to be made between remote villages using
only one satellite hop thereby reducing satellite delay and capacity
requirements while improving quality.
Dark Fiber -- An inactive fiber-optic strand without electronics or optronics.
Dark fiber is not connected to transmitters, receivers and regenerators.
DBS -- Direct Broadcast Satellite -- Subscription television service obtained
from satellite transmissions using frequency bands that are internationally
allocated to the broadcast satellite services. Direct-to-home service such as
DBS has its origins in the large direct-to-home satellite antennas that were
first introduced in the 1970's for the reception of video programming
transmitted via satellite. Because these first-generation direct-to-home
satellites operated in the C-band frequencies at low power, direct-to-home
satellite antennas, or dishes, as they are also known, generally needed to be
seven to ten feet in diameter in order to receive the signals being transmitted.
More recently, licensees have been using the Ku and extended Ku-bands to provide
direct-to-home services enabling subscribers to use a receiving home satellite
parabolic dish less than one meter in diameter. The major providers of DBS are
currently DirecTV and EchoStar (marketed as the DISH Network).
DS-3 -- A data communications circuit that is equivalent to 28 multiplexed T-1
channels capable of transmitting data at 44.736 mbps (sometimes called a T-3).
Dedicated -- Telecommunications lines dedicated or reserved for use by
particular customers.
Digital -- A method of storing, processing and transmitting information through
the use of distinct electronic or optical pulses that represent the binary
digits 0 and 1. Digital transmission and switching technologies employ a
sequence of these pulses to represent information as opposed to the continuously
variable analog signal. The precise digital numbers minimize distortion (such as
graininess or snow in the case of video transmission, or static or other
background distortion in the case of audio transmission).
DLC -- Digital Loop Carrier -- A digital transmission system designed for
subscriber loop plant. Multiplexes a plurality of circuits onto very few wires
or onto a single fiber pair.
DOCSIS 1.1 -- Data-Over-Cable Service Interface Specification 1.1 -- An industry
specification that provides for high-speed Internet service tiers, using
techniques known as data fragmentation and quality of service. Under this
specification, which is compatible with the existing DOCSIS 1.0 specification,
cable operators can deliver high-speed Internet services simultaneously over the
same plant and in a path parallel to core video services.
DSL - Digital Subscriber Line -- Technology that allows Internet access at data
transmission speeds greater than those of modems over conventional telephone
lines.
Equal Access -- Connection provided by a LEC permitting a customer to be
automatically connected to the IXC of the customer's choice when the customer
dials "1". Also refers to a generic concept under which the BOCs must provide
access services to AT&T's competitors that are equivalent to those provided to
AT&T.
FCC -- Federal Communications Commission -- A federal regulatory body empowered
to establish and enforce rules and regulations governing public utility
companies and others, such as the Company.
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Frame Relay -- A wideband (64 kilobits per second to 1.544 mbps) packet-based
data interface standard that transmits bursts of data over WANs. Frame-relay
packets vary in length from 7 to 1024 bytes. Data oriented, it is generally not
used for voice or video.
FTC -- Federal Trade Commission -- A federal regulatory body empowered to
establish and enforce rules and regulations governing companies involved in
trade and commerce.
GCC -- GCI Communication Corp., an Alaska corporation and a wholly owned
subsidiary of Holdings.
GCI -- General Communication, Inc., an Alaska corporation.
GCI, Inc. -- a wholly owned subsidiary of GCI, an Alaska corporation, the
Registrant, and issuer of $180 million of publicly traded bonds.
GFCC -- GCI Fiber Communication Co., Inc., an Alaska corporation and a wholly
owned subsidiary of Holdings. Holdings acquired all minority ownership interests
in GFCC in the third and fourth quarters of 2002. GFCC owns and operates a fiber
optic cable system constructed along the trans-Alaska oil pipeline corridor
extending from Prudhoe Bay to Valdez, Alaska. See Kanas.
Holdings -- a wholly owned subsidiary of GCI, Inc., an Alaska corporation and
party to the Company's Senior Holdings Loan.
ILEC -- Incumbent Local Exchange Carrier -- with respect to an area, the LEC
that -- (A) on the date of enactment of the Telecommunications Act of 1996,
provided telephone exchange service in such area; and (B)(i) on such date of
enactment, was deemed to be a member of the exchange carrier association
pursuant to section 69.601(b) of the FCC's regulations (47 C.F.R. 69.601(b)); or
(ii) is a person or entity that, on or after such date of enactment, became a
successor or assign of a member described in clause (i).
Interexchange -- Communication between two different LATAs or, in Alaska,
between two different local exchange serving areas.
ISDN -- Integrated Services Digital Network -- A set of standards for
transmission of simultaneous voice, data and video information over fewer
channels than would otherwise be needed, through the use of out-of-band
signaling. The most common ISDN system provides one data and two voice circuits
over a traditional copper wire pair, but can represent as many as 30 channels.
Broadband ISDN extends the ISDN capabilities to services in the Gigabit range.
ISP -- Internet Service Provider -- a company providing retail and/or wholesale
Internet services.
Internet -- A global collection of interconnected computer networks which use
TCP/IP, a common communications protocol.
IXC -- Interexchange Carrier -- A long-distance carrier providing services
between local exchanges.
Kanas -- Kanas Telecom, Inc. -- an Alaska corporation that was renamed to GFCC
in 2001.
LAN -- Local Area Network -- The interconnection of computers for sharing files,
programs and various devices such as printers and high-speed modems. LANs may
include dedicated computers or file servers that provide a centralized source of
shared files and programs.
LATA -- Local Access and Transport Area -- The approximately 200 geographic
areas defined pursuant to the AT&T Divestiture Decree. The BOCs were
historically prohibited from providing long-distance service between the LATA in
which they provide local exchange services, and any other LATA.
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LEC -- Local Exchange Carrier -- A company providing local telephone services.
Each BOC is a LEC.
LMDS -- Local Multipoint Distribution System -- LMDS uses microwave signals
(millimeterwave signals) in the 28 GHz spectrum to transmit voice, video, and
data signals within small cells 3-10 miles in diameter. LMDS allows license
holders to control up to 1.3 GHz of wireless spectrum in the 28 GHz Ka-band. The
1.3 GHz can be used to carry digital data at speeds in excess of one gigabit per
second. LMDS uses a specific band in the microwave spectrum, known as millimeter
waves or the 28 GHz "Ka-band." The extremely high frequency used and the need
for point to multipoint transmissions limits the distance that a receiver can be
from a transmitter. This means that LMDS will be a "cellular" technology, based
on multiple, contiguous, or overlapping cells. LMDS is expected to provide
customers with multichannel video programming, telephony, video communications,
and two-way data services. Incumbent LECs and cable companies may not obtain the
in-region 1150 MHz license for three years following the date of the license
grant. Within 10 years following the date of the license grant, licensees will
be required to provide 'substantial service' in their service regions.
Local Exchange -- A geographic area generally determined by a PUC, in which
calls generally are transmitted without toll charges to the calling or called
party.
Local Number Portability -- The ability of an end user to change Local Exchange
Carriers while retaining the same telephone number.
Lower 48 States or Lower 48 -- refers to the 48 contiguous states south of or
below Alaska.
Lower 49 States or Lower 49 -- refers to Hawaii and the Lower 48 States.
MAN -- Metropolitan Area Network -- LANs interconnected within roughly a 50-mile
radius. MANs typically use fiber optic cable to connect various wire LANs.
Transmission speeds may vary from 2 to 100 Mbps.
MDU -- Multiple Dwelling Unit -- MDUs include multiple-family buildings, such as
apartment and condominium complexes.
MMDS -- Multichannel Multipoint Distribution Service - also known as wireless
cable. The FCC established the Multipoint Distribution Service (MDS) in 1972.
Originally, the Commission thought MDS would be used primarily to transmit
business data. However, the service became increasingly popular in transmitting
entertainment programming. Unlike conventional broadcast stations whose
transmissions are received universally, MDS programming is designed to reach
only a subscriber based audience. In 1983, the Commission reassigned eight
channels from the Instructional Television Fixed Service (ITFS) to MDS. These
eight channels make up the MMDS. Frequently, MDS and MMDS channels are used in
combination with ITFS channels to provide video entertainment programming to
subscribers.
MVPD -- Multi-channel Video Programming Distribution -- The distribution of
video programming over multiple platforms, such as cable and satellite.
NPT -- a New Product Tier -- a cable programming service tier offered to
subscribers at prices set by the cable operator.
OCC -- Other Common Carrier -- A long-distance carrier other than the Company.
PCS -- Personal Communication Services -- PCS encompasses a range of advanced
wireless mobile technologies and services. It promises to permit communications
to anyone, anywhere and anytime while on the move. The Cellular
Telecommunications Industry Association (CTIA) defines PCS as a "wide range of
wireless mobile technologies, chiefly cellular, paging, cordless, voice,
personal communications networks, mobile data, wireless PBX, specialized mobile
radio, and satellite-based systems." The FCC defines PCS as a "family of mobile
or portable radio communications services that encompasses mobile and ancillary
fixed
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communications services to individuals and businesses and can be integrated with
a variety of competing networks."
PBX -- Private Branch Exchange -- A customer premise communication switch used
to connect customer telephones (and related equipment) to LEC central office
lines (trunks), and to switch internal calls within the customer's telephone
system. Modern PBXs offer numerous software-controlled features such as call
forwarding and call pickup. A PBX uses technology similar to that used by a
central office switch (on a smaller scale). (The acronym PBX originally stood
for "Plug Board Exchange.")
POP -- Point of Presence -- The physical access location interface between a LEC
and an IXC network. The point to which the telephone company terminates a
subscriber's circuit for long-distance service or leased line communications.
PRI -- Primary Rate Interface -- An ISDN circuit transmitting at T1 (DS-1) speed
(equivalent to 24 voice-grade channels). One of the channels ("D") is used for
signaling, leaving 23 ("B") channels for data and voice communication.
Private Line -- Uses dedicated circuits to connect customer's equipment at both
ends of the line. Does not provide any switching capability (unless supported by
customer premise equipment). Usually includes two local loops and an IXC
circuit.
Private Network -- A communications network with restricted (controlled) access
usually made up of private lines (with some PBX switching).
RCA -- Regulatory Commission Of Alaska -- A state regulatory body empowered to
establish and enforce rules and regulations governing public utility companies
and others, such as the Company, within the State of Alaska (sometimes referred
to as Public Service Commissions, or PSCs, or Public Utility Commissions, or
PUCs). Previously known as the Alaska Public Utilities Commission (APUC).
Reciprocal Compensation -- The same compensation of a new CLEC for termination
of a local call by the ILEC on its network, as the new competitor pays the ILEC
for termination of local calls on the ILEC network.
SchoolAccess(TM) -- The Company's Internet and related services offering to
schools in Alaska. The federal mandate through the 1996 Telecom Act to provide
universal service resulted in schools across Alaska qualifying for varying
levels of discounts to support the provision of Internet services. The Universal
Service Administrative Company through its Schools and Libraries Division
administers this federal program.
SDN -- Software Defined Network -- A switched long-distance service for very
large users with multiple locations. Instead of putting together their own
network, large users can get special usage rates for calls carried on regular
switched long-distance lines.
Securities Reform Act - The Private Securities Litigation Reform Act of 1995.
Senior Holdings Loan -- Holding's $225,000,000 credit facility. On November 1,
2002 we closed a $225.0 million bank facility to refinance the previously
outstanding Holding's loans ($120.1 million) and the Alaska United loan ($60.0
million) facility. The Senior Holdings Loan includes a term loan of $175.0
million and a revolving credit facility of $50.0 million. The Senior Facility
matures on November 1, 2004 and bears interest at LIBOR plus 6.50%. You should
see note 6(b) to the accompanying Notes to Consolidated Financial Statements
included in Part II of this Report for more information.
SMATV -- Satellite Master Antenna Television -- (also known as "private cable
systems") are multichannel video programming distribution systems that serve
residential, multiple-dwelling units ("MDUs"), and various other buildings and
complexes. A SMATV system typically offers the same type of programming as a
cable system, and the operation of a SMATV system largely resembles that of a
cable system -- a satellite
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dish receives the programming signals, equipment processes the signals, and
wires distribute the programming to individual dwelling units. The primary
difference between the two is that a SMATV system typically is an unfranchised,
stand-alone system that serves a single building or complex, or a small number
of buildings or complexes in relatively close proximity to each other.
SONET -- Synchronous Optical Network -- A 1984 standard for optical fiber
transmission on the public network. 52 mbps to 13.22 Gigabits per second,
effective for ISDN services including Asynchronous Transfer Mode.
Sprint -- Sprint Corporation -- one of our significant customers.
TCP/IP -- Transmission Control Protocol/Internet Protocol -- A suite of network
protocols that allows computers with different architectures and operating
system software to communicate with other computers on the Internet.
T-1 -- A data communications circuit capable of transmitting data at 1.5 Mbps.
Tariff -- The schedule of rates and regulations set by communications common
carriers and filed with the appropriate federal and state regulatory agencies;
the published official list of charges, terms and conditions governing provision
of a specific communications service or facility, which functions in lieu of a
contract between the subscriber or user and the supplier or carrier.
UNE -- Unbundled Network Element -- A discrete piece part of a telephone
network. Unbundled network elements are the basic network functions, i.e., the
piece parts needed to provide a full range of telecommunications services. They
are physical facilities as well as all the features, and capabilities provided
by those facilities.
VSAT -- Very Small Aperture Terminal -- A portable satellite terminal that
allows connection via a satellite link.
WAN -- Wide Area Network - A remote computer communications system. WANs allow
file sharing among geographically distributed workgroups (typically at higher
cost and slower speed than LANs or MANs). WANs typically use common carriers'
circuits and networks. WANs may serve as a customized communication backbone
that interconnects all of an organization's local networks with communications
trunks that are designed to be appropriate for anticipated communication rates
and volumes between nodes.
World Wide Web or Web -- A collection of computer systems supporting a
communications protocol that permits multi-media presentation of information
over the Internet.
WorldCom -- WorldCom, Inc. -- owns approximately 9% of GCI's common stock,
presently has one representative on GCI's Board, and is a major customer. Since
we are a wholly-owned subsidiary of GCI, we can be affected by activity in GCI's
common stock and decisions made by GCI's Board. Prior to May 1, 2000, the
Company was named MCI WorldCom, Inc. 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. You should see note 11 to the accompanying Notes to Consolidated
Financial Statements included in Part II of this Report for more information.
1984 Cable Act -- The Cable Communications Policy Act of 1984.
1992 Cable Act -- The Cable Television Consumer Protection and Competition Act
of 1992.
1996 Telecom Act -- The Telecommunications Act of 1996 - The 1996 Telecom Act
was signed into law February 8, 1996. Under its provisions, BOCs were allowed to
immediately begin manufacturing, research and development; GTE Corp. could begin
providing interexchange services through its telephone companies
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nationwide; laws in 27 states that foreclosed competition were knocked down;
co-carrier status for CLECs was ratified; and the physical collocation of
competitors' facilities in LECs central offices was allowed.
The legislation breaks down the old barriers that prevented three groups of
companies, the LECs, including the BOCs, the long-distance carriers, and the
cable TV operators, from competing head-to-head with each other. The Act
requires LECs to let new competitors into their business. It also requires the
LECs to open up their networks to ensure that new market entrants have a fair
chance of competing. The bulk of the legislation is devoted to establishing the
terms under which the LECs, and more specifically the BOCs, must open up their
networks.
The 1996 Telecom Act substantially changed the competitive and regulatory
environment for telecommunications providers by significantly amending the
Communications Act including certain of the rate regulation provisions
previously imposed by the Cable Television Consumer Protection and Competition
Act of 1992 (the "1992 Cable Act"). The 1996 Telecom Act eliminated rate
regulation of the cable programming service tier in 1999. Further, the
regulatory environment will continue to change pending, among other things, the
outcome of legal challenges and FCC rulemaking and enforcement activity in
respect of the 1992 Cable Act and the completion of a significant number of FCC
rulemakings under the 1996 Telecom Act.
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Cautionary Statement Regarding Forward-Looking Statements
You should carefully review the information contained in this Annual Report, but
should particularly consider any risk factors that we set forth in this Annual
Report and in other reports or documents that we file from time to time with the
SEC. In this Annual 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 and those
further described in Part I, Item 1. Factors That May Affect Our Business and
Future Results.
o 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;
o The efficacy of laws enacted by Congress; rules and regulations to be
adopted by the 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;
o 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 long-distance, local, cable and Internet services;
o The extent and pace at which different competitive environments develop
for each segment of our business;
o 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;
o The degree to which we experience material competitive impacts to our
traditional service offerings prior to achieving adequate local service
entry;
o Competitor responses to our products and services and overall market
acceptance of such products and services;
o The outcome of our negotiations with ILECs and state regulatory
arbitrations and approvals with respect to interconnection agreements;
o 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;
o Success and market acceptance for new initiatives, many of which are
untested;
o 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;
o Start-up costs associated with entering new markets, including
advertising and promotional efforts;
o Risks relating to the operations of new systems and technologies and
applications to support new initiatives;
o Local conditions and obstacles;
o The impact of oversupply of capacity resulting from excessive deployment
of network capacity;
o Uncertainties inherent in new business strategies, new product launches
and development plans, including local telephone services, Internet
services, wireless services, digital video services, cable modem
services, digital subscriber line services, transmission services, and
yellow page directories, and
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the offering of these services in geographic areas with which we are
unfamiliar;
o The risks associated with technological requirements, technology
substitution and changes and other technological developments;
o Prolonged service interruptions which could affect our business;
o Development and financing of telecommunication, local telephone,
wireless, Internet and cable networks and services;
o 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;
o Availability of qualified personnel;
o Changes in, or failure, or inability, to comply with, government
regulations, including, without limitation, regulations of the FCC, the
RCA, and adverse outcomes from regulatory proceedings;
o Uncertainties in federal military spending levels and military base
closures in markets in which we operate;
o 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;
o The financial, credit and economic impacts of the WorldCom bankruptcy
filing on the industry in general and on us in particular;
o A conversion of WorldCom's bankruptcy petition to Chapter 7, unfavorable
reaffirmation 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;
o The effect on us of pricing pressures, new program offerings and market
consolidation in the markets served by our major customers, WorldCom and
Sprint;
o Under Statement of Financial Accounting Standard ("SFAS") 142, we must
test our intangibles for impairment at least annually, which may result
in a material, non-cash write-down of goodwill and could have a material
adverse impact on our results of operations and shareholders' equity; and
o 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.
11
Part I
Item 1. Business
General
In this Annual Report, "we," "us" and "our" refer to GCI, Inc. and its direct
and indirect subsidiaries.GCI, Inc. was incorporated in 1997 to effect the
issuance of Senior Notes as further described in note 6 to the accompanying
Consolidated Financial Statements included in Part II of this Report. GCI, Inc.,
as a wholly owned subsidiary of GCI, received through its initial capitalization
all ownership interests in subsidiaries previously held by GCI. GCI, Inc. has
its principal executive offices at 2550 Denali Street, Suite 1000, Anchorage, AK
99503 (telephone number 907-265-5600).
GCI, Inc. is primarily a holding company and together with its direct and
indirect subsidiaries, is a diversified telecommunications provider with a
leading position in facilities-based long-distance service in the state of
Alaska and is Alaska's leading cable television and Internet services provider.
We are a significant provider in Alaska of an integrated package of
long-distance, local and wireless telecommunications services, cable television
services and Internet services and are well positioned to take advantage of
growth opportunities in the communications, data and entertainment markets.
Availability of Reports and Other Information
Internet users can access information about the Company and its services at
http://www.gci.com/, http://www.gcinetworksolutions.com/, and
http://www.alaskaunited.com/. The Company hosts Internet services at
http://www.gci.net/ and SchoolAccess(TM) services at http://www.gcisa.net/. We
make available on the http://www.gci.com/ website, free of charge, access to our
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on
Form 8-K, Proxy Statement on Schedule 14A and amendments to those materials
filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and
Exchange Act of 1934 as soon as reasonably practicable after we electronically
submit such material to the SEC. In addition, the SEC's website is
http://www.sec.gov/. The SEC makes available on this website, free of charge,
reports, proxy and information statements, and other information regarding
issuers, such as us, that file electronically with the SEC. Information on our
website or the SEC's website is not part of this document.
Financial Information About Industry Segments
We have four reportable segments: long-distance services, cable services, local
access services and Internet services. For information required by this section,
you should see Part II, Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations. Also refer to Note 9 included in
Part II, Item 8, Consolidated Financial Statements and Supplementary Data.
Historical Development of our Business During the Past Fiscal Year
20th Year Anniversary
Thanksgiving 2002 marked the 20th anniversary of the first long-distance call we
carried on our network, bringing telecommunications competition to the State of
Alaska.
Properties Expansion
We completed the first phase of a project in February 2002 to connect Palmer and
Wasilla, Alaska to our fiber optic network in Anchorage. This phase connected
our network in Anchorage to our Eagle River earth station and our Wasilla Call
Center with fiber optic cable facilities. The second phase will connect and
expand our facilities to provide cable and entertainment services to the
Palmer-Wasilla area. We expect that work to be complete in early 2003. Upon
completion, we will provide cable television programming content from our
Anchorage head end facility to Palmer and Wasilla.
12
We purchased a second 5ESS digital host switch manufactured by Lucent
Technologies to accommodate Anchorage area customer and traffic growth. We
expect to place the new switch into service in 2003. We have similar Lucent 5E
switches in Anchorage and Seattle, and smaller remote Lucent 5E switches in
Fairbanks and Juneau. We shut down our Seattle, Fairbanks and Juneau Alcatel DSC
DEX switches upon installation of the Lucent 5E switches. DEX is a trade name
for an Alcatel (previously Digital Switch Corporation) electronic digital
switching system.
Cable Services Expansion
We continued to upgrade and expand our cable infrastructure in 2002. These
efforts increased the capacity and reliability of our systems, making possible
further deployment of two-way applications such as cable modems and digital
cable television programming, and provided capacity for additional program and
service offerings.
We continued to extend our digital cable service in the Anchorage, Juneau, Kenai
and Soldotna, Alaska markets in 2002. Digital cable service allows us to use
digital compression to substantially increase the capacity of our cable
communications systems, improve picture quality and provide CD quality audio.
Digital cable subscriber counts in all locations totaled approximately 30,500 in
2002, an increase of 24.3% as compared to 2001.
To meet future bandwidth requirements in the Anchorage and Matanuska-Susitna
valley markets, efforts began in 2002 to move all programming services above the
basic service level to a digital platform. A plant upgrade for the
Matanuska-Susitna valley system began in 2002 and is expected to be completed in
2004.
Approximately 96.1% of our cable customers are able to receive cable modem
service. Cable modems are deployed in approximately 19.1% of the homes passed by
our cable systems in markets offering such service, which we believe is well
above the national average. Cable modem services provide high-speed, dedicated
access to the Internet through our coaxial cable network.
We launched video-on-demand service to certain of our Anchorage commercial
customers and added additional customers in 2002. This service passed 1,389
hotel rooms at December 31, 2002, an increase of 54.5% as compared to 2001.
We initiated digital cable entertainment services in 2002 to 1,050 rooms at the
Kuparuk Oil Field living quarters facilities in Prudhoe Bay, Alaska. This
service includes 100 channels of video, music and pay-per-view choices,
including one Anchorage broadcast television station.
Our Anchorage cable channel lineup was realigned in 2002, allowing us to begin
swapping all of our existing analog boxes for digital boxes. Moving to digital
allows us offer better service, more channels and better quality. We are also
able to reclaim bandwidth for other services, including cable telephony, cable
modems, and additional cable video services.
We signed new seven-year retransmission agreements with five local Anchorage
broadcasters and began up linking and distributing that programming to all of
our cable systems. These agreements allow other locations in Alaska to receive
local Anchorage broadcasting service in addition to programming received from
non-Alaska markets, providing additional value to our cable subscribers and
allowing us to differentiate our programming from that of our DBS competitors.
We continue to evaluate technology and the feasibility of using our cable plant
for telephone services that will enable us to deliver local telephone access
services on our own network. Testing and design is underway with regard to
chosen equipment, cable plant, power delivery, and operational support systems.
Upgrades have been made to a node in our Anchorage plant to create a test
deployment platform for cable telephony. Our upgraded cable plant node was
certified compliant with DOCSIS 1.1 standards in 2002.
13
You should see Part I, Item 1. Business, Narrative Description of our Business -
Cable Services, and Part I, Item 1. Regulation, Franchise Authorizations and
Tariffs - Cable Services Operations for more information.
Local Access Services Expansion
We had approximately 96,100 local access services lines in service in Anchorage,
Fairbanks and Juneau, Alaska at December 31, 2002, a 21.3% increase from
December 31, 2001. In late 2001 we began selling GCI local services in Juneau
with conversions beginning in the first quarter of 2002. We continue to evaluate
expanded implementation of wireless local loop and cable telephony technologies.
We filed a bona fide request with the ILEC, ACS of the Northland, Inc, in 2001
to negotiate rates and services in order to provide competitive local access
services in Nenana, Ft. Greely, North Pole, Delta Junction, Kenai, Soldotna,
Ninilchik, Homer, Seldovia and Kodiak, Alaska. The RCA has approved an
interconnection agreement and GCI can now apply for approval to enter these
markets, which must be granted by the RCA before we begin to provide local
access services
You should see Part I, Item 1. Business, Narrative Description of our Business -
Local Access Services, and Part I, Item 1. Regulation, Franchise Authorizations
and Tariffs - Telecommunication Operations for more information.
Internet and Broadband Services Expansion
We provided Internet service to approximately 70,700 dial-up subscribers at
December 31, 2002, a 2.5% increase from December 31, 2001. We provided service
to approximately 36,200 cable modem subscribers at December 31, 2002, a 36.7%
increase from December 31, 2001.
Approximately 96.1% of our cable customers are able to receive cable modem
service. Cable modems are deployed in approximately 19.1% of the homes passed by
our cable systems in markets offering such service, which we believe is well
above the national average. Cable modem services provide high-speed, dedicated
access to the Internet through our coaxial cable network. After significant
plant upgrades to handle reverse feed and higher bandwidth requirements, we
initiated cable modem services in 2002 in Petersburg, Wrangell, Cordova, Homer,
Bethel, Nome, and Kodiak, Alaska.
We initiated cable modem service in the Kenai and Soldotna, Alaska communities
in 2002. All locations that implemented cable modems in 2002 use the new DOCSIS
1.1 platform. We also upgraded cable modem customers in the Wasilla, Alaska
service area in 2002 to the DOCSIS 1.1 platform. We believe that we are the
first company in North America to successfully deploy the DOCSIS 1.1 platform.
This new non-proprietary platform allows us to provide a higher level of
service, helps us eliminate network congestion and run a cleaner network that is
more efficient to manage. It also protects customers from hackers and helps us
reduce the risk of high speed internet theft.
We increased the speeds of our DoubleUp and Gold cable modem product offerings
in certain markets in 2002, at no cost to our customers. Our premium cable modem
service, The Diamond service package, offers 2.4 megabits per second which is
twice as fast as our competitor's best package DSL offering.
We began offering our PrudhoeNet dialup Internet service to Prudhoe Bay, Alaska
oilfield workers in early 2003. We believe our product offers both lower price
and high quality for oilfield workers who want to stay in touch with family,
friends and business during their off work hours.
Our SchoolAccess(TM) program was first deployed successfully in Alaska where we
provide satellite-delivered voice, video and data services to many of the
state's rural communities. More than 80,000 Alaska students are now connected to
the Internet with SchoolAccess(TM). We provide e-mail service, a custom user
interface, a help desk, onsite training, security, network optimization, network
management, content filtering services and website hosting for 195 schools in
rural Alaska using SchoolAccess(TM), and provide Internet only services to
approximately 100 additional schools. We signed three-year contracts in 2002
with each of the 64 Alaska schools that re-bid their SchoolAccess(TM) service.
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We provide our SchoolAccess(TM) services to nine school districts comprising 25
schools in rural New Mexico and Arizona, serving more than 10,500 students. We
began providing SchoolAccess(TM) services to two school districts in Montana in
the third quarter of 2002.
During the 3rd Quarter of 2002, we launched our SchoolAccess(TM) Distance
Learning Service ("DLS") to approximately 80 rural Alaskan schools.
SchoolAccess(TM) DLS allows schools to conduct two-way videoconferences by
providing each of the six school districts with an autonomous videoconferencing
network. Schools not only have the ability to videoconference within the
district, but have the ability to conference with other schools or entities
worldwide. SchoolAccess(TM) DLS also gives teachers and students access to a
course management system that compliments the interactive service. Circuits for
the service are provided over our broadband satellite network, and all of the
hardware and software is included as part of the managed service.
We continued to deploy high-speed broadband TeleHealth services in 2002 using an
advanced satellite network to an additional 28 villages served by the Bristol
Bay Health Corporation in the Dillingham, Alaska area; eight villages for the
Yukon-Kuskokwim Health Corporation in the Bethel, Alaska area; 16 villages for
the Norton Sound Health Corporation in the Nome, Alaska area; and six villages
in the Eastern Aleutian area. At the end of 2002 we provided TeleHealth services
to approximately 70 western Alaska communities. This broadband service allows
remote communities to access health specialists and others in Alaska and
elsewhere for consultation and diagnostic services using a combination of video,
voice and data services.
We announced in 2001 our intent to provide Internet services to 152 Alaska
communities that we currently serve by 2004. The estimated $15 million project
will deliver high-speed Internet by cable modem, DSL and wireless technologies.
A considerable expansion of facilities was made in 2001 to support cable modem
Internet service launches in Valdez, Sitka, Nome and Seward, Alaska, and in
Kenai and Soldotna, Alaska in January 2002. We deployed cable modem service in
Wasilla/Palmer, Petersburg and Wrangell, Alaska by the end of the second quarter
2002; and Bethel, Cordova, Homer, and Kodiak, Alaska by the end of 2002. We
believe the Kenai and Soldotna launches were the first U.S. deployment of a
cable modem platform using the new DOCSIS 1.1 standard. This new standard
supports tiered levels of service, provides quality of service measurement, and
supports voice traffic over coaxial cable systems.
We provide 56 kbps and 256 kbps high-speed Internet access services to 15 rural
villages in the Northwest Arctic, Aleutian, and Yukon-Kuskokwim delta regions of
Alaska. We deliver high-speed Internet services locally in the villages through
the ILEC's DSL service or our unlicensed 2.4 GHz band fixed wireless service.
All long-haul transport is delivered through our satellite and associated
facilities.
You should see Part I, Item 1. Business, Narrative Description of our Business -
Internet Services, and Part I, Item 1. Regulation, Franchise Authorizations and
Tariffs - Internet Operations for more information.
PCS and LMDS Licenses
We have invested approximately $1.79 million in our PCS license at December 31,
2002. In June 2000 we began providing fixed wireless dial-tone services in
Anchorage over our PCS system, meeting the FCC requirement to provide coverage
of a commercial offering to at least one-third of our market population within
five years of being licensed. We presently offer our fixed wireless service to
customers that are not connected to the ILEC or our physical plant. We have
invested approximately $275,000 in our LMDS license. LMDS licensees are required
to provide 'substantial service' in their service regions within 10 years.
Contract Extension
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.
15
Yellow-Pages Directory
We signed a contract in 2002 with Alltel Publishing Corporation to enter the
directory listing and Yellow Pages market. The first directory will be
distributed in the Anchorage market in December 2003. We expect to continue to
expand our product offerings to other markets in 2004.
Retail Store Expansion
We opened new retail stores in 2002 serving our Wasilla and Anchorage markets.
The new stores combine certain of our customer service and payment centers and
allow customers to pay their bills, sign up for new services and experience our
full range of products.
GCI Fiber Communication System
We reached a significant milestone in 2002 in our agreement with the company
that operates the trans Alaska oil pipeline with the signing of a complex design
document for fiber and satellite circuits to support the pipeline control
system. These circuits operate the remote gate valves that stop the flow of oil
in the event of an emergency. They require an extremely high level of
availability and reliability. The complex design included eleven new earth
stations and supporting equipment that are expected to be placed into service in
2003.
E-Bill Service
We launched an online bill presentment and payment service in 2002 at
https://ebill.gci.com/. Over 27,000 accounts have signed up for the service
through January 2003.
E-Mail Guard Service
We launched a virus and SPAM filtering service for our e-mail platform in July
2002. The service provides our e-mail users with a capability to quarantine
unsolicited e-mail and suspected virus infected e-mail in a safe location. A
highly customer-configurable service, it has been very well received and has
significantly exceeded our 2002 acquisition forecast. Since we launched E-Mail
Guard, an estimated 50 million e-mail messages have been intercepted and
quarantined. In the first week of January 2003, E-Mail Guard prevented 1.8
million messages -- roughly 84 percent of the total volume of e-mail -- from
clogging electronic in-baskets and infecting computers with viruses.
Narrative Description of our Business
General
We operate a broadband communications network that permits the delivery of a
seamless integrated bundle of communications, entertainment and information
services. We offer a wide array of consumer and business communications and
entertainment services--including local telephone, long-distance and wireless
communications, cable television, consulting services, network and desktop
computing outsourced services, and dial-up, broadband (cable modem, wireless and
DSL) and dedicated Internet access services at a wide range of speeds--all under
the GCI brand name.
We believe that the size and growth potential of the voice, video and data
market, the increasing deregulation of telecommunication services, and the
increased convergence of telephony, wireless, and cable services offer us
considerable opportunities to continue to integrate our telecommunication,
Internet and cable services and expand into communications markets both within
and, longer-term, possibly outside of Alaska.
Considerable deregulation has already taken place in the United States because
of the 1996 Telecom Act with the barriers to competition between long-distance,
local exchange and cable providers being lowered. We believe our acquisition of
cable television systems and our development of local exchange service, Internet
services, broadband services, and wireless services leave us well positioned to
take advantage of deregulated markets.
We are one of Alaska's leading providers of telecommunication, Internet and
cable television services and maintain a strong competitive position. There is
active competition in the sale of substantially all products and services we
offer.
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Competition in the Communications Industry
There is substantial competition in the communications industry. The traditional
dividing lines between providers offering long-distance telephone service, local
telephone service, wireless telephone service, Internet services and video
services are increasingly becoming blurred. Through mergers and various service
integration strategies, major providers, including us, are striving to provide
integrated communications service offerings within and across geographic
markets.
Alaska Voice, Video and Data Markets
We estimate that the aggregate telecommunications, cable television, and
Internet markets in Alaska generated revenues in 2002 of approximately $1.1
billion. Of this amount, approximately $470 million was attributable to
interstate and intrastate long-distance service, $350 million was attributable
to local exchange services, $92 million was attributed to cable television, and
$188 million was attributable to all other services, including wireless and
Internet services.
The Alaskan voice, video and data markets are unique within the United States.
Alaska is geographically distant from the rest of the United States and is
generally characterized by large geographical size and relatively small, dense
population clusters (with the exception of population centers such as Anchorage,
Fairbanks and Juneau). It lacks a well-developed terrestrial transportation
infrastructure, and the majority of Alaska's communities are accessible only by
air or water. As a result, Alaska's telecommunication networks are different
from those found in the Lower 49 states.
Alaska continues to rely extensively on satellite-based long-distance
transmission for intrastate calling between remote communities where investment
in a terrestrial network would be uneconomic or impractical. Also, given the
geographic isolation of Alaska's communities and lack, in many cases, of major
civic institutions such as hospitals, libraries and universities, Alaskans are
dependent on telecommunications to access the resources and information of large
metropolitan areas in Alaska, the rest of the U.S. and elsewhere. In addition to
satellite-based communications, the telecommunications infrastructure in Alaska
includes fiber optic cables between Anchorage, Valdez, Fairbanks, Prudhoe Bay,
and Juneau, traditional copper wire, and digital microwave radio on the Kenai
Peninsula and other locations. For interstate and international communication,
Alaska is connected to the Lower 48 states by three fiber optic cables.
Fiber optics is the preferred method of carrying Internet, voice, video, and
data communications over long distances, eliminating the delay commonly found in
satellite connections. Widespread use of high capacity fiber optic facilities is
expected to allow continued expansion of business, government and educational
infrastructure in Alaska.
Long-Distance Services
Industry
Until the 1970s, AT&T had a virtual monopoly on long distance service in the
United States. In the 1970s, competitors such as MCI (now WorldCom) and Sprint
began to offer long distance service. With the gradual emergence of competition,
basic rates dropped, calling surged, and AT&T's dominance declined. More than
700 companies now offer long distance service. AT&T's 1984 toll revenues were
about 90% of those reported by all long distance carriers. The FCC's regulation
of AT&T as a "dominant" carrier ended in 1995. By 2000, AT&T's revenues had
declined to approximately 37% of those reported by all non-LEC long distance
carriers. The two largest market entrants, WorldCom and Sprint, have obtained a
31% combined market share through 2000.
Because of this competition, the cost of long distance calling dropped from 32
cents per minute in 1984 to 12 cents per minute in 2000. The average price of 12
cents per minute represents a mix of international calling (an average of 47
cents per minute) and domestic interstate calling (an average of 9 cents per
minute). The decline in prices since 1984 is more than 70% after adjusting for
the impact of inflation.
17
The FCC reports that more than twenty-three million households have been added
to the nation's telephone system since November 1983. An estimated 1.5 million
households were added between July 2001 and July 2002 as a result of an
increasing number of households. As of November 2001, 102.2 million households
had telephone service. The FCC reports that approximately 2% of all consumer
expenditures are devoted to telephone service. This percentage has remained
relatively constant over the past 15 years, despite major changes in the
telephone industry and in telephone usage. Average annual expenditures on
telephone service increased from $360 per household in 1981 to $877 in 2000.
The FCC reports that an estimated 95.1% of households and virtually all
businesses in the United States subscribed to telephone service in July 2002.
Line growth over time, averaging about 3% per year, has historically reflected
growth in the population and the economy. In recent years, the growth in lines
has increased as households have added additional lines. The percentage of
additional lines for households with telephone service has increased from
approximately 3% in 1988 to about 27% in 2000, but decreased from 29% in 1999.
The FCC reports that approximately $110 billion was derived from toll services
in 2000. 102.2 million households had telephone services, an increase of 23
million households since 1983. Approximately $33 billion is derived from
intrastate, $53 billion from interstate, and $24 billion from international toll
services. Interstate long distance toll revenues increased 103% from $26 billion
in 1984, and intrastate toll revenues increased 58% from $21 billion in 1984.
International telecommunications has become an increasingly important segment of
the telecommunications market. The FCC reports that international revenues
increased over 500% from $4 billion in 1984 to $24 billion in 2000. The FCC
reports that the number of calls made from the United States to other countries
increased from 200 million in 1980 to 6.6 billion in 2000. On average, carriers
billed 51 cents per minute for international calls in 2000, a decline of more
than 60% since 1980. Five markets, the United Kingdom, Canada, Mexico, Japan and
Australia, are currently the top five destinations of U. S. activated circuits
at December 31, 2001. The FCC's year-end 2001 report reflected slow growth in
the use of U.S. international-facilities for international calls and private
line services from the United States. By service type, international message
telephone service accounted for 16% of the total circuits used; international
private line services accounted for 76% of total circuits; and the remaining 8%
of total circuits were used for other data and video services. The percentage of
idle circuits as compared to the total circuit capacity increased from 48% in
2000 to 56% in 2001.
The United States Congress passed the 1996 Telecom Act that permitted the local
phone companies, the long-distance companies, and the cable service firms to
compete in each other's market. Its purpose was to move from a regulated
monopoly model of telecommunications to a deregulatory competitive markets
model. The 1996 Telecom Act has provided the telecommunications industry with
new capabilities resulting in an industry that is more competitive than ever
before.
Advancements are expected to continue to combine wireline and wireless services
directed toward voice communication with other activities such as data sharing,
on-screen collaboration, faxing, Internet access, and game playing, among many
other things.
While the 1996 Telecom Act has facilitated competition and rapid growth in the
telecommunications market, the last two years have been a tumultuous time for
that marketplace. Industry analysts believe that overly optimistic projections
of data growth spurred companies to invest large amounts of capital to boost
network capacity. While demand for telecommunications services grew, it did not
grow at a sufficient pace to justify the substantial build-out of fiber
capacity. A wide gap between the supply of network capacity and the demand for
data transmission occurred. Network owners refocused their efforts to
demonstrate profitability over a much shorter time horizon than initially
projected. A downward spiral ensued, as many telecommunications carriers went
bankrupt after failing to generate sufficient revenues to service their
accelerating debt loads. The resultant slowdown in capital expenditures left
equipment manufacturers with surplus inventory and personnel. Additionally,
several companies appear to have resorted to financial
18
deception to mask poor performance. This compounded the downturn by reducing
confidence in the truthfulness of financial statements.
Deteriorating conditions in the economy and in the telecommunications industry
have led to reorganizations, mergers and divestitures. AT&T and Comcast
Corporation finalized their combination of AT&T Broadband with Comcast in
November 2002, in a transaction that values AT&T Broadband at an aggregate value
of $72 billion (approximately $4,500 per subscriber). The resulting AT&T Comcast
Corporation is expected to develop and deploy new broadband applications such as
video-on-demand and interactive television.
Industry analysts believe companies will be successful in the long-term if they
can minimize regulatory battles and offer a full suite of integrated services to
their customers, using a network that is largely under their control.
Growth in data is expected to continue to be a key component of industry revenue
growth. We believe that the data telecommunications business will eventually
rival and perhaps become larger than the traditional voice telephony market.
ISPs have become major customers and many long-distance companies have acquired
ISPs and web-hosting companies.
The U.S. House of Representatives in February 2002 adopted a measure that would
allow LECs to offer long-distance data services without first opening their
networks to competitors as they must under the 1996 Telecom Act. Local telephone
carriers argue that the measure would accelerate the deployment of high-speed
Internet service using DSL technology. These dominant carriers compete with
cable companies for high-speed Internet access customers. Analysts report that
cable operators have approximately 6.4 million subscribers compared to 3.1
million DSL customers. The U.S. Senate did not act on the measure before the
close of the 107th Congress. To date, the bill has not been reintroduced in the
108th Congress.
We believe that federal and state legislators, courts and regulators will
continue to influence the telecommunications industry in 2003. Consummation of
mergers between and spin-offs from long-distance companies, local access
services companies, and cable television companies have occurred which blur the
distinction between product lines and competitors. Synergies developed through
mergers and acquisitions and obtaining end-to-end connectivity with customers is
expected to continue to drive long-run profitability and success in penetrating
new markets.
General
We supply a full range of common carrier long-distance and other
telecommunication products and services. We operate a modern, competitive
telecommunications network employing the latest digital transmission technology
based upon fiber optic facilities within and between Anchorage, Fairbanks and
Juneau, Alaska. Our facilities include a self-constructed and financed digital
fiber optic cable and additional owned capacity on another undersea fiber optic
cable, both linking Alaska to the networks of other carriers in the Lower 49
states. We use satellite transponders to transmit voice and data traffic to
remote areas of Alaska. We operate digital microwave systems to link Anchorage
with the Kenai Peninsula, and our Prudhoe Bay Earth Station with Deadhorse.
Digital microwave facilities are also used to backup our fiber facilities from
Anchorage to our Eagle River earth station, and to our Fairbanks earth station
from our Fairbanks distribution center. Virtually all switched services are
computer controlled, digitally switched, and interconnected by a packet switched
SS7 signaling network.
We provide interstate and intrastate long-distance services throughout Alaska
using our own facilities or facilities leased from other carriers. We also
provide (or join in providing with other carriers) telecommunication services to
and from Alaska, Hawaii, the Lower 48 states, and many foreign nations and
territories.
We offer cellular services by reselling other cellular providers' services. We
offer wireless local access services over our own facilities, and have purchased
PCS and LMDS wireless broadband licenses in FCC auctions covering markets in
Alaska.
19
Products
Our long-distance services industry segment is engaged in the transmission of
interstate and intrastate-switched message telephone service and private line
and private network communication service between the major communities in
Alaska, and the remaining United States and foreign countries. Our message toll
services include intrastate, interstate and international direct dial, toll-free
800, 888, 877 and 866 services, GCI calling card, operator and enhanced
conference calling, frame relay, SDN, ISDN technology based services, as well as
termination of northbound toll service for WorldCom, Sprint and several large
resellers who do not have facilities of their own in Alaska. We also provide
origination of southbound calling card and toll-free 800, 888, 877 and 866 toll
services for WorldCom, Sprint, and other IXCs. We offer our message services to
commercial, residential, and government subscribers. Subscribers may generally
cancel service at any time. Toll, private line, broadband and related services
account for approximately 53.5%, 53.5% and 60.4% of our 2002, 2001 and 2000
revenues, respectively. Broadband services include our SchoolAccess(TM) and
Rural Health initiatives. Private line and private network services utilize
voice and data transmission circuits, dedicated to particular subscribers, which
link a device in one location to another in a different location.
We have positioned ourselves as a price and customer service leader in the
Alaska telecommunication market. Rates charged for our long-distance services
are generally designed to be equal to or below those for comparable services
provided by our competitors.
In addition to providing communication services, we also design, sell, install,
service and operate, on behalf of certain customers, communication and computer
networking equipment and provide field/depot, third party, technical support,
telecommunications consulting and outsourcing services through our Network
Solutions business. We also supply integrated voice and data communication
systems incorporating interstate and intrastate digital private lines,
point-to-point and multipoint private network and small earth station services.
Our Network Solutions sales and services revenue totaled $12.4 million, $16.3
million, and $9.2 million in the years ended December 31, 2002, 2001 and 2000,
respectively, or approximately 3.4%, 4.6% and 3.2% of total revenues,
respectively. Presently, there are a number of competing companies in Alaska
that actively sell and maintain data and voice communication systems.
Our ability to integrate telecommunications networks and data communication
equipment has allowed us to maintain our market position based on "value added"
support services rather than price competition. These services are blended with
other transport products into unique customer solutions, including managed
services and outsourcing.
Facilities
Our telecommunication facilities include an undersea fiber optic cable
connecting Whittier, Valdez and Juneau, Alaska and Seattle, Washington, which
was placed into service in February 1999. We also own a portion of a second
undersea fiber optic cable linking Alaska to the Lower 48 states. The fiber
optic cables allow us to carry our Anchorage, Eagle River, Wasilla, Palmer,
military base, Kenai Peninsula, Girdwood, Valdez, Whittier, Delta Junction,
Prudhoe Bay, Glenallen, Healy, Fairbanks, Juneau, Ketchikan, and Sitka, Alaska
traffic to and from the contiguous Lower 48 states over terrestrial circuits,
eliminating the one-quarter second delay associated with satellite circuits. We
own other terrestrial fiber optic cables to transport our traffic from Anchorage
to Whittier and from Whittier to Deadhorse, Alaska, including connectivity to
intermediate communities of Valdez, Glenallen, Delta Junction, and Fairbanks.
Other facilities include major earth stations at Eagle River, Kodiak, Dutch
Harbor, Barrow, Bethel, Nome, Dillingham, Kotzebue, King Salmon, and Cordova,
all in Alaska, serving the communities in their vicinity, and at Issaquah,
Washington, which provides interconnection to Seattle and the Lower 48 states
for traffic to and from major Alaska earth stations. The Eagle River earth
station is linked to the Anchorage distribution center by fiber optic
facilities.
20
We completed construction of a fiber optic cable system from the Anchorage
distribution center to the Eagle River central office and to our major hub earth
station in Eagle River in the second quarter of 2000. The Issaquah earth station
is connected with the Seattle distribution center by means of diversely routed
leased fiber optic cable transmission systems, each having the capability to
restore the other in the event of failure. The Juneau earth station and
distribution centers are collocated. We have digital microwave facilities
serving the Kenai Peninsula communities. We maintain earth stations in Fairbanks
(linked by digital microwave to the Fairbanks distribution center), Juneau
(collocated with the Juneau distribution center), Anchorage (Benson earth
station), and in Prudhoe Bay as fiber network restoration earth stations. Our
Benson earth station also uplinks our statewide video service; such service is
pre-empted when earth station capacity is needed to restore our fiber network
between Anchorage and Prudhoe Bay.
In 2002, we constructed 6-meter earth stations at Unalakleet, Mountain Village,
and Ft. Yukon. These stations were constructed to support Distance Learning and
Telemedicine networks and primarily serve surrounding villages.
We use our DAMA facilities to serve 56 additional locations throughout Alaska.
The digital DAMA system allows calls to be made between remote villages using
only one satellite hop thereby reducing satellite delay and capacity
requirements while improving quality. We obtained the necessary RCA and FCC
approvals waiving current prohibitions against construction of competitive
facilities in certain rural Alaska communities, allowing for deployment of DAMA
technology in 56 sites in rural Alaska on a demonstration basis. In addition,
over 90 Ku-band VSAT facilities, and 119 C-band facilities provide dedicated
Internet access, Telehealth and private network services to rural public
schools, hospitals, health clinics, and natural resource development industries
throughout Alaska.
Our Anchorage, Fairbanks, and Juneau distribution centers contain electronic
switches to route calls to and from local exchange companies and, in Seattle, to
obtain access to WorldCom, Sprint and other carriers to distribute our
southbound traffic to the remaining 49 states and international destinations. In
Anchorage, a Lucent 5ESS digital host switch is connected by fiber to seven
remote facilities that are co-located in the ILEC's switching centers, to
provide both local and long distance service. Our extensive metropolitan area
fiber network in Anchorage supports cable television, Internet and telephony
services. The Anchorage, Fairbanks, and Juneau facilities also include digital
access cross-connect systems, frame relay data switches, Internet platforms, and
in Anchorage and Fairbanks, co-location facilities for interconnecting and
hosting equipment for other carriers. We also maintain an operator and customer
service center in Wasilla, Alaska.
In 2001 we constructed a new switching center in Fairbanks and installed a new
Lucent Technologies switch to enable the provisioning of local telephony
services in the Fairbanks market. The existing Fairbanks long distance toll
switch was decommissioned in December 2001. Substantially all toll traffic
originating in Fairbanks is now routed to Anchorage. The first ILEC collocation
office was also constructed during 2001 to enable access to a portion of the
Fairbanks ILEC UNE loop facilities. Fairbanks UNE loop provisioning began in
early 2002. Construction of a second collocation office was completed in 2002.
We installed a new Lucent Technologies switch in our Juneau distribution center,
also enabling local services to be launched in the Juneau market in 2002. This
new switch also replaced the existing toll switch in Juneau, which we
decommissioned in 2002. One collocation office and a second adjacent collocation
facility were completed at two of the Juneau ILEC central offices. We placed
these collocation facilities in service in 2002 enabling UNE loop access to a
portion of the Juneau ILEC's loop facilities.
Our Alcatel DSC DEX switch in Seattle was also decommissioned in 2002 after its
traffic was transitioned to our Lucent 5ESS switch in Seattle, which was placed
into service in 2000.
Efforts continued in 2002 to decommission our digital operator platform. We
expect to complete that work in early 2003 to enable its turndown and to migrate
its operator traffic to our Anchorage Lucent 5ESS host digital switch.
21
We plan to install a second Lucent 5ESS in Anchorage in 2003 that will enable
the turndown and decommissioning of our Anchorage Alcatel DSC DEX toll switch as
early as the fourth quarter of 2003.
We completed construction and placed into service in February 1999 a fiber optic
cable system that interconnects Anchorage, Whittier, Valdez, Fairbanks,
Deadhorse and Juneau, Alaska and Seattle Washington. We also own a portion of a
second undersea fiber optic cable that links Alaska with the Lower 48 states.
The fiber optic cables allow us to carry our Anchorage, Eagle River, Wasilla,
Palmer, Kenai Peninsula, Valdez, Whittier, Delta Junction, Prudhoe Bay,
Glenallen, Fairbanks, Juneau, Ketchikan, and Sitka area traffic to and from the
Lower 48 states over terrestrial circuits, eliminating the one-quarter second
delay associated with satellite circuits. Our preferred routing for this traffic
is via undersea fiber optic cable, which makes available satellite capacity to
carry our rural interstate and intrastate traffic.
We employ satellite transmission for rural intrastate and interstate traffic and
certain other major routes. We acquired satellite transponders on PanAmSat
Corporation ("PanAmSat") Galaxy XR satellite in March 2000 to meet our long-term
satellite capacity requirements. We further augmented capacity on Galaxy XR with
the lease of a seventh C-band transponder in October, 2002.
As demand for redundant capacity on our network increases, we expect that we
will need to further augment our facilities between Alaska and the Lower 48
states. We may lease or acquire capacity from others, or we may build another
undersea fiber optic cable system. We completed design and sub sea survey
efforts in 2002 for an additional undersea system as part of our planning
process. Expenditures through the 2002 totaled $1.6 million and have been
capitalized. We have not made a final decision as to whether we will construct
additional capacity. Acquisition or construction of such additional capacity
will be dependent upon our obtaining the necessary financing.
In 2000 we began deploying a new packet data satellite transmission technology
for the efficient transport of broadband data in support of our rural health and
SchoolAccess(TM) initiatives. We continued to deploy and upgrade this network
during 2002 and expect to further expand and upgrade this network during 2003.
We employ advanced digital transmission technologies to carry as many voice
circuits as possible through a satellite transponder without sacrificing voice
quality. Other technologies such as terrestrial microwave systems, metallic
cable, and fiber optics tend to be favored more for point-to-point applications
where the volume of traffic is substantial. With a sparse population spread over
a wide geographic area, neither terrestrial microwave nor fiber optic
transmission technology is considered to be economically feasible in rural
Alaska in the foreseeable future.
Customers
We had approximately 88,200, 87,900 and 88,600 active Alaska message telephone
service subscribers at December 31, 2002, 2001 and 2000, respectively.
Approximately 11,600, 12,200 and 12,200 of these were business and government
users at December 31, 2002, 2001 and 2000, respectively, and the remainder were
residential customers. Reductions in our business and government customer counts
were primarily attributed to continuing competitive pressures in Anchorage and
other markets we serve. Message telephone service revenues (excluding broadband,
operator services and private line revenues) averaged approximately $11.6
million per month during 2002.
Equal access conversions have been completed in all communities we serve with
owned facilities. We estimate that we carry over 45% of business and over 45% of
residential traffic as a statewide average for both originating interstate and
intrastate message telephone service traffic.
22
A summary of our switched message telephone service traffic (in minutes)
follows:
Interstate Minutes
---------------------------------------
Combined
Interstate
Inter- and Inter- Intra-
South- North- Calling national national State Total
For Quarter ended bound (1) bound Card Minutes Minutes Minutes Minutes
- ----------------------------------------------------------------------------------------------------------------------
(Amounts in thousands)
March 31, 2000 143,659 69,678 2,847 1,577 217,761 37,414 255,175
June 30, 2000 149,095 67,754 2,616 1,610 221,075 38,546 259,621
September 30, 2000 157,993 73,802 2,493 1,698 235,986 39,329 275,315
December 31, 2000 129,091 76,202 2,467 1,429 209,189 35,729 244,918
------- ------- ------ ----- ------- ------- ---------
Total 2000 579,838 287,436 10,423 6,314 884,011 151,018 1,035,029
======= ======= ====== ===== ======= ======= =========
March 31, 2001 126,681 74,252 2,087 1,424 204,444 38,763 243,207
June 30, 2001 141,091 76,256 1,926 1,530 220,803 40,407 261,210
September 30, 2001 160,600 87,230 1,961 1,634 251,425 39,355 290,780
December 31, 2001 130,638 90,812 1,946 1,362 224,758 39,246 264,004
------- ------- ------ ----- ------- ------- ---------
Total 2001 559,010 328,550 7,920 5,950 901,430 157,771 1,059,201
======= ======= ====== ===== ======= ======= =========
March 31, 2002 133,455 91,061 1,683 1,413 227,612 40,781 268,393
June 30, 2002 144,143 105,001 1,582 1,462 252,188 44,528 296,716
September 30, 2002 159,564 90,839 1,463 1,527 253,393 46,860 300,253
December 31, 2002 138,735 78,483 1,341 1,506 220,065 43,595 263,660
------- ------- ------ ----- ------- ------- ---------
Total 2002 575,897 365,384 6,069 5,908 953,258 175,764 1,129,022
======= ======= ====== ===== ======= ======= =========
--------------------------
1 The 2000 Interstate Southbound minutes include traffic carried from
Washington to Oregon by us on behalf of an OCC customer. The 2001
Interstate Southbound minutes include traffic that originates and
terminates in Washington by us on behalf of an OCC customer.
All minutes data were taken from our internal billing statistics reports.
---------------------------
We entered into a significant business relationship with MCI (now WorldCom) in
1993 that included the following agreements, among others.
o We agreed to terminate all Alaska-bound MCI long-distance traffic and MCI
agreed to terminate all of our long-distance traffic terminating in the
Lower 49 states excluding Washington, Oregon and Hawaii.
o The parties agreed to share some communications network resources and
various marketing, engineering and operating resources. We also carry
MCI's 800, 888, 877 and 866 traffic originating in Alaska and terminating
in the Lower 49 states and handle traffic for MCI's calling card
customers when they are in Alaska.
Concurrently with these agreements, MCI purchased approximately 31%
(approximately 9.1% as of December 31, 2002) of GCI's Common Stock and presently
one representative serves on the GCI Board. Since we are a wholly-owned
subsidiary of GCI, we can be affected by activity in GCI's common stock and
decisions made by GCI's Board. In conjunction with the acquisition of certain
cable television companies in
23
1996, MCI purchased an additional two million shares at a premium to the then
current market price for $13 million or $6.50 per share. WorldCom sold 4.5
million shares of GCI Class A common stock in 2002.
Revenues attributed to WorldCom's message telephone traffic from these
agreements (excluding private line and other revenues) in 2002, 2001 and 2000
totaled $54.7 million, $44.8 million, and $47.9 million, or 14.9%, 12.6%, and
16.4% of total revenues, respectively. The contract was amended in March 2001
extending its term five years to March 2006. The amendment reduces the rate to
be charged by us for certain traffic over the extended term of the contract. 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. See note 11 in the
accompanying Notes to Consolidated Financial Statements for additional
information.
In 1993 we entered into a long-term agreement with Sprint, pursuant to which we
agreed to terminate all Alaska-bound Sprint long-distance traffic and Sprint
agreed to handle substantially all of our international traffic. Services
provided pursuant to the contract with Sprint resulted in message telephone
service revenues (excluding private line and other revenues) in 2002, 2001 and
2000 of approximately $23.5 million, $29.7 million, and $20.1 million, or
approximately 6.4%, 8.3%, and 6.9% of total revenues, respectively. The contract
was amended in March 2002 extending its term five years to March 2007, with two
one-year automatic extensions thereafter. The amendment reduces the rate to be
charged by us for certain traffic over the extended term of the contract.
With the contracts and amendment described above, we believe that WorldCom,
subject to reaffirmation of our contract through the bankruptcy process, and
Sprint, our two largest customers, will continue to make use of our services
during the extended term. WorldCom was a major customer of our long-distance
services industry segment through 2002. Sprint met the threshold for
classification as a major customer through 1998, and met the threshold again in
2001.
Other common carrier traffic routed to us for termination in Alaska is largely
dependent on traffic routed to our carrier customers by their customers. Pricing
pressures, new program offerings, revised business plans, and market
consolidation continue to evolve in the markets served by our carrier customers.
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 we may have to reduce our pricing to respond to
competitive pressures. We are unable to predict the effect of such changes on
our business; however the loss of one or both of WorldCom or Sprint as
customers, a material adverse change in our relationships with them or a
material loss of or reduction in their long-distance customers would have a
material adverse effect on our financial condition and results of operations.
We provide various services to BP Alaska, Wells Fargo Bank Alaska and Alyeska
Pipeline Service Company. Although these customers do not meet the threshold for
classification as major customers, we do derive significant revenues and gross
profit from them. There are no other individual customers, the loss of which
would have a material impact on our revenues or gross profit.
We provided private line and private network communication products and
services, including SchoolAccess(TM) private line facilities, to approximately
363 commercial and government customers in 2002. These products and services
generated approximately 9.8%, 9.7% and 9.9% of total revenues during the years
ended December 31, 2002, 2001 and 2000, respectively.
Although we have several agreements to facilitate the origination and
termination of international toll traffic, we have neither foreign operations
nor export sales (see Part I, Item 1. Business, Foreign and Domestic Operations
and Export Sales).
Competition
The long-distance industry is intensely competitive and subject to constant
technological change. Competition is based upon price and pricing plans, the
type of services offered, customer service, billing
24
services, performance, perceived quality, reliability and availability. A number
of our competitors are substantially larger than we are and have greater
financial, technical and marketing resources than we have.
In the long-distance market, we compete against AT&T Alascom, ACS, the Matanuska
Telephone Association and certain smaller rural local telephone carrier
affiliates. There is also the possibility that new competitors will enter the
Alaska market. In addition, wireless services continue to grow as an alternative
to wireline services as a means of reaching customers.
Historically, we have competed in the long-distance market by offering discounts
from rates charged by our competitors and by providing desirable packages of
services. Discounts have been eroded in recent years due to lowering of prices
by AT&T Alascom and entry of other competitors into the long-distance markets we
serve. In addition, our competitors have also begun to offer their own packages
of services. If competitors lower their rates further or develop more attractive
packages of services, we may be forced to reduce our rates or add additional
services, which would have a material adverse effect on our revenues and net
income.
Under the terms of AT&T's acquisition of Alascom, AT&T Alascom rates and
services must mirror those offered by AT&T, so changes in AT&T prices indirectly
affect our rates and services. AT&T's and AT&T Alascom's interstate prices are
regulated under a price cap plan whereby their rate of return is not regulated
or restricted. Price increases by AT&T and AT&T Alascom generally improve our
ability to raise prices while price decreases pressure us to follow. We believe
we have, so far, successfully adjusted our pricing and marketing strategies to
respond to AT&T and other competitors' pricing practices. However, if
competitors significantly lower their rates, we may be forced to reduce our
rates, which could have a material adverse effect on us.
ACS and other LECs have entered the interstate and international long-distance
market, and pursuant to RCA authorization, entered the intrastate long-distance
market. ACS and other LECs generally lease or buy long-haul capacity on
long-distance carriers' facilities to provide their interstate and intrastate
long-distance services.
Another carrier completed construction of fiber optic facilities connecting
points in Alaska to the Lower 48 states in 1999. The additional fiber system
provides direct competition to services we provide on our owned fiber optic
facilities, however the fiber system provides an alternative routing path for us
in case of a major fiber outage in our systems. This carrier filed for Chapter
11 bankruptcy in 2001 its assets were sold in 2002.
In the wireless communications services market, we expect our PCS business
license in the future may be used to compete against the cellular subsidiaries
of AT&T Wireless Services, Inc. ("AT&T Wireless") and ACS and resellers of those
services in Anchorage and other markets. The wireless communications industry
continues to experience significant consolidation. AT&T Wireless has acquired
wireless companies and negotiated roaming arrangements that give it a national
presence. Mergers and joint ventures in the industry have created large,
well-capitalized competitors with substantial financial, technical, marketing
and other resources. These competitors may be able to offer nationwide services
and plans more quickly and more economically than we can, and obtain roaming
rates that are more favorable than those that we obtain. We currently resell
AT&T Wireless analog and digital cellular services and provide limited wireless
local access services on our own facilities. AT&T Wireless has recently
announced that it plans to exchange with Dobson Communications Corporation
("Dobson") its Anchorage wireless properties for properties currently owned by
Dobson in California.
Our long-distance services sales efforts are primarily directed toward
increasing the number of subscribers we serve, selling bundled services, and
generating incremental revenues through product and feature up-sale
opportunities. We sell our long-distance communications services through
telemarketing, direct mail advertising, door-to-door selling, up-selling by our
customer contact personnel, and local media advertising.
We expect competition to increase as new technologies, products and services
continue to develop. We cannot predict which of many possible future
technologies, products or services will be important to maintain
25
our competitive position or what expenditures will be required to develop and
provide these technologies, products or services. Our ability to compete
successfully will depend on marketing and on our ability to anticipate and
respond to various competitive factors affecting the industry, including new
services that may be introduced, changes in consumer preferences, economic
conditions, market and competitor consolidation, and pricing strategies by
competitors. To the extent we do not keep pace with technological advances or
fail to timely respond to changes in competitive factors in our industry and in
our markets we could lose market share or experience a decline in our revenue
and net income. Competitive conditions create a risk of market share loss and
the risk that customers shift to less profitable lower margin services.
Competitive pressures also create challenges to our ability to grow new
businesses or introduce new services successfully and execute on our business
plan. Each of our business segments also faces the risk of potential price cuts
by our competitors that could materially adversely affect our market share and
gross margins.
Cable Services
Industry
The programmed video services industry includes traditional broadcast
television, cable television, DBS systems, private cable operators, LEC entry,
broadband service providers, wireless cable, open video systems, home video
sales and rentals, Internet video, and electric and gas utilities. Cable
television providers have added non-broadcast programming, utilized improved
technology to increase channel capacity and expanded service markets to include
more densely populated areas and those communities in which off-air reception is
not problematic. Broadcast television stations including network affiliates and
independent stations generally serve the urban centers. One or more local
television stations may serve smaller communities. Rural communities may not
receive local broadcasting or have cable systems but may receive direct
broadcast programming via a satellite dish.
Advancements in technology, facility upgrades and plant expansions to enable
migration to digital programming are expected to continue to have a significant
impact on cable services in the future. We expect that changing federal, state
and local regulations, intense competition, and developing technologies and
standards will continue to challenge the industry.
The FCC has reported that although competitive alternatives continue to develop,
cable television still is the dominant technology for the delivery of video
programming to consumers in the MVPD marketplace. As of June 2002, 76.5 percent
of MVPD subscribers received their video programming from a franchised cable
operator, compared to 78 percent a year earlier. The total number of subscribers
to both cable and non-cable MVPDs continues to increase. A total of 89.9 million
households subscribe to multichannel video programming services as of June 2002,
an increase of 1.8 percent over the 88.3 million households subscribing to MVPDs
in June 2001. This subscriber growth accompanied a 1.2 percentage point decrease
in MVPDs' penetration of television households to 85.3 percent as of June 2002.
The FCC reports that the number of cable subscribers grew to almost 68.8 million
as of June 2002, up approximately 0.4 percent from 68.6 million cable
subscribers as of June 2001. The total number of non-cable MVPD subscribers grew
from 19.3 million as of June 2001 to 21.1 million as of June 2002, an increase
of more than nine percent. This subscriber growth accompanied a 1.2% decrease in
MVPDs' penetration of television households to 85.3% as of June 2002, indicating
that television households are increasing at a faster rate than MVPD subscriber
growth. Although industry data reflect continued growth through June 2002, the
FCC reports that a number of major cable system operators have experienced
significant subscriber losses during this period and calendar year 2002 may be
the first year in which the industry as a whole has had a net loss of
subscribers.
The FCC further reports that DBS subscribership has grown significantly and
represented 20.3 percent of all MVPD subscribers as of June 2002. Between June
2001 and June 2002, the number of DBS subscribers grew from approximately 16
million households to approximately 18 million households, which is
significantly higher than the cable subscriber growth rate. The growth of DBS is
still, in part, attributable to the authority granted to DBS operators to
distribute local broadcast television stations in their local markets by the
Satellite Home Viewer Improvement Act of 1999 ("SHVIA"). Continued DBS
subscriber growth is expected as local
26
programming is offered in more markets. See Part I, Item 1. Business,
Regulation, Franchise Authorizations and Tariffs - Cable Services for more
information.
According to the Bureau of Labor Statistics, cable prices rose 6.3 percent
compared to a 1.1 percent increase in the Consumer Price Index between June 2001
and June 2002. The FCC reports that concurrently with these rate increases, the
number of video and non-video services offered increased, and programming costs
increased.
As a converged platform, cable is a viable competitive alternative outside its
traditional video space, not only in the broadband space as a competitor with
technology such as DSL, but also in traditional telephony services. These
developments continue to move forward and will be enhanced as voice becomes
another application that is carried on data centric networks.
The most significant convergence of service offerings over cable plant continues
to be the pairing of Internet service with other service offerings. Cable
operators continue to build-out the broadband infrastructure that permits them
to offer high-speed Internet access. The most popular way to access the Internet
over cable is still through the use of a cable modem and personal computer,
though a small number of users continue to access the Internet through their
television and a specially designed set-top box, rather than a personal
computer. Virtually all of the major multiple system operators offer Internet
access via cable modems in portions of their service areas. Like cable, the DBS
industry is developing ways to bring advanced services to their customers. Many
MMDS and private cable operators also offer Internet access services. In
addition, broadband services providers continue to build advanced systems
specifically to offer a bundle of services, including video, voice, and
high-speed Internet access. We currently offer high-speed cable modem access in
Anchorage, Bethel, Cordova, Juneau, Eielson Air Force Base, Elmendorf Air Force
Base, Fairbanks, Fort Richardson, Fort Wainwright, Homer, Kenai, Kodiak, Nome,
North Pole, Palmer, Petersburg, Seward, Sitka, Soldotna, Wasilla, Wrangell, and
Valdez.
The cable industry has expanded its competitive offerings to include business
and residential telephone services delivered over its fiber optic
infrastructure. Cable-delivered telephone service is a natural extension of a
network already capable of delivering digital and broadband services and
products. Once upgraded to a two-way capability, a cable system can offer
telephone service over the same cable line that already carries digital video,
high speed Internet, and other advanced services to consumers. The FCC reports
that several cable multiple system operators continue to offer telephone
service. Cable operators are beginning to deploy Internet Protocol ("IP")
telephony in addition to circuit-switched telephony offerings. Cable operators
such as Cox and AT&T continue to deploy circuit-switched cable telephony.
Circuit-switched service requires large capital expenditures for switching
equipment in addition to facility upgrades. Others, like Cablevision and
Comcast, continue to offer cable telephony where it has already been deployed,
but generally are waiting for IP technology to become widely available before
accelerating their rollout of telephone service. AT&T, AOL Time Warner, Comcast,
Cox, and Charter are currently offering or continuing to test IP telephony
products. Voice over IP is more modular and does not require the large upfront
cost needed to deploy circuit-switched service. Voice over IP utilizes the data
path already built, and is expected to allow for easy software changes and
additions to service packages including innovative combinations of voice, data,
and fax services.
The National Cable and Telecommunications Association ("NCTA") reports that
cable-delivered residential telephone service subscribers totaled an estimated
2.5 million through December 2002, with analysts projecting 15.4 million
subscribers in 2005.
With digital transmissions and compression, cable operators are better able to
offer a variety and quality of channels to rival DBS, with pay-per-view choices
that can approximate video-on-demand. In 2000 we installed a commercial version
of video-on-demand for the Anchorage hotel market and continue to evaluate the
feasibility of deploying this technology in the residential market. With this
service, customers can access a wide selection of movies and other programming
at any time, with digital picture quality.
27
The FCC reports that consolidation within the cable industry continues as cable
operators acquire and trade systems. Excluding mergers which involve the
transfer and exchange of systems, twelve system transactions occurred during the
first six months of 2002 affecting over 388,000 subscribers. The average dollar
value per subscriber totaled $2,196 as compared to $4,872 per subscriber for the
36 transactions that occurred in 2001, affecting over 17.9 million subscribers.
The ten largest operators served approximately 85 percent of all U.S. cable
subscribers. In terms of one traditional economic measure, national
concentration among the top MVPDs has decreased since last year as the largest
MSOs continue to become more equal in size, and it remains below the levels
reported in earlier years. DBS operators DirecTV and EchoStar rank among the
five largest MVPDs in terms of nationwide subscribership along with three cable
multiple system operators. As of June 2002, more than 52 million of the nation's
cable subscribers were served by systems that are included in regional clusters.
The FCC reported that estimated 2002 total cable industry revenue reached $49.4
billion, an estimated 12.3% increase over 2001, and that revenue per subscriber
per year reached approximately $716, an increase of 11.7% over 2001. Revenue
growth in 2002 occurred primarily in the high speed Internet access, cable
telephony and interactive services category (97.6% increase), the advanced
analog and digital tier category (42.9% increase), and the pay-per-view category
(15.1% increase). Revenues in the premium pay tiers category decreased 1.5%.
The escalation of programming costs continues to adversely impact the economics
of cable operators. Programming costs are reported to be the largest cost item
for major system operators, and the fastest growing operating cost item for
most. Operators face constant pressure to keep rate increases at a minimum. Over
the past several years, operators have averaged annual rate increases in the 5%
range; with escalating programming costs the most often cited principal cause.
While many public-interest groups and press reports note that cable rates have
increased at factors in excess of the general rate of inflation, cable rates are
reported to have lagged national inflation on a per channel basis.
The FCC reports that basic cable penetration as compared to homes passed was
66.9% at June 2002. Our overall penetration of homes passed was 62.2% at
December 31, 2002 with individual systems ranging from 51.2% to 92.4%.
In Alaska, cable television was introduced in the 1970s to provide television
signals to communities with few or no available off-air television signals and
to communities with poor reception or other reception difficulties caused by
terrain interference. Since that time, as on the national level, the cable
television providers in Alaska have added non-broadcast programming.
The market for programmed video services in Alaska includes traditional
broadcast television, cable television, wireless cable, and DBS systems.
Broadcast television stations including network affiliates and independent
stations serve the urban centers in Alaska. Eight, six and two broadcast
stations serve Anchorage, Fairbanks and Juneau, respectively. In addition,
several smaller communities such as Bethel are served by one local television
station that is typically a PBS affiliate. Other rural communities without cable
systems receive a single state sponsored channel of television by a satellite
dish and a low power transmitter.
See Part I, Item I, Business, Regulation, Franchise Authorizations and Tariffs -
Cable Service for more information.
General
We are the largest operator of cable systems in Alaska, serving approximately
136,100 residential, commercial and government basic subscribers. Our cable
television systems serve 33 communities and areas in Alaska, including the
state's three largest urban areas, Anchorage, Fairbanks, and Juneau. Our
statewide cable systems consist of approximately 2,230 miles of installed cable
plant having 330 to 550 MHz of channel capacity.
28
Products
Programming services offered to our cable television systems subscribers differ
by system (all information as of December 31, 2002).
Anchorage system. The Anchorage system, which is located in the urban center for
Alaska, is fully addressable and offers a basic analog service that includes 18
channels and 2 additional analog tiers offering 33 and 6 channels. This system
also carries digital service, offering enhanced picture and audio quality, over
20 digital special interest channels, 45 channels of digital music, and over 50
channels of premium and pay-per-view products. Pay TV services are available
either individually or as part of a value package. Commercial subscribers such
as hospitals, hotels and motels are charged negotiated monthly service fees.
Apartment and other multi-unit dwelling complexes receive basic service at a
negotiated bulk rate.
Fairbanks, Juneau, Kenai, and Soldotna systems. These systems offer a basic
analog service with 12 to 18 channels and an additional analog tier with 34 to
42 channels. These systems also carry digital service, offering enhanced picture
and audio quality, over 18 special interest channels, 45 channels of digital
music, and over 40 channels of premium and pay-per-view products.
Sitka System. This location offers an advanced analog service with a 15 channel
basic service, a 37 channel expanded basic service, five channels of premium
service, four channels of pay-per-view and 32 music channels.
Other systems. We own systems in the Alaska communities and areas of Bethel,
Cordova, Homer, Ketchikan, Kodiak, Kotzebue, Palmer, Wasilla, Nome, Petersburg,
Seward, Valdez, and Wrangell. These analog systems offer a basic service with
nine to 15 channels and an expanded basic service with 35 to 49 channels.
Several channels of premium service are also available in all systems. Music
service is available in Ketchikan, Kodiak, Petersburg, Valdez and Wrangell.
Pay-per-view is available in Homer, Ketchikan, Kodiak, Petersburg, Seward and
Wrangell.
Facilities
Our cable television businesses are located in Anchorage, Palmer, Wasilla,
Bethel, Chugiak, Cordova, Douglas, Eagle River, Eielson AFB, Elmendorf AFB,
Fairbanks, Fort Greely, Fort Richardson, Fort Wainwright, Homer, Juneau,
Kachemak, Kenai, Ketchikan, Kodiak, Kodiak Coast Guard Air Station, Kotzebue,
Mount Edgecombe, Nome, North Pole, Palmer, Petersburg, Peters Creek, Saxman,
Seward, Sitka, Soldotna, Ward Cove, Wasilla, and Wrangell Alaska. Our facilities
include cable plant and head-end distribution equipment. Certain of our head-end
distribution centers are co-located with customer service, sales and
administrative offices.
Customers
Our cable systems passed approximately 197,000, 192,000 and 177,000 homes at
December 31, 2002, 2001 and 2000, respectively, and served approximately
136,100, 132,000 and 120,400 basic subscribers at December 31, 2002, 2001 and
2000, respectively. Revenues derived from cable television services totaled
$88.7 million, $76.6 million and $67.9 million in 2002, 2001 and 2000,
respectively.
Competition
The 1996 Telecom Act removed barriers to telephone company or LEC entry into the
video marketplace to facilitate competition between incumbent cable operators
and telephone companies. At the time of the 1996 Telecom Act, it was expected
that LECs would compete in the video delivery market and that cable operators
would provide local telephone exchange service. The FCC reports that the four
largest ILECs have largely exited the video business. A few smaller LECs
continue to offer, or are preparing to offer, MVPD service over existing
telephone lines.
Our cable television systems face competition from alternative methods of
receiving and distributing television signals, including DBS, wireless and
private SMATV systems, and from other sources of news, information and
entertainment such as off-air television broadcast programming, newspapers,
movie theaters,
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live sporting events, interactive computer services, Internet services and home
video products, including videotape cassette and video disks. Our cable
television systems also face competition from potential overbuilds of our
existing cable systems by other cable television operators and alternative
methods of receiving and distributing television signals.
We believe our greatest source of competition comes from the DBS industry. Two
major companies, DirecTV and Echostar are currently offering nationwide
high-power DBS services. Due to the existing structure of satellite orbital
slots, satellite transmission power and lack of local signals, competition from
DBS providers has been limited.
In the past, the majority of Alaska DBS subscribers were required to install
larger satellite dishes (generally three to six feet in diameter) because of the
weaker satellite signals currently available in northern latitudes, particularly
in communities surrounding, and north of, Fairbanks. In addition, the satellites
had a relatively low altitude above the horizon when viewed from Alaska, making
their signals subject to interference from mountains, buildings and other
structures. Recent satellite placements provide Alaska and Hawaii residents with
a DBS package that requires a smaller satellite dish (typically 18 inches);
however, a second larger dish is required if the subscriber wants to receive a
channel line-up similar to that provided by our cable systems. In addition to
the dish size and cost deterrents, DBS signals are subject to degradation from
atmospheric conditions such as rain and snow.
We expect the potential launch of new satellites, the addition of local
stations, and the changing nature of technology and of the DBS business will
result in greater satellite coverage and competition in Alaska.
Several other cable operators provide cable service in Alaska. All of these
companies are relatively small, with the largest having fewer than 1,500
subscribers. The extent to which our cable television systems are competitive
depends, in part, upon our ability to provide quality programming and other
services at competitive prices.
Competitive forces will be counteracted by offering expanded programming through
digital services and by providing high-speed data services. By December 31,
2003, system upgrades will be completed to make systems reverse activated, thus
creating the necessary infrastructure to offer cable modem service to 99.5% of
our homes passed. Over the succeeding two years, we expect to establish a
digital platform in the majority of our systems. These plant upgrades combined
with local broadcast programming are expected to provide an attractive product
in comparison to competitive offerings. In 2002, seven-year retransmission
agreements were signed with Anchorage broadcasters. These agreements provide for
the uplink/downlink of their signals into all our systems, assuring local
programming is available for the foreseeable future.
High-speed data access competition takes two primary forms: cable modem access
service and DSL service. DSL service allows Internet access to subscribers at
data transmission speeds equal to cable modems over traditional telephone lines.
Numerous companies, including telephone companies, have introduced DSL service
and certain telephone companies are seeking to provide high-speed broadband
services, including interactive online services, without regard to present
service boundaries and other regulatory restrictions. Companies in the lower-49
states, including telephone companies and ISP's, have asked local, state and
federal governments to mandate that cable communications systems operators
provide capacity on their cable infrastructure so that these companies and
others may deliver Internet services directly to customers over cable
facilities. The FCC determined in March 2002 that cable system operators will
not be required to provide such "open access" to others. See Part I, Item 1,
Business, Regulation, Franchise Authorizations and Tariffs - Cable Services for
more information.
Other new technologies may become competitive with non-entertainment services
that cable television systems can offer. The FCC has authorized television
broadcast stations to transmit textual and graphic information useful to both
consumers and businesses. The FCC also permits commercial and non-commercial FM
stations to use their subcarrier frequencies to provide non-broadcast services
including data transmissions. The FCC established an over-the-air interactive
video and data service that will permit two-
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way interaction with commercial and educational programming along with
informational and data services. LECs and other common carriers also provide
facilities for the transmission and distribution to homes and businesses of
interactive computer-based services, including the Internet, as well as data and
other non-video services. The FCC has conducted spectrum auctions for licenses
to provide PCS. PCS will enable license holders, including cable operators, to
provide voice and data services. We own a statewide license to provide PCS
services in Alaska.
Cable television systems generally operate pursuant to franchises granted on a
non-exclusive basis. The 1992 Cable Act gives local franchising authorities
jurisdiction over basic cable service rates and equipment in the absence of
"effective competition," prohibits franchising authorities from unreasonably
denying requests for additional franchises and permits franchising authorities
to operate cable systems. Well-financed businesses from outside the cable
industry (such as the public utilities that own certain of the poles on which
cable is attached) may become competitors for franchises or providers of
competing services.
Our cable services sales efforts are primarily directed toward increasing the
number of subscribers we serve, selling bundled services, and generating
incremental revenues through product and feature up-sale opportunities. We sell
our cable services through telemarketing, direct mail advertising, door-to-door
selling, up-selling by our customer contact personnel, and local media
advertising.
Advances in communications technology as well as changes in the marketplace are
constantly occurring. We cannot predict the effect that ongoing or future
developments might have on the telecommunications and cable television
industries or on us specifically.
Local Access Services
Industry
The FCC reported that end-user customers obtained local service by means of 167
million ILEC switched access lines, 22 million CLEC switched access lines, and
129 million mobile wireless telephone service subscriptions. Total CLEC switched
access lines increased by 10% during the first half of 2002, from 19.7 million
to 21.6 million lines.
The FCC reported that CLECs provided 11.4% of the approximately 189 million
nationwide switched-access lines in service at the end of June 2002, compared to
9.0% at the end of June 2001. The FCC further reported that slightly over half
of reported CLEC switched access lines serve residential and small business
customers, compared to over three-quarters of ILEC lines. CLECs reported 7.8% of
total residential and small business switched access lines, compared to 5.5% a
year earlier.
During the first half of 2002, the FCC reported that cable telephony lines
increased by 16% to 2.6 million lines, from 2.2 million lines at the end of June
2001. The 2.6 million reported cable-telephony lines constituted about 12% of
switched access lines provided by CLECs and about 1% of total switched access
lines. CLECs reported providing about 21% (a decline from 43% in December 1999)
of their switched access lines by reselling the services of other carriers and
about 50% (an increase from 24% in December 1999) by means of UNE loops leased
from other carriers. The remainder of CLEC lines was provided over local loop
facilities owned by the CLECs.
Emerging from the new competitive landscape are CLECs who offer Internet access
and data services to medium and large size businesses. They obtain
interconnection agreements with ILECs for DSL-qualified unbundled network
element loops. One loop, so qualified and equipped with appropriate access
devices, enables the delivery of high speed (generally less than 768 kbps but
sometimes faster rates), always-connected Internet access, LAN/WAN
interconnectivity, and private line and private network circuits.
Cable telephony deployments in the US continue to expand using proprietary,
circuit switched technology. The standardized, packet (IP) technology made
significant progress in 2002, however, significant deployments have not yet
occurred. In 2002, more hardware became available that is DOCSIS 1.1 qualified,
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which provides quality of service necessary for voice services. We continue to
prepare for deployment of a cable telephony solution that meets our needs and
the needs of our customers.
Wireless local loop access technologies (other than fixed rate cellular
telephone service), while developing for international applications, have not
yet developed a significant market presence in the United States. AT&T Wireless'
fixed wireless plan, called Project Angel - was test-marketed in the Anchorage
area. Initially conceived as AT&T's proprietary strategy for bypassing local
phone carriers, industry analysts believe AT&T reconfigured it to primarily
deliver always-on high-speed Internet access at 512 kbps where the carrier lacks
cable system facilities in markets such as Anchorage. AT&T Wireless announced in
October 2001 that it intended to close its fixed wireless operations, citing the
high cost of expanding a business that does not fit into the company's core
strategy.
The telecommunications industry has been weighed down by regulatory uncertainty
as a result of successive court reversals of the FCC's core local competition
rules. These court actions have left providers with little guidance about the
network elements that will be available at regulated cost-based rates and have
put at risk some current business plans that were developed around the
challenged rules. The Supreme Court of the United States, on May 13, 2002,
upheld the FCC's rules, including the important pricing rules, in its Verizon
Communications Inc. et al. v. Federal Communications Commission, decision.
General
Our local access services segment entered the local services market in Anchorage
in 1997, providing services to residential, commercial, and government users. We
can access approximately 92% of Anchorage area local loops from our collocated
remote facilities and DLC installations. We can access approximately 71% of
Fairbanks area and 48% of Juneau area local loops from our collocated remote
facilities and DLC installations.
Products
Our collocated remote facilities access the ILEC's unbundled network element
loops, allowing us to offer full featured, switched-based local service products
to both residential and commercial customers. In areas where we do not have
access to ILEC loop facilities, we offer service using total service resale of
the ILEC's local service in Anchorage, and either total service resale or UNE
platform in Fairbanks and Juneau.
Our package offerings are competitively priced and include popular features,
such as the following.
o Enhanced call waiting o Caller ID
o Caller ID on call waiting o Free caller ID box
o Anonymous call rejection o Call forwarding
o Call forward busy o Call forward no answer
o Enhanced call waiting o Fixed call forwarding
o Follow me call o Intercom service forwarding
o Multi-distinctive ring o Per line blocking
o Selective call forwarding o Selective call acceptance
o Selective call rejection o Selective distinctive alert
o Speed calling o Three way calling
o Voice mail o Inside wire repair plan
o Non-listed number o Non-published number
Facilities
In Anchorage we utilize a centrally located Lucent Technologies 5ESS host
switching system, have collocated six remote facilities adjacent to or within
the ILEC's local switching offices to access unbundled loop network elements,
and have installed a DLC system adjacent to a smaller, seventh ILEC wire center
for access to unbundled loop network elements. Remote and DLC facilities are
interconnected to the host switch via our diversely routed fiber optic links.
Additionally, we provided our own facilities-based services to
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many of Anchorage's larger business customers through further expansion and
deployment of SONET fiber transmission facilities, DLC facilities, and leased
HDSL and T-1 facilities.
In Fairbanks and Juneau we employ Lucent Technologies Distinctive Remote Module
switching systems (5ESS) and have collocated DLC systems adjacent to the ILEC's
local switching office and within the ILEC's wire center to access unbundled
loop network elements.
Customers
We had approximately 96,100, 79,200 and 62,100 local lines in service from
Anchorage, Fairbanks, and Juneau, Alaska subscribers at December 31, 2002, 2001
and 2000, respectively. We began providing local access services in Fairbanks in
2001 and in Juneau in 2002. The 2002 line count consists of approximately 52,700
residential access lines and 43,400 business access lines, including 7,900
Internet service provider access lines. We ended 2002 with market share gains in
all market segments.
Revenues derived from local access services in 2002, 2001 and 2000 totaled $32.1
million, $25.2 million and $20.2 million, respectively, representing
approximately 8.7%, 7.1% and 6.9% of our total revenues in 2002, 2001 and 2000,
respectively.
Competition
In the local access services market the 1996 Telecom Act, judicial decisions,
and state legislative and regulatory developments have increased the likelihood
that barriers to local telephone competition will be substantially reduced or
removed. These initiatives include requirements that ILECs negotiate with
entities, including us, to provide interconnection to the existing local
telephone network, to allow the purchase, at cost-based rates, of access to
unbundled network elements, to establish dialing parity, to obtain access to
rights-of-way and to resell services offered by the incumbent local exchange
carrier.
We have been able to obtain interconnection, access and related services from
the local exchange carriers at rates that allow us to offer competitive
services. However, if we are unable to continue to obtain these services and
access at acceptable rates, our ability to offer local telephone services, and
our revenues and net income, could be materially adversely affected. To date, we
have been successful in capturing a significant portion of the local telephone
market in the locations where we are offering these services.
The 1996 Telecom Act also provides ILECs with new competitive opportunities. We
believe that we have certain advantages over these companies in providing
telecommunications services, including awareness by Alaskan customers of the GCI
brand-name, our facilities-based telecommunications network, and our prior
experience in, and knowledge of, the Alaskan market.
The RCA reports that there are 22 ILECs and five CLECs certified to operate in
the state of Alaska. We compete against ACS, the ILEC in Anchorage, Juneau and
Fairbanks. We also compete against AT&T in the Anchorage service area. AT&T
offers local exchange service only to residential customers through total
service resale.
The RCA has issued an order terminating rural exemptions for the ILECs operating
in the Fairbanks and Juneau markets and the markets served by ACS of the
Northland, Inc., in Nenana, Ft. Greely, North Pole, Delta Junction, Kenai,
Soldotna, Ninilchik, Homer, Seldovia and Kodiak, Alaska . ACS has appealed these
decisions. The appeal has been argued before the Alaska Supreme court and a
decision is pending. As described above, GCI has entered the Fairbanks and
Juneau markets. GCI also filed a bona fide request with ACS of the Northland,
Inc, in 2001 to negotiate rates and services in order to provide competitive
local access services in its markets. The RCA approved an integrated
Interconnection Agreement with ACS of the Northland, Inc. on January 31, 2003.
GCI can now apply for an amendment to our certificate and the RCA must approve
such amendment before we can begin to provide local access services in these
additional service areas. We may file bona fide requests for interconnection and
applications with regulatory agencies to provide local telephone service in
other markets and in other locations in the future where we would face
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other competitors. You should see Part I, Item 1. Regulation, Franchise
Authorizations and Tariffs - Telecommunications Operations - Rural Exemption for
more information.
We expect further competition in the Anchorage, Fairbanks and Juneau
marketplaces, as DSLnet has received certification for various markets. The
Company expects competition in business customer telephone access, Internet
access, DSL and private line markets.
We continue to offer local exchange services to substantially all consumers in
the Anchorage, Juneau and Fairbanks service areas, primarily through our own
facilities and unbundled local loops leased from ACS.
Our local services sales efforts continue to focus on increasing the number of
subscribers we serve, selling bundled services, and generating incremental
revenues through product and feature up-sale opportunities. We sell our local
services through telemarketing, direct mail advertising, up selling by our
customer contact personnel, and door-to-door selling.
You should see Part I, Item 1. Business, Regulation, Franchise Authorizations
and Tariffs - Telecommunications Operations for more information.
Internet Services
Industry
Dial-up Internet service continues to be the most widely used method to access
the Internet. As of July 2001, the FCC reported that 58% of the U.S. population
had Internet access at home. As of year-end 2002, an estimated 75% of all
Internet households were accessing the Internet using dial-up modems. Industry
analysts project that telephone dial-up will remain the principal means of
accessing the Internet until about 2006, when it is expected that 47% of
Internet households will use dial-up access, with the remaining 53% accessing
the Internet through broadband facilities, principally through the use of cable
modems.
The Internet continues to expand at a significant rate. The Internet Software
Consortium reports that approximately 171.6 million web sites were hosted at the
end of January 2003, an increase of 16.5% from 147.3 million at the end of
January 2002. The FCC reported that high-speed lines (those that provide
services at speeds exceeding 200 kbps in at least one direction) connecting
homes and businesses to the Internet increased by 27% during the first half of
2002, from 12.8 million to 16.2 million lines, compared to a 33% increase, from
9.6 million to 12.8 million lines, during the second half of 2001. 14.0 million
of the 16.2 million total lines served residential and small business
subscribers, a 27% increase from the 11.0 million lines reported six months
earlier.
The FCC further reported that of the 16.2 million high-speed lines, 10.4 million
provided advanced services, i.e., services at speeds exceeding 200 kbps in both
directions. Advanced services lines increased 41%, from 7.4 million to 10.4
million lines, during the first half of 2002. Approximately 8.7 million of the
10.4 million advanced services lines served residential and small business
subscribers.
DSL is the most significant broadband competitor to cable modem service, with an
estimated 6.7 million subscribers through December 2002. Industry analysts
report that cable modem subscribers totaled an estimated 11.7 million through
December 2002, an increase of 216% as compared to 3.7 million in 2000. Satellite
technologies currently have less than one percent of the market and are not
expected to appreciably increase market share over the next several years. The
FCC reported that high-speed asymmetric DSL lines in service increased by 29%
during the first half of 2002, from 3.9 million to 5.1 million lines, compared
to a 47% increase, from nearly 2.7 million to 3.9 million lines, during the
preceding six months. High-speed service using cable modems increased by 30%
during the first six months of 2002, from 7.1 million to 9.2 million lines. By
comparison, cable modem service increased by 36%, from nearly 5.2 million to 7.1
million lines, during the second half of 2001.
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Cable modem Internet access has recently been able to maintain and widen its
lead over DSL as the primary means of accessing the Internet in the United
States over broadband networks. Industry analysts believe that a cable network
upgrade is more efficient than is a DSL network upgrade, largely because of the
individual local loops that must be provisioned for DSL, with central office
proximity a severe mitigating factor. In contrast, cable networks are upgraded
into smaller discrete nodes. Less costly and more efficient upgrades required
for cable modem usage lead to greater scalability. Analysts believe that cable
operators have more incentive to upgrade networks and have potentially higher
returns due to the potential for new sources of revenue from digital cable,
telephony and other products that are made possible from such upgrades.
Industry analysts estimate that cable modems and DSL combined account for 95
percent of all business broadband connections in the United States. Their
research suggests that United States businesses are likely to continue to adopt
cable or DSL in the future and that total subscription may rise from more than
4.8 million business subscribers in 2001 to 15 million in 2006. In 2001,
approximately 71 percent of business broadband subscribers were at-home workers.
Analysts predict that at-home workers will continue to account for a significant
portion of business subscribers, particularly in the case of cable modems, where
availability is greater in residential areas.
Industry analysts believe that broadband deployment will bring valuable new
services to consumers, stimulate economic activity, improve national
productivity, and advance many other objectives, such as improving education,
and advancing economic opportunities. With an estimated 75 million cable
households in the United States and an estimated 50 million of those owning a
computer, broadband cable Internet access growth is expected to continue as new
advanced services are deployed.
General
Our Internet services division entered the Internet services market in 1998,
providing retail services to residential, commercial, and government users and
providing wholesale carrier services to other ISPs. We were the first provider
in Anchorage to offer commercially available DSL products.
Products
We primarily offer three types of Internet access for residential use: dial-up,
fixed wireless and high-speed cable modem Internet access. Our residential
high-speed cable modem Internet service offers up to 2.4 Mbps access speeds as
compared with up to 56 kbps access through standard copper wire dial-up modem
access. Our fixed wireless offers low speed 64 kbps and higher speed 256 kbps
versions. We provide 24-hour customer service and technical support via
telephone or online. The entry-level cable modem service also offers free data
transfer up to five gigabytes per month and can be connected 24-hours-a-day,
365-days-a-year, allowing for real-time information and e-mail access. Cable
modems use our coaxial cable plant that provides cable television service,
instead of the traditional ILEC copper wire. Coaxial cable has a much greater
carrying capacity than telephone wire and can be used to simultaneously deliver
both cable television (analog or digital) and Internet access services.
At the end of 2002 we launched a plan to increase the speed of our entry level
cable modem level service from 256 kbps to 384 kbps for new and current
customers. The project was completed in January 2003. We also adjusted the speed
including data transfer for all of our cable modem packages to meet the demand
for higher speed access. Additional cable modem service packages tailored to
both heavy residential and commercial Internet users are also available.
We currently offer several Internet service packages for commercial use: dial-up
access, DSL, T1 and fractional T1 leased line, frame relay, multi-megabit and
high-speed cable modem Internet access. Our business high-speed cable modem
Internet service offers access speeds ranging from 384 kbps to 2.4 Mbps, free
monthly data transfers of up to 30 gigabytes and free 24-hour customer service
and technical support. Our DSL offering can support speeds of up to 768 kbps
over the same copper line used for phone service. Business services also include
a personalized web page, domain name services, and e-mail addressing.
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We also provide dedicated access Internet service to commercial and public
organizations in Alaska. We offer a premium service and currently support many
of the largest organizations in the state such as the Conoco Phillips Alaska and
the Anchorage School District. We have hundreds of other enterprise customers,
both large and small, using this service.
Bandwidth is made available to our Internet segment through our Alaska United
undersea fiber cable and our Galaxy XR transponders as previously described. Our
Internet offerings are coupled with our long-distance and local services
offerings and provide free basic Internet services if certain long-distance
plans are selected. Value-added Internet features are available for additional
charges.
We provide Internet access for schools and health organizations using a platform
including many of the latest advancements in technology. Services are delivered
through a locally available circuit, our existing lines, and/or satellite earth
stations.
Facilities
The Internet is an interconnected global public computer network of tens of
thousands of packet-switched networks using the Internet protocol. The Internet
is effectively a network of networks routing data throughout the world. We
provide access to the Internet using a platform that includes many of the latest
advancements in technology. The physical platform is concentrated in Anchorage
and is extended into many remote areas of the state. Our Internet platform
includes:
o Circuits connecting our Anchorage facilities to multiple Internet access
points in Seattle through multiple, diversely routed networks.
o Multiple routers on each end of the circuits to control the flow of data
and to provide resiliency.
o Our Anchorage facility consists of routers, a bank of servers that
perform support and application functions, database servers providing
authentication and user demographic data, layer 2 gigabit switch fabrics
for intercommunications and broadband services (cable modem and DSL), and
access servers for dial-in users.
o SchoolAccess(TM) Internet service delivery to over 195 schools in rural
Alaska and 25 schools in Montana, New Mexico and Arizona is accomplished
by three variations on primary delivery systems:
o In communities where we have terrestrial interconnects or provide
existing service over regional earth stations, we have configured
intermediate distribution facilities. Schools that are within these
service boundaries are connected locally to one of those facilities.
o In communities where we have extended telecommunications services via our
DAMA earth station program, SchoolAccess(TM) is provided via a satellite
circuit to an intermediate distribution facility at the Eagle River Earth
Station.
o In communities or remote locations where we have not extended
telecommunications services, SchoolAccess(TM) is provided via a dedicated
(usually on premise) DAMA VSAT satellite station. The DAMA connects to an
intermediate distribution facility located in Anchorage.
Dedicated Internet access is delivered to a router located at the service point.
Our Internet management platform constantly monitors this router; continual
communication is maintained with all of the routers in the network. The
availability and quality of service, as well as statistical information on
traffic loading, are continuously monitored for quality assurance. The
management platform has the capability to remotely access routers, permitting
changes in router configuration without the need to physically be at the service
point. This management platform allows us to offer outsourced network monitoring
and management services to commercial businesses. Many of the largest commercial
networks in the State of Alaska use this service.
GCI.net offers a unique combination of innovative network design and aggressive
performance management. Our Internet platform has received a certification that
places it in the top one percent of all service providers worldwide and is the
only ISP in Alaska with such a designation. We operate and maintain what we
believe is the largest, most reliable, and highest performance Internet network
in the state of Alaska.
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Customers
We had approximately 71,700, 69,900 and 62,500 active residential and commercial
dial-up Internet subscribers at December 31, 2002, 2001 and 2000, respectively.
We had approximately 36,200, 26,500 and 16,100 active residential and commercial
cable modem Internet subscribers at December 31, 2002, 2001 and 2000,
respectively. Revenues derived from Internet services totaled $15.6 million,
$12.0 million and $8.4 million, in 2002, 2001 and 2000, respectively,
representing approximately 4.2%, 3.4% and 2.9% of our total revenues in 2002,
2001 and 2000, respectively.
Our Internet services sales efforts are primarily directed toward increasing the
number of subscribers we serve, selling bundled services, and generating
incremental revenues through product and feature upsale opportunities. We sell
our Internet services through telemarketing, direct mail advertising,
door-to-door selling, up-selling by our customer contact and technical support
personnel, and local media advertising.
Competition
The Internet industry is highly competitive, rapidly evolving and subject to
constant technological change. Competition is based upon price and pricing
plans, service packages, the types of services offered, the technologies used,
customer service, billing services, perceived quality, reliability and
availability. As of December 31, 2002, we competed with more than seven Alaska
based Internet providers, and competed with other domestic, non-Alaska based
providers that provide national service coverage. Several of the providers have
substantially greater financial, technical and marketing resources than we do.
With respect to our high-speed cable modem service, ACS and other Alaska
telephone service providers are providing competitive high-speed DSL services.
Direct broadcast satellite providers and others could provide wireless high
speed Internet service in competition with our high-speed cable modem services.
Niche providers in the industry, both local and national, compete with certain
of our Internet service products, such as web hosting, list services and email.
Environmental Regulations
We may undertake activities that, under certain circumstances may affect the
environment. Accordingly, they are subject to federal, state, and local
regulations designed to preserve or protect the environment. The FCC, the Bureau
of Land Management, the U.S. Forest Service, and the National Park Service are
required by the National Environmental Policy Act of 1969 to consider the
environmental impact before the commencement of facility construction. We
believe that compliance with such regulations has no material effect on our
consolidated operations. The principal effect of our facilities on the
environment would be in the form of construction of facilities and networks at
various locations in Alaska and between Alaska and Seattle Washington. Our
facilities have been constructed in accordance with federal, state and local
building codes and zoning regulations whenever and wherever applicable. Some
facilities may be on lands that may be subject to state and federal wetland
regulation.
Uncertainty as to the applicability of environmental regulations is caused in
major part by the federal government's decision to consider a change in the
definition of wetlands. Most of our facilities are on leased property, and, with
respect to all of these facilities, we are unaware of any violations of lease
terms or federal, state or local regulations pertaining to preservation or
protection of the environment.
Our Alaska United project consists, in part, of deploying land-based and
undersea fiber optic cable facilities between Anchorage, Whittier, Valdez, and
Juneau, Alaska, and Seattle, Washington. The engineered route passes over
wetlands and other environmentally sensitive areas. We believe our construction
methods used for buried cable have a minimal impact on the environment. The
agencies, among others, that are involved in permitting and oversight of our
cable deployment efforts are the US Army Corps of Engineers, The National Marine
Fisheries Service, US Fish & Wildlife, US Coast Guard, National Oceanic and
Atmospheric Administration, Alaska Department of Natural Resources, and the
Alaska Office of the Governor - Governmental Coordination. We are unaware of any
violations of federal, state or local regulations or permits pertaining to
preservation or protection of the environment.
37
In the course of operating the cable television and telecommunications systems,
we have used various materials defined as hazardous by applicable governmental
regulations. These materials have been used for insect repellent, locate paint
and pole treatment, and as heating fuel, transformer oil, cable cleaner,
batteries, diesel fuel, and in various other ways in the operation of those
systems. We do not believe that these materials, when used in accordance with
manufacturer instructions, pose an unreasonable hazard to those who use them or
to the environment.
Patents, Trademarks, Licenses, Certificates of Public Convenience and Necessity,
and Military Franchises
We do not hold patents, franchises or concessions for telecommunications
services or local access services. We do hold registered service marks for the
Digistar(TM) logo and letters GCI(TM), and for the terms SchoolAccess(TM), Free
Fridays for Business(TM) and Unlimited Weekends(TM). The Communications Act of
1934 gives the FCC the authority to license and regulate the use of the
electromagnetic spectrum for radio communication. We hold licenses through our
long-distance services industry segment for our satellite and microwave
transmission facilities for provision of long-distance services.
We acquired a license for use of a 30-MHz block of spectrum for providing PCS
services in Alaska. We are required by the FCC to provide adequate broadband PCS
service to at least two-thirds of the population in our licensed areas within
ten years of being licensed. The PCS license has an initial duration of 10
years. At the end of the license period, a renewal application must be filed. We
believe renewal will generally be granted on a routine basis upon showing of
compliance with FCC regulations and continuing service to the public. Licenses
may be revoked and license renewal applications may be denied for cause. We
expect to renew the PCS license for an additional 10-year term under FCC rules.
We acquired a LMDS license in 1998 for use of a 150-MHz block of spectrum in the
28 GHz Ka-band for providing wireless services. The LMDS license has an initial
duration of 10 years. Within 10 years, licensees will be required to provide
'substantial service' in their service regions. Our operations may require
additional licenses in the future.
Earth stations are licensed generally for 10 years. The FCC also issues a single
blanket license for a large number of technically identical earth stations
(e.g., VSATs).
Applications for transfer of control of 15 certificates of public convenience
and necessity held by the acquired cable companies were approved in an RCA order
dated September 23, 1996, with transfers to be effective on October 31, 1996.
Such transfer of control allowed us to take control and operate the cable
systems of the acquired cable companies located in Alaska. The approval of the
transfer of these 15 certificates of public convenience and necessity is not
required under federal law, with one area of limited exception. The cable
companies operate in part using several radio-band frequencies licensed through
the FCC. These certificates were transferred to us before October 31, 1996.
Application for transfer of control of two certificates of public convenience
and necessity associated with the acquired GC Cablevision, Inc. assets and the
Rogers American Cablesystems, Inc. ("Rogers") cable companies were approved in
RCA orders in 2001. The certificates were transferred to us following closing of
the transactions.
We obtained consent of the military commanders at the military bases serviced by
the acquired cable systems to the assignment of the respective franchises for
those bases.
Regulation, Franchise Authorizations and Tariffs
The following summary of regulatory developments and legislation does not
purport to describe all present and proposed federal, state, and local
regulation and legislation affecting our businesses. Other existing federal and
state regulations are currently the subject of judicial proceedings, legislative
hearings and administrative proposals that could change, in varying degrees, the
manner in which these industries operate.
38
We cannot predict at this time the outcome of these proceedings and legislation,
their impact on the industries in which we operate, or their impact on us.
Every two years, the FCC is required (1) to review its rules governing
telecommunications service providers and broadcast ownership, (2) to determine
whether economic competition has made those rules unnecessary in the public
interest, and (3) to modify or repeal any such regulations. On September 18,
2000, the FCC issued its Staff Report summarizing extensive review of the rules
and recommending that no further changes in the broadcast and crossownership
rules were warranted at that time. On December 29, 2000, the FCC adopted its
1998 Biennial Review Regulatory Report and left ownership rules unchanged. This
report stated that the FCC would institute a proceeding on modification of the
newspaper/broadcast crossownership rule. That occurred on September 13, 2001, in
a Notice of Proposed Rulemaking to consider the rule's fate. The next Biennial
Review began in 2001. Before taking action on this proceeding, however, the FCC
released a notice of proposed rulemaking on September 23, 2002, to conduct a
comprehensive Biennial Review of the FCC's media ownership policies (the "third
Biennial Review"). The 2001 Biennial Review was consolidated with the third
Biennial Review. In connection with the third Biennial Review, the FCC also
commissioned and released a series of empirical studies examining the current
media marketplace. Comments were filed on January 2, 2003, and replies were
filed on February 3, 2003.
Telecommunications Operations
General. We are subject to regulation by the FCC and by the RCA as a
non-dominant provider of long-distance services. We file tariffs with the FCC
for interstate access and operator services, and limited international
long-distance services, subject to the FCC's mandatory detariffing policies, and
with the RCA for intrastate service. Such tariffs routinely become effective
without intervention by the FCC, RCA or other third parties since we are a
non-dominant carrier. Military franchise requirements also affect our ability to
provide telecommunications and cable television services to military bases.
Our success in the local telephone market depends on our continued ability to
obtain interconnection, access and related services on terms that are just and
reasonable and that are based on the cost of providing these services. Our local
telephone services business faces the risk of the impact of implementing current
regulations and legislation, unfavorable changes in regulation or legislation,
or the introduction of new regulations. Our ability to enter into the local
telephone market depends on our negotiation or arbitration with ILECs to allow
interconnection to the carrier's existing local telephone network, to allow the
purchase, at cost-based rates, of access to unbundled network elements, to
establish dialing parity, to obtain access to rights-of-way and to resell
services offered by the local exchange carrier. We have in the past been
successful in these arbitration proceedings as to the material terms, including
prices and technical and competitive issues. Future arbitration proceedings with
respect to new or existing markets could result in a change in our cost of
serving these markets via ILEC facilities or via wholesale offerings.
The FCC, the courts of the state of Alaska, the Federal District Court of Alaska
and the Ninth Circuit Court of Appeals also have before them several appeals by
one of our competitors relating to the interpretation by the RCA, of various
provisions of the 1996 Telecom Act. These appeals include the provisions and FCC
regulations dealing with the pricing of unbundled network elements, including
the results of arbitration proceedings before the RCA and the decision of the
RCA to remove an exemption from certain of its rules available to ACS known as
the "rural exemption." We have been largely successful in the appeals of these
arbitration proceedings as to the material terms, including prices and technical
issues, through the current stages. These appeals could also result in a change
in our costs of serving new and existing markets via ILEC facilities or via
wholesale offerings.
We have recently qualified under FCC regulations as an "eligible
telecommunications carrier" ("ETC"), with respect to our provision of local
telephone service in Fairbanks and Juneau. ETCs are entitled to receive a
subsidy paid by the Universal Service Fund. If we do not continue to qualify for
this status in Fairbanks and Juneau or if we do not qualify for this status in
rural areas where we propose to offer new services, we would not receive this
subsidy and our net cost of providing local telephone services in these areas
could be materially adversely impacted.
39
We received approval from the RCA in February 1997 permitting us to provide
local access services throughout ACS's existing Anchorage service area, and in
July 1999 permitting us to provide local access services in ACS's existing
service areas in Fairbanks, Juneau, Ft. Wainwright and Eielson Air Force Base
service areas. We filed a bona fide request with the ILEC, ACS of the Northland,
Inc., in 2001 to negotiate rates and services in order to provide competitive
local access services in Nenana, Ft. Greely, North Pole, Delta Junction, Kenai,
Soldotna, Ninilchik, Homer, Seldovia and Kodiak, Alaska. The request has been
negotiated in part, and arbitrated in part before the RCA under the terms of the
1996 Telecom Act and an integrated Interconnection Agreement has been approved.
GCI can now apply for an amendment to our certificate and the RCA must approve
such amendment before we can begin to provide local access services in these
additional service areas.
The 1996 Telecom Act preempts state statutes and regulations that restrict the
provision of competitive local telecommunications services. State commissions
can, however, impose reasonable terms and conditions upon the provision of
telecommunications service within their respective states. Because we are
authorized to offer local access services, we are regulated as a CLEC by the
RCA. In addition, we will be subject to other regulatory requirements, including
certain requirements imposed by the 1996 Telecom Act on all LECs, which
requirements include permitting resale of LEC services, local number
portability, dialing parity, and reciprocal compensation.
As a PCS and LMDS licensee, we are subject to regulation by the FCC, and must
comply with certain build-out and other conditions of the license, as well as
with the FCC's regulations governing the PCS and LMDS services. On a more
limited basis, we may be subject to certain regulatory oversight by the RCA
(e.g., in the areas of consumer protection), although states are not permitted
to regulate the rates of PCS, LMDS and other commercial wireless service
providers. PCS and LMDS licensees may also be subject to regulatory requirements
of local jurisdictions pertaining to, among other things, the location of tower
facilities.
1996 Telecom Act and Related Rulings. A key industry development was passage of
the 1996 Telecom Act. The Act was intended by Congress to open up the
marketplace to competition and has had a dramatic impact on the
telecommunications industry. The intent of the legislation was to break down the
barriers that have prevented three groups of companies, LECs, including RBOCs,
long-distance carriers, and cable TV operators, from competing head-to-head with
each other. The Act expressly prohibits any legal barriers to competition in
intrastate or interstate communications service under state and local laws, and
empowers the FCC, after notice and an opportunity for comment, to preempt the
enforcement of any statute, regulation or legal requirement that prohibits, or
has the effect of prohibiting, the ability of any entity to provide any
intrastate or interstate telecommunications service.
The Act requires incumbent LECs to let new competitors into their business. It
also requires incumbent LECs to open up their networks to ensure that new market
entrants have a fair chance of competing. The bulk of the legislation is devoted
to establishing the terms under which incumbent LECs must open up their
networks.
The FCC's Wireline Competition Bureau (previously known as the Common Carrier
Bureau) has focused in recent years on adopting market-opening and universal
service rules for the local exchange and long distance markets to provide
meaningful opportunities for competition. The Wireline Competition Bureau has
also focused on review of applications by BOCs to provide long distance service
as well as review of telecommunications company mergers. In addition, they
continue to consider regulatory reforms that could occur as competition in the
provision of telecommunications services develops.
Enactment of the 1996 Telecom Act immediately affected local exchange service
markets by requiring states to authorize local exchange service competition.
Competitors, including resellers, are able to market new bundled service
packages to attract customers. Over the long term, the requirement that
incumbent LECs unbundle access to their networks may lead to increased price
competition. Local exchange service competition has not yet occurred in all
markets on a national basis because interconnection arrangements are not yet in
place in many areas.
40
The 1996 Telecom Act requires the FCC to establish rules and regulations to
implement its local competition provisions. In August 1996, the FCC issued rules
governing interconnection, resale, unbundled network elements, the pricing of
those facilities and services, and the negotiation and arbitration procedures
that would be utilized by states to implement those requirements. These rules
rely on state public utilities commissions to develop the specific rates and
procedures applicable to particular states within the framework prescribed by
the FCC. These rules were vacated in part by a July 1997 ruling of the United
States Court of Appeals for the Eighth Circuit. On January 25, 1999, the United
States Supreme Court issued an opinion upholding the authority of the FCC to
establish rules, including pricing rules, to implement statutory provisions
governing both interstate and intrastate services under the 1996 Telecom Act and
remanded the proceeding back to the Eighth Circuit for further proceedings. The
Supreme Court also upheld rules allowing carriers to select provisions from
among different interconnection agreements approved by state commissions for the
carriers' own agreements and a rule allowing carriers to obtain combinations of
unbundled network elements. On remand, the Eighth Circuit overturned various
interconnection and pricing portions of the FCC regulations under the 1996
Telecom Act, but stayed the application of its pricing decision pending review
by the Supreme Court of the United States. On May 13, 2002, the Supreme Court
issued an opinion upholding the FCC's pricing methodology and the requirement
for ILECs to combine elements of their networks at the request of CLECs who
cannot combine the elements themselves.
The 1996 Telecom Act provides that registered utility holding companies and
subsidiaries may provide telecommunications services, including cable
television, notwithstanding the Public Utility Holding Company Act. Electric
utilities must establish separate subsidiaries, known as "exempt
telecommunications companies" and must apply to the FCC for operating authority.
Like telephone companies, electric utilities have substantial resources at their
disposal, and could be formidable competitors to traditional cable systems.
Several such utilities have been granted broad authority by the FCC to engage in
activities that could include the provision of video programming.
A number of LECs, long-distance companies and others have appealed some or all
of the FCC's orders. The effective date of the orders generally has not been
delayed, but appeals can be expected to take a year or more to conclude. Some
BOCs have also challenged the 1996 Telecom Act restrictions on their entry into
long distance markets as unconstitutional. We are unable to predict the outcome
of such rulemakings or litigation or the effect (financial or otherwise) of the
1996 Telecom Act and the rulemakings on us. The BOCs continue to challenge the
substance of the FCC rules, arguing that the rules do not allow them to fully
recover the money they spent building their networks.
Critics are becoming increasingly vocal asking Congress to modify if not
altogether rework the 1996 Telecom Act, citing a lack of competition in the
local phone and broadband sectors. There is a lack of consensus on what changes
are needed, however, or who is to blame for the Act's perceived failures. The
strongest momentum appears to be in support of loosening regulations on ILECs so
they can better compete in broadband, a move CLECs say could diminish local
phone competition.
Rural Exemption. ACS, through subsidiary companies, provides local telephone
services in Fairbanks and Juneau, Alaska. The ACS subsidiaries are classified as
Rural Telephone Companies under the 1996 Telecom Act, which entitles them to an
exemption of certain material interconnection terms of the 1996 Telecom Act,
until and unless such "rural exemption" is examined and not continued by the
RCA. We requested that continuation of the rural exemption of the ACS
subsidiaries relating to the Fairbanks and Juneau markets be examined. In
January 1998, the APUC denied our request to terminate the rural exemption. The
basis of the APUC's decision was primarily that various rulemaking proceedings
(including universal service and access charge reform) must be completed before
the exemption would be revoked. Those rulemaking proceedings have been largely
completed.
On March 4, 1999, an Alaska Superior Court Judge determined that the APUC erred
in reaching its decision to deny our request to provide full local telephone
service in Fairbanks and Juneau, Alaska. This service would be provided in
competition against the existing monopoly providers. Among other things, the
Court
41
instructed the APUC to correctly assign the burden of proof to the ILECs rather
than us, as a requesting CLEC, and to decide on our requests to provide service
in Fairbanks and Juneau based on criteria established in the 1996 Telecom Act.
The Court stated "this must be accomplished cognizant of the intent of the 1996
Telecom Act to promote competition in the local market." The Court remanded the
case back to the APUC for proceedings leading to their ruling.
On July 1, 1999, the APUC ruled that the rural exemptions from local competition
for the ILECs operating in Juneau, Fairbanks and North Pole would not be
continued, which allowed us to negotiate for unbundled elements for the
provision of competitive local service. ACS requested reconsideration of this
decision and on October 11, 1999, the RCA issued an order terminating rural
exemptions for the ILECs operating in the Fairbanks and Juneau markets. ACS has
appealed these decisions. The appeal presently is before the Alaska Supreme
Court.
On February 11, 2003, the Alaska Supreme Court heard oral argument. One of the
principal issues in dispute concerns the assignment of the burden of proof. In
accordance with instructions from the Alaska Superior Court, the APUC assigned
the burden to ACS at the remand proceeding. At the oral argument, several
Justices expressed concern with the assignment of the burden. At this time, we
cannot reasonably predict what the outcome of the case will be or even what
relief the Court might order if it were to find that the burden of proof was
improperly assigned to ACS. An adverse decision from the Court, however, has the
potential to disrupt our ability to provide service to our Fairbanks and Juneau
customers over our facilities. We expect a decision from the Court within six
months from the date of oral argument. In the end, we are confident that
competition will be allowed to continue in Juneau and Fairbanks.
On the basis of the rural exemption decision, we have arbitrated interconnection
agreements with ACS for unbundled network elements for the provisioning of
competitive local assess services in Juneau and Fairbanks. The RCA approved
these interconnection agreements in October 2000. ACS has sought judicial review
of these decisions.
Internet Service Providers Regulated as Telecommunications Carriers. The FCC
affirmed in a report adopted on April 10, 1998, that Internet service providers
would not be subject to regulation as telecommunications carriers under the 1996
Telecom Act. They thus will not be subject to universal service subsidies and
other regulations. Further, in August 1998, the FCC proposed new rules that
would allow ILECs to provide their own DSL services through separate affiliates
that are not subject to ILEC regulation. On November 18, 1999, the FCC decided
to require ILECs to share telephone lines with DSL providers, an action that may
foster competition by allowing competitors to offer DSL services without their
customers having to lease a second telephone line. In a public meeting on
February 20, 2003, the FCC indicated that it was eliminating the line sharing
requirement by majority vote; however, the text of that decision has not been
issued, so it is not possible to determine the scope of the decision at this
time. We do not rely on line sharing in the provision of any of our services.
Access Fees. The FCC regulates the fees that local telephone companies charge
long distance companies for access to their local networks. In 2001, the FCC
adopted a plan to restructure access charges for rate-of-return regulated
carriers, which has the effect of shifting certain charges from IXCs to end
users. The FCC is continuing to monitor the access charge regime and could
consider other proposals that would restructure and could reduce access charges.
Changes in the access charge structure could fundamentally change the economics
of some aspects of our business.
Access to Unbundled Network Elements. The Supreme Court vacated an FCC rule
setting forth the specific unbundled network elements that ILECs must make
available, finding that the FCC had failed to apply the appropriate statutory
standard. On November 5, 1999, the FCC responded to the Court's decision by
issuing a decision that maintains competitors' access to a wide variety of
unbundled network elements (the "UNE Remand Order"). Six of the seven unbundled
elements the FCC had originally required carriers to provide in its 1996 order
implementing the 1996 Telecom Act remain available to competitors. These
elements are loops, including loops used to provide high-capacity and advanced
telecommunications services; network
42
interface devices; local circuit switching, subject to restrictions in major
urban markets; dedicated and shared transport; signaling and call-related
databases; and operations support systems. The FCC removed access to operator
and directory assistance service from the list of available unbundled network
elements. In addition, the FCC added to its list certain unbundled network
elements that were not at issue in 1996. These elements include subloops, or
portions of loops, and dark fiber loops and transport. The FCC later required
ILECs to unbundle facilities used to provide DSL service. The FCC did not
decide, but sought additional information on, the question of whether carriers
may combine certain unbundled network elements to provide special access
services to compete with those provided by the ILECs. In addition, on December
20, 2001, the FCC initiated its first triennial review of the rules governing
unbundled network elements, to consider the circumstances under which ILECs are
required to make parts of their network available to CLECs subject to the terms
of the 1996 Telecom Act. While that proceeding was pending, the D.C. Circuit
issued its decision in response to appeals of the UNE Remand Order. The D.C.
Circuit remanded the FCC's decision on unbundled network elements and vacated
and remanded the FCC's decision on unbundling facilities used to provide DSL
service. The FCC incorporated its resulting remand proceeding into the pending
Triennial Review. On February 20, 2003, the FCC adopted an order in the
Triennial Review proceeding in a public meeting, in which the FCC reported
changes to the rules governing unbundled network elements; however, the text of
the order has not yet been released.
The ability to obtain unbundled network elements is an important element of our
local access services business, and we believe that the FCC's actions in this
area have generally been positive. However, we cannot predict the extent to
which the existing rules will be sustained in the face of additional legal
action and the scope of the rules that are yet to be determined by the FCC.
Recurring and non-recurring charges for telephone lines and other unbundled
network elements may increase based on the rates proposed by the ILECs and
approved by the RCA from time to time, which could have an adverse effect on the
results of our operations. We are currently involved in arbitration to revise
the interconnection rates and the terms in the existing interconnection
agreement with ACS for the Anchorage service area. The cost-based methodology
for determining these rates remains subject to the FCC's continuing rulemaking
authority, and future regulatory changes could adversely affect our operations.
Universal Service. In 1997, the FCC issued important decisions on universal
service establishing new funding mechanisms for high-cost, low-income service
areas to ensure that certain subscribers living in rural and high-cost areas, as
well as certain low-income subscribers, continue to have access to
telecommunications and information services at prices reasonably comparable to
those charged for similar services in urban areas.
These mechanisms also are meant to foster the provision of advanced
communications services to schools, libraries and rural health-care facilities.
Under the rules adopted by the FCC to implement these requirements, we and all
other telecommunications providers are required to contribute to a fund to
support universal service. The amount that we contribute to the federal
universal service subsidy will be based on our share of specified defined
telecommunications end-user revenues. On December 13, 2002, the FCC revised the
contribution methodology on an interim basis and required carriers to calculate
contributions based on projected, rather than historic defined
telecommunications end-user revenues. The FCC also issued a Second Further
Notice of Proposed Rulemaking to consider adopting a revised methodology for
determining carrier contributions to the universal service fund. Because of the
pending change in methodology, we are uncertain about how the contribution will
be set in the future.
The 1997 order also established significant discounts to be provided to eligible
schools and libraries for all telecommunications services, internal connections
and Internet access. It also established support for rural health care providers
so that they may pay rates comparable to those that urban health care providers
pay for similar services. The FCC estimates that first quarter 2003 net costs to
be funded out of the Universal Service Fund will total approximately $1.5
billion. The fund administrator, based on their interstate end-user revenues,
assesses local and long distance carriers' contributions to the education and
health care funds. The first quarter 2003 contribution factor is 0.072805. We
contribute to the funds and are allowed to recover our contributions through
increased interstate charges.
43
Local Regulation. We may be required to obtain local permits for street opening
and construction permits to install and expand fiber optic networks. Local
zoning authorities often regulate our use of towers for microwave and other
telecommunications sites. We also are subject to general regulations concerning
building codes and local licensing. The 1996 Telecom Act requires that fees
charged to telecommunications carriers be applied in a competitively neutral
manner, but there can be no assurance that ILECs and others with whom we will be
competing will bear costs similar to those we will bear in this regard.
Reciprocal Compensation. The FCC had determined that calls to ISPs within a
caller's local calling area were non-local. To support this conclusion, the FCC
found that calls to ISPs are predominately interstate in nature because the
calls ultimately extend beyond the ISP to websites around the world. However, in
2000 the D.C. Circuit Court rejected the FCC's analysis and found that the "mere
fact that the ISP originates further telecommunications does not imply that the
original telecommunication does not `terminate' at the ISP." Accordingly, the
D.C. Circuit Court vacated and remanded the FCC's ISP-Bound Traffic Order.
The FCC, in response by its April 27, 2001 Order on Remand and Report and Order,
("ISP Remand Order"), explained why the reciprocal compensation requirements of
Section 251(b)(5) of the 1996 Telecom Act do not apply to ISP-bound traffic. The
FCC concluded that section 251(b)(5) is not limited solely to local traffic, but
rather applies to all "telecommunications" traffic, except the categories
specifically enumerated in section 251(g). The FCC concluded that ISP-bound
traffic falls within one of the section 251(g) exceptions - "information access"
- - and is thus exempt from the section 251(b)(5) reciprocal compensation
requirements. In order to retain jurisdiction over ISP-bound traffic, the FCC
also found that such traffic is interstate in nature.
The FCC in its ISP Remand Order established a new "hybrid" interim mechanism for
intercarrier compensation of ISP-bound traffic that "serves to limit, if not
end, the opportunity for regulatory arbitrage, while avoiding a
market-disruptive `flash-cut' to a pure bill and keep regime."
The FCC also held that in cases where carriers are not exchanging traffic
pursuant to interconnection agreements before the adoption of the ISP Remand
Order, such carriers would be required to exchange ISP-bound traffic on a bill
and keep basis during the interim period. However, the FCC stated that the ISP
Remand Order "does not alter existing contractual obligations, except to the
extent that parties are entitled to invoke contractual change-of-law
provisions." Additionally, the FCC held that state commissions would no longer
have authority to address ISP-bound traffic issues. On May 3, 2002, the D.C.
Circuit vacated the FCC's decision, finding fault with the FCC's reliance on
section 251(g); however, the D.C. Circuit did not vacate the ISP Remand Order.
The FCC currently has a proceeding pending to consider issues of intercarrier
compensation, including the delivery of ISP-bound traffic, in CC Docket No.
01-92.
Cable Services Operations
General. The cable television industry is subject to extensive regulation at
various levels, and many aspects of such regulation are currently the subject of
judicial proceedings and administrative or legislative proposals. In particular,
FCC regulations limit our ability to set and increase rates for our basic cable
television service package and for the provision of cable television-related
equipment. The law permits certified local franchising authorities to order
refunds of rates paid in the previous 12-month period determined to be in excess
of the permitted reasonable rates. It is possible that rate reductions or
refunds of previously collected fees may be required of us in the future.
Currently, pursuant to Alaska law, basic cable rates in Juneau are the only
rates in Alaska subject to regulation by the local franchising authority, and
the rates in Juneau were reviewed and approved by the RCA in October 2000. In
addition, the FCC has recently adopted rules that will require cable operators
to carry the digital signals of broadcast television stations. However, the FCC
has tentatively decided that cable operators should not be required to carry
both the analog and digital services of broadcast television stations while
broadcasters are transitioning from analog to digital transmission. Carrying
both the analog and digital services of broadcast television stations would
consume additional cable capacity. As a result, a requirement
44
to carry both analog and digital services of broadcast television stations could
require the removal of popular programming services with materially adverse
results for cable operators, including us. Should the FCC mandate dual carriage,
we will carry the broadcast signals in both analog and digital formats.
Principal responsibility for implementing the policies of the 1984 and 1992
Cable Acts, and the 1996 Telecom Act is allocated between the FCC and state or
local franchising authorities. The FCC and state regulatory agencies are
required to conduct numerous rulemaking and regulatory proceedings to implement
the 1996 Telecom Act, and such proceedings may materially affect the cable
industry.
The FCC has the authority to enforce its regulations through the imposition of
substantial fines, the issuance of cease and desist orders and/or the imposition
of other administrative sanctions, such as the revocation of FCC licenses needed
to operate certain transmission facilities used in connection with cable
operations. The 1996 Telecom Act removed barriers to competition in the cable
television market as well as the local telephone market. Among other things, it
also reduced the scope of cable rate regulation and encourages additional
competition in the video programming industry by allowing local telephone
companies to provide video programming in their own telephone service areas.
The 1996 Telecom Act required the FCC to undertake a number of rulemakings.
Moreover, Congress and the FCC have frequently revisited the subject of cable
regulation. Future legislative and regulatory changes could adversely affect our
operations, and there have been calls in Congress and at the FCC to maintain or
even tighten cable regulation in the absence of widespread effective
competition.
Subscriber Rates. The 1992 Cable Act authorized rate regulation for cable
communications services and equipment in communities that are not subject to
"effective competition," as defined by federal law, which limited the ability of
cable companies to increase subscriber fees. Most cable communications systems
are now subject to rate regulation by local officials for basic cable service,
which typically contains local broadcast stations and public, educational, and
government access channels. Such local regulation is subject to the oversight of
the FCC, which has prescribed detailed criteria for such rate regulation. Before
a local franchising authority begins basic service rate regulation, it must
certify to the FCC that it will follow applicable federal rules. In Alaska, the
local franchising authority certified to regulate basic cable rates is the RCA.
Under state law, however, the cable television service is exempt from regulation
unless subscribers petition the state commission for regulation under the
procedures set forth in AS 42.05.712. At present, the only community where
regulation of the basic rate occurs is in Juneau.
The 1992 Cable Act also requires the FCC to resolve complaints about rates for
Cable Programming Service ("CPS") tiers (other than programming offered on a per
channel or per program basis, which programming is not subject to rate
regulation) and to reduce any such rates found to be unreasonable. The 1996
Telecom Act eliminates the right of individuals to file CPS tier rate complaints
with the FCC and requires the FCC to issue a final order within 90 days after
receipt of CPS tier rate complaints filed by any franchising authority. The 1992
Cable Act limits the ability of cable television systems to raise rates for
basic and certain cable programming services (collectively, the "Regulated
Services").
Rate regulation of non-basic cable programming service tiers ended after March
31, 1999. The 1996 Telecom Act also modifies the uniform rate provision of the
1992 Cable Act by prohibiting regulation of non-predatory bulk discount rates
offered to subscribers in commercial and residential developments and permits
regulated equipment rates to be computed by aggregating costs of broad
categories of equipment at the franchise, system, regional or company level. We
believe elimination of the cable programming service tier regulation affords us
greater pricing flexibility.
FCC regulations govern rates that may be charged to subscribers for Regulated
Services. The FCC uses a benchmark methodology as the principal method of
regulating rates for Regulated Services. Cable operators are also permitted to
justify rates using a cost-of-service methodology, which contains a rebuttable
presumption of an industry-wide 11.25% rate of return on an operator's allowable
rate base. Cost-of-service regulation is a traditional form of rate regulation,
under which a company is allowed to recover its costs of
45
providing the regulated service, plus a reasonable profit. Franchising
authorities are empowered to regulate the rates charged for monthly basic
service, for additional outlets and for the installation, lease and sale of
equipment used by subscribers to receive the basic cable service tier, such as
converter boxes and remote control units. The FCC's rules require franchising
authorities to regulate these rates based on actual cost plus a reasonable
profit, as defined by the FCC. Cable operators required to reduce rates may also
be required to refund overcharges with interest. The FCC has also adopted
comprehensive and restrictive regulations allowing operators to modify their
regulated rates on a quarterly or annual basis using various methodologies that
account for changes in the number of regulated channels, inflation and increases
in certain external costs, such as franchise and other governmental fees,
copyright and retransmission consent fees, taxes, programming fees and
franchise-related obligations. We cannot predict whether the FCC will modify
these "going forward" regulations in the future.
Anti-Buy Through Provisions. The 1992 Cable Act requires cable systems to permit
subscribers to purchase video programming offered by the operator on a per
channel or a per program basis without the necessity of subscribing to any tier
of service, other than the basic cable service tier, unless the system's lack of
addressable converter boxes or other technological limitations does not permit
it to do so. The statutory exemption for cable systems that do not have the
technological capability to offer programming in the manner required by the
statute expired in December 2002. Our systems comply with these anti-buy through
provisions.
Cable Entry into Telecommunications. The 1996 Telecom Act creates a more
favorable environment for us to provide telecommunications services beyond
traditional video delivery. It provides that no state or local laws or
regulations may prohibit or have the effect of prohibiting any entity from
providing any interstate or intrastate telecommunications service. A cable
operator is authorized under the 1996 Telecom Act to provide telecommunications
services without obtaining a separate local franchise. States are authorized,
however, to impose "competitively neutral" requirements regarding universal
service, public safety and welfare, service quality, and consumer protection.
State and local governments also retain their authority to manage the public
rights-of-way and may require reasonable, competitively neutral compensation for
management of the public rights-of-way when cable operators provide
telecommunications service.
Cable System Delivery of Internet Service. Although there is at present no
significant federal regulation of cable system delivery of Internet services,
and the FCC has issued several reports finding no immediate need to impose such
regulation, this situation may change as cable systems expand their broadband
delivery of Internet services. In particular, proposals have been advanced at
the FCC and Congress that would require cable operators to provide access to
unaffiliated Internet service providers and online service providers. The FCC
rejected a petition by certain Internet service providers attempting to use
existing modes of access that are commercially leased to gain access to cable
system delivery. Some states and local franchising authorities are considering
the imposition of mandatory Internet access requirements as part of cable
franchise renewals or transfers and a few local jurisdictions have adopted these
requirements. The Federal Trade Commission and the FCC recently imposed certain
"open-access" requirements on Time Warner and AOL in connection with their
merger, but those requirements are not applicable to other cable operators.
In June 2000, the Federal Court of Appeals for the Ninth Circuit rejected an
attempt by the City of Portland, Oregon to impose mandatory Internet access
requirements on the local cable operator. In reversing a contrary ruling by the
lower court, the Ninth Circuit court held that Internet service was not a cable
service, and therefore could not be subject to local cable franchising. At the
same time, the Court suggested that at least the transport component of
broadband Internet service could be subject to regulation as a
"telecommunications" service. Although regulation of this form of
telecommunications service would presumably be reserved for the FCC (which has
so far resisted requests for active regulation), some states may argue that they
are entitled to impose "open-access" requirements pursuant to their authority
over intrastate telecommunications. In addition, some local governments may
argue that a cable operator must secure a local telecommunications franchise
before providing Internet service.
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In response to the Ninth Circuit decision, the FCC has initiated a new
proceeding to determine what regulatory treatment, if any, should be accorded to
cable modem service and the cable modem platform used in providing this service.
More specifically, the FCC notice seeks comment on the parameters the Commission
should use in determining the appropriate level of access to cable networks for
the provision of high-speed data services. The Ninth Circuit decision is the
leading case on cable-delivered Internet service at this point, but the Federal
District Court for the Eastern District of Virginia reached a similar result in
a May 2000 ruling, concluding that broadband Internet service was a cable
service, but that multiple provisions of the 1996 Telecom Act preempted local
regulation. A Federal district court in Florida recently addressed a similar
"open-access" requirement in a local franchise and struck down the requirement
as unconstitutional. There are other instances where "open-access" requirements
have been imposed and judicial challenges are pending.
On March 14, 2002, the FCC took steps toward ensuring a light regulatory touch
on broadband services delivered through the use of cable facilities (such as our
cable modem services). In a 3-1 vote, the FCC defined high-speed Internet over
cable as an "information service" not subject to local cable-franchise fees,
like cable service is, or any explicit requirements for "open access," as
telecommunications service is. The "information service" designation for cable
broadband reportedly sends a strong signal that cable-Internet services will be
able to continue to develop in a business environment that favors competition
over regulation. The FCC traditionally hasn't regulated information services.
Industry analysts believe the policy of regulatory restraint is particularly
appropriate, given the strong competition among cable, satellite and
digital-subscriber-line service via telephone lines.
If regulators are allowed to impose Internet access requirements on cable
operators, it could burden the capacity of cable systems and complicate our own
plans for providing expanded Internet access services. These access obligations
could adversely affect our profitability.
LEC Ownership of Cable Systems. The 1996 Telecom Act made far-reaching changes
in the regulation of LECs that provide cable services. The 1996 Telecom Act
eliminated federal legal barriers to competition in the local telephone and
cable communications businesses, preempted legal barriers to competition that
previously existed in state and local laws and regulations, and set basic
standards for relationships between telecommunications providers. The 1996
Telecom Act eliminated the statutory telephone company/cable television
cross-ownership prohibition, thereby allowing LECs to offer video services in
their telephone service areas. LECs may provide service as traditional cable
operators with local franchises or they may opt to provide their programming
over unfranchised "open video systems," subject to certain conditions,
including, but not limited to, setting aside a portion of their channel capacity
for use by unaffiliated program distributors on a non-discriminatory basis. The
1996 Telecom Act generally limits acquisitions and prohibits certain joint
ventures between LECs and cable operators in the same market.
A federal appellate court overturned various parts of the FCC's open video
rules, including the FCC's preemption of local franchising requirements for open
video operators. The FCC has modified its open video rules to comply with the
federal court's decision. It is unclear what effect this ruling will have on the
entities pursuing open video system operation.
Although local exchange carriers and cable operators can now expand their
offerings across traditional service boundaries, the general prohibition remains
on local exchange carrier buyouts of co-located cable systems. Co-located cable
systems are cable systems serving an overlapping territory. Cable operator
buyouts of co-located local exchange carrier systems, and joint ventures between
cable operators and local exchange carriers in the same market are also
prohibited. The 1996 Telecom Act provides a few limited exceptions to this
buyout prohibition, including a carefully circumscribed "rural exemption." The
1996 Telecom Act also provides the FCC with the limited authority to grant
waivers of the buyout prohibition.
Ownership Limitations. The 1996 Telecom Act generally prohibits us from owning
or operating a SMATV or wireless cable system in any area where we provide
franchised cable service. We may, however, acquire
47
and operate SMATV systems in our franchised service areas if the programming and
other services provided to SMATV subscribers are offered according to the terms
and conditions of our franchise agreement.
In February 2002, a U.S. appeals court set aside a FCC rule that bars a company
from owning television stations that reach more than 35% of U.S. homes. A
three-judge panel concluded the FCC's "decision to retain the rules was
arbitrary and capricious and contrary to law." The court overturned altogether
an FCC ban on a company owning a cable TV system in a market where it also
operates a broadcast television station. This limitation was held on March 2,
2001 to violate the First Amendment. The U.S. Court of Appeals for the District
of Columbia Circuit ruled that the limit must either be justified by the FCC "as
not burdening substantially more speech than necessary," or rewritten by the
FCC. In addition, the D.C. Circuit panel vacated on constitutional grounds the
FCC rule limiting to 40% the number of channels on which a cable operator can
offer operator-affiliated programming.
A petition for certiorari was filed with the U.S. Supreme Court asking for
review of the D.C. Circuit Court's ruling on the 30% cap but did not challenge
the court's ruling striking down the 40% cap on the channels that a cable
operator may use to offer affiliated programmers. The FCC adopted a Further
Notice of Proposed Rulemaking on September 13, 2001 concerning its horizontal
(30% of national audience reach) and vertical (40% of channels showing
operator-affiliated programming) limits and certain aspects of its attribution
rules. Comments and reply comments were due on January 4, 2002, and February 4,
2002, respectively. This proceeding was consolidated with the third Biennial
Review of media ownership rules in September 2002.
Similar to the broadcast and cable prohibition, the broadcast and newspaper
crossownership rule bans common ownership of a radio or television station and a
daily newspaper if certain conditions are met. Acquisition of a daily newspaper
in conflict with this rule requires divestiture of one of the properties before
the next license expiration date of the broadcast station, or in one year,
whichever is later. In its 1998 Broadcast Ownership Biennial Review Report
adopted May 30, 2000, the FCC recommended a rulemaking to consider changes, but
kept the rule in place. At its September 13, 2001 meeting, the FCC adopted a
Notice of Proposed Rulemaking seeking comment on modification of its
newspaper/broadcast crossownership rule and waiver policies. Comments were due
December 3, 2001, and reply comments were due January 7, 2002. This proceeding
also was consolidated with the third Biennial Review of media ownership rules on
September 23, 2002.
Under the FCC's TV duopoly rule, no one may hold an attributable interest in two
television stations under certain circumstances. In December 2000, the FCC
terminated its 1998 Biennial Review of the television duopoly rules and affirmed
the ban on owning a second television station in a market having fewer than
eight separately owned TV stations. On February 20, 2001, Sinclair Broadcast
Group filed a Petition for Review with the U.S. Court of Appeals for the
District of Columbia Circuit. Sinclair also sought a court stay of an FCC
decision ordering Sinclair to terminate local marketing agreements it had
entered after the November 5, 1996, start of an FCC rulemaking examining TV
local marketing agreements. The Court granted the stay pending completion of the
appeal. On April 2, 2002, the Court granted the appeal and remanded the
proceeding to the FCC. On August 12, 2002, the Court denied petitions for
rehearing and rehearing en banc. The FCC's further consideration of these issues
has been incorporated with the third Biennial Review of media ownership rules,
issued on September 23, 2002.
Must Carry/Retransmission Consent. The 1992 Cable Act contains broadcast signal
carriage requirements that allow local commercial television broadcast stations
to elect once every three years to require a cable system to carry the station,
subject to certain exceptions, or to negotiate for "retransmission consent" to
carry the station. Broadcast signal carriage is the transmission of broadcast
television signals over a cable system to cable customers. A cable system
generally is required to devote up to one-third of its activated channel
capacity for the carriage of local commercial television stations whether
pursuant to the mandatory carriage or retransmission consent requirements of the
1992 Cable Act. Local non-commercial television stations are also given
mandatory carriage rights; however, such stations are not given the option to
negotiate retransmission consent for the carriage of their signals by cable
systems. Additionally, cable systems are required to obtain retransmission
consent for all distant commercial television stations (except for commercial
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satellite-delivered independent "superstations" such as WGN), commercial radio
stations and certain low-power television stations carried by such systems.
Must carry requests can dilute the appeal of a cable system's programming
offerings because a cable system with limited channel capacity may be required
to forego carriage of popular channels in favor of less popular broadcast
stations electing must carry. Retransmission consent demands may require
substantial payments or other concessions.
The FCC tentatively decided against imposition of dual digital and analog must
carry in a January 2001 ruling. The ruling resolved a number of technical and
legal matters, and clarifies that a digital-only TV station, commercial or
non-commercial, can immediately assert its right to carriage on a local cable
system. The FCC also said that a TV station that returns its analog spectrum and
converts to digital operations must be carried by local cable systems. At the
same time, however, it initiated further fact gathering that ultimately could
lead to a reconsideration of the tentative conclusion.
Satellite Home Viewer Improvement Act of 1999. A major change introduced by the
SHVIA was a "local into local" provision allowing satellite carriers, for the
first time, to retransmit the signals of local television stations by satellite
back to viewers in their local markets. The intent was to promote multichannel
video competition by removing the prohibition on satellite retransmission of
local signals, which cable operators already offered to their subscribers under
the must-carry/retransmission consent scheme of regulation described above.
SHVIA applies a similar scheme to satellite carriage. Television stations had
until July 1, 2001, to elect must-carry or retransmission consent on satellite
carriers in their markets. Beginning January 1, 2002, a satellite company that
has chosen to provide any local-into-local service in a market will be required
to provide subscribers with the signals of all qualified television stations
assigned to that designated market area and that ask to be carried on the
satellite system. To qualify, stations must meet conditions such as providing,
at station expense, a good-quality signal to the carrier's local receive
facility.
On November 29, 2000, the FCC adopted rules governing satellite signal carriage.
These rules bar carriers from charging subscribers more for must-carry stations
than for stations that elect to be carried under retransmission consent. Rules
also prevent carriers from requiring subscribers to purchase additional
equipment (e.g., a second dish) to receive stations that insist on carriage. The
FCC allowed satellite carriers to sell local stations to subscribers a la carte,
rather than only as a package. But a satellite carrier that carries at least one
local station under the new local-into-local copyright compulsory license
without which DBS operators would not carry the signals at all, contained in the
SHVIA, must-carry all qualifying stations in the market; this is the carry
one/carry all provision that is among those on appeal.
FCC reconsideration of the rules was petitioned for by DirecTV and the
Association of Local Television Stations, and supported and opposed by several
others. In an Order on Reconsideration released September 5, 2001, the
Commission affirmed its rules for the most part, but also clarified, on its own
motion, important aspects of carrier obligations to implement station elections
of must-carry.
Various court appeals have been consolidated in the Fourth Circuit, where oral
argument was held September 25, 2001, focusing on carry one/carry all and a la
carte. The FCC, in its Reconsideration Order of September 5, 2001, addressed
complaints by broadcasters that satellite carriers, particularly EchoStar, have
not complied with SHVIA must-carry implementation requirements, and ordered the
carriers to comply. On December 7, 2001, the Court upheld the a la carte rule
and affirmed that the carry one, carry all rule was a reasonable,
content-neutral restriction on satellite carriers' speech. On June 17, 2002, the
Supreme Court declined to consider the case. In the 11th Circuit Echostar
injunction case, the broadcast plaintiffs will provide new evidence of
nationwide noncompliance to the U.S. District Court in Miami. By statute and FCC
rule, satellite carriage of eligible local stations must begin January 1, 2002.
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Designated Access Channels. The 1996 Telecom Act permits local franchising
authorities to require cable operators to set aside certain channels for public,
educational and governmental access programming. The 1984 Cable Act also
requires cable systems to designate a portion of their channel capacity, up to
15 percent in some cases, for commercial leased access by unaffiliated third
parties to provide programming that may compete with services offered by the
cable operator. The FCC has adopted rules regulating the terms, conditions and
maximum rates a cable operator may charge for commercial leased access use. The
FCC recently rejected a request that unaffiliated Internet service providers be
found eligible for commercial leased access.
Access to Programming. To spur the development of independent cable programmers
and competition to incumbent cable operators, the 1992 Cable Act imposed
restrictions on the dealings between cable operators and cable programmers. Of
special significance from a competitive business posture, the 1992 Cable Act
precludes video programmers affiliated with cable companies from favoring their
cable operators over new competitors and requires such programmers to sell their
programming to other multichannel video distributors. This provision limits the
ability of vertically integrated cable programmers to offer exclusive
programming arrangements to cable companies. This prohibition was scheduled to
expire on October 5, 2002. On June 13, 2002, the FCC adopted an order extending
the prohibition until October 5, 2007. There also has been interest expressed in
further restricting the marketing practices of cable programmers, including
subjecting programmers who are not affiliated with cable operators to all of the
existing program access requirements, and subjecting terrestrially delivered
programming to the program access requirements. Terrestrially delivered
programming is programming delivered other than by satellite. Pursuant to the
Satellite Home Viewer Improvement Act, the FCC has adopted regulations governing
retransmission consent negotiations between broadcasters and all multichannel
video programming distributors, including cable and DBS.
Inside Wiring; Subscriber Access. In an order issued in 1997, the FCC
established rules that require an incumbent cable operator upon expiration of a
multiple dwelling unit service contract to sell, abandon, or remove home run
wiring that was installed by the cable operator in a multiple dwelling unit
building. These inside wiring rules are expected to assist building owners in
their attempts to replace existing cable operators with new programming
providers who are willing to pay the building owner a higher fee, where such a
fee is permissible. The FCC has also proposed abrogating all exclusive multiple
dwelling unit service agreements held by incumbent operators, but allowing such
contracts when held by new entrants. In another proceeding, the FCC has
preempted restrictions on the deployment of private antennas on rental property
within the exclusive use of a tenant, such as balconies and patios. We have no
agreements containing such restrictions.
Video Description. On July 21, 2000, the FCC ruled that top-25-market affiliates
of the four major national networks, and MVPDs having 50,000 or more
subscribers, must provide video descriptions to make television programs more
accessible to people with visual impairments. Such broadcasters and MVPDs must
provide, in prime time or children's programming, 50 hours per calendar quarter
of video description. Other television stations and MVPDs must pass through
video descriptions contained in programs, and must add an aural tone crawl or
scroll to local emergency messages. Video description, which is in addition to
closed captioning for the hearing impaired, includes voice descriptions of a
program's visual elements inserted in audio pauses in the program. The FCC
generally affirmed its video description rules on reconsideration on January 4,
2001. On March 28, 2001, the Motion Picture Association of America, National
Association of Broadcasters and NCTA filed a joint Petition for Review, and on
April 2, 2001, the National Federation of the Blind filed a Petition for Review
with the U.S. Court of Appeals for the District of Columbia Circuit of the FCC's
January 4, 2001, reconsideration decision. On November 8, 2002, the Court
reversed and vacated the FCC's order to the extent that it required broadcasters
to implement video descriptions.
Franchise Procedures. The 1984 Cable Act affirms the right of franchising
authorities (state or local, depending on the practice in individual states) to
award one or more franchises within their jurisdictions and prohibits
non-grandfathered cable systems from operating without a franchise in such
jurisdictions. The 1992 Cable Act encourages competition with existing cable
systems by:
50
o Allowing municipalities to operate their own cable systems without
franchises;
o Preventing franchising authorities from granting exclusive franchises or
from unreasonably refusing to award additional franchises covering an
existing cable system's service area; and
o Prohibiting (with limited exceptions) the common ownership of cable
systems and collocated MMDS or SMATV systems.
The FCC has relaxed its restrictions on ownership of SMATV systems to permit a
cable operator to acquire SMATV systems in the operator's existing franchise
area so long as the programming services provided through the SMATV system are
offered according to the terms and conditions of the cable operator's local
franchise agreement. The 1996 Telecom Act provides that the cable/SMATV and
cable/MMDS cross-ownership rules do not apply in any franchise area where the
operator faces effective competition as defined by federal law.
The Cable Acts also provide that in granting or renewing franchises, local
authorities may establish requirements for cable-related facilities and
equipment, but not for video programming or information services other than in
broad categories. The Cable Acts limit the payment of franchise fees to 5
percent of revenues derived from cable operations and permit the cable operator
to obtain modification of franchise requirements by the franchise authority or
judicial action if warranted by changed circumstances. A federal appellate court
held that a cable operator's gross revenue includes all revenue received from
subscribers, without deduction, and overturned an FCC order which had held that
a cable operator's gross revenue does not include money collected from
subscribers that is allocated to pay local franchise fees. We cannot predict the
ultimate resolution of these matters. The 1996 Telecom Act generally prohibits
franchising authorities from:
o Imposing requirements in the cable franchising process that require,
prohibit or restrict the provision of telecommunications services by an
operator;
o Imposing franchise fees on revenues derived by the operator from
providing telecommunications services over its cable system; or
o Restricting an operator's use of any type of subscriber equipment or
transmission technology.
The 1984 Cable Act contains renewal procedures designed to protect incumbent
franchisees against arbitrary denials of renewal. The 1992 Cable Act made
several changes to the renewal process that could make it easier for a
franchising authority to deny renewal. Moreover, even if the franchise is
renewed, the franchising authority may seek to impose new and more onerous
requirements such as significant upgrades in facilities and services or
increased franchise fees as a condition of renewal. Similarly, if a franchising
authority's consent is required for the purchase or sale of a cable system or
franchise, such authority may attempt to impose more burdensome or onerous
franchise requirements in connection with a request for such consent.
Historically, franchises have been renewed for cable operators that have
provided satisfactory services and have complied with the terms of their
franchises. We believe that we have generally met the terms of our franchises
and have provided quality levels of service. Furthermore, our franchises are
issued by the state public utility commission (the RCA) and do not require
periodic renewal.
Various courts have considered whether franchising authorities have the legal
right to limit the number of franchises awarded within a community and to impose
certain substantive franchise requirements (e.g. access channels, universal
service and other technical requirements). These decisions have been
inconsistent and, until the US Supreme Court rules definitively on the scope of
cable operators' First Amendment protections, the legality of the franchising
process generally and of various specific franchise requirements is likely to be
in a state of flux.
Pole Attachment. The Communications Act requires the FCC to regulate the rates,
terms and conditions imposed by public utilities for cable systems' use of
utility pole and conduit space unless state authorities can demonstrate that
they adequately regulate pole attachment rates. In the absence of state
regulation, the FCC administers pole attachment rates on a formula basis.
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The FCC has concluded that, in the absence of state regulation, it has
jurisdiction to determine whether utility companies have justified their demand
for additional rental fees and that the Communications Act does not permit
disparate rates based on the type of service provided over the equipment
attached to the utility's pole. The FCC's existing pole attachment rate formula,
which may be modified by a pending rulemaking, governs charges for utilities for
attachments by cable operators providing only cable services. The 1996 Telecom
Act and the FCC's implementing regulations modify the current pole attachment
provisions of the 1984 Cable Act by immediately permitting certain providers of
telecommunications services to rely upon the protections of the current law and
by requiring that utilities provide cable systems and telecommunications
carriers with nondiscriminatory access to any pole, conduit or right-of-way
controlled by the utility.
The FCC's new rate formula, effective in 2001, governs the maximum rate certain
utilities may charge for attachments to their poles and conduit by companies
providing telecommunications services, including cable operators. Several
parties have requested the FCC to reconsider its new regulations and several
parties have challenged the new rules in court. On December 20, 2002, the D.C.
Circuit affirmed the FCC's rules in large measure. The Court did not address the
merits of certain rules for which the Court concluded that petitioners'
challenge was not ripe.
The favorable pole attachment rates afforded cable operators under federal law
can be gradually increased by utility companies owning the poles if the operator
provides telecommunications service, as well as cable service, over its plant.
The FCC clarified that a cable operator's favorable pole rates are not
endangered by the provision of Internet access, but a decision by the 11th
Circuit Court of Appeals disagreed and suggested that Internet traffic is
neither cable service nor telecommunications service and might leave cable
attachments that carry Internet traffic ineligible for Pole Attachment Act
protections. This decision could have lead to substantial increases in pole
attachment rates. The cable industry sought review by the United States Supreme
Court, which issued an opinion reversing a decision from the United States Court
of Appeals for the Eleventh Circuit. The Eleventh Circuit court held that
commingled services are not covered by the Pole Attachment Act; and the Pole
Attachment Act does not grant the FCC authority to regulate wireless
communications.
Shortly after the Eleventh Circuit, opinion was issued, the U.S. Supreme Court
granted writ of certiorari and issued an order staying the Eleventh Circuit's
decision pending further review. The U.S. Supreme Court reversed the Eleventh
Circuit's ruling. While the Supreme Court's decision does not mean an end to
arbitrations and litigation over similar issues, it does mean that the FCC's
Pole Attachment rules remain in effect.
In 2002, the RCA concluded a rulemaking in Docket R-00-5 that examined whether
to change state regulations governing interconnection and joint use of utility
facilities. These regulations include a default pricing methodology for
determining pole attachment rates that cable providers would pay pole owners in
the event the parties cannot agree to rates on their own. The state formula,
which the APUC adopted in 1987, is patterned after the maximum cable rate
formula adopted by Congress in the 1978 Pole Attachment Act. With the passage of
the 1996 Telecommunications Act, Congress amended the 1978 Pole Attachment Act
in several respects, which included providing a different pole attachment rate
methodology for telecommunication carriers and their pole attachments than the
methodology used for cable companies. These changes prompted some pole owners in
Alaska (principally electric companies) to file a petition with the RCA to adopt
the new federal formula for setting pole attachment rates. The RCA concluded the
rulemaking proceeding in 2002 and made minor changes to the regulations but
largely retained the existing pole attachment formula that has been in state
regulation since 1987.
Copyright. Cable television systems are subject to federal copyright licensing
covering carriage of television and radio broadcast signals. In exchange for
filing certain reports and contributing a percentage of their revenues to a
federal copyright royalty pool, that varies depending on the size of the system,
the number of distant broadcast television signals carried, and the location of
the cable system, cable operators can obtain blanket permission to retransmit
copyrighted material included in broadcast signals. The U.S. copyright office
adopted an industry agreement providing for an increase in the copyright royalty
rates. The possible
52
modification or elimination of this compulsory copyright license is the subject
of continuing legislative review and could adversely affect our ability to
obtain desired broadcast programming. We cannot predict the outcome of this
legislative activity. Copyright clearances for nonbroadcast programming services
are arranged through private negotiations.
Cable operators distribute locally originated programming and advertising that
use music controlled by the two principal major music performing rights
organizations, the American Society of Composers, Authors and Publishers and
Broadcast Music, Inc. The cable industry has had a long series of negotiations
and adjudications with both organizations. A prior voluntarily negotiated
agreement with Broadcast Music has now expired, and is subject to further
proceedings. The governing rate court recently set retroactive and prospective
cable industry rates for American Society of Composers music based on the
previously negotiated Broadcast Music rate. Although we cannot predict the
ultimate outcome of these industry proceedings or the amount of any license fees
we may be required to pay for past and future use of association-controlled
music, we do not believe such license fees will be significant to our business
and operations.
Other Statutory and FCC Provisions. The 1992 Cable Act requires cable operators
to block fully both the video and audio portion of sexually explicit or indecent
programming on channels that are primarily dedicated to sexually oriented
programming or alternatively to carry such programming only at "safe harbor"
time periods currently defined by the FCC as the hours between 10 p. m. to 6 a.
m. A three-judge federal district court determined that this provision was
unconstitutional. The United States Supreme Court is currently reviewing the
lower court's ruling. The Communications Act also includes provisions, among
others, concerning customer service, subscriber privacy, marketing practices,
equal employment opportunity, regulation of technical standards and equipment
compatibility.
The FCC has various rulemaking proceedings pending that will implement the 1996
Telecom Act; it also has adopted regulations implementing various provisions of
the 1992 Cable Act and the 1996 Telecom Act that are the subject of petitions
requesting reconsideration of various aspects of its rulemaking proceedings. The
FCC has the authority to enforce its regulations through the imposition of
substantial fines, the issuance of cease and desist orders and/or the imposition
of other administrative sanctions, such as the revocation of FCC licenses needed
to operate certain transmission facilities often used in connection with cable
operations.
Other Regulations of the FCC. In addition to the FCC regulations noted above,
there are other regulations of the FCC covering such areas as the following.
o Programming practices, including, among other things:
o Syndicated program exclusivity, which is a FCC rule which requires a
cable system to delete particular programming offered by a distant
broadcast signal carried on the system which duplicates the programming
for which a local broadcast station has secured exclusive distribution
rights
o Network program nonduplication
o Local sports blackouts
o Indecent programming
o Lottery programming
o Political programming
o Sponsorship identification
o Children's programming advertisements
o Closed captioning
o Registration of cable systems and facilities licensing
o Maintenance of various records and public inspection files
o Aeronautical frequency usage
o Lockbox availability
o Antenna structure notification
o Tower marking and lighting
o Emergency alert systems
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The FCC has ruled that cable customers must be allowed to purchase cable
converters from third parties and established a multi-year phase-in during which
security functions, which would remain in the operator's exclusive control,
would be unbundled from basic converter functions, which could then be satisfied
by third party vendors. The first phase implementation date was July 1, 2000.
Compliance was technically and operationally difficult in our locations, so we
and several other cable operators filed a request with the FCC that the
requirement be waived in those systems. The request resulted in a temporary
deferral of the compliance deadline for those systems. The necessary changes
were implemented in 2002 to comply with these requirements.
The FCC recently initiated an inquiry to determine whether the cable industry's
future provision of interactive services should be subject to regulations
ensuring equal access and competition among service vendors. The inquiry is
another indication of regulatory concern regarding control over cable capacity.
Other bills and administrative proposals pertaining to cable communications have
previously been introduced in Congress or have been considered by other
governmental bodies over the past several years. It is possible that Congress
and other governmental bodies will make further attempts to regulate cable
communications services.
State and Local Regulation. Because our cable communications systems use local
streets and rights-of-way, our systems are subject to state and local
regulation. Cable communications systems generally are operated pursuant to
franchises, permits or licenses granted by a municipality or other state or
local government entity. In Alaska, the RCA is the franchising authority for the
state. We provide cable television service throughout Alaska pursuant to various
certificates of authority issued by the RCA. These certificates are not subject
to terms of renewal and continue in effect until and unless the state commission
were to seek to modify or revoke them for good cause.
Internet Operations
General. With significant growth in Internet activity and commerce over the past
several years the FCC and other regulatory bodies have been challenged to
develop new models that allow them to achieve the public policy goals of
competition and universal service. Many aspects of regulation and coordination
of Internet activities and traffic are evolving and are facing unclear
regulatory futures. Changes in regulations and in the regulatory environment,
including changes that affect communications costs or increase competition from
the ILEC or other communications service providers, could adversely affect the
prices at which we sell ISP services.
The Internet has been able to grow and develop outside the existing regulatory
structure because the FCC has made conscious decisions to limit the application
of its rules. The federal government's efforts have been directed away from
burdening the Internet with regulation. ISPs and other companies in the Internet
industry have not been required to gain regulatory approval for their actions.
The 1996 Telecom Act adopts such a position. The 1996 Act states that it is the
policy of the United States "to preserve the vibrant and competitive free market
that presently exists for the Internet and other interactive computer services,
unfettered by Federal or State regulation."
Regulatory policy approaches toward the Internet have focused on several areas:
avoiding unnecessary regulation, questioning the applicability of traditional
rules, Internet governance (such as the allocation of domain names),
intellectual property, network reliability, privacy, spectrum policy, standards,
security, and international regulation.
Government may influence the evolution of the Internet in many ways, including
directly regulating, participating in technical standards development, providing
funding, restricting anti-competitive behavior by dominant firms, facilitating
industry cooperation otherwise prohibited by antitrust laws, promoting new
technologies, encouraging cooperation between private parties, representing the
United States in international intergovernmental bodies, and large-scale
purchasing of services.
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There are many ways Internet growth could be negatively impacted which may
require future regulation and oversight. Moving toward proprietary standards or
closed networks would reduce the degree to which new services could leverage the
existing infrastructure. The absence of competition in the ISP market, or the
telecommunications infrastructure market, could reduce incentives for
innovation. Excessive or misguided government intervention could distort the
operation of the marketplace, and lead companies to expend valuable resources
working through the regulatory process. Insufficient government involvement may
also, however, have negative consequences. Some issues may require a degree of
central coordination, even if only to establish the initial terms of a
distributed, locally-controlled system. The final result, in the absence of
collective action, may be an outcome that no one favors. In addition, the
failure of the federal government to identify Internet-related areas that should
not be subject to regulation leaves open opportunities for state, local, or
international bodies to regulate excessively and/or inconsistently.
Internet Governance and Standards. There is no one entity or organization that
governs the Internet. Each facilities-based network provider that is
interconnected with the global Internet controls operational aspects of their
own network. Certain functions, such as domain name routing and the definition
of the TCP/IP protocol, are coordinated by an array of quasi-governmental,
intergovernmental, and non-governmental bodies. The United States government, in
many cases, has handed over responsibilities to these bodies through contractual
or other arrangements.
In other cases, entities have emerged to address areas of need such as the
Internet Society ("ISOC"), a non-profit professional society founded in 1992.
ISOC organizes working groups and conferences, and coordinates some of the
efforts of other Internet administrative bodies. The Internet Engineering Task
Force ("IETF"), an open international body mostly comprised of volunteers, is
primarily responsible for developing Internet standards and protocols. The work
of the IETF is coordinated by the Internet Engineering Steering Group, and the
Internet Architecture Board, which are affiliated with ISOC. The Internet
Assigned Numbers Authority handles Internet addressing matters under a contract
between the Department of Defense and the Information Sciences Institute at the
University of Southern California.
The legal authority of any of these bodies is unclear. Most of the underlying
architecture of the Internet was developed under the auspices, directly or
indirectly, of the United States government. The government has not, however,
defined whether it retains authority over Internet management functions, or
whether these responsibilities have been delegated to the private sector. The
degree to which any existing body can lay claim to representing "the Internet
community" is also unclear. Membership in the existing Internet governance
entities is drawn primarily from the research and technical communities.
1996 Telecom Act. The 1996 Telecom Act provides little direct guidance as to
whether the FCC has authority to regulate Internet-based services. Section 223
concerns access by minors to obscene, harassing, and indecent material over the
Internet and other interactive computer networks, and sections 254, 706, and 714
address mechanisms to promote the availability of advanced telecommunications
services, possibly including Internet access. None of these sections, however,
specifically addresses the FCC's jurisdiction.
Nothing in the 1996 Telecom Act expressly limits the FCC's authority to regulate
services and facilities connected with the Internet, to the extent that they are
covered by more general language in any section of the Act. Moreover, it is not
clear what such a limitation would mean even if it were adopted. The
Communications Act directs the FCC to regulate "interstate and foreign commerce
in communication by wire and radio," and the FCC and state public utility
commissions indisputably regulate the rates and conditions under which ISPs
purchase services and facilities from telephone companies. Given the absence of
clear statutory guidance, the FCC must determine whether it has the authority or
the obligation to exercise regulatory jurisdiction over specific Internet-based
activities. The FCC may also decide whether to forebear from regulating certain
Internet-based services. Forbearance allows the FCC to decline to adopt rules
that would otherwise be required by statute. Under section 401 of the 1996
Telecom Act, the FCC must forbear if regulation would not be necessary to
prevent anticompetitive practices and to protect consumers, and
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forbearance would be consistent with the public interest. Finally, the FCC could
consider whether to preempt state regulation of Internet services that would be
inconsistent with achievement of federal goals.
FCC Regulations. The FCC has not attempted to regulate the companies that
provide the software and hardware for Internet telephony, or the access
providers that transmit their data, as common carriers or telecommunications
service providers. In March 1996, America's Carriers Telecommunication
Association ("ACTA"), a trade association primarily comprised of small and
medium-size interexchange carriers, filed a petition with the FCC asking the FCC
to regulate Internet telephony. ACTA argues that providers of software that
enables real-time voice communications over the Internet should be treated as
common carriers and subject to the regulatory requirements of Title II. The FCC
has sought comment on ACTA's request. Other countries are considering similar
issues. In addition, the FCC is considering a proposal to classify broadband
Internet access service provided over the wireline network as an "information
service," and thus, potentially excluding such services from Title II
regulation.
The FCC has not considered whether any of the rules that relate to radio and
television broadcasters should also apply to analogous Internet-based services.
The vast majority of Internet traffic today travels over wire facilities, rather
than the radio spectrum. As a policy matter, however, a continuous, live,
generally-available music broadcast over the Internet may appear similar to a
traditional radio broadcast, and the same arguments may be made about streaming
video applications. The FCC will need to consider the underlying policy
principles that, in the language of the Act and in FCC decisions, have formed
the basis for regulation of the television and radio broadcast industries.
The FCC does not regulate the prices charged by ISPs or Internet backbone
providers. However, the vast majority of users connect to the Internet over
facilities of existing telecommunications carriers. Those telecommunications
carriers are subject to varying levels of regulation at both the federal and the
state level. Thus, regulatory decisions exercise a significant influence over
the economics of the Internet market. Economics is expected to drive the
development of both the Internet and of other communications technologies.
Internet access is understood to be an enhanced service under FCC rules;
therefore, ISPs are treated as end users, rather than carriers, for purposes of
the FCC's interstate access charge rules. This distinction was created when the
FCC established the access charge system in 1983. Thus, when ISPs purchase lines
from LECs, the ISPs buy those lines under the same tariffs that any business
customer would use. Although these services generally involve a per-minute usage
charge in addition to a monthly fee, the usage charge is assessed only for
outbound calls. ISPs, however, exclusively use these lines to receive calls from
their customers, and thus effectively pay flat monthly rates. By contrast, IXCs
that interconnect with LECs are considered carriers, and thus are required to
pay interstate access charges for the services they purchase. Most of the access
charges that carriers pay are usage-sensitive in both directions. Thus, IXCs are
assessed per-minute charges for both originating and terminating calls. The FCC
concluded in their Local Competition Order that the rate levels of access
charges appear to significantly exceed the incremental cost of providing these
services. The FCC in December 1996 launched a comprehensive proceeding to reform
access charges in a manner consistent with economic efficiency and the
development of local competition. The FCC has adopted access charge reform for
carriers regulated under price cap and rate-of-return regulation, which reforms
are subject to periodic review and adjustment.
State and Local Regulations. The revenue effects of Internet usage today depend
to a significant extent on the structure of state and local tariffs. Internet
usage generates less revenue for LECs in states and jurisdictions where flat
local service rates have been set low, with compensating revenues in the form of
per-minute intrastate toll charges. Because ISPs only receive local calls, they
do not incur these usage charges. By contrast, in states and jurisdictions where
flat charges make up a higher percentage of LEC revenues, ISPs will have a less
significant revenue effect. ISP usage is also affected by the relative pricing
of services such as ISDN PRI, frame relay, and fractional T-1 connections, which
are alternatives to analog business lines. Prices for these services, and the
price difference on a per-voice-channel basis between the options available to
ISPs, vary widely across different states and jurisdictions. In many cases,
tariffs for these and other data
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services are based on assumptions that do not reflect the realities of the
Internet access market today. The scope of local calling areas also affects the
architecture of Internet access services. In states and jurisdictions with
larger unmeasured local calling areas, ISPs need fewer POPs in order to serve
the same customers through a local call.
Court Decisions and Legislative Action. We believe major court decisions and
legislative and FCC action will shape the worldwide Internet in 2003 and beyond,
including:
o The February 20, 2003 FCC decision to deregulate new networks for
high-speed Internet access and expected legal challenges.
o Continuing concerns and litigation over alleged copyright infringement.
o Minimum-regulation approaches to information privacy.
o The impact of more Internet patents preventing others from doing certain
things, such as designing and maintaining certain types of Web sites.
o The legality of hyperlinking without permission.
o Decisions regarding whether cryptographic source code is First Amendment
speech, and hence exportable, or that no program is covered by the First
Amendment.
o Continuing calls for domestic controls of obscenity-related cryptography.
Financial Information about our Foreign and Domestic Operations and Export Sales
Although we have several agreements to help originate and terminate
international toll traffic, we do not have foreign operations or export sales.
We conduct our operations throughout the western contiguous United States and
Alaska and believe that any subdivision of our operations into distinct
geographic areas would not be meaningful. Revenues associated with international
toll traffic were $3.5 million, $4.4 million and $4.9 million for the years
ended December 31, 2002, 2001 and 2000, respectively.
Seasonality
Our long-distance revenues 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. Our cable television revenues, on the other hand, are higher in
the winter months because consumers tend to watch more television, and spend
more time at home, during these months. Our local service and Internet
operations are not expected to exhibit significant seasonality, with the
exception of SchoolAccess(TM) Internet services that are reduced during the
summer months. Revenues and cost of sales for yellow-page directories are
recognized upon publication of directories, which for the Anchorage directory is
expected to occur in the fourth quarter, beginning in 2003. Our ability to
implement construction projects is also reduced during the winter months because
of cold temperatures, snow and short daylight hours.
Customer-Sponsored Research
We have not expended material amounts during the last three fiscal years on
customer-sponsored research activities.
Backlog of Orders and Inventory
As of December 31, 2002 and 2001, our long-distance services segment had a
backlog of private line orders of approximately $318,000 and $450,000,
respectively, which represents recurring monthly charges for private line and
broadband services. The decreased backlog is due to decreased private line
circuit orders pending at December 31, 2002 as compared to 2001. As of December
31, 2002 and 2001, we had a backlog of equipment sales orders of approximately
$601,000 and $85,000, respectively for services included in the All Other
category described in note 9 to the Notes to Consolidated Financial Statements
included in Part II of this Report. The increase in backlog as of December 31,
2002 can be attributed to increased outstanding sales orders at December 31,
2002 as compared to 2001. We expect that all of the private line orders and
equipment sales in backlog at the end of 2002 will be delivered during 2003.
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Geographic Concentration and 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 our operations depend upon economic conditions in Alaska. The
economy of State of Alaska is dependent upon the natural resource industries,
and in particular oil production, as well as investment earnings (including
earnings from the State of Alaska Permanent Fund), tourism, government, and
United States military spending. Any deterioration in these markets could have
an adverse impact on us. Oil revenues are now the second largest source of state
revenues, following funds from federal sources. The economic stagnation in the
lower 48 states appears to have dampened demand for services provided by our
large common carrier customers. To the extent that these customers experience
reduced demand for traffic destined for and originating in Alaska, it could
adversely affect our common carrier traffic and associated revenues. You should
see Part II, Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations for more information about the effect of geographic
concentration and the Alaska economy on us.
Factors That May Affect Our Business and Future Results
Our use of leverage will reduce cash flow from operations available to fund our
business and may cause a decline in our credit rating and/or limit our ability
to raise additional capital. As of December 31, 2002, we had total outstanding
debt of $404.3 million. We may incur additional indebtedness in the future as we
implement our business plan, subject to limitations imposed by our credit
agreements. In connection with the execution of our business strategies, we
routinely evaluate acquisition opportunities with respect to each of our
business segments and we may elect to finance acquisitions by incurring
additional indebtedness. We must use a portion of our future cash flow from
operations to pay the principal and interest on our indebtedness, which will
reduce the funds available for our operations, including capital investments and
business expenses. This could hinder our ability to adjust to changing market
and economic conditions. If we incur significant additional indebtedness, our
credit rating could be adversely affected. As a result, our borrowing costs
would likely increase and our access to capital may be adversely affected.
Our credit facilities restrict our ability to incur additional indebtedness and
make capital expenditures, and contain certain other restrictions on our
business operations. Our existing credit facilities restrict our and certain of
our subsidiaries' ability to incur additional indebtedness, make certain capital
expenditures, pay dividends or make certain other restricted payments,
consummate certain asset sales, enter into certain transactions with affiliates
and incur liens. These credit facilities also impose restrictions on the ability
of a subsidiary to pay dividends or make certain payments to us, merge or
consolidate with any other person or sell, assign, transfer, lease, convey or
otherwise dispose of all or substantially all of our assets. These credit
facilities also require that we maintain certain financial ratios. A breach of
any of these covenants could result in a default under the credit facilities.
Our current business strategy includes the acquisition of additional assets and
the expansion of our existing businesses and service offerings. In addition, our
business strategy may in the future be expanded to include activities outside
the state of Alaska. It is possible that our current and future expansion and
growth plans will require significant additional capital in excess of capital
generated from operations and will result in significant capital expenditures.
If we are unable to negotiate modifications to these restrictions, they could
hinder our ability to follow through with expansion and growth plans.
We have a history of operating losses. If we do not maintain profitability, we
may be unable to make capital expenditures necessary to implement our business
plan, meet our debt service requirements or otherwise conduct our business in an
effective and competitive manner. This would require us to divert cash from
other uses, which may not be possible or may detract from the growth of our
businesses. These events could limit our ability to increase our revenues and
net income or cause these amounts to decline.
We depend on a small number of customers for a substantial portion of our
revenue and business. As previously described (see Part I, Item 1. Business,
Long Distance Services, Customers), services that we provide to WorldCom and to
Sprint contribute significantly to our total revenues. These two customers are
free to seek out long-distance communication services from our competitors upon
expiration of their contracts (in March 2006, in the case of WorldCom, subject
to reaffirmation of the contract in the bankruptcy process,
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and in March 2007, in the case of Sprint) or earlier upon a default or the
occurrence of certain events. These events are a force majeure event or a
substantial change in applicable law or regulation under the applicable
contract.
The impact of WorldCom's Bankruptcy filing on us. We provide long-distance and
other services to WorldCom, a related party and a major customer, as further
described in notes 9 and 11 to the Notes to Consolidated Financial Statements
included in Part II of this Report. 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. Through December 31, 2002 we have
recognized a $11.6 million bad debt reserve for uncollected balances due from
WorldCom as of 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. A conversion of WorldCom's bankruptcy petition to Chapter 7,
unfavorable reaffirmation or cancellation 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 material adverse effect on our financial condition and
results of operations.
We expect that our contract with WorldCom will ultimately be reaffirmed and that
we will work out some form of agreement with respect to the pre-petition
receivables balance and that WorldCom will ultimately exit bankruptcy with their
business intact. We cannot predict how long it may take WorldCom to work their
way through the bankruptcy process or what effect the process or the economy may
have on their traffic levels and ultimately, their requirements for service in
Alaska.
Mergers and acquisitions in the telecommunications industry are relatively
common. If a change in control of WorldCom or Sprint were to occur, it would not
permit them to terminate their existing contracts with us, but could in the
future result in the termination of or a material adverse change in our
relationships with WorldCom or Sprint. In addition, WorldCom and Sprint's need
for our long-distance services depends directly upon their ability to obtain and
retain their own long-distance customers and upon the needs of those customers
for long-distance services.
The loss of one or both of WorldCom or Sprint as customers, a material adverse
change in our relationships with them or a material loss of or reduction in
their long-distance customers would have a material adverse effect on our
financial condition and results of operations.
We depend on a limited number of third-party vendors to supply
telecommunications equipment. We depend on a limited number of third-party
vendors to supply cable, Internet and telephony-related equipment. If our
providers of this equipment are unable to timely supply the equipment necessary
to meet our needs or provide them at an acceptable cost, we may not be able to
satisfy demand for our services and competitors may fulfill this demand.
Prolonged service interruptions could affect our business. We rely heavily on
our network equipment, telecommunications providers, data and software, to
support all of our functions. We rely on our networks and the networks of others
for substantially all of our revenues. We are able to deliver services only to
the extent that we can protect our network systems against damage from power or
telecommunication failures, computer viruses, natural disasters, unauthorized
access and other disruptions. While we endeavor to provide for failures in the
network by providing back-up systems and procedures, we cannot guarantee that
these back-up systems and procedures will operate satisfactorily in an
emergency. Should we experience a prolonged failure, it could seriously
jeopardize our ability to continue operations. In particular, should a
significant service interruption occur, our ongoing customers may choose a
different provider, and our reputation may be damaged, reducing our
attractiveness to new customers.
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To the extent that any disruption or security breach results in a loss or damage
to our customers' data or applications, or inappropriate disclosure of
confidential information, we may incur liability and suffer from adverse
publicity. In addition, we may incur additional costs to remedy the damage
caused by these disruptions or security breaches.
Certain of our major switching centers and transmission hubs carry significant
concentrations of our traffic. While we have followed industry practices to
construct, secure and protect these facilities from extended power outages,
fire, earthquakes, and other natural or man-made disasters, such an event could
result in an extended outage for a significant portion of our traffic. Such an
extended outage could have a material impact on our business and results of
operations.
If a failure occurs in our undersea fiber optic cable, our ability to
immediately restore the entirety of our service may be limited. Our
telecommunications facilities include an undersea fiber optic cable that carries
a large portion of our Internet voice and data traffic to and from the
contiguous Lower 48 states. We have obtained what we believe is adequate backup
capacity through early 2004 and continue to seek arrangements to obtain
alternative telecommunications facilities as backup facilities. If a failure of
our undersea fiber optic facilities occurs before we are able to secure adequate
backup facilities, some of the telecommunications services we offer to our
customers could be interrupted, which could have a material impact on our
business and results of operations.
We serve many rural and remote Alaska locations solely via satellite
communications. Each of our C- and Ku-band satellite transponders is backed up
on the same spacecraft with multiple backup transponders. We have arranged for
backup satellite capacity on another spacecraft for all of our current C-band
satellite transponders in the unlikely event of a total primary spacecraft
failure. If such a failure occurs, service may not be fully restored for up to a
week or longer. Due to variations in satellite earth coverage and other
technical performance differences between the primary satellite and the backup
satellite, a small percentage of our services may not be restorable on the
backup satellite. We own one Ku-band satellite transponder on the same primary
spacecraft that provides our C-band service. In the event of total primary
spacecraft failure, we would not be able to restore our Ku-band transponder
traffic, as no other spacecraft offering is presently suitable and similar
performance coverage of Alaska on which we have prior arranged restoration
services. PanAmSat has announced plans to launch and place in service during
2003 a spacecraft with identical performance to our current primary spacecraft
which could provide us with Ku-band and additional C-band backup capacity at
that time.
Our businesses are currently geographically concentrated in Alaska. We offer a
variety of voice, video and data services to residential, commercial and
governmental customers in the state of Alaska. Because of this geographic
concentration, our growth and operations depend in part upon economic conditions
in Alaska. We may not be able to continue to increase our market share of the
existing markets for our services and no assurance can be given that the Alaskan
economy will continue to grow and increase the size of the markets we serve or
increase the demand for the services we offer. You should see Part II, Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations for more information.
Our best growth opportunities may be in geographic areas that differ from those
of our existing businesses. We have achieved significant market penetration in
the state of Alaska for many of the services we offer. However, opportunities
for expanding our market geographically in the state of Alaska or attaining
significant additional market penetration in the State of Alaska are limited. As
a result, the best opportunities for expanding our business may arise in other
geographic areas such as the contiguous Lower 48 states. There can be no
assurance that we will find attractive opportunities to grow our businesses
outside the State of Alaska or that we will have the necessary expertise to take
advantage of such opportunities. The Alaska voice, video and data
telecommunications markets are unique and distinct within the United States due
to Alaska's large geographical size and its distance from the rest of the United
States. The expertise we have developed in operating our businesses in the State
of Alaska may not provide us with the necessary expertise to successfully enter
other geographic markets.
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We may fail to develop our wireless services. We offer wireless mobile services
by reselling other providers' wireless mobile services. We offer wireless local
telephone services over our own facilities, and have purchased PCS and LMDS
wireless broadband licenses in FCC auctions covering markets in Alaska. We have
fewer subscribers to our wireless services than to our other service offerings.
The geographic coverage of our wireless services is also smaller than the
geographic coverage of our other services. Some of our competitors offer or
propose to offer an integrated bundle of communications, entertainment and
information services, including wireless services. If we are unable to expand
and further develop our wireless services, we may not be able to meet the needs
of customers who desire packaged services, and our competitors who offer theses
services would have an advantage. This could result in the loss of market share
for our other service offerings.
Our efforts to develop cable telephony may be unsuccessful. An element of our
business strategy is to develop voice telephone service utilizing our coaxial
cable facilities. If we are able to develop this service, we will be able to
utilize our own cable facilities to provide local access to our customers and
avoid paying local loop charges to ILECs. In order to successfully develop and
market this new service, we must integrate new technology with our existing
facilities. The viability of this service depends on the availability of the
equipment necessary to provide the service at cost-effective prices. The
development and marketing of this service will require a substantial capital
investment. If we are unable to successfully develop and market voice telephone
service, we will not be able to fully recover any capital investment we may make
and the margins on our local telephone services business will not improve.
We do not have insurance to cover certain risks to which we are subject. We are
self-insured for damage or loss to certain of our transmission facilities,
including our buried, under sea, and above-ground transmission lines. We
self-insure with respect to employee health insurance and workers compensation,
subject to stop-loss insurance with other parties that caps our liability at
specified limits. If we become subject to substantial uninsured liabilities, our
financial results may be adversely affected.
Economic and Security Impacts on Telecommunications. The economic stagnation in
the United States began with a decline in business capital spending and
investment. Businesses continue to limit spending on equipment, software, real
estate, inventories and other investments. The terrorist attacks on America on
September 11, 2001 and their aftermath worsened already deteriorating economic
conditions. Recent economic indicators reflect an improving economy, however
concerns over war and renewed terrorist threats continue to mute economic growth
and optimism.
The telecommunications sector has been significantly impacted by the recent
economic downturn. The NASDAQ Telecommunications Index through February 2003 has
dropped 90% from the high reached in February 2000, including a 54% drop during
2002. Investors reportedly fear that carriers with high debt loads may face
liquidity crises. The telecommunications sector has been affected by such
liquidity concerns, bankruptcy filings of WorldCom, Global Crossing Ltd. and
McLeodUSA Inc., and concerns about the possibility of improper accounting.
The economic stagnation in the lower 48 states appears to have dampened demand
for services provided by our large common carrier customers. To the extent that
these customers experience reduced demand for traffic destined for and
originating in Alaska, it could adversely affect our common carrier traffic. A
protracted economic malaise in the lower 48 states or a further disruption in
the economy resulting from a war or renewed terrorist activity could affect our
carrier customers which, in turn, could affect our revenues and cash flows. If
the economic conditions in the United States worsen or if a wider or global
economic slowdown occurs, our results of operations and financial condition may
be adversely affected.
As our business has grown, we have become increasingly subject to adverse
changes in general economic conditions and economic conditions in the State of
Alaska, which can result in reductions in capital expenditures by customers,
longer sales cycles, deferral or delay of purchase commitments for products or
services and increased price competition. Although these factors have not
materially affected us in recent
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years, if the current economic slowdown continues or worsens, these factors
could adversely affect our business and results of operations.
With the terrorist events of September 11, the FCC and the communications
community are determining their respective roles in ensuring homeland security.
The FCC's principal objectives are reportedly to secure the U.S.'s
communications infrastructure and to enhance emergency response through
communications. Expected FCC actions include re-chartering the Network
Reliability and Interoperability Council ("NRIC"), consideration of a media
counter-part to NRIC, working with other agencies to ensure network protection,
reliability and redundancy, continuing efforts to solve remaining public safety
spectrum issues, continuing to work on interoperability restraints, continuing
to address emergency 911 issues, and working with other agencies on wireless
priority access that balances the need for government response and critical
needs of subscribers.
Since we are a wholly-owned subsidiary of GCI, we can be affected by activity in
GCI's common stock. Sales of a substantial number of shares of GCI's Class A
common stock, or the perception that such sales may occur, could cause the
market price of GCI's Class A common stock to decline and impede our ability to
raise capital through sales of GCI's Class A common stock or securities
convertible into or exercisable for GCI's Class A common stock. A significant
percentage of GCI's voting securities are held by a small number of shareholders
and these shareholders can control stockholder decisions on very important
matters. As of December 31, 2002, WorldCom owned approximately 9% and our
executive officers and directors and their affiliates owned approximately 21% of
GCI's combined outstanding Class A and Class B common stock. Because each share
of GCI's Class A common stock has one vote per share and each share of GCI's
Class B common stock has ten votes per share, WorldCom and our executive
officers and directors and their affiliates have approximately 42% of the
combined voting power of that stock (including GCI's outstanding series B
preferred stock voting with GCI's Class A common stock on an as-converted
basis). These GCI shareholders can significantly influence if not control our
management policy and all fundamental corporate actions, including mergers,
substantial acquisitions and dispositions, and election of directors to GCI's
Board. This concentration of ownership may have the effect of discouraging third
parties from making bids for us or GCI, delaying or preventing a change of
control, or reducing premiums paid to GCI's shareholders for their stock and
could have an adverse effect on the market price of GCI's Class A common stock.
It may be difficult for a third party to acquire us or GCI, even if doing so may
be beneficial to GCI's shareholders. Since we are a wholly-owned subsidiary of
GCI, we can be affected by activity in GCI's common stock and ownership. Certain
provisions of GCI's Restated Articles of Incorporation may discourage, delay or
prevent a change in control of GCI that a GCI shareholder may consider
favorable. These provisions include the following:
o Authorizing GCI's board of directors to issue preferred stock under
terms developed by GCI's board, which could increase the number of
outstanding shares and thwart a takeover attempt; and
o Classifying GCI's board of directors with staggered three-year terms,
which may lengthen the time required to gain control of GCI's board of
directors.
If we are required to account for the market value of GCI's stock options as
compensation expense, our net income will be significantly reduced. This topic
is currently under reexamination by accounting standards setters and regulators.
Some companies have begun to account for stock options as a compensation expense
thus resulting in a reduction of their net income. We currently record
compensation expense to the extent that GCI stock options are priced below
market value at the time of grant. It is possible that future laws and
regulations will require us to record the full fair market value of all stock
options as a compensation expense in our consolidated financial statements. If
such a change occurs, our net income would be significantly reduced. See notes
1(r), 1(s) and 8 to the Notes to Consolidated Financial Statements included in
Part II of this Report.
62
Employees
We employed 1,230 persons as of January 31, 2003, and are not parties to union
contracts with our employees. We believe our future success will depend upon our
continued ability to attract and retain highly skilled and qualified employees.
We believe that relations with our employees are satisfactory.
Other
No material portion of our businesses is subject to renegotiation of profits or
termination of contracts at the election of the federal government.
Item 2. Properties
General
Our properties do not lend themselves to description by character or location of
principal units. Our investment in property, plant and equipment in our
consolidated operations consisted of the following at December 31:
2002 2001
----------------------
Telephone distribution systems 56.4% 57.5%
Cable television distribution systems 24.4% 23.1%
Support equipment 6.5% 7.9%
Property and equipment under capital leases 8.5% 8.7%
Construction in progress 2.8% 1.4%
Transportation equipment 0.9% 0.9%
Land and buildings 0.5% 0.5%
----------------------
Total 100.0% 100.0%
======================
These properties are divided among our operating segments at December 31, 2002
as follows: long-distance services, 55.3%; cable services, 26.0%; local access
services, 7.7%; Internet services, 5.7%; and all other, 5.3%.
These properties consist primarily of switching equipment, satellite earth
stations, fiber-optic networks, microwave radio and cable and wire facilities,
cable head-end equipment, coaxial distribution networks, routers, servers,
transportation equipment, computer equipment and general office equipment.
Substantially all of our properties secure our new Senior Credit Facility. You
should see note 6 to the Notes to Consolidated Financial Statements included in
Part II of this Report for more information.
Our construction in progress totaled $17.0 million at December 31, 2002,
consisting of telecommunications, cable, local service and support system
projects that were incomplete at December 31, 2002. Our construction in progress
totaled $11.0 million at December 31, 2001, consisting of telecommunications,
cable, Internet and support systems projects that were incomplete at December
31, 2001.
Long-Distance Services
We operate a modern, competitive telecommunications network employing the latest
digital transmission technology based upon fiber optic and digital microwave
facilities within and between Anchorage, Fairbanks and Juneau, Alaska. Our
network includes digital fiber optic cables linking Alaska to the contiguous 48
states and providing access to other carriers' networks for communications
around the world. We use satellite transmission to remote areas of Alaska and
for certain interstate and intrastate traffic, and to provide backup facilities
for certain portions of our long-haul fiber networks.
Our long-distance services segment owns properties and facilities including
satellite earth stations, and distribution, transportation and office equipment.
Additionally, in December 1992 we acquired access to capacity on an undersea
fiber optic cable from Seward, Alaska to Pacific City, Oregon. We completed
construction of an additional fiber optic cable facility linking Alaska to
Seattle, Washington in February 1999.
63
We entered into a purchase and lease-purchase option agreement in August 1995
for the acquisition of satellite transponders on the PanAmSat Galaxy XR
satellite to meet our long-term satellite capacity requirements. We use the
satellite transponders pursuant to a long-term capital lease arrangement with a
leasing company. The purchase and lease-purchase option agreement provided for
the interim lease of transponder capacity on the PanAmSat Galaxy IX satellite
through the delivery of the purchased transponders on Galaxy XR in March 2000.
Effective June 30, 2001, we acquired, through GCI's issuance of its preferred
stock, a controlling interest in the corporation owning the 800-mile fiber optic
cable system that extends from Prudhoe Bay, Alaska to Valdez, Alaska via
Fairbanks.
We lease our long-distance services industry segment's executive, corporate and
administrative facilities in Anchorage, Fairbanks and Juneau, Alaska. Our
operating, executive, corporate and administrative properties are in good
condition. We consider our properties suitable and adequate for our present
needs and they are being fully utilized.
Cable Services
The Cable Systems serve 33 communities and areas in Alaska including Anchorage,
Fairbanks and Juneau, the state's three largest urban areas. As of December 31,
2002, the Cable Systems consisted of approximately 2,230 miles of installed
cable plant having between 330 to 550 MHz of channel capacity. Our principal
physical assets consist of cable television distribution plant and equipment,
including signal receiving, encoding and decoding devices, headend reception
facilities, distribution systems and customer drop equipment for each of our
cable television systems.
Our cable television plant and related equipment are generally attached to
utility poles under pole rental agreements with local public utilities and
telephone companies, and in certain locations are buried in underground ducts or
trenches. We own or lease real property for signal reception sites and business
offices in many of the communities served by our systems and for our principal
executive offices.
We own the receiving and distribution equipment of each system. In order to keep
pace with technological advances, we are maintaining, periodically upgrading and
rebuilding the physical components of our cable communications systems. Such
properties are in good condition. We own all of our service vehicles. We
consider our properties suitable and adequate for our present and anticipated
future needs.
Local Access Services
We operate a modern, competitive local access telecommunications network
employing the latest digital transmission technology based upon fiber optic
facilities within Anchorage, Fairbanks and Juneau, Alaska. Our outside plant
consists of connecting lines (aerial, underground and buried cable), the
majority of which is on or under public roads, highways or streets, while the
remainder is on or under private property. Central office equipment primarily
consists of digital electronic switching equipment and circuit carrier
transmission equipment. Operating equipment consists of motor vehicles and other
equipment.
Substantially all of our local access services' central office equipment,
administrative and business offices, and customer service centers are in leased
facilities. Such properties are in good condition. We consider our properties
suitable and adequate for our present and anticipated future needs.
Internet Services
We operate a modern, competitive Internet network employing the latest available
technology. We provide access to the Internet using a platform that includes
many of the latest advancements in technology. The physical platform is
concentrated in Anchorage and is extended into many remote areas of the state.
Our Internet platform includes trunks connecting our Anchorage, Fairbanks, and
Juneau facilities to Internet access points in Seattle through multiple,
diversely routed upstream Internet networks, and various other routers, servers
and support equipment.
64
We lease our Internet services industry segment's operating facilities, located
primarily in Anchorage. Such properties are in good condition. We consider our
properties suitable and adequate for our present and anticipated future needs.
Capital Expenditures
Capital expenditures consist primarily of (a) gross additions to property, plant
and equipment having an estimated service life of one year or more, plus the
incidental costs of preparing the asset for its intended use, and (b) gross
additions to capitalized software.
The total investment in property, plant and equipment has increased from $242.9
million at January 1, 1998 to $611.2 million at December 31, 2002, including
construction in progress and not including deductions of accumulated
depreciation. Significant additions to property, plant and equipment will be
required in the future to meet the growing demand for communications, Internet
and entertainment services and to continually modernize and improve such
services to meet competitive demands.
Our capital expenditures for 1998 through 2002 were as follows (in millions):
1998 $ 149.0
1999 $ 36.6
2000 $ 48.9
2001 $ 68.0
2002 $ 66.1
We project capital expenditures of $40 million to $55 million for 2003 for which
we have made no significant purchase commitments through February 28, 2003. A
majority of the expenditures will expand, enhance and modernize our current
networks, facilities and operating systems, and will develop other businesses.
Additional capital expenditures will be incurred if we acquire backup or standby
facilities. You should see note 12 to the accompanying Notes to Consolidated
Financial Statements included in Part II of this Report for more information.
During 2002, we funded our normal business capital requirements substantially
through internal sources and, to the extent necessary, from external financing
sources. We expect expenditures for 2003 to be financed in the same manner.
Insurance
We have insurance to cover risks incurred in the ordinary course of business,
including general liability, property coverage, director and officers and
employment practices liability, auto, crime, fiduciary, aviation, and business
interruption insurance in amounts typical of similar operators in our industry
and with reputable insurance providers. Central office equipment, buildings,
furniture and fixtures and certain operating and other equipment are insured
under a blanket property insurance program. This program provides substantial
limits of coverage against "all risks" of loss including fire, windstorm, flood,
earthquake and other perils not specifically excluded by the terms of the
policies. As is typical in the communications industry, we are self-insured for
damage or loss to certain of our transmission facilities, including our buried,
under sea, and above-ground transmission lines. We self-insure with respect to
employee health insurance and workers compensation, subject to stop-loss
insurance with other parties that caps our liability at specified limits. We
believe our insurance coverage is adequate, however if we become subject to
substantial uninsured liabilities due to damage or loss to such facilities, our
financial results may be adversely affected.
Item 3. Legal Proceedings
Except as set forth in this item, neither the Company, its property nor any of
its subsidiaries or their property is a party to or subject to any material
pending legal proceedings. We are parties to various claims and pending
litigation as part of the normal course of business. We are also involved in
several administrative
65
proceedings and filings with the FCC, Department of Labor and state regulatory
authorities. In the opinion of management, the nature and disposition of these
matters are considered routine and arising in the ordinary course of business.
Except as previously disclosed concerning rural exemption proceedings (see Part
I, Item 1. Regulation, Franchise Authorizations and Tariffs), even if resolved
unfavorably to us, management believes these matters would not have a materially
adverse affect on our business or financial position, results of operations or
liquidity.
Item 4. Submissions of Matters to a Vote of Security Holders
Omitted per General Instruction J(1)(a) and (b) of Form 10-K.
Part II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Market Information for Common Stock
All issued and outstanding shares of GCI, Inc.'s Class A common stock are held
by General Communication, Inc. and are not publicly traded. General
Communication, Inc.'s Class A and Class B common stock are publicly traded.
Dividends
GCI and GCI, Inc. have never paid cash dividends on their common stock and have
no present intention of doing so. Payment of cash dividends in the future, if
any, will be determined by GCI's and GCI, Inc.'s Board of Directors in light of
our earnings, financial condition and other relevant considerations. Our
existing bank loan agreements contain provisions that prohibit payment of
dividends on common stock, other than stock dividends (you should see note 6 to
the Consolidated Financial Statements included in Part II of this Report for
more information).
Stock Transfer Agent and Registrar
Mellon Investor Services LLC is GCI's stock transfer agent and registrar.
66
Item 6. Selected Financial Data
The following table presents selected historical information relating to
financial condition and results of operations over the past five years.
Years ended December 31,
-------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(Amounts in thousands)
Revenues $ 367,842 357,258 292,605 279,179 246,795
Net earnings (loss) before income taxes,
extraordinary item and cumulative effect of a
change in accounting principle $ 12,322 8,659 (21,649) (14,866) (10,920)
Cumulative effect of a change in accounting
principal, net of income tax benefit of $245 $ 0 0 0 344 0
Net earnings (loss) $ 6,663 4,589 (13,234) (9,527) (6,797)
Total assets $ 738,782 734,679 679,007 643,151 649,445
Long-term debt, including current portion $ 357,700 351,700 334,400 339,400 351,657
Obligations under capital leases, including
current portion $ 46,632 47,282 48,696 1,674 2,186
Total stockholder's equity $ 206,622 206,622 206,622 206,622 206,622
Dividends declared per Common share $ 0.00 0.00 0.00 0.00 0.00
The Selected Financial Data should be read in conjunction with Part II,
Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations.
67
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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, long-distance cost of
sales and services accruals, 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. Shares of GCI, Inc.'s
common stock are not publicly traded.
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.
Consolidated revenues increased by more than $10 million in 2002 as compared to
2001, or almost $30 million from core operations if the $19.5 million 2001 fiber
sale is excluded. Our operating income increased by 11.6% in 2002. This increase
occurred in spite of our recording bad debt expense in 2002 of $11.6 million
related to our WorldCom receivables, and because we discontinued the
amortization of goodwill and cable certificates upon the adoption of SFAS 142,
"Goodwill and Other Intangible Assets" on January 1, 2002. Adoption of SFAS 142
resulted in a decrease in 2002 amortization expense of approximately $6.5
million as compared to 2001. Our pre-tax income increased by 42.3% and our net
income increased by 45.2%. Excluding the 2001 fiber sale, our four business
segments experienced year over year growth in units and revenues as we continued
to strengthen our position in the markets we serve. Operating income increased
in the long-distance services and cable services segments, and decreased in the
local access services and Internet services segments.
Long-Distance Services Overview
During 2002 long-distance services revenue represented 55.7% of consolidated
revenues. Our provision of interstate and intrastate long-distance services,
private line and leased dedicated capacity services, and broadband services
accounted for 96.0% of our total long-distance services revenues during 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.
68
Our long-distance services segment faces significant competition from AT&T
Alascom, Inc., long-distance resellers, and local telephone companies that have
entered the long-distance market. We believe our approach to 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. See note 11 in
the accompanying Notes to Consolidated Financial Statements for a discussion of
WorldCom's Chapter 11 bankruptcy filing.
Due in large part to the favorable synergistic effects of our integrated
approach, the long distance segment continues to be a significant contributor to
our overall performance, although the migration of traffic from voice to data
continues.
Cable Services Overview
During 2002, cable television revenues represented 24.1% of consolidated
revenues. Our 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 and installation; (3) cable modem services (shared with our
Internet services segment); and (4) advertising sales. During 2002 programming
services generated 76.9% of total cable services revenues, equipment rental and
installation fees accounted for 9.3% of such revenues, cable services' allocable
share of cable modem services accounted for 9.0% of such revenues, advertising
sales accounted for 3.9% of such revenues, and other services accounted for the
remaining 0.9% 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.
Our cable services segment faces 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 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
69
and other charges, including voice mail, caller ID, distinctive ring, inside
wiring and subscriber line charges. During 2002 local exchange services revenues
represented 8.7% 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 monthly rates
charged for non-traffic sensitive services, the number and type of additional
premium features selected, and the traffic sensitive access rates charged to
carriers.
Our local access services segment faces significant competition in Anchorage,
Fairbanks, and Juneau from the ILEC ACS and from AT&T Alascom, Inc. We began
providing service in the Juneau market 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 2002 Internet services
segment revenues represented 4.3% 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 9 in the
accompanying Notes to Consolidated Financial Statements include our managed
services, product sales, and cellular telephone services.
Revenues included in the All Other category represented 7.2% of total revenues
in 2002 and include managed services revenues totaling $22.0 million and product
sales and cellular telephone services revenues totaling $4.6 million.
Results of Operations
The following table sets forth selected Statement of Operations data as a
percentage of total revenues for the periods indicated (underlying data rounded
to the nearest thousands):
Year Ended December 31, Percentage Change (1)
----------------------- ---------------------
2001 2000
vs. vs.
2002 2001 2000 2002 2001
---- ---- ---- ---- ----
Statement of Operations Data:
Revenues:
Long-distance services 55.7% 56.2% 62.4% 2.1% 9.9%
Cable services 24.1% 21.4% 23.2% 15.9% 12.7%
70
Year Ended December 31, Percentage Change (1)
----------------------- ---------------------
2001 2000
vs. vs.
2002 2001 2000 2002 2001
---- ---- ---- ---- ----
Local access services 8.7% 7.1% 6.9% 27.1% 24.9%
Internet services 4.3% 3.3% 2.9% 29.9% 42.4%
All other services 7.2% 12.0% 4.6% (37.9%) 219.3%
-----------------------------------------------------------------
Total revenues 100.0% 100.0% 100.0% 3.0% 22.1%
Cost of sales and services 33.6% 39.1% 40.9% (11.6%) 16.8%
Selling, general and administrative expenses 35.1% 32.6% 34.2% 10.7% 16.6%
Bad debt expense 3.6% 1.2% 1.7% 206.7% (14.6%)
Depreciation and amortization 15.3% 15.6% 17.3% 1.3% 9.9%
-----------------------------------------------------------------
Operating income 12.4% 11.5% 5.9% 11.6% 136.6%
Net income (loss) before income taxes 3.3% 2.4% (7.4%) 42.3% 140.0%
Net income (loss) 1.8% 1.3% (4.5%) 45.2% 134.7%
Other Operating Data (2):
Long-distance services operating income (3) 38.6% 34.0% 27.6% 16.0% 35.0%
Cable services operating income (4) 28.8% 18.1% 16.3% 84.2% 25.5%
Local access services operating income (loss) (5) (2.3%) 5.8% (11.7%) (150.2%) 162.2%
Internet services operating loss (6) (117.2%) (125.2%) (164.4%) (21.6%) (8.5%)
- --------------------------
1 Percentage change in underlying data.
2 Includes customer service, marketing and advertising costs.
3 Computed as a percentage of total external long-distance services revenues.
4 Computed as a percentage of total external cable services revenues.
5 Computed as a percentage of total external local access services revenues.
6 Computed as a percentage of total external Internet services revenues.
- --------------------------
Year Ended December 31, 2002 ("2002") Compared To Year Ended December 31,
2001 ("2001").
Overview of Revenues and Cost of Sales and Services
Total revenues increased 3.0% from $357.3 million in 2001 to $367.8 million in
2002. Excluding the fiber optic cable system capacity sale of $19.5 million in
2001 as described in note 1(m) in the accompanying Notes to Consolidated
Financial Statements, total revenues increased 8.9% in 2002. The long-distance
services, cable services, local access services and Internet services segments
contributed to the increase in total revenues, partially off-set by a decrease
in revenues from All Other Services. See the discussions below for more
information by segment.
Total cost of sales and services decreased 11.6% to $123.6 million in 2002. As a
percentage of total revenues, total cost of sales and services decreased from
39.1% in 2001 to 33.6% in 2002. Excluding the 2001 fiber system capacity sale,
total cost of sales and services as a percentage of total revenues decreased
from 38.2% in 2001 to 33.6% in 2002. The long-distance services segment and All
Other Services contributed to the decrease in total cost of sales and services,
partially off-set by increases in cost of sales and services in the cable
services, local access services and Internet services segments. See the
discussions below for more information by segment.
Long-distance Services Segment Revenues
Long-distance services segment revenues increased 2.1% to $204.9 million in
2002.
71
Message Telephone Service Revenue from Common Carrier Customers
Message telephone service revenues from other common carriers (principally
WorldCom and Sprint) increased 10.9% to $88.8 million in 2002 resulting from a
14.7% increase in wholesale minutes carried to 819.8 million minutes. After
excluding certain 2001 low-margin wholesale minutes no longer carried for other
common carriers, comparable wholesale minutes carried for other common carriers
increased 19.5% over the prior year. Revenue increases resulting from increased
wholesale minutes carried for other common carriers was partially off-set by a
3.3% decrease in the average rate per minute on minutes carried for other common
carriers. The increase is also due to the reclassification of approximately 12.0
million minutes of traffic generated by a certain customer from retail in 2001
to wholesale in 2002. The average rate per minute decrease is primarily 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 6.5% from the prior year.
Revenues from and minutes carried for WorldCom increased in 2002 as compared to
2001.
The economic stagnation in the lower 48 states appears to have dampened demand
for services provided by our large common carrier customers. To the extent that
these customers experience reduced demand for traffic destined for and
originating in Alaska, it could adversely affect our common carrier traffic. A
protracted economic malaise in the lower 48 states or a further disruption in
the economy resulting from a war or renewed terrorist activity could affect our
carrier customers which, in turn, could affect our revenues and cash flows.
We believe that our contract with WorldCom will ultimately be reaffirmed and
that we will develop an agreement with respect to the pre-petition receivables
balance and that WorldCom may ultimately exit bankruptcy with their business
intact. We cannot predict how long it may take WorldCom to complete the
bankruptcy process or what effect the process or the economy may have on their
traffic levels and ultimately, their requirements for service to and from
Alaska.
Message Telephone Service Revenue from Residential, Commercial and Governmental
Customers
Message telephone service revenues from residential, commercial, and
governmental customers decreased 12.2% to $53.3 million in 2002 primarily due to
the following:
o A 10.2% decrease in retail minutes carried for these customers to 309.2
million minutes. The decrease is primarily due to the loss of
approximately 8.0 million to 10.0 million minutes earned annually from a
certain retail customer and the reclassification of approximately 12.0
million minutes of traffic generated by a certain customer from retail in
2001 to wholesale in 2002, and
o A 4.6% decrease in the average rate per minute to $0.124 per minute paid
by these customers due to our promotion of and customers' enrollment in
calling plans offering a certain number of minutes for a flat monthly
fee.
Through May 2001 discounts recognized on revenue from certain private line and
private network customers totaling $2.8 million off-set 2001 message telephone
service revenue from residential, commercial and governmental customers.
Beginning June 2001 these discounts off-set revenue from private line and
private network customers. If these discounts had not been recognized in the
2001 message telephone service revenue from residential, commercial and
governmental customers through May 2001, revenues would have decreased 16.1% to
$53.3 million in 2002 as compared to 2001.
The decreases in message telephone service revenues from residential,
commercial, and governmental customers described above are partially off-set by
a 0.3% increase in the number of active residential, commercial, and
governmental customers billed to 88,200 at December 31, 2002.
Revenue from Private Line and Private Network Customers
Private line and private network transmission services revenues increased 4.2%
to $36.2 million in 2002. The increase is partially off-set by the effect of a
reclassification of discounts recognized on revenue from certain
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private line and private network customers. Through May 2001 these discounts
totaled approximately $2.8 million and off-set message telephone service revenue
from residential, commercial and governmental customers, beginning July 2001
these discounts off-set revenue from private line and private network customers.
If the discounts had been recognized in revenue from private line and private
network customers during all of 2001 the increase in revenue would be 13.4% to
$36.2 million. The increase in revenue from private line and private network
customers in 2002 is primarily due to an increased number of circuits leased by
governmental customers.
Revenue from Broadband Customers
Revenues from our packaged telecommunications offering to rural hospital and
health clinic service and our SchoolAccess(TM) offering to rural school
districts increased 17.4% in 2002 to $18.4 million. The increase is primarily
due to the addition in the second quarter of 2001 of two new subscribers to our
rural hospital and health clinic service for which we recognized a full year of
revenue in 2002, and our new SchoolAccess(TM) offering called Distance Learning
that started in late 2002. Distance Learning is a video-conference based service
and is used by six school districts in Alaska.
Long-distance Services Segment Cost of Sales and Services
Long-distance services segment cost of sales and services decreased 18.0% to
$60.1 million in 2002. Long-distance services segment cost of sales and services
as a percentage of long-distance services segment revenues decreased from 36.5%
in 2001 to 29.3% in 2002 primarily due to the following:
o Reductions in access costs due to distribution and termination of our
traffic on our own local access 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,
o The FCC Multi-Association Group ("MAG") reform order reducing the
interstate access rates paid by interexchange carriers to LECs in January
and again in July 2002, and
o In the course of business we estimate unbilled long-distance services
cost of sales and services based upon minutes of use processed through
our network and established rates. Such estimates are revised when
subsequent billings are received, payments are made, billing matters are
researched and resolved, tariffed billing periods lapse, or when disputed
charges are resolved. In 2002 and 2001, we had favorable and
(unfavorable) adjustments of $4.7 million and ($2.8) million,
respectively. Excluding the adjustments, long-distance services cost of
sales and services as a percentage of long-distance services revenues was
35.1% and 31.6% in 2001 and 2002, respectively.
Long-distance services cost of sales and services in 2001 included a reversal of
$2.0 million in accrued costs upon the conclusion of a dispute with ACS and a
$450,000 non-recurring refund from ACS in respect of its earnings that exceeded
regulatory requirements.
Cable Services Segment Revenues and Cost of Sales and Services
Cable services segment revenues increased 15.9% to $88.7 million and average
gross revenue per average basic subscriber per month increased $3.38 or 6.4% in
2002. The increases in revenues and rates per subscriber were accomplished
without any meaningful rate increases during 2002 and are due primarily to
continued deployment of our high value services including digital cable
television and cable modems. Programming services revenues increased 11.9% to
$68.2 million in 2002 resulting from the following:
o Basic subscribers served increased approximately 4,100 to approximately
136,100 at December 31, 2002 as compared to December 31, 2001,
o New facility construction efforts in 2002 resulted in approximately 4,700
additional homes passed, a 2.5% increase from 2001, and
o Digital subscriber counts increased 24.0% to approximately 30,500 at
December 31, 2002 as compared to December 31, 2001. Programming services
revenues from digital subscribers increased 59.8% or $2.6 million from
2001 to 2002.
73
Effective February 2003, we increased rates charged for certain cable services
and premium packages in six communities, including the state's three largest
population centers Anchorage, Fairbanks and Juneau.
The cable services segment's share of cable modem revenue (offered through our
Internet services segment) increased $3.1 million to $8.0 million in 2002 due to
an increased number of cable modems deployed. Approximately 96% of our cable
homes passed are able to subscribe to our cable modem service. We expect that
that number will increase to approximately 99% when we complete our upgrade of
the Ketchikan cable system which we expect to accomplish in 2003.
We now offer digital programming in Anchorage, Fairbanks, Juneau, Kenai, and
Soldotna, which markets represent approximately 80% of our homes passed at
December 31, 2002.
We signed new seven-year retransmission agreements with the five local Anchorage
broadcasters and began up linking and distributing the local Anchorage
programming to all of our cable systems. This was done to provide additional
value to our cable subscribers and to allow us to differentiate our programming
from that of our DBS competitors. In addition, we have been successful in
growing advertising revenues from our statewide advertising platform. Our ad
insertion revenues increased approximately 28.9% in 2002.
Cable services cost of sales and services increased 13.5% to $23.6 million in
2002. Cable services cost of sales and services as a percentage of cable
services revenues, which is less as a percentage of revenues than are
long-distance, local access and Internet services cost of sales and services,
decreased from 27.2% in 2001 to 26.7% in 2002.
Revenues earned from equipment rental and installation, cable services'
allocable share of cable modem services and advertising sales do not have
significant corresponding costs of sales and services. The decrease in cable
services cost of sales and services as a percentage of cable services revenues
is primarily due to an increase in the percentage of cable services revenues
earned from equipment rental and installation, cable services' allocable share
of cable modem services and advertising sales from 20.4% in 2001 to 23.1% in
2002.
The decrease in cable services cost of sales and services as a percentage of
cable services revenues described above is off-set by an increase in cable
programming services cost of sales and services as a percentage of cable
programming services revenue from 34.2% in 2001 to 34.7% 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 Segment Revenues and Cost of Sales and Services
Local access services segment revenues increased 27.1% in 2002 to $32.1 million
primarily due to growth in the average number of customers served. At December
31, 2002 an estimated 96,100 lines were in service as compared to approximately
79,200 lines in service at December 31, 2001. We estimate that our 2002 lines in
service total represents a statewide market share of approximately 20%. At
December 31, 2002 approximately 1,700 additional lines were awaiting connection.
The increase in local access services revenues described above was partially
off-set by the following:
o The FCC MAG reform order reducing the interstate access rates paid by
interexchange carriers to LECs in January and again in July 2002, and
o A reduction in interstate access rates charged by us to interexchange
carriers in response to an FCC order forcing a competitor to reduce their
interstate access rates.
Local access services cost of sales and services increased 43.9% to $20.2
million in 2002. Local access services cost of sales and services as a
percentage of local access services revenues increased from 55.6% in 2001 to
63.0% in 2002, primarily due to the following:
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o Decreased network access services revenues from other carriers as the
number of customers purchasing both long-distance and local access
services from us increases,
o An increase in the Anchorage loop lease rates and residential wholesale
rates paid to ACS as described below,
o 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 and services for such new customers,
and
o The lease of wholesale circuits from ACS 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 and services 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.
Our access line mix continued to hold steady in 2002, with residential lines
representing approximately 55% of our lines, business customers representing
approximately 37%, and Internet access customers representing approximately 8%.
Approximately 86% of our lines are provided on our own facilities or using
leased local loops.
In Anchorage, ACS requested and received permission for a 7.7% increase in the
UNE loop rate to $14.92 per month 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
per month. Additionally, the cost of most residential features increased 24.0%
to approximately $1.35 per line per month. The increased rates resulted in an
approximately $1.2 million increase in our local access services cost of sales
and services in 2002.
The size of the local access services segment operating loss is exacerbated by
the allocation of the benefit of access cost savings to the long-distance
services segment. If the local access services segment received credit for the
access charge reductions recorded by the long distance services segment, the
local access services segment operating loss would have decreased by
approximately $7.0 million and the long distance services segment would be
reduced by an equal amount in 2002. Avoided access charges totaled approximately
$7.0 million during 2002 as compared to $6.3 in 2001. The local access services
segment operating loss is affected by the expected start-up losses we are
experiencing in the new Fairbanks and Juneau markets and our continued
evaluation and testing of IP cable telephony technology.
Internet Services Segment Revenues and Cost of Sales and Services
Internet services segment revenues increased 29.9% to $15.6 million in 2002
primarily due to growth in the number of customers served and the number of
cable modems deployed. We had approximately 71,700 Internet subscribers at
December 31, 2002 as compared to approximately 69,900 at December 31, 2001, of
which approximately 36,200 are cable modem subscribers at December 31, 2002 as
compared to approximately 26,500 at December 31, 2001. The Internet services
segment's allocable share of cable modem revenues increased 60.3% to $6.5
million in 2002 as compared to 2001.
The Internet services segment does not share in plan fee revenues associated
with our bundled Internet and long distance service package. Estimated annual
plan fees related to this service offering is in excess of $4.0 million per year
and those revenues are included in the long distance services segment.
Internet services cost of sales and services increased 0.9% to $4.8 million in
2002, and as a percentage of Internet services revenues, totaled 30.8% and 39.6%
in 2002 and 2001, respectively. The decrease as a percentage of Internet
services revenues is primarily due to a $2.5 million increase in Internet's
portion of cable modem revenue to $6.5 million 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.
75
We enhanced the value of our Internet offerings in 2002 through the addition of
electronic billing and presentment capabilities and the rollout of a product
called e-mail guard, which filters out e-mail spam and viruses. We upgraded the
download speeds of all of our cable modem Internet service offerings. These new
services and enhancements have proven to be very popular with our customers and
are helping to further solidify our customer relationships.
All Other Revenues and Costs of Sales and Services
The 37.9% decrease in All Other revenues to $26.6 million in 2002 is primarily
due to the $19.5 million fiber system capacity sale in 2001, as described in
note 1(m) in the accompanying Notes to Consolidated Financial Statements. The
decrease in revenues is partially offset by a $3.0 million increase in managed
services revenue to $22.0 million in 2002 primarily due to the provision of
additional services to and increased revenues from a certain customer as
performance criteria was met.
Revenues from our GCI Fiber system that runs along the pipeline corridor are
continuing to increase and we expect the annual revenue run rate to increase by
an additional four to five million dollars per year by the end of 2003.
All Other costs of sales decreased 44.8% to $14.9 million in 2002, and as a
percentage of All Other revenues, totaled 56.0% and 62.9% in 2002 and 2001,
respectively. The 2002 decrease is due to $10.9 million in costs of sale for the
fiber system capacity sale in 2001, as described in note 1(m) in the
accompanying Notes to Consolidated Financial Statements. Excluding the 2001
fiber system capacity sale, cost of sales and services as a percentage of
revenues totaled 56.0% and 68.9% in 2002 and 2001, respectively. The decrease is
primarily due to the provision of additional services to and increased revenues
from a certain customer as performance criteria was met without a corresponding
increase in cost of sales and services.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 10.7% to $129.0 million
in 2002 and, as a percentage of total revenues, increased to 35.1% in 2002 from
32.6% in 2001. Excluding the fiber system capacity sale in 2001, selling,
general and administrative expenses, as a percentage of total revenues,
increased from 34.1% in 2001 to 35.1% 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 WCI
Cable, Inc. and its subsidiaries ("WCIC"), partially offset by a decreased
accrual for company-wide success sharing bonus costs.
Marketing and advertising expenses as a percentage of total revenues decreased
from 3.4% in 2001 to 3.3% in 2002. Excluding revenues from the fiber system
capacity sale in 2001, marketing and advertising expenses as a percentage of
total revenues were 3.6% in 2001.
Bad Debt Expense
Bad debt expense increased 206.7% to $13.1 million in 2002 and, as a percentage
of total revenues, increased to 3.6% in 2002 from 1.2% in 2001. Excluding
revenues from the fiber system capacity sale in 2001, bad debt expense as a
percentage of total revenues was 1.3% in 2001. The 2002 increase is primarily
due to the $11.0 million bad debt expense for uncollected accounts due from
WorldCom as further described in note 11 in the accompanying Notes to
Consolidated Financial Statements.
Depreciation and Amortization
Depreciation and amortization expense increased 1.3% to $56.4 million in 2002.
The increase is primarily attributable to an increase of 15.1% to $55.6 million
in depreciation expense due to our $68.0 million investment in equipment and
facilities placed into service during 2001 for which a full year of depreciation
was recorded in 2002, and the $59.2 million investment in equipment and
facilities placed into service during 2002 for which a partial year of
depreciation will be recorded in 2002.
Partially offsetting the depreciation expense increase described above is the
discontinuation of amortization of Goodwill and Cable Certificates upon the
adoption of SFAS 142, "Goodwill and Other Intangible Assets" on
76
January 1, 2002, resulting in a decrease in 2002 amortization expense of
approximately $6.5 million as compared to 2001.
Other Expense, Net
Other expense, net of other income, increased 3.4% to $33.4 million in 2002. The
increase is primarily due to the following:
o A $3.2 million increase in deferred loan fee expense to $4.6 million
primarily due to the recognition of $2.3 million in unamortized deferred
loan fees upon refinancing our Senior Holdings Loan and Fiber Facility,
and
o Increased interest expense in November and December 2002 due to the
increased interest rate paid on our new Senior Facility starting November
1, 2002.
Partially offsetting these increases were decreased 2002 interest rates on our
Senior Holdings Loan and Fiber Facility through November 1, 2002.
Income Tax Expense
Income tax expense was $5.7 million in 2002 and $4.1 million in 2001. The
increase was due to increased net income before income taxes in 2002 as compared
to 2001. Our effective income tax rate decreased from 47.0% in 2001 to 45.9% in
2002 due to the effect of items that are nondeductible for income tax purposes.
At December 31, 2002, we have (1) tax net operating loss carryforwards of
approximately $191.2 million that will begin expiring in 2005 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 which would result in
additional income tax expense. We estimate that our effective income tax rate
for financial statement purposes will be 42% to 45% in 2003.
Year Ended December 31, 2001 ("2001") Compared To Year Ended December 31,
2000 ("2000").
Overview of Revenues and Cost of Sales and Services
Total revenues increased 22.1% from $292.6 million in 2000 to $357.3 million in
2001. Excluding the fiber optic cable capacity sale in 2001 as described in note
1(m) in the accompanying Notes to Consolidated Financial Statements, total
revenues increased 15.4%. All of our segments contributed to the increase in
total revenues.
Total cost of sales and services increased 16.8% to $139.8 million in 2001. As a
percentage of total revenues, total cost of sales and services decreased from
40.9% in 2000 to 39.1% in 2001. Excluding the 2001 fiber capacity sale, total
cost of sales and services as a percentage of total revenues decreased from
40.9% in 2000 to 36.1% in 2001. The cable services, local access services,
Internet services segments and All Other Services contributed to the increase in
total cost of sales and services, partially off-set by a decrease in cost of
sales and services in the long-distance services segment.
Long-distance Services Segment Revenues
Long-distance services segment revenues increased 9.9% to $200.7 million in
2001.
77
Message Telephone Service Revenue from Common Carrier Customers
Message telephone service revenues from other common carriers (principally
WorldCom and Sprint) increased 11.5% to $80.1 million in 2001 resulting from a
4.8% increase in wholesale minutes carried for other common carriers and a 6.5%
increase in the average rate per minute on minutes carried for other common
carriers. After excluding certain 2000 low-margin wholesale minutes no longer
carried for other common carriers, comparable wholesale minutes increased 23.5%
over the prior year. The increase in the average rate per minute is primarily
due to the discontinued carriage of certain low-margin wholesale minutes.
Message Telephone Service Revenue from Residential, Commercial and Governmental
Customers
Message telephone service revenues from residential, commercial, and
governmental customers decreased 9.7% in 2001 to $60.7 million primarily due to
the following:
o A 2.8% decrease in retail minutes carried for these customers to 344.2
million minutes,
o A 15.0% decrease in the average rate per minute to $0.130 per minute paid
by these customers due to our promotion of and customers' enrollment in
calling plans offering a certain number of minutes for a flat monthly
fee, and
o A 0.9% decrease in the number of active residential, commercial, and
governmental customers billed to 87,900 at December 31, 2001.
Revenue from Private Line and Private Network Customers
Private line and private network transmission services revenues increased 19.7%
to $34.7 million in 2001 due to an increased number of leased circuits in
service. The increase is partially off-set by the effect of a reclassification
of discounts recognized on revenue from certain private line and private network
customers. Through May 2001 these discounts totaled approximately $2.8 million
and off-set message telephone service revenue from residential, commercial and
governmental customers, beginning July 2001 these discounts off-set revenue from
private line and private network customers. If the discounts had been recognized
in revenue from private line and private network customers during all of 2001
the increase in revenue would be 10.0% to $34.7 million.
Revenue from Broadband Customers
Revenues from our packaged telecommunications offering to rural hospitals and
health clinics and our SchoolAccess(TM) offering to rural school districts
increased 82.7% to $15.7 million in 2001. The increase is primarily due to an
increase in circuits and services sold to rural hospitals and health clinics
from 51 circuits at December 31, 2000 to 74 circuits at December 31, 2001.
Long-distances Services Segment Cost of Sales and Services
Long-distance services segment cost of sales and services decreased 4.3% to
$73.3 million in 2001. Long-distance services segment cost of sales and services
as a percentage of long-distance services segment revenues decreased from 41.9%
in 2000 to 36.5% in 2001 primarily due to the following:
o Reduced satellite transponder cost of sales and services beginning April
2000 upon our acquiring owned satellite transponder capacity,
o Reductions in access costs due to distribution and termination of our
traffic on our own local access services network instead of paying other
carriers to distribute and terminate our traffic,
o The conclusion of a dispute with ACS which allowed us to reverse $2.0
million in accrued costs,
o A $450,000 non-recurring refund in 2001 from ACS in respect of its
earnings that exceeded regulatory requirements, and
o In the course of business we estimate unbilled long-distance services
cost of sales and services based upon minutes of use processed through
our network and established rates. Such estimates are revised when
subsequent billings are received, payments are made, billing matters are
researched and resolved, tariffed billing periods lapse, or when disputed
charges are resolved. In 2001 and 2000 we had unfavorable adjustments of
$2.8 million and $781,000, respectively. Excluding the unfavorable
adjustments, the long-distance services cost of sales and services as a
percentage of long-distance
78
services revenues was 41.5% and 35.1% in 2000 and 2001, respectively.
Cable Services Segment Revenues and Cost of Sales and Services
Cable services segment revenues increased 12.7% to $76.6 million in 2001 and
average gross revenue per average basic subscriber per month increased $3.87 or
7.9% in 2001. Programming services revenues increased 9.4% to $60.9 million in
2001 resulting from the following:
o Basic subscribers served increased approximately 11,600 to approximately
132,000 at December 31, 2001 as compared to December 31, 2000 (the 2001
increase includes approximately 1,000 basic subscribers acquired from
G.C. Cablevision, Inc. on March 31, 2001 and approximately 7,000 basic
subscribers acquired from Rogers on November 19, 2001),
o Rates charged to subscribers in most systems increased as of February
2001,
o New facility construction efforts in 2001 and the acquisition of GC
Cablevision, Inc. and Rogers subscribers resulted in approximately 14,800
additional homes passed, a 8.3% increase from 2000, and
o Digital subscriber counts increased 81.8% to approximately 24,600 at
December 31, 2001 as compared to December 31, 2000.
The cable services segment's share of cable modem revenue (offered through our
Internet services segment) increased $2.5 million to $4.9 million in 2001.
Cable services cost of sales and services increased 16.9% to $20.8 million in
2001. 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
26.2% in 2000 to 27.2% in 2001. Cable services rate increases did not keep pace
with increases in programming costs in 2001. Programming costs increased for
most of our cable services offerings, and we incurred additional costs on new
programming introduced in 2000 and 2001.
Revenues earned from equipment rental and installation, cable services'
allocable share of cable modem services and advertising sales do not have
corresponding costs of sales and services. The increase in cable services cost
of sales and services as a percentage of cable services revenues is partially
off-set by an increase in the percentage of cable services revenues earned from
equipment rental and installation, cable services' allocable share of cable
modem services and advertising sales from 17.9% in 2000 to 20.4% in 2001.
Local Access Services Segment Revenues and Cost of Sales and Services
Local access services segment revenues increased 24.9% in 2001 to $25.2 million
due to growth in the average number of customers served. At December 31, 2001
approximately 79,200 lines were in service as compared to approximately 62,100
lines in service at December 31, 2000.
Local access services cost of sales and services increased 30.4% to $14.0
million in 2001. Local access services cost of sales and services as a
percentage of local access services revenues increased from 53.3% in 2000 to
55.6% in 2001. The local access services cost of sales and services increase as
a percentage of local access services revenues is due to decreased network
access services revenues from other carriers as the number of customers
purchasing both long-distance and local access services from us increases. The
increases in local access services cost of sales and services as a percentage of
local access services revenues described above are partially off-set by
economies of scale and more efficient network utilization as local access
services revenues increase.
In Anchorage, 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 24.0% to approximately
$1.35 per line.
79
Internet Services Segment Revenues and Cost of Sales and Services
Internet services segment revenues increased 42.4% to $12.0 million in 2001
primarily due to growth in the average number of customers served. We had
approximately 69,900 Internet subscribers at December 31, 2001 as compared to
approximately 62,600 at December 31, 2000, of which approximately 26,500 are
cable modem subscribers at December 31, 2001 as compared to approximately 16,000
at December 31, 2000. Approximately 850 cable modem subscribers were acquired
from Rogers on November 19, 2001. Internet services allocable share of cable
modem revenues increased $3.0 million to $4.1 million in 2001 as compared to
2000.
Internet services cost of sales and services increased 8.2% to $4.7 million in
2001. Internet services costs of sales as a percentage of Internet services
revenues totaled 39.6% and 52.1% in 2001 and 2000, respectively. The Internet
services costs of sales decrease as a percentage of Internet services revenues
is primarily due to a $3.0 million increase in Internet's portion of cable modem
revenue that generally has higher margins than do other Internet 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 Internet services revenues.
All Other Revenues and Cost of Sales and Services
All Other revenues increased $29.4 million to $42.8 million in 2001 primarily
due to the $19.5 million fiber capacity sale in 2001, as described in note 1(m)
in the accompanying Notes to Consolidated Financial Statements, and increased
revenues from managed services to a certain customer and for management services
sold to Kanas through the six month period ended June 30, 2001.
All Other costs of sales and services increased approximately $16.8 million to
$26.9 million in 2001. The increase is primarily due to the $10.9 million in
cost of sale for the fiber system capacity sale in 2001, as described in note
1(o) in the accompanying Notes to Consolidated Financial Statements, and
increased costs associated with the sale of additional services to a certain
customer.
All Other costs of sales and services as a percentage of All Other revenues,
totaled 62.9% and 75.9% in 2001 and 2000, respectively. Excluding the 2001 fiber
system capacity sale, cost of sales and services as a percentage of revenues
totaled 68.9% and 75.9% in 2001 and 2000, respectively. The decrease is
primarily due to the provision of management services to Kanas without a
corresponding increase in cost of sales and services.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 16.6% to $116.5 million
in 2001 and, as a percentage of total revenues, decreased from 34.2% in 2000 to
32.6% in 2001. Excluding the fiber capacity sale in 2001, selling, general and
administrative expenses, as a percentage of total revenues, were 34.1% in 2001.
The increase in selling, general and administrative expenses in 2001 is due to
increased labor and health insurance costs, increased accrual of a company-wide
success sharing bonus, and incremental new costs to operate GFCC (see note 3 to
the accompanying Notes to Consolidated Financial Statements).
Marketing and advertising expenses as a percentage of total revenues decreased
from 4.0% in 2000 to 3.4% in 2001. Excluding the fiber capacity sale in 2001,
marketing and advertising expenses as a percentage of total revenues were 3.6%
in 2001.
Bad Debt Expense
Bad debt expense decreased 14.6% to $4.3 million in 2002 and, as a percentage of
total revenues, decreased from 1.7% in 2000 to 1.2% in 2001. Excluding revenues
from the fiber system capacity sale in 2001, bad debt expense as a percentage of
total revenues was 1.3% in 2001.
Depreciation and Amortization
Depreciation and amortization expense increased 9.9% to $55.7 million in 2001.
The increase is attributable to our $43.7 million investment in equipment and
facilities placed into service during 2000 for which a full
80
year of depreciation was recorded during the year ended December 31, 2001 and
the $68.0 million investment in equipment and facilities placed into service
during the year ended December 31, 2001 for which a partial year of depreciation
was recorded during 2001.
Other Expense, Net
Other expense, net of other income, decreased 17.1% to $32.3 million primarily
due to a 19.7% decrease in interest expense to $31.2 million in 2001. This
decrease resulted primarily from decreased interest rates in 2001 on our
variable rate debt, a $943,000 net interest benefit earned in 2001 from our two
interest rate swap agreements, decreased average outstanding long-term debt
balances during the first six months of 2001 and a charge of $2.0 million to
interest expense in 2000 to write-off previously capitalized interest expense.
Partially offsetting these decreases were an increase in average outstanding
indebtedness in the last six months of 2001 and an increase in our average
outstanding capital lease obligation balances in the last six months of 2000.
Income Tax (Expense) Benefit
Income tax (expense) benefit was ($4.1) million in 2001 and $8.4 million in
2000. The change was due to our generation of net income before income taxes in
2001 as compared to a net loss before income taxes in 2000. Our effective income
tax rate increased from 38.9% in 2000 to 47.0% in 2001 due to the effect of
items that are nondeductible for income tax purposes.
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 53,778 48,711 204,932
Cable services $ 21,346 21,919 22,057 23,366 88,688
Local access services $ 7,308 8,106 8,096 8,561 32,071
Internet services $ 3,573 3,912 3,927 4,172 15,584
All Other services $ 5,915 6,428 6,692 7,532 26,567
-------------------------------------------------------------
Total revenues $ 88,210 92,740 94,550 92,342 367,842
Operating income (1) $ 11,133 4,766 16,353 13,473 45,725
Net income (loss) before income taxes (1) $ 3,858 (1,686) 8,662 1,488 12,322
Net income (loss) (1) $ 2,212 (1,103) 5,063 491 6,663
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(Amounts in thousands)
-------------------------------------------------------------
First Second Third Fourth Total
Quarter Quarter Quarter Quarter Year
-------------------------------------------------------------
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) $ 13,385 8,759 10,540 8,291 40,975
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 and third quarters of 2002 include the provision of $9.7
million and $1.2 million, respectively, of bad debt expense for
estimated uncollectible accounts from WorldCom.
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.
-------------------
Overview of Revenues and Cost of Sales and Services
Total revenues for the quarter ended December 31, 2002 ("fourth quarter") were
$92.3 million, representing a 2.3% decrease from $94.6 million for the quarter
ended September 30, 2002 ("third quarter"). The long-distance services segment
contributed to the decrease in total revenues, partially off-set by an increase
in revenues from the cable services, local access services and Internet services
segments and All Other Services.
Cost of sales and services increased from $30.4 million in the third quarter to
$31.1 million in the fourth quarter. As a percentage of revenues, third and
fourth quarter cost of sales and services totaled 32.1% and 33.7%, respectively.
The cable services segment and All Other Services contributed to the increase in
total cost of sales and services, partially off-set by decreases in cost of
sales and services in the long-distance services, local access services and
Internet services segments.
Long-distance Services Segment Revenues and Cost of Sales and Services
In the fourth quarter long-distance services segment revenues decreased 9.4% to
$48.7 million. The decrease primarily resulted from a decrease in long-distance
services revenues from residential, commercial, governmental, and other common
carrier customers.
Revenues from other common carriers decreased 15.7% to $20.6 million primarily
due to the following:
o A decrease of approximately $1.6 million due to a loss of minutes carried
for other common carriers. The decline in revenues and minutes is due in
part to the substitution effects that are being experienced by other
common carriers including WorldCom and Sprint. In the past, these effects
on us were partially off-set by the strong growth in our wholesale other
common carrier traffic. During the fourth quarter of 2002, in addition to
expected seasonality, our wholesale other common carrier traffic was
affected by the weak lower 48 economy and changes in the carrier market,
o A 15.4% decrease in minutes carried for other common carriers to 189.9
million minutes,
o A 0.3% decrease in the average rate per minute on minutes carried for
other common carriers, and
o A $920,000 incentive credit provided to an other common carrier customer
in the fourth quarter of 2002.
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Revenues from residential, commercial, and governmental customers decreased
17.8% to $11.2 million primarily due to the following:
o A 7.4% decrease in the average rate per minute to $0.113 per minute paid
by residential, commercial and governmental customers, and
o A 2.5% decrease in retail minutes carried for residential, commercial and
governmental customers to 73.8 million minutes
Long-distance revenues 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.
Long-distance services cost of sales and services decreased 0.3% to $14.3
million in the fourth quarter. Long-distance services cost of sales and services
as a percentage of long-distance services revenues increased from 26.8% in third
quarter to 29.5% in fourth quarter primarily due to the following:
o The $920,000 incentive credit provided during the fourth quarter as
previously described,
o The effect of seasonality which resulted in a decrease in long-distance
service revenues in the fourth quarter with no corresponding decrease in
certain fixed cost of sales and services,
o Increased costs associated with additional transponder and network backup
capacity incurred in the fourth quarter, and
o Reduced revenues from WorldCom and Sprint of approximately $1.6 million
in the fourth quarter, as described above. Some of these revenues have a
lower cost of sales and services as a percentage of revenues as compared
to revenues from other traffic we carry.
Cable Services Segment Revenues and Cost of Sales and Services
Cable services segment revenues increased 5.9% to $23.4 million and average
gross revenue per average basic subscriber per month increased $3.16 or 5.7% in
fourth quarter. Programming services revenues increased 4.2% to $17.7 million in
fourth quarter resulting from the following:
o Basic subscribers served increased approximately 1,500 to approximately
136,100 at December 31, 2002 as compared to September 30, 2002,
o New facility construction efforts in 2002 resulted in approximately 1,000
additional homes passed, a 0.5% increase from September 30, 2002, and
o Digital subscriber counts increased 7.0% to approximately 30,500 at
December 31, 2002 as compared to September 30, 2002. Revenue from digital
subscribers increased approximately 13.5% or $240,000 from 2001 to 2002.
The increase in number of basic subscribers is attributed primarily to the
effects of normal seasonality.
Cable programming services revenues have historically been highest in the winter
months because consumers spend more time at home and tend to watch more
television during these months.
The cable services segment's share of cable modem revenue (offered through our
Internet services segment) increased $151,000 to $2.3 million in fourth quarter
due to an increased number of cable modems deployed.
Cable services cost of sales and services increased 2.6% to $5.9 million in
fourth quarter as compared to the third quarter. 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, decreased from 26.1% in the third quarter to 25.3% in the
fourth quarter. Equipment rental and installation, cable services' allocable
share of cable modem services and advertising sales revenues do not have
corresponding costs of sales and services. The decrease in cable services cost
of sales and services as a percentage of cable revenues is primarily due to an
increase in the percentage of cable revenues earned from equipment rental and
installation, cable services' allocable share of cable modem services, and
advertising
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sales revenues from 23.1% in third quarter to 24.4% in fourth quarter.
Increasing revenues from our new high value services are helping mitigate the
effect of increasing programming costs on our margins.
Local Access Services Segment Revenues and Cost of Sales and Services
Local access services segment revenues increased $465,000 in the fourth quarter
to $8.6 million primarily due to growth in the average number of customers
served. At December 31, 2002 an estimated 96,100 lines were in service as
compared to approximately 95,800 lines in service at September 30, 2002.
Local access services segment cost of sales and services decreased $90,000 to
$5.2 million in the fourth quarter. Local access services segment cost of sales
and services as a percentage of local access services segment revenues decreased
from 65.9% in the third quarter to 61.2% in the fourth quarter.
Internet Services Segment Revenues and Cost of Sales and Services
Internet services segment revenues increased $245,000 to $4.2 million in the
fourth quarter primarily due to growth in the number of customers served and the
number of cable modems deployed. We had approximately 71,700 Internet
subscribers at December 31, 2002 as compared to approximately 71,200 at
September 30, 2002, of which approximately 36,200 are cable modem subscribers at
December 31, 2002 as compared to approximately 33,000 at September 30, 2002. The
Internet services segment's allocable share of cable modem revenues increased
$118,000 to $1.8 million in the fourth quarter as compared to the third quarter.
Internet services cost of sales and services was $1.2 million in the third and
fourth quarters, and as a percentage of Internet services revenues, totaled
31.3% and 29.2% in the third and fourth quarters, respectively.
All Other Revenues and Costs of Sales and Services
All Other revenues increased $840,000 to $7.5 million in the fourth quarter
primarily due to the provision of additional services to and increased revenues
from a certain customer.
All Other costs of sales increased $713,000 to $4.4 million in the fourth
quarter, and as a percentage of All Other revenues, totaled 54.8% and 58.1% in
the third and fourth quarters, respectively.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $725,000 to $32.9 million
in the fourth quarter as compared to the third quarter. As a percentage of
revenues, fourth quarter selling, general and administrative expenses were 35.7%
as compared to 34.1% for the third quarter. The fourth quarter increase in
selling, general and administrative expenses as a percentage of revenues is
primarily due to increased labor costs.
Bad Debt Expense
Bad debt expense decreased $1.4 million to $250,000 in the fourth quarter as
compared to the third quarter. As a percentage of revenues, fourth quarter bad
debt expense was 0.3% as compared to 1.8% for the third quarter. The third
quarter included a $1.2 million bad debt expense for uncollected accounts due
from WorldCom; no additional bad debt expense for uncollected accounts due from
WorldCom was recognized in the fourth quarter.
Other Expense, Net
Other expense, net of other income, increased 55.8% to $12.0 million due to the
following:
o A 20.5% increase in interest expense to $9.0 million in the fourth
quarter as compared to the third quarter due to the increased interest
rate paid on our new Senior Facility starting November 1, 2002,
o Recognition of $2.3 million in unamortized deferred loan fees upon the
refinance of our Senior Holdings Loan and Fiber Facility on November 1,
2002, and
o Increased deferred loan fees from our Senior Facility starting November
1, 2002.
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Net Income
We reported net income of $491,000 for the fourth quarter as compared to net
income of $5.1 million for the third quarter. The decrease is primarily due to
seasonal and other decreases in revenues without a corresponding decrease in
cost of sales, and increased other expense, net of other income, in the fourth
quarter as previously described, partially off-set by decreased income tax
expense in the fourth quarter.
Liquidity and Capital Resources
Cash flows from operating activities totaled $74.5 million in 2002 as compared
to $79.9 million in 2001. 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 some of our segments. Uses of cash during 2002 include $65.1 million
of expenditures for property and equipment, including construction in progress,
principal payments of long-term borrowings and capital lease obligations of
$17.3 million and payment of $3.1 million in notes receivable issued to related
parties. Other sources of cash in 2002 include $14.8 million in long-term
borrowings and receipt of $946,000 in repayments of notes receivable issued to
related parties.
Net receivables decreased $4.2 million from December 31, 2001 to December 31,
2002 primarily due to decreases in trade receivables for broadband services
provided to hospitals and health clinics and telecommunication services provided
to other common carriers. The decrease in broadband trade receivables is due to
a payment received in 2002 from the federal government. The decrease in other
common carrier trade receivables is net of the allowance for amounts due from
WorldCom preceding their filing for Chapter 11 bankruptcy, and due to the timing
of payments received from a certain common carrier customer.
Working capital deficit totaled $450,000 at December 31, 2002, a $12.0 million
increase in working capital as compared to a deficit of ($12.4) million as of
December 31, 2001. The increase is primarily attributed to classification of
$5.7 million of our Senior Holdings Loan as current maturities of long-term debt
as of December 31, 2001. The Senior Holdings Loan and Fiber Facility were
subject to a refinancing agreement on November 1, 2002 as further described
below, resulting in the classification of all such debt as long-term at December
31, 2002.
On November 1, 2002 we closed our $225.0 million bank facility ("Senior
Facility") to refinance the Senior Holdings Loan and Fiber Facility. The Senior
Holdings Loan and Fiber Facility had balances of approximately $120.1 million
and $60.0 million, respectively, at November 1, 2002. The Senior Facility
includes a term loan of $175.0 million and a revolving credit facility of $50.0
million. The Senior Facility matures on November 1, 2004 and bears interest at
LIBOR plus 6.50%. We are required to pay a commitment fee equal to 1.5% per
annum on the unused portion of the commitment. If the unused revolver is more
than $25.0 million the commitment fee increases to 2.0% per annum on the unused
portion of the commitment. We recognized $116,000 in commitment fee expense
during the year ended December 31, 2002.
On November 30, 2003 we are required to prepay the term loan in an amount equal
to 50% of the amount by which earnings before interest, taxes, depreciation, and
amortization exceeds certain fixed charges as defined in the Senior Facility
agreement ("Excess Cash Flow") during the year ended September 30, 2003. On May
30, 2004 we are required to prepay the term loan in an amount equal to 50% of
the Excess Cash Flow during the six months ended March 31, 2004. The prepayment
required on November 30, 2003, if any, may be funded by a draw on the revolving
credit facility.
The Senior Facility contains, among others, covenants limiting additional
indebtedness and except for cash dividends on existing outstanding GCI preferred
stock, prohibits any direct or indirect distribution, dividend, redemption or
other payment to any person on account of any general or limited partnership
interest in, or shares of capital stock or other securities of GCI, Inc. and
subsidiaries. Under the Senior Facility we may not allow the:
o Ratio of total indebtedness to annualized operating cash flow to be
greater than 4.5:1,
85
o Ratio of senior secured indebtedness to annualized operating cash flow to
be greater than 2.25:1, and
o Ratio of annualized operating cash flow to total interest expense to be
less than 2.50:1.
Capital expenditures, other than those incurred to build additional fiber optic
cable system capacity, in any of the years ended September 30, 2003, March 31,
2004 and September 30, 2004 may not exceed:
o $25.0 million, plus
o 50% of any Excess Cash Flow during the applicable period less certain
permitted investments of up to $5.0 million during the applicable period.
The Senior Facility allows the issuance of up to $58 million of subordinated
debt, the proceeds of which could be used for the acquisition of backup fiber
facilities.
We expect our 2003 expenditures for property and equipment for our core
operations, including construction in progress, will total $40 million to $55
million.
$3.0 million of the Senior Facility has been used to provide a letter of credit
to secure payment of certain access charges associated with our provision of
telecommunications services within the State of Alaska.
The term loan is fully drawn and we have drawn $2.7 million against the
revolving credit facility plus a $3.0 million letter of credit, which leaves
$44.3 million available at December 31, 2002 to draw under the revolving credit
facility if needed. The new facility provides us the flexibility to continue to
pursue opportunities in the marketplace, however we are not planning to draw
down the facility as we expect to continue investing only a portion of what we
generate in cash flow in additional capital expenditures for our core business
operations.
In connection with the funding of the Senior Facility, we paid bank fees and
other expenses of approximately $7,141,000 during the year ended December 31,
2002 which will be charged to Deferred Loan Fee Expense over the life of the
agreement. We funded $6,809,000 of the bank fees and other expenses by a draw on
the Senior Facility.
On January 3, 2001 we entered into an interest rate swap agreement to convert
$50 million in 9.75% fixed rate to variable rate debt. This interest rate swap
agreement was called by the counter party at no cost and terminated on August 1,
2002.
Effective September 21, 2001, we entered into an interest rate swap agreement to
convert $25 million of variable interest rate debt equal to the 90 day LIBOR
rate plus 334 basis points to 3.98% fixed rate debt plus applicable margins.
Terms of the interest rate swap mirror the underlying variable rate debt, except
the interest rate swap terminates on September 21, 2004.
We were in compliance with all loan covenants at December 31, 2002.
Our semi-annual Senior Notes interest payment of $8.8 million was due February
1, 2003 and was paid in full at that time out of existing cash balances. Our
next Senior Notes interest payment of $8.8 million is due August 1, 2003.
Our expenditures for property and equipment, including construction in progress,
totaled $65.1 million and $65.6 million during 2002 and 2001, respectively. Our
capital expenditures requirements are largely success driven and are a result of
the progress we are making in the marketplace. We expect our 2003 expenditures
for property and equipment for our core operations, including construction in
progress, to total $40 million to $55 million, depending on available
opportunities and the amount of cash flow we generate during 2003. That number
excludes any investment we may make with respect to additional undersea fiber
capacity. Planned capital expenditures over the next five years include those
necessary for continued expansion of our
86
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 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. Unpaid balances due from WorldCom for services rendered
prior to their filing date total approximately $12.9 million at December 31,
2002, against which we have reserved $11.6 million. We believe that payment for
services provided to WorldCom subsequent to their bankruptcy filing date will
continue to be made timely, consistent with our status in WorldCom's filing as a
key service provider or utility to WorldCom.
A conversion of WorldCom's bankruptcy petition to Chapter 7, unfavorable
reaffirmation 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.
The long-distance, local access, cable, Internet and wireless services
industries continue to experience substantial competition, regulatory
uncertainty, and continuing technological changes. Our future results of
operations will be affected by our ability to react to changes in the
competitive and regulatory environment and by our ability to fund and implement
new or enhanced technologies. We are unable to determine how competition,
economic conditions, and regulatory 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 and to obtain new debt under
acceptable terms and conditions in the short-term and long-term may be
diminished as a result.
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, capital expenditures will likely
be reduced.
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 adopt this statement January 1, 2003. Upon adoption, we
expect to record a cumulative effect of approximately $910,000 as a decrease in
equity due to a change in accounting principle, and expect to record an asset
retirement obligation of approximately $1.6 million and capitalized costs of
approximately $650,000.
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
87
are part of restructuring activities. We will adopt this statement January 1,
2003 and do not expect it to have a material effect on our results of
operations, financial position and cash flows.
On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure". This Statement amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The transition provisions and annual statement disclosure requirements
of SFAS No. 148 have been adopted for the year ended December 31, 2002. The
interim statement disclosure requirements are effective for the first interim
statement that includes financial information after December 15, 2002. We have
elected to continue to apply the intrinsic-value method.
Critical Accounting Policies
Our accounting and reporting policies comply with accounting principles
generally accepted in the United States. The preparation of financial statements
in conformity with generally accepted accounting principles requires management
to make estimates and assumptions. The financial position and results of
operations can be affected by these estimates and assumptions, which are
integral to understanding reported results. Critical accounting policies are
those policies that management believes are the most important to the portrayal
of the Company's financial condition and results, and require management to make
estimates that are difficult, subjective or complex. Most accounting policies
are not considered by management to be critical accounting policies. Several
factors are considered in determining whether or not a policy is critical in the
preparation of financial statements. These factors include, among other things,
whether the estimates are significant to the financial statements, the nature of
the estimates, the ability to readily validate the estimates with other
information including third parties or available prices, and sensitivity of the
estimates to changes in economic conditions and whether alternative accounting
methods may be utilized under generally accepted accounting principles. For all
of these policies, management cautions that future events rarely develop exactly
as forecast, and the best estimates routinely require adjustment. Management has
discussed the development and the selection of critical accounting policies with
the GCI's Audit Committee.
Those policies considered to be critical accounting policies for the year ended
December 31, 2002 are described below.
o 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,
financial health of specific customers, and our historical write-off
experience, net of recoveries. If the financial condition of our
customers were to deteriorate or if they are unable to emerge from
reorganization proceedings, resulting in an impairment of their ability
to make payments, additional allowances may be required. If their
financial condition improves or they emerge successfully from
reorganization proceedings, allowances may be reduced. Such allowance
changes could have a material effect on our consolidated financial
condition and results of operations. Refer to Note 11 in the accompanying
Notes to Consolidated Financial Statements for additional information
regarding our provision of a $11.6 million allowance for WorldCom
receivable balances.
o We record all assets and liabilities acquired in purchase acquisitions,
including goodwill and other intangibles, at fair value as required by
SFAS 141. Goodwill and indefinite-lived assets such as our cable segment
franchise agreements are no longer amortized but are subject, at a
minimum, to annual tests for impairment. Other intangible assets are
amortized over their estimated useful lives using the straight-line
method, and are subject to impairment if events or circumstances indicate
a possible inability to realize the carrying amount. The initial goodwill
and other intangibles recorded and subsequent impairment analysis
requires management to make subjective judgments concerning estimates of
how the acquired asset will perform in the future using a discounted cash
flow analysis. Additionally, estimated cash flows may extend beyond ten
years and, by their nature, are difficult to
88
determine over an extended timeframe. Events and factors that may
significantly affect the estimates include, among others, competitive
forces, customer behaviors and attrition, changes in revenue growth
trends, cost structures and technology, and changes in discount rates,
performance compared to peers, material and ongoing negative economic
trends, and specific industry or market sector conditions. In determining
the reasonableness of cash flow estimates, we review historical
performance of the underlying asset or similar assets in an effort to
improve assumptions utilized in our estimates. In assessing the fair
value of reportable operating segments, we may consider other information
to validate the reasonableness of our valuations including public market
comparables, multiples of recent mergers and acquisitions of similar
businesses and third-party assessments. These evaluations could result in
a change in useful lives in future periods and could result in write-down
of the value of intangible assets. Because of the significance of the
identified intangible assets and goodwill to our consolidated balance
sheet, the annual impairment analysis will be critical. Any changes in
key assumptions about the business and its prospects, or changes in
market conditions or other externalities, could result in an impairment
charge and such a charge could have a material adverse effect on our
consolidated financial condition and results of operations. Refer to Note
4 in the accompanying Notes to Consolidated Financial Statements for
additional information regarding intangible assets.
o We estimate unbilled long-distance segment cost of sales based upon
minutes of use carried through our network and established rates. We
estimate unbilled costs for new circuits and services, and when network
changes occur that result in traffic routing changes or a change in
carriers. Carriers that provide service to us regularly change their
networks which can lead to new, revised or corrected billings. Such
estimates are revised or removed when subsequent billings are received,
payments are made, billing matters are researched and resolved, tariffed
billing periods lapse, or when disputed charges are resolved. Revisions
to previous estimates could either increase or decrease costs in the year
in which the estimate is revised which could have a material effect on
our consolidated financial condition and results of operations.
o Our income tax policy provides for deferred income taxes to show the
effect of temporary differences between the recognition of revenue and
expenses for financial and income tax reporting purposes and between the
tax basis of assets and liabilities and their reported amounts in the
financial statements in accordance with SFAS No. 109, "Accounting for
Income Taxes." We have recorded deferred tax assets of approximately
$76.9 million associated with income tax net operating losses that were
generated from 1980 to 2002, and that expire from 2005 to 2022.
Pre-acquisition income tax net operating losses associated with acquired
companies are subject to additional deductibility limits. We have
recorded deferred tax assets of approximately $1.9 million associated
with alternative minimum tax credits that do not expire. Significant
management judgment is required in developing our provision for income
taxes, including the determination of deferred tax assets and liabilities
and any valuation allowances that may be required against the deferred
tax assets. In conjunction with certain 1996 acquisitions, we determined
that approximately $20 million of the acquired net operating losses would
not be utilized for income tax purposes, and elected with our December
31, 1996 income tax returns to forego utilization of such acquired
losses. Deferred tax assets were not recorded associated with the
foregone losses and, accordingly, no valuation allowance was provided. We
have not recorded a valuation allowance on the deferred tax assets as of
December 31, 2002 based on management's belief that future reversals of
existing taxable temporary differences and estimated future taxable
income exclusive of reversing temporary differences and carryforwards,
will, more likely than not, be sufficient to realize the benefit of these
assets over time. In the event that actual results differ from these
estimates or if our historical trends change, we may be required to
record a valuation allowance on deferred tax assets, which could have a
material adverse effect on our consolidated financial condition and
results of operations. Refer to Note 7 in the accompanying Notes to
Consolidated Financial Statements for additional information regarding
income taxes.
Other significant accounting policies, not involving the same level of
measurement uncertainties as those discussed above, are nevertheless important
to an understanding of the financial statements. Polices related to revenue
recognition (including fiber sales transactions) and financial instruments
require difficult judgments
89
on complex matters that are often subject to multiple sources of authoritative
guidance. Certain of these matters are among topics currently under
reexamination by accounting standards setters and regulators. Although no
specific conclusions reached by these standard setters appear likely to cause a
material change in our accounting policies, outcomes cannot be predicted with
confidence. Significant accounting policies are discussed in Note 1 in the
accompanying Notes to Consolidated Financial Statements.
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 2002 the State's preliminary actual
results indicate that Alaska's oil revenues and federal funding supplied 47% and
44%, respectively, of the state's total revenues. All of the federal funding is
dedicated for specific purposes, leaving oil revenues as the primary funding
source of general operating expenditures. In fiscal 2003 state economists
forecast that Alaska's federal funding and oil revenues will supply 44% and 35%,
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
1.003 million barrels produced per day in fiscal 2002. The state forecasts the
production of 0.994 million barrels per day in fiscal 2003, and a production
rate slightly above 1.0 million barrels per day starting in fiscal 2008. The
state attributes the production rate increase to future development of recent
discoveries in the National Petroleum Reserve Alaska and other new fields.
Market prices for North Slope oil averaged $21.78 in fiscal 2002 and are
forecasted to average $25.94 in fiscal 2003. State economists forecast the
average price of North Slope oil to decline to $23.25 in fiscal 2004. The
closing price per barrel was $35.61 on February 25, 2003. The state's forecasted
2003 average oil price assumes there will not be a war with Iraq. If there is a
war, the state expects oil prices to increase to over $30 per barrel in 2003
with a price decrease after a war, as Iraq may increase its own oil production
to raise needed cash to rebuild the country. To the extent that actual oil
prices vary materially from the state's projected prices the state's projected
revenues and deficits will change. Every $1 change in the price of oil results
in a $50.0 to $60.0 million change in the state's revenue. 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 2005. The
date the Constitutional Budget Reserve Fund is depleted is highly influenced by
the price of oil. 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. The governor submitted a
budget proposal to the Alaska Legislature on March 5, 2003 that includes a
number of cost reductions totaling over $189 million, and proposes increased
revenues totaling over $100 million through, among other things, increased user
fees, license fees, motor fuel tax, gaming fees, and filing fees.
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. The
Governor has proposed legislation to the Alaska Legislature requesting that the
RCA be extended for an additional four years.
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 $2.3 billion are
90
expected to be distributed to the State of Alaska for highways and other
federally supported projects in fiscal 2003.
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 ("ANWR"). The U.S. Energy Information Agency
estimates it could take nine years to begin oil field drilling 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 Conoco Phillips, Alaska's large natural gas owners,
believe either natural gas pipeline makes financial sense based upon their
preliminary analysis, though BP and Conoco Phillips have proposed certain
federal income tax incentives that would take effect if the price for Alaska
natural gas goes below a certain level. 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, among other
items, federal tax incentives for a natural gas pipeline from the North Slope to
the Lower 48. This energy bill lapsed during the subsequent congressional
adjournment.
Development of the ballistic missile defense system project may have a
significant impact on Alaskan telecommunication requirements and the Alaska
economy. The proposed system would be a fixed, land-based, non-nuclear missile
defense system with a land and space based detection system capable of
responding to limited strategic ballistic missile threats to the United States.
The preferred alternative is deployment of a system with up to 100 ground-based
interceptor silos and battle management command and control facilities at Fort
Greely, Alaska; and an X-Band Radar at Eareckson Air Station on Shemya Island,
Alaska.
The U.S. Army Corps of Engineers awarded a construction contract in 2002 for
test bed facilities. The contract is reported to contain basic requirements and
various options that could amount to $250 million in construction, or possibly
more, if all items are executed. Site preparation has been underway at Fort
Greely since August of 2001 and construction began on the Fort Greely test bed
shortly after the June 15, 2002 groundbreaking. The test bed is due to be
operational by September 30, 2004.
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
644,000 people. The State of Alaska's population is distributed as follows:
o 42% are located in the Municipality of Anchorage,
o 13% are located in the Fairbanks North Star Borough,
o 10% are located in the Matanuska-Susitna Borough, and
o 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
91
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.
Off-Balance Sheet Arrangements
We have not created, and are not party to, any special-purpose or off-balance
sheet entities for the purpose of raising capital, incurring debt or operating
parts of our business that are not consolidated into our financial statements.
We do not have any arrangements or relationships with entities that are not
consolidated into our financial statements that are reasonably likely to
materially affect our liquidity or the availability of our capital resources.
Schedule of Certain Contractual Obligations
The following table details future projected payments associated with our
significant contractual obligations as of December 31, 2002 (amounts in
thousands).
Payments Due by Period
--------------------------------------------------------
Less than 1 to 3 4 to 5 More Than
Total 1 Year Years Years 5 Years
---------- ----------- --------- ------------ ----------
Long-term debt $ 357,700 --- 177,700 180,000 ---
Interest on long-term debt 87,750 17,550 35,100 35,100 ---
Capital lease obligations, including
interest 68,943 5,115 19,845 18,536 25,447
Operating lease commitments 67,673 11,780 18,607 12,878 24,408
---------- ----------- --------- ------------ ----------
Total contractual obligations $ 582,066 34,445 251,252 246,514 49,855
========== =========== ========= ============ ==========
For long-term debt included in the above table, we have included principal
payments on our Senior Facility and our Senior Notes. Interest on amounts
outstanding under our Senior Facility is based on variable rates and therefore
the amount is not determinable. Our Senior Notes require semi-annual interest
payments of approximately $8.78 million through 2007. For a discussion of our
long-term debt, see note 6 to the Notes to Consolidated Financial Statements
included in Part II of this Report.
For a discussion of our capital and operating leases, see note 12 to the Notes
to Consolidated Financial Statements included in Part II of this Report.
Regulatory Developments
You should read Part I, Item 1 Business, Regulation, Franchise Authorizations
and Tariffs for more information about regulatory developments affecting us.
Inflation
We do not believe that inflation has a significant effect on our operations.
Audit Committee
GCI's Audit Committee, composed entirely of outside directors, meets
periodically with our independent auditors and management to review the
Company's financial statements and the results of audit activities.
92
The Audit Committee, in turn, reports to the GCI Board of Directors on the
results of its review and recommends the selection of independent auditors.
The Audit Committee has approved the independent auditor to provide the
following services:
o Audit (audit of financial statements filed with the SEC, quarterly
reviews, comfort letters, consents, review of registration statements,
accounting consultations); and
o Audit-related (employee benefit plan audits and accounting consultation
on proposed transactions).
Item 7A. 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 new Senior Facility carries interest rate risk. Amounts borrowed under this
Agreement bear interest at Libor plus 6.5%. Should the Libor rate change, our
interest expense will increase or decrease accordingly. On September 21, 2001,
we entered into an interest rate swap agreement to convert $25.0 million of
variable interest rate debt to 3.98% fixed rate debt plus applicable margin. As
of December 31, 2002, we have borrowed $177.7 million of which $152.7 million
subject to interest rate risk. On this amount, a 1% increase in the interest
rate would cost us $1,527,000 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 December 31, 2002, we have borrowed $44.9 million subject to interest rate
risk. On this amount, a 1% increase in the interest rate would cost us $449,000
in additional gross interest cost on an annualized basis.
Item 8. Consolidated Financial Statements and Supplementary Data
Our consolidated financial statements are filed under this Item, beginning on
Page 96. The financial statement schedules required under Regulation S-X are
filed pursuant to Item 14 of this Report.
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
Part III
Items 10, 11, 12 and 13 are omitted per General Instruction J(1)(a) and (b) of
Form 10-K..
93
Item 14. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Within the 90 days prior to the date of this report, we carried out an
evaluation of the effectiveness of the design and operation of our "disclosure
controls and procedures" (as defined in the Securities Exchange Act of 1934
("Exchange Act") Rules 13a-14(c) and 15d-14(c)) under the supervision and with
the participation of our management, including our Chief Executive Officer and
our Chief Financial Officer. Based upon that evaluation, our Chief Executive
Officer and our Chief Financial Officer concluded that our disclosure controls
and procedures are effective.
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in our reports
filed or submitted under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed in our
reports filed under the Exchange Act is accumulated and communicated to
management to allow timely decisions regarding required disclosure.
Changes in Internal Controls
There were no significant changes in our internal controls or, to our knowledge,
in other factors that could significantly affect our disclosure controls and
procedures subsequent to the date we carried out this evaluation.
We may enhance, modify, and supplement internal controls and disclosure controls
and procedures based on experience.
94
Part IV
Item 15. Exhibits, Consolidated Financial Statement Schedules, and Reports on Form 8-K
(a)(l) Consolidated Financial Statements Page No.
--------
Included in Part II of this Report:
Independent Auditors' Report..............................................................96
Consolidated Balance Sheets, December 31, 2002 and 2001...................................97 -- 98
Consolidated Statements of Operations,
Years ended December 31, 2002, 2001 and 2000...........................................99
Consolidated Statements of Stockholder's Equity,
Years ended December 31, 2002, 2001 and 2000...........................................100
Consolidated Statements of Cash Flows,
Years ended December 31, 2002, 2001 and 2000...........................................101
Notes to Consolidated Financial Statements................................................102 -- 132
(a)(2) Consolidated Financial Statement Schedules
Included in Part IV of this Report:
Independent Auditors' Report..............................................................138
Schedule VIII - Valuation and Qualifying Accounts,
Years ended December 31, 2002, 2001 and 2000...........................................139
(b) Exhibits...........................................................................................133
Other schedules are omitted, as they are not required or are not
applicable, or the required information is shown in the applicable
financial statements or notes thereto.
95
INDEPENDENT AUDITORS' REPORT
The Board of Directors
GCI, Inc.:
We have audited the accompanying consolidated balance sheets of GCI, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of operations, stockholder's equity and cash flows for each of the
years in the three-year period ended December 31, 2002. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of GCI, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2002 in conformity with accounting principles generally
accepted in the United States of America.
/s/
KPMG LLP
Anchorage, Alaska
February 26, 2003
96
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS 2002 2001
- ------------------------------------------------------------------------------------------- ----------- ------------
(Amounts in thousands)
Current assets:
Cash and cash equivalents $ 11,940 11,097
----------- -----------
Receivables:
Trade 63,111 58,895
Employee 391 358
Other 3,093 1,678
----------- -----------
66,595 60,931
Less allowance for doubtful receivables 14,010 4,166
----------- -----------
Net receivables 52,585 56,765
----------- -----------
Prepaid and other current assets 9,171 3,061
Deferred income taxes, net 8,509 4,690
Property held for sale 1,037 481
Notes receivable from related parties 697 182
Inventories 400 542
----------- -----------
Total current assets 84,339 76,818
----------- -----------
Property and equipment in service, at cost:
Land and buildings 2,982 3,116
Telephony distribution systems 344,566 335,238
Cable television distribution systems 149,415 134,697
Support equipment 39,807 46,013
Transportation equipment 5,687 4,890
Property and equipment under capital leases 51,770 50,771
----------- -----------
594,227 574,725
Less accumulated depreciation 212,833 178,838
----------- -----------
Net property and equipment in service 381,394 395,887
Construction in progress 16,958 11,041
----------- -----------
Net property and equipment 398,352 406,928
----------- -----------
Cable certificates, net of amortization of $26,884,000 at December 31, 2002 and 2001 191,132 191,132
Goodwill, net of amortization of $7,200,000 at December 31, 2002 and 2001 41,972 40,940
Other intangible assets, net of amortization of $1,807,000 and $1,252,000 at December 31,
2002 and 2001, respectively 2,689 3,387
Deferred loan and senior notes costs, net of amortization of $4,110,000 and $5,568,000 at
December 31, 2002 and 2001, respectively 9,961 7,630
Notes receivable from related parties 5,142 3,246
Other assets, at cost, net of amortization of $65,000 and $70,000 at December
31, 2002 and 2001, respectively 5,195 4,598
----------- -----------
Total other assets 256,091 250,933
----------- -----------
Total assets $ 738,782 734,679
=========== ===========
See accompanying notes to consolidated financial statements.
97 (Continued)
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Continued)
December 31,
LIABILITIES AND STOCKHOLDER'S EQUITY 2002 2001
- ------------------------------------------------------------------------------------------- ------------ -----------
(Amounts in thousands)
Current liabilities:
Current maturities of long-term debt and obligations under capital leases $ 1,857 7,346
Accounts payable 33,605 36,464
Deferred revenue 18,290 11,129
Accrued payroll and payroll related obligations 11,821 15,289
Accrued interest 7,938 8,049
Accrued liabilities 5,522 4,697
Due to related party 4,871 5,160
Subscriber deposits 889 1,121
----------- -----------
Total current liabilities 84,793 89,255
Long-term debt, excluding current maturities 357,700 346,000
Obligations under capital leases, excluding current maturities 44,072 44,933
Obligation under capital lease due to related party, excluding current maturities 703 703
Deferred income taxes, net of deferred income tax benefit 16,061 25,069
Other liabilities 4,956 4,339
----------- -----------
Total liabilities 508,285 510,299
----------- -----------
Stockholder's equity:
Class A common stock. Authorized 10,000 shares; issued 100 shares at December 31,
2002 and 2001 206,622 206,622
Paid-in capital 44,904 44,902
Retained deficit (20,489) (27,152)
Accumulated other comprehensive income (loss) (540) 8
----------- -----------
Total stockholder's equity 230,497 224,380
----------- -----------
Commitments and contingencies
Total liabilities and stockholder's equity $ 738,782 734,679
=========== ===========
See accompanying notes to consolidated financial statements.
98
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2002, 2001 and 2000
2002 2001 2000
------------- ------------ -------------
(Amounts in thousands)
Revenues $ 367,842 357,258 292,605
Cost of sales and services 123,564 139,793 119,712
Selling, general and administrative expenses 129,029 116,536 99,908
Bad debt expense 13,124 4,279 5,010
Depreciation and amortization expense 56,400 55,675 50,655
------------- ------------ -------------
Operating income 45,725 40,975 17,320
------------- ------------ -------------
Other income (expense):
Interest expense (29,316) (31,208) (38,845)
Deferred loan and senior notes fee expense (4,612) (1,402) (1,317)
Interest income 525 294 702
Gain on sale of property and equipment --- --- 491
------------- ------------ -------------
Other expense, net (33,403) (32,316) (38,969)
------------- ------------ -------------
Net income (loss) before income taxes 12,322 8,659 (21,649)
Income tax (expense) benefit (5,659) (4,070) 8,415
------------- ------------ -------------
Net income (loss) $ 6,663 4,589 (13,234)
============= ============ =============
See accompanying notes to consolidated financial statements.
99
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Shares of Accumulated
Class A Class A Other
Common Common Paid-in Retained Comprehensive
(Amounts in thousands) Stock Stock Capital Deficit Income (Loss) Total
-----------------------------------------------------------------------------
Balances at December 31, 1999 100 $206,622 25,503 (18,507) --- 213,618
Net loss --- --- --- (13,234) --- (13,234)
Contribution from General Communication, Inc. --- --- 4,438 --- --- 4,438
-----------------------------------------------------------------------------
Balances at December 31, 2000 100 206,622 29,941 (31,741) --- 204,822
Components of comprehensive income:
Net income --- --- --- 4,589 --- 4,589
Fair value of cash flow hedge, net of income tax
benefit of $5 --- --- --- --- 8 8
-----------
Comprehensive income 4,597
Contribution from General Communication, Inc. --- --- 14,961 --- --- 14,961
-----------------------------------------------------------------------------
Balances at December 31, 2001 100 $206,622 44,902 (27,152) 8 224,380
Components of comprehensive income:
Net income --- --- --- 6,663 --- 6,663
Fair value of cash flow hedge, net of income tax
liability of $459 --- --- --- --- (548) (548)
-----------
Comprehensive income 6,115
Contribution from General Communication, Inc. --- --- 2 --- --- 2
-----------------------------------------------------------------------------
Balances at December 31, 2002 100 $206,622 44,904 (20,489) (540) 230,497
=============================================================================
See accompanying notes to consolidated financial statements.
100
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---------- --------- ---------
(Amounts in thousands)
Cash flows from operating activities:
Net income (loss) $ 6,663 4,589 (13,234)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation and amortization 56,400 55,675 50,655
Amortization charged to selling, general and administrative expense --- --- 554
Deferred loan cost expense 4,612 1,402 1,317
Non-cash cost of sales --- 10,877 ---
Deferred income tax expense (benefit) 5,754 3,958 (8,415)
Deferred compensation and compensatory stock options 978 1,191 982
Bad debt expense, net of write-offs 9,844 1,294 983
Employee Stock Purchase Plan expense funded with issuance of General
Communication, Inc. Class A common stock 791 --- 2,773
Write-off of capitalized interest --- 170 1,955
Gain on sale of property and equipment --- --- (491)
Other noncash income and expense items 90 (44) 356
Change in operating assets and liabilities (10,654) 815 5,919
---------- --------- ---------
Net cash provided by operating activities 74,478 79,927 43,354
---------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment, including construction period interest (65,140) (65,638) (50,873)
Proceeds from sale of property and equipment --- --- 802
Acquisition of Rogers net of cash received --- (18,533) ---
Advances and billings to Kanas --- (5,404) ---
(Payment) refund of deposit --- (1,200) 9,100
Purchases of other assets and intangible assets (1,657) (1,096) (2,957)
Payments received on notes receivable from related parties 946 1,065 455
Notes receivable issued to related parties (3,055) (959) (971)
Purchases of and additions to property held for sale (38) (101) (1,550)
---------- --------- ---------
Net cash used in investing activities (68,944) (91,866) (45,994)
---------- --------- ---------
Cash flows from financing activities:
Long-term borrowings - bank debt 14,766 29,000 5,000
Repayments of long-term borrowings and capital lease obligations (17,279) (13,667) (11,151)
Cash contribution from (to) General Communication, Inc. (1,826) 2,370 1,654
Payment of debt issuance costs (352) (629) (635)
---------- --------- ---------
Net cash provided by (used in) financing activities (4,691) 17,074 (5,132)
---------- --------- ---------
Net increase (decrease) in cash and cash equivalents 843 5,135 (7,772)
Cash and cash equivalents at beginning of year 11,097 5,962 13,734
---------- --------- ---------
Cash and cash equivalents at end of year $ 11,940 11,097 5,962
========== ========= =========
See accompanying notes to consolidated financial statements.
101
GCI, INC.
Notes to Consolidated Financial Statements
(l) Business and Summary of Significant Accounting Principles
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:
o Long-distance telephone service between Anchorage, Fairbanks,
Juneau, and other communities in Alaska and the remaining
United States and foreign countries
o Cable television services throughout Alaska
o Facilities-based competitive local access services in
Anchorage, Fairbanks and Juneau, Alaska
o Internet access services
o Termination of traffic in Alaska for certain common carriers
o Private line and private network services
o Managed services to certain commercial customers
o Broadband services, including our SchoolAccess(TM) offering to
rural school districts and a similar offering to rural
hospitals and health clinics
o Sales and service of dedicated communications systems and
related equipment
o 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 consolidated financial statements include the accounts of GCI,
Inc., GCI, Inc.'s subsidiary GCI Holdings, Inc. ("Holdings"), GCI
Holdings, Inc.'s subsidiaries GCI Communication Corp., GCI Cable,
Inc., GCI Transport Co., Inc., GCI Fiber Communication Co., Inc.
("GFCC," formerly known as Kanas Telecom, Inc. ("Kanas")), GCI
Fiber Co., Inc. and Fiber Hold Co., Inc. and GCI Fiber Co., Inc.'s
and Fiber Hold Co., Inc.'s partnership Alaska United Fiber System
Partnership ("Alaska United"), GCI Communication Corp.'s subsidiary
Potter View Development Co., Inc., GCI Cable, Inc.'s subsidiary GCI
American Cablesystems, Inc., GCI American Cablesystems, Inc.'s
subsidiary GCI Cablesystems of Alaska, Inc., and GCI Transport Co.,
Inc.'s subsidiary GCI Satellite Co., Inc. All subsidiaries are
wholly-owned at December 31, 2002.
Effective January 1, 2003 GCI American Cablesystems, Inc. and GCI
American Cablesystems, Inc.'s subsidiary GCI Cablesystems of
Alaska, Inc. were merged with GCI Cable, Inc.
The consolidated financial statements include the consolidated
accounts of GCI, Inc. and its wholly owned subsidiaries with all
significant intercompany transactions eliminated.
(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) Cash and Cash Equivalents
Cash equivalents consist of short-term, highly liquid investments
that are readily convertible into cash.
102 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(e) Inventories
Inventory of merchandise for resale and parts is stated at the
lower of cost or market. Cost is determined using the average cost
method.
(f) Property and Equipment
Property and equipment is stated at cost. Construction costs of
facilities are capitalized. Equipment financed under capital leases
is recorded at the lower of fair market value or the present value
of future minimum lease payments. Construction in progress
represents distribution systems and support equipment not placed in
service on December 31, 2002; management intends to place this
equipment in service during 2003 and 2004.
Depreciation is computed on a straight-line basis based upon the
shorter of the estimated useful lives of the assets or the lease
term, if applicable, in the following ranges:
Asset Category Asset Lives
------------------------------------------- -----------
Telephony distribution and fiber optic
cable systems 10-20 years
Cable television distribution systems 10 years
Support equipment 3-5 years
Transportation equipment 5-10 years
Property and equipment under capital leases 5-15 years
Repairs and maintenance are charged to expense as incurred.
Expenditures for major renewals and betterments are capitalized.
Gains or losses are recognized at the time of retirements, sales or
other dispositions of property.
(g) Intangible Assets
Effective January 1, 2002, we adopted Statement of Financial
Accounting Standard ("SFAS") No. 142, "Goodwill and Other
Intangible Assets." Cable certificates (certificates of convenience
and public necessity) represent certain perpetual operating rights
to provide cable services and were amortized on a straight-line
basis over 20 to 40 years in the years ended December 31, 2001 and
2000. Goodwill represents the excess of cost over fair value of net
assets acquired and was amortized on a straight-line basis over
periods of 10 to 40 years in the years ended December 31, 2001 and
2000. We have not recognized amortization expense for Cable
certificates or goodwill in the year ended December 31, 2002.
Cable certificates and goodwill are tested for impairment annually.
As of January 1, 2002 and December 31, 2002 cable certificates and
goodwill were tested for impairment by comparing the fair values to
the carrying amounts of the intangible assets. The fair values were
greater than the carrying amounts, therefore these intangible
assets were determined not to be impaired at December 31, 2002. The
remaining useful lives of our Cable certificates and goodwill were
evaluated as of December 31, 2002 and events and circumstances
continue to support an indefinite useful life.
Intangible assets are recorded at unamortized cost. Management
reviews the valuation and amortization of amortizable intangible
assets on a periodic basis, taking into consideration any events or
circumstances that might indicate diminished value. The assessment
of recoverability is based on whether the asset can be recovered
through undiscounted future cash flows.
The cost of our Personal Communication Services license and related
financing costs were capitalized as an amortizable intangible
asset. The associated assets were placed into service during 2000
and the recorded cost of the license and related financing costs
are being amortized over a 40-year period using
103 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
the straight-line method. All other amortizable intangible assets
are being amortized over 2-10 year periods using the straight-line
method.
(h) Deferred Loan and Senior Notes Costs
Debt and Senior Notes issuance costs are deferred and amortized
using the straight-line method, which approximates the interest
method, over the term of the related debt and notes. Amortization
costs are reported as a component of Other Income (Expense) in the
Consolidated Statements of Operations.
(i) Other Assets
Other Assets are recorded at cost and are amortized on a
straight-line basis over periods of 2-15 years. Other Assets
primarily include long-term deposits, non-trade accounts receivable
and prepaid expenses.
(j) Accounting for Derivative Instruments and Hedging Activities
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", as amended requires companies to record derivatives on
the balance sheet as assets or liabilities, measured at fair value.
We have adopted the provisions of SFAS No. 133. Our only derivative
activity relates to interest rate swaps (see note 10).
(k) Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income" requires us to
report and display comprehensive income or (loss) and its
components in a financial statement that is displayed with the same
prominence as other financial statements. During the years ended
December 31, 2002 and 2001 we had other comprehensive income (loss)
of approximately ($548,000) and $8,000, respectively, as a result
of the cash flow hedge discussed in note 10. Total comprehensive
income at December 31, 2002 and 2001 is $6,115,000 and $4,597,000,
respectively. There were no components of other comprehensive
income (loss) during the year ended December 31, 2000.
(l) Revenue Recognition
All revenues are recognized when the earnings process is complete
in accordance with Securities and Exchange Commission ("SEC") Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements." Revenues generated from long-distance and managed
services are recognized when the services are provided. Revenues
from the sale of equipment are recognized at the time the equipment
is delivered or installed. Technical services revenues are derived
primarily from maintenance contracts on equipment and are
recognized on a prorated basis over the term of the contracts.
Cable television service, local access service, Internet service
and private line telecommunication revenues are billed in advance,
recorded as Deferred Revenue on the balance sheet, and are
recognized as the associated service is provided. Revenues from
yellow-page directories are recognized upon publication of
directories, which typically corresponds with distribution and is
when the earnings process is complete. Other revenues are
recognized when the service is provided. We recognize unbilled
revenues when the service is provided based upon minutes of use
processed or established rates, net of credits and adjustments.
(m) 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 capacity sale") in a cash transaction. The
sale included both capacity within Alaska, and between Alaska and
the contiguous 48 states. We used the proceeds from the fiber
capacity sale to repay $11.7 million of the Fiber Facility debt and
to fund capital expenditures and working capital.
The fiber capacity sale was pursuant to a contract giving the
purchaser an indefeasible right to use a certain amount of fiber
system capacity expiring 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
104 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
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 SFAS No. 66, "Accounting for Sales of Real
Estate" we accounted for the fiber capacity sale as a sales-type
lease. We recognized $19.5 million in revenue from the fiber
capacity sale. We recognized $10.9 million as cost of sales during
the year ended December 31, 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 capacity, if any, over the term
the capacity is provided.
(n) Advertising Expense
We expense advertising costs in the fiscal year during which the
first advertisement appears. Advertising expenses were
approximately $2,967,000, $3,168,000 and $3,438,000 for the years
ended December 31, 2002, 2001 and 2000, respectively.
(o) Interest Expense
Interest costs incurred during the construction period of
significant capital projects, such as the construction of an
undersea fiber optic cable system, are capitalized. No interest was
capitalized during the years ended December 31, 2002, 2001 and
2000.
(p) Income Taxes
Income taxes are accounted for using the asset and liability
method. Deferred tax assets and liabilities are recognized for
their future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply
to taxable earnings in the years in which those temporary
differences are expected to be recovered or settled. Deferred tax
assets are recognized to the extent that the benefits are more
likely to be realized than not. GCI, Inc. and its wholly-owned
subsidiaries file corporate income tax returns as part of the GCI
consolidated group of companies.
(q) Incumbent Local Exchange Carrier ("ILEC") Over-earnings Refunds
We receive refunds from time to time from ILECs with which we do
business in respect of their earnings that exceed regulatory
requirements. Telephone companies that are rate regulated by the
Federal Communications Commission ("FCC") using the rate of return
method are required by the FCC to refund earnings from interstate
access charges assessed to long-distance carriers when their
earnings exceed their authorized rate of return. Such refunds are
computed based on the regulated carrier's earnings in several
access categories. Uncertainties exist with respect to the amount
of their earnings, the refunds (if any), their timing, and their
realization. We account for such refundable amounts as gain
contingencies, and, accordingly, do not recognize them until
realization is a certainty upon receipt.
(r) Stock Option Plan
At December 31, 2002, we had one stock-based employee compensation
plan, which is described more fully in note 8. We account for this
plan under the recognition and measurement principles of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. We use the
intrinsic-value method and compensation expense is recorded on the
date of grant only if the current market price of the underlying
stock exceeds the exercise price. We have adopted SFAS 123,
"Accounting for Stock-Based Compensation," which permits entities
to recognize as expense over the vesting period the fair value of
all stock-based awards on the date of
105 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
grant. Alternatively, SFAS 123 also allows entities to continue to
apply the provisions of APB Opinion No. 25.
We have adopted SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure". This Statement amends SFAS
No. 123 to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results.
We have elected to continue to apply the provisions of APB Opinion
No. 25 and provide the pro forma disclosure as required by SFAS
148.
Stock-based employee compensation cost is reflected over the
options' vesting period of generally 5 years and compensation cost
for options granted prior to January 1, 1996 is not considered. The
following table illustrates the effect on net income (loss) for the
years ended December 31, 2002, 2001 and 2000, if we had applied the
fair-value recognition provisions of SFAS 123 to stock-based
employee compensation (amounts in thousands):
2002 2001 2000
------------ ------------ ----------
Net income (loss), as reported $ 6,663 4,589 (13,234)
Total stock-based employee compensation expense
included in reported net income (loss), net of
related tax effects 257 472 255
Total stock-based employee compensation expense
under the fair-value based method for all awards,
net of related tax effects (2,504) (3,483) (2,667)
------------ ------------ ----------
Pro forma net income (loss) $ 4,416 1,578 (15,646)
============ ============ ==========
(s) Stock Options and Stock warrants Issued for Non-employee Services
We account for stock options and warrants issued in exchange for
nonemployee services pursuant to the provisions of SFAS 123,
Emerging Issues Task Force ("EITF") 96-3 and EITF 96-18, wherein
such transactions are accounted for at the fair value of the
consideration or services received or the fair value of the equity
instruments issued, whichever is more reliably measurable.
When a stock option or warrant is issued for non-employee services
where the fair value of such services is not stated, we estimate
the value of the stock option or warrant issued using the Black
Scholes method.
The fair value determined using these principles is charged to
operating expense over the shorter of the term for which
non-employee services are provided, if stated, or the stock option
or warrant vesting period.
(t) Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principles requires us to make
estimates and assumptions that affect the reported amounts of
assets and liabilities and 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. Actual results could differ from those estimates.
106 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(u) 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 December 31, 2002 and 2001, substantially all of
our cash and cash equivalents were invested in short-term liquid
money instruments at one highly rated financial institution.
We have two major customers, WorldCom, Inc. ("WorldCom") (see note
11) and Sprint Corporation ("Sprint") (see note 9). There is
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, 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.
(v) Fair Value of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments," requires disclosure of the fair value of financial
instruments for which it is practicable to estimate that value (see
note 10). SFAS No. 107 specifically excludes certain items from its
disclosure requirements. The fair value of a financial instrument
is the amount at which the instrument could be exchanged in a
current transaction between willing parties, other than in a forced
sale or liquidation.
(w) Accounting for the Impairment or Disposal of Long-lived Assets
Effective January 1, 2002, we adopted 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.
(x) Business Combinations
SFAS No. 141, "Business Combinations," requires that the purchase
method of accounting be used for all business combinations
initiated after June 30, 2001. We used the purchase method of
accounting for our November 19, 2001 acquisition of all of the
common stock of Rogers American Cablesystems, Inc. ("Rogers") (see
note 3).
(y) Software Capitalization Policy
Internally used software, whether purchased or developed, is
capitalized and amortized using the straight-line method over an
estimated useful life of 5 years. In accordance with Statement of
Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use", we capitalize
certain costs associated with internally developed software such as
payroll costs of employees devoting time to the projects and
external direct costs for materials and services. Costs associated
with internally developed software to be used internally are
expensed until the point the project has reached the development
stage. Subsequent additions, modifications or upgrades to
internal-use software are capitalized only to the extent that they
allow the software to perform a task it
107 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
previously did not perform. Software maintenance and training costs
are expensed in the period in which they are incurred. The
capitalization of software requires judgment in determining when a
project has reached the development stage. Further, the recovery of
software projects is periodically reviewed and may result in
significant write-offs.
(z) Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections
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:
o SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt" is rescinded, 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. 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,
o 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,
o 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
o 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, prior
period items that do not meet the extraordinary item classification
criteria in Opinion No. 30 must be reclassified. Unamortized bank
fees and other expenses totaling approximately $2.3 million
associated with the November 1, 2002 refinancing of the Senior
Holdings Loan and the Fiber Facility (see note 6) were not
classified as an extraordinary item and were charged to Deferred
Loan Fee Expense during the year ended December 31, 2002.
(aa) Reclassifications
Reclassifications have been made to the 2000 and 2001 financial
statements to make them comparable with the 2002 presentation.
108 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(2) Consolidated Statements of Cash Flows Supplemental Disclosures
Changes in operating assets and liabilities consist of (amounts in
thousands):
Year ended December 31, 2002 2001 2000
---------- ---------- ---------
Increase in accounts receivable $ (5,476) (10,229) (3,451)
Increase in prepaid and other current assets (6,005) (487) (390)
(Increase) decrease in inventories 446 (88) 14
Increase (decrease) in accounts payable (2,859) 5,701 3,773
Increase in accrued liabilities 825 1,091 982
Increase (decrease) in accrued payroll and payroll
related obligations (3,468) 4,872 2,260
Increase in deferred revenue 6,161 1,519 2,178
Increase (decrease) in accrued interest (111) (1,207) 1,271
Decrease in subscriber deposits (232) (253) (826)
Increase (decrease) in components of other long-term
liabilities 65 (104) 108
---------- ---------- ---------
$ (10,654) 815 5,919
========== ========== =========
We paid interest totaling approximately $29,427,000, $32,415,000 and
$35,618,000 during the years ended December 31, 2002, 2001 and 2000,
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 paid income taxes totaling $112,000 during the year
ended December 31, 2001. We paid no income taxes during the years ended
December 31, 2002 and 2000. Net income tax refunds received totaled
$283,700 during the year ended December 31, 2002. We received no income
tax refunds during the years ended December 31, 2001 and 2000.
During the year ended December 31, 2002 we funded the employer match
portion of Employee Stock Purchase Plan contributions by GCI's issuance
of its Class A common stock valued at $791,000 and by purchasing GCI
Class A common stock on the open market. During the year ended December
31, 2001 all employer match shares were purchased on the open market.
During the year ended December 31, 2000 we funded all of the employer
match portion by GCI's issuance of its Class A common stock valued at
$2,773,000.
We financed the acquisition of satellite transponder capacity pursuant
to a long-term capital lease arrangement with a leasing company during
the year ended December 31, 2000 at a cost of $48.2 million (see note
12).
We financed the acquisition of approximately $1.0 million of telephony
distribution equipment pursuant to a long-term capital lease arrangement
with a leasing company during the year ended December 31, 2002.
Effective March 31, 2001 we acquired the assets and customer base of
G.C. Cablevision, Inc. The seller received 238,199 unregistered shares
of GCI Class A common stock (see note 3).
Effective June 30, 2001 we acquired from WorldCom their 85% controlling
interest in Kanas (renamed to GFCC, see note 3) in exchange for $10.0
million of Series C preferred stock issued by GCI.
We acquired all minority shareholders' ownership interests in GFCC by
GCI's issuance of 15,000 shares of its Class A common stock in 2002.
109 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(3) Acquisitions
Effective March 31, 2001 we acquired the assets and customer base of
G.C. Cablevision, Inc. of Fairbanks. The seller received 238,199
unregistered shares of GCI Class A common stock with a future payment in
additional shares contingent upon certain conditions. The property and
equipment was valued at $2,088,000 on the date of acquisition. The value
of the remaining assets and liabilities acquired was not material.
Effective June 30, 2001 we completed the acquisition of WorldCom's 85
percent controlling interest in Kanas, which owns the 800-mile fiber
optic cable system that extends from Prudhoe Bay to Valdez via
Fairbanks. The corporation owning the fiber optic system was renamed and
is now operated as GFCC. The fiber optic cable system was valued at
approximately $21,198,000 on the date of acquisition. On June 30, 2001
GCI issued to WorldCom, a related party, shares of its Series C
preferred stock valued at $10.0 million. The balance of the carrying
value consisted of payments to and services performed on behalf of Kanas
to maintain its operations prior to June 30, 2001. The value of the
remaining assets and liabilities acquired was not material. We acquired
the remaining 15 percent ownership interest of GFCC by GCI's issuance of
15,000 shares of its Class A common stock in 2002.
Effective November 19, 2001 we acquired all of the stock of Rogers, a
cable television service provider in Palmer and Wasilla, Alaska for
$18.5 million in cash. Per the acquisition agreement $467,000 was
withheld from the original payment to account for the amount by which
Rogers' current liabilities exceeded current assets and for certain
capital expenditures incurred by the previous owners of Rogers through
May 2001. The final settlement of $345,000 was paid in the first quarter
of 2003. This acquisition was funded through a $19.0 million draw on our
then existing Senior Holdings Loan. The results of Roger's operations
have been included in the consolidated financial statements in the cable
services segment since the acquisition date. This acquisition added
approximately 10,000 homes passed and approximately 7,000 subscribers to
our cable services segment in 2001.
The following table, updated to reflect refinements of original
estimates, summarizes the estimated fair values of assets acquired and
liabilities assumed at the date of the Rogers acquisition (amounts in
thousands):
Current assets $ 556
Property and equipment, net of
accumulated depreciation 5,160
Franchise agreement 10,976
Goodwill 3,324
--------
Total assets 20,016
Current liabilities 642
Long-term deferred tax liability 374
--------
Net assets acquired $ 19,000
========
110 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(4) 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 (loss) as if goodwill and cable certificates were not subject to
amortization for the years ended December 31, 2001 and 2000 (amounts in
thousands):
Years Ended December 31,
2002 2001 2000
---------- ---------- ----------
Net income (loss), as reported $ 6,663 4,589 (13,234)
Add cable certificate amortization, net of
income taxes --- 3,113 3,087
Add goodwill amortization, net of income
taxes --- 756 755
---------- ---------- ----------
Adjusted net income (loss) $ 6,663 8,458 (9,392)
========== ========== ==========
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 9.
Amortization expense for amortizable intangible assets for the years
ended December 31, 2002, 2001 and 2000 follow:
Years Ended December 31,
2002 2001 2000
---------- ----------- ----------
Amortization expense for amortizable
intangible assets $ 790 7,372 6,951
========== =========== ==========
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,
2003 $ 402
2004 $ 278
2005 $ 123
2006 $ 119
2007 $ 111
No intangible assets have been impaired based upon impairment testing
performed as of December 31, 2002 (see note 1(g)) and no indicators of
impairment have occurred since the impairment testing was performed.
111 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(5) Notes Receivable from Related Parties
Notes receivable from related parties consist of the following (amounts
in thousands):
December 31,
2002 2001
--------------- -------------
Notes receivable from officers bearing interest up to 6.5%
or at the rate paid by us on our senior indebtedness,
unsecured, due through February 8, 2007 $ 3,479 1,339
Notes receivable from officers bearing interest up to 9.0%
or at the rate paid by us on our senior indebtedness,
secured by GCI common stock, a life insurance policy, and
a personal residence, due through August 26, 2004 469 654
Notes receivable from other related parties bearing
interest up to 8.305% or at the rate paid by us on our
senior indebtedness, unsecured and secured by property,
due through December 31, 2007 660 593
Interest receivable 1,231 842
--------------- -------------
Total notes receivable from related parties 5,839 3,428
Less current portion, including current interest receivable 697 182
--------------- -------------
Long-term portion, including long-term interest receivable $ 5,142 3,246
=============== =============
(6) Long-term Debt
Long-term debt consists of the following (amounts in thousands):
December 31,
2002 2001
------------- --------------
Senior Notes (a) $ 180,000 180,000
Senior Facility (b) 177,700 ---
Senior Holdings Loan (c) --- 106,000
Fiber Facility (d) --- 60,000
------------- --------------
Long-term debt, excluding current maturities $ 357,700 346,000
============= ==============
(a) On August 1, 1997 we issued $180,000,000 of 9.75% senior notes
due 2007 ("Senior Notes"). The Senior Notes were issued at face
value. Net proceeds to us after deducting underwriting discounts
and commissions totaled $174,600,000. Issuance costs of
$6,496,000 are being charged to Deferred Loan Fee Expense over
the term of the Senior Notes.
The Senior Notes were not callable before August 1, 2002. After
August 1, 2002, the Senior Notes are callable at our option under
certain conditions and at stated redemption prices. The Senior
Notes include limitations on additional indebtedness and prohibit
payment of dividends, payments for the purchase, redemption,
acquisition or retirement of our stock, payments for early
retirement of debt subordinate to the notes, liens on property,
and asset sales (excluding sales of Alaska United assets). We
currently have no plans to call the Senior Notes during the year
ended December 31, 2003.
We were in compliance with all covenants during the year ending
December 31, 2002. The Senior Notes are unsecured obligations.
112 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(b) On November 1, 2002 we closed our $225.0 million Senior Facility
to refinance the Holdings $150.0 million and $50.0 million credit
facilities ("Senior Holdings Loan") and the Alaska United $75.0
million project finance facility ("Fiber Facility"). The Senior
Holdings Loan and Fiber Facility had balances of approximately
$120.1 million and $60.0 million, respectively, at November 1,
2002. The Senior Facility includes a term loan of $175.0 million
and a revolving credit facility of $50.0 million. The Senior
Facility matures on November 1, 2004 and bears interest at LIBOR
plus 6.50%. We are required to pay a commitment fee equal to 2.0%
per annum on the unused portion of the commitment unless the
undrawn portion of the revolver is less than $25.0 million, in
which case the commitment fee decreases to 1.5% per annum on the
unused portion of the commitment. We recognized $116,000 in
commitment fee expense during the year ended December 31, 2002.
On November 30, 2003 we are required to prepay the term loan in
an amount equal to 50% of the amount by which earnings before
interest, taxes, depreciation, and amortization exceeds certain
fixed charges as defined in the Senior Facility agreement
("Excess Cash Flow") during the year ended September 30, 2003. On
May 30, 2004 we are required to prepay the term loan in an amount
equal to 50% of the Excess Cash Flow during the six months ended
March 31, 2004. The prepayment required on November 30, 2003, if
any, may be funded by a draw on the revolving credit facility.
The Senior Facility contains, among others, covenants limiting
additional indebtedness and prohibits any direct or indirect
distribution, dividend, redemption or other payment to any person
on account of any general or limited partnership interest in, or
shares of our capital stock or other securities. Under the Senior
Facility we may not allow the:
o Ratio of total indebtedness to annualized operating cash
flow to be greater than 4.5:1,
o Ratio of senior secured indebtedness to annualized operating
cash flow to be greater than 2.25:1, and
o Ratio of annualized operating cash flow to total interest
expense to be less than 2.50:1.
Capital expenditures, other than those incurred to build
additional fiber optic cable system capacity, in any of the years
ended September 30, 2003, March 31, 2004 and September 30, 2004
may not exceed:
o $25.0 million, plus
o 50% of any Excess Cash Flow during the applicable period
less certain permitted investments of up to $5.0 million
during the applicable period.
Substantially all of Holdings' assets collateralize the Senior
Holdings Loan.
$3.0 million of the Senior Facility has been used to provide a
letter of credit to secure payment of certain access charges
associated with our provision of telecommunications services
within the State of Alaska.
In connection with the funding of the Senior Facility, we paid
bank fees and other expenses of approximately $7,141,000 during
the year ended December 31, 2002 which will be charged to
Deferred Loan Fee Expense over the life of the agreement. We
funded $6,809,000 of the bank fees and other expenses by a draw
on the Senior Facility.
(c) The Senior Holdings Loan facilities were refinanced by the Senior
Facility on November 1, 2002. The Senior Holdings Loan facilities
incurred interest, as amended, at either LIBOR plus 1.00% to
2.50%, 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 0.00% to 1.375%, depending on the
leverage ratio of Holdings and certain of its subsidiaries. We
were
113 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
required to pay a commitment fee equal to 0.50% per annum on the
unused portion of the commitment. Commitment fee expense on the
Senior Holdings Loan totaled $189,000, $405,000 and $570,000
during the years ended December 31, 2002, 2001 and 2000,
respectively.
We borrowed an additional $9.0 million on our Senior Holdings
Loan in the first quarter of 2002 to fund our Senior Notes
interest payment.
The facilities contained, among others, covenants requiring
maintenance of specific levels of operating cash flow to
indebtedness and to interest expense, and limitations on
acquisitions and additional indebtedness. The facilities
prohibited any direct or indirect distribution, dividend,
redemption or other payment to any person on account of any
general or limited partnership interest in, or shares of capital
stock or other securities of Holdings or any of its subsidiaries.
Holdings paid bank fees and other expenses of approximately
$3,893,000 for the initial funding and subsequent amendments to
the Senior Holdings Loan facilities. Those fees and other
expenses were charged to Deferred Loan Fee Expense over the term
of the facilities which ended October 31, 2002. Approximately
$438,000 of amendment fees were charged to Selling, General and
Administrative Expense in the Consolidated Statements of
Operations during the year ended December 31, 2001. During the
year ended December 31, 2002, approximately $1.3 million in
unamortized bank fees and other expenses were charged to Deferred
Loan Fee Expense upon refinancing the Senior Holdings Loan
facilities.
(d) On January 27, 1998 Alaska United closed the Fiber Facility to
construct a fiber optic cable system connecting Anchorage,
Fairbanks, Valdez, Whittier, Juneau and Seattle. The Fiber
Facility was refinanced by the Senior Facility on November 1,
2002. The Fiber Facility was a 10-year term loan that was
interest only for the first 5 years. The Fiber Facility interest
rate was either Libor plus 3.0%, or at the lender's prime rate
plus 1.75% while the loan balance was greater than $60 million.
The interest rate declined to Libor plus 2.5%-2.75%, or, at our
option, the lender's prime rate plus 1.25%-1.5% when the loan
balance was reduced to $60 million.
The Fiber Facility contained covenants requiring certain
intercompany loans and advances in order to maintain specific
levels of cash flow necessary to pay operating costs and interest
and principal installments.
In connection with the funding of the Fiber Facility, Alaska
United paid bank fees and other expenses of $2,183,000 since the
initial funding through October 31, 2002. These fees and other
expenses were charged to Deferred Loan Fee Expense over the term
of the agreement which ended October 31, 2002. During the year
ended December 31, 2002, approximately $1.0 million in
unamortized bank fees and other expenses were charged to Deferred
Loan Fee Expense upon refinancing the Fiber Facility.
As of December 31, 2002 maturities of long-term debt were as
follows (amounts in thousands):
Years ending December 31,
2003 $ ---
2004 177,700
2005 ---
2006 ---
2007 180,000
--------
$ 357,700
========
114 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(7) Income Taxes
Total income tax (expense) benefit was allocated as follows (amounts in
thousands):
Years ended December 31,
2002 2001 2000
------------ ------------ ------------
Net (income) loss from continuing operations $ (5,659) (4,070) 8,415
Stockholder's equity, for stock option compensation
expense for tax purposes in excess of amounts
recognized for financial reporting purposes 317 2,317 640
------------ ------------ ------------
$ (5,342) (1,753) 9,055
============ ============ ============
Income tax (expense) benefit consists of the following (amounts in
thousands):
Years ended December 31,
2002 2001 2000
------------ ------------ -----------
Current tax (expense):
Federal taxes $ (1,754) --- ---
State taxes (536) --- ---
------------ ------------ -----------
(2,290) --- ---
------------ ------------ -----------
Deferred tax (expense) benefit:
Federal taxes (2,580) (3,115) 6,494
State taxes (789) (955) 1,921
------------ ------------ -----------
(3,369) (4,070) 8,415
------------ ------------ -----------
$ (5,659) (4,070) 8,415
============ ============ ===========
Total income tax (expense) benefit differed from the "expected" income
tax (expense) benefit determined by applying the statutory federal
income tax rate of 34% as follows (amounts in thousands):
Years ended December 31,
2002 2001 2000
------------ ------------ -------------
"Expected" statutory tax (expense) benefit $ (4,189) (2,944) 7,361
State income taxes, net of federal benefit (873) (630) 1,268
Income tax effect of goodwill amortization,
nondeductible expenditures and other items, net (597) (496) (399)
Other --- --- 185
------------ ------------ -------------
$ (5,659) (4,070) 8,415
============ ============ =============
115 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 2002 and 2001 are presented below (amounts in thousands):
December 31,
2002 2001
-------------- -------------
Current deferred tax assets:
Accounts receivable, principally due to allowance for
doubtful accounts $ 5,649 1,351
Compensated absences, accrued for financial reporting
purposes 1,914 1,599
Workers compensation and self insurance reserves,
principally due to accrual for financial reporting
purposes 805 637
Inventory expense for financial reporting purposes in
excess of amounts recognized for tax purposes 141 1,323
Other --- (220)
-------------- -------------
Total current deferred tax assets $ 8,509 4,690
============== =============
Long-term deferred tax assets:
Net operating loss carryforwards $ 76,855 62,760
Alternative minimum tax credits 1,892 2,081
Deferred compensation expense for financial reporting
purposes in excess of amounts recognized for tax
purposes 1,239 1,913
Employee stock option compensation expense for financial
reporting purposes in excess of amounts recognized for
tax purposes 411 145
Sweepstakes award in excess of amounts recognized for tax
purposes 184 188
State income taxes 1,555 1,755
Charitable contributions expense for financial reporting
in excess of amount recognized for tax purposes 586 423
Deferred loan fees for financial reporting purposes in
excess of amounts recognized for tax purposes --- 347
Cost of sales and services for financial reporting in
excess of amounts recognized for tax purposes 181 402
Cash flow hedge expense for financial reporting purposes
in excess of amounts recognized for tax purposes 464 5
Other 360 345
-------------- -------------
Total long-term deferred tax assets $ 83,727 70,364
-------------- -------------
116 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
December 31,
2002 2001
-------------- -------------
Long-term deferred tax liabilities:
Property and equipment, principally due to differences in
depreciation $ 90,522 80,516
Amortizable assets 8,920 13,670
Costs recognized for tax purposes in excess of amounts
recognized for book purposes --- 891
Other 346 356
-------------- -------------
Total gross long-term deferred tax liabilities 99,788 95,433
-------------- -------------
Net combined long-term deferred tax liabilities $ 16,061 25,069
============== =============
We recorded net deferred tax assets of $15.8 million in 2002 associated
with the Rogers and Kanas acquisitions (see note 3), resulting in
adjustments to the recorded financial statement cost basis of associated
goodwill and property and equipment.
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 net operating loss carryforwards and income tax benefit
reflect the consolidated group's activity and balances.
In conjunction with the 1996 Cable Companies acquisition, we incurred a
net deferred income tax liability of $24.4 million and acquired net
operating losses totaling $57.6 million. We determined that
approximately $20 million of the acquired net operating losses would not
be utilized for income tax purposes, and elected with our December 31,
1996 income tax returns to forego utilization of such acquired losses
under Internal Revenue Code section 1.1502-32(b)(4). Deferred tax assets
were not recorded associated with the foregone losses and, accordingly,
no valuation allowance was provided. At December 31, 2002, we have (1)
federal and state tax net operating loss carryforwards of approximately
$191 million that will begin expiring in 2005 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.
The following schedule shows our tax net operating loss carryforwards by
year of expiration (amounts in thousands):
Years ending December 31, Federal State
------------- -------------
2005 $ 292 ---
2006 393 ---
2007 4,017 3,006
2008 8,077 7,509
2009 11,767 11,482
2010 9,134 8,935
2011 6,919 6,685
2018 19,995 19,390
2019 27,910 27,905
2020 45,403 45,400
2021 32,740 33,420
2022 24,534 27,074
------------- -------------
Total tax net operating loss
carryforwards $ 191,181 190,806
============= =============
Our utilization of remaining acquired net operating loss carryforwards
is subject to annual limitations pursuant to Internal Revenue Code
section 382 which could reduce or defer the utilization of these losses.
117 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Tax benefits associated with recorded deferred tax assets are considered
to be more likely than not realizable through taxable income earned in
carryback years, 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.
(8) Stockholder's Equity
Common Stock
We were incorporated in 1997 and issued 100 shares of our no par Class A
common stock to GCI in our initial capitalization. We received all
ownership interests in subsidiaries previously held by GCI and proceeds
from GCI's August 1, 1997 common stock offering. We recorded
$206,622,000 associated with our initial capitalization. All of our
issued and outstanding Class A common stock is owned by GCI.
Stock Option Plan
In December 1986, GCI adopted a Stock Option Plan (the "Option Plan") in
order to provide a special incentive to our officers, non-employee
directors, and employees by offering them an opportunity to acquire an
equity interest in GCI. The Option Plan, as amended in 1999, provides
for the grant of options for a maximum of 10,700,000 shares of GCI Class
A common stock, subject to adjustment upon the occurrence of stock
dividends, stock splits, mergers, consolidations or certain other
changes in corporate structure or capitalization. If an option expires
or terminates, the shares subject to the option will be available for
further grants of options under the Option Plan. The Option Committee of
GCI's Board of Directors administers the Option Plan.
The Option Plan provides that all options granted under the Option Plan
must expire not later than ten years after the date of grant. If at the
time an option is granted the exercise price is less than the market
value of the underlying common stock, the difference in these amounts at
the time of grant is expensed ratably over the vesting period of the
option. Options granted pursuant to the Option Plan are only exercisable
if at the time of exercise the option holder is our employee,
non-employee director, or a consultant or advisor working on our behalf.
Our employees and employees of our subsidiaries are eligible to
participate in the Option Plan. Expenses associated with the grant of
options to employees are recorded pursuant to the provisions of APB
Number 25 and Interpretive Responses 1 and 2 of SAB Topic 1B1, which
amounts were not material in 2002, 2001 or 2000. We believe the
allocation method used is reasonable.
118 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Information for the years 2000, 2001 and 2002 with respect to the Option
Plan follows:
Weighted
Average Range of
Shares Exercise Price Exercise Prices
------------- --------------- ------------------
Outstanding at December 31, 1999 4,354,715 $4.94 $0.01-$7.63
Granted 1,970,599 $5.96 $3.00-$7.50
Exercised (513,289) $2.37 $0.01-$6.50
Forfeited (398,460) $5.18 $0.01-$7.63
-------------
Outstanding at December 31, 2000 5,413,565 $5.54 $0.01-$7.63
Granted 755,277 $7.34 $2.84-$11.25
Exercised (1,044,511) $4.01 $0.01-$7.50
Forfeited (24,200) $6.53 $6.00-$10.98
-------------
Outstanding at December 31, 2001 5,100,131 $6.11 $0.01-$11.25
Granted 1,995,700 $6.90 $3.11-$7.52
Exercised (583,888) $5.78 $3.00-$7.50
Forfeited (223,177) $7.42 $3.25-$11.25
-------------
Outstanding at December 31, 2002 6,288,766 $6.34 $0.01-$11.25
=============
Available for grant at December 31, 2002 886,757
=============
Stock Warrants Not Pursuant to a Plan
We entered into a stock warrant agreement in exchange for services in
December 1998 with certain of our legal counsel which provides for the
purchase of 16,667 shares of GCI Class A common stock, vesting in
December 1999, with an exercise price of $3.00 per share, and expiring
December 2003. The fair value of the stock warrant was approximately
$23,000.
We entered into a stock warrant agreement in exchange for services in
June 1999 with certain of our legal counsel which provides for the
purchase of 25,000 shares of GCI Class A common stock, vesting through
December 2001, with an exercise price of $3.00 per share, and expiring
December 2003. The fair value of the stock warrant was approximately
$94,000.
SFAS 123 Disclosures
Our stock options and warrants expire at various dates through December
2012. At December 31, 2002, 2001, and 2000, the weighted-average
remaining contractual lives of options outstanding were 6.93, 6.95 and
6.88 years, respectively.
At December 31, 2002, 2001, and 2000, the number of exercisable shares
under option was 3,187,618, 2,837,361 and 2,350,334, respectively, and
the weighted-average exercise price of those options was $5.87, $5.75
and $4.78, respectively.
The per share weighted-average fair value of stock options granted
during 2002 was $3.05 per share for compensatory and $0.61 for
non-compensatory options; for 2001 was $6.99 per share for compensatory
and $10.58 for non-compensatory options; and for 2000 was $4.07 per
share for compensatory and $2.71 for non-compensatory options. The
amounts were determined as of the options' grant dates using a
Black-Scholes option-pricing model with the following weighted-average
assumptions: 2002 - risk-free interest rate of 3.079%, volatility of
0.6844 and an expected life of 6.18 years; 2001 - risk-free interest
rate of 4.664%, volatility of 0.6178 and an expected life of 6.67 years;
and 2000 - risk-free interest rate of 4.987%, volatility of 0.6203 and
an expected life of 5.82 years.
119 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Summary information about our stock options and warrants outstanding at
December 31, 2002:
Options and Warrants Outstanding Options and Warrants Exercisable
----------------------------------------------------------------------- --------------------------------------
Weighted
Average
Number Remaining Weighted Number
Range of Exercise outstanding as Contractual Average Exercisable as Weighted Average
Prices of 12/31/02 Life Exercise Price of 12/31/02 Exercise Price
----------------------------------------------------------------------- --------------------------------------
$0.01-$4.00 681,131 4.73 $3.48 661,131 $3.49
$4.06-$5.69 432,804 6.56 $4.97 251,757 $4.94
$6.00-$6.00 1,101,783 7.42 $6.00 466,646 $6.00
$6.13-$6.35 51,000 7.99 $6.13 20,000 $6.13
$6.50-$6.50 1,762,900 6.76 $6.50 950,520 $6.50
$6.63-$6.99 81,000 5.14 $6.80 62,666 $6.80
$7.00-$7.00 775,622 5.63 $7.00 525,622 $7.00
$7.25-$7.25 1,150,000 9.10 $7.25 0 $0.00
$7.50-$10.98 505,193 6.86 $7.88 241,276 $7.68
$11.25-$11.25 40,000 8.50 $11.25 8,000 $11.25
------------------------------------------------- --------------------------------------
$0.01-$11.25 6,581,433 6.93 $6.33 3,187,618 $5.87
================================================= ======================================
Employee Stock Purchase Plan
In December 1986, we adopted an Employee Stock Purchase Plan ("Plan")
qualified under Section 401 of the Internal Revenue Code of 1986
("Code"). The Plan provides for acquisition of GCI's Class A and Class B
common stock at market value. The Plan permits each employee who has
completed one year of service to elect to participate in the Plan.
Through December 31, 2002, eligible employees could elect to reduce
their compensation in any even dollar amount up to 10 percent of such
compensation up to a maximum of $11,000. As of January 1, 2003, eligible
employees can elect to reduce their compensation in any even dollar
amount up to 50 percent of such compensation (subject to certain
limitations) up to a maximum of $12,000. Eligible employees may
contribute up to 10 percent of their compensation with after-tax
dollars, or they may elect a combination of salary reductions and
after-tax contributions.
Beginning in 2002 eligible employees are allowed to make catch-up
contributions of no more than $1,000 in 2002 and $2,000 in 2003. We do
not match employee catch-up contributions.
We may match employee salary reductions and after tax contributions in
any amount, elected by GCI's Board of Directors each year, but not more
than 10 percent of any one employee's compensation will be matched in
any year. For the year ended December 31, 2001 the combination of salary
reductions, after tax contributions and matching contributions could not
exceed the lesser of 25 percent of an employee's compensation
(determined after salary reduction) or $35,000. For the years ended
December 31, 2002 and 2003 the combination of salary reductions, after
tax contributions and matching contributions cannot exceed the lesser of
100 percent of an employee's compensation or $40,000 (determined after
salary reduction) for any year. Matching contributions vest over six
years.
Employee contributions may be invested in GCI class A common stock,
WorldCom and MCI Group common stock (through February 14, 2003), AT&T
common stock, Comcast Corporation common stock, or various mutual funds.
TCI common stock was previously offered to employees as an investment
choice however TCI's merger with AT&T in March 1999 resulted in the
conversion of TCI shares of common stock into AT&T shares of common
stock.
120 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
WorldCom and MCI Group common stocks were delisted from the NASDAQ stock
exchange as a result of their bankruptcy filing in July 2002 (see note
11). The impaired market for shares of these common stocks has resulted
in difficulty executing trades on behalf of participating employees.
Accordingly, as of February 14, 2003, participating employees were no
longer allowed to invest in the common stock of WorldCom or MCI Group.
Employee contributions invested in GCI common stock receive up to 100%
matching, as determined by GCI's Board of Directors each year, in GCI
common stock. Employee contributions invested in other than GCI common
stock receive up to 50% matching, as determined by GCI's Board of
Directors each year, in GCI common stock. Our matching contributions
allocated to participant accounts totaled approximately $3,665,000,
$3,194,000, and $2,773,000 for the years ended December 31, 2002, 2001,
and 2000, respectively. The Plan may, at its discretion, purchase shares
of GCI common stock from GCI at market value or may purchase GCI's
common stock on the open market. In 2002 and 2000 we funded some and
all, respectively, of our employer-matching contributions through the
issuance of new shares of GCI common stock rather than market purchases.
In 2001 we funded all of our employer-matching contributions through the
purchase of shares on the open market.
Effective July 1, 2000, we transferred all of the Plan assets to
Merrill, Lynch, Pierce, Fenner and Smith, Incorporated who became the
Plan's new recordkeeper.
In March 2002 we allowed participating employees to diversify 25 percent
of their holdings of GCI common stock at December 31, 2001 in other
investments offered by the Plan. We allowed diversification of the
remaining 75 percent of their holdings of GCI common stock at December
31, 2001 ratably over the following three years. Effective January 1,
2003 the original diversification plan was superceded by a new plan
which allowed participating employees to diversify 100 percent of their
holdings of GCI common stock at December 31, 2002 in other investments
offered by the Plan.
On January 23, 2003 we added seven additional mutual fund investment
choices to the Plan.
(9) 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,
Kenai and Soldotna and retail cable modem service (through our Internet
services segment) in all of our locations in Alaska except Ketchikan
and Kotzebue. We plan to offer cable modem service in Ketchikan in
2003, and plan to continue 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 and subject to availability of capital.
121 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Internet services. We offer wholesale and retail Internet services. We
offer cable modem service as further described under Cable services
above. Our undersea fiber optic cable allows us to offer enhanced
services with high-bandwidth requirements.
Included in the "All Other" category in the tables that follow are our
managed services, product sales, cellular telephone services, and,
during the year ended December 31, 2001, management services for 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(m)).
The December 31, 2001 and 2000 Form 10-K "Industry Segments Data"
reported marketing expenses in the "All Other" category. Such 2001 and
2000 expenses have been reclassified to the applicable reportable
segments in this December 31, 2002 Form 10-K. We adopted SFAS 142,
"Goodwill and Other Intangible Assets" on January 1, 2002, resulting in
a $6.5 million decrease in depreciation and amortization expense
primarily in the cable services segment during the year ended December
31, 2002 as compared to the years ended December 31, 2001 and 2000.
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 for the
years ended December 31, 2002, 2001 and 2000 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 $ 22,639 2,094 9,723 10,023 44,479 744 45,223
External 204,930 88,688 32,071 15,584 341,273 26,569 367,842
------------------------------------------------------------------------------
Total revenues 227,569 90,782 41,794 25,607 385,752 27,313 413,065
------------------------------------------------------------------------------
Cost of sales and services:
Intersegment 18,284 --- 2,100 22,985 43,369 752 44,121
External 60,053 23,649 20,205 4,792 108,699 14,865 123,564
------------------------------------------------------------------------------
Total cost of sales and
services 78,337 23,649 22,305 27,777 152,068 15,617 167,685
------------------------------------------------------------------------------
Contribution:
Intersegment 4,355 2,094 7,623 (12,962) 1,110 (8) 1,102
External 144,877 65,039 11,866 10,792 232,574 11,704 244,278
------------------------------------------------------------------------------
Total contribution 149,232 67,133 19,489 (2,170) 233,684 11,696 245,380
122 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Reportable Segments
--------------------------------------------------------
Long- Local Total
Distance Cable Access Internet Reportable All
Services Services Services Services Segments Other Total
------------------------------------------------------------------------------
Selling, general and
administrative expenses $ 36,378 25,264 16,600 8,855 87,097 41,932 129,029
Bad debt expense 12,388 428 162 54 13,032 92 13,124
------------------------------------------------------------------------------
Earnings (loss) from
operations before
depreciation, amortization,
net interest expense and
income taxes 100,466 41,441 2,727 (11,079) 133,555 (30,328) 103,227
Depreciation and amortization 21,427 15,882 3,466 7,187 47,962 8,438 56,400
------------------------------------------------------------------------------
Operating income (loss) $ 79,039 25,559 (739) (18,266) 85,593 (38,766) 46,827
==============================================================================
Total assets $ 288,680 322,899 35,276 28,102 674,957 63,825 738,782
==============================================================================
Capital expenditures $ 22,832 17,395 10,388 4,215 54,830 10,310 65,140
==============================================================================
2001
----
Revenues:
Intersegment $ 20,239 1,650 8,716 6,110 36,715 355 37,070
External 200,694 76,554 25,229 11,996 314,473 42,785 357,258
------------------------------------------------------------------------------
Total revenues 220,933 78,204 33,945 18,106 351,188 43,140 394,328
------------------------------------------------------------------------------
Cost of sales and services:
Intersegment 16,739 --- 1,586 17,345 35,670 461 36,131
External 73,257 20,829 14,037 4,749 112,872 26,921 139,793
------------------------------------------------------------------------------
Total cost of sales and
services 89,996 20,829 15,623 22,094 148,542 27,382 175,924
------------------------------------------------------------------------------
Contribution:
Intersegment $ 3,500 1,650 7,130 (11,235) 1,045 (106) 939
External 127,437 55,725 11,192 7,247 201,601 15,864 217,465
------------------------------------------------------------------------------
Total contribution 130,937 57,375 18,322 (3,988) 202,646 15,758 218,404
Selling, general and
administrative expenses 38,102 21,740 13,138 8,066 81,046 35,490 116,536
Bad debt expense 2,790 1,053 181 86 4,110 169 4,279
------------------------------------------------------------------------------
Earnings (loss) from
operations before
depreciation, amortization,
net interest expense and
income taxes 90,045 34,582 5,003 (12,140) 117,490 (19,901) 97,589
Depreciation and amortization 21,899 20,704 3,530 2,879 49,012 6,663 55,675
------------------------------------------------------------------------------
Operating income (loss) $ 68,146 13,878 1,473 (15,019) 68,478 (26,564) 41,914
==============================================================================
Total assets $ 294,175 321,722 30,040 27,363 673,300 61,379 734,679
==============================================================================
Capital expenditures $ 24,497 16,433 8,085 6,516 55,531 10,107 65,638
==============================================================================
123 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Reportable Segments
--------------------------------------------------------
Long- Local Total
Distance Cable Access Internet Reportable All
Services Services Services Services Segments Other Total
------------------------------------------------------------------------------
2000
----
Revenues:
Intersegment $ 15,750 1,493 6,675 3,173 27,091 123 27,214
External 182,676 67,898 20,205 8,425 279,204 13,401 292,605
------------------------------------------------------------------------------
Total revenues 198,426 69,391 26,880 11,598 306,295 13,524 319,819
------------------------------------------------------------------------------
Cost of sales and services:
Intersegment 13,554 --- 1,401 11,692 26,647 123 26,770
External 76,568 17,821 10,768 4,389 109,546 10,166 119,712
------------------------------------------------------------------------------
Total cost of sales and
services 90,122 17,821 12,169 16,081 136,193 10,289 146,482
------------------------------------------------------------------------------
Contribution:
Intersegment 2,196 1,493 5,274 (8,519) 444 --- 444
External 106,108 50,077 9,437 4,036 169,658 3,235 172,893
------------------------------------------------------------------------------
Total contribution 108,304 51,570 14,711 (4,483) 170,102 3,235 173,337
Selling, general and
administrative expenses 34,816 20,879 12,316 7,288 75,299 24,609 99,908
Bad debt expense 3,510 691 388 162 4,751 259 5,010
------------------------------------------------------------------------------
Earnings (loss) from
operations before
depreciation, amortization,
net interest expense and
income taxes 69,978 30,000 2,007 (11,933) 90,052 (21,633) 68,419
Depreciation and amortization 19,500 18,942 4,375 1,915 44,732 5,923 50,655
------------------------------------------------------------------------------
Operating income (loss) $ 50,478 11,058 (2,368) (13,848) 45,320 (27,556) 17,764
==============================================================================
Total assets $ 257,913 304,094 24,827 22,768 609,602 69,405 679,007
==============================================================================
Capital expenditures $ 18,062 10,966 3,430 7,902 40,360 10,513 50,873
==============================================================================
Long-distance services, local access services and Internet services are
billed utilizing a unified accounts receivable system and are not
reported separately by business segment. All such accounts receivable
are included above in the long-distance services segment for all periods
presented.
A reconciliation of reportable segment revenues to consolidated revenues
follows (amounts in thousands):
Years ended December 31, 2002 2001 2000
--------------- --------------- --------------
Reportable segment revenues $ 385,752 351,188 306,295
Plus All Other revenues 27,313 43,140 13,524
Less intersegment revenues eliminated in consolidation 45,223 37,070 27,214
--------------- --------------- --------------
Consolidated revenues $ 367,842 357,258 292,605
=============== =============== ==============
124 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
A reconciliation of reportable segment earnings from operations before
depreciation, amortization, net interest expense and income taxes to
consolidated net income (loss) before income taxes follows (amounts in
thousands):
Years ended December 31, 2002 2001 2000
-------------- ---------------- --------------
Reportable segment earnings from operations before
depreciation, amortization, net interest expense and income
taxes $ 133,555 117,490 90,052
Less All Other loss from operations before depreciation,
amortization, net interest expense and income taxes 30,328 19,901 21,633
Less intersegment contribution eliminated in consolidation 1,102 939 444
-------------- ---------------- --------------
Consolidated earnings from operations before
depreciation, amortization, net interest expense and
income taxes 102,125 96,650 67,975
Less depreciation and amortization expense 56,400 55,675 50,655
-------------- ---------------- --------------
Consolidated operating income 45,725 40,975 17,320
Less other expense, net 33,403 32,316 38,969
-------------- ---------------- --------------
Consolidated net income (loss) before income taxes $ 12,322 8,659 (21,649)
============== ================ ==============
A reconciliation of reportable segment operating income to consolidated
net income (loss) before income taxes follows (amounts in thousands):
Years ended December 31, 2002 2001 2000
--------------- --------------- --------------
Reportable segment operating income $ 85,593 68,478 45,320
Less All Other operating loss 38,766 26,564 27,556
Less intersegment contribution eliminated in consolidation 1,102 939 444
--------------- --------------- --------------
Consolidated operating income 45,725 40,975 17,320
Less other expense, net 33,403 32,316 38,969
--------------- --------------- --------------
Consolidated net income (loss) before income taxes $ 12,322 8,659 (21,649)
=============== =============== ==============
We provide long-distance services to WorldCom (see note 11) and Sprint,
major customers. We earned revenues from Sprint, net of discounts,
included in the long-distance segment, totaling approximately
$36,899,000 for the year ended December 31, 2001. As a percentage of
total revenues, Sprint revenues totaled 10.3% for the year ended
December 31, 2001. Sprint was not a major customer for segment
disclosure purposes for the years ended December 31, 2002 and 2000.
125 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(10) Financial Instruments
Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing
parties. The carrying amounts and estimated fair values of our financial
instruments at December 31, 2002 and 2001 follows (amounts in
thousands):
2002 2001
--------------------------- -----------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------------------------- -----------------------------
Short-term assets $ 65,222 65,222 68,044 68,044
Notes receivable with related parties $ 5,142 5,142 3,246 3,246
Short-term liabilities $ 44,289 44,289 52,980 52,980
Long-term debt and capital lease
obligations $ 402,475 419,305 397,096 411,712
Fair value hedge asset $ --- --- 1,261 1,261
Cash flow hedge asset (liability) $ (999) (999) 13 13
The following methods and assumptions were used to estimate fair values:
Short-term assets: The fair values of cash and cash equivalents, net
receivables and current portion of notes receivable from related
parties approximate their carrying values due to the short-term
nature of these financial instruments.
Notes receivable from related parties: The carrying value of notes
receivable from related parties is estimated to approximate fair
values. Although there are no quoted market prices available for
these instruments, the fair value estimates were based on the change
in interest rates and risk related interest rate spreads since the
note origination dates.
Short-term liabilities: The fair values of current maturities of
long-term debt and capital lease obligations, accounts payable,
accrued interest, and subscriber deposits approximate their carrying
value due to the short-term nature of these financial instruments.
Long-term debt and capital lease obligations: The fair value of
long-term debt is based primarily on discounting the future cash
flows of each instrument at rates currently offered to us for similar
debt instruments of comparable maturities by our bankers.
Derivative Instruments and Hedging Activities
Effective January 3, 2001, we entered into an interest rate swap
agreement to convert $50 million of 9.75% fixed rate debt to a variable
interest rate equal to the 90 day LIBOR rate plus 334 basis points. This
interest rate swap was cancelled by the counterparty on August 1, 2002.
The differential paid to us was recorded as a decrease in Interest
Expense in the Consolidated Statements of Operations in the period in
which it was recognized. During the years ended December 31, 2002 and
2001 we recognized approximately $1.2 million and $1.1 million,
respectively, as a reduction of interest expense.
Effective September 21, 2001, we entered into an interest rate swap
agreement to convert $25 million of variable interest rate debt equal to
the 90 day LIBOR rate plus 334 basis points to 3.98% fixed rate debt
plus applicable margins. Terms of the interest rate swap mirror the
underlying variable rate debt, except the interest rate swap terminates
on September 21, 2004. We entered into the transaction to help insulate
us from future increases in interest rates. Under SFAS No. 133, the
interest rate swap is accounted for as a cash flow
126 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
hedge. The change in the fair value of the interest rate swap net of
income taxes is recorded as an increase or decrease in other
comprehensive income (loss) in the Consolidated Statements of
Stockholder's Equity. The accrual of interest income or expense is
recognized in Interest Expense in the Consolidated Statements of
Operations. During the years ended December 31, 2002 and 2001 we
recognized approximately $555,000 and $112,000, respectively, in
incremental interest expense resulting from this transaction.
(11) Related Party Transactions
We earned revenues from WorldCom, a major shareholder of GCI (see note
8), net of discounts, of approximately $73,637,000, $58,225,000 and
$53,065,000 for the years ended December 31, 2002, 2001 and 2000,
respectively. As a percentage of total revenues, WorldCom revenues
totaled 20.0%, 16.3% and 18.1% for the years ended December 31, 2002,
2001 and 2000, respectively. Amounts receivable, net of accounts
payable, from WorldCom totaled $21,677,000 and $15,379,000 at December
31, 2002 and 2001, respectively. We paid WorldCom for distribution of
our traffic in the contiguous 48 states and Hawaii amounts totaling
approximately $6,413,000, $7,289,000 and $9,124,000 for the years ended
December 31, 2002, 2001 and 2000, respectively.
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 year ended December 31, 2002 we have recognized $11.0 million
in bad debt expense for uncollected amounts due from WorldCom. At
December 31, 2002 the bad debt reserve for uncollected amounts due from
WorldCom ("WorldCom reserve") totaled $11.6 million and consisted of all
billings for services rendered prior to July 21, 2002 that were not paid
or deemed recoverable as of December 31, 2002 and which have not been
subsequently paid through the date of this report. The WorldCom reserve
includes approximately $655,000 in reserves recognized prior to the
bankruptcy in addition to the $11.0 million in bad debt expense
previously discussed. Any payments received on amounts included in the
WorldCom reserve will reduce the reserve and bad debt expense in the
period of receipt. We currently cannot predict the timing or ultimate
amount, if any, that WorldCom will pay on outstanding balances due us as
of their bankruptcy filing date of July 21, 2002. WorldCom has made
timely payments for services rendered subsequent to July 21, 2002.
We entered into a long-term capital lease agreement in 1991 with the
wife of our president for property occupied by us. The leased asset was
capitalized in 1991 at the owner's cost of $900,000 and the related
obligation was recorded in the accompanying financial statements. The
lease agreement was amended in September 2002. The amended lease
terminates on September 30, 2011. Through September 30, 2003 our monthly
payment is $20,000, increasing to $20,860 per month October 1, 2003
through September 30, 2006 and increasing to $21,532 per month October
1, 2006 through September 30, 2011. Since the property was not sold
prior to the tenth year of the lease, the owner was required to pay us
the greater of one-half of the appreciated value of the property over
$900,000, or $500,000. Accordingly, we received $500,000 in the form of
a note in the first quarter of 2002. The owner paid us $135,000 in 2002
in the form of a note as additional consideration for the execution of
the September 2002 amendment.
During the six-month period ended June 30, 2001 and the year ended
December 31, 2000 we provided management services to Kanas. Effective
June 30, 2001 we completed the acquisition of WorldCom's 85% controlling
interest in Kanas (see note 3). During the six-month period ended June
30, 2001 and the year ended December 31, 2000 we earned revenues of
approximately $618,000 and $690,000, respectively, for management
services and long-distance services provided to Kanas. We paid
approximately $372,000 and $744,000 to Kanas for the lease and
maintenance of fiber optic cable capacity during the six-month period
ended June 30, 2001 and the year ended December 31, 2000, respectively.
We advanced approximately $4.9
127 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
million and $3.0 million to Kanas to partially fund its operations
during the six-month period ended June 30, 2001 and the year ended
December 31, 2000, respectively. Accounts receivable from Kanas were
approximately $3.7 million at December 31, 2000 and were classified as
Other Assets in the Consolidated Balance Sheets at December 31, 2000.
During the year ended December 31, 2002, we acquired the remaining 15%
interest in Kanas by GCI's issuance to the minority shareholders of
15,000 shares of its Class A common stock.
In January 2001 we entered into an aircraft operating lease agreement
with a company owned by GCI's president. The lease was amended effective
January 1, 2002. The lease is month-to-month and may be terminated at
any time upon one hundred and twenty days written notice. The monthly
lease rate in 2001 was $40,000, increasing to $50,000 per month on
January 1, 2002. Upon signing the lease, the lessor was granted an
option to purchase 250,000 shares of GCI Class A common stock at $6.50
per share. At December 31, 2002 all of the shares under the option
agreement are exercisable. We paid a deposit of $1.5 million in
connection with the lease. The deposit will be repaid to us, as amended,
upon the earlier of six months after the agreement terminates, or nine
months after the date of a termination notice. The lessor may sell to us
the stock arising from the exercise of the stock option or surrender the
right to purchase all or a portion of the stock option to repay the
deposit, as allowed by our debt and GCI's preferred stock instruments in
effect at such time.
(12) Commitments and Contingencies
Leases
Operating Leases as Lessee. We lease business offices, have entered into
site lease agreements and use satellite transponder capacity and certain
equipment pursuant to operating lease arrangements. Rental costs under
such arrangements amounted to approximately $13,445,000, $9,292,000 and
$8,152,000 for the years ended December 31, 2002, 2001 and 2000,
respectively.
Satellite Transponder Capacity Capital Lease
We lease satellite transponder capacity through a capital lease
arrangement with a leasing company. The capital lease was entered into
in March 2000. The effective term of the lease is nine years from the
closing date. The capital lease includes certain covenants requiring
maintenance of specific levels of operating cash flow to indebtedness
and limitations on additional indebtedness. We were in compliance with
all covenants during the year ending December 31, 2002.
We began operating the satellite transponders on April 1, 2000. The
satellite transponders are recorded at a cost of $48.2 million and are
being depreciated over twelve years. At December 31, 2002 and 2001 $44.9
million and $45.9 million, respectively, was financed under this capital
lease.
128 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
A summary of future minimum lease payments for all leases follows
(amounts in thousands):
Years ending December 31: Operating Capital
------------ -------------
2003 $ 11,780 5,115
2004 9,613 9,602
2005 8,994 10,243
2006 7,343 9,723
2007 5,535 8,813
2008 and thereafter 24,408 25,447
------------ -------------
Total minimum lease payments $ 67,673 68,943
============
Less amount representing interest (22,311)
Less current maturities of obligations under capital
leases (1,857)
-------------
Subtotal - long-term obligations under capital leases 44,775
Less long-term obligations under capital leases due to
related party, excluding current maturities (703)
-------------
Long-term obligations under capital leases, excluding
related party, excluding current maturities $ 44,072
=============
The leases generally provide that we pay the taxes, insurance and
maintenance expenses related to the leased assets. We expect that in the
normal course of business leases that expire will be renewed or replaced
by leases on other properties.
Operating Leases as Lessor. In 1999 we signed agreements with a large
commercial customer for the lease of DS3 circuits on Alaska United
facilities within Alaska, and between Alaska and the Lower 48 states.
The lease agreements were for three years with renewal options. One
lease was canceled in January 2002, approximately two months before its
expiration. The remaining two leases were not renewed after their
initial three year terms expired.
Telecommunication Services Agreement
We lease a portion of our 800-mile fiber optic system capacity that
extends from Prudhoe Bay to Valdez via Fairbanks, and provide management
and maintenance services for this capacity to a customer. The
telecommunications service agreement is for fifteen years and may be
extended for up to two successive three-year periods and, upon
expiration of the extensions, one additional year.
A summary of minimum future service revenues, assuming the agreement is
not terminated pursuant to contract provisions, follows (amounts in
thousands):
Years ending December 31,
2003 $ 7,620
2004 7,620
2005 7,620
2006 7,620
2007 7,620
2008 and thereafter 64,467
---------
Total minimum future service revenues $ 102,567
=========
In December 2001 we signed a letter of agreement with our customer in
which we agreed, amongst other things, to upgrade the 800-mile fiber
optic system, install multiple earth stations, and potentially provide
other services. We have completed the projects outlined in the letter of
agreement and expect testing and
129 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
acceptance to be completed no later than the fourth quarter of 2003. We
expect the contract to be amended in 2003 consistent with the terms of
the letter of agreement. We expect the following additional minimum
future service revenues, assuming the agreement is amended and is not
terminated pursuant to contract provisions (amounts in thousands):
Years ending December 31,
2003 $ 2,810
2004 5,580
2005 5,580
2006 5,580
2007 5,580
2008 and thereafter 47,208
--------
Total minimum future service revenues $ 72,338
========
Deferred Compensation Plan
During 1995, we adopted a non-qualified, unfunded deferred compensation
plan to provide a means by which certain employees may elect to defer
receipt of designated percentages or amounts of their compensation and
to provide a means for certain other deferrals of compensation. We may
contribute matching deferrals at a rate selected by us. Participants
immediately vest in all elective deferrals and all income and gain
attributable thereto. Matching contributions and all income and gain
attributable thereto vest over a six-year period. Participants may elect
to be paid in either a single lump sum payment or annual installments
over a period not to exceed 10 years. Vested balances are payable upon
termination of employment, unforeseen emergencies, death and total
disability. Participants are general creditors of us with respect to
deferred compensation plan benefits. Compensation deferred pursuant to
the plan totaled approximately $82,000, $39,000 and $0 for the years
ended December 31, 2002, 2001 and 2000, respectively.
Performance Based Incentive Compensation Plan
During 2002 we adopted a non-qualified, performance based incentive
compensation plan. The incentive compensation plan provides additional
compensation to certain officers and key employees based upon the
Company's achievement of specified financial performance goals. The
Compensation Committee of GCI's Board of Directors establishes goals on
which executive officers are compensated, and management establishes the
goals for other covered employees. Awards may be payable in cash or
GCI's Class A common stock. No amounts were charged to expense in 2002
under the new plan.
Self-Insurance
We are self-insured for losses and liabilities related primarily to
health and welfare claims up to predetermined amounts above which third
party insurance applies. A reserve of $1.6 million and $1.5 million was
recorded at December 31, 2002 and 2001, respectively, to cover estimated
reported losses, estimated unreported losses based on past experience
modified for current trends, and estimated expenses for investigating
and settling claims. Actual losses will vary from the recorded reserve.
While we use what we believe is pertinent information and factors in
determining the amount of reserves, future additions to the reserves may
be necessary due to changes in the information and factors used.
We are self-insured for damage or loss to certain of our transmission
facilities, including our buried, under sea, and above-ground
transmission lines. If we become subject to substantial uninsured
liabilities due to damage or loss to such facilities, our financial
position, results of operations or liquidity may be adversely affected.
Beginning January 1, 2003, we will be self-insured for losses and
liabilities related to workers' compensation claims up to predetermined
amounts above which third party insurance applies. A reserve will be
recorded in 2003 to cover estimated reported losses and estimated
expenses for investigating and settling claims. Actual losses will vary
from the recorded reserve.
130 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
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.
On July 1, 1999, the APUC ruled that the rural exemptions from local
competition for the ILECs operating in Juneau, Fairbanks and North Pole
would not be continued, which allowed us to negotiate for unbundled
elements for the provision of competitive local service. ACS requested
reconsideration of this decision and on October 11, 1999, the RCA issued
an order terminating rural exemptions for the ILECs operating in the
Fairbanks and Juneau markets. ACS has appealed these decisions. The
appeal presently is before the Alaska Supreme Court. On February 11,
2003, the Alaska Supreme Court heard oral argument. One of the principal
issues in dispute concerns the assignment of the burden of proof. In
accordance with instructions from the Alaska Superior Court, the APUC
assigned the burden to ACS at the remand proceeding. At the oral
argument, several Justices expressed concern with the assignment of the
burden. At this time, we cannot reasonably predict what the outcome of
the case will be or even what relief the Court might order if it were to
find that the burden of proof was improperly assigned to ACS. An adverse
decision from the Court, however, has the potential to disrupt our
ability to provide service to our Fairbanks and Juneau customers over
our facilities. We expect a decision from the Court within six months
from the date of oral argument.
While the ultimate results of these items cannot be predicted with
certainty, except for the rural exemption proceedings described above,
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
liquidity.
Cable Service Rate Reregulation
Federal law permits regulation of basic cable programming services
rates. However, Alaska law provides that cable television service is
exempt from regulation by the Regulatory Commission of Alaska ("RCA")
unless 25% of a system's subscribers request such regulation by filing a
petition with the RCA. At December 31, 2002, only the Juneau system is
subject to RCA regulation of its basic service rates. No petition
requesting regulation has been filed for any other system. (The Juneau
system serves 7.1% of our total basic service subscribers at December
31, 2002.) On July 27, 2000 the RCA approved in full a requested rate
increase for the Juneau system, which was effective October 1, 2000. The
cable rate increase in the Juneau system effective February 1, 2003, did
not effect basic programming service and therefore did not require RCA
approval.
Internal Revenue Service Examination
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. GCI's 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.
131 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
ILEC Over-earnings Refund
The FCC ruled in February 2001 that earnings of Alaska Communications
Systems, Inc. ("ACS") for the 1997 to 1998 reporting period exceeded
their authorized rate of return and ordered a refund to us from ACS.
Rate of return carriers such as ACS are required by the FCC to refund
earnings from interstate access charges assessed to long-distance
carriers when their earnings exceed their authorized rate of return. ACS
appealed the FCC ruling to the U.S. Court of Appeals for the District of
Columbia circuit ("Court"). On May 21, 2002, the Court granted in part
and denied in part the ACS appeal of the FCC's earlier decision
requiring ACS to refund the over-earnings. The court remanded the case
to the FCC for a determination of the appropriate refund due as a result
of the decision. The parties have briefed the relevant issues before the
FCC, and a decision in the remand proceeding is pending. That decision,
once issued, itself can be appealed. GCI and ACS have entered into
discussions concerning the possible settling of the dispute, which
discussions have not yet produced a final agreement. We are unable to
determine the final amount to be refunded and when it may be refunded.
The refundable amount has been accounted for as a gain contingency, and,
accordingly, has not been recorded. The refundable amount, if any, will
be recorded upon receipt when realization is a certainty.
(13) Supplementary Financial Data
The following is a summary of unaudited quarterly results of operations
for the years ended December 31, 2002 and 2001 (amounts in thousands):
First Second Third Fourth Total
Quarter Quarter Quarter Quarter Year
------------ ----------- ------------ ----------- ------------
2002
----
Total revenues $ 88,210 92,740 94,550 92,342 367,842
Gross profit $ 56,973 61,879 64,175 61,251 244,278
Net income (loss) (1) $ 2,212 (1,103) 5,063 491 6,663
2001
----
Total revenues (2) $ 96,917 85,535 88,019 86,787 357,258
Gross profit $ 54,831 51,704 55,276 55,654 217,465
Net income (2) $ 2,423 166 1,527 473 4,589
----------------
1 We adopted SFAS 142, "Goodwill and Other Intangible Assets" on January
1, 2002, resulting in a $6.5 million decrease in depreciation and
amortization expense primarily in the cable services segment during the
year ended December 31, 2002 as compared to the years ended December
31, 2001.
2 The first quarter of 2001 includes $19.5 million of revenue and $8.7 of
operating income from the sale of long-haul capacity in the Alaska
United undersea fiber optic cable system.
----------------
132
Item 15(b). Exhibits
Listed below are the exhibits that are filed as a part of this Report
(according to the number assigned to them in Item 601 of Regulation S-K):
Exhibit No. Description
------------------------------------------------------------------------------------------------------------------
3.1 Articles of Incorporation of the Registrant (18)
3.2 Bylaws of the Registrant (18)
10.3 Westin Building Lease (5)
10.4 Duncan and Hughes Deferred Bonus Agreements (6)
10.5 Compensation Agreement between General Communication, Inc. and William C. Behnke dated
January 1, 1997 (19)
10.6 Order approving Application for a Certificate of Public Convenience and Necessity to operate
as a Telecommunications (Intrastate Interexchange Carrier) Public Utility within Alaska
(3)
10.7 1986 Stock Option Plan, as amended (21)
10.13 MCI Carrier Agreement between MCI Telecommunications Corporation and General Communication,
Inc. dated January 1, 1993 (8)
10.14 Contract for Alaska Access Services Agreement between MCI Telecommunications Corporation and
General Communication, Inc. dated January 1, 1993 (8)
10.15 Promissory Note Agreement between General Communication, Inc. and Ronald A. Duncan, dated
August 13, 1993 (9)
10.16 Deferred Compensation Agreement between General Communication, Inc. and Ronald A. Duncan,
dated August 13, 1993 (9)
10.17 Pledge Agreement between General Communication, Inc. and Ronald A. Duncan, dated August 13,
1993 (9)
10.19 Summary Plan Description pertaining to Qualified Employee Stock Purchase Plan of General
Communication, Inc., as amended and restated January 1, 2003 *
10.20 The GCI Special Non-Qualified Deferred Compensation Plan (11)
10.21 Transponder Purchase Agreement for Galaxy X between Hughes Communications Galaxy, Inc. and
GCI Communication Corp. (11)
10.25 Licenses: (5)
10.25.1 214 Authorization
10.25.2 International Resale Authorization
10.25.3 Digital Electronic Message Service Authorization
10.25.4 Fairbanks Earth Station License
10.25.5 Fairbanks (Esro) Construction Permit for P-T-P Microwave Service
10.25.6 Fairbanks (Polaris) Construction Permit for P-T-P Microwave Service
10.25.7 Anchorage Earth Station Construction Permit
10.25.8 License for Eagle River P-T-P Microwave Service
10.25.9 License for Juneau Earth Station
10.25.10 Issaquah Earth Station Construction Permit
10.26 ATU Interconnection Agreement between GCI Communication Corp. and Municipality of Anchorage,
executed January 15, 1997 (18)
10.29 Asset Purchase Agreement, dated April 15, 1996, among General Communication, Inc., ACNFI,
ACNJI and ACNKSI (12)
10.30 Asset Purchase Agreement, dated May 10, 1996, among General Communication, Inc., and Alaska
Cablevision, Inc. (12)
10.31 Asset Purchase Agreement, dated May 10, 1996, among General Communication, Inc., and
McCaw/Rock Homer Cable System, J.V. (12)
10.32 Asset Purchase Agreement, dated May 10, 1996, between General Communication, Inc., and
McCaw/Rock Seward Cable System, J.V. (12)
10.33 Amendment No. 1 to Securities Purchase and Sale Agreement, dated October 31, 1996, among
General Communication, Inc., and the Prime Sellers Agent (13)
133
Exhibit No. Description
------------------------------------------------------------------------------------------------------------------
10.34 First Amendment to Asset Purchase Agreement, dated October 30, 1996, among General
Communication, Inc., ACNFI, ACNJI and ACNKSI (13)
10.36 Order Approving Arbitrated Interconnection Agreement as Resolved and Modified by Order
U-96-89(8) dated January 14, 1997 (18)
10.37 Amendment to the MCI Carrier Agreement executed April 20, 1994 (18)
10.38 Amendment No. 1 to MCI Carrier Agreement executed July 26, 1994 (16)
10.39 MCI Carrier Addendum--MCI 800 DAL Service effective February 1, 1994 (16)
10.40 Third Amendment to MCI Carrier Agreement dated as of October 1, 1994 (16)
10.41 Fourth Amendment to MCI Carrier Agreement dated as of September 25, 1995 (16)
10.42 Fifth Amendment to the MCI Carrier Agreement executed April 19, 1996 (18)
10.43 Sixth Amendment to MCI Carrier Agreement dated as of March 1, 1996 (16)
10.44 Seventh Amendment to MCI Carrier Agreement dated November 27, 1996 (20)
10.45 First Amendment to Contract for Alaska Access Services between General Communication, Inc.
and MCI Telecommunications Corporation dated April 1, 1996 (20)
10.46 Service Mark License Agreement between MCI Communications Corporation and General
Communication, Inc. dated April 13, 1994 (19)
10.47 Radio Station Authorization (Personal Communications Service License), Issue Date June 23,
1995 (19)
10.50 Contract No. 92MR067A Telecommunications Services between BP Exploration (Alaska), Inc.
and GCI Network Systems dated April 1, 1992 (20)
10.51 Amendment No. 03 to BP Exploration (Alaska) Inc. Contract No. 92MRO67A effective August 1,
1996 (20)
10.52 Lease Agreement dated September 30, 1991 between RDB Company and General Communication,
Inc. (3)
10.54 Order Approving Transfer Upon Closing, Subject to Conditions, and Requiring Filings dated
September 23, 1996 (19)
10.55 Order Granting Extension of Time and Clarifying Order dated October 21, 1996 (19)
10.58 Employment and Deferred Compensation Agreement between General Communication, Inc. and
John M. Lowber dated July 1992 (19)
10.59 Deferred Compensation Agreement between GCI Communication Corp. and Dana L. Tindall dated
August 15, 1994 (19)
10.60 Transponder Lease Agreement between General Communication Incorporated and Hughes
Communications Satellite Services, Inc., executed August 8, 1989 (9)
10.61 Addendum to Galaxy X Transponder Purchase Agreement between GCI Communication Corp. and
Hughes Communications Galaxy, Inc. dated August 24, 1995 (19)
10.62 Order Approving Application, Subject to Conditions; Requiring Filing; and Approving
Proposed Tariff on an Inception Basis, dated February 4, 1997 (19)
10.66 Supply Contract Between Submarine Systems International Ltd. And GCI Communication Corp.
dated as of July 11, 1997. (23)
10.67 Supply Contract Between Tyco Submarine Systems Ltd. And Alaska United Fiber System
Partnership Contract Variation No. 1 dated as of December 1, 1997. (23)
10.71 Third Amendment to Contract for Alaska Access Services between General Communication, Inc.
and MCI Telecommunications Corporation dated February 27, 1998 (25)
10.77 General Communication, Inc. Preferred Stock Purchase Agreement (26)
10.78 Qualified Employee Stock Purchase Plan of General Communication, Inc., as amended and restated
January 01, 2003 *
10.79 Statement of Stock Designation (Series B) (26)
10.80 Fourth Amendment to Contract for Alaska Access Services between General Communication,
Inc. and its wholly owned subsidiary GCI Communication Corp., and MCI WorldCom. (27)
134
Exhibit No. Description
------------------------------------------------------------------------------------------------------------------
10.82 Lease Intended for Security between GCI Satellite Co., Inc. and General Electric Capital
Corporation (29)
10.89 Fifth Amendment to Contract for Alaska Access Services between General Communication, Inc.
and its wholly owned subsidiary GCI Communication Corp., and MCI WorldCom Network
Services, Inc., formerly known as MCI Telecommunications Corporation dated August 7, 2000
# (31)
10.90 Sixth Amendment to Contract for Alaska Access Services between General Communication, Inc.
and its wholly owned subsidiary GCI Communication Corp., and MCI WorldCom Network
Services, Inc., formerly known as MCI Telecommunications Corporation dated February 14,
2001 # (31)
10.91 Seventh Amendment to Contract for Alaska Access Services between General Communication,
Inc. and its wholly owned subsidiary GCI Communication Corp., and MCI WorldCom Network
Services, Inc., formerly known as MCI Telecommunications Corporation dated March 8, 2001
# (31)
10.99 Statement of Stock Designation (Series C) (34)
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 # (35)
10.101 Credit, Guaranty, Security and Pledge Agreement between GCI Holdings, Inc. and Credit
Lyonnais New York Branch as Administrative Agent, Issuing Bank, Co-Bookrunner and
Co-Arranger, General Electric Capital Corporation as Documentation Agent, Co-Arranger
and Co-Bookrunner and CIT Lending Services Corporation as Syndication Agent, dated as
of November 1, 2002. (36)
10.102 First Amendment to Lease Agreement dated as of September 2002 between RDB Company and GCI
Communication Corp. as successor in interest to General Communication, Inc. *
10.103 Agreement and plan of merger of GCI American Cablesystems, Inc. a Delaware corporation and
GCI Cablesystems of Alaska, Inc. an Alaska corporation each with and into GCI Cable,
Inc. an Alaska corporation, adopted as of December 10, 2002 *
10.104 Articles of merger between GCI Cablesystems of Alaska, Inc. and GCI Cable, Inc., adopted
as of December 10, 2002 *
10.105 Aircraft lease agreement between GCI Communication Corp., and Alaska corporation and 560
Company, Inc., an Alaska corporation, dated as of January 22, 2001 *
10.106 First amendment to aircraft lease agreement between GCI Communication Corp., and Alaska
corporation and 560 Company, Inc., an Alaska corporation, dated as of February 8, 2002
*
21.1 Subsidiaries of the Registrant *
99 Additional Exhibits:
99.1 The Articles of Incorporation of GCI Communication Corp. (2)
99.2 The Bylaws of GCI Communication Corp. (2)
99.7 The Bylaws of GCI Cable, Inc. (14)
99.8 The Articles of Incorporation of GCI Cable, Inc. (14)
99.15 The Bylaws of GCI Holdings, Inc. (19)
99.16 The Articles of Incorporation of GCI Holdings, Inc. (19)
99.19 The Bylaws of GCI Transport, Inc. (23)
99.20 The Articles of Incorporation of GCI Transport, Inc. (23)
99.21 The Bylaws of Fiber Hold Co., Inc. (23)
99.22 The Articles of Incorporation of Fiber Hold Co., Inc. (23)
99.23 The Bylaws of GCI Fiber Co., Inc. (23)
99.24 The Articles of Incorporation of GCI Fiber Co., Inc. (23)
99.25 The Bylaws of GCI Satellite Co., Inc. (23)
135
Exhibit No. Description
------------------------------------------------------------------------------------------------------------------
99.26 The Articles of Incorporation of GCI Satellite Co., Inc. (23)
99.27 The Partnership Agreement of Alaska United Fiber System (23)
99.28 The Bylaws of Potter View Development Co., Inc. (32)
99.29 The Articles of Incorporation of Potter View Development Co., Inc. (32)
99.30 The Bylaws of GCI American Cablesystems, Inc. (34)
99.31 The Articles of Incorporation of GCI American Cablesystems, Inc. (34)
99.32 The Bylaws of GCI Cablesystems of Alaska, Inc. (34)
99.33 The Articles of Incorporation of GCI Cablesystems of Alaska, Inc. (34)
99.34 The Bylaws of GCI Fiber Communication, Co., Inc. (34)
99.35 The Articles of Incorporation of GCI Fiber Communication, Co., Inc. (34)
99.36 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 *
-------------------------
# Certain information has been redacted from this document which we desire to keep undisclosed.
* Filed herewith.
-------------------------
Exhibit
Reference Description
------------------------------------------------------------------------------------------------------------------
2 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1990
3 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1991
5 Incorporated by reference to GCI's Registration Statement on Form 10 (File No.
0-15279), mailed to the Securities and Exchange Commission on December 30, 1986
6 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1989.
8 Incorporated by reference to GCI's Current Report on Form 8-K dated June 4, 1993.
9 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1993.
10 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1994.
11 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1995.
12 Incorporated by reference to GCI's Form S-4 Registration Statement dated October 4, 1996.
13 Incorporated by reference to GCI's Current Report on Form 8-K dated November 13, 1996.
14 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1996.
16 Incorporated by reference to GCI's Current Report on Form 8-K dated March 14, 1996,
filed March 28, 1996.
18 Incorporated by reference to GCI's Form S-3 Registration Statement (File No. 333-28001)
dated May 29, 1997.
19 Incorporated by reference to GCI's Amendment No. 1 to Form S-3/A Registration Statement
(File No. 333-28001) dated July 8, 1997.
20 Incorporated by reference to GCI's Amendment No. 2 to Form S-3/A Registration Statement
(File No. 333-28001) dated July 21, 1997.
21 Incorporated by reference to GCI's Amendment No. 3 to Form S-3/A Registration
136
Exhibit
Reference Description
------------------------------------------------------------------------------------------------------------------
Statement (File No. 333-28001) dated July 22, 1997.
23 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 1997.
24 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 1998.
25 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 1998.
26 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended March 31, 1999.
27 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 1999.
28 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 1999.
29 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 2000.
30 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 2000.
31 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended March 31, 2001.
32 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 2001.
33 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended September 30, 2001.
34 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 2001.
35 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 2002.
36 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended September 30, 2002.
(c) Reports on Form 8-K
None.
137
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholder
GCI, Inc.:
Under date of February 26, 2003, we reported on the consolidated balance sheets
of GCI, Inc. and subsidiaries ("Company") as of December 31, 2002 and 2001 and
the related consolidated statements of operations, stockholder's equity and cash
flows for each of the years in the three-year period ended December 31, 2002,
which are included in the Company's 2002 Annual Report on Form 10-K. In
connection with our audit of the aforementioned consolidated financial
statements, we also audited the related consolidated financial statement
schedule which is listed in the index in Item 15(a)(2) of the Company's 2002
Annual Report on Form 10-K. This consolidated financial statement schedule is
the responsibility of the Company's management. Our responsibility is to express
an opinion on this consolidated financial statement schedule based on our
audits.
In our opinion this consolidated financial statement schedule, when considered
in relation to the consolidated financial statements taken as a whole, presents
fairly, in all material respects the information set forth therein.
/s/
KPMG LLP
Anchorage, Alaska
February 26, 2003
138
Schedule VIII
GCI, INC. AND SUBSIDIARIES
Valuation and Qualifying Accounts
Years ended December 31, 2002, 2001 and 2000
Additions Deductions
--------- ----------
Balance at Charged to Write-offs Balance
beginning profit and net of at end of
Description of year loss Other recoveries year
- ------------------------------------------------------- --------------------------------------------------------------
(Amounts in thousands)
Allowance for doubtful receivables, year ended:
December 31, 2002 (1) $ 4,166 13,124 --- 3,280 14,010
============= ============ ========= ============= ===========
December 31, 2001 $ 2,864 4,076 --- 2,774 4,166
============= ============ ========= ============= ===========
December 31, 2000 $ 2,833 5,546 --- 5,515 2,864
============= ============ ========= ============= ===========
1 The Allowance for Doubtful Receivables at December 31, 2002 includes the
provision of $11.6 million of bad debt expense for estimated uncollectible
accounts due from WorldCom. See note 11 to the accompanying Notes to
Consolidated Financial Statements included in Part II of this Report for more
information.
139
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/ Ronald A. Duncan
---------------------------
Ronald A. Duncan, President
(Chief Executive Officer)
Date: March 24, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
Signatures Title Date
---------- ----- ----
/s/ Ronald A. Duncan President and Director March 24, 2003
------------------------------- ------------------------------
Ronald A. Duncan
/s/ G. Wilson Hughes Vice President and Director March 24, 2003
------------------------------- ------------------------------
G. Wilson Hughes
/s/ John M. Lowber Secretary, Treasurer and Director March 24, 2003
------------------------------- (Principal Financial and ------------------------------
John M. Lowber Accounting Officer)
140
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTIONS 302 AND 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Ronald A. Duncan, certify that:
1. I have reviewed this annual report on Form 10-K of GCI, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
the annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly represent in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have;
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluations Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluations as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
or registrants board of directors (or persons performing the equivalent
function);
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in the annual
report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluations, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 24, 2003 /s/ Ronald A. Duncan
-------------------------
Ronald A. Duncan
President
(Chief Executive Officer)
141
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTIONS 302 AND 906 OF THE SARBANES-OXLEY ACT OF 2002
I, John M. Lowber, certify that:
1. I have reviewed this annual report on Form 10-K of GCI, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
the annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly represent in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have;
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluations Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluations as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
or registrants board of directors (or persons performing the equivalent
function);
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in the annual
report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluations, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 24, 2003 /s/ John M. Lowber
-----------------------------
John M. Lowber
Secretary & Treasurer
(Principal Financial Officer)
142