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As filed with the Securities and Exchange Commission on August 8, 2003
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-5890
GCI, INC.
(Exact name of registrant as specified in its charter)
STATE OF ALASKA 91-1820757
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2550 Denali Street
Suite 1000
Anchorage, Alaska 99503
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (907) 265-5600
Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (l) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No .
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
$180,000,000 9.75% Senior Notes due August 2007.
1
GCI, INC.
A WHOLLY-OWNED SUBSIDIARY OF GENERAL COMMUNICATION, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2003
TABLE OF CONTENTS
Page No.
--------
Cautionary Statement Regarding Forward-Looking Statements.................................................3
PART I. FINANCIAL INFORMATION
Item l. Consolidated Balance Sheets as of June 30, 2003
(unaudited) and December 31, 2002..................................................5
Consolidated Statements of Operations for the
three and six months ended June 30, 2003
(unaudited) and 2002 (unaudited)...................................................7
Consolidated Statements of Stockholder's Equity
for the six months ended June 30, 2003
(unaudited) and 2002 (unaudited)...................................................8
Consolidated Statements of Cash Flows for the six
months ended June 30, 2003 (unaudited)
and 2002 (unaudited)...............................................................9
Notes to Interim Condensed Consolidated Financial
Statements.........................................................................10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................................................21
Item 3. Quantitative and Qualitative Disclosures About
Market Risk...........................................................................53
Item 4. Controls and Procedures...............................................................54
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.....................................................................54
Item 6. Exhibits and Reports on Form 8-K......................................................55
Other items are omitted, as they are not applicable.
SIGNATURES................................................................................................56
CERTIFICATIONS............................................................................................57
2
Cautionary Statement Regarding Forward-Looking Statements
You should carefully review the information contained in this Quarterly Report,
but should particularly consider any risk factors that we set forth in this
Quarterly Report and in other reports or documents that we file from time to
time with the Securities and Exchange Commission ("SEC"). In this Quarterly
Report, in addition to historical information, we state our future strategies,
plans, objectives or goals and our beliefs of future events and of our future
operating results, financial position and cash flows. In some cases, you can
identify those so-called "forward-looking statements" by words such as "may,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," "project," or "continue" or the negative of those words
and other comparable words. All forward-looking statements involve known and
unknown risks, uncertainties and other important factors that may cause our
actual results, performance, achievements, plans and objectives to differ
materially from any future results, performance, achievements, plans and
objectives expressed or implied by these forward-looking statements. In
evaluating those statements, you should specifically consider various factors,
including those outlined below. Those factors may cause our actual results to
differ materially from any of our forward-looking statements. For these
statements, we claim the protection of the safe harbor for forward-looking
statements provided by the Securities Reform Act. Such risks, uncertainties and
other factors include but are not limited to those identified below and those
further described in Part I, Item 1. Factors That May Affect Our Business and
Future Results of our December 31, 2002 Form 10-K.
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 Federal Communications Commission ("FCC") and state
public regulatory agencies to implement the provisions of the 1996
Telecom Act; the outcome of litigation relative thereto; and the impact
of regulatory changes relating to access reform;
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 Incumbent Local Exchange Carriers
("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 existing and
new initiatives, particularly local telephone services expansion,
Internet services expansion and wireless services;
o Start-up costs associated with entering new markets, including
advertising and promotional efforts;
3
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 on our industry and indirectly on us of oversupply of
capacity resulting from excessive deployment of network capacity in
certain markets we do not serve;
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 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
Regulatory Commission of Alaska ("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 MCI (previously
"WorldCom, Inc.") bankruptcy filing on the industry in general and on
us in particular;
o A conversion of MCI's bankruptcy petition to Chapter 7, a significant
delay in MCI's emergence from bankruptcy, or a migration of MCI'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, MCI 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.
4
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands) (Unaudited)
June 30, December 31,
ASSETS 2003 2002
- --------------------------------------------------------------------------- ---------------- ---------------
Current assets:
Cash and cash equivalents $ 17,977 11,940
--------------- ----------------
Receivables:
Trade 70,549 63,111
Employee 320 391
Other 2,621 3,093
--------------- ----------------
73,490 66,595
Less allowance for doubtful receivables 13,522 14,010
--------------- ----------------
Net receivables 59,968 52,585
--------------- ----------------
Prepaid and other current assets 9,938 9,171
Deferred income taxes, net 8,829 8,509
Notes receivable with related parties 1,059 697
Property held for sale 1,037 1,037
Inventories 408 400
--------------- ----------------
Total current assets 99,216 84,339
--------------- ----------------
Property and equipment in service, net of depreciation 376,838 381,394
Construction in progress 13,530 16,958
--------------- ----------------
Net property and equipment 390,368 398,352
--------------- ----------------
Cable certificates, net of amortization of $26,775 and $26,884 at June
30, 2003 and December 31, 2002, respectively 191,241 191,132
Goodwill, net of amortization of $7,200 at June 30, 2003 and December 31,
2002 41,972 41,972
Other intangible assets, net of amortization of $1,327 and $1,848 at June
30, 2003 and December 31, 2002, respectively 3,393 3,460
Deferred loan and senior notes costs, net of amortization of $5,999 and
$4,110 at June 30, 2003 and December 31, 2002, respectively 10,838 9,961
Notes receivable with related parties 5,060 5,142
Other assets, at cost, net of amortization of $39 and $24 at June 30, 2003
and December 31, 2002, respectively 5,282 4,424
--------------- ----------------
Total other assets 257,786 256,091
--------------- ----------------
Total assets $ 747,370 738,782
=============== ================
See accompanying notes to interim condensed consolidated financial statements.
5 (Continued)
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Continued)
(Amounts in thousands) (Unaudited)
June 30, December 31,
LIABILITIES AND STOCKHOLDER'S EQUITY 2003 2002
- -------------------------------------------------------------------------- ---------------- ----------------
Current liabilities:
Current maturities of obligations under long-term debt and capital
leases $ 22,900 1,857
Accounts payable 29,227 33,605
Deferred revenue 18,094 18,290
Accrued payroll and payroll related obligations 13,933 11,821
Accrued interest 8,000 7,938
Accrued liabilities 5,746 5,522
Due to related party 5,104 4,871
Subscriber deposits 758 889
---------------- ----------------
Total current liabilities 103,762 84,793
Long-term debt, excluding current maturities 335,000 357,700
Obligations under capital leases, excluding current maturities 42,094 44,072
Obligations under capital leases due to related party, excluding
current maturities 691 703
Deferred income taxes, net of deferred income tax benefit 21,902 16,061
Other liabilities 6,807 4,956
---------------- ----------------
Total liabilities 510,256 508,285
---------------- ----------------
Stockholder's equity:
Class A common stock. Authorized 10 shares; issued 0.01 shares at June
30, 2003 and December 31, 2002 206,622 206,622
Paid-in capital 44,147 44,904
Retained deficit (13,128) (20,489)
Accumulated other comprehensive loss (527) (540)
---------------- ----------------
Total stockholder's equity 237,114 230,497
Commitments and contingencies
---------------- ----------------
Total liabilities and stockholder's equity $ 747,370 738,782
================ ================
See accompanying notes to interim condensed consolidated financial statements.
6
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
-------------- -------------- --------------- --------------
(Amounts in thousands)
Revenues $ 95,939 92,740 188,716 180,950
Cost of sales and services 30,071 30,861 60,319 62,098
Selling, general and administrative expenses 34,294 32,585 67,287 63,886
Bad debt expense 802 10,616 1,399 11,197
Depreciation, amortization and accretion expense 12,800 13,912 26,301 27,870
-------------- -------------- --------------- --------------
Operating income 17,972 4,766 33,410 15,899
-------------- -------------- --------------- --------------
Other income (expense):
Interest expense (9,138) (6,236) (18,292) (12,827)
Amortization of loan and senior notes fees (625) (371) (1,698) (1,128)
Interest income 165 155 331 228
-------------- -------------- --------------- --------------
Other expense, net (9,598) (6,452) (19,659) (13,727)
-------------- -------------- --------------- --------------
Net income (loss) before income taxes and
cumulative effect of a change in
accounting principle 8,374 (1,686) 13,751 2,172
Income tax (expense) benefit (3,564) 583 (5,846) (1,063)
-------------- -------------- --------------- --------------
Net income (loss) before cumulative effect
of a change in accounting principle 4,810 (1,103) 7,905 1,109
Cumulative effect of a change in accounting
principle, net of income tax benefit of $367 --- --- (544) ---
-------------- -------------- --------------- --------------
Net income (loss) $ 4,810 (1,103) 7,361 1,109
============== ============== =============== ==============
See accompanying notes to interim condensed consolidated financial statements.
7
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
SIX MONTHS ENDED JUNE 30, 2003 AND 2002
(Unaudited)
Shares of Accumulated
Class A Class A Other
Common Common Paid-in Retained Comprehensive
(Amounts in thousands, except share amounts) Stock Stock Capital Deficit Income (Loss) Total
-----------------------------------------------------------------------------
Balances at December 31, 2001 100 $206,622 44,902 (27,152) 8 224,380
Components of comprehensive income:
Net income --- --- --- 1,109 --- 1,109
Change in fair value of cash flow hedge, net of
change in income tax liability of $151 --- --- --- --- (232) (232)
-----------
Comprehensive income 877
Contribution from General Communication, Inc. --- --- (409) --- --- (409)
-----------------------------------------------------------------------------
Balances at June 30, 2002 100 $206,622 44,493 (26,043) (224) 224,848
=============================================================================
Balances at December 31, 2002 100 $206,622 44,904 (20,489) (540) 230,497
Components of comprehensive income:
Net income --- --- --- 7,361 --- 7,361
Change in fair value of cash flow hedge, net of
change in income tax benefit of $105 --- --- --- --- 13 13
-----------
Comprehensive income 7,374
Contribution from General Communication, Inc. --- --- (757) --- --- (757)
-----------------------------------------------------------------------------
Balances at June 30, 2003 100 $206,622 44,147 (13,128) (527) 237,114
=============================================================================
See accompanying notes to interim condensed consolidated financial statements.
8
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
2003 2002
-------------- --------------
(Amounts in thousands)
Operating activities:
Net income $ 7,361 1,109
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, amortization and accretion expense 26,301 27,870
Deferred income tax expense 5,846 1,158
Amortization of loan and senior notes fees 1,698 1,128
Cumulative effect of a change in accounting principle, net of
income tax benefit of $367 544 ---
Bad debt expense, net of write-offs (488) 9,713
Deferred compensation and compensatory stock options 567 634
Other noncash income and expense items (254) 18
Change in operating assets and liabilities (9,935) (11,705)
-------------- --------------
Net cash provided by operating activities 31,640 29,925
-------------- --------------
Investing activities:
Purchases of property and equipment (17,375) (36,192)
Payment of deposit (721) ---
Notes receivable issued to related parties (48) (3,055)
Payments received on notes receivable with related parties 22 858
Purchases of other assets (403) (940)
-------------- --------------
Net cash used by investing activities (18,525) (39,329)
-------------- --------------
Financing activities:
Repayments of long-term borrowings and capital lease obligations (3,647) (395)
Long-term borrowings - bank debt --- 9,000
Payment of debt issuance costs (2,575) (250)
Cash contribution to General Communication, Inc. (856) (1,091)
-------------- --------------
Net cash provided (used) by financing activities (7,078) 7,264
-------------- --------------
Net increase (decrease) in cash and cash equivalents 6,037 (2,140)
Cash and cash equivalents at beginning of period 11,940 11,097
-------------- --------------
Cash and cash equivalents at end of period $ 17,977 8,957
============== ==============
See accompanying notes to interim condensed consolidated financial
statements.
9
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
The accompanying unaudited interim condensed consolidated financial statements
include the accounts of GCI, Inc. and its subsidiaries and have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. They should be read in
conjunction with our audited consolidated financial statements for the year
ended December 31, 2002, filed as part of our annual report on Form 10-K. In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. The results of
operations for interim periods are not necessarily indicative of the results
that may be expected for an entire year or any other period.
(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 Alaska 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., GCI Holdings,
Inc.'s subsidiaries GCI Communication Corp., GCI Cable, Inc., GCI
Transport Co., Inc., GCI Fiber Communication Co., Inc., 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, GCI Communication Corp.'s subsidiaries Potter View
Development Co., Inc., Wok 1, Inc. and Wok 2, Inc. and GCI
Transport Co., Inc.'s subsidiary GCI Satellite Co., Inc. All
subsidiaries are wholly-owned at June 30, 2003.
The consolidated financial statements include the consolidated
accounts of GCI, Inc. and its wholly owned subsidiaries with all
significant intercompany transactions eliminated.
10 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
(c) Earnings per Share and Common Stock
We are a wholly owned subsidiary of GCI and, accordingly, we are
not required to present earnings per share. Our common stock is not
publicly traded.
(d) Asset Retirement Obligations
On January 1, 2003 we adopted 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. Upon adoption, we recorded the cumulative effect of
accretion and depreciation expense as a cumulative effect of a
change in accounting principle of approximately $544,000, net of
income tax benefit of $367,000.
Following is a reconciliation of the beginning and ending aggregate
carrying amount of our asset retirement obligations at June 30,
2003 (amounts in thousands):
Balance at December 31, 2002 $ ---
Liability recognized upon adoption of SFAS
No. 143 1,565
Accretion expense for the six months
ended June 30, 2003 64
----------
Balance at June 30, 2003 $ 1,629
==========
Following is the amount of the liability for asset retirement
obligations as if SFAS No. 143 had been applied at December 31,
2001 (amounts in thousands):
Balance at December 31, 2001 $ 1,350
==========
Balance at June 30, 2002 $ 1,457
==========
Balance at June 30, 2003 $ 1,629
==========
(e) Payments Received from Suppliers
On March 20, 2003 the Financial Accounting Standards Board issued
Emerging Issues Task Force ("EITF") Issue No. 02-16, "Accounting by
a Reseller for Cash Consideration Received from a Vendor" ("EITF
No. 02-16"). We have applied EITF No. 02-16 prospectively for
arrangements entered into or modified after December 31, 2002. Our
cable services segment occasionally receives reimbursements for
costs to promote suppliers' services, called cooperative
advertising arrangements. The supplier payment is classified as a
reduction of selling, general and administrative expenses if it
reimburses specific, incremental and identifiable costs incurred to
resell the suppliers' services. Excess consideration, if any, is
classified as a reduction of cost of sales and services.
Occasionally our cable services segment enters into a binding
arrangement with a supplier in which we receive a rebate dependent
upon us meeting a specified goal. We recognize the rebate as a
reduction of cost of sales and services systematically as we make
progress toward the
11 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
specified goal, provided the amounts are probable and reasonably
estimable. If earning the rebate is not probable and reasonably
estimable, it is recognized only when the goal is met.
(f) Costs Associated with Exit or Disposal Activities
On January 1, 2003 we adopted SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". Upon adoption of SFAS
No. 146, enterprises may only record exit or disposal costs when
they are incurred and can be measured at fair value. The recorded
liability will be subsequently adjusted for changes in estimated
cash flows. SFAS 146 revises accounting for specified employee and
contract terminations that are part of restructuring activities.
Adoption of SFAS No. 146 did not have a material effect on our
results of operations, financial position and cash flows.
(g) Stock Option Plan
At June 30, 2003, we had one stock-based employee compensation
plan. 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 No. 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 grant. Alternatively, SFAS No. 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 No.
148.
12 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Stock-based employee compensation cost is reflected over the
options' vesting period of generally five 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 three and six months ended June 30, 2003 and
2002, if we had applied the fair-value recognition provisions of
SFAS No. 123 to stock-based employee compensation (amounts in
thousands):
Three Months Ended Six Months Ended
June 30, June 30,
----------- ---------- --------- -----------
2003 2002 2003 2002
----------- ---------- --------- -----------
Net income (loss), as reported $ 4,810 (1,103) 7,361 1,109
Total stock-based employee
compensation expense included in
reported net income, net of related
tax effects 91 83 159 142
Total stock-based employee
compensation expense under the
fair-value based method for all
awards, net of related tax effects (451) (488) (925) (1,063)
----------- ---------- --------- -----------
Pro forma net income (loss) $ 4,450 (1,508) 6,595 188
=========== ========== ========= ===========
The calculation of total stock-based employee compensation expense
under the fair-value based method includes weighted-average
assumptions of a risk-free interest rate, volatility and an
expected life.
(h) Concentrations of Credit Risk
Financial instruments that potentially subject us to concentrations
of credit risk are primarily cash and cash equivalents and accounts
receivable. Excess cash is invested in high quality short-term
liquid money instruments issued by highly rated financial
institutions. At June 30, 2003 and December 31, 2002, 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, MCI and Sprint Corporation. 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 MCI 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.
(i) Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others
On January 1, 2003 we adopted FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others". This
Interpretation elaborates on the disclosures to be made by a
guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also
clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a
13 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
liability for the fair value of the obligation undertaken in
issuing the guarantee. This Interpretation does not prescribe a
specific approach for subsequently measuring the guarantor's
recognized liability over the term of the related guarantee. This
Interpretation also incorporates, without change, the guidance in
FIN No. 34, "Disclosure of Indirect Guarantees of Indebtedness of
Others", which is being superseded. Adoption of FIN No. 45 did not
have a material effect on our results of operations, financial
position and cash flows.
(j) Reclassifications
Reclassifications have been made to the 2002 financial statements
to make them comparable with the 2003 presentation.
(2) Consolidated Statements of Cash Flows Supplemental Disclosures
Changes in operating assets and liabilities consist of (amounts in
thousands):
Six month periods ended June 30, 2003 2002
------------ ------------
Increase in accounts receivable $ (6,894) (7,819)
Increase in inventories (8) (820)
(Increase) decrease in prepaid and other current assets (767) 455
Decrease in accounts payable (4,379) (1,124)
Decrease in deferred revenues (196) (162)
Increase (decrease) in accrued payroll and payroll
related obligations 2,112 (4,783)
Increase in accrued interest 62 196
Increase in accrued liabilities 224 1,258
Increase (decrease) in subscriber deposits (130) 202
Increase in components of other long-term liabilities 41 892
------------ ------------
$ (9,935) (11,705)
============ ============
We paid interest totaling approximately $18,230,000 and $12,631,000
during the six months ended June 30, 2003 and 2002, respectively.
Effective March 31, 2001 we acquired the assets and customer base of G.C.
Cablevision, Inc. Upon acquisition the seller received shares of GCI
Class A common stock with a future payment in additional shares
contingent upon the market price of our common stock on March 31, 2003.
At March 31, 2003 the market price condition was not met and GCI issued
approximately 222,600 shares of its Class A common stock.
(3) Intangible Assets
Cable certificates are allocated to our cable services segment. Goodwill
is primarily allocated to the cable services segment and the remaining
amount is not allocated to a reportable segment, but is included in the
All Other category in note 5.
14 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Amortization expense for amortizable intangible assets was as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
----------- ----------- ---------- ---------
Amortization expense $ 132 181 332 387
=========== =========== ========== =========
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 $ 526
2004 $ 470
2005 $ 338
2006 $ 334
2007 $ 273
No intangible assets have been impaired based upon impairment testing
performed as of December 31, 2002 and no indicators of impairment have
occurred since the impairment testing was performed.
(4) Long-term Debt
On April 22, 2003 we amended our $225.0 million Senior Facility. The
amendment provides for the followings changes:
o The final maturity date has been extended to October 31, 2007,
o We may fund capital expenditures, including construction or
acquisition of additional fiber optic cable system capacity,
through our own cash flow or by draws on the revolving credit
facility of the Senior Facility not to exceed $25.0 million, and
o The definition of Excess Cash Flow has been changed to the
amount by which earnings before interest, taxes, depreciation,
and amortization exceeds certain fixed charges as defined in the
Senior Facility agreement plus one-time fiber sales to the
extent such fiber sales are not included in earnings before
interest, taxes, depreciation, and amortization,
The amendment requires us to prepay the term loan as follows (amounts in
thousands):
Date Amount
------------------------------------------ --------
Quarterly from September 30, 2003 to
December 31, 2004 $ 5,000
Quarterly from March 31, 2005 to December
31, 2005 $ 6,000
Quarterly from March 31, 2006 to December
31, 2006 $ 8,000
Quarterly from March 31, 2007 to September
30, 2007 $ 10,000
The remaining balance of the term loan will be payable in full on October
31, 2007.
15 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Under the amended Senior Facility capital expenditures, other than those
incurred to build or acquire additional fiber optic cable system
capacity, in any of the years ended December 31, 2003, 2004, 2005 and
2006 may not exceed:
o $25.0 million, plus
o 100% of any Excess Cash Flow during the applicable period less
certain permitted investments of up to $5.0 million during the
applicable period.
Under the amended Senior Facility we must either have repaid in full or
successfully refinanced our Senior Notes by February 1, 2007.
In connection with the amendment of the Senior Facility, we paid bank
fees and other expenses of approximately $2,379,000 during the six months
ended June 30, 2003 which will be amortized over the life of the amended
agreement.
(5) Industry Segments Data
Our reportable segments are business units that offer different products.
The reportable segments are each managed separately and offer distinct
products with different production and delivery processes.
We have four reportable segments as follows:
Long-distance services. We offer a full range of common carrier
long-distance services to commercial, government, other
telecommunications companies and residential customers, through our
networks of fiber optic cables, digital microwave, and fixed and
transportable satellite earth stations and our SchoolAccess(TM)
offering to rural school districts and a similar offering to rural
hospitals and health clinics.
Cable services. We provide cable television services to residential,
commercial and government users in the State of Alaska. Our cable
systems serve 33 communities and areas in Alaska, including the state's
four largest urban areas, Anchorage, Fairbanks, the Matanuska-Susitna
Valley and Juneau. We offer digital cable television services in
Anchorage, the Matanuska-Susitna Valley, Fairbanks, Juneau, Kenai and
Soldotna and retail cable modem service (through our Internet services
segment) in all of our locations in Alaska except Kotzebue. We 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.
Internet services. We offer wholesale and retail Internet services to
both consumer and commercial customers. 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 and cellular telephone services. 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 information technology,
accounting, legal and regulatory, human resources and other general and
administrative expenses. Operating expenses for the preparation of our
new phone directory are included in the All Other category. The revenue
and costs of sales and service for our new phone directory will be
included in the All Other category upon their recognition.
16 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
We evaluate performance and allocate resources based on (1) earnings or
loss from operations before depreciation, amortization and accretion
expense, net other 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, except approximately 72% of our undersea
fiber optic cable system which transits international waters.
Summarized financial information for our reportable segments for the six
months ended June 30, 2003 and 2002 follows (amounts in thousands):
Reportable Segments
--------------------------------------------------------
Long- Local Total
Distance Cable Access Internet Reportable All
Services Services Services Services Segments Other Total
------------------------------------------------------------------------------
2003
----
Revenues:
Intersegment $ 7,251 1,258 5,015 6,382 19,906 372 20,278
External 100,056 47,310 17,671 9,380 174,417 14,299 188,716
------------------------------------------------------------------------------
Total revenues $ 107,307 48,568 22,686 15,762 194,323 14,671 208,994
==============================================================================
Earnings (loss) from
operations before
depreciation,
amortization, net interest
expense and income taxes $ 53,239 22,806 1,607 1,339 78,991 (18,049) 60,942
==============================================================================
Operating income (loss) $ 43,482 13,744 (129) (361) 56,736 (22,095) 34,641
==============================================================================
2002
----
Revenues:
Intersegment $ 10,847 1,017 5,490 4,548 21,902 372 22,274
External 102,442 43,265 15,414 7,485 168,606 12,344 180,950
------------------------------------------------------------------------------
Total revenues $ 113,289 44,282 20,904 12,033 190,508 12,716 203,224
==============================================================================
Earnings (loss) from
operations before
depreciation,
amortization, net interest
expense and income taxes $ 43,212 20,351 2,127 (5,658) 60,032 (15,806) 44,226
==============================================================================
Operating income (loss) $ 30,953 12,085 459 (7,432) 36,065 (19,709) 16,356
==============================================================================
17 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
A reconciliation of reportable segment revenues to consolidated revenues
follows (amounts in thousands):
Six months ended June 30, 2003 2002
--------------- ---------------
Reportable segment revenues $ 194,323 190,508
Plus All Other revenues 14,671 12,716
Less intersegment revenues eliminated in consolidation 20,278 22,274
--------------- ---------------
Consolidated revenues $ 188,716 180,950
=============== ===============
A reconciliation of reportable segment earnings from operations before
depreciation, amortization and accretion expense, net other expense and
income taxes to consolidated net income before income taxes and
cumulative effect of a change in accounting principle follows (amounts in
thousands):
Six months ended June 30, 2003 2002
-------------- ----------------
Reportable segment earnings from operations before
depreciation, amortization and accretion expense, net other
expense and income taxes $ 78,991 60,032
Less All Other loss from operations before depreciation,
amortization and accretion expense, net other expense and
income taxes 18,049 15,806
Less intersegment contribution eliminated in consolidation 1,231 457
-------------- ----------------
Consolidated earnings from operations before
depreciation, amortization and accretion expense, net
other expense and income taxes 59,711 43,769
Less depreciation, amortization and accretion expense 26,301 27,870
-------------- ----------------
Consolidated operating income 33,410 15,899
Less other expense, net 19,659 13,727
-------------- ----------------
Consolidated net income before income taxes and cumulative
effect of a change in accounting principle $ 13,751 2,172
============== ================
A reconciliation of reportable segment operating income to consolidated
net income before income taxes and cumulative effect of a change in
accounting principle follows (amounts in thousands):
Six months ended June 30, 2003 2002
--------------- ---------------
Reportable segment operating income $ 56,736 36,065
Less All Other operating loss 22,095 19,709
Less intersegment contribution eliminated in consolidation 1,231 457
--------------- ---------------
Consolidated operating income 33,410 15,899
Less other expense, net 19,659 13,727
--------------- ---------------
Consolidated net income before income taxes and cumulative
effect of a change in accounting principle $ 13,751 2,172
=============== ===============
18 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
(6) Commitments and Contingencies
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 Alaska Public Utilities Commission ("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. Alaska Communications Systems, Inc. ("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 are unable to predict when the Court will issue their
decision.
While the ultimate results of these items cannot be predicted with
certainty, we do not expect at this time the resolution of them, except
for the rural exemption proceedings described above, to have a material
adverse effect on our financial position, results of operations or
liquidity.
Fiber Optic Cable System Construction Commitment
In June 2003 we began work on the construction of a fiber optic cable
system connecting Seward, Alaska and Warrenton, Oregon, with leased
backhaul facilities to connect it to our switching and distribution
centers in Anchorage, Alaska and Seattle, Washington. A consortium of
companies has been selected to design, engineer, manufacture and install
the undersea fiber optic cable system and a contract has been signed at a
total cost to us of $35.2 million. We expect to fund construction of the
fiber optic cable system through our operating cash flows and, to the
extent necessary, with draws on our Senior Facility.
(7) Subsequent Events
On July 21, 2002 MCI 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. During the six months ended June 30, 2002 we recognized
$9.7 million in bad debt expense for uncollected amounts due from MCI.
During the three months ended September 30, 2002 we recognized an
additional $1.2 million in bad debt expense. At June 30, 2003 we had
total pre-petition amounts due from MCI of $12.9 million. At June 30,
2003 the bad debt reserve for uncollected amounts due from MCI ("MCI
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 June 30, 2003. The MCI reserve includes approximately
$0.7 million in reserves recognized prior to the bankruptcy in addition
to the bad debt expense previously discussed.
On July 22, 2003, the United States Bankruptcy Court approved the
settlement of pre-petition amounts owed to us by MCI and affirmed all of
our existing contracts with MCI. The settlement settles unpaid
19 (Continued)
GCI, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
balances due from MCI for services rendered prior to their bankruptcy
filing date, settles billing disputes between us, and establishes a right
to set-off certain of our pre-petition accounts payable to MCI. Under the
terms of the settlement:
o We will reduce our pre-petition accounts receivable from MCI by
approximately $800,000, and
o We may set-off approximately $1.0 million of our pre-petition
accounts payable to MCI. The $1.0 million in amounts due from
MCI which will be off-set by an equal amount of pre-petition
accounts payable was not included in the MCI reserve.
The remaining pre-petition accounts receivable balance owed by MCI to us
after these adjustments is $11.1 million which we will use as a credit
against amounts payable for future services purchased from MCI. We expect
to reduce the MCI reserve as we utilize credits for services otherwise
payable to MCI in the future. We expect to evaluate the likelihood that
we will receive full credit offset for our remaining pre-petition
accounts receivable balance when MCI exits bankruptcy proceedings and may
change our recognition method at that time.
On July 24, 2003, our contract to provide interstate and intrastate
long-distance services to MCI was extended for a minimum of five years to
July 2008. The agreement sets the terms and conditions under which we
originate and terminate certain types of long distance and data services
in Alaska on MCI's behalf. In exchange for extending the term of this
exclusive contract, MCI will receive a series of rate reductions
implemented in phases over the life of the contract.
20
PART I.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
In the following discussion, GCI, Inc. and its direct and indirect subsidiaries
are referred to as "we," "us" and "our."
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an on-going basis, we evaluate our estimates and
judgments, including those related to unbilled revenues, cost of sales and
services accruals, allowance for doubtful accounts, depreciation, amortization
and accretion 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. Historically, cash requirements for significant
acquisitions and major capital expenditures have been provided largely through
our financing activities. We expect to fund the construction of a new fiber
optic cable system through our operating cash flows and, to the extent
necessary, with draws on our Senior Facility, as further discussed in Liquidity
and Capital Resources included in Part I, Item 2 of this report.
Consolidated revenues increased by more than $3 million during the second
quarter of 2003 ("2003") as compared to the second quarter in 2002 ("2002"). Our
operating income increased by more than $13 million in 2003. Our net income
before income tax and cumulative effect of a change in accounting principle
increased by more than $10 million and our net income increased by almost $6
million. Three of our reportable business segments experienced growth in
external revenues from 2002 to 2003 as we continued to strengthen our position
in the markets we serve. The long-distance services segment experienced a
decrease in revenue in 2003 as compared to 2002. The long-distance services,
cable services and Internet services segments improved their operating results
in 2003. The operating results for the local access services segment decreased
in 2003.
21
Long-Distance Services Overview
Second quarter 2003 long-distance services revenue represented 53.8% of
consolidated revenues. Our provision of interstate and intrastate long-distance
services, private line and leased dedicated capacity services, and broadband
services accounted for 94.6% of our total long-distance services revenues during
the second quarter of 2003.
Factors that have the greatest impact on year-to-year changes in long-distance
services revenues may 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.
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. Additional contractual rate reductions occur
annually through the end of the initial term of the contract.
On July 21, 2002 MCI 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. During the six months
ended June 30, 2002 we recognized $9.7 million in bad debt expense for
uncollected amounts due from MCI. During the three months ended September 30,
2002 we recognized an additional $1.2 million in bad debt expense. At June 30,
2003 we had total pre-petition amounts due from MCI of $12.9 million. At June
30, 2003 the bad debt reserve for uncollected amounts due from MCI ("MCI
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
June 30, 2003. The MCI reserve includes approximately $0.7 million in reserves
recognized prior to the bankruptcy in addition to the bad debt expense
previously discussed.
On July 22, 2003, the United States Bankruptcy Court approved the settlement of
pre-petition amounts owed to us by MCI and affirmed all of our existing
contracts with MCI. The settlement settles unpaid balances due from MCI for
services rendered prior to their bankruptcy filing date, settles billing
disputes between us, and establishes a right to set-off certain of our
pre-petition accounts payable to MCI. Under the terms of the settlement:
o We will reduce our pre-petition accounts receivable from MCI by
approximately $800,000, and
o We may set-off approximately $1.0 million of our pre-petition accounts
payable to MCI. The $1.0 million in amounts due from MCI which will be
off-set by an equal amount of pre-petition accounts payable was not
included in the MCI reserve.
The remaining pre-petition accounts receivable balance owed by MCI to us after
these adjustments is $11.1 million which we will use as a credit against amounts
payable for future services purchased from MCI. We expect to reduce the MCI
reserve as we utilize credits for services otherwise payable to MCI in the
future. We expect to evaluate the likelihood that we will receive full credit
offset for our remaining pre-petition accounts receivable balance when MCI exits
bankruptcy proceedings and may change our recognition method at that time.
22
On July 24, 2003, our contract to provide interstate and intrastate
long-distance services to MCI was extended for a minimum of five years to July
2008. The agreement sets the terms and conditions under which we originate and
terminate certain types of long distance and data services in Alaska on MCI's
behalf. In exchange for extending the term of this exclusive contract, MCI will
receive a series of rate reductions implemented in phases over the life of the
contract.
We believe that MCI may ultimately exit bankruptcy with their business intact.
We cannot predict how long it may take MCI 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.
Recent announcements, hearings and media coverage reflect a political movement
that may be attempting to deny MCI from continuing to provide services to
government agencies. We estimate that 25% of our MCI revenues are attributed to
their provision of service to government agencies. Our MCI revenues could be
significantly reduced if MCI's government contract traffic moves from their
network to other carriers' networks for which we do not provide service to.
Other common carrier traffic routed to us for termination in Alaska is largely
dependent on traffic routed to MCI 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
MCI 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.
Due in large part to the favorable synergistic effects of our integrated
approach, the long-distance services segment continues to be a significant
contributor to our overall performance, although the migration of traffic from
voice to data continues.
Cable Services Overview
Second quarter 2003 cable television revenues represented 24.9% of consolidated
revenues. Our cable systems serve 33 communities and areas in Alaska, including
the state's four largest population centers, Anchorage, Fairbanks, the
Matanuska-Susitna Valley and Juneau.
We generate cable services revenues from four primary sources: (1) digital and
analog programming services, including monthly basic and premium subscriptions,
pay-per-view movies and 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 the second quarter
of 2003 programming services generated 77.6% of total cable services revenues,
cable services' allocable share of cable modem services accounted for 11.4% of
such revenues, equipment rental and installation fees accounted for 7.0% of such
revenues, advertising sales accounted for 3.2% of such revenues, and other
services accounted for the remaining 0.8% of total cable services revenues.
Effective February 2003, we increased rates charged for certain cable services
and premium packages in six communities, including three of the state's four
largest population centers, Anchorage, Fairbanks and Juneau. Rates increased
approximately 4% for those customers who experienced an adjustment.
The primary factors that contribute to year-to-year changes in cable services
revenues may include 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.
23
Our cable services segment faces competition from alternative methods of
receiving and distributing television signals, including but not limited to
direct broadcast satellite and, expected to begin in the third quarter of 2003,
digital video service over telephone lines, and from other sources of news,
information and entertainment. Several ILECs in the lower-48 states have
announced marketing arrangements to provide direct broadcast satellite services
along with local telephone and other services. Similar arrangements could be
extended to ILECs in the markets we serve in Alaska. We believe our cable
television services will continue to be competitive by providing, at reasonable
prices, a greater variety of communication services than are available off-air
or through other alternative delivery sources. Additionally, we believe we offer
superior technical performance and responsive community-based customer service.
Local Access Services Overview
We generate local access services revenues from three primary sources: (1)
business and residential basic dial tone services; (2) business private line and
special access services; and (3) business and residential features and other
charges, including voice mail, caller ID, distinctive ring, inside wiring and
subscriber line charges. During the second quarter of 2003 local access services
revenues represented 9.6% of consolidated revenues.
The primary factors that contribute to year-to-year changes in local access
services revenues may include 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 the second quarter of
2003 Internet services segment revenues represented 5.0% of consolidated
revenues.
The primary factors that contribute to year-to-year changes in Internet services
revenues may include the average number of subscribers to our services during a
given reporting period, the average monthly subscription rates, the amount of
bandwidth purchased by large commercial customers, 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.
24
All Other Services Overview
Revenues reported in the All Other category as described in note 5 in the
accompanying Notes to Interim Condensed Consolidated Financial Statements
include our managed services, product sales, and cellular telephone services.
Revenues included in the All Other category represented 6.7% of total revenues
in the second quarter of 2003 and include managed services revenues totaling
$5.3 million, cellular telephone services revenues totaling $905,000 and product
sales revenues totaling $215,000.
25
RESULTS OF OPERATIONS
The following table sets forth selected Statement of Operations data as a
percentage of total revenues for the periods indicated (unaudited, underlying
data rounded to the nearest thousands):
Three Months Ended Six Months Ended
June 30, June 30,
Percent- Percent-
age age
Change (1) Change (1)
2003 vs. 2003 vs.
2003 2002 2002 2003 2002 2002
---- ---- ---- ---- ---- ----
Statement of Operations Data:
Revenues
Long-distance services 53.8% 56.5% (1.5%) 53.0% 56.6% (2.3%)
Cable services 24.9% 23.6% 8.9% 25.1% 23.9% 9.3%
Local access services 9.6% 8.8% 14.1% 9.4% 8.5% 14.6%
Internet services 5.0% 4.2% 22.4% 5.0% 4.2% 25.3%
All Other services 6.7% 6.9% 0.5% 7.5% 6.8% 15.8%
-----------------------------------------------------------------------
Total revenues 100.0% 100.0% 3.4% 100.0% 100.0% 4.3%
Cost of sales and services 31.3% 33.3% (2.6%) 32.0% 34.3% (2.9%)
Selling, general and administrative
expenses 35.8% 35.1% 5.2% 35.7% 35.3% 5.3%
Bad debt expense 0.8% 11.5% (92.4%) 0.7% 6.2% (87.5%)
Depreciation, amortization and accretion
expense 13.3% 15.0% (8.0%) 13.9% 15.4% (5.6%)
-----------------------------------------------------------------------
Operating income 18.8% 5.1% 277.1% 17.7% 8.8% 110.1%
Net income (loss) before income
taxes and cumulative effect of a
change in accounting principle 8.7% (1.8%) 596.7% 7.3% 1.2% 533.1%
Net income (loss) before
cumulative effect of a change in
accounting principle 5.0% (1.2%) 536.1% 4.2% 0.6% 612.8%
Net income (loss) 5.0% (1.2%) 536.1% 3.9% 0.6% 563.8%
Other Operating Data:
Long-distance services operating income (2) 45.2% 23.5% 89.8% 43.5% 30.2% 40.5%
Cable services operating income (3) 30.5% 29.1% 14.4% 29.1% 27.9% 13.7%
Local access services operating (loss)
income (4) (5.4%) 5.2% (218.2%) (0.7%) 3.0% (128.1%)
Internet services operating income (loss) (5) 1.4% (92.2%) 101.9% (3.8%) (99.3%) 95.1%
- --------------------------
1 Percentage change in underlying data.
2 Computed as a percentage of total external long-distance services revenues.
3 Computed as a percentage of total external cable services revenues.
4 Computed as a percentage of total external local access services revenues.
5 Computed as a percentage of total external Internet services revenues.
- --------------------------
26
Three Months Ended June 30, 2003 ("2003") Compared To Three Months Ended
June 30, 2002 ("2002").
Overview of Revenues and Cost of Sales and Services
Total revenues increased 3.4% from $92.7 million in 2002 to $95.9 million in
2003. The cable services, local access services and Internet services segments
and All Other Services contributed to the increase in total revenues, partially
off-set by a decrease in revenues in the long-distance services segment. See the
discussion below for more information by segment.
Total cost of sales and services decreased 2.6% to $30.1 million in 2003. As a
percentage of total revenues, total cost of sales and services decreased from
33.3% in 2002 to 31.3% in 2003. The long-distance services segment 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 and All Other Services. See the
discussion below for more information by segment.
Long-distance Services Segment Revenues
Total long-distance services segment revenues decreased 1.5% to $51.6 million in
2003.
Message Telephone Service Revenue from Common Carrier Customers
Message telephone service revenues from other common carriers (principally MCI
and Sprint) decreased 9.8% to $23.0 million in 2003 resulting from a 4.2%
decrease in wholesale minutes carried to 208.5 million minutes, a 1.8% decrease
in the average rate per minute on minutes carried for other common carriers, and
a re-rating of certain other common carrier minutes in 2002 that did not recur
in 2003.
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 renewed terrorist activity could affect our carrier
customers which, in turn, could affect our revenues and cash flows.
Message Telephone Service Revenue from Residential, Commercial and Governmental
Customers
Message telephone service revenues from residential, commercial, and
governmental customers decreased 14.5% to $10.2 million in 2003 primarily due to
the following:
o A 8.2% decrease in minutes carried for these customers to 72.4 million
minutes. The decrease is primarily due to the loss of approximately 1.0
million to 1.5 million minutes earned from a certain retail customer in
2002 but not earned in 2003 and the effect of customers substituting
cellular phone and prepaid calling card usage for direct dial minutes,
o A 9.0% decrease in the average rate per minute to $0.091 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 2.0% decrease in the number of active residential, commercial, and
governmental customers billed to 88,300 at June 30, 2003.
Revenue from Private Line and Private Network Customers
Private line and private network transmission services revenues increased 2.6%
to $9.4 million in 2003.
27
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 37.6% to $6.3 million in 2003. The increase is primarily due
to the following:
o 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,
o An increased number of circuits sold to rural hospitals and health
clinics, and o Equipment sales to one customer.
Long-distance Services Segment Cost of Sales and Services
Long-distance services segment cost of sales and services decreased 13.8% to
$13.0 million in 2003. Long-distance services segment cost of sales and services
as a percentage of long-distance services segment revenues decreased from 28.9%
in 2002 to 25.3% in 2003 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 $.014 and $.051 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 Local
Exchange Carriers ("LECs") beginning July 2002,
o A $861,000 refund in 2003 from an intrastate access cost pool that
previously overcharged us for access services, 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 2003 and 2002, we had favorable
adjustments of $749,000 and $1.8 million, respectively. Excluding the
adjustments, long-distance services cost of sales and services as a
percentage of long-distance services revenues was 26.7% and 32.3% in
2003 and 2002, respectively.
The decrease in the long-distance services segment cost of sales and services as
a percentage of long-distance services segment revenues is partially off-set by
increased costs associated with additional transponder and network back-up
capacity in 2003 as compared to 2002.
Cable Services Segment Revenues and Cost of Sales and Services
Total cable services segment revenues increased 8.9% to $23.9 million and
average gross revenue per average basic subscriber per month increased $3.11 or
5.6% in 2003. Programming services revenues increased 9.7% to $18.5 million in
2003 resulting from the following:
o Basic subscribers served increased approximately 2,100 to approximately
137,200 at June 30, 2003 as compared to June 30, 2002,
o New facility construction efforts in 2002 and 2003 resulted in
approximately 5,600 additional homes passed, a 2.9% increase from June
30, 2002. New facility construction efforts in 2003 resulted in
approximately 4,600 additional homes passed and a review of homes
passed in the system acquired from Rogers American Cablesystems, Inc.
resulted in approximately 1,000 additional homes passed,
o Digital subscriber counts increased 16.3% to approximately 30,700 at
June 30, 2003 as compared to June 30, 2002, and
o Effective February 2003, we increased rates charged for certain cable
services and premium packages in six communities, including three of
the state's four largest population centers Anchorage,
28
Fairbanks and Juneau. Rates increased approximately 4% for those
customers who experienced an adjustment.
The cable services segment's share of cable modem revenue (offered through our
Internet services segment) increased $750,000 to $2.7 million in 2003 due to an
increased number of cable modems deployed. Approximately 99% of our cable homes
passed are able to subscribe to our cable modem service. In the second quarter
of 2003 we completed our upgrade of the Ketchikan cable system. Customers in
this system are now able to subscribe to cable modem service.
We now offer digital programming service in Anchorage, the Matanuska-Susitna
Valley, Fairbanks, Juneau, Kenai, and Soldotna, representing approximately 85%
of our total homes passed at June 30, 2003. We expect that number will increase
to approximately 89% when digital programming service is launched in the
Ketchikan cable system during the third quarter of 2003.
In the second quarter of 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.
Cable services cost of sales and services increased 5.8% to $6.4 million in 2003
due to programming cost increases for most of our cable programming services
offerings. Cable services cost of sales and services as a percentage of cable
services revenues, which is less as a percentage of revenues than are local
access and Internet services cost of sales and services, decreased from 27.5% in
2002 to 26.7% in 2003. The decrease is primarily due to a $182,000 favorable
adjustment to cable services cost of sales and services after completion of
audits by certain cable programming service vendors, and increasing amounts of
cable modem services sold that generally have higher margins than do cable
programming services.
Local Access Services Segment Revenues and Cost of Sales and Services
Local access services segment revenues increased 14.1% in 2003 to $9.2 million
primarily due to growth in the average number of customers served. At June 30,
2003 an estimated 101,900 lines were in service as compared to approximately
95,800 lines in service at June 30, 2002. We estimate that our 2003 lines in
service total represents a statewide market share of approximately 21%. At June
30, 2003 approximately 1,000 additional lines were awaiting connection. The
increase in local access services segment revenues is also caused by a change in
how we provision local access lines in Fairbanks and Juneau. In 2002 we
primarily resold service purchased from ACS. In 2003 we are benefiting from our
facilities build-out with an increased number of access lines provisioned on our
own facilities, unbundled network element ("UNE") loop and UNE platform which
allows us to collect interstate and intrastate access revenues. 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 beginning July 2002, and
o A reduction in July 2002 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 segment cost of sales and services increased 19.1% to $5.9
million in 2003. Local access services segment cost of sales and services as a
percentage of local access services segment revenues increased from 60.8% in
2002 to 63.4% in 2003, primarily due to the following:
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, and
29
o The effect of the revenue decreases from interstate access rates
described above with no corresponding decrease in the cost of sales and
services.
Partially offsetting the items described above are reductions in access costs
attributed to our conversion of service provided on a wholesale basis to service
provided through our own facilities.
Our access line mix at June 30, 2003 follows:
o Residential lines represent approximately 57% of our lines,
o Business customers represent approximately 35% of our lines, and
o Internet access customers represent approximately 8% of our lines.
Approximately 87% of our lines are provided on our own facilities and leased
local loops. Approximately 5% of our lines are provided using UNE platform.
The local access services segment operating results are negatively affected 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 results would have improved by
approximately $1.7 million and the long distance services segment operating
results would have been reduced by an equal amount in the second quarter of
2003. Avoided access charges totaled approximately $1.7 million during the
second quarter of 2003 as compared to $2.1 in the same period of 2002. The
decrease in the avoided access charge in the second quarter of 2003 is due to
the FCC MAG reform order reducing the interstate access rates paid by
interexchange carriers to LECs beginning July 2002 and a reduction in July 2002
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.
The local access services segment operating results are affected by our
continued evaluation and testing of digital local phone service and Internet
protocol-based technology to deliver phone service through our cable facilities.
Internet Services Segment Revenues and Cost of Sales and Services
Total Internet services segment revenues increased 22.4% to $4.8 million in 2003
primarily due to a 34.7% increase in its allocable share of cable modem revenues
to $2.2 million in 2003 as compared to 2002. The increase in cable modem
revenues is primarily due to growth in the number of cable modems deployed.
Cable modem subscribers increased from approximately 31,300 at June 30, 2002 to
approximately 40,500 at June 30, 2003.
At June 30, 2003 we had 92,200 total Internet subscribers, which includes 51,700
dial-up subscribers who do not have any form of cable modem service and 24,900
dial-up subscribers who also have cable modem service. At June 30, 2003
approximately 6,300 of the dial-up subscribers who also have cable modem service
have not activated their dial-up service. Our total dial-up Internet subscribers
decreased 1,100 to 70,300 subscribers at June 30, 2003 as compared to June 30,
2002 as more customers continue to migrate to cable modems.
We reported a total of 71,400 Internet subscribers at June 30, 2002. This
subscriber count was based upon the total number of active dial-up subscribers
at June 30, 2002. As discussed above, not all cable modem subscribers paying for
a dial-up plan have activated their dial-up service. When we first started
selling cable modem service it was packaged in a way that almost all cable modem
subscribers were also dial up subscribers. As we introduced new packages and
plans and started promoting our new cable modem LiteSpeed service the number of
cable modem subscribers without a dial up plan increased substantially. An
internal review during the second quarter of 2003 revealed that these subscriber
counts had risen
30
substantially enough that they should be reported separately. In future quarters
we will report Internet subscribers in the format described above.
The Internet services segment does not share in plan fee revenues associated
with our bundled Internet and long-distance service package. Estimated plan fees
related to this service offering are approximately $1.0 million per quarter and
those revenues are included in the long-distance services segment.
Internet services cost of sales and services increased 23.5% to $1.4 million in
2003, and as a percentage of Internet services revenues, totaled 29.7% and 29.4%
in 2003 and 2002, respectively. The 2003 increase as a percentage of Internet
services revenues is primarily due to increased labor costs. The increase is
partially off-set by a $571,000 increase in Internet's portion of cable modem
revenue to $2.2 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.
We enhanced the value of our Internet offerings throughout 2002 through the
addition of electronic billing and presentment capabilities and the rollout of a
product called eMail 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 popular with
our customers which we believe is helping to further solidify our customer
relationships.
All Other Revenues and Costs of Sales and Services
All Other revenues increased 0.5% to $6.5 million in 2003.
Revenues from our GCI Fiber system that runs along the oil pipeline corridor are
continuing to increase and we expect the annual recurring revenue run rate to
increase by an additional two to three million dollars per year by the end of
2003. Additionally, we expect to recognize approximately seven million dollars
in special project revenue in the fourth quarter of 2003.
All Other costs of sales and services decreased 7.2% to $3.4 million in 2003,
and as a percentage of All Other revenues, totaled 52.5% and 56.8% in 2003 and
2002, respectively. The decrease in All Other costs of sales and services as a
percentage of All Other revenues is primarily due to a $140,000 favorable
adjustment due to a revision of an estimate of a previously unbilled cost of
sales and service upon receipt of the invoice.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 5.2% to $34.3 million in
2003 and, as a percentage of total revenues, increased to 35.8% in 2003 from
35.1% in 2002. The 2003 increase in selling, general and administrative expenses
is primarily due to an increased accrual for company-wide success sharing bonus
costs and increased labor costs. The 2003 increase is off-set by costs incurred
in 2002 for our unsuccessful bid to purchase certain assets of WCI Cable, Inc.
and its subsidiaries.
Marketing and advertising expenses as a percentage of total revenues decreased
from 2.6% in 2002 to 2.3% in 2003.
Bad Debt Expense
Bad debt expense decreased 92.4% to $802,000 in 2003 and, as a percentage of
total revenues, decreased to 0.8% in 2003 from 11.5% in 2002. The 2003 decrease
is primarily due to the provision of a $9.7 million bad debt reserve for
uncollected amounts due from MCI resulting from substantially all of its active
U.S. subsidiaries filing voluntary petitions for reorganization under Chapter 11
of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the
Southern District of New York on July 21, 2002. For a
31
discussion of the settlement of the uncollected amounts due from MCI, see Long
Distance Service Overview included in Part I, Item 2 of this report.
Depreciation, Amortization and Accretion Expense
Depreciation, amortization and accretion expense decreased 8.0% to $12.8 million
in 2003. The decrease is primarily attributed to a reduction in the value of
Property and Equipment due to an adjustment of $18.5 million which was recorded
in 2002 associated with the Kanas Telecom, Inc acquisition.
The decrease in depreciation, amortization and accretion expense described above
was partially off-set by an increase in depreciation expense due to our $59.2
million investment in equipment and facilities placed into service during 2002
for which a full year of depreciation will be recorded in 2003, and the $20.8
million investment in equipment and facilities placed into service during 2003
for which a partial year of depreciation will be recorded in 2003.
Other Expense, Net
Other expense, net of other income, increased 48.8% to $9.6 million in 2003. The
increase is primarily due to the following:
o Increased interest expense due to the increased interest rate paid on
our amended Senior Facility,
o Increased deferred loan fee expense due to increased deferred loan fees
associated with the amended Senior Facility, and
o A $961,000 interest benefit earned in 2002 from an interest rate swap
agreement which was called at no cost and terminated on August 1, 2002.
Partially offsetting these increases was a decrease in the average outstanding
indebtedness in 2003.
Income Tax (Expense) Benefit
GCI, Inc., as a wholly owned subsidiary and member of the GCI controlled group
of corporations, files its income tax returns as part of the consolidated group
of corporations under GCI. Accordingly, the following discussions of net
operating loss carryforwards and income tax (expense) benefit reflect the
consolidated group's activity and balances.
Income tax (expense) benefit was ($3.6) million in 2003 and $583,000 in 2002.
The change was due to increased net income before income taxes and cumulative
effect of a change in accounting principle in 2003 as compared to 2002. Our
effective income tax rate changed from 34.6% in 2002 to 42.6% in 2003 due to the
effect of items that are nondeductible for income tax purposes.
At June 30, 2003, we have (1) tax net operating loss carryforwards of
approximately $196.6 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 certain net operating loss carryforwards is subject to
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.
32
Six Months Ended June 30, 2003 ("2003") Compared To Six Months Ended June 30,
2002 ("2002").
Overview of Revenues and Cost of Sales and Services
Total revenues increased 4.3% from $181.0 million in 2002 to $188.7 million in
2003. The cable services, local access services and Internet services segments
and All Other Services contributed to the increase in total revenues, partially
off-set by a decrease in revenues in the long-distance services segment. See the
discussion below for more information by segment.
Total cost of sales and services decreased 2.9% to $60.3 million in 2003. As a
percentage of total revenues, total cost of sales and services decreased from
34.3% in 2002 to 32.0% in 2003. The long-distance services segment contributed
to the decrease in total cost of sales and services, partially off-set by
increases in costs of sales and services in the cable services, local access
services and Internet services segments and All Other Services. See the
discussion below for more information by segment.
Long-distance Services Segment Revenues
Total long-distance services segment revenues decreased 2.3% to $100.1 million
in 2003.
Message Telephone Service Revenue from Common Carrier Customers
Message telephone service revenues from other common carriers (principally MCI
and Sprint) decreased 8.6% to $44.0 million in 2003 resulting from a 2.4%
decrease in wholesale minutes carried to 395.7 million minutes and a 6.3%
decrease in the average rate per minute on minutes carried for other common
carriers. 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.
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 renewed terrorist activity could affect our carrier
customers which, in turn, could affect our revenues and cash flows.
Message Telephone Service Revenue from Residential, Commercial and Governmental
Customers
Message telephone service revenues from residential, commercial, and
governmental customers decreased 15.0% to $20.4 million in 2003 primarily due to
the following:
o A 9.6% decrease in minutes carried for these customers to 144.4 million
minutes. The decrease is primarily due to the loss of approximately 4.0
million to 4.5 million minutes earned from a certain retail customer in
2002 but not earned in 2003 and the effect of customers substituting
cellular phone and prepaid calling card usage for direct dial minutes,
o A 7.9% decrease in the average rate per minute to $0.093 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 2.0% decrease in the number of active residential, commercial, and
governmental customers billed to 88,300 at June 30, 2003.
Revenue from Private Line and Private Network Customers
Private line and private network transmission services revenues increased 1.3%
to $18.2 million in 2003.
33
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 33.6% to $12.0 million in 2003. The increase is primarily
due to the following:
o 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,
o An increased number of circuits sold to rural hospitals and health
clinics, and
o Equipment sales to one customer.
Long-distance Services Segment Cost of Sales and Services
Long-distance services segment cost of sales and services decreased 19.9% to
$25.1 million in 2003. Long-distance services segment cost of sales and services
as a percentage of long-distance services segment revenues decreased from 30.6%
in 2002 to 25.1% in 2003 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 $.014 and $.051 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 MAG reform order reducing the interstate access rates paid by
interexchange carriers to LECs beginning July 2002,
o A $2.3 million refund ($1.9 million after deducting certain direct
costs) in 2003 from a local exchange carrier in respect of its earnings
that exceeded regulatory requirements,
o A $861,000 refund in 2003 from an intrastate access cost pool that
previously overcharged us for access services, 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 2003 and 2002, we had favorable
adjustments of $749,000 and $2.5 million, respectively. Excluding the
adjustments, long-distance services cost of sales and services as a
percentage of long-distance services revenues was 25.8% and 33.0% in
2003 and 2002, respectively.
The decrease in the long-distance services segment cost of sales and services as
a percentage of long-distance services segment revenues is partially off-set by
increased costs associated with additional transponder and network back-up
capacity in 2003 as compared to 2002.
Cable Services Segment Revenues and Cost of Sales and Services
Total cable services segment revenues increased 9.3% to $47.3 million and
average gross revenue per average basic subscriber per month increased $4.27 or
7.8% in 2003. Programming services revenues increased 9.7% to $36.8 million in
2003 resulting from the following:
o Basic subscribers served increased approximately 2,100 to approximately
137,200 at June 30, 2003 as compared to June 30, 2002,
o New facility construction efforts in 2002 and 2003 resulted in
approximately 5,600 additional homes passed, a 2.9% increase from June
30, 2002. New facility construction efforts in 2003 resulted in
approximately 4,600 additional homes passed and a review of homes
passed in the system acquired from Rogers American Cablesystems, Inc.
resulted in approximately 1,000 additional homes passed,
o Digital subscriber counts increased 16.3% to approximately 30,700 at
June 30, 2003 as compared to June 30, 2002, and
34
o Effective February 2003, we increased rates charged for certain cable
services and premium packages in six communities, including three of
the state's four largest population centers Anchorage, Fairbanks and
Juneau. Rates increased approximately 4% for those customers who
experienced an adjustment.
The cable services segment's share of cable modem revenue (offered through our
Internet services segment) increased 44.0% to $5.2 million in 2003 due to an
increased number of cable modems deployed. Approximately 99% of our cable homes
passed are able to subscribe to our cable modem service. In the second quarter
of 2003 we completed our upgrade of the Ketchikan cable system. Customers in
this system are now able to subscribe to cable modem service.
We now offer digital programming service in Anchorage, the Matanuska-Susitna
Valley, Fairbanks, Juneau, Kenai, and Soldotna, representing approximately 85%
of our total homes passed at June 30, 2003. We expect that number will increase
to approximately 89% when digital programming service is launched in the
Ketchikan cable system during the third quarter of 2003.
In the second quarter of 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.
Cable services cost of sales and services increased 7.1% to $12.8 million in
2003 due to programming cost increases for most of our cable programming
services offerings. Cable services cost of sales and services as a percentage of
cable services revenues, which is less as a percentage of revenues than are
local access and Internet services cost of sales and services, decreased from
27.7% in 2002 to 27.1% in 2003. The decrease is primarily due to the following:
o A $182,000 favorable adjustment to cable services cost of sales and
services after completion of audits by certain cable programming
service vendors,
o Increased revenue resulting from increased rates charged for certain
cable services and premium packages as described above, and
o Increasing amounts of cable modem services sold that generally have
higher margins than do cable programming services.
In October 2002 we, along with the other largest publicly traded multiple system
operators ("MSOs") signed a pledge to support and adhere to new voluntary
reporting guidelines on common operating statistics to provide investors and
others with a better understanding of our operations. Our operating statistics
include capital expenditures and customer information from our cable services,
local access services and Internet services segments.
Our capital expenditures by standard reporting category for the six months
ending June 30, 2003 and 2002 follows (amounts in thousands):
2003 2002
--------- ---------
Customer premise equipment ("CPE") $ 3,830 3,233
Commercial 171 325
Scalable infrastructure 459 2,199
Line extensions 243 242
Upgrade/rebuild 963 2,533
Support capital 263 4,118
--------- ---------
$ 5,929 12,650
========= =========
35
During the six months ending June 30, 2003 we decreased our capital expenditures
for all of our reportable segments as compared to the same period in 2002. The
decrease was due, in part, to capital expenditure limitations required by our
Senior Facility, which we closed on November 1, 2002. In April 2003 we amended
our Senior Facility agreement which, among other items, increases the amount we
may incur for capital expenditures. For a discussion of the Senior Facility
amendment, see Liquidity and Capital Resources included in Part I, Item 2 of
this report.
The standardized definition of a customer relationship is the number of
customers that receive at least one level of service, encompassing voice, video,
and data services, without regard to which services customers purchase. At June
30, 2003 and 2002 we have 124,318 and 123,257 customer relationships,
respectively.
The standardized definition of a revenue generating unit is the sum of all
primary analog video, digital video, high-speed data, and telephony customers,
not counting additional outlets. At June 30, 2003 and 2002 we have 177,793 and
166,432 revenue generating units, respectively. The increase in the revenue
generating units of 4,512 and 3,852 from March 31, 2003 and 2002, respectively,
is due to an increase in the number of hotels which subscribe to cable
television services for their summer tourist season. Each hotel room is
considered to be a revenue generating unit.
Local Access Services Segment Revenues and Cost of Sales and Services
Local access services segment revenues increased 14.6% in 2003 to $17.7 million
primarily due to growth in the average number of customers served. At June 30,
2003 an estimated 101,900 lines were in service as compared to approximately
95,800 lines in service at June 30, 2002. We estimate that our 2003 lines in
service total represents a statewide market share of approximately 21%. At June
30, 2003 approximately 1,000 additional lines were awaiting connection. The
increase in local access services segment revenues is also caused by a change in
how we provision local access lines in Fairbanks and Juneau. In 2002 we
primarily resold service purchased from ACS. In 2003 we are benefiting from our
facilities build-out with an increased number of access lines provisioned on our
own facilities, unbundled network element ("UNE") loop and UNE platform which
allows us to collect interstate and intrastate access revenues. 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 beginning July 2002, and
o A reduction in July 2002 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 segment cost of sales and services increased 19.5% to
$11.5 million in 2003. Local access services segment cost of sales and services
as a percentage of local access services segment revenues increased from 62.5%
in 2002 to 65.2% in 2003, primarily due to the following:
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, and
o The effect of the revenue decreases from interstate access rates
described above with no corresponding decrease in the cost of sales and
services.
Partially offsetting the items described above are reductions in access costs
attributed to our conversion of service provided on a wholesale basis to service
provided through our own facilities.
36
Our access line mix at June 30, 2003 follows:
o Residential lines represent approximately 57% of our lines,
o Business customers represent approximately 35% of our lines, and
o Internet access customers represent approximately 8% of our lines.
Approximately 87% of our lines are provided on our own facilities and leased
local loops. Approximately 5% of our lines are provided using UNE platform.
The local access services segment operating results are negatively affected 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 results would have improved by
approximately $3.5 million and the long distance services segment operating
results would have been reduced by an equal amount in 2003. Avoided access
charges totaled approximately $3.5 million during 2003 as compared to $4.1 in
2002. The decrease in the avoided access charge in 2003 is due to the FCC MAG
reform order reducing the interstate access rates paid by interexchange carriers
to LECs beginning July 2002 and a reduction in July 2002 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. The local access
services segment operating results are affected by our continued evaluation and
testing of digital local phone service and Internet protocol-based technology to
deliver phone service through our cable facilities.
Internet Services Segment Revenues and Cost of Sales and Services
Total Internet services segment revenues increased 25.3% to $9.4 million in 2003
primarily due to the $1.3 million increase in its allocable share of cable modem
revenues to $4.3 million in 2003 as compared to 2002. The increase in cable
modem revenues is primarily due to growth in the number of cable modems
deployed. Approximately 40,500 of the total Internet subscribers are cable modem
subscribers at June 30, 2003 as compared to approximately 31,300 at June 30,
2002.
At June 30, 2003 we had 92,200 total Internet subscribers, which includes 51,700
dial-up subscribers who do not have any form of cable modem service and 24,900
dial-up subscribers who also have cable modem service. At June 30, 2003
approximately 6,300 of the dial-up subscribers who also have cable modem service
have not activated their dial-up service. Our total dial-up Internet subscribers
decreased 1,100 to 70,300 subscribers at June 30, 2003 as compared to June 30,
2002 as more customers continue to migrate to cable modems. .
We reported a total of 71,400 Internet subscribers at June 30, 2002. This
subscriber count was based upon the total number of active dial-up subscribers
at June 30, 2002. As discussed above, not all cable modem subscribers paying for
a dial-up plan have activated their dial-up service. When we first started
selling cable modem service it was packaged in a way that almost all cable modem
subscribers were also dial up subscribers. As we introduced new packages and
plans and started promoting our new cable modem LiteSpeed service the number of
cable modem subscribers without a dial up plan increased substantially. An
internal review during the second quarter of 2003 revealed that these subscriber
counts had risen substantially enough that they should be reported separately.
In future quarters we will report Internet subscribers in the format described
above.
The Internet services segment does not share in plan fee revenues associated
with our bundled Internet and long-distance service package. Estimated plan fees
related to this service offering are approximately $1.0 million per quarter and
those revenues are included in the long-distance services segment.
37
Internet services cost of sales and services increased 20.5% to $2.8 million in
2003, and as a percentage of Internet services revenues, totaled 30.1% and 31.3%
in 2003 and 2002, respectively. The 2003 decrease as a percentage of Internet
services revenues is primarily due to a $1.3 million increase in Internet's
portion of cable modem revenue that generally has higher margins than do other
Internet services products. As Internet services revenues increase, economies of
scale and more efficient network utilization continue to result in reduced
Internet cost of sales and services as a percentage of revenues.
We enhanced the value of our Internet offerings throughout 2002 through the
addition of electronic billing and presentment capabilities and the rollout of a
product called eMail 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 popular with
our customers which we believe is helping to further solidify our customer
relationships.
All Other Revenues and Costs of Sales and Services
All Other revenues increased 15.8% to $14.3 million in 2003. The increase in
revenues is primarily due to the following:
o A $1.3 million increase in product sales to $1.8 million due to sales
of product to two customers in 2003, and
o A $508,000 increase in managed services revenue to $10.8 million in
2003 primarily due to a one-time payment of $327,000 from a customer to
acknowledge our ability to maintain certain costs below a stated
budget.
Revenues from our GCI Fiber system that runs along the oil pipeline corridor are
continuing to increase and we expect the annual recurring revenue run rate to
increase by an additional two to three million dollars per year by the end of
2003. Additionally, we expect to recognize approximately seven million dollars
in special project revenue in the fourth quarter of 2003.
All Other costs of sales and services increased 18.0% to $8.1 million in 2003,
and as a percentage of All Other revenues, totaled 56.3% and 55.3% in 2003 and
2002, respectively. The increase in All Other costs of sales and services as a
percentage of All Other revenues is primarily due to the sales of product to two
customers in 2003 which have a higher costs of sales as a percentage of revenues
than do managed services. The increase in All Other costs of sales and services
as a percentage of All Other revenues is partially off-set by a $140,000
favorable adjustment due to a revision of an estimate of a previously unbilled
cost of sales and service upon receipt of the invoice.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 5.3% to $67.3 million in
2003 and, as a percentage of total revenues, increased to 35.7% in 2003 from
35.3% in 2002. The 2003 increase in selling, general and administrative expenses
is primarily due to an increased accrual for company-wide success sharing bonus
costs, increased labor costs and costs associated with State of Alaska
regulatory affairs.
Marketing and advertising expenses as a percentage of total revenues decreased
from 3.4% in 2002 to 2.5% in 2003.
Bad Debt Expense
Bad debt expense decreased 87.5% to $1.4 million in 2003 and, as a percentage of
total revenues, decreased to 0.7% in 2003 from 6.2% in 2002. The 2003 decrease
is primarily due to the provision of a $9.7 million bad debt reserve for
uncollected amounts due from MCI resulting from substantially all of its active
U.S. subsidiaries filing voluntary petitions for reorganization under Chapter 11
of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the
Southern District of New York on July 21, 2002. For a
38
discussion of the settlement of the uncollected amounts due from MCI, see Long
Distance Service Overview included in Part I, Item 2 of this report.
Depreciation, Amortization and Accretion Expense
Depreciation, amortization and accretion expense decreased 5.6% to $26.3 million
in 2003. The decrease is primarily attributed to a reduction in the value of
Property and Equipment due to an adjustment of $18.5 million which was recorded
in 2002 associated with the Kanas Telecom, Inc. acquisition.
The decrease in depreciation, amortization and accretion expense described above
was partially off-set by an increase in depreciation expense due to our $59.2
million investment in equipment and facilities placed into service during 2002
for which a full year of depreciation will be recorded in 2003, and the $20.8
million investment in equipment and facilities placed into service during 2003
for which a partial year of depreciation will be recorded in 2003.
Other Expense, Net
Other expense, net of other income, increased 43.2% to $19.7 million in 2003.
The increase is primarily due to the following:
o Increased interest expense due to the increased interest rate paid on
our amended Senior Facility,
o Increased deferred loan fee expense due to the increased deferred loan
fees associated with the amended Senior Facility, and
o A $1.4 million interest benefit earned in 2002 from an interest rate
swap agreement which was called at no cost and terminated on August 1,
2002.
Partially offsetting these increases was a decrease in the average outstanding
indebtedness in 2003.
Income Tax Expense
GCI, Inc., as a wholly owned subsidiary and member of the GCI controlled group
of corporations, files its income tax returns as part of the consolidated group
of corporations under GCI. Accordingly, the following discussion reflects the
consolidated group's activity.
Income tax expense was $5.8 million in 2003 and $1.1 million in 2002. The change
was due to increased net income before income taxes and cumulative effect of a
change in accounting principle in 2003 as compared to 2002. Our effective income
tax rate decreased from 48.9% in 2002 to 42.5% in 2003 due to the effect of
items that are nondeductible for income tax purposes.
39
FLUCTUATIONS IN QUARTERLY RESULTS OF OPERATIONS
The following chart provides selected unaudited statement of operations data
from our quarterly results of operations during 2003 and 2002:
(Amounts in thousands)
---------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
---------------------------------------------------------
2003
----
Revenues:
Long-distance services $ 48,486 51,570 100,056
Cable services $ 23,438 23,872 47,310
Local access services $ 8,426 9,245 17,671
Internet services $ 4,590 4,790 9,380
All Other services $ 7,837 6,462 14,299
------------------------ ---------
Total revenues $ 92,777 95,939 188,716
Operating income $ 15,438 17,972 33,410
Net income before income taxes and
cumulative effect of a change in
accounting principle $ 5,377 8,374 13,751
Net income before cumulative effect of a
change in accounting principle $ 3,095 4,810 7,905
Net income $ 2,551 4,810 7,361
======================== =========
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
=========================================================
-------------------
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 due from MCI.
-------------------
Overview of Revenues and Cost of Sales and Services
Total revenues for the quarter ended June 30, 2003 ("second quarter") were $95.9
million, representing a 3.4% increase from $92.8 million for the quarter ended
March 31, 2003 ("first quarter"). The long-distance services, cable services,
local services and Internet services segments contributed to the increase in
total revenues, partially off-set by a decrease in revenues from All Other
Services.
Cost of sales and services decreased from $30.2 million in the first quarter to
$30.1 million in the second quarter. As a percentage of revenues, first and
second quarter cost of sales and services totaled 32.6% and 31.3%, respectively.
The cable 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 long-distance, local access and Internet services
segments.
40
Long-distance Services Segment Revenues and Cost of Sales and Services
Second quarter long-distance services segment revenues increased 6.4% to $51.6
million as compared to the first quarter. The increase resulted primarily from
increased revenues from other common carrier customers and increased private
line and broadband revenues, off-set by a decrease in revenues from residential,
commercial, and governmental customers.
Revenues from other common carrier customers increased 9.0% to $23.0 million in
the second quarter as compared to the first quarter. Minutes carried for other
common carriers increased 11.4% to 208.5 million minutes. The increased revenues
from other common carrier customers was partially off-set by a 2.2% decrease in
the average rate per minute on minutes carried for other common carriers in the
second quarter as compared to the first quarter.
Revenues from residential, commercial, and governmental customers decreased 0.1%
to $10.2 million in the second quarter primarily due to a 3.2% decrease in the
average rate per minute to $0.091 per minute paid by residential, commercial and
governmental customers.
The decrease described above is partially off-set by the following:
o A 1.1% increase in the number of active residential, commercial, and
governmental customers billed to 88,300 at June 30, 2003, and
o A 0.7% increase in retail minutes carried for residential, commercial
and governmental customers to 72.4 million minutes.
Private line and private network transmission services revenues increased 6.1%
to $9.4 million in second quarter as compared to first quarter. The increase is
primarily due to an increased number of leased circuits in service and
approximately $175,000 in credits given to customers in the first quarter.
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.
Revenues from our packaged telecommunications offering to rural hospital and
health clinic service and our SchoolAccess(TM) offering to rural school
districts increased 9.1% to $6.3 million in the second quarter. The increase is
primarily due to the following:
o 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,
o An increased number of circuits sold to rural hospitals and health
clinics, and
o Equipment sales to one customer.
Long-distance services cost of sales and services increased 7.8% to $13.0
million in the second quarter. Long-distance services cost of sales and services
as a percentage of long-distance services revenues increased from 24.9% in the
first quarter to 25.3% in the second quarter primarily due to a $2.3 million
refund in the first quarter from a local exchange carrier in respect of its
earnings that exceeded regulatory requirements.
Partially off-setting the increased long-distance services cost of sales and
services as a percentage of long-distance services revenues in the second
quarter as compared to the first quarter were the following:
o A $861,000 refund in the second quarter from an intrastate access cost
pool that previously overcharged us for access services, and
41
o A favorable adjustment of $749,000 in the second quarter. 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. We had no significant favorable or
unfavorable adjustments in the first quarter.
Cable Services Segment Revenues and Cost of Sales and Services
Cable services segment revenues increased 1.9% to $23.9 million and average
gross revenue per average basic subscriber per month remained steady in the
second quarter as compared to the first quarter. Programming services revenues
increased 1.6% to $18.5 million in second quarter resulting from the following:
o Basic subscribers served increased approximately 900 to approximately
137,200 at June 30, 2003 as compared to March 31, 2003,
o Homes passed increased approximately 2,000, a 1.0% increase from March
31, 2003. New facility construction efforts in second quarter 2003
resulted in approximately 1,000 additional homes passed and a review of
homes passed in the system acquired from Rogers American Cablesystems,
Inc. resulted in approximately 1,000 additional homes passed,
o Effective February 2003, we increased rates charged for certain cable
services and premium packages in six communities, including three of
the state's four largest population centers Anchorage, Fairbanks and
Juneau. Rates increased approximately 4% for those customers who
experienced an adjustment, and
o Digital subscriber counts increased 1.7% to approximately 30,700 at
June 30, 2003 as compared to March 31, 2003.
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 $215,000 to $2.7 million in second quarter
due to an increased number of cable modems deployed.
Cable services cost of sales and services decreased 1.3% to $6.4 million in the
second quarter as compared to the first quarter. Cable services cost of sales
and services as a percentage of cable services segment revenues, which is less
as a percentage of revenues than are local access and Internet services cost of
sales and services, decreased from 27.6% in the first quarter to 26.7% in the
second quarter. The decrease is primarily due to a $182,000 favorable adjustment
to cable services cost of sales and services after completion of audits by
certain cable programming service vendors.
Local Access Services Segment Revenues and Cost of Sales and Services
Local access services segment revenues increased 9.7% in the second quarter to
$9.2 million primarily due to increased lines in service in the second quarter
and a adjustment to an intrastate carrier common line customer account in the
first quarter. At June 30, 2003 an estimated 101,900 lines were in service as
compared to approximately 98,900 lines in service at March 31, 2003.
42
Local access services segment cost of sales and services increased $214,000 to
$5.9 million in the second quarter. Local access services segment cost of sales
and services as a percentage of local access services segment revenues decreased
from 67.0% in the first quarter to 63.4% in the second quarter. The decrease in
cost of sales and services as a percentage of local access services segment
revenues is due to the following:
o The build-out of our facilities resulting in an increased number of
access lines provisioned on our own facilities, UNE loop and UNE
platform has resulted in decreased cost of sales and services and
increased interstate and intrastate access revenue, and
o Further economies of scale and more efficient network utilization as
the number of local access services subscribers and resulting revenues
increase.
The decrease is partially off-set by 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 local access services segment operating results are negatively effected 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 results would have improved by
approximately $1.7 million and the long distance services segment operating
results would have been reduced by an equal amount in the second quarter.
Avoided access charges totaled approximately $1.8 million in the first quarter.
Internet Services Segment Revenues and Cost of Sales and Services
Total Internet services segment revenues increased $200,000 to $4.8 million in
the second quarter primarily due to the $172,000 increase in Internet services
segment's allocable share of cable modem revenues to $2.2 million in the second
quarter as compared to the first quarter. The increase in cable modem revenues
is primarily due to growth in the number of cable modems deployed. Cable modem
subscribers increased from approximately 38,600 at March 31, 2003 to
approximately 40,500 at June 30, 2003.
We reported a total of 71,600 Internet subscribers at March 31, 2003. This
subscriber count was based upon the total number of active dial-up subscribers
at March 31, 2003. As discussed above, not all cable modem subscribers paying
for a dial-up plan have activated their dial-up service. When we first started
selling cable modem service it was packaged in a way that almost all cable modem
subscribers were also dial up subscribers. As we introduced new packages and
plans and started promoting our new cable modem LiteSpeed service the number of
cable modem subscribers without a dial up plan increased substantially. An
internal review during the second quarter of 2003 revealed that these subscriber
counts had risen substantially enough that they should be reported separately.
In future quarters we will report Internet subscribers in the format described
above.
Internet services cost of sales and services increased $18,000 in the second
quarter to $1.4 million, and as a percentage of Internet services revenues,
totaled 29.7% and 30.6% in the second and first quarters, respectively.
All Other Revenues and Costs of Sales and Services
All Other revenues decreased $1.4 million to $6.5 million in the second quarter
primarily due to sales of product to two customers in the first quarter.
43
All Other costs of sales decreased $1.3 million to $3.4 million in the second
quarter, and as a percentage of All Other revenues, totaled 52.5% and 59.5% in
the second and first quarters, respectively. The decrease in All Other costs of
sales and services as a percentage of All Other revenues is primarily due to the
following:
o A $140,000 favorable adjustment in the second quarter due to a revision
of an estimate of a previously unbilled cost of sales and service upon
receipt of the invoice, and
o Sales of product to two customers in first quarter which have a higher
costs of sales as a percentage of revenues than do managed services.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 3.9% to $34.3 million in
the second quarter as compared to the first quarter. As a percentage of
revenues, selling, general and administrative expenses were 35.8% and 35.6% in
the second and first quarters, respectively.
Bad Debt Expense
Bad debt expense increased $205,000 to $802,000 in the second quarter as
compared to the first quarter. As a percentage of total revenues, second and
first quarter bad expense was 0.8% and 0.6%, respectively.
Depreciation, Amortization and Accretion Expense
Depreciation, amortization and accretion expense decreased 5.2% to $12.8 million
in second quarter as compared to first quarter due to several individually
insignificant decreases in depreciation and amortization expense.
Other Expense, Net
Other expense, net of other income, decreased $463,000 in the second quarter to
$9.6 million due to the amendment of our Senior Facility in April 2003 which
extended the final maturity date from two years to five years. The extension
resulted in an increased amortization period for deferred loan costs on our
amended Senior Facility which began in the second quarter.
Net Income
We reported net income of $4.8 million for the second quarter as compared to net
income of $2.6 million for the first quarter. The increase is primarily due to
increased revenues without a corresponding increase in cost of sales and
services due to a refund in the long distance services segment and favorable
cost of sales and services adjustments in the long distance and cable services
segments and All Other Services in second quarter, as previously described.
The increased net income in second quarter as compared to first quarter is
partially off-set by a $2.3 million refund in the first quarter as previously
described. Additionally, first quarter net income was decreased by the
implementation of SFAS No. 143 on January 1, 2003 resulting in a cumulative
effect of an accounting change, net of income tax benefit of $367,000, of
$544,000.
Liquidity and Capital Resources
Cash flows from operating activities totaled $31.6 million in 2003 as compared
to $29.9 million in 2002. The increase in 2003 is primarily due to increased
cash flow in 2003 from some of our segments, a $2.3 million refund from a local
exchange carrier in respect of its earnings that exceeded regulatory
requirements, and a $861,000 refund from an intrastate access cost pool that
previously overcharged us for access services. Uses of cash during 2003 included
$17.4 million of expenditures for property and equipment, including construction
in progress, principal payments on long-term debt and capital lease obligations
of $3.6 million, payment of $2.6 million in fees associated with the original
and amended Senior Facility and payment of a $721,000 deposit on a workers'
compensation stop-loss policy.
44
Net receivables increased $7.4 million from December 31, 2002 to June 30, 2003
primarily due to an increase in:
o Trade receivables for broadband services provided to hospitals and
health clinics, and
o Trade receivables for telecommunication services provided to certain
customers. The accounts receivable for these customers were
subsequently paid in July 2003.
Working capital totaled $317,000 at June 30, 2003, a $3.9 million decrease as
compared to $4.2 million at December 31, 2002. The decrease is primarily
attributed to classification of $20.0 million of our Senior Facility as current
maturities of long-term debt as of June 30, 2003, upon the April 22, 2003
amendment described below.
The decrease in working capital was partially off-set by:
o A $6.0 million increase in our cash balance at June 30, 2003 and a $4.4
million decrease in accounts payable at June 30, 2003 as compared to
December 31, 2002, primarily due to decreased capital expenditures
during the six months ended June 30, 2003, and
o A $7.4 million increase in net receivables at June 30, 2003 as compared
to December 31, 2002 as previously described.
On April 22, 2003 we amended our $225.0 million Senior Facility. The amendment
provides for the followings changes:
o The final maturity date has been extended to October 31, 2007,
o We may fund capital expenditures, including construction or acquisition
of additional fiber optic cable system capacity, through our own cash
flow or by draws on the revolving credit facility of the Senior
Facility not to exceed $25.0 million, and
o The definition of Excess Cash Flow has been changed to the amount by
which earnings before interest, taxes, depreciation, and amortization
exceeds certain fixed charges as defined in the Senior Facility
agreement plus one-time fiber sales to the extent such fiber sales are
not included in earnings before interest, taxes, depreciation, and
amortization.
The amendment requires us to prepay the term loan as follows (amounts in
thousands):
Date Amount
------------------------------------------ --------
Quarterly from September 30, 2003 to
December 31, 2004 $ 5,000
Quarterly from March 31, 2005 to December
31, 2005 $ 6,000
Quarterly from March 31, 2006 to December
31, 2006 $ 8,000
Quarterly from March 31, 2007 to September
30, 2007 $ 10,000
The remaining balance of the term loan will be payable in full on October 31,
2007.
45
Under the amended Senior Facility capital expenditures, other than those
incurred to build or acquire additional fiber optic cable system capacity, in
any of the years ended December 31, 2003, 2004, 2005 and 2006 may not exceed:
o $25.0 million, plus
o 100% of any Excess Cash Flow during the applicable period less certain
permitted investments of up to $5.0 million during the applicable
period.
Under the amended Senior Facility we may not allow the ratio of total
indebtedness to annualized operating cash flow to be greater than:
Period Ratio
--------------------------------------------------------- -------
April 22, 2003 through December 30, 2003 4.25:1
December 31, 2003 through December 30, 2004 4.00:1
December 31, 2004 through December 30, 2005 3.75:1
December 31, 2005 through June 29, 2006 3.50:1
June 30, 2006 through June 29, 2007 3.25:1
June 30, 2007 through September 29, 2007 3.00:1
September 30, 2007 through October 31, 2007 2.75:1
Under the amended Senior Facility we may not allow the ratio of senior secured
indebtedness to annualized operating cash flow to be greater than:
Period Ratio
--------------------------------------------------------- -------
April 22, 2003 through December 30, 2004 2.00:1
December 31, 2004 through September 29, 2006 1.75:1
September 30, 2006 through June 29, 2007 1.50:1
June 30, 2007 through September 29, 2007 1.25:1
September 30, 2007 through October 31, 2007 1.00:1
Under the amended Senior Facility we must either have repaid in full or
successfully refinanced our Senior Notes by February 1, 2007.
In connection with the amendment of the Senior Facility, we paid bank fees and
other expenses of approximately $2,379,000 during the six months ended June 30,
2003 which will be charged to Amortization of Loan and Senior Notes Fees over
the life of the amended agreement.
The term loan is fully drawn and we have a $3.0 million letter of credit, which
leaves $47.0 million available at June 30, 2003 to draw under the revolving
credit facility if needed. In April 2003, we made a $2.7 million principal
payment on the revolving credit facility.
We were in compliance with all loan covenants at June 30, 2003.
Our semi-annual Senior Notes interest payment of $8.8 million was paid in
February 2003 out of existing cash balances. Our next Senior Notes interest
payment of $8.8 million is due August 1, 2003 and will be paid out of existing
cash balances.
Our expenditures for property and equipment, including construction in progress,
totaled $17.4 million and $36.2 million during the six months ended June 30,
2003 and 2002, 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
46
in progress and excluding the new fiber system construction costs described
below, to total $40 million to $55 million, depending on available opportunities
and the amount of cash flow we generate during 2003.
We have begun work on the construction of a $50 million fiber optic cable system
connecting Seward, Alaska and Warrenton, Oregon, with leased backhaul facilities
to connect it to our switching and distribution centers in Anchorage, Alaska and
Seattle, Washington. The 1,544-statute mile cable has a total design capacity of
960 Gigabits per second access speed and is planned to be operational by May
2004. The cable will complement our existing fiber optic cable between Whittier,
Alaska and Seattle, Washington. The two cables will provide physically diverse
backup to each other in the event of an outage. We expect to fund construction
of the fiber optic cable system through our operating cash flows and, to the
extent necessary, with draws on our Senior Facility.
Planned capital expenditures over the next five years include those necessary
for continued expansion of our long-distance, local exchange and Internet
facilities, supplementation of our existing network backup facilities,
continuing development of our Personal Communication Services, or PCS, network,
digital local phone service, and upgrades to our cable television plant.
The financial, credit and economic impacts of MCI's July 2002 bankruptcy filing
on the industry in general and on us in particular are not yet fully understood
and are not predictable. See Long Distance Overview for a discussion of the
settlement of the uncollected amounts due from MCI.
We believe that payment for services provided to MCI subsequent to their
bankruptcy filing date will continue to be made timely, consistent with our
status in MCI's filing as a key service provider or utility to MCI.
A conversion of MCI's bankruptcy petition to Chapter 7, or a migration of MCI'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 obtain new debt under acceptable terms and conditions
in the future 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 April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 amends and
clarifies financial accounting and reporting for
47
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives) and for hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities". SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003, except for certain provisions that relate to SFAS
No. 133 Implementation Issues which should continue to be applied in accordance
with their respective effective dates, and for hedging relationships designated
after June 30, 2003. We do not expect implementation of SFAS No. 149 to have a
material effect on our results of operations, financial position and cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. Some of the provisions of this SFAS No.
150 are consistent with the current definition of liabilities in FASB Concepts
Statement No. 6, "Elements of Financial Statements". The remaining provisions of
SFAS No. 150 are consistent with the FASB's proposal to revise the current
definition of liabilities to encompass certain obligations that a reporting
entity can or must settle by issuing its own equity shares, depending on the
nature of the relationship established between the holder and the issuer. We do
not expect implementation of SFAS No. 150 to have a material effect on our
results of operations, financial position and cash flows.
In January 2003 the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities". This Interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements", addresses consolidation by business
enterprises of variable interest entities, which have one or both of the
following characteristics:
1. The equity investment at risk is not sufficient to permit the
entity to finance its activities without additional subordinated
financial support from other parties, which is provided through
other interests that will absorb some or all of the expected losses
of the entity.
2. The equity investors lack one or more of the following essential
characteristics of a controlling financial interest:
a. The direct or indirect ability to make decisions about the
entity's activities through voting rights or similar rights
b. The obligation to absorb the expected losses of the entity if
they occur, which makes it possible for the entity to finance
its activities
c. The right to receive the expected residual returns of the entity
if they occur, which is the compensation for the risk of
absorbing the expected losses.
We do not expect implementation of FIN No. 46 to have a material effect on our
results of operations, financial position and cash flows.
Critical Accounting Policies
Our accounting and reporting policies comply with accounting principles
generally accepted in the United States of America. 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
48
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 accounting principles
generally accepted in the United States of America. 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 Company's
Audit Committee.
Those policies considered to be critical accounting policies for the three and
six months ended June 30, 2003 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.
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 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 3 in the accompanying Notes to Interim Condensed 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
49
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 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 reflects the consolidated group's activity and
balances. 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 $79.0 million associated with income tax net operating
losses that were generated from 1990 to 2003, and that expire from 2005
to 2023. 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 June 30, 2003 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.
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 and financial instruments require difficult judgments on complex
matters that are often subject to multiple sources of authoritative guidance.
Certain of these matters, including but not limited to the requirement to
account for the market value of stock options as compensation expense, 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. A complete discussion of our significant
accounting policies can be found in Note 1 in the Notes to Consolidated
Financial Statements included in our December 31, 2002 Form 10-K. A condensed
discussion of our significant accounting policies can be found in Note 1 in the
accompanying Notes to Interim Condensed 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 actual results indicate
that Alaska's oil revenues and federal funding supplied 47% and 43%,
50
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 51% and 44%,
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 2009. 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 $28.14 in fiscal 2003. State economists forecast the
average price of North Slope oil to decline to $25.28 in fiscal 2004. The
closing price per barrel was $30.31 on July 21, 2003. 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 2006. 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. Through a combination of
revenue enhancements and reductions in spending the governor of the State of
Alaska and the State legislature approved a fiscal 2004 budget which is
projected to spend approximately $380 million of the Constitutional Budget
Reserve Fund.
In 2003 the Alaska Legislature passed and the Governor signed legislation that
extended the life of the RCA until 2007.
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 $2.4 billion are 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
51
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.
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.
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,
o 5% are located in the City and Borough of Juneau, and
o The remaining 30% are located in other communities across the State of
Alaska.
No assurance can be given that the driving forces in the Alaska economy, and in
particular, oil production, will continue at appropriate levels to provide an
environment for expanded economic activity.
No assurance can be given that oil companies doing business in Alaska will be
successful in discovering new fields or further developing existing fields which
are economic to develop and produce oil with access to the pipeline or other
means of transport to market, even with a reduced level of royalties. We are not
able to predict the effect of changes in the price and production volumes of
North Slope oil on Alaska's economy or on us.
Seasonality
Long-distance revenues (primarily those derived from our other common carrier
customers) have historically been highest in the summer months because of
temporary population increases attributable to tourism and increased seasonal
economic activity such as construction, commercial fishing, and oil and gas
activities. Cable television revenues, on the other hand, are higher in the
winter months because consumers spend more time at home and tend to watch more
television during these months. Local access and Internet services are not
expected to exhibit significant seasonality. Our ability to implement
construction projects is also hampered during the winter months because of cold
temperatures, snow and short daylight hours.
Inflation
We do not believe that inflation has a significant effect on our operations.
52
Schedule of Certain Known Contractual Obligations
The following table details future projected payments associated with our
certain known contractual obligations as of December 31, 2002, the date of our
most recent fiscal year-end balance sheet. Our schedule of certain known
contractual obligations has been updated to reflect the April 22, 2003 amendment
of our Senior Facility and to include certain purchase obligations.
Payments Due by Period
Less than 1 1 to 3 4 to 5 More Than 5
Total Year Years Years Years
------------ ----------- ---------- ----------- ------------
(Amounts in thousands)
Long-term debt $ 357,700 15,000 47,000 295,700 ---
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
Purchase obligations 39,136 21,549 17,587 --- ---
------------ ----------- ---------- ----------- ------------
Total contractual obligations $ 621,202 70,994 138,139 362,214 49,855
============ =========== ========== =========== ============
Purchase obligations include our fiber optic cable system construction
commitment of $35.4 million as further described in note 6 to the Notes to
Interim Condensed Consolidated Financial Statements included in Part I, Item 1
of this report. The contract associated with this commitment is non-cancelable.
For long-term debt included in the above table, we have included principal
payments on our Senior Facility and on 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 our December 31, 2002 Form 10-K.
For a discussion of our capital and operating leases, see note 12 to the Notes
to Consolidated Financial Statements included in Part II of our December 31,
2002 Form 10-K.
Audit Committee
GCI's Audit Committee, composed entirely of independent directors, meets
periodically with our independent auditors and management to review the
Company's financial statements and the results of audit activities. 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).
PART I.
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various types of market risk in the normal course of business,
including the impact of interest rate changes. We do not hold derivatives for
trading purposes.
53
Our 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 June 30, 2003, we have borrowed $175.0 million of which $150.0 million is
subject to interest rate risk. On this amount, a 1% increase in the interest
rate would cost us $1,500,000 in additional gross interest cost on an annualized
basis.
Our Satellite Transponder Capital Lease carries interest rate risk. Amounts
borrowed under this Agreement bear interest at Libor plus 3.25%. Should the
Libor rate change, our interest expense will increase or decrease accordingly.
As of June 30, 2003, we have borrowed $44.2 million subject to interest rate
risk. On this amount, a 1% increase in the interest rate would cost us $442,000
in additional gross interest cost on an annualized basis.
PART I.
ITEM 4.
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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information regarding pending legal proceedings to which we are a party is
included in note 6 to the Interim Condensed Consolidated Financial Statements
and is incorporated herein by reference.
54
PART II.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -
Exhibit No. Description
--------------------------------------------------------------------------------------------------------
10.108 Bonus Agreement between General Communication, Inc. and Wilson Hughes
10.109 Eighth 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. *
10.110 Settlement and Release Agreement between General Communication, Inc. and WorldCom,
Inc.
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.
-------------------------
(b) Reports on Form 8-K filed during the quarter ended June 30,
2003 - None
55
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GCI, INC.
Signature Title Date
- -------------------------------------- ---------------------------------------- ----------------------
/s/ Ronald A. Duncan President and Director August 6, 2003
- -------------------------------------- (Principal Executive Officer) ----------------------
Ronald A. Duncan
/s/ G. Wilson Hughes Vice President and Director August 6, 2003
- -------------------------------------- ----------------------
G. Wilson Hughes
/s/ John M. Lowber Secretary, Treasurer and Director August 6, 2003
- -------------------------------------- (Principal Financial and Accounting ----------------------
John M. Lowber Officer)
56
SECTION 302 CERTIFICATION
I, Ronald A. Duncan, certify that:
1. I have reviewed this report on Form 10-Q of GCI, Inc.;
2. Based on my knowledge, this 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 this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present 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
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-15(e) and 15d-15(e)) for the registrant and we
have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The Registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 6, 2003 /s/ Ronald A. Duncan
Ronald A. Duncan
President and Director
(Chief Executive Officer)
57
I, John M. Lowber, certify that:
1. I have reviewed this report on Form 10-Q of GCI, Inc.;
2. Based on my knowledge, this 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 this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present 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
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-15(e) and 15d-15(e)) for the registrant and we
have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The Registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: August 6, 2003 /s/ John M. Lowber
John M. Lowber
Secretary, Treasurer and Director
(Principal Financial Officer)
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