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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(X) ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-5890
GCI, INC.
(Exact name of registrant as specified in its charter)
ALASKA 91-1820757
--------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2550 Denali Street Suite 1000 Anchorage, Alaska 99503
------------------------------------------------ -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (907) 868-5600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes No X
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(a) AND
(b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE
FORMAT.
1
GCI, INC.
A WHOLLY-OWNED SUBSIDIARY OF GENERAL COMMUNICATION, INC.
2004 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Glossary....................................................................................................................3
Cautionary Statement Regarding Forward-Looking Statements..................................................................11
Part I.....................................................................................................................13
Item 1. Business.......................................................................................................13
Item 2. Properties.....................................................................................................62
Item 3. Legal Proceedings..............................................................................................64
Item 4. Submissions of Matters to a Vote of Security Holders............................................................65
Part II....................................................................................................................65
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters......................................65
Item 6. Selected Financial Data........................................................................................66
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..........................66
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...................................................101
Item 8. Consolidated Financial Statements and Supplementary Data......................................................101
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure..........................102
Item 9A. Controls and Procedures......................................................................................102
Item 9B. Other Information............................................................................................102
Part III..................................................................................................................102
Items 10, 11, 12, 13 and 14 are omitted per General Instruction I(1)(a) and (b) of Form 10-K
Part IV...................................................................................................................103
Item 15. Exhibits, Consolidated Financial Statement Schedules.........................................................103
Item 15(b). Exhibits..................................................................................................147
SIGNATURES................................................................................................................154
This Annual Report on Form 10-K is for the year ending December 31, 2004. This
Annual Report modifies and supersedes documents filed prior to this Annual
Report. The Securities and Exchange Commission ("SEC") allows us to "incorporate
by reference" information that we file with them, which means that we can
disclose important information to you by referring you directly to those
documents. Information incorporated by reference is considered to be part of
this Annual Report. In addition, information that we file with the SEC in the
future will automatically update and supersede information contained in this
Annual Report.
2
Glossary
Access Charges -- Fees for accessing the local networks of the LECs in order to
originate and terminate long-distance calls and provide the customer connection
for Private Line services.
ACS -- Alaska Communications Systems Group, Inc., previously ALEC Holdings, Inc.
- -- ACS, one of our competitors, includes acquired properties from Century
Telephone Enterprises, Inc. and the Anchorage Telephone Utility ("ATU"). ATU
provided local telephone and long distance services primarily in Anchorage and
cellular telephone services in Anchorage and other Alaska markets.
Alaska United or AULP -- Alaska United Fiber System Partnership -- An Alaska
partnership, indirectly wholly owned by the Company. Alaska United was organized
to construct and operate fiber optic cable systems connecting various locations
in Alaska and the Lower 49 States and foreign countries through Seattle,
Washington.
AT&T -- AT&T Corp. -- A long distance carrier, parent company to AT&T Alascom.
AT&T Alascom -- Alascom, Inc. -- A wholly owned subsidiary of AT&T and one of
our competitors.
AULP East -- An undersea fiber optic cable system connecting Whittier, Valdez
and Juneau, Alaska and Seattle, Washington, which was placed into service in
February 1999.
AULP West -- A new undersea fiber optic cable system connecting Seward, Alaska
to Warrenton, Oregon which was placed into service in June 2004.
Basic Service -- The basic service tier includes, at a minimum, signals of local
television broadcast stations, any public, educational, and governmental
programming required by the franchise to be carried on the basic tier, and any
additional video programming service added to the basic tier by the cable
operator.
BOC -- Bell System Operating Company -- A LEC owned by any of the remaining
Regional Bell Operating Companies, which are holding companies established
following the AT&T Divestiture Decree to serve as parent companies for the BOCs.
Backbone -- A centralized high-speed network that interconnects smaller,
independent networks.
Bandwidth -- A range or band of the frequency spectrum, measured in Hertz (Hz).
It has become vogue, though strictly a misuse of the term, to say bandwidth is
the number of bits of data per second that can move through a communications
medium.
Broadband -- A high-capacity communications circuit/path, usually implying
speeds of 256 kilobits per second ("kbps") or better.
CAP -- Competitive Access Provider -- A company that provides its customers with
an alternative to the LEC for local transport of Private Line and special access
communications services.
Central Offices -- The switching centers or central switching facilities of the
LECs.
CLEC -- Competitive Local Exchange Carrier -- A company that provides its
customers with an alternative to the ILEC for local transport of communications
services, as allowed under the 1996 Telecom Act.
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Co-Carrier Status -- A regulatory scheme under which the ILEC is required to
integrate new, competing providers of local exchange service, into the systems
of traffic exchange, inter-carrier compensation, and other inter-carrier
relationships that already exist among LECs in most jurisdictions.
Collocation -- The ability of a CAP or CLEC to connect its network to the LEC's
central offices. Physical collocation occurs when a connecting carrier places
its network connection equipment inside the LEC's central offices. Virtual
collocation is an alternative to physical collocation pursuant to which the LEC
permits a CAP or CLEC to connect its network to the LEC's central offices on
comparable terms, even though the CAP's or CLEC's network connection equipment
is not physically located inside the central offices.
The Company -- GCI, Inc. and its direct and indirect subsidiaries, also referred
to as "we," "us" and "our."
Compression or Decompression -- A method of encoding, decoding and processing
signals that allows transmission (or storage) of more information than the
medium would otherwise be able to support. Both compression and decompression
require processing capacity, but with many products, the signal delay time due
to processing is not noticeable.
DAMA -- Demand Assigned Multiple Access -- The Company's digital satellite earth
station technology that allows calls to be made between remote villages using
only one satellite hop thereby reducing satellite delay and capacity
requirements while improving quality.
Dark Fiber -- An inactive fiber-optic strand without electronics or optronics.
Dark fiber is not connected to transmitters, receivers and regenerators.
DBS -- Direct Broadcast Satellite -- Subscription television service obtained
from satellite transmissions using frequency bands that are internationally
allocated to the broadcast satellite services. The major providers of DBS are
currently DirecTV and EchoStar (marketed as the DISH Network).
DS-0 -- A data communications circuit that carries data at the rate of 64 kbps.
DS-1 -- A data communications circuit that carries data at the rate of 1.544
Megabits per second (Mb/s), often interchangeably referred to as a T-1.
DS-3 -- A data communications circuit that is equivalent to 28 multiplexed T-1
channels capable of transmitting data at 44.736 Mbps (sometimes called a T-3).
Dedicated -- Communications lines dedicated or reserved for use by particular
customers.
Digital -- A method of storing, processing and transmitting information through
the use of distinct electronic or optical pulses that represent the binary
digits 0 and 1. Digital transmission and switching technologies employ a
sequence of these pulses to represent information as opposed to the continuously
variable analog signal. Digital transmission is advantageous in that it is more
resistant to the signal degrading effects of noise (such as graininess or snow
in the case of video transmission, or static or other background distortion in
the case of audio transmission).
DLC -- Digital Loop Carrier -- A digital transmission system designed for
subscriber loop plant. Multiplexes a plurality of circuits onto very few wires
or onto a single fiber pair.
DLPS -- Digital Local Phone Service -- A term we use referring to our deployment
of voice telephone service utilizing our hybrid-fiber coax cable facilities.
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DOCSIS 1.1 -- Data-Over-Cable Service Interface Specification 1.1 -- An industry
specification that provides for high-speed Internet service tiers, using
techniques known as data fragmentation and quality of service. Under this
specification, which is compatible with the existing DOCSIS 1.0 specification,
cable operators can deliver high-speed Internet services simultaneously over the
same plant and in a path parallel to core video services.
DSL -- Digital Subscriber Line -- Technology that allows Internet access and
other high-speed data services at data transmission speeds greater than those of
modems over conventional telephone lines.
Equal Access -- Connection provided by a LEC permitting a customer to be
automatically connected to the IXC of the customer's choice when the customer
dials "1". Also refers to a generic concept under which the BOCs must provide
access services to AT&T's competitors that are equivalent to those provided to
AT&T.
FCC -- Federal Communications Commission -- A federal regulatory body empowered
to establish and enforce rules and regulations governing public utility
companies and others, such as the Company.
Frame Relay -- A wideband (64 kilobits per second to 1.544 Mbps) packet-based
data interface standard that transmits bursts of data over WANs. Frame-relay
packets vary in length from 7 to 1024 bytes. Data oriented, it is generally not
used for voice or video.
FTC -- Federal Trade Commission -- A federal regulatory body empowered to
establish and enforce rules and regulations governing companies involved in
trade and commerce.
GCC -- GCI Communication Corp. -- An Alaska corporation and a wholly owned
subsidiary of Holdings.
GCI -- General Communication, Inc. -- An Alaska corporation and the parent of
GCI, Inc.
GCI, Inc. -- The Registrant, a wholly owned subsidiary of GCI, an Alaska
corporation and issuer of $320 million of senior notes.
GFCC -- GCI Fiber Communication Co., Inc. -- An Alaska corporation and a wholly
owned subsidiary of Holdings. Holdings acquired all minority ownership interests
in GFCC in the third and fourth quarters of 2002. GFCC owns and operates a fiber
optic cable system constructed along the trans-Alaska oil pipeline corridor
extending from Prudhoe Bay to Valdez, Alaska. See Kanas.
Holdings -- GCI Holdings, Inc. -- A wholly owned subsidiary of GCI, Inc., an
Alaska corporation and party to the Company's Senior Credit Facility.
HDTV -- High-Definition Television -- A digital television format delivering
theater-quality pictures and CD-quality sound. HDTV offers an increase in
picture quality by providing up to 1,920 active horizontal pixels by 1,080
active scanning lines, representing an image resolution of more than two million
pixels. In addition to providing improved picture quality with more visible
detail, HDTV offers a wide screen format and Dolby(R) Digital 5.1 surround
sound.
ILEC -- Incumbent Local Exchange Carrier -- With respect to an area, the LEC
that -- (A) on the date of enactment of the Telecommunications Act of 1996,
provided telephone exchange service in such area; and (B)(i) on such date of
enactment, was deemed to be a member of the exchange carrier association
pursuant to section 69.601(b) of the FCC's regulations (47 C.F.R. 69.601(b)); or
(ii) is a person or entity that, on or after such date of enactment, became a
successor or assign of a member described in clause (i).
Interexchange -- Communication between two different LATAs or, in Alaska,
between two different local exchange serving areas.
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IP -- Internet Protocol -- The method or protocol by which data is sent from one
computer to another on the Internet. Each computer (known as a host) on the
Internet has at least one IP address that uniquely identifies it from all other
computers on the Internet.
ISDN -- Integrated Services Digital Network -- A set of standards for
transmission of simultaneous voice, data and video information over fewer
channels than would otherwise be needed, through the use of out-of-band
signaling. The most common ISDN system provides one data and two voice circuits
over a traditional copper wire pair, but can represent as many as 30 channels.
Broadband ISDN extends the ISDN capabilities to services in the Gigabit per
second range.
ISP -- Internet Service Provider -- A company providing retail and/or wholesale
Internet services.
Internet -- A global collection of interconnected computer networks which use
TCP/IP, a common communications protocol.
IXC -- Interexchange Carrier -- A long-distance carrier providing services
between local exchanges.
Kanas -- Kanas Telecom, Inc. -- An Alaska corporation that was renamed GFCC in
2001.
LAN -- Local Area Network -- The interconnection of computers for sharing files,
programs and various devices such as printers and high-speed modems. LANs may
include dedicated computers or file servers that provide a centralized source of
shared files and programs.
LATA -- Local Access and Transport Area -- The approximately 200 geographic
areas defined pursuant to the AT&T Divestiture Decree. The BOCs were
historically prohibited from providing long-distance service between the LATA in
which they provide local exchange services, and any other LATA.
LEC -- Local Exchange Carrier -- A company providing local telephone services.
Each BOC is a LEC.
LMDS -- Local Multipoint Distribution System -- LMDS uses microwave signals
(millimeterwave signals) in the 28 GHz spectrum to transmit voice, video, and
data signals within small cells 3-10 miles in diameter. LMDS allows license
holders to control up to 1.3 GHz of wireless spectrum in the 28 GHz Ka-band. The
1.3 GHz can be used to carry digital data at speeds in excess of one gigabit per
second. The extremely high frequency used and the need for point to multipoint
transmissions limits the distance that a receiver can be from a transmitter.
This means that LMDS will be a "cellular" technology, based on multiple,
contiguous, or overlapping cells. LMDS is expected to provide customers with
multichannel video programming, telephony, video communications, and two-way
data services. ILECs and cable companies may not obtain the in-region 1150 MHz
license for three years following the date of the license grant. Within 10 years
following the date of the license grant, licensees will be required to provide
'substantial service' in their service regions.
Local Exchange -- A geographic area generally determined by a state regulatory
body, in which calls generally are transmitted without toll charges to the
calling or called party.
Local Number Portability -- The ability of an end user to change Local Exchange
Carriers while retaining the same telephone number.
Lower 48 States or Lower 48 -- Refers to the 48 contiguous states south of or
below Alaska.
Lower 49 States or Lower 49 -- Refers to Hawaii and the Lower 48 States.
MAN -- Metropolitan Area Network -- LANs interconnected within roughly a 50-mile
radius. MANs typically use fiber optic cable to connect various wire LANs.
Transmission speeds may vary from 2 to 100 Mbps.
6
Mat-Su Valley -- The Matanuska and Susitna valleys are located in south-central
Alaska, to the north of Anchorage, and include the communities of Palmer and
Wasilla and the immediately surrounding areas.
MCI, Inc. ("MCI") -- Owns approximately 2% of GCI's common stock at December 31,
2004, presently has two representatives on GCI's Board, and is a major customer.
Prior to May 1, 2000, the company was named MCI WorldCom, Inc. See also MWNS. On
July 21, 2002, MCI and substantially all of its active United States
subsidiaries filed voluntary petitions for reorganization under Chapter 11 of
the United States Bankruptcy Code in the United States Bankruptcy Court. On
December 7, 2004, we closed a transaction with MCI to repurchase 3,751,509
shares of GCI's Class A common stock at $8.33 per share (for a total purchase
price of approximately $31.3 million). In addition to the common stock
repurchase, the transaction included the redemption of all issued and
outstanding shares of GCI's Series C preferred stock held by MCI for an
aggregate redemption price of $10 million. MCI will retain its ownership of
almost 1.3 million shares of GCI's Class B common stock and will retain their
two seats on GCI's board of directors. You should see note 14 to the
accompanying "Notes to Consolidated Financial Statements" included in Part II of
this Report for more information.
MDU -- Multiple Dwelling Unit -- MDUs include multiple-family buildings, such as
apartment and condominium complexes.
MMDS -- Multichannel Multipoint Distribution Service -- Also known as wireless
cable. The FCC established the Multipoint Distribution Service (MDS) in 1972.
Originally, the FCC thought MDS would be used primarily to transmit business
data. However, the service became increasingly popular in transmitting
entertainment programming. Unlike conventional broadcast stations whose
transmissions are received universally, MDS programming is designed to reach
only a subscriber based audience. In 1983, the FCC reassigned eight channels
from the Instructional Television Fixed Service (ITFS) to MDS. These eight
channels make up the MMDS. Frequently, MDS and MMDS channels are used in
combination with ITFS channels to provide video entertainment programming to
subscribers.
MVPD -- Multi-channel Video Programming Distribution -- The distribution of
video programming over multiple platforms, such as cable and satellite.
MWNS -- MCI WorldCom Network Services -- A subsidiary of MCI, which had
previously entered into service agreements with the Company on behalf of MCI.
OCC -- Other Common Carrier -- A long-distance carrier other than the Company.
OC-n -- An optical communications circuit that optically signals at a data rate
of n times 51.84 Mbps, where n can be 1, 3, 12, 24, 48, 96, or 192.
Pay-per-view -- Offering television broadcasts to viewers in a manner whereby
they pay only for the programs they watch rather than having to subscribe to the
whole channel or station on a full-time basis.
PCS -- Personal Communication Services -- PCS encompasses a range of advanced
wireless mobile technologies and services. It promises to permit communications
to anyone, anywhere and anytime while on the move. The Cellular
Telecommunications Industry Association (CTIA) defines PCS as a "wide range of
wireless mobile technologies, chiefly cellular, paging, cordless, voice,
personal communications networks, mobile data, wireless PBX, specialized mobile
radio, and satellite-based systems." The FCC defines PCS as a "family of mobile
or portable radio communications services that encompasses mobile and ancillary
fixed communications services to individuals and businesses and can be
integrated with a variety of competing networks."
7
PBX -- Private Branch Exchange -- A customer premise communication switch used
to connect customer telephones (and related equipment) to LEC central office
lines (trunks), and to switch internal calls within the customer's telephone
system. Modern PBXs offer numerous software-controlled features such as call
forwarding and call pickup. A PBX uses technology similar to that used by a
central office switch (on a smaller scale). (The acronym PBX originally stood
for "Plug Board Exchange.")
POP -- Point of Presence -- The physical access location interface between a LEC
and an IXC network. The point to which the telephone company terminates a
subscriber's circuit for long-distance service or leased line communications.
PRI -- Primary Rate Interface -- An ISDN circuit transmitting at T-1 (DS-1)
speed (equivalent to 24 voice-grade channels). One of the channels ("D") is used
for signaling, leaving 23 ("B") channels for data and voice communication.
Private Line -- Uses dedicated circuits to connect customer's equipment at both
ends of the line. Does not provide any switching capability (unless supported by
customer premise equipment). Usually includes two local loops and an IXC
circuit.
Private Network -- A communications network with restricted (controlled) access
usually made up of Private Lines (with some PBX switching).
RCA -- Regulatory Commission of Alaska -- A state regulatory body empowered to
establish and enforce rules and regulations governing public utility companies
and others, such as the Company, within the State of Alaska (sometimes referred
to as Public Service Commissions, or PSCs, or Public Utility Commissions, or
PUCs). Previously known as the Alaska Public Utilities Commission (APUC).
Reciprocal Compensation -- The same compensation of a CLEC for termination of a
local call by the ILEC on its network, as the new competitor pays the ILEC for
termination of local calls on the ILEC network.
SchoolAccess(TM) -- The Company's Internet and related services offering to
schools in Alaska, and some sites in Arizona, Montana and New Mexico. The
federal mandate through the 1996 Telecom Act to provide universal service
resulted in schools across Alaska qualifying for varying levels of discounts to
support the provision of Internet services. The Universal Service Administrative
Company through its Schools and Libraries Division administers this federal
program.
SDN -- Software Defined Network -- A switched long-distance service for very
large users with multiple locations. Instead of putting together their own
network, large users can get special usage rates for calls carried on regular
switched long-distance lines.
Securities Reform Act -- The Private Securities Litigation Reform Act of 1995.
Senior Credit Facility -- Holding's $220.0 million credit facility. The Senior
Credit Facility includes a term loan of $170.0 million and a revolving credit
facility of $50.0 million. The new Senior Credit Facility matures on October 31,
2007 and bears interest at LIBOR plus 2.25%. You should see note 7 to the
accompanying "Notes to Consolidated Financial Statements" included in Part II of
this Report for more information.
SMATV -- Satellite Master Antenna Television -- (Also known as "private cable
systems") are multichannel video programming distribution systems that serve
residential, multiple-dwelling units ("MDUs"), and various other buildings and
complexes. A SMATV system typically offers the same type of programming as a
cable system, and the operation of a SMATV system largely resembles that of a
cable system -- a satellite dish receives the programming signals, equipment
processes the signals, and wires distribute the programming to individual
dwelling units. The primary difference between
8
the two is that a SMATV system typically is an unfranchised, stand-alone system
that serves a single building or complex, or a small number of buildings or
complexes in relatively close proximity to each other.
SONET -- Synchronous Optical Network -- A 1984 standard for optical fiber
transmission on the public network. 51.84 Mbps to 9.95 Gigabits per second,
effective for ISDN services including asynchronous transfer mode.
Sprint -- Sprint Corporation -- One of our significant customers.
T-1 -- A data communications circuit capable of transmitting data at 1.5 Mbps.
Tariff -- The schedule of rates and regulations set by communications common
carriers and filed with the appropriate federal and state regulatory agencies;
the published official list of charges, terms and conditions governing provision
of a specific communications service or facility, which functions in lieu of a
contract between the subscriber or user and the supplier or carrier.
TCP/IP -- Transmission Control Protocol/Internet Protocol -- A suite of network
protocols that allows computers with different architectures and operating
system software to communicate with other computers on the Internet.
TDM -- Time Division Multiplex -- A means by which multiple signals are combined
and carried on one transport medium by sequentially sharing the medium in slices
of time (time slots) for each of the various signals.
UNE -- Unbundled Network Element -- A discrete piece part of a telephone
network. Unbundled network elements are the basic network functions, i.e., the
piece parts needed to provide a full range of communications services. They are
physical facilities as well as all the features and capabilities provided by
those facilities.
VSAT -- Very Small Aperture Terminal -- A small, sometimes portable satellite
terminal that allows connection via a satellite link.
WAN -- Wide Area Network -- A remote computer communications system. WANs allow
file sharing among geographically distributed workgroups (typically at higher
cost and slower speed than LANs or MANs). WANs typically use common carriers'
circuits and networks. WANs may serve as a customized communication backbone
that interconnects all of an organization's local networks with communications
trunks that are designed to be appropriate for anticipated communication rates
and volumes between nodes.
World Wide Web or Web -- A collection of computer systems supporting a
communications protocol that permits multi-media presentation of information
over the Internet.
1984 Cable Act -- The Cable Communications Policy Act of 1984.
1992 Cable Act -- The Cable Television Consumer Protection and Competition Act
of 1992.
1996 Telecom Act -- The Telecommunications Act of 1996 -- The 1996 Telecom Act
was signed into law February 8, 1996. Under its provisions, BOCs were allowed to
immediately begin manufacturing, research and development; GTE Corp. could begin
providing interexchange services through its telephone companies nationwide;
laws in 27 states that foreclosed competition were pre empted; co-carrier status
for CLECs was ratified; and the physical collocation of competitors' facilities
in LECs central offices was allowed.
9
The purpose of the 1996 Telecom Act was to move from a regulated monopoly model
of telecommunications to a deregulatory competitive markets model. The act
eliminated the old barriers that prevented three groups of companies, the LECs,
including the BOCs, the long-distance carriers, and the cable TV operators, from
competing head-to-head with each other. The act requires LECs to let new
competitors into their business. It also requires the LECs to open up their
networks to ensure that new market entrants have a fair chance of competing. The
bulk of the act is devoted to establishing the terms under which the LECs, and
more specifically the BOCs, must open up their networks.
The 1996 Telecom Act substantially changed the competitive and regulatory
environment for telecommunications providers by significantly amending the
Communications Act of 1934 including certain of the rate regulation provisions
previously imposed by the Cable Television Consumer Protection and Competition
Act of 1992 (the "1992 Cable Act"). The 1996 Telecom Act eliminated rate
regulation of the cable programming service tier in 1999. Further, the
regulatory environment will continue to change pending, among other things, the
outcome of legal challenges, legislative activity, and FCC rulemaking and
enforcement activity in respect of the 1992 Cable Act and the completion of a
significant number of continuing FCC rulemakings under the 1996 Telecom Act.
10
Cautionary Statement Regarding Forward-Looking Statements
You should carefully review the information contained in this Annual Report, but
should particularly consider any risk factors that we set forth in this Annual
Report and in other reports or documents that we file from time to time with the
Securities and Exchange Commission ("SEC"). In this Annual Report, in addition
to historical information, we state our future strategies, plans, objectives or
goals and our beliefs of future events and of our future operating results,
financial position and cash flows. In some cases, you can identify those
so-called "forward-looking statements" by words such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential," "project," or "continue" or the negative of those words and other
comparable words. All forward-looking statements involve known and unknown
risks, uncertainties and other important factors that may cause our actual
results, performance, achievements, plans and objectives to differ materially
from any future results, performance, achievements, plans and objectives
expressed or implied by these forward-looking statements. In evaluating those
statements, you should specifically consider various factors, including those
outlined below. Those factors may cause our actual results to differ materially
from any of our forward-looking statements. For these statements, we claim the
protection of the safe harbor for forward-looking statements provided by the
Securities Reform Act. Such risks, uncertainties and other factors include but
are not limited to those identified below.
o Local and general market conditions and obstacles, including possible
material adverse changes in the economic conditions in the markets we
serve and in general economic conditions; the continuing impact of the
current stagnant communications industry due to high levels of
competition in the long-distance market resulting in continuing
pressures to reduce prices; and an oversupply of long-haul capacity and
high debt loads;
o The efficacy of laws enacted by Congress and the State of Alaska
legislature; 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 The outcome of our negotiations with ILECs and state regulatory
arbitrations and approvals with respect to interconnection agreements;
o Changes in, or failure, or inability, to comply with, government
regulations, including, without limitation, regulations of the FCC, the
RCA, and adverse outcomes from regulatory proceedings;
o Changes in regulations governing UNEs;
o Changes in the treatment or classification of services using a
particular technology, including Internet protocol;
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
communications industries are able to offer combined or full service
packages prior to our being able to do so;
o Competitor responses to our products and services and overall market
acceptance of such products and services;
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, some of which are
untested;
o The level and timing of the growth and profitability of existing and
new initiatives, particularly local telephone services expansion
including deploying digital local telephone service, and wireless
services;
o Start-up costs associated with entering new markets, including
advertising and promotional efforts;
11
o Risks relating to the operations of new systems and technologies and
applications to support new initiatives;
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 communications, 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 Uncertainties in federal military spending levels in markets in which
we operate;
o Uncertainties surrounding the 2005 base realignment and closure program
and potential military base closures in markets in which we operate;
o The effect on us of industry consolidation including the potential
acquisition of one or more of our large wholesale customers by a
company with commercial relationships with other providers; and the
ongoing global and domestic trend towards consolidation in the
communications industry, which may result in our competitors being
larger and better financed, and provide these competitors with
extensive resources and greater geographic reach, allowing them to
compete more effectively;
o The effect on us of pricing pressures, new program offerings and
continuing market consolidation in the markets served by our
significant customers, MCI and Sprint; 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.
12
Part I
Item 1. Business
General
In this Annual Report, "we," "us" and "our" refer to GCI, Inc. and its direct
and indirect subsidiaries.
GCI, Inc. was incorporated under the laws of the State of Alaska in 1997 to
effect the issuance of Senior Notes as further described in note 11 to the
accompanying "Consolidated Financial Statements" included in Part II of this
Report. GCI, Inc., as a wholly owned subsidiary of GCI, received through its
initial capitalization all ownership interests in subsidiaries previously held
by GCI. GCI, Inc. has its principal executive offices at 2550 Denali Street,
Suite 1000, Anchorage, AK 99503-2781 (telephone number 907-868-5600).
GCI, Inc. is primarily a holding company and together with its direct and
indirect subsidiaries, is a diversified communications provider with a leading
position in facilities-based long-distance service in the State of Alaska and is
Alaska's leading cable television and Internet services provider.
We are the leading integrated, facilities-based communications provider in
Alaska, offering local and long-distance voice, cable video, data and Internet
communications services to residential and business customers under our GCI
brand. A substantial number of our customers subscribe to product bundles that
include two or more of our services.
Since our founding in 1979, we have consistently expanded our product portfolio
to satisfy our customers' needs. We have benefited from the attractive and
unique demographic and economic characteristics of the Alaskan market. We are
pioneers of bundled communications services offerings, and believe our
integrated strategy of providing innovative bundles of voice, video and data
services provides us with an advantage over our competitors and will allow us to
continue to attract new customers, retain existing customers and expand our
addressable market. We hold leading market shares in long-distance, cable video
and Internet services and have gained significant market share in local access
against the incumbent provider.
Through our focus on long-term results and strategic capital investments, we
have consistently grown our revenues and expanded our margins. Our integrated
strategy provides us with competitive advantages in addressing the challenges of
converging telephony, video and broadband markets and has been a key driver of
our success. Today, using our extensive communications networks, we provide
customers with integrated communications services packages that we believe are
unmatched by any other competitor in Alaska.
Availability of Reports and Other Information
Internet users can access information about the Company and its services at
http://www.gci.com/, http://www.gcinetworksolutions.com/, and
http://www.alaskaunited.com/. The Company hosts Internet services at
http://www.gci.net/ and SchoolAccess(TM) services at http://www.gcisa.net/. Our
online telephone directory and yellow pages are hosted at
http://www.gcidirectory.com/. We make available on the http://www.gci.com/
website, free of charge, access to our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statement on Schedule
14A and amendments to those materials filed or furnished pursuant to Section
13(a) or 15(d) of the Securities and Exchange Act of 1934 as soon as reasonably
practicable after we electronically submit such material to the SEC. In
addition, the SEC's website is http://www.sec.gov/. The SEC makes available on
this website, free of charge, reports, proxy and information statements, and
other information regarding issuers, such as us, that file electronically with
the SEC. Information on our website or the SEC's website is not part of this
document.
13
Financial Information About Industry Segments
We have four reportable segments: long-distance services, cable services, local
access services and Internet services. For information required by this section,
you should see Part II, Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations. Also refer to Note 12 included in
Part II, Item 8, Consolidated Financial Statements and Supplementary Data.
Recent Developments
Intrastate Access Charge Ruling. On May 15, 2003, AT&T filed a petition with the
FCC requesting a declaratory ruling that intrastate access charges do not apply
to certain of its calling card offerings. When AT&T Alascom, a subsidiary of
AT&T, characterized calling card calls that originate and terminate in Alaska as
interstate, they shifted to us the charges for certain intrastate access payable
to Alaska LECs. In a proceeding before the RCA, the RCA had already declared
this AT&T Alascom practice to be improper. After AT&T petitioned the FCC, the
RCA stayed AT&T Alascom's obligations to make back payments of intrastate access
charges to Alaska LECs for the period prior to April, 2004, but ordered AT&T
Alascom to pay such charges on an ongoing basis from April 1, 2004. On February
23, 2005, the FCC also ruled against AT&T, consistent with the RCA's prior
findings. With this ruling, we can now seek to collect refunds for the
intrastate access charge amounts that AT&T Alascom improperly shifted to us
prior to April 1, 2004. We have not completed our calculations of the amounts
due to us and cannot predict at this time the ultimate amount to be refunded
pursuant to this gain contingency, however it could be material to our results
of operations, financial position and cash flows.
Barrow Cable TV Asset Purchase. We closed the asset purchase of Barrow Cable TV
in February 2005 for approximately $1.6 million, or approximately $1,700 per
subscriber. We plan to upgrade the plant of Barrow Cable TV in order to deliver
digital services as well as high-speed cable modem service. Upgrades are
scheduled to be implemented by the beginning of 2006. In January 2005, the RCA
approved the transfer of the Certificate of Public Convenience and Necessity to
us. We expect to add additional subscribers totaling approximately 950 and
additional homes passed totaling approximately 1,600 as a result of this asset
purchase.
Local Service Expansion Filing. In January 2005 we filed with the RCA to expand
our provision of competitive local telephone services into rural Alaska. We plan
to invest approximately $60 million dollars into local economies in
construction, technologies and facilities. We requested authorization to provide
service in competition with the existing service provider's entire service area
in the service area of Ketchikan Public Utilities, Cordova Telephone
Cooperative, Copper Valley Telephone Cooperative, Matanuska Telephone
Cooperative, and the "Glacier State" study area, including Delta Junction,
Homer, Kenai, Kodiak, Soldotna, Nenana, and North Pole. In addition, we are
seeking approval to offer local service in Wrangell, Petersburg, Sitka, Seward,
Bethel, and Nome. We are seeking certification in these markets for the area
covered by our cable facilities only.
We plan to offer service in these new areas using a combination of methods. To a
large extent, we will use our existing cable network to deliver local services.
Where we do not have cable plant, we may use wireless technologies and resale of
other carrier's services. We may lease portions of an existing carrier's network
or seek wholesale discounts, but our application is not dependent upon access to
either the incumbent's network or wholesale discount rates for resale of
services.
The RCA may only decide this application on the basis of whether or not we are
fit to provide the service. It has already been decided, under federal law, that
competition is permissible. Because we are not requesting use of the existing
carrier's network, there is no public interest issue for the RCA to decide. We
are requesting that the RCA decide this application as soon as possible, and in
any case, within six months.
14
MTA Rural Exemption Determination. By letter, submitted also to the RCA, on
January 12, 2004, we made a bona fide request for interconnection for the
purposes of local access competition with the Matanuska Telephone Association
("MTA"), under the provisions of the Telecommunications Act of 1996. We
submitted this request to MTA on the grounds that it waived its rural exemption
under the terms of Section 251(f)(1)(C) of the 1996 Telecom Act when it launched
its new video service through its wholly owned subsidiary MTA Vision, Inc. in
competition with our cable television service. MTA, however, refused to comply
with the negotiation and arbitration provisions under the 1996 Telecom Act
claiming that it still retains a rural exemption. We filed a complaint with the
RCA to resolve this dispute, and the RCA conducted a public hearing on the
matter on October 20, 2004. On February 22, 2005, the RCA released a ruling that
MTA's rural exemption for the areas served by MTA Vision, Inc. had been lifted
and that we may negotiate and arbitrate interconnection with MTA. We tendered a
new interconnection request to MTA on February 25, 2005 and are proceeding with
such negotiations. In the event negotiations are unsuccessful, an arbitration
will be requested which must be completed under the provisions of the 1996
Telecom Act by November 25, 2005. Following the entry into an Interconnection
Agreement, we intend to commence local service entry into the Mat-Su Valley
during 2007.
Cellular Service Expansion. We launched cellular services in the Southeast
Alaska cities of Petersburg and Wrangell in February 2005. This completes our
cellular services roll-out. Our cellular services are also provided in
Anchorage, Fairbanks, Homer, Juneau, Kenai/Soldotna, Ketchikan, Palmer/Wasilla,
Seward, Sitka, and Valdez.
Rural Internet Program Expansion. We expect to complete during the first quarter
of 2005 the last of the 50 wireless internet (WISP) sites that we began work on
in 2004. When these sites are completed, we will have provided internet services
to 150 remote communities in Alaska at faster speeds and lower rates than
they've experienced before.
AU East Capacity Expansion. We expect to complete a capacity expansion of our
AULP East fiber system during the first quarter of 2005. We are upgrading the
system using wavelength division multiplexing from its current five gigabit per
second ("Gbps") capacity to 20 Gbps.
Historical Development of our Business During the Past Fiscal Year
ConnectMD Services Expansion. We have developed an agreement with Alaska
Psychiatric Institute to expand our ConnectMD service to provide tele-psychiatry
services to health clinics across the state of Alaska. This new service will
triple the number of communities that have access to clinical staff via a video
link and we believe it will allow for better and more cost-efficient care for
patients. With this service, behavioral health patients in remote areas of
Alaska can now be treated in their own environment, instead of having to travel
to Anchorage for treatment.
Conversion to Digital Completed. In 2004 we completed the conversion of our
Anchorage and Fairbanks cable television systems from analog to digital service
delivery for service levels above basic. Digital service delivery allows us to
offer more programming content and advanced digital services, including digital
local phone service.
New Telephone Directories. We completed the distribution of our new telephone
directories to Fairbanks and Juneau areas homes and businesses. The directories
include an online version (http://www.gcidirectory.com/) so users can link to
advertisers' websites and e-mail addresses. They can also find arts, education,
government organizations and public safety information.
Galaxy XR Satellite Propulsion System Failure. Galaxy XR, our primary
satellite used to provide voice, data and internet services to our rural Alaska
customers, Galaxy XR, experienced a failure August 3, 2004 of its secondary
xenon ion propulsion system (XIPS) that maintains the satellite's proper orbital
position. The primary XIPS failed in February 2004. The satellite is now using
its backup bi-propellant thrusters to maintain its orbital position. These
thrusters are a space flight proven
15
technology. The failure of the primary and secondary XIPS had no short term
impact on service to our customers. PanAmSat, the owner and operator of Galaxy
XR, believes the satellite has sufficient fuel to continue normal operations
until November 2007. The terms of our Galaxy XR transponder purchase agreement
extends through March 2012. PanAmSat intends to replace the satellite before its
estimated end-of-life. We purchased a warranty with the original agreement to
cover a loss of this nature. We have had an agreement in place that provides
backup transponder capacity on the Galaxy XIII satellite in the event of a
catastrophic failure of Galaxy XR.
Cellular Services Distribution Agreement. We closed a 10-year distribution
agreement with a cellular service provider Dobson Communications ("Dobson") in
2004 that allows us to offer a full line of state-of-the-art voice and data
wireless products and services to our customers throughout Alaska. We are
marketing these products and services under our own brand as stand alone
wireless products and as additions to packaged offerings. The agreement also
allows us to develop new products and services combining both wireless and
wireline technologies. We will provide billing and all customer support services
for our wireless services. Under a separate agreement, Dobson will lease 10 MHz
of our 1900 MHz wireless spectrum and will expand services in existing and new
Alaska markets. Dobson's wireless spectrum is in the 800 MHz spectrum band. The
lease agreement enables us and Dobson to expand overall system capacity. This
will create a more efficient wireless system providing better service to
customers. Expansion of service under the terms of the agreement fulfills our
wireless buildout requirement to retain our PCS "B" block license.
Stock Repurchase Approvals. GCI's Board of Directors authorized us and we
obtained permission from our lenders and GCI's preferred shareholder to
repurchase up to $10 million of GCI's common stock during the six-month period
ended June 30, 2005. We expect to continue the purchases throughout 2005 subject
to the availability of free cash flow, credit facilities, the price of the stock
and the requisite consents of lenders and GCI's preferred shareholder. The
purchases will comply with the restrictions of Securities Exchange Commission
rule 10b-18.
AULP East Cable System Repair. Our AULP East system experienced powering
irregularities during the first quarter of 2004. We completed the repair of AULP
East in July 2004.
AULP West Cable System Completion. 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 was selected to design, engineer, manufacture, and
install the undersea fiber optic cable system. We placed AULP West into service
in June 2004.
Anchorage Local Service Rates. The RCA released an order on June 28, 2004 that,
among other things, increased the Unbundled Network Element (UNE) rate we pay
ACS each month from $14.92 to $19.15 per line (subsequently reduced to $18.64
per line). In setting this rate, the RCA ruled on a variety of factors such as
depreciation, cost of capital, cost of the network, maintenance and
administrative overhead.
New Retail Store. In March 2004 we opened a new retail store in Eagle River that
serves our customers in Eagle River, Chugiak, and Peters Creek. Customers have a
more convenient opportunity to pay their bill, sign up for new services and
obtain answers to their questions from one of our customer service
representatives. HDTV and Digital Video Recorder Deployment. We began offering
HDTV programming in our Anchorage and Mat-Su Valley market areas in 2004. New
HDTV converters with digital video recorder capabilities were introduced to our
customers in these markets.
New Senior Notes and Senior Credit Facility Waiver and Amendment. In February
2004, GCI, Inc. issued $250 million principal amount of senior notes. These
senior notes bear interest at 7.25% and are due in February 2014. GCI, Inc. used
the proceeds from issuance of these senior notes to retire
16
or repay other indebtedness. In connection with the issuance of these senior
notes, GCI, Inc. offered to purchase all of its outstanding 9.75% Senior Notes
due 2007 (the "2007 Notes") for cash at 103.5% of the principal amount.
Approximately $114.6 million principal amount of the 2007 Notes were tendered
and accepted pursuant to this offer. GCI, Inc. called for redemption of the
remaining outstanding 2007 Notes at the redemption price of 103.25% of the
principal amount. In addition to the purchase and redemption of the 2007 Notes,
approximately $53.8 million of proceeds received from the issuance of the new
senior notes were used to repay indebtedness under our Senior Credit Facility.
Compliance with the redemption notice requirements in the 2007 Notes Indenture
resulted in a delay between the date the new senior notes were issued and the
final redemption date of the 2007 Notes. As a result of such delay, our total
debt temporarily increased during the overlap period between the redemption of
the outstanding 2007 Notes and the issuance of the new senior notes. This
temporary increase did not comply with certain provisions of our Senior Credit
Facility. We received a waiver of these provisions from the lenders under our
Senior Credit Facility until April 30, 2004.
On November 19, 2004, we entered into an Amendment No. 3 to our Senior Credit
Facility. The amendment modifies the terms of the existing credit facility to
permit the incurrence by GCI, Inc. of up to $100 million in aggregate principal
amount of additional senior notes due 2014. The amended credit facility permits
up to $70 million of the proceeds from such additional senior notes to be used
to purchase shares of GCI stock held by MCI and Toronto Dominion Investments,
Inc. (or the proceeds may be distributed to GCI for such purpose), so long as
there exists no default under the credit facility both before and after giving
effect to such transaction. The amended credit facility also permits the
proceeds to be used for additional capital expenditures.
Add-on Senior Notes and Stock Retirements. On December 7, 2004, we issued $70
million of additional 7.25% senior notes due 2014. In a private transaction
concurrent with the closing of the additional senior notes, we repurchased
3,751,509 of GCI's Class A common shares at $8.33 per share and $10 million face
value of GCI's Series C preferred stock from MCI. The aggregate amount of the
equity repurchase totaled $41.3 million. In addition, $10 million of the
proceeds of the additional senior notes were used to repay the outstanding
balance on our revolving credit facility. The remaining balance of the bond
proceeds of more than $17 million, after fees and expenses, will be used for
other general corporate purposes.
Fiber System Taken out of Service. We own a portion of the capacity of an
undersea fiber optic cable system linking Alaska to the Lower 48 states known as
the Alaska spur of the North Pacific Cable ("NPC"). The Alaska spur of the NPC
was removed from service in January 2004 by PT Cable, Inc. due to a dispute over
billings between PT Cable, Inc. and AT&T. We determined that the recorded value
for our NPC fiber asset was impaired at December 31, 2003 and recorded a $5.4
million charge in the fourth quarter in the financial statements included in
Part II of this report.
Free Cable Modem Service. On January 26, 2004, we began offering new and current
customers free LiteSpeed cable modem Internet service when they sign up for
certain of our other services. LiteSpeed uses cable modems and is designed for
dial-up Internet access customers who want more Internet download speed and
greater convenience. Cable modems transmit data reliably at a much faster rate
than dial-up connections and do not tie up the telephone line. Our cable modem
service is available to a high percentage of Alaska homes in Anchorage, Bethel,
Cordova, Fairbanks, Homer, Juneau, Kenai, Ketchikan, Kodiak, Nome, Palmer,
Petersburg, Seward, Sitka, Soldotna, Valdez, Wasilla, and Wrangell.
Alaska Supreme Court Decision and Settlement. ACS, through subsidiary companies,
provides local telephone services in Fairbanks and Juneau, Alaska. The ACS
subsidiaries are classified as Rural Telephone Companies under the 1996 Telecom
Act, which entitles them to an exemption of certain material interconnection
terms of the 1996 Telecom Act, until and unless such "rural exemption" is
examined and not continued by the RCA. On October 11, 1999, the RCA issued an
order terminating
17
rural exemptions for the ILECs operating in the Fairbanks and Juneau markets so
that we could compete with these companies in the provision of local telephone
service. Upon appeal by ACS, on December 12, 2003, the Alaska Supreme Court
issued a decision in which it reversed the RCA's rural exemption decision on the
procedural ground that the competitor, not the incumbent, must shoulder the
burden of proof. The Court remanded the matter to the RCA for reconsideration
with the burden of proof assigned to us. Additionally, the Court left it to the
RCA to decide as a matter of discretion whether to change the state of
competition during the remand period. In accordance with the Court's ruling, the
RCA re-opened the rural exemption dockets and scheduled a hearing to commence on
April 19, 2004. Additionally, the RCA issued a ruling on January 16, 2004, in
which the RCA determined that we can continue to rely on unbundled network
elements from ACS to serve our existing customers in Juneau and Fairbanks but
that we may not serve new customers through purchase of unbundled network
elements pending the completion of the remand proceeding.
On April 20, 2004, we announced that a joint settlement was reached that
substantially resolved a number of legal and regulatory proceedings between ACS
and us. Among other things, terms of the settlement are as follows:
o ACS relinquishes all claims to exemptions from full local telephone
competition in Fairbanks and Juneau,
o New rates for unbundled loops in Fairbanks and Juneau beginning January
1, 2005,
o Resolution of UNE loops provided with ILEC switching (UNE-Platform)
leasing issues for the Fairbanks and Juneau markets, and
o Extension of existing interconnection agreements between ACS and us for
Fairbanks and Juneau until January 1, 2008.
See "Part I -- Item 1 -- Business -- Regulation, Franchise Authorizations and
Tariffs -- Communications Operations -- Rural Exemption" for more information.
Narrative Description of our Business
General
We are the largest Alaska-based and operated integrated communications provider.
A pioneer in bundled service offerings, we provide facilities-based local and
long distance voice, cable video, Internet and data communications services, and
resell wireless telephone services, to residential and business customers under
our GCI brand.
We generated consolidated revenues of $424.8 million in 2004. We ended the year
with approximately 91,300 long-distance customers, 112,100 local access lines in
service, 134,700 basic cable subscribers, and 101,600 Internet subscribers,
including 65,500 cable modem subscribers. A substantial number of our customers
subscribe to product bundles that include two or more of our services. The
National Cable and Telecommunications Association ("NCTA") reports that we were
the 25th largest MSO in the U.S. as of September 30, 2004.
Since our founding in 1979, we have consistently expanded our product portfolio
to satisfy our customers' needs. We have benefited from the attractive and
unique demographic and economic characteristics of the Alaskan market. We
believe our integrated strategy of providing innovative bundles of voice, video
and data services provides us with an advantage over our competitors and will
allow us to continue to attract new customers, retain existing customers and
expand our addressable market. We hold leading market shares in long-distance,
cable video and Internet services and have gained significant market share in
local access against an incumbent provider.
Through our focus on long-term results and strategic capital investments, we
have consistently grown our revenues and expanded our margins. Our integrated
strategy provides us with competitive advantages in addressing the challenges of
converging telephony, video and broadband markets and has been a key driver of
our success. Today, using our extensive communications networks, we
18
provide customers with integrated communications services packages that we
believe are unmatched by any other competitor in Alaska.
We operate a broadband communications network that permits the delivery of a
seamless integrated bundle of communications, entertainment and information
services. We offer a wide array of consumer and business communications and
entertainment services -- including local telephone, long-distance and wireless
communications, cable television, consulting services, network and desktop
computing outsourced services, and dial-up, broadband (cable modem, wireless and
DSL) and dedicated Internet access services at a wide range of speeds -- all
under the GCI brand name.
We believe that the size and growth potential of the voice, video and data
market, the increasing deregulation of communications services, and the
increased convergence of telephony, wireless, and cable services offer us
considerable opportunities to continue to integrate our communications, Internet
and cable services and expand into communications markets both within and,
longer-term, possibly outside of Alaska.
Considerable deregulation has already taken place in the United States because
of the 1996 Telecom Act with the barriers to competition between long-distance,
local exchange and cable providers being lowered. We believe our acquisition of
cable television systems and our development of local exchange service, Internet
services, broadband services, and wireless services leave us well positioned to
take advantage of deregulated markets.
We are Alaska's leading provider of long-distance, cable television and data and
Internet services, as measured by revenues, and we are the second largest local
access provider, as measured by local access lines. We attribute our leadership
position to our commitment to provide our customers with high-quality products
in bundled offerings that maximize their satisfaction. We maintain a strong
competitive position, however there is active competition in the sale of
substantially all products and services we offer.
Competition in the Communications Industry
There is substantial competition in the communications industry. The traditional
dividing lines between providers offering long-distance telephone service, local
telephone service, wireless telephone service, Internet services and video
services are increasingly becoming blurred. Through mergers and various service
integration and product bundling strategies, major providers, including us, are
striving to provide integrated communications service offerings within and
across geographic markets.
Competitive Strengths
Market Leader. We are Alaska's leading provider of long-distance, cable
television and data and Internet services, as measured by revenues, and we are
the second largest local access provider, as measured by local access lines. We
attribute our leadership position to our commitment to provide our customers
with high-quality products in bundled offerings that maximize their
satisfaction.
Advanced Infrastructure and Robust Network Assets. We own and operate advanced
networks that provide integrated end-to-end solutions. Our hybrid-fiber coax
cable network enables us to offer last-mile broadband connectivity to our
customers. Our interstate and undersea fiber optic cable systems connect our
major markets in Alaska to the Lower 48 States. We employ satellite transmission
for rural intrastate and interstate traffic in markets where terrestrial based
network alternatives are not available. We have or expect to be able to obtain
satellite transponders to meet our long-term satellite capacity requirements. In
our local service markets, we offer services using our own facilities, unbundled
network elements and wholesale/resale.
19
Bundled Service Offerings. Ownership and control of our network and
communications assets have enabled us to effectively market bundled service
offerings. Bundling facilitates the integration of operations and administrative
support to meet the needs of our customers. Our product and service portfolio
includes stand-alone offerings and bundled combinations of local and
long-distance voice and data services, cable video, broadband (cable modem,
fixed wireless and DSL), dedicated Internet access services and other services.
Well-Recognized Brand Name. Our GCI brand is the oldest brand among major
communications providers in Alaska and positively differentiates our services
from those of our competitors. We believe our customers associate our brand name
with quality products. We continue to benefit from high name recognition and
strong customer loyalty, and the majority of our customers purchase multiple
services from us. We have been successful in selling new and enhanced products
to our customers based on perceived quality of products and brand recognition.
Favorable Alaskan Market Dynamics. The Alaskan communications market is
characterized by its large geographic size and isolated markets that include a
combination of major metropolitan areas and small, dense population clusters,
which create a deterrent to potential new entrants. Due to the remote nature of
its communities, the state's residents and businesses rely extensively on our
systems to meet their communications needs. We believe that, when compared to
national averages, Alaskan households spend more on communications services.
According to the United States Census Bureau, the median household income in
Alaska was 27% higher than the three-year United States national average from
2001 to 2003, and according to the Alaska Department of Revenue, in 2003,
federal spending in Alaska was up 4%, year over year. We believe there is a
positive outlook for continued growth.
Experienced Management Team. Our experienced management team has a proven track
record and has consistently expanded our business and improved our operations.
Our senior management averages more than 24 years of experience in the
communications industry and more than 19 years with our company.
Business Strategy
We intend to continue to increase revenues and cash flow using the following
strategies:
Continue to Offer Bundled Products. We offer innovative service bundles to
meet the needs of our residential and business customers. Bundling our
services significantly improves customer retention, increases revenue per
customer and reduces customer acquisition expenses. Our experience
indicates that our bundled customers are significantly less likely to
churn, and we experience less price erosion when we effectively combine our
offerings. Bundling improves our top line growth, provides operating cost
efficiencies that expand our margins and drives our overall business
performance. As a measure of success to date, substantially all of our
local customers subscribe to our long-distance service and approximately
one-half of our cable video subscribers also subscribe to our high-speed
Internet service.
Maximize Sales Opportunities. We successfully sell new and enhanced
services and products between and within our business segments to our
existing customer base to achieve increased revenues and penetration of our
services. Through close coordination of our customer service and sales and
marketing efforts, our customer service representatives cross sell and up
sell our products. Many calls into our customer service centers result in
sales of additional products and services. We actively seek to continue to
encourage our existing customers to acquire higher value, enhanced
services.
Deliver Industry Leading Customer Service. We have positioned ourselves as
a customer service leader in the Alaska communications market. We operate
our own customer service department and maintain and staff our own call
centers. We have empowered our customer service
20
representatives to handle most service issues and questions on a single
call. We prioritize our customer services to expedite handling of our most
valuable customers' issues, particularly for our largest business
customers. We believe our integrated approach to customer service,
including setting up the service, programming various network databases
with the customer's information, installation, and ongoing service, allows
us to provide a customer experience that fosters customer loyalty.
Leverage Communications Operations. We continue to expand and evolve our
integrated network for the delivery of our services. Our bundled strategy
and integrated approach to serving our customers creates efficiencies of
scale and maximizes network utilization. By offering multiple services, we
are better able to leverage our network assets and increase returns on our
invested capital. We periodically evaluate our network assets and
continually monitor technological developments that we can potentially
deploy to increase network efficiency and performance.
Expand Our Product Portfolio and Footprint in Alaska. Throughout our
history, we have successfully added and expect to continue to add new
products to our product portfolio. Management has a demonstrated history of
evaluating potential new products for our customers, and we will continue
to assess revenue-enhancing opportunities that create value for our
customers. In addition to new services such as digital video recorders,
HDTV and video-on-demand, we are also expanding the reach of our core
products to new markets. Where feasible and where economic analysis
supports geographic expansion of our network coverage, we expect to pursue
opportunities to increase the scale of our facilities, enhance our ability
to serve our existing customers' needs and attract new customers.
Alaska Voice, Video and Data Markets
The Alaskan voice, video and data markets are unique within the United States.
Alaska is geographically distant from the rest of the United States and is
generally characterized by large geographical size and relatively small, dense
population clusters (with the exception of population centers such as Anchorage,
Fairbanks and Juneau). It lacks a well-developed terrestrial transportation
infrastructure, and the majority of Alaska's communities are accessible only by
air or water. As a result, Alaska's communication networks are different from
those found in the Lower 49 States.
Alaskans continue to rely extensively on satellite-based long-distance
transmission for intrastate calling between remote communities where investment
in a terrestrial network would be uneconomic or impractical. Also, given the
geographic isolation of Alaska's communities and lack, in many cases, of major
civic institutions such as hospitals, libraries and universities, Alaskans are
dependent on communications services to access the resources and information of
large metropolitan areas in Alaska, the rest of the United States and elsewhere.
In addition to satellite-based communications, the communications services
infrastructure in Alaska includes fiber optic cables between Anchorage, Valdez,
Fairbanks, Prudhoe Bay, Seward, Kenai/Soldotna, Palmer/Wasilla, Homer and
Juneau, traditional copper wire, and digital microwave radio on the Kenai
Peninsula and other locations. For interstate and international communications,
Alaska is connected to the Lower 48 States by four fiber optic cables, one of
which was taken out of service in January 2004. See "Part I -- Item 1 --
Business -- Historical Development of our Business During the Past Fiscal Year
- -- Fiber System Taken out of Service" for more information.
Fiber optics is currently the preferred method of carrying Internet, voice,
video, and data communications over long-distances, eliminating the delay
commonly found in satellite connections. Widespread use of high capacity fiber
optic facilities is expected to allow continued expansion of business,
government, educational, and health care infrastructure in Alaska.
21
Long-Distance Services
Industry. Until the 1970s, AT&T had a virtual monopoly on long distance service
in the United States. In the 1970s, competitors such as MCI and Sprint began to
offer long distance service. With the gradual emergence of competition, basic
rates dropped, calling surged, and AT&T's dominance declined. More than 900
companies now offer wire-line long distance service. AT&T's 1984 toll revenues
were approximately 90% of those reported by all long distance carriers. The
FCC's regulation of AT&T as a "dominant" carrier ended in 1995. By 2003, AT&T's
revenues had declined to approximately 29% of all toll revenues. The two largest
market entrants, MCI and Sprint, have obtained a 28% combined market share
through 2003. BellSouth, Quest, SBC and Verizon have obtained a 15% combined
market share in 2003 as compared to 9% in 2000.
The FCC reports that approximately $78.6 billion was derived from toll services
in 2003 as compared to $109.6 billion in 2000. In 2002, residential customers
generated over 45% of toll revenues, and 35% of residential toll phone calls
were interstate as opposed to 47% of minutes. In 2002, approximately 31% of
total toll services revenue was derived from intrastate, 51% was derived from
domestic interstate, and 18% was derived from international toll services.
Interstate long distance toll revenues increased approximately 62% from $26
billion in 1984 to $43 billion in 2002, and intrastate toll revenues increased
approximately 23% from $21 billion in 1984 to $26 billion in 2002, despite
significant rate reductions in both categories during this period. Significant
decreases occurred in 2002 as compared to 2001, with interstate long distance
and intrastate toll revenues each decreasing approximately 13%.
The FCC reports that total interstate switched access minutes have declined
21.7% from 2000 to 2003; from 566.9 billion to 444.1 billion, respectively.
Average revenue per minute of long distance calling dropped from $0.32 in 1984,
when competitive discount and promotional long distance plans were introduced,
to $0.09 in 2002. This average price per minute represents a mix of
international calling (an average of 28 cents per minute) and domestic
interstate calling (an average of 7 cents per minute). The decline in prices
since 1984 is more than 80% after adjusting for the impact of inflation. The
annual rate of change in the consumer price index for all telephone services
between 2002 and 2003 was reported to be -2.7% as compared to 1.9% for all
services. Local residential services (based on monthly service charges, message
unit charges, leased equipment, installation, enhanced services, taxes,
subscriber line charges, and all other consumer expenditures associated with
telephone services except long distance charges) increased 2.6% in 2003 as
compared to 2002, while interstate toll service decreased 10.9% and intrastate
toll service decreased 9.4% during the same period. The average revenue per
minute for interstate and international calls in 1990 was $0.28 (adjusted for
inflation) as compared to $0.09 in 2002.
The FCC reports that approximately 2% of all consumer expenditures are devoted
to telephone service. This percentage has remained relatively constant over the
past 15 years, despite major changes in the industry and in telephone usage.
Average annual expenditures for telephone service increased from $877 per
household in 2000 to $996 in 2002.
The FCC reports that approximately 106 million U.S. households had telephone
services as of March 2004, an increase of 28 million households since 1983. An
estimated 93.8% of households and virtually all businesses in the United States
subscribed to telephone service in July 2004. Approximately 92.9% of households
subscribed to telephone service in 1980.
The FCC reports that primary lines in service in the United States have grown
over time, averaging approximately 3% per year, which, until 2000, had
historically reflected growth in the population and the economy. Since then, the
number of lines provided by wireline carriers has declined. The FCC reports that
consumer substitution of wireless service for wireline service, and consumer
elimination of second lines when they move from dial-up Internet service to
broadband service may explain the decrease. The percentage of additional
wirelines for households with telephone service has
22
increased significantly, from approximately 3% in 1988 to approximately 26% in
2000, and decreased back to 18% in 2002.
International communications continues to be an important segment of the
communications market. The FCC reports that the number of calls made from the
United States to other countries increased from 200 million in 1980 to 6.1
billion in 2002, and that Americans spent approximately $11.5 billion on
international telephone and private line services in 2002. Consistent with
domestic toll rates per minute, international toll rates per minute have
decreased significantly. On average, carriers billed 28 cents per minute for
international calls in 2002, a decline of more than 79% since 1980. Five
markets, Canada, Mexico, the United Kingdom, Germany, and India, accounted for
approximately 41% of the international calls billed in the United States in
2002. AT&T, MCI, and Sprint combined accounted for 82% of the international
service billed in the United States in 2002.
While the 1996 Telecom Act has facilitated competition and rapid growth in the
communications market, the last three years have been a tumultuous time for that
marketplace. Industry analysts believe that overly optimistic projections of
data growth spurred companies to invest large amounts of capital to boost
network capacity. While demand for communications services grew, it did not grow
at a sufficient pace to justify the substantial build-out of fiber capacity. A
wide gap developed between the supply of network capacity and the demand for
data transmission. Network owners refocused their efforts to demonstrate
profitability over a much shorter time horizon than initially projected. A
downward spiral ensued, as some communications carriers went out of business
after failing to generate sufficient revenues to service their accelerating debt
loads. The resultant slowdown in capital expenditures left equipment
manufacturers with surplus inventory and personnel. Excess capacity and new
technology is expected to enable more competition.
The communications industry stabilized in 2003, but remains stagnant. Intense
price competition continues, with continuing technological innovations
threatening established services.
Growth in demand for data services is expected to continue to be a key component
of industry revenue growth. We believe that the data communications business
will eventually rival and perhaps become larger than the traditional voice
telephony market. The continuing migration of voice and other traffic from
analog to digital transmission and the growth in data attributed to broadband
applications are expected to fuel the growth in data with inevitable industry
realignment expected to continue.
The FCC issued a Report and Order (FCC 03-197) in 2003 eliminating a policy that
prohibited the installation or operation of more than one satellite earth
station in any Alaska rural community for competitive carriage of interstate
message telephone service ("MTS") communications. The FCC found that through a
series of regulatory steps, the environment that once called for restrictions on
competitive facilities-based entry had changed. This policy change allows us to
install facilities and provide competitive interstate MTS and other
communications services over our own equipment and network in rural communities
where we presently have no facilities.
We believe that federal and state legislators, courts and regulators will
continue to influence the communications industry in 2005. Consummation of
mergers between and spin-offs from long-distance companies, local access
services companies, ISPs and cable television companies is expected to continue
to occur which blurs the distinction between product lines and competitors.
Industry analysts believe companies will be successful in the long-term if they
can achieve and maintain a superior operating cost position, minimize regulatory
battles, offer a full suite of integrated services to their customers using a
network that is largely under their control, and continue to offer new and
enhanced services that customers wish to purchase.
See "Part I -- Item I -- Business -- Regulation, Franchise Authorizations and
Tariffs -- Long-Distance Services" for more information.
23
General. We supply a full range of common carrier long-distance and other
communications products and services. We operate a modern, competitive
communications network employing the latest digital transmission technology
based upon fiber optic facilities within and between Anchorage, Fairbanks and
Juneau, Alaska. Our facilities include two self-constructed and financed
undersea digital fiber optic cables and additional owned capacity on another
undersea fiber optic cable (which was taken out of service in January 2004, (see
"Part I -- Item 1 -- Business -- Historical Development of our Business During
the Past Fiscal Year -- Fiber System Taken out of Service"), linking our Alaska
terrestrial networks to the networks of other carriers in the Lower 49 States.
We use satellite transponders to transmit voice and data traffic to remote areas
of Alaska. We operate digital microwave systems to link Anchorage with the Kenai
Peninsula, and our Prudhoe Bay Earth Station with Deadhorse. Digital microwave
facilities also are used to back up our fiber facilities from Anchorage to our
Eagle River earth station, and to our Fairbanks earth station from our Fairbanks
distribution center. Virtually all switched services are computer controlled,
digitally switched, and interconnected by a packet switched SS7 signaling
network.
We provide interstate and intrastate long-distance services throughout Alaska
using our own facilities or facilities leased from or swapped with other
carriers. We also provide (or join in providing with other carriers)
communications services to and from Alaska, Hawaii, the Lower 48 States, and
many foreign nations and territories.
We offer cellular services by reselling another cellular provider's services. We
offer wireless local access services over our own facilities, and have purchased
PCS and LMDS wireless broadband licenses in FCC auctions covering markets in
Alaska.
Products. Our long-distance services industry segment is engaged in the
transmission of interstate and intrastate-switched message telephone service and
Private Line and Private Network communications service between the major
communities in Alaska, and the remaining United States and foreign countries.
Our message toll services include intrastate, interstate and international
direct dial, toll-free 800, 888, 877 and 866 services, our calling card,
operator and enhanced conference calling, frame relay, SDN, ISDN technology
based services, as well as terminating northbound MTS traffic for MCI, Sprint
and several large resellers who do not have facilities of their own in Alaska.
We also provide origination of southbound calling card and toll-free 800, 888,
877 and 866 toll services for MCI, Sprint, and other IXCs. We offer our message
services to commercial, residential, and government subscribers. Subscribers
generally may cancel service at any time. Toll, Private Line, broadband and
related services account for approximately 45.7%, 49.6% and 53.5% of our 2004,
2003 and 2002 revenues, respectively. Broadband services include our
SchoolAccess(TM) and Rural Health initiatives. Private Line and Private Network
services utilize voice and data transmission circuits, dedicated to particular
subscribers, which link a device in one location to another in a different
location.
We have positioned ourselves as a price, quality, and customer service leader in
the Alaska communications market. The value of our long-distance services is
generally designed to be equal to or greater than that for comparable services
provided by our competitors.
In addition to providing communications services, we also design, sell, install,
service and operate, on behalf of certain customers, communications and computer
networking equipment and provide field/depot, third party, technical support,
communications consulting and outsourcing services through our Network Solutions
business. We also supply integrated voice and data communications systems
incorporating interstate and intrastate digital Private Lines, point-to-point
and multipoint Private Network and small earth station services. Our Network
Solutions sales and services revenue totaled $13.8 million, $11.9 million, and
$12.4 million in the years ended December 31, 2004, 2003 and 2002, respectively,
or approximately 3.2%, 3.0% and 3.4% of total revenues, respectively. Presently,
there are a number of competing companies in Alaska that actively sell and
maintain data and voice communications systems. Network Solutions' managed
services and product sales results
24
are reported in the All Other category in the Consolidated Financial Statements
included in Part IV of this report.
Our ability to integrate communications networks and data communications
equipment has allowed us to maintain our market position based on "value added"
support services rather than price competition. These services are blended with
other transport products into unique customer solutions, including managed
services and outsourcing.
Facilities. Our communication facilities include an undersea fiber optic cable
system connecting Whittier, Valdez and Juneau, Alaska and Seattle, Washington,
which was placed into service in February 1999.
We constructed a new undersea fiber optic cable system connecting Seward, Alaska
to Warrenton, Oregon that we placed into service in June 2004. This fiber optic
cable system is designated AULP West and the original undersea fiber optic cable
system is now designated AULP East. The Seward cable landing station connects to
our network in Anchorage and the Warrenton cable landing station connects to our
network in Seattle via long-term leased capacity. The combination of AULP West
and AULP East provides us with the ability to provide fully protected
geographically diverse routing of service between Alaska and the Lower 48
States.
These undersea fiber optic cable systems allow us to carry our military base
traffic and our Anchorage, Delta Junction, Eagle River, Fairbanks, Girdwood,
Glenallen, Healy, Juneau, Seward, Valdez, Wasilla, and Whittier, Alaska traffic
to and from the contiguous Lower 48 States and between these instate locations
over terrestrial circuits, eliminating the one-half second round trip delay
associated with satellite circuits.
Other facilities include major earth stations at Barrow, Bethel, Cordova,
Dillingham, Dutch Harbor, Eagle River, Ketchikan, King Salmon, Kodiak, Kotzebue,
Nome, Prudhoe Bay, and Sitka, all in Alaska, serving the communities in their
vicinity, and at Issaquah, Washington, which provides interconnection to Seattle
and the Lower 48 States for traffic to and from major Alaska earth stations. The
Eagle River earth station is linked to the Anchorage distribution center by
fiber optic facilities.
We use SONET as a service delivery method for our terrestrial metropolitan area
networks as well as our long-haul terrestrial and undersea fiber optic cable
networks. As of December 31, 2004 we have completed interconnection of
approximately 203 businesses and co-location facilities within the Anchorage,
Juneau and Fairbanks metropolitan areas, as well as the 800-mile long
TransAlaska Pipeline System pipeline right of way that connects Valdez to
Prudhoe Bay, Alaska. We currently connect Anchorage, Whittier, Juneau and
Seattle through our AULP East undersea fiber network. We use SONET-based next
generation multi-service nodes for purposes of delivering traditional TDM
services (at DS-0, DS-1 and DS-3 data rates) as well as next generation
services, such as optical OC-n and Ethernet. We have expanded our digital
cross-connect capacity through the addition of three large 3:1 cross connects
located in Anchorage and Seattle.
A fiber optic cable system from our Anchorage distribution center connects to
the MTA Eagle River central office and to our major hub earth station in Eagle
River. The Issaquah earth station is connected with the Seattle distribution
center by means of diversely routed leased fiber optic cable transmission
systems, each having the capability to restore the other in the event of
failure. The Juneau earth station and distribution centers are collocated. We
have digital microwave facilities serving the Kenai Peninsula communities. We
maintain earth stations in Fairbanks (linked by digital microwave to the
Fairbanks distribution center), Juneau (collocated with the Juneau distribution
center), Anchorage (Benson earth station), and in Prudhoe Bay as fiber network
restoration earth stations. Our Benson earth station also uplinks our statewide
video service; such service may be pre-empted if earth station capacity is
needed to restore our fiber network between Anchorage and Prudhoe Bay.
25
We constructed an earth station in Platinum, Alaska in 2004. This station was
constructed to support our telemedicine network. Two additional earth stations
in McGrath and Yakutat, Alaska are expected to be placed into service in the
first quarter of 2005.
We use our DAMA facilities to serve 57 additional locations throughout Alaska.
DAMA is a digital satellite earth station technology that allows calls to be
made between remote villages using only one satellite hop thereby reducing
satellite delay and capacity requirements while improving quality. In 1996, we
obtained the necessary RCA and FCC approvals waiving prohibitions against
construction of competitive facilities in certain rural Alaska communities,
allowing for deployment of DAMA technology in 56 sites in rural Alaska on a
demonstration basis. These prohibitions were removed by the FCC on August 6,
2003 allowing us to begin deploying earth stations in more locations in Alaska.
In addition, 72 (for a total of 129) C-band facilities provide dedicated
Internet access, Telehealth and Private Network services to rural public
schools, hospitals, health clinics, and natural resource development industries
throughout Alaska. Our Network of 86 Ku- band facilities provide dedicated
Internet access, Telehealth and private network services to rural public
schools, hospitals, health clinics, and natural resource development industries
throughout Alaska, and in 13 locations in the Lower 48 States.
Our Anchorage, Fairbanks, and Juneau distribution centers contain electronic
switches to route calls to and from local exchange companies and, in Seattle, to
obtain access to MCI, Sprint and other carriers to distribute our southbound
traffic to the remaining 49 states and international destinations. In Anchorage,
a Lucent Technologies Inc. ("Lucent") 5ESS digital host switch is connected by
fiber to seven remote facilities that are co-located in the ILEC switching
centers, to provide both local and long-distance service. Our extensive
metropolitan area fiber network in Anchorage supports cable television, Internet
and telephony services. The Anchorage, Fairbanks, and Juneau facilities also
include digital access cross-connect systems, frame relay data switches,
Internet platforms, and in Anchorage and Fairbanks, co-location facilities for
interconnecting and hosting equipment for other carriers. We also maintain an
operator and customer service center in Wasilla, Alaska.
We have constructed a switching center and ILEC collocation offices in
Fairbanks, and have installed a Lucent switch to enable the provisioning of
local telephone access services in that market. Substantially all toll traffic
originating in Fairbanks is routed to Anchorage. Fairbanks UNE loop provisioning
began in early 2002.
We installed a Lucent switch in our Juneau distribution center and collocation
offices at several of the Juneau ILEC central offices, enabling local services
to be launched in the Juneau market in 2002. Our collocation facilities enable
UNE loop access to a portion of the Juneau ILEC's loop facilities. See "Part I
- -- Item 1 -- Business -- Historical Development of our Business During the Past
Fiscal Year -- Alaska Supreme Court Decision and Settlement" for more
information.
We own and use Lucent 5ESS switches in Anchorage and Seattle. The Anchorage
switch serves as our primary long distance switch in Alaska, enabling additional
network efficiencies.
Our operator services traffic is processed by an integrated services platform
that also hosts answering services, directory assistance, and internal
conferencing services.
We employ satellite transmission for rural intrastate and interstate traffic and
certain other major routes. We acquired satellite transponders on PanAmSat
Corporation ("PanAmSat") Galaxy XR satellite in March 2000 to meet our long-term
satellite capacity requirements. We further augmented capacity on Galaxy XR with
the lease of a seventh C-band transponder in October, 2002. See "Part I -- Item
1 -- Business -- Historical Development of our Business During the Past Fiscal
Year -- Galaxy XR Satellite Propulsion System Failure" for more information.
As demand for redundant, geographically diverse capacity on our network
increases, we will need to further augment our facilities between Alaska and the
Lower 48 States. See "Part I -- Item 1 --
26
Business -- Historical Development of our Business During the Past Fiscal Year
- -- AU East Capacity Expansion" for more information.
In June 2004 we completed the construction of AULP West 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. Capital expenditures for this project totaled approximately $50.1
million, most of which was funded through our operating cash flows.
We employ a packet data satellite transmission technology for the efficient
transport of broadband data in support of our rural health and SchoolAccessTM
initiatives. We expect to further expand and upgrade this network during 2005.
An upgrade of the packet data satellite transmission equipment to a more
bandwidth efficient modulation scheme is expected to be completed during the
first quarter of 2005. In addition, our SchoolAccessTM and rural wireless
Internet service is partially provisioned over a satellite based digital video
broadcast carrier that is scheduled to convert to a more efficient modulation
scheme during the first quarter of 2005. These projects reduce the requirement
for new satellite transponder bandwidth to support expected growth in rural
health, distance learning and rural Internet services.
Emerging technology that facilitates more efficient transport of fixed assigned
point-to-point satellite transmissions is expected to become available during
the first quarter of 2005. This technology allows fixed point-to-point
transmissions between two earth stations to transmit at the same frequency.
Successful implementation of this new technology may reduce the requirement for
new satellite bandwidth to meet our needs as expected growth in demand for our
services occurs. We are investigating the possible use of this new technology to
further increase the efficiency of bandwidth utilization for a portion of our
satellite network.
We employ advanced digital transmission technologies to carry as many voice
circuits as possible through a satellite transponder without sacrificing voice
quality. Other technologies such as terrestrial microwave systems, metallic
cable, and fiber optics tend to be favored more for point-to-point applications
where the volume of traffic is substantial. With a sparse population spread over
a large geographic area, neither terrestrial microwave nor fiber optic
transmission technology is considered to be economically feasible in rural
Alaska in the foreseeable future.
Customers. We had approximately 91,300, 85,600 and 88,200 active Alaska
long-distance message telephone service subscribers at December 31, 2004, 2003
and 2002, respectively. Approximately 11,200, 11,300 and 11,600 of these were
business and government users at December 31, 2004, 2003 and 2002, respectively,
and the remainder were residential customers. Increases in our total customer
counts were primarily attributed to our successful efforts to acquire and retain
customers due to popular product bundle offerings. Decreases in our business and
government customer counts were primarily attributed to continuing competitive
pressures in Anchorage and other markets we serve. Message telephone service
revenues (excluding broadband, operator services and Private Line revenues)
averaged approximately $9.9 million per month during 2004.
Equal access conversions have been completed in all communities we serve with
owned facilities. We estimate that we carry nearly 50% of combined business and
residential traffic as a statewide average for both originating interstate and
intrastate message telephone service traffic.
27
A summary of our switched long-distance message telephone service traffic (in
minutes) follows:
Interstate Minutes
---------------------------------------
Combined
Interstate
Inter- and Inter- Intra-
South- North- Calling national national state Total
For Quarter ended bound bound Card Minutes Minutes Minutes Minutes
- -----------------------------------------------------------------------------------------------------------------------
(Amounts in thousands)
March 31, 2002 133,455 91,061 1,683 1,413 227,612 40,781 268,393
June 30, 2002 144,143 105,001 1,582 1,462 252,188 44,528 296,716
September 30, 2002 159,564 90,839 1,463 1,527 253,393 46,860 300,253
December 31, 2002 138,735 78,483 1,341 1,506 220,065 43,595 263,660
------------------------------------------------------------------------------------------
Total 2002 575,897 365,384 6,069 5,908 953,258 175,764 1,129,022
==========================================================================================
March 31, 2003 132,172 78,882 1,186 1,487 213,727 45,345 259,072
June 30, 2003 142,333 83,749 1,107 1,508 228,697 52,489 281,186
September 30, 2003 159,439 96,512 1,055 1,514 258,520 55,918 314,438
December 31, 2003 144,829 107,620 1,013 1,546 255,008 49,553 304,561
------------------------------------------------------------------------------------------
Total 2003 578,773 366,763 4,361 6,055 955,952 203,305 1,159,257
==========================================================================================
March 31, 2004 149,354 94,845 909 1,685 246,793 54,629 301,422
June 30, 2004 150,804 83,268 820 1,755 236,647 57,140 293,787
September 30, 2004 164,019 82,190 767 1,776 248,752 62,055 310,807
December 31, 2004 147,487 86,285 744 1,713 236,229 54,839 291,068
------------------------------------------------------------------------------------------
Total 2004 611,664 346,588 3,240 6,929 968,421 228,663 1,197,084
==========================================================================================
--------------------------
All minutes data were taken from our internal billing statistics reports.
---------------------------
We entered into a significant business relationship with MCI in 1993 that
included the following agreements, among others.
o We agreed to terminate all Alaska-bound MCI long-distance traffic and
MCI agreed to terminate all of our long-distance traffic terminating in
the Lower 49 States excluding Washington, Oregon and Hawaii.
o The parties agreed to share certain communications network resources
and various marketing, engineering and operating resources. We also
carry MCI's 800, 888, 877 and 866 traffic originating in Alaska and
terminating in the Lower 49 States and handle traffic for MCI's calling
card customers when they are traveling in Alaska.
Concurrently with these agreements, MCI purchased approximately 31% of GCI's
Common Stock and presently two representatives serve on GCI's Board. In
conjunction with our acquisition of cable television companies in 1996, MCI
purchased an additional two million shares of GCI's Common Stock at a premium to
the then current market price for $13 million or $6.50 per share. MCI sold 4.5
million shares of GCI Class A common stock in 2002. On December 7, 2004 we
repurchased 3,751,509 of GCI's Class A common shares at $8.33 per share and $10
million face value of GCI's Series C preferred stock from MCI. The aggregate
amount of the equity repurchase totaled $41.3 million. At December 31, 2004, MCI
owns approximately 2.0% of GCI's Common Stock.
Revenues attributed to MCI's message telephone traffic from these agreements
(excluding Private Line and other revenues) in 2004, 2003 and 2002 totaled $52.8
million, $57.8 million and $54.7 million, or 12.4%, 14.8% and 14.9% of total
revenues, respectively. The contract was amended in March 2001 extending its
term five years to March 2006. The amendment reduced the rate to be charged by
us for certain traffic over the extended term of the contract.
28
On July 21, 2002 MCI and substantially all of its active United States
subsidiaries filed voluntary petitions for reorganization under Chapter 11 of
the United States 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. 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.
On October 31, 2003, MCI's reorganization plan was approved by the United States
Bankruptcy Court and MCI emerged from bankruptcy protection on April 20, 2004.
On February 14, 2005 Verizon Communications Inc. announced it has agreed to
acquire MCI for $4.8 billion in equity and $488 million in cash. In addition,
MCI will pay its shareowners quarterly and special dividends of $4.50 per share,
worth $1.463 billion. In total, the transaction values MCI shares at $20.75 a
share, or $6.746 billion. The board of directors of both companies are reported
to have approved the agreement. In addition to MCI shareowner approval, the
acquisition requires regulatory approvals, which the companies are targeting to
obtain in about a year. Verizon has allowed MCI two weeks beginning in early
March 2005 to conduct additional talks with Quest Communications International,
Inc., another potential buyer. We are unable to predict the impact that a merger
with or an acquisition of MCI will have upon us in the long-term, however given
the materiality of MCI's 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.
In 1993 we entered into a long-term agreement with Sprint, pursuant to which we
agreed to terminate all Alaska-bound Sprint long-distance traffic and Sprint
agreed to handle substantially all of our international traffic. Services
provided pursuant to the contract with Sprint resulted in message telephone
service revenues (excluding Private Line and other revenues) in 2004, 2003 and
2002 of approximately $14.9 million, $18.3 million and $23.5 million, or
approximately 3.5%, 4.7% and 6.4% of total revenues, respectively. The contract
was amended in March 2002 extending its term five years to March 2007, with two
one-year automatic extensions thereafter. The amendment reduces the rate to be
charged by us for certain traffic over the extended term of the contract.
With the contracts and amendment described above, we believe that MCI and
Sprint, our two largest customers, will continue to make use of our services
during the extended term. MCI was a major customer of our long-distance services
industry segment through 2004. Sprint met the threshold for classification as a
major customer through 1998, and met the threshold again in 2001.
Other common carrier traffic routed to us for termination in Alaska is largely
dependent on traffic routed to our carrier customers by their customers. Pricing
pressures, new program offerings, revised business plans, and market
consolidation continue to evolve in the markets served by our carrier customers.
If, as a result, their traffic is reduced, or if their competitors' costs to
terminate or originate traffic in Alaska are reduced, our traffic will also
likely be reduced, and we may have to respond to competitive pressures,
consistent with federal law. We are unable to predict the effect of such changes
on our business; however the loss of one or both of MCI or Sprint as customers,
a material adverse change in our relationships with them or a material loss of
or reduction in their long-distance customers would have a material adverse
effect on our financial position, results of operations or liquidity.
We provide various services to the State of Alaska, BP Alaska, Wells Fargo Bank
Alaska, First National Bank of Alaska, and Alyeska Pipeline Service Company.
Although these customers do not meet the threshold for classification as major
customers, we do derive significant revenues and gross profit from them. There
are no other individual customers, the loss of which would have a material
impact on our revenues or gross profit.
29
We provided broadband, Private Line and Private Network communications products
and services, including SchoolAccessTM and rural health Private Line facilities,
to 452 commercial and government customers at the end of 2004. These products
and services generated approximately 17.2%, 15.9% and 14.8% of total revenues
during the years ended December 31, 2004, 2003 and 2002, respectively.
Although we have several agreements to facilitate the origination and
termination of international toll traffic, we have neither foreign operations
nor export sales. See "Part I -- Item 1 -- Business -- Financial Information
about our Foreign and Domestic Operations and Export Sales" for more
information.
Competition. The long-distance industry is intensely competitive and subject to
constant technological change. Competition is based upon price and pricing
plans, the type of services offered, customer service, billing services,
performance, perceived quality, reliability and availability. AT&T Alascom, as a
subsidiary of AT&T, has access to greater financial, technical and marketing
resources than we have. Future competitors could also be substantially larger
than we are, and have greater financial, technical and marketing resources than
we have.
In the long-distance market, we compete against AT&T Alascom, ACS, MTA, and
certain smaller rural local telephone carrier affiliates. There is also the
possibility that new competitors will enter the Alaska market. In addition,
wireless services continue to grow as an alternative to wireline services as a
means of reaching customers.
Historically, we have competed in the long-distance market by offering discounts
from rates charged by our competitors and by providing desirable packages of
services. Discounts have been eroded in recent years due to lowering of prices
by AT&T Alascom and entry of other competitors into the long-distance markets we
serve. In addition, our competitors have also begun to offer their own packages
of services. If competitors lower their rates further or develop more attractive
packages of services, we may be forced to reduce our rates or add additional
services, which would have a material adverse effect on our financial position,
results of operations or liquidity.
Under the terms of the acquisition of Alascom by AT&T Corp., AT&T Alascom rates
and services must mirror those offered by AT&T Corp., so changes in AT&T Corp.
prices indirectly affect our rates and services. AT&T Corp.'s and AT&T Alascom's
interstate prices are regulated under a price cap plan whereby their rate of
return is not regulated or restricted. Price increases by AT&T Corp. and AT&T
Alascom generally improve our ability to raise prices while price decreases
pressure us to follow. We believe we have, so far, successfully adjusted our
pricing and marketing strategies to respond to AT&T Corp. and other competitors'
pricing practices. However, if competitors significantly lower their rates, we
may be forced to reduce our rates, which could have a material adverse effect on
our financial position, results of operations or liquidity.
On January 31, 2005 SBC Communications Inc. ("SBC") and AT&T announced an
agreement for SBC to acquire AT&T. Under terms of the agreement, approved by the
boards of directors of both companies, shareholders of AT&T will receive total
consideration currently valued at $19.71 per share, or approximately $16
billion. The acquisition, which is subject to approval by AT&T's shareholders
and regulatory authorities, and other customary closing conditions, is expected
to close by the first half of 2006. We cannot predict how this transaction will
affect us at this time.
ACS and other LECs have entered the interstate and international long-distance
market, and pursuant to RCA authorization, entered the intrastate long-distance
market. ACS and other LECs generally lease or buy long-haul capacity on
long-distance carriers' facilities to provide their interstate and intrastate
long-distance services.
Another carrier completed construction of fiber optic facilities connecting
points in Alaska to the Lower 48 States in 1999. The additional fiber system
provides direct competition to services we
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provide on our owned fiber optic facilities, however this fiber system also
provides an alternative routing path for us in case of a major fiber outage in
our systems. This carrier filed for Chapter 11 bankruptcy in 2001 and its assets
were sold in 2002. We completed construction of the AULP West fiber optic cable
system in June 2004 that provides us with owned capacity for route diversity.
In the wireless communications services market, we closed a 10-year distribution
agreement with Dobson in 2004 allowing us to resell Dobson cellular services.
See "Part I -- Item 1 -- Business -- Historical Development of our Business
During the Past Fiscal Year -- Cellular Services Distribution Agreement" for
more information. We provide limited wireless local access and Internet services
using our own facilities. We compete against Dobson, ACS, Alaska DigiTel LLC,
and resellers of those services in Anchorage and other markets.
The wireless communications industry continues to experience significant
consolidation. In October 2004 Cingular Wireless LLC, a joint venture between
SBC Communications Inc. and BellSouth Corp., reported that it completed its
previously announced merger with AT&T Wireless Services Inc. Dobson acquired its
Anchorage wireless properties in a 2003 asset exchange with AT&T Wireless.
Dobson has acquired wireless companies and negotiated roaming arrangements that
give it a national presence. Mergers and joint ventures in the industry have
created large, well-capitalized competitors with substantial financial,
technical, marketing and other resources. These competitors may be able to offer
nationwide services and plans more quickly and more economically than we can,
and obtain roaming rates that are more favorable than those that we obtain.
Our long-distance services sales efforts are primarily directed toward
increasing the number of subscribers we serve, selling bundled services, and
generating incremental revenues through product and feature up-sale
opportunities. We sell our long-distance communications services through
telemarketing, direct mail advertising, door-to-door selling, up-selling by our
customer service personnel, and local media advertising.
We expect competition to increase as new technologies, products and services
continue to develop. We cannot predict which of many possible future
technologies, products or services will be important to maintain our competitive
position or what expenditures will be required to develop and provide these
technologies, products or services. Our ability to compete successfully will
depend on marketing and on our ability to anticipate and respond to various
competitive factors affecting the industry, including new services that may be
introduced, changes in consumer preferences, economic conditions, market and
competitor consolidation, and pricing strategies by competitors. To the extent
we do not keep pace with technological advances or fail to timely respond to
changes in competitive factors in our industry and in our markets we could lose
market share or experience a decline in our revenue and net income. Competitive
conditions create a risk of market share loss and the risk that customers shift
to less profitable lower margin services. Competitive pressures also create
challenges to our ability to grow new business or introduce new services
successfully and execute our business plan. Each of our business segments also
faces the risk of potential price cuts by our competitors that could materially
adversely affect our long-distance segment market share and results of
operations.
Cable Services
Industry. The programmed video services industry includes traditional broadcast
television, cable television, satellite systems such as DBS, private cable
operators, LEC entry, broadband service providers, wireless cable, open video
systems, home video sales and rentals, Internet video, and electric and gas
utilities. Cable television providers have added non-broadcast programming,
utilized improved technology to digitize signals and increase channel capacity,
and expanded service markets to include more densely populated areas and those
communities in which off-air reception is not problematic. Broadcast television
stations including network affiliates and independent stations generally serve
the urban centers. One or more local television stations may serve smaller
communities. Rural communities may not receive local broadcasting or have cable
systems but may
31
receive direct broadcast programming via a satellite dish. More rural
communities are receiving local and regional station programming as satellite
system providers obtain local and regional programming content.
During the last 50 years, the cable television industry has experienced
extensive growth and transformation. From initially offering clear reception of
broadcast stations, cable has grown into a broadband provider of video, Internet
and voice telephone services, expanding from analog technology to an
increasingly digital platform. The NCTA reports that more than one-third of U.S.
cable customers were reported to have subscribed to digital cable television
service at the end of the third quarter of 2004.
The 1996 Telecom Act enabled cable television operators to undertake a multiyear
upgrade of cable system infrastructure and lead in the transition from an analog
platform to a broadband digital platform. Industry progress was made in 2004 to
further deploy HDTV, video-on-demand, interactive and other new consumer-driven
services that rely on the broadband digital platform.
Cable television operators and programmers began providing HDTV services in
2002. HDTV has been described by some analysts as the most dramatic change for
viewers since the introduction of color television. The NCTA reports that as of
September 1, 2004, 90 million U.S. television households were passed by a cable
system that offered HDTV, a growth of 140% since January 1, 2003, when HDTV was
available to 37.5 million households. In addition, the amount of cable HDTV
programming increased steadily, and now comes from a broader programming
services group.
The NCTA reported that in December 2002, the consumer electronics and cable
industries reached agreement on standards for the creation of digital cable
ready equipment for the home. The FCC approved those standards in September 2003
and new sets are readily available in retail outlets. However, this first
generation of standards does not address interactive services, including, among
other things, pay-per-view programming, video-on-demand, interactive program
guides, interactive gaming, and interactive retailing. Customers must still use
set-top boxes to receive those services.
The NCTA reported that at December 31, 2004, more than 113 million homes were
passed by cable plant with a capacity of at least 550MHz, and over 99 million
homes were passed by systems with a capacity of 750MHz or higher. The FCC
reports that the cable industry has upgraded almost 91% of its plant to 750MHz
capacity or higher. The NCTA reported that more than 105 million households were
reported to have been passed by activated two-way plant at the end of 2004.
Industry analysts forecast that more than 109 million households will be passed
by activated two-way plant by the end of 2005. These upgrades position cable
companies to compete more effectively with their DBS competitors.
The growth of DBS is still, in part, attributable to the authority granted to
DBS operators to distribute local broadcast television stations in their local
markets by the Satellite Home Viewer Improvement Act of 1999 ("SHVIA"). In
November 2004, the U.S. Congress passed a five-year extension of the SHVIA,
which allows DBS operators to retransmit distant broadcast TV signals to
underserved areas. Continued DBS subscriber growth is expected as local
programming is offered in more markets. The FCC reports that DBS continues to
increase its share of the MVPD market, while other MVPD providers continue to
experience losses in market share.
The NCTA reports that basic cable customers increased approximately 0.3% in 2004
to 73.6 million, while non-cable MVPD customers increased 7.7% to 26.9 million
customers during the first three quarters of 2004. Between December 1994 and
September 2004, the number of non-cable MVPD customers increased from 4.2
million to 26.9 million.
The North American cable TV market was reported by the FCC to have remained
stable in 2004, while DBS subscriberships increased at double-digit rates of
growth. The FCC reports that DBS
32
subscribership continues to grow at nearly double digit rates of growth every
year, and its share of the marketplace is increasing.
The NCTA reports that while the number of basic cable TV subscribers increased
approximately 0.3% in 2004, digital cable TV subscriber growth reached 13%
during the year ended September 30, 2004. Analysts believe that cable TV
subscriber growth in the future may result from cable television operators'
ability to attract new subscribers to their traditional analog video services,
and from ongoing deployments of digital video, video-on-demand, voice, and
high-speed data services. Analysts believe that expanded digital services allow
cable operators to differentiate their services from competing
telecommunications and pay-TV service providers.
As a converged platform, cable is a viable competitive alternative outside its
traditional video space, not only in the broadband space as a competitor with
technology such as DSL, but also in traditional telephony services as voice
becomes another application that is carried on data centric networks.
The most significant convergence of service offerings over cable plant continues
to be the pairing of Internet service with other service offerings. Cable
operators continue to build-out the broadband infrastructure that permits them
to offer high-speed Internet access. The most popular way to access the Internet
over cable is still through the use of a cable modem and personal computer.
Virtually all of the major multiple system operators offer Internet access via
cable modems in portions of their service areas. Like cable, the DBS industry is
developing ways to bring advanced services to their customers. Many MMDS and
private cable operators also offer Internet access services. In addition,
broadband services providers continue to build advanced systems specifically to
offer a bundle of services, including video, voice, and high-speed Internet
access. We currently offer high-speed cable modem access in Anchorage, Bethel,
Cordova, Juneau, Eielson Air Force Base, Elmendorf Air Force Base, Fairbanks,
Fort Richardson, Fort Wainwright, Homer, Kenai, Kodiak, Ketchikan, Nome, North
Pole, Palmer, Petersburg, Seward, Sitka, Soldotna, Wasilla, Wrangell, and
Valdez.
The cable industry has expanded its competitive offerings to include business
and residential telephone services delivered over its fiber optic
infrastructure. Cable-delivered telephone service is a natural extension of a
network already capable of delivering digital and broadband services and
products. Once upgraded to a two-way capability, a cable system can offer
telephone service over the same cable line that already carries digital video,
high speed Internet, and other advanced services to consumers. Cable operators
are beginning to deploy voice over IP telephony in addition to circuit-switched
telephony offerings. Circuit-switched service requires large capital
expenditures for switching equipment in addition to facility upgrades. Voice
over IP is more modular and does not require the large upfront cost needed to
deploy circuit-switched service. Voice over IP utilizes the data path already
built, and is expected to allow for easy software changes and additions to
service packages including innovative combinations of voice, data, and fax
services. The NCTA reports that cable-delivered residential telephone service
subscribers in the United States totaled an estimated 2.8 million through
September 2004.
With digital transmissions and compression, cable operators are better able to
offer a variety and quality of channels to rival DBS and video-on-demand. In
2000 we installed a commercial version of video-on-demand for the Anchorage
hotel market and continue to evaluate the feasibility of deploying a
video-on-demand technology in the residential market. With this service,
customers can access a wide selection of movies and other programming at any
time, with digital picture quality.
Kagan World Media reported that estimated 2004 total cable industry revenue
reached $57.6 billion, an approximate 12.3% increase from $51.3 billion in 2003.
Operators face constant pressure to keep rate increases at a minimum. According
to the FCC, the average monthly rate for cable services rose 5.4% over the
12-month period ending January 1, 2004 to $45.32, as compared to a 7.8 percent
increase reported over the 12-month period ending January 1, 2003. Over the past
several years, the FCC reports that operators have averaged annual rate
increases in the 5% range.
33
The FCC reports that cable operators attributed rate increases to increased
programming costs, an increase in the number of video and non-video services
offered, system upgrades, and general inflationary pressures. The escalation of
programming costs continues to adversely impact the economics of cable
operators. Programming costs are reported to be the largest cost item for major
system operators and the fastest growing operating cost item for most. The NCTA
reported that, on the basis of financial data supplied to them by nine cable
operators, they found that these operators' yearly programming expenses, on a
per-subscriber basis, increased from $122 in 1999 to $180 in 2002 -- a 48
percent increase.
The NCTA reports that cable penetration of TV households totaled 67.1% at
December 31, 2004. Our overall average penetration of homes passed was 65.0% at
December 31, 2004 with individual systems ranging from 49.8% to 83.4%.
In Alaska, cable television was introduced in the 1970s to provide television
signals to communities with few or no available off-air television signals and
to communities with poor reception or other reception difficulties caused by
terrain interference. Since that time, as on the national level, the cable
television providers in Alaska have added non-broadcast programming, and DBS
providers have added local broadcast programming.
The market for programmed video services in Alaska includes traditional
broadcast television, cable television, wireless cable, and DBS systems.
Broadcast television stations including network affiliates and independent
stations, serve the urban centers in Alaska. Eight, six and five broadcast
stations serve Anchorage, Fairbanks and Juneau, respectively. In addition,
several smaller communities are served by one local television station that is
typically a PBS affiliate. Other rural communities without cable systems receive
a single state sponsored channel of television by a satellite dish and a low
power transmitter.
Advancements in technology, facility upgrades and plant expansions to enable the
ongoing migration to digital programming are expected to continue to have a
significant impact on cable services in the future. We expect that changing
federal, state and local regulations, intense competition, and developing
technologies and standards will continue to challenge the industry.
See "Part I -- Item I -- Business, Regulation, Franchise Authorizations and
Tariffs -- Cable Services" for more information.
General. We are the largest operator of cable systems in Alaska, serving
approximately 134,700 residential, commercial and government basic subscribers
at December 31, 2004. Our cable television systems serve 35 communities and
areas in Alaska, including the state's four largest urban areas, Anchorage,
Fairbanks, the Mat-Su Valley and Juneau. Our statewide cable systems consist of
approximately 2,300 miles of installed cable plant having 450 to 625 MHz of
channel capacity.
Products. Programming services offered to our cable television systems
subscribers differ by system, The following information describes our service
offerings as of December 31, 2004.
Anchorage and Mat-Su Valley system. The Anchorage and Mat-Su Valley system,
which is located in the urban center for Alaska, offers a basic analog
service that includes approximately 18 channels and a fully addressable
digitally delivered expanded basic service with 50 video programming
channels and 47 digital music channels. This system also carries three
digital tiers totaling 34 channels, two HD channels with the rental of an
HD set-top converter, a five channel HD tier, digital video recorders , and
over 75 channels of premium (including two foreign language channels and
three HD channels) and pay-per-view products. Commercial subscribers such
as hospitals, hotels and motels are charged negotiated monthly service
fees. Apartment and other multi-unit dwelling complexes can receive service
at a negotiated bulk rate with the opportunity for additional services on a
tenant-pay basis.
34
Fairbanks system. This system offers a basic analog service with 12
channels and a fully addressable digitally delivered expanded basic service
with 46 channels. This system also carries 17 digital special interest
channels, 47 channels of digital music, and over 70 channels of premium and
pay-per-view products.
Juneau, Kenai, Soldotna, and Ketchikan systems. These systems offer a basic
analog service with 13 to 18 channels and an additional analog tier (analog
and digital delivery technologies are used in Ketchikan) with 35 to 44
channels. These systems also carry a digital programming tier with over 17
special interest channels, 47 channels of digital music, and over 50
channels of digitally delivered premium and pay-per-view products.
Sitka System. This location offers an advanced analog service with a 15
channel basic service, a 37 channel expanded basic service, five channels
of premium service, four channels of pay-per-view and 31 music channels.
Cordova, Kodiak, Nome, Seward, and Valdez systems. These systems offer a
basic analog service with 12 to 15 channels and an additional analog tier
(analog and digital delivery technologies are used in Kodiak) with 35 to 38
channels. These systems also carry 47 channels of digital music and over 56
channels of digitally delivered premium and pay-per-view products.
Other systems. We own systems in the Alaska communities and areas of
Bethel, Homer, Kotzebue, Petersburg, and Wrangell. These analog systems
offer a basic service with 11 to 15 channels and an expanded basic service
with 36 to 38 channels. Five channels of premium service are also available
in all systems. Music service is available in Petersburg and Wrangell.
Pay-per-view is available in Homer, Kotzebue, Petersburg, and Wrangell.
Beginning in February, 2005, our Barrow system has one tier of service with
53 channels, four premium channels, and three pay-per-view channels.
Facilities. Our cable television businesses are located in Anchorage, Bethel,
Chugiak, Cordova, Douglas, Eagle River, Eielson AFB, Elmendorf AFB, Fairbanks,
Fort Greely, Fort Richardson, Fort Wainwright, Homer, Juneau, Kachemak, Kenai,
Ketchikan, Kodiak, Kodiak Coast Guard Air Station, Kotzebue, Mount Edgecombe,
Nome, North Pole, Palmer, Petersburg, Peters Creek, Prudhoe Bay, Saxman, Seward,
Sitka, Soldotna, Valdez, Ward Cove, Wasilla, and Wrangell, Alaska. Our
facilities include cable plant and head-end distribution equipment. Certain of
our head-end distribution centers are co-located with customer service, sales
and administrative offices.
Customers. Our cable systems passed approximately 207,200, 202,200 and 196,900
homes at December 31, 2004, 2003 and 2002, respectively, and served
approximately 134,700, 134,400 and 136,100 basic subscribers at December 31,
2004, 2003 and 2002, respectively. Revenues derived from cable television
services totaled $101.4 million, $96.0 million and $88.7 million in 2004, 2003
and 2002, respectively.
Competition. The 1996 Telecom Act removed barriers to telephone company or LEC
entry into the video marketplace to facilitate competition between incumbent
cable operators and telephone companies. At the time of the 1996 Telecom Act, it
was expected that LECs would compete in the video delivery market and that cable
operators would provide local telephone exchange service. Two of the largest
ILECs have announced plans to offer video via Internet protocol technology. A
few smaller LECs continue to offer, or are preparing to offer, multi-channel
video programming distribution.
We believe our greatest source of competition comes from the DBS industry. Two
major companies, DirecTV and Echostar are currently offering nationwide
high-power DBS services. In the past, the majority of Alaska DBS subscribers
were required to bear the cost of and install larger satellite dishes (generally
three to six feet in diameter) because of the weaker satellite signals available
in northern latitudes, particularly in communities surrounding, and north of,
Fairbanks. In addition, the satellites
35
had a relatively low altitude above the horizon when viewed from Alaska, making
their signals subject to interference from mountains, buildings and other
structures. Recent satellite placements provide Alaska and Hawaii residents with
a DBS package that requires a smaller satellite dish (typically 18 inches);
however, a second larger dish is required if the subscriber wants to receive a
channel line-up similar to that provided by our cable systems with HD
programming. In addition to the dish and equipment cost deterrents, DBS signals
are subject to degradation from atmospheric conditions such as rain and snow.
Our cable television systems face competition from alternative methods of
receiving and distributing television signals, including digital video service
over telephone lines, broadband IP based services, wireless and SMATV systems,
and from other sources of news, information and entertainment such as off-air
television broadcast programming, newspapers, movie theaters, live sporting
events, interactive computer services, Internet services and home video
products, including videotape cassette and video disks. Our cable television
systems also face competition from potential overbuilds of our existing cable
systems by other cable television operators.
Several ILECs in the Lower 48 and the largest ILEC in Alaska have announced
marketing arrangements to provide DBS services along with local telephone and
other services. Similar arrangements could be extended to other ILECs in the
markets we serve in Alaska. In August 2003 DBS service provider EchoStar
launched Anchorage local network programming for an additional fee. We will
continue to strive to compete effectively by providing, at reasonable prices and
in competitive bundles, 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.
In November 2003, the ILEC in the Mat-Su Valley launched digital video service
over telephone lines in limited areas. Its product offerings and price points
are similar to our product offerings. The ILEC in Ketchikan has indicated its
intent to launch a similar service in 2005.
Competitive forces will be counteracted by offering expanded programming through
digital services and by providing high-speed data services. System upgrades have
been completed to make our systems reverse activated, providing the necessary
infrastructure to offer cable modem service to greater than 99% of our homes
passed. Digital delivery technology is being utilized in all but six of our
systems. We expect to utilize this technology in the remaining six systems
within two years. These plant upgrades combined with local broadcast programming
and bundled packages are expected to provide an attractive product in comparison
to competitive offerings. In 2002, seven-year retransmission agreements were
signed with Anchorage broadcasters. These agreements provide for the
uplink/downlink of their signals into all our systems, and local programming for
our customers.
High-speed data access competition takes two primary forms: cable modem access
service and DSL service. Wireless services are also becoming more prevalent. DSL
service provides Internet access to subscribers at data transmission speeds
similar to cable modems over traditional telephone lines. Numerous companies,
including telephone companies, have introduced DSL service, and certain
telephone companies are seeking to provide high-speed broadband services,
including interactive online services, without regard to present service
boundaries and other regulatory restrictions. Wireless, both from a fixed and
mobile implementation, is becoming more available. Fixed wireless providers are
using newer technologies to deliver broadband to subscribers. Wireless vendors
in Anchorage are competing for broadband subscribers. In other locations in the
Lower 49 States, public organizations such as municipalities and education
organizations have begun implementing mobile wireless broadband over specific
geographic areas such as parks, campuses and major downtown business areas.
Companies in the Lower 49 States, including telephone companies and ISPs, have
asked local, state and federal governments to mandate that cable communications
systems operators provide capacity on their cable infrastructure, so these
companies and others may deliver Internet services directly to customers over
cable facilities. The FCC determined in March 2002 that cable system operators
will not be required to provide such "open access" to others. See
36
"Part I -- Item 1 -- Business, Regulation, Franchise Authorizations and Tariffs
- -- Cable Services" for more information.
Other new technologies may become competitive with non-entertainment services
that cable television systems can offer. The FCC has authorized television
broadcast stations to transmit textual and graphic information useful to both
consumers and businesses. The FCC also permits commercial and non-commercial FM
stations to use their subcarrier frequencies to provide non-broadcast services
including data transmissions. The FCC established an over-the-air interactive
video and data service that will permit two-way interaction with commercial and
educational programming along with informational and data services. LECs and
other common carriers also provide facilities for the transmission and
distribution to homes and businesses of interactive computer-based services,
including the Internet, as well as data and other non-video services. The FCC
has conducted spectrum auctions for licenses to provide PCS, as well as other
services. PCS and other services will enable license holders, including cable
operators, to provide voice and data services. We own a statewide license to
provide PCS in Alaska.
Cable television systems generally operate pursuant to franchises granted on a
non-exclusive basis. The 1992 Cable Act gives local franchising authorities
jurisdiction over basic cable service rates and equipment in the absence of
"effective competition," prohibits franchising authorities from unreasonably
denying requests for additional franchises and permits franchising authorities
to operate cable systems. Well-financed businesses from outside the cable
industry (such as the public utilities that own certain of the poles on which
cable is attached) may become competitors for franchises or providers of
competing services.
On December 30, 2004, GCI Cable, Inc, applied to the Regulatory Commission of
Alaska to amend its certificates to include areas where population growth has
occurred and is likely to occur over the next five years. The proposed service
area changes are in Anchorage, Bethel, Cordova, Fairbanks, Homer,
Juneau-Douglas, Kenai, Soldotna, Sterling, Ketchikan, Kodiak, Kotzebue, Nome,
Palmer-Wasilla, Petersburg, Seward, Sitka, Valdez and Wrangell.
Our cable service sales efforts are primarily directed toward increasing the
number of subscribers we serve, selling bundled services, and generating
incremental revenues through product and feature up-sale opportunities. We sell
our cable services through telemarketing, direct mail advertising, door-to-door
selling, up-selling by our customer service personnel, and local media
advertising.
Advances in communications technology as well as changes in the marketplace are
constantly occurring. We cannot predict the effect that ongoing or future
developments might have on the communications and cable television industries or
on us specifically.
Local Access Services
Industry. The FCC reported that end-user customers in the U.S. obtained local
service at June 30, 2004 by means of 148 million ILEC switched access lines, 32
million CLEC switched access lines, and 167 million mobile wireless telephone
service subscriptions.
The FCC reported that total CLEC end-user switched access lines increased by 7%
during the first half of 2004, from 30 million to 32 million lines. By
comparison, total CLEC lines increased by 10% during the preceding six months,
from 27 to 30 million lines. For the full twelve month period ending June 30,
2004, CLEC end-user lines increased by 19%. Approximately 18% of the 180 million
total end-user switched access lines were reported by CLECs, compared to 16% a
year earlier.
The FCC further reported that approximately 65% of reported CLEC switched access
lines serve residential and small business customers, compared to approximately
77% of ILEC lines. CLECs reported 15% of total residential and small business
switched access lines, and 25% of the total medium and large business,
institutional, and government customer access lines.
37
The FCC reported that CLECs reported providing about 16% (a decline from 43% in
December 1999) of their switched access lines by reselling the services of other
carriers, about 61% (an increase from 24% in December 1999) by means of UNE
loops leased from other carriers, and about 23% of switched access lines over
their own local loop facilities.
The FCC reports that since December 1999, the percentage of nationwide CLEC
switched access lines reported to be provisioned by reselling services has
declined steadily, to 16% at the end of June 2004, and the percentage
provisioned over UNE loops has grown steadily, to 61% at June 30, 2004. The FCC
reported that ILECs provided about 1.6 million switched access lines to
unaffiliated carriers on a resale basis at the end of June 2004, down from 1.8
million six months earlier. The FCC reported that ILECS provided 21.4 million
unbundled loops (with or without unbundled switching) to unaffiliated carriers
at June 30, 2004, up from 19.4 million six months earlier.
UNE loops provided with ILEC switching (UNE-Platform) have increased faster than
UNE loops provided without switching. The FCC reported that ILECs provided
approximately 13% more UNE loops with switching to unaffiliated carriers at the
end of June 2003 than they reported six months earlier (17.1 million compared to
15.2 million) and about 1% fewer UNE loops without switching (about 4.3
million).
The FCC reports that at June 30, 2004 in the U.S., local telephone service was
provided by CLECs to over 3.3 million coaxial cable connections, which
constituted approximately 45% of the 7.5 million switched access lines provided
by CLECs over their own local loop facilities, approximately 10% of all switched
access lines reported by CLECs, and approximately 2% of total switched access
lines.
Cable telephony deployments in the U. S. continue to expand using proprietary,
circuit switched technology. More hardware has become available that is DOCSIS
1.1 qualified, which provides quality of service necessary for voice services.
Cable telephony services continue to expand as cable television operators expand
their video, data, and voice service offerings. A significant driver for cable
telephony is the bundling of telephony services with existing digital video and
high speed data services.
Industry analysts estimate that worldwide cable telephony subscribers totaled
11.8 million at the end of 2004, are expected to exceed 14 million by late 2005,
and will grow to over 22 million by the end of 2008. The vast majority of
cable-telephony subscribers reportedly rely on circuit-switched technology. Of
the 11.8 million worldwide cable-telephony subscribers at the end of 2004, less
than 500,000 were using Voice over Internet Protocol ("VoIP") technology.
We began deploying a cable telephony solution in the second quarter of 2004 that
meets our needs and we believe meets the needs of our customers.
The communications industry has been burdened by regulatory uncertainty as a
result of successive court reversals of the FCC's core local competition rules.
In response to such court reversals and to remove uncertainty, the FCC adopted
new rules for network unbundling obligations of ILECs in December 2004. See
"Part I -- Item I -- Business, Regulation, Franchise Authorizations and Tariffs
- -- Local Access Services" for more information.
General. Our local exchange and exchange access services ("local access
services") segment entered the local services market in Anchorage in 1997,
providing services to residential, commercial, and government users. At December
31, 2004 we could access approximately 93%, 71%, and 48% of Anchorage,
Fairbanks, and Juneau area local loops, respectively, from our collocated remote
facilities and DLC installations, excluding Wainwright and Eielson areas.
Products. Our own DLPS facilities and collocated remote facilities that access
the ILEC's unbundled network element loops allow us to offer full featured local
service products to both residential and
38
commercial customers, and provide Private Line service products to commercial
customers. In areas where we do not have our own DLPS facilities or access to
ILEC loop facilities, we offer service using total service resale of the ILEC's
local service in Anchorage, and either total service resale or UNE platform in
Fairbanks and Juneau.
Our package offerings are competitively priced and include popular features,
such as the following.
o Enhanced call waiting o Caller ID
o Caller ID on call waiting o Free caller ID box
o Anonymous call rejection o Call forwarding
o Call forward busy o Call forward no answer
o Enhanced call waiting o Fixed call forwarding
o Follow me call o Intercom service forwarding
o Multi-distinctive ring o Per line blocking
o Selective call forwarding o Selective call acceptance
o Selective call rejection o Selective distinctive alert
o Speed calling o Three way calling
o Voice mail o Inside wire repair plan
o Non-listed number o Non-published number
Facilities. In Anchorage we utilize a centrally located Lucent 5ESS host
switching system, have collocated six remote facilities adjacent to or within
the ILEC's local switching offices to access unbundled loop network elements,
and have installed a DLC system adjacent to a smaller, seventh ILEC wire center
for access to unbundled loop network elements. Remote and DLC facilities are
interconnected to the host switch via our diversely routed fiber optic links.
Additionally, we provide our own facilities-based services to many of
Anchorage's larger business customers through expansion and deployment of SONET
fiber transmission facilities, DLC facilities, and leased HDSL and T-1
facilities.
In April 2004 we successfully launched our Digital Local Phone Service ("DLPS")
deployment utilizing our Anchorage coaxial cable facilities. This delivery
method allows us to utilize our own cable facilities to provide local access
service to our customers and avoid paying local loop charges to the ILEC. To
ensure the necessary equipment is available to us we have committed to purchase
a certain number of outdoor network powered multi-media adapters.
In Fairbanks and Juneau we employ Lucent Distinctive Remote Module switching
systems (5ESS) and have collocated DLC systems adjacent to the ILEC's local
switching office and within the ILEC's wire center to access unbundled loop
network elements.
Customers. We had approximately 112,100, 106,100 and 96,100 local lines in
service from Anchorage, Fairbanks, and Juneau, Alaska subscribers at December
31, 2004, 2003 and 2002, respectively. We began providing local access services
in Fairbanks in 2001 and in Juneau in 2002. The 2004 line count consists of
approximately 60.3% residential access lines and 35.3% business access lines,
including 4.4% Internet service provider access lines. We ended 2004 with market
share gains in substantially all market segments.
Revenues derived from local access services in 2004, 2003 and 2002 totaled $47.0
million, $39.0 million and $32.1 million, respectively, representing
approximately 11.1%, 10.0% and 8.7% of our total revenues in 2004, 2003 and
2002, respectively.
Competition. In the local access services market the 1996 Telecom Act, judicial
decisions, and state legislative and regulatory developments have increased the
overall likelihood that barriers to local telephone competition will be reduced
or removed. These initiatives include requirements that ILECs negotiate with
entities, including us, to provide interconnection to the existing local
telephone
39
network, to allow the purchase, at cost-based rates, of access to unbundled
network elements, to establish dialing parity, to obtain access to rights-of-way
and to resell services offered by the ILEC.
The 1996 Telecom Act also provides ILECs with new competitive opportunities. We
believe that we have certain advantages over these companies in providing
communications services, including awareness by Alaskan customers of the GCI
brand-name, our facilities-based communications network, and our prior
experience in, and knowledge of, the Alaskan market.
Data obtained from the RCA indicates that there are 23 ILECs and 17 CLECs
certified to operate in the State of Alaska. We compete against ACS, the ILEC in
Anchorage, Juneau and Fairbanks, and with AT&T Alascom in the Anchorage service
area. AT&T Alascom offers local exchange service only to residential customers
through total service resale. We also compete in the business market against
TelAlaska Long Distance, Inc. ("TelAlaska") in the Anchorage service area.
ACS, through subsidiary companies, provides local telephone services in
Fairbanks and Juneau, Alaska. These ACS subsidiaries were classified as Rural
Telephone Companies under the 1996 Telecom Act, which entitled them to an
exemption of certain material interconnection terms of the 1996 Telecom Act,
until and unless such "rural exemption" were examined and discontinued by the
RCA. On October 11, 1999, the RCA issued an order terminating rural exemptions
for the ACS subsidiaries operating in the Fairbanks and Juneau markets so that
we could compete with these companies in the provision of local telephone
service pursuant to the terms of Section 251(c) of the 1996 Telecom Act. These
rural exemptions limited the obligation of the ILECs in these markets to provide
us access to UNEs at rates under the pricing standard established by the FCC.
ACS appealed these decisions.
On December 12, 2003, the Alaska Supreme Court issued a decision in which it
reversed the RCA's rural exemption decision on the procedural ground that the
competitor, not the incumbent, must shoulder the burden of proof. The Court
remanded the matter to the RCA for reconsideration with the burden of proof
assigned to us. In accordance with the Court's ruling, the RCA re-opened the
rural exemption dockets and scheduled a hearing to take place on April 19, 2004.
On April 18, 2004, we and ACS entered into a comprehensive settlement that, in
part, included a relinquishment by ACS of its rural exemption for Juneau and
Fairbanks. In accordance with the settlement, the parties moved the RCA for a
dismissal of the rural exemption inquiry, which the Commission granted on April
21, 2004.
By letter, submitted also to the RCA, on January 12, 2004, we made a bona fide
request for interconnection for the purposes of local access competition with
the MTA, under the provisions of the 1996 Telecom Act. We submitted this request
to MTA on the grounds that it waived its rural exemption under the terms of
Section 251(f)(1)(C) when it launched its new video service through its wholly
owned subsidiary MTA Vision, Inc. in competition with our cable television
service. MTA, however, refused to comply with the negotiation and arbitration
provisions under the Act claiming that it still retains a rural exemption. We
filed a complaint with the RCA to resolve this dispute, and the RCA conducted a
public hearing on the matter on October 20, 2004. On February 22, 2005, the RCA
released a ruling that MTA's rural exemption for the areas served by MTA Vision,
Inc. had been lifted and that we may negotiate and arbitrate interconnection
with MTA. We tendered a new interconnection request to MTA on February 25, 2005
and are proceeding with such negotiations. In the event negotiations are
unsuccessful, an arbitration will be requested which must be completed under the
provisions of the 1996 Telecom Act by November 25, 2005. Following the entry
into an Interconnection Agreement by arbitration, we intend to commence local
service entry into the Mat-Su Valley during 2007.
We expect further competition in the marketplaces we serve as other companies
may receive certifications. We expect further competition in business customer
telephone access, Internet access, DSL and Private Line markets.
40
We continue to offer local exchange services to substantially all consumers in
the Anchorage, Juneau and Fairbanks service areas, primarily through our own
facilities and unbundled local loops leased from ACS.
Our local services sales efforts continue to focus on increasing the number of
subscribers we serve, selling bundled services, and generating incremental
revenues through product and feature up-sale opportunities. We sell our local
services through telemarketing, direct mail advertising, up selling by our
customer service personnel, and door-to-door selling.
You should see "Part I -- Item 1 -- Business, Regulation, Franchise
Authorizations and Tariffs -- Communications Operations" for more information.
Internet Services
Industry. The Internet continues to expand at a significant rate. The Internet
Systems Consortium reports that, worldwide, approximately 285 million web sites
were hosted at the end of July 2004, an increase of 22% from 233 million at the
end of January 2004. Jupiter Research reports that the percent of U. S.
households with a computer grew from 71.1 million in 2001 to a projected 80.8
million in 2004, which represents approximately 73% of U.S. households.
Nielsen//NetRatings reports that an estimated 197.8 million Internet users
existed in the U.S. in November 2004, representing approximately 66.8% of the
total U.S. population.
For the first time broadband Internet service users exceed dial-up users. As of
July 2004, an estimated 49% of U. S. Internet connected households were reported
by Nielsen//NetRatings to access the Internet using dial-up modems. Growth in
the proportion of households accessing the Internet with broadband connections
continues, but at a slower rate as compared to 2003. We believe high-speed
Internet access will likely become the dominant access method for residential
Internet users as broadband becomes more widely available, more flexibly priced,
and as new kinds of entertainment, content and services emerge.
The FCC reported that high-speed lines (those that provide services at speeds
exceeding 200 kbps in at least one direction) connecting homes and businesses to
the Internet in the U.S. increased by 15% during the first half of 2004, from
28.2 million to 32.5 million lines, compared to a 20% increase, from 23.5
million to 28.2 million lines, during the second half of 2003. Approximately
30.1 million of the 32.5 million total lines served residential and small
business subscribers, a 16% increase from the 26.0 million lines reported six
months earlier.
The FCC further reported that of the 32.5 million high-speed lines, 23.5 million
provided advanced services, i.e., services at speeds exceeding 200 kbps in both
directions. Advanced services lines increased 15% from 20.3 million lines to
23.5 million lines during the first half of 2004. Approximately 21.2 million of
the 23.5 million advanced services lines served residential and small business
subscribers.
Cable modem Internet access continues to be the primary means of accessing the
Internet in the United States over broadband networks. Industry analysts believe
that a cable network upgrade is more efficient than is a DSL network upgrade,
largely because of the individual local loops that must be provisioned for DSL,
with central office proximity a severe mitigating factor. In contrast, cable
networks are upgraded into smaller discrete nodes. Less costly and more
efficient upgrades required for cable modem usage lead to greater scalability.
Analysts believe that cable operators have more incentive to upgrade networks
and have potentially higher returns due to the potential for new sources of
revenue from digital cable, telephony and other products that are made possible
from such upgrades.
DSL is the most significant broadband competitor to cable modem service, with an
estimated 11.4 million U. S. subscribers through June 2004 according to FCC
reports. High-speed asymmetric DSL
41
lines in service increased by 20% during the first half of 2004. Cable's
offering of high-speed Internet access was reported by the FCC to have
experienced customer growth of 13% during the first six months of 2004. The FCC
reports that U. S. cable modem subscribers totaled an estimated 18.6 million
through June 2004. In-Stat reports that there were 42 million worldwide cable
modem users at the end of 2004, up from a total of 31 million at the end of
2003.
The FCC reports that high-speed connections to end users by means of satellite
or terrestrial wireless technologies increased by 15% in the U.S. during the
first half of 2004, accounting for approximately 1.1 million connections at the
end of June 2004.
Industry analysts believe that broadband deployment will continue to bring
valuable new services to consumers and advance many other objectives, such as
improving education advancing economic opportunities. With an estimated 74
million basic cable households in the United States and an estimated 81 million
households owning a computer, broadband cable Internet access growth is expected
to continue as new advanced services are deployed.
On December 3, 2004 President Bush signed into law a three-year moratorium on
Internet access taxes. The law extends a ban on Internet taxes that expired on
November 1, 2003. Analysts believe that keeping the Internet free of such taxes
will create an environment for innovation and will ensure that electronic
commerce will remain a vital and growing part of the economy of the United
States.
See "Part I -- Item I -- Business, Regulation, Franchise Authorizations and
Tariffs -- Internet Services" for more information.
General. Our Internet services division entered the Internet services market in
1998, providing retail services to residential, commercial, and government users
and providing wholesale carrier services to other ISPs. We were the first
provider in Anchorage to offer commercially available DSL products.
Products. We primarily offer three types of Internet access for residential use:
dial-up, fixed wireless and high-speed cable modem Internet access. Our
residential high-speed cable modem Internet service offers up to 4 Mbps access
speeds as compared with up to 56 kbps access through standard copper wire
dial-up modem access. Our fixed wireless product is available in 129 communities
with plans to expand to 13 more in 2005. Three distinct products are offered; 56
kbps, 256 kbps, and 256 kbps for multiple computers. We provide 24-hour customer
service and technical support via telephone or online. An entry-level cable
modem service also offers free data transfer up to one gigabyte per month at a
rate of 64 Kbps and can be connected 24-hours-a-day, 365-days-a-year, allowing
for real-time information and e-mail access. This product acts as a dialup
replacement and upgrade since it is always connected and provides more efficient
data transfer. Cable modems use our coaxial cable plant that provides cable
television service, instead of the traditional ILEC copper wire. Coaxial cable
has a much greater carrying capacity than telephone copper wire and can be used
to simultaneously deliver both cable television (analog or digital) and Internet
access services.
At the end of 2003 we launched an initiative to increase the speed of our entry
level broadband cable modem level service from 512 kbps to 1 mbps for new and
current customers in Anchorage, Kenai/Soldotna and the Mat-Su Valley. The
initiative was completed in September 2004. This new service level was available
in Fairbanks in December of 2004 and Juneau in January 2005. Additional cable
modem service packages tailored to high-use residential and commercial Internet
users are also available.
We currently offer several Internet service packages for commercial use: dial-up
access, DSL, T-1 and fractional T-1 leased line, frame relay, multi-megabit and
high-speed cable modem Internet access. Our business high-speed cable modem
Internet service offers access speeds ranging from 512 kbps to 2.4 Mbps, free
monthly data transfers of up to 30 gigabytes and free 24-hour customer service
and technical support. Our DSL offering can support speeds of up to 1.5 mbps
over the same copper line
42
used for phone service. Business services also include a personalized web page,
domain name services, and e-mail.
We also provide dedicated access Internet service to commercial and public
organizations in Alaska. We offer a premium service and currently support many
of the largest organizations in the state such as Conoco Phillips Alaska, the
State of Alaska and the Anchorage School District. We have hundreds of other
enterprise customers, both large and small, using this service.
Bandwidth is made available to our Internet segment through our AULP undersea
fiber cable systems and our Galaxy XR transponders. Our Internet offerings are
coupled with our long-distance, cable television, and local services offerings
and provide free basic Internet services (both dialup and cable modem access) if
certain plans are selected. Value-added Internet features are available for
additional charges.
We provide Internet access for schools and health organizations using a platform
including many of the latest advancements in technology. Services are delivered
through a locally available circuit, our existing lines, and/or satellite earth
stations.
Facilities. The Internet is an interconnected global public computer network of
tens of thousands of packet-switched networks using the Internet protocol. The
Internet is effectively a network of networks routing data throughout the world.
We provide access to the Internet using a platform that includes many of the
latest advancements in technology. The physical platform is concentrated in
Anchorage and is extended into many remote areas of the state. Our Internet
platform includes the following:
o Our Anchorage facilities are connected to multiple Internet access
points in Seattle through multiple, diversely routed networks.
o We use multiple routers on each end of the circuits to control the
flow of data and to provide resiliency.
o Our Anchorage facility consists of routers, a bank of servers that
perform support and application functions, database servers
providing authentication and user demographic data, layer 2
gigabit switch fabrics for intercommunications and broadband
services (cable modem, wireless and DSL), and access servers for
dial-in users.
o SchoolAccess(TM) Internet service delivery to over 210 schools in
rural Alaska and 30 schools in Montana, New Mexico and Arizona is
accomplished by three variations on primary delivery systems:
o In communities where we have terrestrial interconnects or
provide existing service over regional earth stations, we
have configured intermediate distribution facilities.
Schools that are within these service boundaries are
connected locally to one of those facilities.
o In communities where we have extended communications
services via our DAMA earth station program,
SchoolAccessTM is provided via a satellite circuit to an
intermediate distribution facility at the Eagle River
Earth Station.
o In communities or remote locations where we have not
extended communications services, SchoolAccessTM is
provided via a dedicated (usually on premise) DAMA VSAT
satellite station. The DAMA connects to an intermediate
distribution facility located in Anchorage.
Dedicated Internet access is delivered to a router located at the service point.
Our Internet management platform constantly monitors this router and continual
communications are maintained with all of the core and distribution routers in
the network. The availability and quality of service, as well as statistical
information on traffic loading, are continuously monitored for quality
assurance. The management platform has the capability to remotely access
routers, servers and layer 2 switches, permitting changes in configuration
without the need to physically be at the service point. This
43
management platform allows us to offer outsourced network monitoring and
management services to commercial businesses. Many of the largest commercial
networks in the state of Alaska use this service, including the state
government.
GCI.net offers a unique combination of innovative network design and aggressive
performance management. Our Internet platform has received a certification that
places it in the top one percent of all service providers worldwide and is the
only ISP in Alaska with such a designation. We operate and maintain what we
believe is the largest, most reliable, and highest performance Internet network
in the State of Alaska.
Customers. We had approximately 101,600, 95,700 and 89,500 total active
residential and commercial Internet subscribers at December 31, 2004, 2003 and
2002, respectively. Included in these totals were approximately 65,500, 46,000
and 36,200 active residential and commercial cable modem Internet subscribers at
December 31, 2004, 2003 and 2002, respectively. Revenues derived from Internet
services totaled $26.0 million, $19.8 million and $15.6 million, in 2004, 2003
and 2002, respectively, representing approximately 6.1%, 5.1% and 4.2% of our
total revenues in 2004, 2003 and 2002, respectively.
Our Internet services sales efforts are primarily directed toward increasing the
number of subscribers we serve, selling bundled services, and generating
incremental revenues through product and feature upsale opportunities. We sell
our Internet services through telemarketing, direct mail advertising,
door-to-door selling, up selling by our customer service and technical support
personnel, and local media advertising.
Competition. The Internet industry is highly competitive, rapidly evolving and
subject to constant technological change. Competition is based upon price and
pricing plans, service packages, the types of services offered, the technologies
used, customer service, billing services, perceived quality, reliability and
availability. As of December 31, 2004, we competed with more than eight Alaska
based Internet providers, and competed with other domestic, non-Alaska based
providers that provide national service coverage. Several of the providers have
substantially greater financial, technical and marketing resources than we do.
ACS and other Alaska telephone service providers are providing competitive
high-speed DSL services over their telephone lines in direct competition with
our high-speed cable modem service. DBS providers and others provide wireless
high speed Internet service in competition with our high-speed cable modem
services. Competitive local fixed wireless providers are providing service in
certain of our markets.
Niche providers in the industry, both local and national, compete with certain
of our Internet service products, such as web hosting, list services and email.
Marketing and Sales
Our marketing and sales strategy hinges on our ability to leverage (i) our
unique position as an integrated provider of multiple communications, Internet
and cable services, (ii) our well-recognized and respected brand name in the
Alaskan marketplace and (iii) our leading market positions in long-distance,
Internet and cable television services. By continuing to pursue a marketing
strategy that takes advantage of these characteristics, we believe we can
increase our residential and commercial customer market penetration and
retention rates, increase our share of our customers' aggregate voice, video and
data services expenditures and achieve continued growth in revenues and
operating cash flow.
44
Environmental Regulations
We may undertake activities that, under certain circumstances may affect the
environment. Accordingly, they are subject to federal, state, and local
regulations designed to preserve or protect the environment. The FCC, the Bureau
of Land Management, the United States Forest Service, and the National Park
Service are required by the National Environmental Policy Act of 1969 to
consider the environmental impact before the commencement of facility
construction.
We believe that compliance with such regulations has had no material effect on
our consolidated operations. The principal effect of our facilities on the
environment would be in the form of construction of facilities and networks at
various locations in Alaska and between Alaska, Seattle, Washington, and
Warrenton, Oregon. Our facilities have been constructed in accordance with
federal, state and local building codes and zoning regulations whenever and
wherever applicable. Some facilities may be on lands that may be subject to
state and federal wetland regulation.
Uncertainty as to the applicability of environmental regulations is caused in
major part by the federal government's decision to consider a change in the
definition of wetlands. Most of our facilities are on leased property, and, with
respect to all of these facilities, we are unaware of any violations of lease
terms or federal, state or local regulations pertaining to preservation or
protection of the environment.
Our Alaska United projects consist, in part, of deploying land-based and
undersea fiber optic cable facilities between Anchorage, Juneau, Seward, Valdez,
and Whittier, Alaska, Seattle, Washington, and Warrenton, Oregon. The engineered
routes pass over wetlands and other environmentally sensitive areas. We believe
our construction methods used for buried cable have a minimal impact on the
environment. The agencies, among others, that are involved in permitting and
oversight of our cable deployment efforts are the United States Army Corps of
Engineers, The National Marine Fisheries Service, United States Fish & Wildlife,
United States Coast Guard, National Oceanic and Atmospheric Administration,
Alaska Department of Natural Resources, and the Alaska Office of the
Governor-Governmental Coordination. We are unaware of any violations of federal,
state or local regulations or permits pertaining to preservation or protection
of the environment.
In the course of operating the cable television and communications systems, we
have used various materials defined as hazardous by applicable governmental
regulations. These materials have been used for insect repellent, paint used to
mark the location of our facilities, and pole treatment, and as heating fuel,
transformer oil, cable cleaner, batteries, diesel fuel, and in various other
ways in the operation of those systems. We do not believe that these materials,
when used in accordance with manufacturer instructions, pose an unreasonable
hazard to those who use them or to the environment.
Patents, Trademarks and Licenses
We do not hold patents, franchises or concessions for communications services or
local access services. We do hold registered service marks for the DigistarTM
logo and letters GCITM, and for the term SchoolAccessTM. The Communications Act
of 1934 gives the FCC the authority to license and regulate the use of the
electromagnetic spectrum for radio communications. We hold licenses through our
long-distance services industry segment for our satellite and microwave
transmission facilities for provision of long-distance services.
We acquired a license for use of a 30-MHz block of spectrum for providing PCS
services in Alaska. We are required by the FCC to provide adequate broadband PCS
service to at least two-thirds of the population in our licensed areas within 10
years of being licensed. The PCS license has an initial duration of 10 years. At
the end of the license period, a renewal application must be filed. We believe
renewal will generally be granted on a routine basis upon showing of compliance
with FCC regulations and continuing service to the public. Licenses may be
revoked and license renewal applications may
45
be denied for cause. We expect to renew the PCS license for an additional
10-year term under FCC rules.
We acquired a LMDS license in 1998 for use of a 150-MHz block of spectrum in the
28 GHz Ka-band for providing wireless services. The LMDS license has an initial
duration of 10 years. Within 10 years, licensees will be required to provide
"substantial service" in their service regions. Our operations may require
additional licenses in the future.
Earth stations are licensed generally for 15 years. The FCC also issues a single
blanket license for a large number of technically identical earth stations
(e.g., VSATs).
Regulation, Franchise Authorizations and Tariffs
The following summary of regulatory developments and legislation does not
purport to describe all present and proposed federal, state, and local
regulation and legislation affecting our businesses. Other existing federal and
state regulations are currently the subject of judicial proceedings, legislative
hearings and administrative proposals that could change, in varying degrees, the
manner in which these industries operate. We cannot predict at this time the
outcome of these proceedings and legislation, their impact on the industries in
which we operate, or their impact on us.
Communications Operations
General. We are subject to regulation by the FCC and by the RCA as a
non-dominant provider of long-distance services. We file tariffs with the FCC
for interstate access and operator services, and limited international
long-distance services, subject to the FCC's mandatory detariffing policies, and
with the RCA for intrastate service. Such tariffs routinely become effective
without intervention by the FCC, RCA or other third parties since we are a
non-dominant carrier. Military franchise requirements also affect our ability to
provide communications and cable television services to military bases.
The 1996 Telecom Act preempts state statutes and regulations that restrict the
provision of competitive local communications services. State commissions can,
however, impose reasonable terms and conditions upon the provision of
communications services within their respective states. Because we are
authorized to offer local access services, we are regulated as a CLEC by the
RCA. In addition, we are subject to other regulatory requirements, including
certain requirements imposed by the 1996 Telecom Act on all LECs, which
requirements include permitting resale of LEC services, local number
portability, dialing parity, and reciprocal compensation.
As a PCS and LMDS licensee, we are subject to regulation by the FCC, and must
comply with certain build-out and other conditions of the license, as well as
with the FCC's regulations governing the PCS and LMDS services (described
above). On a more limited basis, we may be subject to certain regulatory
oversight by the RCA (e.g., in the areas of consumer protection), although
states are not permitted to regulate the rates or entry of PCS, LMDS and other
commercial wireless service providers. PCS and LMDS licensees may also be
subject to regulatory requirements of local jurisdictions pertaining to, among
other things, the location of tower facilities.
Rural Exemption. ACS, through subsidiary companies, provides local telephone
services in Fairbanks and Juneau, Alaska. These ACS subsidiaries were classified
as Rural Telephone Companies under the 1996 Telecom Act, which entitled them to
an exemption of certain material interconnection terms of the 1996 Telecom Act,
until and unless such "rural exemption" were examined and discontinued by the
RCA. On October 11, 1999, the RCA issued an order terminating rural exemptions
for the ACS subsidiaries operating in the Fairbanks and Juneau markets so that
we could compete with these companies in the provision of local telephone
service pursuant to the terms of Section 251(c) of the 1996 Telecom Act. These
rural exemptions limited the obligation of the ILECs in these markets to provide
us with access to unbundled network elements at rates under the pricing standard
established by the FCC. ACS appealed these decisions.
46
On December 12, 2003, the Alaska Supreme Court issued a decision in which it
reversed the RCA's rural exemption decision on the procedural ground that the
competitor, not the incumbent, must shoulder the burden of proof. The Court
remanded the matter to the RCA for reconsideration with the burden of proof
assigned to us. In accordance with the Court's ruling, the RCA re-opened the
rural exemption dockets and scheduled a hearing to take place on April 19, 2004.
On April 18, 2004, we and ACS entered into a comprehensive settlement that, in
part, included a relinquishment by ACS of its rural exemption for Juneau and
Fairbanks. In accordance with the settlement, the parties moved the RCA for a
dismissal of the rural exemption inquiry, which the Commission granted on April
21, 2004.
By letter, submitted also to the RCA, on January 12, 2004, we made a bona fide
request for interconnection for the purposes of local access competition with
MTA, under the provisions of the 1996 Telecom Act. We submitted this request to
MTA on the grounds that it waived its rural exemption under the terms of Section
251(f)(1)(C) when it launched its new video service through its wholly owned
subsidiary MTA Vision, Inc. in competition with our cable television service.
MTA, however, refused to comply with the negotiation and arbitration provisions
under the Act claiming that it still retains a rural exemption. We filed a
complaint with the RCA to resolve this dispute, and the RCA conducted a public
hearing on the matter on October 20, 2004. On February 2, 2005, the RCA ruled
that MTA's rural exemption for the areas served by MTA Vision, Inc. had been
lifted and that we may negotiate and arbitrate interconnection with MTA. We are
proceeding with such negotiations.
Access Fees. The FCC regulates the fees that local telephone companies charge
long-distance companies for access to their local networks. In 2001, the FCC
adopted a plan to restructure access charges for rate-of-return regulated
carriers, which has the effect of shifting certain charges from IXCs to end
users. The FCC is continuing to monitor the access charge regime and is
considering other proposals that would restructure and could reduce access
charges. Changes in the access charge structure or the introduction of new
technologies that are not subject to the access charge structure could
fundamentally change the economics of some aspects of our business.
Carriers also pay fees for transport services in and out of Alaska. To the
extent these services were offered by AT&T Alascom, they were previously subject
to tariffed rates filed at the FCC. As of January 22, 2005 and for a five-year
period, the rates for such services offered by and to any provider are governed
by federal legislation effective December 8, 2004.
Access to Unbundled Network Elements. On March 2, 2004, the Court issued a
decision affirming in part, vacating in part, and remanding in part the FCC's
Triennial Review Order, in which the FCC reviewed its regulations governing
access that ILECs must make available to competitors to unbundled network
elements pursuant to Section 251(c) of the 1996 Telecom Act. On February 4,
2005, the FCC issued its Order responding to the Court's remand. Though the FCC
adopted new standards that generally curb access to certain ILEC high capacity
loop and transport facilities, we do not believe that any of these standards are
met for the markets we serve. The FCC also eliminated access to mass market
switching, which we self-provision and have generally not relied on stand-alone
access to this network element. The outcome of either requests for
reconsideration to the FCC or further court appeals could result in a change in
our cost of serving new and existing markets via the facilities of the ILEC or
via wholesale offerings. The ability to obtain unbundled network elements is an
important element of our local exchange and exchange access services business,
and we believe that the FCC's actions in this area have generally been positive.
However, we cannot predict the extent to which the existing rules will be
sustained in the face of additional legal action and the scope of any further
rules that are yet to be determined by the FCC.
The FCC has pending a notice of proposed rulemaking in which it is currently
reviewing its pricing standard that governs the rates ILECs may charge
competitors for access to unbundled network elements. The outcome of this
regulatory proceeding could result in a change in our cost of serving new and
existing markets via the facilities of the ILEC or via wholesale offerings.
Recurring and non-
47
recurring charges for telephone lines and other unbundled network elements may
increase based on the rates proposed by the ILECs and approved by the RCA from
time to time, which could have an adverse effect on our financial position,
results of operations or liquidity.
An arbitration proceeding to revise the interconnection agreement with ACS for
the Anchorage service area went to hearing before the RCA, such hearing ending
November 13, 2003. On June 25, 2004, the RCA issued a comprehensive decision
setting forth new rates for unbundled network elements, resale, and terms and
conditions for interconnection in the Anchorage arbitration. Significantly, the
RCA raised the loop rate in Anchorage to $19.15 but subsequently reduced the
loop rate on reconsideration to $18.64. The RCA also issued other various
arbitration rulings adverse to us, including adopting ACS' non-recurring and
collocation cost models. On December 7, 2004, the Commission issued a final
order approving an interconnection agreement. We have appealed various of the
Commission's arbitration rulings.
Critics continue to ask Congress to modify, if not altogether rework, the 1996
Telecom Act, citing the level of competition in the local phone and broadband
sectors. There is a lack of consensus on what changes are needed, however, or
who is to blame for the 1996 Telecom Act's perceived failures. Loosened
regulations on ILECs that control bottleneck facilities could diminish CLEC
local phone competition.
Universal Service. We have qualified under FCC regulations as a competitive
"eligible telecom carrier," or ETC, with respect to our provision of local
telephone service in Anchorage, Fairbanks, and Juneau. ETCs are entitled to
receive subsidies paid by the Universal Service Fund. If we do not continue to
qualify for this status in Anchorage, Fairbanks and/or Juneau, or if we do not
qualify for this status in other rural areas where we propose to offer new
services, we would not receive this subsidy and our net cost of providing local
telephone services in these areas would be materially adversely affected.
In addition, the FCC had previously referred issues concerning the designation
of ETCs, portability of support, and the basis for calculating support to a
Federal-State Joint Board on Universal Service. On February 27, 2004, the Joint
Board issued a recommendation, and the FCC has reported that on February 25,
2005, it adopted, among other things, minimum requirements to guide ETC
designations. We do not believe that the adopted changes, as reported, will have
a material effect on our operations. We cannot predict any further changes that
may be adopted, but future regulatory action or court appeals could affect the
subsidy and result in a change in our net costs of providing local telephone
services in new and existing markets.
Local Regulation. We may be required to obtain local permits for street opening
and construction permits to install and expand our networks. Local zoning
authorities often regulate our use of towers for microwave and other
communications sites. We also are subject to general regulations concerning
building codes and local licensing. The 1996 Telecom Act requires that fees
charged to communications carriers be applied in a competitively neutral manner,
but there can be no assurance that ILECs and others with whom we will be
competing will bear costs similar to those we will bear in this regard.
Cable Services Operations
General. The FCC has adopted rules that will require cable operators to carry
the digital signals of broadcast television stations. However, the FCC has
decided that cable operators should not be required to carry both the analog and
digital services of broadcast television stations while broadcasters are
transitioning from analog to digital transmission. Carrying both the analog and
digital services of broadcast television stations would consume additional cable
capacity. As a result, a requirement to carry both analog and digital services
of broadcast television stations could require the removal of other programming
services. Should the FCC mandate dual carriage, we will carry the broadcast
signals in both analog and digital formats.
48
Subscriber Rates. In Alaska, the RCA is the local franchising authority
certified to regulate basic cable rates. Under state law, however, the cable
television service is exempt from regulation unless subscribers petition the
state commission for regulation under the procedures set forth in AS 42.05.712.
At present, the only community where regulation of the basic rate occurs is
Juneau.
FCC regulations govern rates that may be charged to subscribers for regulated
services. The FCC uses a benchmark methodology as the principal method of
regulating rates. Cable operators are also permitted to justify rates using a
cost-of-service methodology, which contains a rebuttable presumption of an
industry-wide 11.25% rate of return on an operator's allowable rate base.
Cost-of-service regulation is a traditional form of rate regulation, under which
a company is allowed to recover its costs of providing the regulated service,
plus a reasonable profit. Franchising authorities are empowered to regulate the
rates charged for monthly basic service, for additional outlets and for the
installation, lease and sale of equipment used by subscribers to receive the
basic cable service tier, such as converter boxes and remote control units. The
FCC's rules require franchising authorities to regulate these rates based on
actual cost plus a reasonable profit, as defined by the FCC. Cable operators
required to reduce rates may also be required to refund overcharges with
interest. The FCC has also adopted comprehensive and restrictive regulations
allowing operators to modify their regulated rates on a quarterly or annual
basis using various methodologies that account for changes in the number of
regulated channels, inflation and increases in certain external costs, such as
franchise and other governmental fees, copyright and retransmission consent
fees, taxes, programming fees and franchise-related obligations. We cannot
predict whether the FCC will modify these "going forward" regulations in the
future.
Cable System Delivery of Internet Service. Although there is at present no
significant federal regulation of cable system delivery of Internet services,
and the FCC has issued several reports finding no immediate need to impose such
regulation, this situation may change as cable systems expand their broadband
delivery of Internet services and as a result of legislative, regulatory and
judicial developments.
In particular, proposals have been advanced at the FCC and Congress that would
require cable operators to provide access to unaffiliated Internet service
providers and online service providers.
In an October 6, 2003 decision, the United States Court of Appeals for the Ninth
Circuit reversed an FCC decision defining high-speed Internet over cable as an
"information service" not subject to local cable-franchise fees, like cable
service is, or any explicit requirements for "open access," as
telecommunications service is. If Internet access requirements are imposed on
cable operators, it could burden the capacity of cable systems and complicate
our own plans for providing expanded Internet access services. These access
obligations could adversely affect our financial position, results of operations
or liquidity. The decision is on appeal to the Supreme Court, which is scheduled
to hear oral arguments in the case on March 29, 2005.
Must Carry/Retransmission Consent. The 1992 Cable Act contains broadcast signal
carriage requirements that allow local commercial television broadcast stations
to elect once every three years to require a cable system to carry the station,
subject to certain exceptions, or to negotiate for "retransmission consent" to
carry the station.
The FCC decided against imposition of dual digital and analog must carry in a
January 2001 ruling. The ruling resolved a number of technical and legal
matters, and clarified that a digital-only television station, commercial or
non-commercial, can immediately assert its right to carriage on a local cable
system. The FCC also said that a television station that returns its analog
spectrum and converts to digital operations must be carried by local cable
systems. At the same time, however, it initiated further fact gathering that
ultimately could lead to a reconsideration of the conclusion. Further, on
February 23, 2005, the FCC released its order affirming its decisions not to
impose a dual carriage
49
requirement on cable operators and not to require cable operators to carry more
than a single digital programming stream from any particular broadcaster.
Satellite Home Viewer Improvement Act. A major change introduced by the SHVIA
was a "local into local" provision allowing satellite carriers, for the first
time, to retransmit the signals of local television stations by satellite back
to viewers in their local markets. The intent was to promote multichannel video
competition by removing the prohibition on satellite retransmission of local
signals, which cable operators already offered to their subscribers under the
must-carry/retransmission consent scheme of regulation described above. Congress
has reauthorized this Act through December 31, 2009, and we do not believe that
changes to the requirements will have a material effect on our operations.
Access to Programming. To spur the development of independent cable programmers
and competition to incumbent cable operators, the 1992 Cable Act imposed
restrictions on the dealings between cable operators and cable programmers. The
Act precludes video programmers affiliated with cable companies from favoring
their cable operators over new competitors and requires such programmers to sell
their programming to other multichannel video distributors. The current
prohibition extends until October 5, 2007.
Franchise Procedures. The 1984 Cable Act contains renewal procedures designed to
protect incumbent franchisees against arbitrary denials of renewal. The 1992
Cable Act made several changes to the renewal process that could make it easier
for a franchising authority to deny renewal. Moreover, even if the franchise is
renewed, the franchising authority may seek to impose new and more onerous
requirements such as significant upgrades in facilities and services or
increased franchise fees as a condition of renewal. Similarly, if a franchising
authority's consent is required for the purchase or sale of a cable system or
franchise, such authority may attempt to impose more burdensome or onerous
franchise requirements in connection with a request for such consent.
Historically, franchises have been renewed for cable operators that have
provided satisfactory services and have complied with the terms of their
franchises. We believe that we have generally met the terms of our franchises
and have provided quality levels of service. Furthermore, our franchises are
issued by the state public utility commission (the RCA) and do not require
periodic renewal.
Various courts have considered whether franchising authorities have the legal
right to limit the number of franchises awarded within a community and to impose
certain substantive franchise requirements (e.g. access channels, universal
service and other technical requirements). These decisions have been
inconsistent and, until the United States Supreme Court rules definitively on
the scope of cable operators' First Amendment protections, the legality of the
franchising process generally and of various specific franchise requirements is
likely to be in a state of flux.
Pole Attachment. The Communications Act requires the FCC to regulate the rates,
terms and conditions imposed by public utilities for cable systems' use of
utility pole and conduit space unless state authorities can demonstrate that
they adequately regulate pole attachment rates. In the absence of state
regulation, the FCC administers pole attachment rates on a formula basis. This
formula governs the maximum rate certain utilities may charge for attachments to
their poles and conduit by companies providing communications services,
including cable operators.
The RCA has largely retained the existing pole attachment formula that has been
in state regulation since 1987. This formula could be subject to further
revisions upon petition to the RCA. We cannot predict at this time the outcome
of any such proceedings.
Copyright. Cable television systems are subject to federal copyright licensing
covering carriage of television and radio broadcast signals. In exchange for
filing certain reports and contributing a percentage of their revenues to a
federal copyright royalty pool that varies depending on the size of the system,
the number of distant broadcast television signals carried, and the location of
the cable system, cable operators can obtain blanket permission to retransmit
copyrighted material included in broadcast signals. The United States Copyright
Office adopted an industry agreement providing for an
50
increase in the copyright royalty rates. The possible modification or
elimination of this compulsory copyright license is the subject of continuing
legislative review and could adversely affect our ability to obtain desired
broadcast programming. We cannot predict the outcome of this legislative
activity. Copyright clearances for nonbroadcast programming services are
arranged through private negotiations.
Cable operators distribute locally originated programming and advertising that
use music controlled by the two principal major music performing rights
organizations, the American Society of Composers, Authors and Publishers and
Broadcast Music, Inc. The cable industry has had a long series of negotiations
and adjudications with both organizations. Although we cannot predict the
ultimate outcome of these industry proceedings or the amount of any license fees
we may be required to pay for past and future use of association-controlled
music, we do not believe such license fees will be significant to our business
and operations.
Other Statutory and FCC Provisions. The Communications Act includes provisions,
among others, concerning customer service, subscriber privacy, marketing
practices, equal employment opportunity, regulation of technical standards and
equipment compatibility.
The FCC has various rulemaking proceedings pending implementing the 1996 Telecom
Act; it also has adopted regulations implementing various provisions of the 1992
Cable Act and the 1996 Telecom Act that are the subject of petitions requesting
reconsideration of various aspects of its rulemaking proceedings. The FCC has
the authority to enforce its regulations through the imposition of substantial
fines, the issuance of cease and desist orders and/or the imposition of other
administrative sanctions, such as the revocation of FCC licenses needed to
operate certain transmission facilities often used in connection with cable
operations.
Other Regulations of the FCC. The FCC has previously initiated an inquiry to
determine whether the cable industry's future provision of interactive services
should be subject to regulations ensuring equal access and competition among
service vendors. The inquiry is another indication of regulatory concern
regarding control over cable capacity. In addition, other bills and
administrative proposals pertaining to cable communications are introduced in
Congress from time to time or have been considered by other governmental bodies
over the past several years. It is possible that Congress and other governmental
bodies will make further attempts to regulate cable communications services.
State and Local Regulation. Because our cable communications systems use local
streets and rights-of-way, our systems are subject to state and local
regulation. Cable communications systems generally are operated pursuant to
franchises, permits or licenses granted by a municipality or other state or
local government entity. In Alaska, the RCA is the franchising authority for the
state. We provide cable television service throughout Alaska pursuant to various
certificates of authority issued by the RCA. These certificates are not subject
to terms of renewal and continue in effect until and unless the state commission
were to seek to modify or revoke them for good cause.
Internet Operations
General. With significant growth in Internet activity and commerce over the past
several years the FCC and other regulatory bodies have been challenged to
develop new models that allow them to achieve the public policy goals of
competition and universal service. Many aspects of regulation and coordination
of Internet activities and traffic are evolving and are facing unclear
regulatory futures. Changes in regulations and in the regulatory environment,
including changes that affect communications costs or increase competition from
ILECs or other communications services providers, could adversely affect the
prices at which we sell ISP services.
Internet Governance and Standards. There is no one entity or organization that
governs the Internet. Each facilities-based network provider that is
interconnected with the global Internet controls operational aspects of their
own network. Certain functions, such as IP addressing, domain name
51
routing and the definition of the TCP/IP protocol, are coordinated by an array
of quasi-governmental, intergovernmental, and non-governmental bodies.
The legal authority of any of these bodies is unclear. Most of the underlying
architecture of the Internet was developed under the auspices, directly or
indirectly, of the United States government. The government has not, however,
defined whether it retains authority over Internet management functions, or
whether these responsibilities have been delegated to the private sector.
1996 Telecom Act. The 1996 Telecom Act provides little direct guidance as to
whether the FCC has authority to regulate Internet-based services.
Given the absence of clear statutory guidance, the FCC must determine whether it
has the authority or the obligation to exercise regulatory jurisdiction over
specific Internet-based activities, or to decline from doing so under the
appropriate standards.
FCC Regulations. The FCC does not regulate the prices charged by ISPs or
Internet backbone providers. However, the vast majority of users connect to the
Internet over facilities of existing communications carriers. Those
communications carriers are subject to varying levels of regulation at both the
federal and the state level. Thus, regulatory decisions exercise a significant
influence over the economics of the Internet market. There are pending
complaints and proceedings at the FCC that may affect access charges,
compensation and other aspects of Internet service, and we cannot predict the
effect or outcome of such proceedings. The FCC has somewhat clarified VoIP
regulation by determining that it is not subject to local regional commission
oversight.
Financial Information about our Foreign and Domestic Operations and Export Sales
Although we have several agreements to help originate and terminate
international toll traffic, we do not have foreign operations or export sales.
We conduct our operations throughout the western contiguous United States and
Alaska and believe that any subdivision of our operations into distinct
geographic areas would not be meaningful. Revenues associated with international
toll traffic were $2.9 million, $2.9 million and $3.5 million for the years
ended December 31, 2004, 2003 and 2002, respectively.
Seasonality
Our long-distance and commercial cable television revenues have historically
been highest in the summer months because of temporary population increases
attributable to tourism and increased seasonal economic activity such as
construction, commercial fishing, and oil and gas activities. Our residential
cable television and Internet revenues are higher in the winter months because
consumers tend to watch more television and spend more time at home using the
Internet during these months. Our local services do not exhibit significant
seasonality, with the exception of SchoolAccess(TM) Internet services that are
reduced during the summer months. Our ability to implement construction projects
is also reduced during the winter months because of cold temperatures, snow and
short daylight hours.
Customer-Sponsored Research
We have not expended material amounts during the last three fiscal years on
customer-sponsored research activities.
Backlog of Orders and Inventory
As of December 31, 2004 and 2003, our long-distance services segment had a
backlog of Private Line orders of approximately $74,000 and $271,000,
respectively, which represents recurring monthly charges for Private Line and
broadband services. As of December 31, 2004 and 2003, we
52
had a backlog of equipment sales orders of approximately $468,000 and $745,000,
respectively for services included in the All Other category described in note
12 to the "Notes to Consolidated Financial Statements" included in Part II of
this Report. The decrease in backlogs as of December 31, 2004 can be attributed
to a combination of decreased private line circuit orders pending at December
31, 2004 as compared to 2003 and faster completion of outstanding sales orders
at December 31, 2004 as compared to 2003. We expect that all of the Private Line
orders and equipment sales in backlog at the end of 2004 will be delivered
during 2005.
Geographic Concentration and Alaska Economy
We offer voice and data communications and video services to customers primarily
in the State of Alaska. Because of this geographic concentration, growth of our
business and operations depends upon economic conditions in Alaska. The economy
of the State of Alaska is dependent upon natural resource industries, in
particular oil production, as well as investment earnings (including earnings
from the State of Alaska Permanent Fund), tourism, government, and United States
military spending. Any deterioration in these markets could have an adverse
impact on us. Oil revenues are the second largest source of state revenues,
following funds from investment sources. The slow economic recovery in the Lower
48 States appears to have dampened demand for services provided by our large
common carrier customers. To the extent that these customers experience reduced
demand for traffic destined for and originating in Alaska, it could adversely
affect our common carrier traffic and associated revenues. See "Part I -- Item 1
- -- Business -- Risks Relating to Our Business and Operations -- Our business is
currently geographically concentrated in Alaska," and "Part II -- Item 7 --
Management's Discussion and Analysis of Financial Condition and Results of
Operations" for more information about the effect of geographic concentration
and the Alaska economy on us.
Factors That May Affect Our Business and Future Results
Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial may also materially and adversely affect our
business operations. Any of the following risks could materially and adversely
affect our business, financial position, results of operations or liquidity.
Risks Relating to Our Business and Operations
We face competition that may reduce our market share and harm our financial
performance. There is substantial competition in the communications industry.
The traditional dividing lines between long-distance telephone service, local
telephone service, wireless telephone service, Internet services and video
services are increasingly becoming blurred. Through mergers and various service
integration strategies, major providers are striving to provide integrated
communications services offerings within and across geographic markets.
We expect competition to increase as a result of the rapid development of new
technologies, products and services. We cannot predict which of many possible
future technologies, products or services will be important to maintain our
competitive position or what expenditures will be required to develop and
provide these technologies, products or services. Our ability to compete
successfully will depend on marketing and on our ability to anticipate and
respond to various competitive factors affecting the industry, including new
services that may be introduced, changes in consumer preferences, economic
conditions and pricing strategies by competitors. To the extent we do not keep
pace with technological advances or fail to timely respond to changes in
competitive factors in our industry and in our markets, we could lose market
share or experience a decline in our revenue and net income. Competitive
conditions create a risk of market share loss and the risk that customers shift
to less profitable lower margin services. Competitive pressures also create
challenges for our ability to grow new businesses or introduce new services
successfully and execute our business plan. Each of our business segments also
faces the risk of potential price cuts by our competitors that could materially
adversely affect our market share and gross margins.
53
Long-distance services. The long-distance industry is intensely competitive and
subject to constant technological change. Competition is based upon price and
pricing plans, the type of services offered, customer service, billing services,
performance, perceived quality, reliability and availability. Current or future
competitors could be substantially larger than we are, or have greater
financial, technical and marketing resources than we do.
In the long-distance market, we compete against AT&T Alascom, ACS, MTA and
certain smaller rural local telephone carrier affiliates. There is also the
possibility that new competitors will enter the Alaska market. In addition,
wireless services continue to grow as an alternative to wireline services as a
means of reaching customers.
Historically, we have competed in the long-distance market by offering discounts
from rates charged by our competitors and by providing desirable packages of
services. Discounts have been eroded in recent years due to lowering of prices
by AT&T Alascom and entry of other competitors into the long-distance markets we
serve. In addition, our competitors offer their own packages of services. If
competitors lower their rates further or develop more attractive packages of
services, we may be forced to reduce our rates or add additional services, which
would have a material adverse effect on our financial position, results of
operations or liquidity.
Cable Services. Our cable television systems face competition from alternative
methods of receiving and distributing television signals, including DBS and
digital video over telephone lines, and from other sources of news, information
and entertainment such as off-air television broadcast programming, newspapers,
movie theaters, live sporting events, interactive computer services, Internet
services and home video products, including videotape cassettes and video disks.
Our cable television systems also face competition from potential overbuilds of
our existing cable systems by other cable television operators and alternative
methods of receiving and distributing television signals. The extent to which
our cable television systems are competitive depends, in part, upon our ability
to provide quality programming and other services at competitive prices.
We believe that the greatest source of potential competition for video services
could come from the DBS industry. We also are subject to competition from
providers of digital video over telephone lines in the Mat-Su Valley and
potentially in Ketchikan in 2005. With the addition of Anchorage local broadcast
stations, increased marketing, ILEC and DBS alliances, and emerging technologies
creating new opportunities, competition from these sources has increased and
will likely continue to increase. The changing nature of technology and of the
DBS business may result in greater satellite coverage within the State of
Alaska. The resulting increase in competition may adversely affect our market
share and results of operations from our cable services segment.
Local Telephone Services. In the local telephone market, we compete against ACS
(the ILEC), in Anchorage, Juneau and Fairbanks. We may provide local telephone
service in other locations in the future where we would face other competitors.
In the local telephone services market, the 1996 Telecom Act, judicial decisions
and state legislative and regulatory developments have increased the overall
likelihood that barriers to local telephone competition will be substantially
reduced or removed. These initiatives include requirements that local exchange
carriers negotiate with entities, including us, to provide interconnection to
the existing local telephone network, to allow the purchase, at cost-based
rates, of access to unbundled network elements, to establish dialing parity, to
obtain access to rights-of-way and to resell services offered by the ILEC. We
have been able to obtain interconnection, access and related services from the
LECs, at rates that allow us to offer competitive services. However, if we are
unable to continue to obtain these services and access at acceptable rates, our
ability to offer local telephone services, and our revenues and net income,
could be materially adversely affected. To date, we have been successful in
capturing a significant portion of the local telephone market in the locations
where we are offering these services. However, there can be no assurance that we
will continue to be successful in attracting or retaining these customers.
54
Internet Services. The Internet industry is highly competitive, rapidly evolving
and subject to constant technological change. Competition is based upon price
and pricing plans, service packages, the types of services offered, the
technologies used, customer service, billing services, perceived quality,
reliability and availability. We compete with several Alaska based Internet
providers and other domestic, non-Alaska based providers. Several of the
providers have substantially greater financial, technical and marketing
resources than we do.
With respect to our high-speed cable modem service, ACS and other Alaska
telephone service providers are providing competitive high-speed Internet access
over their telephone lines. DBS providers and others also provide wireless
high-speed Internet service in competition with our high-speed cable modem
services. Competitive local fixed wireless providers are providing service in
certain of our markets. Niche providers in the industry, both local and
national, compete with certain of our Internet service products, such as web
hosting, list services and email.
Our business is subject to extensive governmental legislation and regulation.
Applicable legislation and regulations and changes to them could adversely
affect our business, financial position, results of operations or liquidity.
Local Telephone Services. Our success in the local telephone market depends on
our continued ability to obtain interconnection, access and related services
from local exchange carriers on terms that are just and reasonable and that are
based on the cost of providing these services. Our local telephone services
business faces the risk of the impact of the implementation of current
regulations and legislation, unfavorable changes in regulation or legislation or
the introduction of new regulations. Our ability to enter into the local
telephone market depends on our negotiation or arbitration with local exchange
carriers to allow interconnection to the carrier's existing local telephone
network, to allow the purchase, at cost-based rates, of access to unbundled
network elements, to establish dialing parity, to obtain access to rights-of-way
and to resell services offered by the local exchange carrier. In most Alaska
markets, it also depends on our ability to have the rural exemption for certain
carriers terminated, so these carriers are obligated to provide access to
unbundled network elements at economic costs, and on our ability to gain
interconnection at economic costs. Future arbitration and rural exemption
proceedings with respect to new or existing markets could result in a change in
our cost of serving these markets via the facilities of the ILEC or via
wholesale offerings.
Cable Services. The cable television industry is subject to extensive regulation
at various levels, and many aspects of such regulation are currently the subject
of judicial proceedings and administrative or legislative proposals. The law
permits certified local franchising authorities to order refunds of rates paid
in the previous 12-month period determined to be in excess of the reasonable
rates. It is possible that rate reductions or refunds of previously collected
fees may be required of us in the future. Currently, pursuant to Alaska law, the
basic cable rates in Juneau are the only rates in Alaska subject to regulation
by the local franchising authority, and the rates in Juneau were reviewed and
approved by the Regulatory Commission of Alaska, or RCA, in October 2000.
Other existing federal regulations, currently the subject of judicial,
legislative, and administrative review, could change, in varying degrees, the
manner in which cable television systems operate. Neither the outcome of these
proceedings nor their impact upon the cable television industry in general, or
on our activities and prospects in the cable television business in particular,
can be predicted at this time. There can be no assurance that future regulatory
actions taken by Congress, the FCC or other federal, state or local government
authorities will not have a material adverse effect on our business, financial
position, results of operations or liquidity.
Proposals may be made before Congress and the FCC to mandate cable operators
provide "open access" over their cable systems to Internet service providers. As
of the date of this report, the FCC has declined to impose such requirements. If
the FCC or other authorities mandate additional access
55
to our cable systems, we cannot predict the effect that this would have on our
Internet service offerings.
Internet Services. Changes in the regulatory environment relating to the
Internet access market, including changes in legislation, FCC regulation,
judicial action or local regulation that affect communications costs or increase
competition from the ILEC or other communications services providers, could
adversely affect the prices at which we sell Internet services.
We depend on a small number of customers for a substantial portion of our
revenue and business. The loss of any of such customers would have a material
adverse effect on our financial position, results of operations or liquidity.
For the year ended December 31, 2004, we provided long-distance services
(excluding private lines and other revenue) to MCI and to Sprint Corporation, or
Sprint, which generated combined revenues of approximately 15.9% of our total
revenues for 2004. These two customers are free to seek out long-distance
communications services from our competitors upon expiration of their contracts
(in July 2008 in the case of MCI, and in March 2007 in the case of Sprint) or
earlier upon the occurrence of certain contractually stipulated events including
a default, the occurrence of a force majeure event, or a substantial change in
applicable law or regulation under the applicable contract. Additionally, the
contracts provide for periodic reviews to assure that the prices paid by MCI and
Sprint for their services remain competitive.
Mergers and acquisitions in the communications industry are relatively common.
If a change in control of MCI or Sprint were to occur, it would not permit them
to terminate their existing contracts with us, but could in the future result in
the termination of or a material adverse change in our relationships with MCI or
Sprint.
In addition, MCI's and Sprint's need for our long-distance services
depends directly upon their ability to obtain and retain their own long-distance
customers and upon the needs of those customers for long-distance services.
The loss of one or both of MCI or Sprint as customers, a material adverse change
in our relationships with either of them or a material loss of or reduction in
their long-distance customers would have a material adverse effect on our
financial position, results of operations and liquidity.
Our businesses are currently geographically concentrated in Alaska. Any
deterioration in the economic conditions in Alaska could have a material adverse
effect on our financial position, results of operations or liquidity.
We offer voice and data communication and video services to customers primarily
in the State of Alaska. Because of this geographic concentration, our growth and
operations depend upon economic conditions in Alaska. The economy of Alaska is
dependent upon natural resource industries, in particular oil production, as
well as tourism, and government spending including substantial amounts for the
United States military. Any deterioration in these markets could have an adverse
impact on the demand for communication and cable television services and on our
results of operations and financial condition. In addition, the customer base in
Alaska is limited. Alaska has a population of approximately 649,000 people,
approximately 42% of whom are located in the Anchorage area. We have already
achieved significant market penetration with respect to our service offerings in
Anchorage and in other locations in Alaska.
We may not be able to continue to increase our market share of the existing
markets for our services and no assurance can be given that the Alaskan economy
will continue to grow and increase the size of the markets we serve or increase
the demand for the services we offer. As a result, the best opportunities for
expanding our business may arise in other geographic areas such as the
contiguous lower 48 states. There can be no assurance that we will find
attractive opportunities to grow our businesses outside the State of Alaska or
that we will have the necessary expertise to take advantage
56
of such opportunities. The markets in Alaska for voice and data communications
and video services are unique and distinct within the United States due to
Alaska's large geographical size and its distance from the rest of the United
States. The expertise we have developed in operating our businesses in the State
of Alaska may not provide us with the necessary expertise to successfully enter
other geographic markets.
We may not develop our wireless services, in which case we could not meet the
needs of our customers who desire packaged services.
We offer wireless mobile services by distributing other providers' wireless
mobile services. We offer wireless local telephone services over our own
facilities, and have purchased personal communications system, or PCS, and local
multipoint distribution system, or LMDS, wireless broadband licenses in FCC
auctions covering markets in Alaska. We have fewer subscribers to our wireless
services than to our other service offerings. The geographic coverage of our
wireless services is also smaller than the geographic coverage of our other
services. Some of our competitors offer or propose to offer an integrated bundle
of communications, entertainment and information services, including wireless
services. If we are unable to expand and further develop our wireless services,
we may not be able to meet the needs of customers who desire packaged services,
and our competitors who offer these services would have an advantage. This could
result in the loss of market share for our other service offerings.
As a PCS and LMDS licensee, we are subject to regulation by the FCC, and must
comply with certain build-out and other conditions of the licenses, as well as
with the FCC's regulations governing the PCS and LMDS services. The conditions
of our PCS licenses require us to satisfy certain build-out requirements on or
before June, 2005. In February 2005 we submitted a filing to the FCC supporting
our compliance with such requirements.
Our efforts to deploy DLPS may be unsuccessful, in which case the margins on our
local telephone services business will not improve and we will not recover any
capital investment that we have made in DLPS.
An element of our business strategy is to deploy voice telephone service
utilizing our hybrid fiber coax cable facilities. In April 2004 we successfully
launched our DLPS deployment utilizing our Anchorage coaxial cable facilities.
DLPS allows us to utilize our own cable facilities to provide local access to
our customers and avoid paying local loop charges to the ILEC. To continue to
successfully deploy this service, we must integrate new technology with our
existing facilities and modify our operating procedures to timely detect and
effect repairs of our outside plant network. The long-term viability of this
service depends on the adoption of industry-wide standards for the sending and
receiving of voice communications over cable facilities and the availability of
the equipment necessary to provide the service at a cost-effective price. The
deployment of this service may require a substantial capital investment by us.
If we are unable to successfully deploy DLPS to a sufficiently large portion of
our customer base, we will not be able to recover all of the capital investment
we may make and the margins on our local telephone services business will not
improve.
Prolonged service interruptions could affect our business.
We rely heavily on our network equipment, communications providers, data and
software, to support all of our functions. We rely on our networks and the
networks of others for substantially all of our revenues. We are able to deliver
services only to the extent that we can protect our network systems against
damage from power or communication failures, computer viruses, natural
disasters, unauthorized access and other disruptions. While we endeavor to
provide for failures in the network by providing back-up systems and procedures,
we cannot guarantee that these back-up systems and procedures will operate
satisfactorily in an emergency. Should we experience a prolonged failure, it
could seriously jeopardize our ability to continue operations. In particular,
should a significant service
57
interruption occur, our ongoing customers may choose a different provider, and
our reputation may be damaged, reducing our attractiveness to new customers.
To the extent that any disruption or security breach results in a loss or damage
to our customers' data or applications, or inappropriate disclosure of
confidential information, we may incur liability and suffer from adverse
publicity. In addition, we may incur additional costs to remedy the damage
caused by these disruptions or security breaches.
If failures occur in our undersea fiber optic cables, our ability to immediately
restore the entirety of our service may be limited, which could lead to a
material adverse effect on our business, financial position, results of
operations or liquidity.
Our communications facilities include an undersea fiber optic cable that carries
a large portion of our Internet voice and data traffic to and from the
contiguous lower 48 states. We completed construction of AULP West in June 2004
that provides an alternative backup communications facility. If a failure of
both sides of the ring of our undersea fiber optic facilities occurs and we are
not able to secure alternative facilities, some of the communications services
we offer to our customers could be interrupted, which could have a material
adverse effect on our business, financial position, results of operations or
liquidity.
If a failure occurs in our satellite communications systems, our ability to
immediately restore the entirety of our service may be limited.
We serve many rural and remote Alaska locations solely via satellite
communications. Each of our C and Ku-band satellite transponders is backed up on
the same spacecraft with multiple backup transponders. Our primary spacecraft is
PanAmSat's Galaxy XR, but we also lease capacity on two other spacecraft for
services we provide, SES Americom's AMC-7 and AMC-8. On Galaxy XR, we use 7
C-band transponders. We have arranged for backup C-band satellite capacity on
another PanAmSat spacecraft, Galaxy XIII, for all of those satellite
transponders in the unlikely event of a total primary spacecraft failure. If
such a failure occurs, service may not be fully restored for up to a week or
longer due to the time necessary to redirect earth station antennae. We also own
one Ku-band satellite transponder on the same primary spacecraft (Galaxy XR)
that provides our C-band service. In the event of total primary spacecraft
failure, we believe we would be able to restore our Ku-band transponder traffic
on Galaxy XIII, although no pre-arrangement for its backup is currently in
place. We lease on a short-term basis an additional 27 megahertz of protected
but un-backed up transponder capacity on another Galaxy XR transponder. Such
capacity is protected by the same satellite for transponder failure, but in the
event of total spacecraft failure, this leased space segment would not be
restored. We also lease approximately 13 megahertz of protected and backed-up
C-band capacity on SES Americom's AMC-8 spacecraft. SES Americom's AMC-7 is the
backup spacecraft for AMC-8. We also lease certain C-band transponder capacity
on AMC-7 that can be preempted in the case of a satellite failure. The services
that are preempted would not be immediately restored should AMC-7 fail or be
called up to provide restoration of another of SES Americom's spacecraft.
We depend on a limited number of third-party vendors to supply communications
equipment. If we do not obtain the necessary communications equipment, we will
not be able to meet the needs of our customers.
We depend on a limited number of third-party vendors to supply cable, Internet,
DLPS and telephony-related equipment. If our providers of this equipment are
unable to timely supply the equipment necessary to meet our needs or provide
them at an acceptable cost, we may not be able to satisfy demand for our
services and competitors may fulfill this demand.
58
We do not have insurance to cover certain risks to which we are subject, which
could lead to the incurrence of uninsured liabilities that adversely affect our
financial position, results of operations or liquidity.
We are self-insured for damage or loss to certain of our transmission
facilities, including our buried, under sea and above-ground transmission lines.
If we become subject to substantial uninsured liabilities due to damage or loss
to such facilities, our financial position, results of operations or liquidity
may be adversely affected.
New corporate governance rules impose increased costs and internal control
assessment requirements on us.
The Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by
the SEC, the Public Company Accounting Oversight Board, and the Nasdaq National
Market, have required changes in corporate governance practices of public
companies. We expect to incur ongoing costs to comply with these rules and
regulations, as well as increased legal and financial compliance costs. For
example, Section 404 of the Sarbanes-Oxley Act of 2002 requires that we evaluate
and report on our system of internal controls over financial reporting and have
our auditor attest to such evaluation. In 2004 we incurred operating costs
totaling $2.0 million and capital costs totaling $714,000 to comply with Section
404. Since our systems, processes and internal controls thereon change over
time, we cannot assure you that there may not be material weaknesses that would
be required to be reported in the future.
We must apply a direct value method to determine the fair value of our cable
certificate assets for purposes of impairment testing on an annual basis.
Impairment testing may result in a material, non-cash write-down of our cable
certificate or goodwill assets and could have a material adverse impact on our
results of operations.
Under Statement of Financial Accounting Standard No. 142, "Goodwill and Other
Intangible Assets," we must test our goodwill and other intangible assets with
indefinite lives for impairment at least annually. On September 29, 2004, the
SEC issued SEC Staff Announcement Topic "Use of the Residual Method to Value
Acquired Assets Other than Goodwill," requiring us to apply no later than
January 1, 2005 a direct value method to determine the fair value of our
intangible assets with indefinite lives other than goodwill for purposes of
impairment testing. We must also recognize previously unrecognized intangible
assets, if any, in the determination of fair value for impairment testing
purposes. Our cable certificate assets are our only indefinite-lived assets
other than goodwill as of December 31, 2004. Our cable certificate assets were
originally valued and recorded using the residual method. Impairment testing of
our cable certificate assets in future periods under Statement of Financial
Accounting Standard No. 142 must use a direct value method pursuant to such SEC
Staff Announcement, which may result in a material, non-cash write-down of our
cable certificate assets and could have a material adverse impact on our results
of operations.
Our significant debt could adversely affect our business and prevent us from
fulfilling our obligations under our senior notes.
We have and will continue to have a significant amount of debt. On December 31,
2004, we had total debt of approximately $476.8 million. Our high level of debt
could have important consequences, including the following:
o use of a large portion of our cash flow to pay principal and interest
on our Senior Notes, the senior secured credit facility and our other
debt, which will reduce the availability of our cash flow to fund
working capital, capital expenditures, research and development
expenditures and other business activities;
o current and future debt under our senior secured credit facility will
continue to be secured;
o increase our vulnerability to general adverse economic and industry
conditions;
59
o limit our flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate;
o restrict us from making strategic acquisitions or exploiting business
opportunities;
o make it more difficult for us to satisfy our obligations with respect
to the senior notes and our other debt;
o place us at a competitive disadvantage compared to our competitors that
have less debt; and
o limit, along with the financial and other restrictive covenants in our
debt, among other things, our ability to borrow additional funds,
dispose of assets or pay cash dividends.
In addition, a substantial amount of our debt bears interest at variable rates.
If market interest rates increase, variable-rate debt will create higher debt
service requirements, which would adversely affect our financial position,
results of operations or liquidity.
We will require a significant amount of cash to service our debt. Our ability to
generate cash depends on many factors beyond our control.
Our ability to make payments on and to refinance our debt and to fund planned
capital expenditures and business development efforts will depend on our ability
to generate cash in the future. This is subject to general economic, financial,
competitive, legislative, regulatory and other factors that may be beyond our
control.
Our business may not generate sufficient cash flow from operations and future
borrowings may not be available to us under our senior secured credit facility
or otherwise in an amount sufficient to enable us to pay our debt or to fund our
other liquidity needs. We may need to refinance all or a portion of our debt on
or before maturity. We may not be able to refinance any of our debt on
commercially reasonable terms or at all.
Despite our current significant level of debt, we may still be able to incur
substantially more debt. This could further exacerbate the risks associated with
our substantial debt.
We may be able to incur substantial debt in the future. Although the indenture
governing the senior notes contains restrictions on the incurrence of additional
debt, these restrictions are subject to a number of qualifications and
exceptions and, under certain circumstances, debt incurred in compliance with
these restrictions could be substantial. If new debt is added to our current
debt levels, the substantial risks described above would intensify.
The terms of our debt impose restrictions on us that may affect our ability to
successfully operate our business and our ability to make payments on the senior
notes.
The indenture governing our senior notes contains and/or the credit agreement
governing our senior secured credit facility contains covenants that, among
other things, limit our ability to:
o incur additional debt and issue preferred stock;
o pay dividends or make other restricted payments;
o make certain investments;
o create liens;
o allow restrictions on the ability of certain of our subsidiaries to pay
dividends or make other payments to us;
o sell assets;
o merge or consolidate with other entities; and
o enter into transactions with affiliates.
60
The senior secured credit facility also requires us to comply with specified
financial ratios and tests, including, but not limited to, minimum interest
coverage ratio, maximum leverage ratio and maximum annual capital expenditures.
These covenants could materially and adversely affect our ability to finance our
future operations or capital needs and to engage in other business activities
that may be in our best interest.
All of these covenants may restrict our ability to expand or to pursue our
business strategies. Our ability to comply with these covenants may be affected
by events beyond our control, such as prevailing economic conditions and changes
in regulations, and if such events occur, we cannot be sure that we will be able
to comply. A breach of these covenants could result in a default under the
indenture governing our senior notes and/or the senior secured credit facility.
If there were an event of default under the indenture for the senior notes
and/or the senior secured credit facility, holders of such defaulted debt could
cause all amounts borrowed under these instruments to be due and payable
immediately. Additionally, if we fail to repay the debt under the senior secured
credit facility when it becomes due, the lenders under the senior secured credit
facility could proceed against certain of our assets and capital stock of our
subsidiaries that we have pledged to them as security. Our assets or cash flow
may not be sufficient to repay borrowings under our outstanding debt instruments
in the event of a default thereunder.
A significant percentage of GCI's voting securities are owned by a small number
of shareholders and these shareholders can control stockholder decisions on very
important matters.
As of December 31, 2004, our executive officers and directors and their
affiliates owned approximately 9.4% of GCI's combined outstanding Class A and
class B common stock, representing approximately 25.9% of the combined voting
power of that stock (including outstanding GCI Series B preferred stock voting
with GCI Class A common stock on an as-converted basis). These shareholders can
significantly influence, if not control, our management policy and all
fundamental corporate actions, including mergers, substantial acquisitions and
dispositions, and election of directors to GCI's Board.
Terrorist attacks, such as the attacks that occurred on September 11, 2001, and
other attacks or acts of war may adversely affect us.
The attacks of September 11, 2001, and subsequent events have caused instability
in the local, national and international economies and markets and have led, and
may continue to lead, to further armed hostilities or to further acts of
terrorism in the United States or elsewhere, which could cause further
instability in such economies and markets. In addition, armed hostilities and
further acts of terrorism may directly impact our physical facilities and
operations or those of our customers. Furthermore, terrorist attacks, subsequent
events and future developments may adversely affect our customers or their
facilities or otherwise result in reduced demand from our customers for our
services. Any of the foregoing could subject our operations to increased risks
and, depending on their magnitude, could have a material adverse effect on our
financial position, results of operations or liquidity.
Employees
We employed 1,345 persons as of January 31, 2005, and we are not party to union
contracts with our employees. We believe our future success will depend upon our
continued ability to attract and retain highly skilled and qualified employees.
We believe that relations with our employees are satisfactory.
Other
No material portion of our businesses is subject to renegotiation of profits or
termination of contracts at the election of the federal government.
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Item 2. Properties
General. Our properties do not lend themselves to description by character or
location of principal units. Our investment in property, plant and equipment in
our consolidated operations consisted of the following at December 31:
2004 2003
------------------------------
Telephone distribution systems 59.0% 53.5%
Cable television distribution systems 22.9% 24.9%
Support equipment 6.7% 7.1%
Property and equipment under capital leases 6.9% 7.9%
Construction in progress 3.0% 5.2%
Transportation equipment 0.9% 0.9%
Land and buildings 0.6% 0.5%
------------------------------
Total 100.0% 100.0%
==============================
These properties are divided among our operating segments at December 31, 2004
as follows: long-distance services, 49.7%; cable services, 24.3%; local access
services, 9.1%; Internet services, 6.0%; and all other, 10.9%.
These properties consist primarily of switching equipment, satellite earth
stations, fiber-optic networks, microwave radio and cable and wire facilities,
cable head-end equipment, coaxial distribution networks, routers, servers,
transportation equipment, computer equipment and general office equipment.
Substantially all of our properties secure our new Senior Credit Facility. You
should see note 7 to the "Notes to Consolidated Financial Statements" included
in Part II of this Report for more information.
Our construction in progress totaled $22.5 million at December 31, 2004,
consisting of long-distance, cable, local and Internet services, and support
systems projects that were incomplete at December 31, 2004. Our construction in
progress totaled $33.6 million at December 31, 2003, consisting of $16.5 million
for AULP West with the remainder consisting of long-distance, cable, local and
Internet services, and support systems projects that were incomplete at December
31, 2003.
Long-Distance Services. We operate a modern, competitive communications network
employing the latest digital transmission technology based upon fiber optic and
digital microwave facilities within and between Anchorage, Fairbanks and Juneau,
Alaska. Our network includes digital fiber optic cables linking Alaska to the
Lower 48 States and providing access to other carriers' networks for
communications around the world. We use satellite transmission to remote areas
of Alaska and for certain interstate and intrastate traffic, and to provide
backup facilities for certain portions of our long-haul fiber networks.
Our long-distance services segment owns properties and facilities including
satellite earth stations, and distribution, transportation and office equipment.
Additionally, in December 1992 we acquired capacity on an undersea fiber optic
cable from Seward, Alaska to Pacific City, Oregon which was taken out of service
in January 2004. See "Part I -- Item 1 -- Business -- Historical Development of
our Business During the Past Fiscal Year -- Fiber System Taken out of Service"
for more information. We completed construction of AULP East linking Alaska to
Seattle, Washington in February 1999. In June 2004, we completed the
construction of AULP West 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.
We entered into a purchase and lease-purchase option agreement in August 1995
for the acquisition of satellite transponders on the PanAmSat Galaxy XR
satellite to meet our long-term satellite capacity requirements. We use the
satellite transponders pursuant to a long-term capital lease arrangement with a
leasing company. The purchase and lease-purchase option agreement provided for
the interim
62
lease of transponder capacity on the PanAmSat Galaxy IX satellite through the
delivery of the purchased transponders on Galaxy XR in March 2000. See "Part I
- -- Item 1 -- Business -- Historical Development of our Business During the Past
Fiscal Year -- Galaxy XR Satellite Propulsion System Failure" for more
information.
Effective June 30, 2001, we acquired, through GCI's issuance of preferred stock,
a controlling interest in the corporation owning the 800-mile fiber optic cable
system that extends from Prudhoe Bay, Alaska to Valdez, Alaska via Fairbanks.
We lease our long-distance services industry segment's executive, corporate and
administrative facilities in Anchorage, Fairbanks and Juneau, Alaska. Our
operating, executive, corporate and administrative properties are in good
condition. We consider our properties suitable and adequate for our present
needs and they are being fully utilized.
Cable Services. The cable systems serve 35 communities and areas in Alaska
including Anchorage, Fairbanks, the Mat-Su Valley, and Juneau, the state's four
largest urban areas. As of December 31, 2004, the Cable Systems consisted of
approximately 2,300 miles of installed cable plant having between 450 to 625 MHz
of channel capacity. Our principal physical assets consist of cable television
distribution plant and equipment, including signal receiving, encoding and
decoding devices, headend reception facilities, distribution systems and
customer drop equipment for each of our cable television systems.
Our cable television plant and related equipment are generally attached to
utility poles under pole rental agreements with local public utilities and
telephone companies, and in certain locations are buried in underground ducts or
trenches. We own or lease real property for signal reception sites and business
offices in the communities served by our systems and for our principal executive
offices.
We own the receiving and distribution equipment of each system. In order to keep
pace with technological advances, we are maintaining, periodically upgrading and
rebuilding the physical components of our cable communications systems. Such
properties are in good condition. We own all of our service vehicles. We
consider our properties suitable and adequate for our present and anticipated
future needs.
Local Access Services. We operate a modern, competitive local access
communications network employing analog and the latest digital transmission
technology based upon fiber optic facilities within Anchorage, Fairbanks and
Juneau, Alaska. Our outside plant consists of connecting lines (aerial,
underground and buried cable), the majority of which is on or under public
roads, highways or streets, while the remainder is on or under private property.
Central office equipment primarily consists of digital electronic switching
equipment and circuit carrier transmission equipment. Operating equipment
consists of motor vehicles and other equipment.
Substantially all of our local access services' central office equipment,
administrative and business offices, and customer service centers are in leased
facilities. Such properties are in good condition. We consider our properties
suitable and adequate for our present and anticipated future needs.
Internet Services. We operate a modern, competitive Internet network employing
the latest available technology. We provide access to the Internet using a
platform that includes many of the latest advancements in technology. The
physical platform is concentrated in Anchorage and is extended into many remote
areas of Alaska. Our Internet platform includes trunks connecting our Anchorage,
Fairbanks, and Juneau facilities to Internet access points in Seattle through
multiple, diversely routed upstream Internet networks, and various other
routers, servers and support equipment.
We lease our Internet services industry segment's operating facilities, located
primarily in Anchorage. Such properties are in good condition. We consider our
properties suitable and adequate for our present and anticipated future needs.
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Capital Expenditures
Capital expenditures consist primarily of (a) gross additions to property, plant
and equipment having an estimated service life of one year or more, plus the
incidental costs of preparing the asset for its intended use, and (b) gross
additions to capitalized software.
The total investment in property, plant and equipment has increased from $507.9
million at January 1, 2000 to $745.3 million at December 31, 2004, including
construction in progress and not including deductions of accumulated
depreciation. Significant additions to property, plant and equipment will be
required in the future to meet the growing demand for communications, Internet
and entertainment services and to continually modernize and improve such
services to meet competitive demands.
Our capital expenditures for 2000 through 2004 were as follows (in millions):
2000 $ 50.9
2001 $ 65.6
2002 $ 65.1
2003 $ 62.5
2004 $ 111.8
We project capital expenditures of $80 million to $85 million for 2005. We have
made purchase commitments totaling approximately $43 million at December 31,
2004. A majority of the expenditures are expected to expand, enhance and
modernize our current networks, facilities and operating systems, and to develop
other businesses.
During 2004, we funded our normal business capital requirements substantially
through internal sources and, to the extent necessary, from external financing
sources. We expect expenditures for 2005 to be financed in the same manner.
Insurance
We have insurance to cover risks incurred in the ordinary course of business,
including general liability, property coverage, director and officers and
employment practices liability, auto, crime, fiduciary, aviation, and business
interruption insurance in amounts typical of similar operators in our industry
and with reputable insurance providers. Central office equipment, buildings,
furniture and fixtures and certain operating and other equipment are insured
under a blanket property insurance program. This program provides substantial
limits of coverage against "all risks" of loss including fire, windstorm, flood,
earthquake and other perils not specifically excluded by the terms of the
policies. As is typical in the communications industry, we are self-insured for
damage or loss to certain of our transmission facilities, including our buried,
under sea, and above-ground transmission lines. We self-insure with respect to
employee health insurance and workers compensation, subject to stop-loss
insurance with other parties that caps our liability at specified limits. We
believe our insurance coverage is adequate, however if we become subject to
substantial uninsured liabilities due to damage or loss to such facilities, our
financial results may be adversely affected.
Item 3. Legal Proceedings
Except as set forth in this item, neither the Company, its property nor any of
its subsidiaries or their property is a party to or subject to any material
pending legal proceedings. We are parties to various claims and pending
litigation as part of the normal course of business. We are also involved in
several administrative proceedings and filings with the FCC, Department of Labor
and state regulatory authorities. In the opinion of management, the nature and
disposition of these matters are considered routine and arising in the ordinary
course of business. Management believes these
64
matters would not have a materially adverse affect on our business or financial
position, results of operations or liquidity.
Item 4. Submissions of Matters to a Vote of Security Holders
Omitted per General Instruction I(1)(a) and (b) of Form 10-K.
Part II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Market Information for Common Stock
All issued and outstanding shares of GCI, Inc.'s Class A common stock are held
by GCI and are not publicly traded. GCI's Class A and Class B common stock are
publicly traded. Dividends
Neither we nor GCI have ever paid cash dividends on our common stock and neither
of us have a present intention of doing so. Payment of cash dividends in the
future, if any, will be determined by GCI's Board of Directors in light of our
earnings, financial condition and other relevant considerations. Our existing
bank loan agreements contain provisions that prohibit payment of dividends on
common stock, other than stock dividends (you should see note 7 to the
"Consolidated Financial Statements" included in Part II of this Report for more
information).
Stock Transfer Agent and Registrar
Mellon Investor Services is GCI's stock transfer agent and registrar.
65
Item 6. Selected Financial Data
The following table presents selected historical information relating to
financial condition and results of operations over the past five years.
Years ended December 31,
----------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Amounts in thousands except per share amounts)
Revenues $ 424,826 390,797 367,842 357,258 292,605
Net income (loss) before income taxes and
cumulative effect of a change in accounting
principle $ 38,715 26,160 12,322 8,659 (21,649)
Cumulative effect of a change in accounting
principal, net of income tax benefit of $367 in
2003 $ --- (544) --- --- ---
Net income (loss) $ 21,252 15,542 6,663 4,589 (13,234)
Total assets $ 849,191 763,020 738,782 734,679 679,007
Long-term debt, including current portion $ 437,137 345,000 357,700 351,700 334,400
Obligations under capital leases, including
current portion $ 39,661 44,775 46,632 47,282 48,696
Total stockholder's equity $ 228,604 246,271 230,497 224,450 204,822
Dividends declared per common share $ 0.00 0.00 0.00 0.00 0.00
The Selected Financial Data should be read in conjunction with "Part II --
Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
In the following discussion, GCI, Inc. and its direct and indirect subsidiaries
are referred to as "we," "us" and "our."
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. 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
Goods Sold (exclusive of depreciation, amortization and accretion shown
separately) ("Cost of Goods Sold") 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
66
stock are traded on the Over-the-Counter market. Shares of GCI, Inc.'s common
stock are not publicly traded.
General Overview
Through our focus on long-term results, acquisitions, and strategic capital
investments, we strive to consistently grow our revenues and expand our margins.
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 funded the construction of a new fiber optic cable
system through our operating cash flows and with draws on our new Senior Credit
Facility, as further discussed in Liquidity and Capital Resources in this
report.
Results of Operations
The following table sets forth selected Statement of Operations data as a
percentage of total revenues for the periods indicated (underlying data rounded
to the nearest thousands):
Year Ended December 31, Percentage Change (1)
----------------------- ---------------------
2004 2003
vs. vs.
2004 2003 2002 2003 2002
---- ---- ---- ---- ----
Statement of Operations Data:
Revenues:
Long-distance services segment 49.5% 52.3% 55.7% 2.7% (0.2%)
Cable services segment 23.9% 24.6% 24.1% 5.7% 8.2%
Local access services segment 11.0% 10.0% 8.7% 20.4% 21.6%
Internet services segment 6.1% 5.1% 4.3% 30.9% 27.3%
All other 9.5% 8.0% 7.2% 28.5% 18.1%
-----------------------------------------------------------------
Total revenues 100.0% 100.0% 100.0% 8.7% 6.2%
Cost of goods sold 32.8% 32.1% 33.6% 11.3% 1.5%
Selling, general and administrative expenses 34.7% 35.5% 35.1% 6.2% 7.5%
Bad debt expense (recovery) (0.3%) 0.0% 3.6% (503.4%) (101.4%)
Impairment charge 0.0% 1.4% 0.0% NM NM
Depreciation, amortization and accretion
expense 14.9% 13.6% 15.3% 18.2% (5.3%)
-----------------------------------------------------------------
Operating income 17.9% 17.4% 12.4% 11.4% 48.9%
Net income before income taxes and
cumulative effect of a change in
accounting principle in 2003 9.1% 6.7% 3.3% 48.0% 112.3%
Net income before cumulative effect of a
change in accounting principle in 2003 5.0% 4.1% 3.3% 32.1% 141.4%
Net income 5.0% 4.0% 1.8% 37.7% 133.3%
67
Year Ended December 31, Percentage Change (1)
----------------------- ---------------------
2004 2003
vs. vs.
2004 2003 2002 2003 2002
---- ---- ---- ---- ----
Other Operating Data:
Long-distance services segment operating
income (2) 44.4% 43.5% 34.7% 5.0% 25.3%
Cable services segment operating income (3) 26.0% 26.0% 26.5% 5.8% 6.4%
Local access services segment operating loss (4) (12.1%) (15.8%) (26.1%) 7.9% 26.4%
Internet services segment operating income
(loss) (5) 21.0% 8.2% (10.5%) 236.6% 198.9%
--------------------------
1 Percentage change in underlying data.
2 Computed by dividing total external long-distance services segment operating
income by total external long-distance services segment revenues.
3 Computed by dividing total external cable services segment operating income by
total external cable services segment revenues.
4 Computed by dividing total external local access services segment operating
loss by total external local access services segment revenues.
5 Computed by dividing total external Internet services segment operating income
(loss) by total external Internet services segment revenues.
NM - Not meaningful
--------------------------
Year Ended December 31, 2004 ("2004") Compared To Year Ended December 31, 2003
("2003")
Overview of Revenues and Cost of Goods Sold
Total revenues increased 8.7% from $390.8 million in 2003 to $424.8 million in
2004. All of our segments and All Other Services contributed to the increase in
total revenues. See the discussion below for more information by segment.
Total Cost of Goods Sold increased 11.3% from $125.4 million in 2003 to $139.6
million in 2004. All of our segments and All Other Services contributed to the
increase in total Cost of Goods Sold. See the discussion below for more
information by segment.
Long-Distance Services Segment Overview
Long-distance services segment revenue in 2004 represented 49.5% of consolidated
revenues. Our provision of interstate and intrastate long-distance services,
private line and leased dedicated capacity services, and broadband services
accounted for 92.3% of our total long-distance services segment revenues during
2004.
Factors that have the greatest impact on year-to-year changes in long-distance
services segment revenues include the rate per minute charged to customers,
usage volumes expressed as minutes of use, and the number of private line,
leased dedicated service and broadband products in use.
Due in large part to the favorable synergistic effects of our bundling strategy,
the long-distance services segment continues to be a significant contributor to
our overall performance, although the migration of traffic from voice to data
and from fixed to mobile wireless continues.
Our long-distance services segment faces significant competition from AT&T
Alascom, 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.
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On July 21, 2002 MCI and substantially all of its active United States
subsidiaries, on a combined basis a major customer, filed voluntary petitions
for reorganization under Chapter 11 of the United States Bankruptcy Code in the
United States Bankruptcy Court. On July 22, 2003, the United States Bankruptcy
Court approved a settlement agreement for pre-petition amounts owed to us by MCI
and affirmed all of our existing contracts with MCI. MCI emerged from bankruptcy
protection on April 20, 2004. The remaining pre-petition accounts receivable
balance owed by MCI to us after this settlement was $11.1 million ("MCI credit")
which we have used and will continue to use as a credit against amounts payable
for services purchased from MCI.
After settlement, we began reducing the MCI credit as we utilized it for
services otherwise payable to MCI. We have accounted for our use of the MCI
credit as a gain contingency, and, accordingly, are recognizing a reduction of
bad debt expense as services are provided by MCI and the credit is realized.
During 2004 and 2003 we realized approximately $4.2 million and $2.8 million,
respectively, of the MCI credit against amounts payable for services received
from MCI.
The remaining unused MCI credit totaled $3.7 million and $7.9 million at
December 31, 2004 and 2003, respectively. The credit balance is not recorded on
the Consolidated Balance Sheet as we are recognizing recovery of bad debt
expense as the credit is realized.
In February 2005 Verizon Communications, Inc. agreed to purchase MCI. The
agreement requires approval of shareholders and anti-trust regulators. Verizon
has allowed MCI two weeks beginning in early March 2005 to conduct additional
talks with Quest Communications International, Inc., another potential buyer. We
are unable to predict the impact that a merger with or an acquisition of MCI
will have upon us in the long-term, however given the materiality of MCI's
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.
The initial term of our contract to provide interstate and intrastate
long-distance services to Sprint ends in March 2007 with two one-year automatic
extensions to March 2009. In June 2004 we amended the original agreement
resulting in new annual rate reductions beginning July 2004. Contractual rate
reductions will continue to occur annually through the end of the initial term
of the contract.
In December 2004 Sprint and Nextel Communications, Inc. announced a merger. The
agreement requires approval of shareholders and anti-trust regulators, as well
as state utility commissions that license phone service. We are unable to
predict the outcome this merger will have upon us in the long-term.
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, new program offerings, business failures, and market and business
consolidations 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, consistent with federal law. Additionally, disruption in the economy
resulting from terrorist attacks and other attacks or acts of war could affect
our carrier customers. 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.
69
Long-distance Services Segment Revenues
Total long-distance services segment revenues increased 2.7% to $210.1 million
in 2004. The components of long-distance services segment revenues are as
follows (amounts in thousands):
2004 2003 Percentage Change
-------------- ------------- -----------------
Common carrier message telephone services $ 81,873 91,700 (10.7%)
Residential, commercial and governmental message
telephone services 39,045 39,701 (1.7%)
Private line and private network services 42,885 37,123 15.5%
Broadband services 30,173 25,167 19.9%
Lease of fiber optic cable system capacity 16,159 10,876 48.6%
-------------- ------------- ----------------
Total long-distance services segment revenue $ 210,135 204,567 2.7%
============== ============= ================
Common Carrier Message Telephone Services Revenue
The 2004 decrease in message telephone service revenues from other common
carriers (principally MCI and Sprint) resulted from the following:
o A 10.0% decrease in the average rate per minute on minutes carried for
other common carriers primarily due to the decreased average rate per
minute as agreed to in the June 2004 amendment of our contract to
provide interstate and intrastate long-distance services to Sprint and
in the July 2003 extension of our contract to provide interstate and
intrastate long-distance services to MCI,
o A $708,000 credit given to a certain other common carrier customer in
the fourth quarter of 2004 resulting from a rate per minute overcharge
in 2004 and 2003, and
o A $411,000 increase in 2004 as compared to 2003 in a discount given to
a certain other common carrier customer which started in the third
quarter of 2003.
The decrease in message telephone service revenues from other common carriers in
2004 was partially off-set by a 1.9% increase in wholesale minutes carried to
891.2 million minutes.
Residential, Commercial and Governmental Message Telephone Services Revenue
Selected key performance indicators for our offering of message telephone
service to residential, commercial and governmental customers follow:
2004 2003 Percentage Change
------------------ ------------------ ----------------
Retail minutes carried 305.9 million 284.3 million 7.6%
Average rate per minute (1) $0.131 $0.138 (5.1%)
Number of active residential,
commercial and governmental
customers (2) 91,300 85,600 6.7%
- -------------------
1 Residential, commercial and governmental message telephone services
excluding plan fees associated with the carriage of data services divided
by the retail minutes carried.
2 All current subscribers who have had calling activity during December 2004
and 2003, respectively.
The decrease in message telephone service revenues from residential, commercial,
and governmental customers in 2004 is primarily due to a decrease in the average
rate per minute. Our average rate per minute decrease is primarily due to our
promotion of and customers' enrollment in calling plans offering a certain
number of minutes for a flat monthly fee.
70
The decrease in message telephone service to residential, commercial and
governmental customers in 2004 is partially off-set by the following:
o Increased minutes carried for these customers primarily due to our
contract to provide services to the State of Alaska starting in the
first quarter of 2004, and
o An increase in the number of active residential, commercial, and
governmental customers billed primarily due to our promotion of and our
customers' enrollment in a new bundled offering to our residential
customers, partially off-set by the effect of customers substituting
cellular phone, prepaid calling card, and email usage for direct dial
minutes.
Broadband Services Revenue
The increase in revenues from our packaged telecommunications offering to rural
hospitals and health clinics and our SchoolAccess(TM) offering to rural school
districts in 2004 is primarily due to the following:
o An increased number of circuits leased to rural hospitals, health
clinics, and rural school districts to both existing and a new customer
resulting in increased revenue of $2.2 million, and
o A $2.7 million increase in special project revenue for services sold to
the federal government.
Fiber Optic Cable System Capacity Lease Revenue
The increase in revenues from the lease of fiber optic cable system capacity is
primarily due to a lease of capacity on the AULP East fiber optic cable system
resulting in increased monthly revenue of approximately $430,000 starting in
July 2004.
Long-distance Services Segment Cost of Goods Sold
Long-distance services segment Cost of Goods Sold increased 1.4% to $54.1
million in 2004 primarily due to the following:
o A 7.6% increase in retail minutes carried,
o A 1.9% increase in wholesale minutes carried, and
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 that did not recur in 2004.
The increase in the long-distance services segment Cost of Goods Sold is
partially off-set by the following:
o In the course of business we estimate unbilled long-distance services
Cost of Goods Sold 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. Our favorable adjustments decreased to
$2.2 million in 2004 from $3.4 million in 2003.
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 $.010 and $.061 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.
71
Long-distance Services Segment Operating Income
Long-distance services segment operating income increased 5.0% to $93.4 million
from 2003 to 2004 primarily due to the following:
o The 2.7% increase in long-distance services segment revenues to $210.1
million in 2004,
o Realization of approximately $4.2 million of the MCI credit through a
reduction to bad debt expense in 2004, as further discussed in the
"Long Distance Service Overview" above. We realized approximately $2.8
million of the MCI credit through
a reduction to bad debt expense in 2003, and
o In 2003, we reported an impairment charge of $5.4 million representing
the remaining net book value recorded for our North Pacific Cable asset
as further described in the "Impairment Charge" section below.
The long-distance services segment operating income increase was partially
off-set by the following:
o The 1.4% increase in long-distance services segment costs of goods sold
to $54.1 million in 2004, as discussed above,
o A 6.3% increase in long-distance services segment selling, general and
administrative expenses to $40.1 million primarily due to an
approximately $1.0 million increase in fiber repair expenses in 2004
compared to 2003. The increase in fiber repair expenses is the result
of the repair of AULP East in July 2004 with a total repair cost of
approximately $311,000 and the reversal of an accrual for estimated
fiber repair costs of $700,000 in 2003, and
o A 26.3% increase in long-distance services segment depreciation,
amortization and accretion expense to $25.5 million in 2004 as compared
to 2003 primarily due to our investment in long-distance services
segment equipment and facilities placed into service during the year
ended December 31, 2003 for which a full year of depreciation was
recorded in the year ended December 31, 2004, and our investment in
long-distance services segment equipment and facilities placed into
service during the year ended December 31, 2004 for which a partial
year of depreciation was recorded in the year ended December 31, 2004.
Cable Services Segment Overview
Cable services segment revenues in 2004 represented 23.9% of consolidated
revenues. Our cable systems serve 35 communities and areas in Alaska, including
the state's four largest population centers, Anchorage, Fairbanks, the Mat-Su
Valley and Juneau. On February 1, 2005 we acquired all of the assets of Barrow
Cable TV, Inc. ("BCTV") for approximately $1.6 million. We expect the BCTV asset
purchase to result in additional subscribers totaling approximately 950 and
additional homes passed totaling approximately 1,600.
We generate cable services segment 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 2004
programming services generated 72.6% of total cable services segment revenues,
cable services' allocable share of cable modem services accounted for 12.6% of
such revenues, equipment rental and installation fees accounted for 9.6% of such
revenues, advertising sales accounted for 4.3% of such revenues, and other
services accounted for the remaining 0.9% of total cable services segment
revenues.
The primary factors that contribute to year-to-year changes in cable services
segment revenues include average monthly subscription rates and pay-per-view
buys, the mix among basic, premium and digital tier services, the average number
of cable television and cable modem subscribers during a given reporting period,
set-top box utilization and related rates, revenues generated from new product
offerings, and sales of cable advertising services.
72
We distribute local Anchorage broadcaster signals to all of our cable systems.
This local programming provides additional value to our cable subscribers that
not all our DBS competitors can provide. In the third quarter of 2003 DBS
service provider Dish Network (EchoStar Communications Corporation) began
providing, for an additional fee, Anchorage based broadcaster programming in
Anchorage and in other Alaska communities where there is not a similar local
broadcast affiliate.
Cable Services Segment Revenues and Cost of Goods Sold
Selected key performance indicators for our cable services segment follow:
December 31, Percentage
2004 2003 Change
------------- ------------- ----------------
Basic subscribers 134,700 134,400 0.2%
Digital programming tier subscribers 46,100 34,900 32.1%
Cable modem subscribers 65,500 46,000 42.4%
Homes passed 207,200 202,200 2.5%
A basic cable subscriber is defined as one basic tier of service delivered to an
address or separate subunits thereof regardless of the number of outlets
purchased. A digital programming tier subscriber is defined as one digital
programming tier of service delivered to an address or separate subunits thereof
regardless of the number of outlets purchased.
A cable modem subscriber is defined by the purchase of cable modem service
regardless of the level of service purchased. If one entity purchases multiple
cable modem service access points, each access point is counted as a subscriber.
Total cable services segment revenues increased 5.7% to $101.4 million and
average gross revenue per average basic subscriber per month increased $3.27 or
5.4% in 2004.
The increase in cable services segment revenues is primarily due to the
following:
o A 76.8% increase in digital set-top box rental revenue to $8.2 million
in 2004 primarily caused by the increased use of digital distribution
technology,
o A 17.1% increase in its share of cable modem revenue (offered through
our Internet services segment) to $12.8 million in 2004 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,
and
o A 33.1% increase in advertising sales revenue to $4.3 million in 2004
primarily caused by an increase in Olympic and national and local
political advertising.
Cable services segment Cost of Goods Sold increased 3.7% to $27.0 million in
2004 due to programming cost increases for most of our cable programming service
offerings. The increase in Cable services segment Cost of Goods Sold is
partially off-set by a refund received in 2004 from a supplier retroactive to
August 2003 and arrangements with suppliers in which we received rebates in 2004
upon us meeting specified goals.
Cable Services Segment Operating Income
Cable services segment operating income increased $1.4 million to $26.4 million
from 2003 to 2004 primarily due to the 5.7% increase in cable services segment
revenues to $101.4 million in 2004, partially off-set by the following:
o The 3.7% increase in cable services segment Costs of Goods Sold to
$27.0 million in 2004, as described above,
73
o A $999,000 increase in cable services segment selling, general and
administrative expenses to $28.1 million primarily due to a $408,000
increase in labor and employee benefits costs, and
o A 10.1% increase in cable services segment depreciation, amortization
and accretion expense to $19.0 million in 2004 as compared to 2003
primarily due to our investment in cable services segment equipment and
facilities placed into service during the year ended December 31, 2003
for which a full year of depreciation was recorded in the year ended
December 31, 2004, and our investment in cable services segment
equipment and facilities placed into service during the year ended
December 31, 2004 for which a partial year of depreciation was recorded
in the year ended December 31, 2004.
Multiple System Operator ("MSO") Operating Statistics
Our operating statistics include capital expenditures and customer information
from our cable services segment and the components of our local access services
and Internet services segments which offer services utilizing our cable services
segment's facilities.
Our capital expenditures by standard reporting category for the year ended
December 31, 2004 and 2003 follows (amounts in thousands):
2004 2003
-------------- -------------
Customer premise equipment $ 16,772 10,713
Commercial 574 705
Scalable infrastructure 4,979 2,221
Line extensions 1,752 1,270
Upgrade/rebuild 9,476 3,800
Support capital 1,427 503
-------------- -------------
Sub-total 34,980 19,212
Remaining reportable segments and
All Other capital expenditures 76,824 43,267
-------------- -------------
$ 111,804 62,479
============== =============
The standardized definition of a customer relationship is the number of
customers that receive at least one level of service utilizing our cable
services segment's facilities, encompassing voice, video, and data services,
without regard to which services customers purchase. At December, 2004 and 2003
we had 122,700 and 121,900 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 December 31, 2004 and 2003 we had 208,300
and 180,400 revenue generating units, respectively.
Local Access Services Segment Overview
During 2004 local access services segment revenues represented 11.0% of
consolidated revenues. We generate local access services segment 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.
The primary factors that contribute to year-to-year changes in local access
services segment revenues 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, the traffic sensitive access rates charged
to carriers and the Universal Service Program.
74
Our local access services segment faces significant competition in Anchorage,
Fairbanks, and Juneau from ACS, which is the largest ILEC in Alaska, and from
AT&T Alascom, Inc. in Anchorage for residential services. 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.
At December 31, 2004, 112,100 lines were in service as compared to approximately
106,100 lines in service at December 31, 2003. We estimate that our 2004 lines
in service represents a statewide market share of approximately 24%. A line in
service is defined as a revenue generating circuit or channel connecting a
customer to the public switched telephone network.
Our access line mix at December 31, 2004 follows:
o Residential lines represent approximately 60% of our lines,
o Business customers represent approximately 35% of our lines, and
o Internet access customers represent approximately 5% of our lines.
In April 2004 we successfully launched our DLPS deployment utilizing our
Anchorage coaxial cable facilities. This service delivery method allows us to
utilize our own cable facilities to provide local access service to our
customers and avoid paying local loop charges to the ILEC. To ensure the
necessary equipment is available to us, we have committed to purchase a certain
number of outdoor, network powered multi-media adapters. At December 31, 2004 we
had approximately 8,000 DLPS lines in service. We plan to continue to deploy
additional DLPS lines during the year ended December 31, 2005.
Approximately 85% of our lines are provided on our own facilities and leased
local loops. Approximately 6% of our lines are provided using the UNE platform
delivery method.
In January 2005 we applied to the RCA to expand our existing certification for
the provision of competitive local service. We requested to provide service in
competition with the existing service provider in five service areas which
include the communities of Ketchikan, Cordova, Chitina, Glenallen, McCarthy,
Mentasta, Tatitlek, Valdez, Delta Junction, Homer, Kenai, Kodiak, Soldotna,
Nenana, North Pole, and the area from Eagle River to Healy. In addition, we have
requested approval to offer local service in six areas covered by our cable
facilities only which include the communities of Wrangell, Petersburg, Sitka,
Seward, Bethel, and Nome.
We plan to offer service in these new areas using a combination of methods. To a
large extent, we plan to use our existing cable network to deliver local
services. Where we do not have cable plant, we may use wireless technologies and
resale of other carrier's services. We may lease portions of an existing
carrier's network or seek wholesale discounts, but our application is not
dependent upon access to either unbundled network elements of the ILEC's network
or wholesale discount rates for resale of ILEC services. We have requested the
RCA decide this application within at least six months.
On June 25, 2004 the RCA issued an order in our arbitration with ACS to revise
the rates, terms, and conditions that govern access to UNEs in the Anchorage
market. The RCA's ruling set rates for numerous elements of ACS' network, the
most significant being the lease rate for local loops. The order initially
increased the loop rate from $14.92 to $19.15 per loop per month. We immediately
filed a petition for reconsideration with the RCA to correct computational
errors and raise other issues. On August 20, 2004, the RCA ruled on the petition
and retroactively lowered the loop rate to $18.64 per month. We estimate the
ruling, absent other measures would increase our local access services segment
Cost of Goods Sold by as much as approximately $4.0 million during the year
ended December 31, 2005. In January 2005 we appealed the RCA ruling to the
Federal Circuit Court arguing that the pricing and methodology used by ACS and
approved by the RCA was flawed
75
and in violation of federal law. We cannot predict at this time the outcome of
the petition for reconsideration or the lawsuit.
In December 2003 we distributed our new Anchorage phone directory and began
recognizing revenue and Cost of Goods Sold in the local access services segment.
We recognized one month of revenue and Cost of Goods Sold in the fourth quarter
of 2003 and the remaining eleven months of revenue and Cost of Goods Sold were
recognized in 2004. In December 2004 we distributed a second Anchorage phone
directory and are using the same recognition method for revenue and Cost of
Goods Sold.
In October 2004 we completed distribution of our new Fairbanks and Juneau area
directories. We recognized three months of revenue and Cost of Goods Sold in
2004 and will recognize the remaining nine months of revenue and Cost of Goods
Sold in 2005.
Local Access Services Segment Revenues and Cost of Goods Sold
Local access services segment revenues increased 20.4% in 2004 to $47.0 million
primarily due to the following:
o Growth in the number of lines in service from 106,100 to 112,100,
o $1.5 million increase to $4.1 million in support from the Universal
Service Program, and
o $2.0 million increase in revenues to $2.2 million from our phone
directories.
The increase in local access services segment revenues is partially off-set by
access rate decreases.
Local access services segment Cost of Goods Sold increased 22.4% to $29.1
million in 2004 primarily due to the growth in the average number of lines in
service and the increased costs resulting from the RCA's Anchorage UNE
arbitration settlement order in June 2004 discussed above.
Local Access Services Segment Operating Loss
Local access services segment operating loss decreased 7.9% to ($5.7) million
from 2003 to 2004 primarily due to the 20.4% revenue increase to $47.0 million
partially off-set by the following:
o The 22.4% increase in Cost of Goods Sold to $29.1 million,
o A $598,000 increase in local services segment selling, general and
administrative expenses to $18.3 million, and
o A 39.1% increase in local services segment depreciation, amortization
and accretion expense to $4.9 million in 2004 as compared to 2003
primarily due to our investment in local access services segment
equipment and facilities placed into service during the year ended
December 31, 2003 for which a full year of depreciation was recorded in
the year ended December 31, 2004, and our investment in local access
services segment equipment and facilities placed into service during
the year ended December 31, 2004 for which a partial year of
depreciation was recorded in the year ended December 31, 2004.
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 loss would have improved by
approximately $7.1 million and the long distance services segment operating
income would have been reduced by an equal amount in 2004. Avoided access
charges totaled approximately $6.9 million in 2003. The amount of allocated
access cost savings is affected by access rate decreases from 2003 to 2004.
Internet Services Segment Overview
During 2004 Internet services segment revenues represented 6.1% of consolidated
revenues. We generate Internet services segment revenues from three primary
sources: (1) access product services, including commercial, Internet service
provider, and retail dial-up access; (2) network
76
management services; and (3) Internet services segment's allocable share of
cable modem revenue (a portion of cable modem revenue is also recognized by our
cable services segment).
The primary factors that contribute to year-to-year changes in Internet services
segment revenues 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 products. Our Internet offerings are bundled with
various combinations of our long-distance, cable, and local access services
segments' offerings and provide free or discounted basic or premium Internet
services. 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.
Internet Services Segment Revenues and Cost of Goods Sold
Selected key performance indicators for our Internet services segment follow:
December 31, Percentage
2004 2003 Change
------------ ------------ ---------------
Total Internet subscribers 101,600 95,700 6.2%
Cable modem subscribers 65,500 46,000 42.4%
Dial-up subscribers 36,100 49,600 (27.2%)
Total Internet subscribers are defined by the purchase of Internet access
service regardless of the level of service purchased. If one entity purchases
multiple Internet access service points, that entity is included in our total
Internet subscriber count at a rate equal to the number of access points
purchased. A subscriber with both cable modem and dial-up service is included
once as a cable modem subscriber.
A dial-up subscriber is defined by the purchase of dial-up Internet service
regardless of the level of service purchased. If one entity purchases multiple
dial-up service access points, each access point is counted as a subscriber.
Total Internet services segment revenues increased 30.9% to $26.0 million in
2004 primarily due to the 26.1% increase in its allocable share of cable modem
revenues to $11.4 million in 2004 as compared to 2003. The increase in cable
modem revenues is primarily due to growth in cable modem subscribers.
Internet services Cost of Goods Sold increased 19.3% to $7.0 million in 2004
associated with increased Internet services segment revenues.
Internet Services Segment Operating Income
Internet services segment operating income increased 236.7% to $5.5 million from
2003 to 2004 primarily due to the 30.9% increase in Internet services segment
revenues to $26.0 million in 2004 partially off-set by the 19.3% increase in
Internet services segment Cost of Goods Sold to $7.0 million in 2004, and a
$788,000 increase in selling, general and administrative expenses to $9.4
million. The increase in selling, general and administrative expenses is due to
an approximately $771,000 increase in labor and employee benefits costs.
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All Other Overview
Revenues reported in the All Other category as described in note 12 in the
accompanying "Notes to Consolidated Financial Statements" include our managed
services, product sales, and cellular telephone services.
Revenues included in the All Other category represented 9.5% of total revenues
in 2004.
All Other Revenues and Cost of Goods Sold
All Other revenues increased 28.5% to $40.3 million in 2004. The increase is
primarily due to the following:
o $4.8 million in special project revenue earned from our fiber system
that transits the Trans Alaska oil pipeline corridor in 2004,
o Increased monthly revenue earned from our fiber system that transits
the Trans Alaska oil pipeline corridor,
o Revenue generated from our contract to provide services to the State of
Alaska starting in the first quarter of 2004, and
o Special project revenue for services sold to the State of Alaska.
The increase described above is partially off-set by a $685,000 decrease in
product sales revenue to $2.2 million in 2004. The decrease is due to sales of
product to two customers in 2003 that were not repeated in 2004.
All Other Cost of Goods Sold increased 36.5% to $22.4 million in 2004. The
increase in All Other Cost of Goods Sold is primarily due to a $5.7 million
increase to $5.8 million in costs associated with special project revenue earned
from our fiber system that transits the Trans Alaska oil pipeline corridor in
2004, costs associated with increased monthly revenue earned from our recurring
service contracts in 2004, and costs associated with the special project revenue
described above.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 6.2% to $147.4 million in
2004 primarily due to the following
o A $7.1 million increase in labor and health insurance costs,
o A $4.6 million increase in contract labor and contract services
expenses associated with our Sarbanes-Oxley Act of 2002 ("SOX") Section
404 compliance efforts and other special projects,
o A $1.2 million write-off of previously capitalized mobile wireless
network costs upon finalization of a long-term distribution agreement,
and
o A $1.0 million increase in fiber repair expenses in 2004 and compared
to 2003. The increase in fiber repair expenses is the result of the
repair of AULP East in July 2004 with a total repair cost of
approximately $311,000 and the reversal of an accrual for estimated
fiber repair costs of $700,000 in 2003.
The increases previously described are partially off-set by a $4.1 million
decrease in our company-wide success sharing bonus accrual. As a percentage of
total revenues, selling, general and administrative expenses decreased to 34.7%
in 2004 from 35.5% in 2003, primarily due to an increase in revenues without a
corresponding increase in selling, general and administrative expenses.
Bad Debt Recovery
Bad debt recovery increased $896,000 to a net recovery of $1.1 million in 2004.
The 2004 increase is primarily due to realization of approximately $4.2 million
of the MCI credit through a reduction to bad debt expense in 2004, as further
discussed in the "Long Distance Service Overview" above. We realized
approximately $2.8 million of the MCI credit through a reduction to bad debt
expense in 2003.
78
Impairment Charge
In 2003, we reported an impairment charge of $5.4 million in our long-distance
services segment which equaled the remaining net book value recorded for our
North Pacific Cable asset. In 1991 GCI purchased one DS-3 of capacity on a fiber
optic cable system owned by AT&T. This fiber optic cable system is a spur off of
a trans-Pacific fiber optic cable system owned by another group. We used our
owned capacity to carry traffic to and from Alaska and the Lower 48 States. The
section of the North Pacific Cable in which we owned capacity was taken out of
service in January 2004 due to a billing dispute between AT&T and the owner of
the trans-Pacific cable system causing us to re-route certain of our traffic. We
were relieved of all future obligations required by our purchase agreement and
ceased payment of maintenance and vessel standby costs totaling approximately
$324,000 per year that would otherwise be payable over the remaining life of the
system. The AULP West fiber optic cable system we built was put into service in
June 2004 and provides us with route diversity and redundancy in excess of that
previously provided by the North Pacific Cable.
Depreciation, Amortization and Accretion Expense
Depreciation, amortization and accretion expense increased 18.2% to $63.1
million in 2004. The increase is primarily attributed to our $45.8 million
investment in equipment and facilities placed into service during 2003 for which
a full year of depreciation was recorded in 2004, and the $122.9 million
investment in equipment and facilities placed into service during 2004 for which
a partial year of depreciation was recorded in 2004.
Other Expense, Net
Other expense, net of other income, decreased 11.4% to $37.1 million in 2004
primarily due to a $7.9 million decrease in interest expense in 2004 on our new
Senior Credit Facility due to a decrease in the average outstanding balance owed
on our new Senior Credit Facility and a decreased average new Senior Credit
Facility interest rate as compared to 2003.
Partially offsetting the decreases described above were the following:
o In 2004 we paid bond call premiums totaling $6.1 million to redeem our
old Senior Notes,
o As a result of redeeming our old Senior Notes in 2004 we recognized
$2.3 million in unamortized old Senior Notes fee expense, and
o A $1.6 million increase in interest expense on our new Senior Notes due
to an increase in the outstanding balance owed, partially off-set by a
decreased interest rate in 2004 as compared to 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 and balances.
Income tax expense was $17.5 million in 2004 and $10.1 million in 2003. The
change was due to increased net income before income taxes in 2004 as compared
to 2003 and an approximately $3.1 million increase in income tax expense
resulting from a true-up of the deferred tax assets and liabilities associated
primarily with fixed assets and net operating loss carryforwards. Our effective
income tax rate increased from 38.5% in 2003 to 45.1% in 2004 due to an
adjustment of deferred tax assets and liabilities in 2004.
At December 31, 2004, we have (1) tax net operating loss carryforwards of
approximately $175.6 million that will begin expiring in 2007 if not utilized,
and (2) alternative minimum tax credit carryforwards of approximately $1.9
million available to offset regular income taxes payable in future years. We
utilized net operating loss carryforwards of approximately $11.3 million during
the year ended December 31, 2004. Our utilization of certain net operating loss
carryforwards is subject to limitations pursuant to Internal Revenue Code
section 382.
79
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 annual income tax
rate for financial statement purposes will be 42% to 44% in 2005.
On October 22, 2004 the American Jobs Creation Act of 2004 was signed into law.
We believe this new law will not have a material effect on our results of
operations, financial position and cash flows.
Cumulative Effect of a Change in Accounting Principle
On January 1, 2003 we adopted Statement of Financial Accounting Standard
("SFAS") No. 143, "Accounting for Asset Retirement Obligations," and 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.
Year Ended December 31, 2003 ("2003") Compared To Year Ended December 31, 2002
("2002")
Overview of Revenues and Cost of Goods Sold
Total revenues increased 6.2% from $367.8 million in 2002 to $390.8 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 decreased revenues in the long-distance services segment. See the
discussion below for more information by segment.
Total cost of goods sold increased 1.5% from $123.6 million in 2002 to $125.4
million in 2003. The cable services, local access services and Internet services
segments and All Other Services contributed to the increase in total cost of
goods sold, partially off-set by decreased cost of goods sold in the
long-distance services segment. See the discussion below for more information by
segment.
Long-Distance Services Segment Overview
Long-distance services segment revenue in 2003 represented 52.3% of consolidated
revenues. Our provision of interstate and intrastate long-distance services,
Private Line and leased dedicated capacity services, and broadband services
accounted for 94.7% of our total long-distance services segment revenues during
2003.
Long-distance Services Segment Revenues
Total long-distance services segment revenues decreased 0.2% to $204.6 million
in 2003. The components of long-distance services segment revenues are as
follows (amounts in thousands):
2003 2002 Percentage Change
-------------- ------------- -----------------
Common carrier message telephone services $ 91,700 95,947 (4.4%)
Residential, commercial and governmental message
telephone services 39,701 46,169 (14.0%)
Private line and private network services 37,123 36,157 2.7%
Broadband services 25,167 18,432 36.5%
Lease of fiber optic cable system capacity 10,876 8,225 32.2%
-------------- ------------- -----------------
Total long-distance services segment revenue $ 204,567 204,930 (0.2%)
============== ============= =================
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Common Carrier Message Telephone Services Revenue
The 2003 decrease in message telephone service revenues from other common
carriers (principally MCI and Sprint) results from the following:
o A 10.0% decrease in the average rate per minute on minutes carried for
other common carriers primarily due to the decreased average rate per
minute as agreed to in the July 24, 2003 extension of our contract to
provide interstate and intrastate long-distance services to MCI,
o A discount given to a certain other common carrier customer starting in
2003, and
o Revenue earned due to a 2002 increase in the rate per minute of certain
other common carrier minutes retroactive to April 2002 which did not
recur in 2003.
The decrease in message telephone service revenues from other common carriers in
2003 was off-set by a 6.7% increase in wholesale minutes carried to 875.0
million minutes.
Residential, Commercial and Governmental Message Telephone Services Revenue
Selected key performance indicators for our offering of message telephone
service to residential, commercial and governmental customers follow:
2003 2002 Percentage Change
------------------ ------------------ -----------------
Retail minutes carried 284.3 million 309.2 million (8.1%)
Average rate per minute $0.138 $0.142 (2.8%)
Number of active residential,
commercial and governmental
customers (1) 85,600 88,200 (2.9%)
------------------------------------
1 All current subscribers who have had calling activity during December of 2003 and 2002,
respectively.
The decrease in message telephone service revenues from residential, commercial,
and governmental customers in 2003 is primarily due to the following:
o A decrease in minutes carried for these customers primarily due to the
effect of customers substituting cellular phone, prepaid calling card
and email usage for direct dial minutes,
o A decrease in the average rate per minute primarily 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 decrease in the number of active residential, commercial, and
governmental customers billed primarily due to the effect of customers
substituting cellular phone, prepaid calling card, and email usage for
direct dial minutes.
Broadband Services Revenue
The increase in revenues from our packaged telecommunications offering to rural
hospitals and health clinics and our SchoolAccess(TM) offering to rural school
districts in 2003 is primarily due to the following:
o Our SchoolAccess(TM) offering called Distance Learning Service that
started in late 2002. Distance Learning Service is a video-conference
based service that enables eight school districts in Alaska to provide
additional educational opportunities for their students, and
o An increased number of circuits leased to rural hospitals and health
clinics in Alaska.
Long-distance Services Segment Cost of Goods Sold
Long-distance services segment cost of goods sold decreased 11.1% to $53.4
million in 2003 primarily due to the following:
o Reductions in access costs due to distribution and termination of our
traffic on our own local
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access services network instead of paying other carriers to distribute
and terminate our traffic. The statewide average cost savings is
approximately $.011 and $.061 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 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, and
o A $1.7 million refund in 2003 from an intrastate access cost pool that
previously overcharged us for access services.
The decrease in the long-distance services segment cost of goods sold is
partially off-set by increased costs associated with additional transponder and
network back-up capacity in 2003 as compared to 2002.
Long-distance Services Segment Operating Income
Long-distance services segment operating income increased 20.3% to $89.0 million
from 2002 to 2003 primarily due to the following:
o The 11.1% decrease in long-distance services segment cost of goods sold
to $53.4 million in 2003,
o An increase of 108.9% to a net bad debt recovery of $1.1 million in
2003 due to realization of approximately $2.8 million of the MCI credit
through a reduction to bad debt expense in 2003, as further discussed
in the "Long Distance Service Overview" above. We recognized bad debt
expense of approximately $11.0 million due to the MCI bankruptcy in
2002, and
o A 8.8% decrease in long-distance services segment depreciation,
amortization and accretion expense to $20.2 million in 2003 as compared
to 2002 primarily due to a 2003 reduction of $1.3 million in
depreciation expense associated with a portion of the 2002 Kanas
Telecom, Inc. acquisition included in the long-distance services
segment partially off-set by our investment in long-distance services
segment equipment and facilities placed into service during the year
ended December 31, 2003 for which a full year of depreciation was
recorded in the year ended December 31, 2004, and our investment in
long-distance services segment equipment and facilities placed into
service during the year ended December 31, 2004 for which a partial
year of depreciation was recorded in the year ended December 31, 2004.
The long-distance services segment operating income increase was partially
off-set by the following:
o The 0.2% decrease in long-distance services segment revenue to $204.6
million in 2003, as discussed above,
o In 2003, we reported an impairment charge of $5.4 million which equaled
the remaining net book value recorded for our North Pacific Cable asset
as further described in the "Impairment Charge" section below, and
o A 3.6% increase in long-distance services segment selling, general and
administrative expenses to $37.7 million primarily due to an increase
of approximately $1.8 for labor and employee benefit costs and the
reversal of an accrual for estimated fiber repair costs $700,000 in
2003.
Cable Services Segment Overview
Cable television revenues in 2003 represented 24.6% of consolidated revenues.
During 2003 programming services generated 76.3% of total cable services segment
revenues, cable services' allocable share of cable modem services accounted for
11.4% of such revenues, equipment rental and installation fees accounted for
8.1% of such revenues, advertising sales accounted for 3.4% of such revenues,
and other services accounted for the remaining 0.8% of total cable services
segment revenues.
82
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.
In the second quarter of 2002 we signed seven-year retransmission agreements
with the five local Anchorage broadcasters and began up-linking and distributing
the local Anchorage broadcaster signals to all of our cable systems. This local
programming provides additional value to our cable subscribers that not all our
DBS competitors can provide. In 2003 DBS service provider Dish Network (EchoStar
Communications Corporation) began providing, for an additional fee, Anchorage
based broadcaster programming in Anchorage and in other Alaska communities where
there is not a similar local broadcast affiliate.
Cable Services Segment Revenues and Cost of Goods Sold
Selected key performance indicators for our cable services segment follow:
Percentage
2003 2002 Change
------------- ------------- ----------------
Basic subscribers 134,400 136,100 (1.2%)
Digital programming tier subscribers 34,900 30,500 14.4%
Cable modem subscribers 46,000 36,200 27.1%
Homes passed 202,200 196,900 2.7%
Total cable services segment revenues increased 8.2% to $96.0 million and
average gross revenue per average basic subscriber per month increased $4.35 or
7.8% in 2003.
Programming services revenues increased 7.4% to $73.2 million in 2003 resulting
from the following:
o An increase in the number of digital subscribers, and
o The February 2003 rate increase of approximately 4% for those customers
who experienced an adjustment.
The increase in programming services revenue is partially off-set by a decrease
in basic subscribers due to increased competition from DBS.
The cable services segment's share of cable modem revenue (offered through our
Internet services segment) increased 36.6% to $10.9 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 able to subscribe to cable modem service.
At December 31, 2003 we offered digital programming service in Anchorage, the
Mat-Su Valley, Fairbanks, Juneau, Ketchikan, Kenai, and Soldotna, representing
approximately 89% of our total homes passed. We launched digital programming
services in the Mat-Su Valley and Ketchikan cable systems in 2003.
Cable services cost of goods sold increased 9.9% to $26.0 million in 2003 due to
programming cost increases for most of our cable programming services offerings.
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Cable Services Segment Operating Income
Cable services segment operating income increased $1.5 million to $25.0 million
from 2002 to 2003 primarily due to the 8.2% increase in cable services segment
revenues to $96.0 million in 2003, partially off-set by the following:
o The 9.9% increase in cable services segment Costs of Goods Sold to
$26.0 million in 2003, as described above,
o A $1.8 million increase in cable services segment selling, general and
administrative expenses to $27.1 million primarily due to an increase
of approximately $913,000 in labor and employee benefits costs and an
increase of approximately $981,000 in promotion expenses, and
o A 8.9% increase in cable services segment depreciation, amortization
and accretion expense to $17.3 million in 2003 as compared to 2002
primarily due to our investment in cable services segment equipment and
facilities placed into service during the year ended December 31, 2002
for which a full year of depreciation was recorded in the year ended
December 31, 2003, and our investment in cable services segment
equipment and facilities placed into service during the year ended
December 31, 2003 for which a partial year of depreciation was recorded
in the year ended December 31, 2003.
MSO Operating Statistics
Our operating statistics include capital expenditures and customer information
from our cable services segment and the components of our local access services
and Internet services segments which offer services utilizing our cable
services' facilities.
Our capital expenditures by standard reporting category for the year ending
December 31, 2003 and 2002 follows (amounts in thousands):
2003 2002
-------------- -------------
Customer premise equipment $ 10,713 10,609
Commercial 705 597
Scalable infrastructure 2,221 3,082
Line extensions 1,270 866
Upgrade/rebuild 3,800 4,567
Support capital 503 5,413
-------------- -------------
Sub-total 19,212 25,134
Remaining reportable segments and
All Other capital expenditures 43,267 40,006
-------------- -------------
$ 62,479 65,140
============== =============
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
December 31, 2003 and 2002 we had 121,900 and 124,400 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 December 31, 2003 and 2002 we had 180,400
and 172,200 revenue generating units, respectively.
Local Access Services Segment Overview
During 2003 local access services segment revenues represented 10.0% of
consolidated revenues.
We began providing service in the Juneau market in the first quarter of 2002.
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At December 31, 2003, 106,100 lines were in service as compared to approximately
96,100 lines in service at December 31, 2002. At December 31, 2003 approximately
1,940 additional lines were awaiting connection. We estimate that our 2003 lines
in service total represents a statewide market share of approximately 22%.
Our access line mix at December 31, 2003 follows:
o Residential lines represent approximately 58% of our lines,
o Business customers represent approximately 35% of our lines, and
o Internet access customers represent approximately 7% of our lines.
Approximately 86% of our lines are provided on our own facilities and leased
local loops. Approximately 5% of our lines are provided using UNE platform.
In December 2003 we distributed our new phone directory and began recognizing
revenue and costs of sales and service in the local access services segment. We
recognized one month of revenue and cost of sales and service in the fourth
quarter of 2003 and the remaining eleven months in 2004. Operating expenses
incurred and recognized throughout 2003 to prepare our new phone directory are
reported in the local access services segment.
Local Access Services Segment Revenues and Cost of Goods Sold
Local access services segment revenues increased 21.6% in 2003 to $39.0 million
primarily due to the following:
o Growth in the lines in service,
o $1.9 million of support from the Universal Service Program, and
o 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 benefited from our facilities build-out with an increased number of
access lines provisioned on our own facilities using UNEs, allowing us
to collect interstate and intrastate access revenues.
Local access services segment cost of goods sold increased 17.6% to $23.8
million in 2003 primarily due to the growth in the average number of lines in
service.
Local Access Services Segment Operating Loss
Local access services segment operating loss decreased 26.4% to ($6.2) million
from 2002 to 2003 primarily due to the 21.6% revenue increase to $39.0 million
partially off-set by the following:
o The 17.6% increase in Cost of Goods Sold to $23.8 million, and
o A $1.1 million increase in local services segment selling, general and
administrative expenses to $17.7 million primarily due to an
approximately $591,000 increase in costs associated with State of
Alaska regulatory affairs.
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 $6.9 million and the long distance services segment operating
results would have been reduced by an equal amount in 2003. Avoided access
charges totaled approximately $7.0 million in 2002.
The local access services segment operating results in 2003 were affected by our
evaluation and testing of digital local phone service and Internet
protocol-based technology to deliver phone service through our cable facilities.
85
Internet Services Segment Overview
During 2003 Internet services segment revenues represented 5.1% of consolidated
revenues.
Internet Services Segment Revenues and Cost of Goods Sold
Selected key performance indicators for our Internet services segment follow:
Percentage
2003 2002 Change
------------ ------------ --------------
Total Internet subscribers 95,700 89,500 6.9%
Cable modem subscribers 46,000 36,200 27.1%
Dial-up subscribers 49,600 53,300 (6.9%)
Total Internet services segment revenues increased 27.3% to $19.8 million in
2003 primarily due to the 39.1% increase in its allocable share of cable modem
revenues to $9.1 million in 2003 as compared to 2002. The increase in cable
modem revenues is primarily due to growth in cable modem subscribers and the
termination in the first quarter of 2003 of our offering in which customers
received up to two months of free cable modem service. Additionally, the growth
in cable modem revenues is affected by the level of service our subscribers
select. In 2003 and 2002, 8.1% and 6.0%, respectively, of our subscribers
selected our highest level of cable modem service resulting in increased revenue
of approximately $897,000 in 2003 as compared to 2002.
We previously reported a total of 71,700 Internet subscribers at December 31,
2002. This subscriber count was based upon the total number of active dial-up
subscribers at December 31, 2002. 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 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 are now being reported
separately.
Internet services cost of goods sold increased 22.3% to $5.9 million in 2003
primarily due to the increased number of cable modems deployed.
Internet Services Segment Operating Income
Internet services segment operating income increased 198.9% to $1.6 million from
2002 to 2003 primarily due to the 27.3% increase in Internet services segment
revenues to $19.8 million in 2003 partially off-set by the 22.3% increase in
Internet services segment Cost of Goods Sold to $5.9 million in 2003.
All Other Services Overview
Revenues included in the All Other category represented 8.0% of total revenues
in 2003.
All Other Revenues and Cost of Goods Sold
All Other revenues increased 18.1% to $31.4 million in 2003. The increase in
revenues is primarily due to the following:
o Increased monthly revenue earned in 2003 as compared to 2002 from our
GCI Fiber system that transits the Trans Alaska oil pipeline corridor,
and
o $2.0 million in special project revenue earned from our GCI Fiber
system in 2003.
All Other costs of sales and services increased 10.3% to $16.4 million in 2003
primarily due to increased costs associated with the increased monthly revenue
from our GCI fiber system.
86
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 7.5% to $138.7 million in
2003 and, as a percentage of total revenues, increased to 35.5% in 2003 from
35.1% in 2002. The 2003 increase in selling, general and administrative expenses
is primarily due to a $4.9 million increase in labor and health insurance costs
and a $4.3 million increase in the accrual for company-wide success sharing
bonus costs.
Bad Debt Expense (Recovery)
Bad debt expense (recovery) decreased 101.4% to ($178,000) in 2003. The 2003
decrease is primarily due to the following:
o Utilization of approximately $2.8 million of the MCI credit as a
reduction to bad debt expense in 2003, and
o Provision in 2002 of a $11.0 million bad debt reserve for uncollected
amounts due from MCI.
Impairment Charge
In 2003, we reported an impairment charge of $5.4 million which equaled the
remaining net book value recorded for our North Pacific Cable asset. In 1991 GCI
purchased one DS-3 of capacity on a fiber optic cable system owned by AT&T. This
fiber optic cable system is a spur off of a trans-Pacific fiber optic cable
system owned by another group. We used our owned capacity to carry traffic to
and from Alaska and the Lower 48 States. The section of the North Pacific Cable
in which we owned capacity was taken out of service in January 2004 due to a
billing dispute between AT&T and the owner of the trans-Pacific cable system
causing us to re-route certain of our traffic. Our AULP West fiber optic cable
system provides us with route diversity and redundancy in excess of that
previously provided by the North Pacific Cable.
Depreciation, Amortization and Accretion Expense
Depreciation, amortization and accretion expense decreased 5.3% to $53.4 million
in 2003. The decrease is primarily attributed to a reduction in the depreciable
value of Property and Equipment due to a basis adjustment of $18.5 million which
was recorded in 2002 associated with the Kanas Telecom, Inc. acquisition, and a
2003 reduction of $1.3 million in depreciation expense which was also associated
with the 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 was recorded in 2003, and the $45.8
million investment in equipment and facilities placed into service during 2003
for which a partial year of depreciation was recorded in 2003.
Other Expense, Net
Other expense, net of other income, increased 25.5% to $41.9 million in 2003.
The increase is primarily due to the following:
o We recognized approximately $5.0 million in Amortization of Loan and
Senior Notes Fees in 2003 because a portion of the new Senior Credit
Facility was a substantial modification of the April 22, 2003 amended
Senior Credit Facility,
o Increased interest expense due to increased interest rates on our amended
Senior Credit Facility from November 2002 through October 2003, when the
amended Senior Credit Facility was replaced with the new Senior Credit
Facility,
o Increased amortization of loan fees due to additional loan fees incurred
to amend our Senior Credit Facility, and
o A $1.2 million interest benefit earned in 2002 from an interest rate swap
agreement which was called at no cost by the counter party and terminated
on August 1, 2002.
87
Partially offsetting these increases was a decrease in the average outstanding
indebtedness in 2003 and decreased interest expense in November and December
2003 due to the decreased interest rate paid on our new Senior Credit Facility.
Income Tax Expense
Income tax expense was $10.1 million in 2003 and $5.7 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 45.9% in 2002 to 38.5% in 2003 due to the effect
of items that are nondeductible for income tax purposes and adjustments made to
ending temporary difference balances in 2003.
Cumulative Effect of a Change in Accounting Principle
On January 1, 2003 we adopted SFAS No. 143, "Accounting for Asset Retirement
Obligations," and 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.
Fluctuations in Fourth Quarter Results of Operations
The following is a summary of unaudited quarterly results of operations for the
years ended December 31, 2004 and 2003 (amounts in thousands):
First Second Third Fourth Total
Quarter Quarter Quarter Quarter Year
------------ ----------- ------------ ----------- ------------
2004
----
Total revenues $ 108,916 103,786 106,622 105,502 424,826
Operating income $ 19,406 19,210 21,406 15,842 75,864
Net income $ 1,925 7,725 9,295 2,307 21,252
2003
----
Total revenues $ 92,777 95,939 98,327 103,754 390,797
Operating income $ 15,438 17,972 17,595 17,072 68,077
Net income before cumulative effect of a
change in accounting principle $ 3,095 4,810 4,529 3,652 16,086
Net income $ 2,551 4,810 4,529 3,652 15,542
The following describes unusual or infrequently occurring items recognized in
the following quarters of 2004 and 2003:
o In the first, second, third and fourth quarters of 2004 we recognized
approximately $1.2 million, $1.1 million, $1.1 million and $824,000,
respectively, in recoveries of bad debt expense for uncollected accounts
due from MCI. In the first and second quarters of 2003 we recognized no
recoveries of bad debt expense for uncollected accounts due from MCI. In
the third and fourth quarters of 2003 we recognized approximately
$647,000 and $2.2 million, respectively, in recoveries of bad debt
expense for uncollected accounts due from MCI,
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. In the fourth
quarter of 2004 we recognized an approximately $3.1 million increase in
income tax expense resulting from a true-up of the deferred tax assets
and liabilities associated primarily with fixed assets and net operating
loss carryforwards,
o In the fourth quarter of 2003 we reported an impairment charge of $5.4
million which equaled the remaining net book value recorded for our North
Pacific Cable asset, as discussed in
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"Impairment Charge" above, and
o In the fourth quarter of 2003 we recognized approximately $5.0 million in
Amortization of Loan and Senior Notes Fees due to classifying a portion
of the new Senior Credit Facility as a substantial modification of the
April 22, 2003 amended Senior Credit Facility.
Liquidity and Capital Resources
Cash flows from operating activities totaled $102.6 million in 2004 as compared
to $87.1 million in 2003. The 2004 increase is primarily due to increased cash
flow from all of our reportable segments and a $1.4 million increase in the MCI
credit recovery, as further discussed in the "Long Distance Service Overview"
above, partially off-set by decreased cash flow from All Other Services, a $4.3
million payment of our company-wide success sharing bonus in 2004, and a $2.3
million refund in 2003 from a local exchange carrier in respect of its earnings
that exceeded regulatory requirements.
Other sources of cash during 2004 include $315.7 million from the issuance of
our new Senior Notes, draws of $20.0 million under the revolving credit portion
of our new Senior Credit Facility, and $2.6 million in payments of notes
receivable from related parties. Uses of cash during 2004 included expenditures
of $111.8 million for property and equipment, including construction in
progress, the $180.0 million repayment of our old Senior Notes, the $63.8
million repayment of the term and revolving credit portions of our new Senior
Credit Facility, the repurchase of $33.6 million of GCI's common stock, the
redemption of $10.0 million of GCI's Series C preferred stock, payment of $8.3
million in fees associated with the new Senior Notes and new Senior Credit
Facility, payment of bond call premiums totaling $6.1 million to redeem our old
Senior Notes, and repayment of $5.1 million in capital lease obligations.
Net receivables increased $3.8 million from December 31, 2003 to December 31,
2004 primarily due to an increase in trade receivables for broadband services
provided to hospitals and health clinics and private line and private network
services.
Working capital totaled $39.1 million at December 31, 2004, a $37.0 million
increase as compared to $2.1 million at December 31, 2003. The increase is
primarily due to the $18.8 million in cash proceeds from our $70.0 million bond
issuance in December 2004, an $8.3 million current deferred tax asset for the
net operating loss carryforward we expect to utilize during the year ended
December 31, 2005, a $4.1 million decrease in accrued payroll primarily due to a
decreased accrual for company-wide success sharing bonus costs, and a $7.0
million decrease in accrued capital expenditures related to AULP West. The $7.0
million payment was funded by a $10.0 million draw under the revolving credit
portion of our new Senior Credit Facility in January 2004. The $10.0 million
draw under the revolving credit portion of our new Senior Credit Facility was
repaid in February 2004 with proceeds from the $250.0 million bond issuance
described below.
In February 2004 we sold $250.0 million in aggregate principal amount of senior
unsecured debt securities due in 2014 ("February Senior Notes"). In December
2004 we sold $70.0 million in aggregate principal amount of senior unsecured
debt securities due in 2014 ("December Senior Notes"). The February and December
Senior Notes are treated as a single class ("new Senior Notes").
February Senior Notes
The February Senior Notes were sold at a discount of $4.3 million. The February
Senior Notes are carried on our Consolidated Balance Sheet net of the
unamortized portion of the discount, which is being amortized to Interest
Expense over the life of the new Senior Notes.
The net proceeds of the offering were primarily used to repay our existing
$180.0 million 9.75% Senior Notes and to repay approximately $43.8 million of
the term portion and $10.0 million of the revolving portion of our original
Senior Credit Facility. In connection with the issuance, we paid fees
89
and other expenses of approximately $6.5 million that are being amortized over
the life of the new Senior Notes.
The February Senior Notes were offered only to qualified institutional buyers
pursuant to exemptions from registration under the Securities Act. On July 7,
2004, we commenced an offer to exchange the privately issued February Senior
Notes for a like amount of February Senior Notes that have been registered under
the Securities Act and have otherwise identical terms to the privately issued
original Senior Notes (except for provisions relating to our obligations to
consummate the exchange offer).
The exchange offer closing occurred on August 11, 2004, at which time all $250.0
million in aggregate principal amount of the privately issued February Senior
Notes were tendered and exchanged for the February Senior Notes that have been
registered under the Securities Act.
December Senior Notes
The December Senior Notes were sold at face value.
The net proceeds of the offering were primarily used to repurchase 3,751,509 of
GCI's Class A common shares at $8.33 per share and $10.0 million of GCI's Series
C preferred stock from MCI. The aggregate amount of the equity repurchase
totaled $41.3 million. In addition we used the proceeds to repay $10.0 million
of the revolving portion of our new Senior Credit Facility. In connection with
the issuance, we paid fees and other expenses of approximately $1.6 million that
are being amortized over the life of the new Senior Notes.
The December Senior Notes were offered only to qualified institutional buyers
pursuant to Rule 144A and non-United States persons pursuant to Regulation S.
The December Senior Notes have not been registered under the Securities Act and,
unless so registered, may not be offered or sold except pursuant to an exemption
from, or in a transaction not subject to, the registration requirements of the
Securities Act and applicable state securities laws. Beginning April 6, 2005, we
plan to commence an offer to exchange the privately issued December Senior Notes
that have been registered under the Securities Act and have otherwise identical
terms to the privately issued original Senior Notes (except for provisions
relating to GCI Inc.'s obligations to consummate the exchange offer).
New Senior Notes
We pay interest of 7.25% on the new Senior Notes.
The new Senior Notes are not redeemable prior to February 15, 2009. At any time
on or after February 15, 2009, the new Senior Notes are redeemable at our
option, in whole or in part, on not less than thirty days nor more than sixty
days notice, at the following redemption prices, plus accrued and unpaid
interest (if any) to the date of redemption:
If redeemed during the twelve month period
commencing February 1 of the year indicated: Redemption Price
-------------------------------------------- ----------------
2009 103.625%
2010 102.417%
2011 101.208%
2012 and thereafter 100.000%
We may, on or prior to February 17, 2007, at our option, use the net cash
proceeds of one or more underwritten public offerings of our qualified stock to
redeem up to a maximum of 35% of the initially outstanding aggregate principal
amount of our new Senior Notes at a redemption price equal to 107.25% of the
principal amount of the new Senior Notes, together with accrued and unpaid
interest, if any, thereon to the date of redemption, provided that not less than
65% of the principal amount of the new Senior Notes originally issued remain
outstanding following such a redemption.
90
The new Senior Notes restrict GCI, Inc. and certain of its subsidiaries from
incurring debt in most circumstances unless the result of incurring debt does
not cause our leverage ratio to exceed 6.0 to one. The new Senior Notes do not
allow debt under the new Senior Credit Facility to exceed the greater of (and
reduced by certain stated items):
o $250 million, reduced by the amount of any prepayments, or
o 3.0 times earnings before interest, taxes, depreciation and
amortization for the last four full fiscal quarters of GCI, Inc. and
certain of its subsidiaries.
The new Senior Notes limit our ability to make cash dividend payments.
We conducted a Consent Solicitation and Tender Offer for the old Senior Notes.
Through February 13, 2004 we accepted for payment $114.6 million principal
amount of notes which were validly tendered. Such notes accepted for payment
received additional consideration as follows:
o $4.0 million based upon a payment of $1,035 per $1,000 principal
amount, consisting of the purchase price of $1,025 per $1,000 principal
amount and the consent payment of $10 per $1,000 principal amount, and
o $497,000 in accrued and unpaid interest through February 16, 2004.
The remaining principal amount of $65.4 million was redeemed on March 18, 2004
for additional consideration as follows:
o $2.1 million based upon a payment of $1,032.50 per $1,000 principal
amount, and
o $833,000 in accrued and unpaid interest through March 18, 2004.
The total redemption cost was $186.1 million. The premium to redeem our old
Senior Notes was $6.1 million (excluding interest cost of $1.3 million) and was
recognized as a loss on early extinguishment of debt, a component of Other
Income (Expense), during the year ended December 31, 2004.
Compliance with the redemption notice requirements in the Indenture resulted in
a delay before final payment of some of the old Senior Notes. As a result of
such delay, our total debt increased during the overlap period between the
redemption of the old Senior Notes and the issuance of the February Senior Notes
making us out of compliance with Section 6.11 of our Credit, Guaranty, Security
and Pledge Agreement, dated as of October 30, 2003. We received a waiver from
compliance with Section 6.11 until April 30, 2004. After the final redemption
payment on March 18, 2004 we were in compliance with Section 6.11.
A semi-annual interest payment of approximately $9.0 million was paid in August
2004. We will make semi-annual interest payments of $11.6 million in February
and August 2005.
We were in compliance with all loan covenants at December 31, 2004.
New Senior Credit Facility
In 2004 we drew the following amounts under the revolving credit portion of our
new Senior Credit Facility (amounts in millions):
January 2004 $ 10.0
May 2004 5.0
August 2004 5.0
--------
$ 20.0
========
Our ability to draw down on the revolving portion of our new Senior Credit
Facility could be diminished if we are not in compliance with all new Senior
Credit Facility covenants or have a material adverse
91
change at the date of the request for the draw. In February 2004 we used a
portion of the proceeds from the issuance of our February Senior Notes to repay
approximately $43.8 million of the term portion and $10.0 million of the
revolving portion of our new Senior Credit Facility. In December 2004 we used a
portion of the proceeds from the issuance of our December Senior Notes to repay
approximately $10.0 million of the revolving portion of our new Senior Credit
Facility.
On May 21, 2004 we amended our $220.0 million new Senior Credit Facility. The
amendment reduced the interest rate on the $170.0 million term portion of the
credit facility from LIBOR plus 3.25% to LIBOR plus 2.25%. The amendment reduced
the interest rate on the $50.0 million revolving portion of the credit facility
from LIBOR plus 3.25% to LIBOR plus a margin dependent upon our Total Leverage
Ratio (as defined) as follows:
Total Leverage Ratio
(as defined) LIBOR Plus:
---------------------- --------------------
>3.75 2.50%
-
>3.25 but <3.75 2.25%
-
>2.75 but <3.25 2.00%
-
< 2.75 1.75%
The commitment fee we are required to pay on the unused portion of the
commitment was amended as follows:
Total Leverage Ratio
(as defined) Commitment Fee
---------------------- --------------------
>3.75 0.625%
-
>2.75 but <3.75 0.50%
-
< 2.75 0.375%
Under certain circumstances the amendment allows for an increase in the term and
revolving commitments not to exceed an aggregate commitment increase of $50.0
million. Any additional term and revolving credit facility commitments are
payable in full on October 31, 2007.
In connection with the May 21, 2004 amended Senior Credit Facility, we paid bank
fees and other expenses of approximately $215,000 during the year ended December
31, 2004.
On November 17, 2004 we amended our $220.0 million new Senior Credit Facility.
The amendment allows us to repurchase up to $10.0 million of GCI's common stock
each year and to complete the repurchase of 3,751,509 of GCI's Class A common
shares and $10.0 million of GCI's Series C preferred stock from MCI as described
below.
The November 2004 amendment reduced our leverage ratios for certain periods as
follows:
Period Total Leverage Ratio
------ --------------------
December 31, 2003 through December 30, 2004 4.25:1
December 31, 2004 through December 30, 2005 4.00:1
December 31, 2005 through June 29, 2006 3.75:1
June 30, 2006 through June 29, 2007 3.50:1
June 30, 2007 through September 29, 2007 3.25:1
September 30, 2007 through final maturity date 3.00:1
The November amendment also increased our allowable capital expenditures during
the year ended December 31, 2004 by the $18.8 million net proceeds from the
December Senior Notes.
In connection with the November 17, 2004 amended Senior Credit Facility, we paid
bank fees and other expenses of approximately $129,000 during the year ended
December 31, 2004.
92
The term loan is fully drawn and we have letters of credit totaling $4.7
million, which left $45.3 million available at December 31, 2004 to draw under
the revolving credit facility if needed. Our ability to draw down the revolving
portion of our new Senior Credit Facility could be diminished if we are not in
compliance with all new Senior Credit Facility covenants or have a material
adverse change at the date of the request for the draw.
We are required to pay down $168,000 in term loan principal on our new Senior
Credit Facility by December 31, 2005. The new Senior Credit Facility is due
October 31, 2007.
We were in compliance with all loan covenants at December 31, 2004.
Our expenditures for property and equipment, including construction in progress,
totaled $111.8 million and $62.5 million during 2004 and 2003, respectively. Our
capital expenditures requirements in excess of approximately $25 million per
year are largely success driven and are a result of the progress we are making
in the marketplace. We expect our 2005 expenditures for property and equipment
for our core operations, including construction in progress, to total $80.0
million to $85.0 million, depending on available opportunities and the amount of
cash flow we generate during 2005.
In June 2004 we placed into service our AULP West fiber optic cable system
connecting Seward, Alaska and Warrenton, Oregon, with leased backhaul facilities
connecting it to our switching and distribution centers in Anchorage, Alaska and
Seattle, Washington. The 1,544-statute mile cable system has a total design
capacity of 960 Gigabits per second access speed. The cable complements our
existing fiber optic cable system between Whittier, Alaska and Seattle,
Washington. The two cables provide physically diverse backup to each other in
the event of an outage. During 2004 our capital expenditures for this project
have totaled approximately $32.2 million, and from inception have totaled $50.3
million, most of which have been funded through our operating cash flows.
Planned capital expenditures over the next five years include those necessary
for continued expansion of our long-distance, local exchange and Internet
facilities, supplementing our existing network backup facilities, continuing
deployment of DLPS, and upgrades to and expansions of our cable television
plant.
In April 2004 we successfully launched our DLPS service delivery method. To
ensure the necessary equipment is available to us we have entered into an
agreement to purchase a certain number of outdoor, network powered multi-media
adapters. The agreement has a remaining outstanding commitment at December 31,
2004 of $13.5 million of which approximately $5.5 million and $8.0 million will
be paid during the years ended December 31, 2005 and 2006, respectively.
In August 2003 we entered into an agreement with Alaska Airlines, Inc. ("Alaska
Airlines") to offer our residential and business customers who make qualifying
purchases from us the opportunity to accrue mileage awards in the Alaska
Airlines Mileage Plan. The agreement was amended in October 2004. The agreement
as amended requires the purchase of Alaska Airlines miles during the year ended
December 31, 2004 and in future years. The agreement has a remaining commitment
at December 31, 2004 totaling $13.9 million.
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. See "Long
Distance Services Overview" for a discussion of the settlement of the
uncollected amounts due from MCI.
In December 2004 Sprint and Nextel Communications, Inc. announced a merger. The
agreement requires approval of shareholders and anti-trust regulators, as well
as state utility commissions that
93
license phone service. We are unable to predict the outcome this merger will
have on us in the long-term.
In February 2005 Verizon Communications, Inc. agreed to purchase MCI. The
agreement requires approval of shareholders and anti-trust regulators. We are
unable to predict the outcome this merger will have on us in the long-term,
however given the materiality of MCI's 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.
A migration of MCI's or Sprint'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.
Dividends accrued on GCI's Series B preferred stock are payable in cash at the
semi-annual payment dates of April 30 and October 31 of each year. We paid
dividends on GCI's behalf of $592,000 and $484,000 on April 30, 2004 and October
31, 2004, respectively. GCI's next Series B preferred stock dividend is due
April 30, 2005. Redemption is required on April 30, 2011.
In January 2004, 3,108 shares of GCI's Series B preferred stock was converted to
560,000 shares of GCI's Class A common stock at the stated conversion price of
$5.55 per share. In August 2004, 3,328 shares of GCI's Series B preferred stock
was converted to 599,640 shares of GCI's Class A common stock at the stated
conversion price of $5.55 per share. In November 2004, 4,995 shares of GCI's
Series B preferred stock was converted to 900,000 shares of GCI's Class A common
stock at the stated conversion price of $5.55 per share. The conversions will
reduce our future semi-annual cash dividends paid by us on GCI's behalf.
GCI's board of directors has authorized a common stock buyback program for the
repurchase of GCI's Class A and Class B common stock. We pay for the stock
repurchases on GCI's behalf. GCI's Board of Directors authorized us and we
obtained permission from our lenders and GCI's preferred shareholder to
repurchase up to $5.0 million per quarter during the third and fourth quarters
of 2004. The repurchase of MCI's 3,751,509 shares of GCI's Class A common stock
using proceeds from our December Senior Notes offering was not part of the
buyback program. During the year ended December 31, 2004 we have repurchased on
GCI's behalf 252,600 shares of GCI's Class A common stock at a cost of
approximately $2.4 million through the buyback program. GCI's Board of Directors
authorized us and we obtained permission from our lenders and GCI's preferred
shareholder for up to $10.0 million of repurchases during the six month period
ended June 30, 2005. During the months of January and February 2005 we
repurchased on GCI's behalf 252,600 shares of GCI's Class A common stock at a
cost of approximately $2.6 million. We expect to continue the repurchases on
GCI's behalf throughout 2005 subject to the availability of free cash flow,
credit facilities, the price of GCI's Class A and Class B common stock and the
requisite consents of our lenders and GCI's preferred shareholder. The
repurchases will comply with the restrictions of SEC rule 10b-18.
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 under acceptable terms and conditions.
We believe that we will be able to meet our current and long-term liquidity and
capital requirements, fixed charges and GCI's preferred stock dividends 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.
94
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 our financial condition and results, and require management to make estimates
that are difficult, subjective or complex. Most accounting policies are not
considered by management to be critical accounting policies. Several factors are
considered in determining whether or not a policy is critical in the preparation
of financial statements. These factors include, among other things, whether the
estimates are significant to the financial statements, the nature of the
estimates, the ability to readily validate the estimates with other information
including third parties or available prices, and sensitivity of the estimates to
changes in economic conditions and whether alternative accounting methods may be
utilized under 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 GCI's Audit Committee.
Those policies considered to be critical accounting policies for the year ended
December 31, 2004 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 also maintain an allowance for doubtful accounts based on
our assessment of the likelihood that our customers will satisfactorily
comply with rules necessary to obtain supplemental funding from the
Universal Service Administration Company ("USAC") for services provided
by us under our packaged communications offerings to rural hospitals,
health clinics and school districts. We base our estimates on the aging
of our accounts receivable balances, financial health of specific
customers, regional economic data, changes in our collections process,
our customers' compliance with USAC rules, 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 No. 141, "Business Combinations." Goodwill and indefinite-lived
assets such as our cable certificates are not amortized but are
subject, at a minimum, to annual tests for impairment and quarterly
evaluations of whether events and circumstances continue to support an
indefinite useful life as required by SFAS No. 142. 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 as required by SFAS No. 142. The initial goodwill and other
intangibles recorded and subsequent impairment analysis requires
management to make subjective judgments concerning estimates of the
applicability of quoted market prices in active markets and, if quoted
market prices are not available and/or are not applicable, how the
acquired asset will perform in the future using a discounted cash flow
analysis. 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
95
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 goodwill and
other intangibles, we may consider other information to validate the
reasonableness of our valuations including 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. The SEC Staff Announcement issued on September 29, 2004
requires us to value our indefinite-lived intangible assets other than
goodwill using the direct value method for impairment testing purposes
no later than January 1, 2005. Our cable certificate assets are our
only indefinite-lived intangible assets other than goodwill and were
originally valued and recorded using the residual method. Because of
the significance of the identified intangible assets and goodwill to
our consolidated balance sheet, our annual impairment analysis pursuant
to the SEC Staff Announcement and quarterly evaluation of remaining
useful life will be critical. Any changes in key assumptions about the
business and its prospects, changes in market conditions or other
externalities, or recognition of previously unrecognized intangible
assets for impairment testing purposes could result in an impairment
charge and such a charge could have a material adverse effect on our
consolidated results of operations. Refer to note 1(j) in the
accompanying "Notes to Consolidated Financial Statements" for
additional information regarding the SEC Staff Announcement and
intangible assets, respectively.
o We estimate unbilled long-distance services segment Cost of Goods Sold
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 make
network changes that can lead to new, revised or corrected billings.
Such estimates are revised or removed when subsequent billings are
received, payments are made, billing matters are researched and
resolved, tariffed billing periods lapse, or when disputed charges are
resolved. Revisions to previous estimates could either increase or
decrease costs in the year in which the estimate is revised which could
have a material effect on our consolidated financial condition and
results of operations.
o 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 $71.9 million associated with income tax net operating
losses that were generated from 1990 to 2003, and that expire from 2007
to 2024. 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, GCI determined that approximately $20.0 million of the
acquired net operating losses would not be utilized for income tax
purposes, and elected with its 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 utilized approximately $5.6
million of our tax net operating loss carryforwards in 2004. We have
not recorded a valuation
96
allowance on the deferred tax assets as of December 31, 2004 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 position or 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. Policies 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 are among topics currently under reexamination by
accounting standards setters and regulators. No specific conclusions reached by
these standard setters appear likely to cause a material change in our
accounting policies, although outcomes cannot be predicted with confidence. A
complete discussion of our significant accounting policies can be found in note
1 in the accompanying "Notes to Consolidated Financial Statements."
New Accounting Standards
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123R, "Share-Based Payment," requiring all companies to measure compensation
cost for all share-based payments (including employee stock options) at fair
value. SFAS No. 123R is effective for public companies for interim or annual
periods beginning after June 15, 2005. As of July 1, 2005, all public entities
will apply SFAS No. 123R using a modified version of prospective application.
Under that transition method, compensation cost is recognized on or after July
1, 2005 for the portion of outstanding awards for which the requisite service
has not yet been rendered, based on the grant-date fair value of those awards
calculated under SFAS 123 for either recognition or pro forma disclosures. We
estimate the application of SFAS No. 123R will result in an increase in our
compensation cost for all share-based payments of approximately $1.4 million
during the year ended December 31, 2005.
In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary Assets,"
which amends Accounting Principle Board ("APB") Opinion No. 29, "Accounting for
Nonmonetary Transactions". The guidance in APB Opinion No. 29 is based on the
principle that exchanges of nonmonetary assets should be measured based on the
fair value of the assets exchanged. The guidance in that Opinion, however,
included certain exceptions to that principle. SFAS No. 153 amends APB Opinion
No. 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. We will adopt this statement
July 1, 2005 and do not expect it to have a material effect on our results of
operations, financial position and cash flows.
In November 2004, the FASB ratified the consensus reached by the Emerging Issues
Task Force ("EITF") with respect to EITF Issue No. 03-13, "Applying the
Conditions in Paragraph 42 of FASB Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," in Determining Whether to Report
Discontinued Operations." A number of issues have arisen in practice in applying
the criteria in paragraph 42, and the following broad categories of issues
related to the application of both criteria in that paragraph have been
identified: (a) whether the intent of the paragraph is that all operations and
cash flows of the disposal component be eliminated from the ongoing operations
of the entity or whether some minor level of operations or cash flows may
remain; (b) if some insignificant level of operations or cash flows of the
disposal component can continue without precluding discontinued operations
reporting, the level at which "significance" should be measured; and (c) in
applying the paragraph, the factors to consider in determining whether the
selling entity has retained "significant continuing involvement" in the disposed
97
component. At December 31, 2004 we do not have a component that has been
identified for disposal. We will adopt this EITF January 1, 2005 and do not
expect it to have a material effect on our results of operations, financial
position and cash flows.
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. All of the federal funding and the majority of
investment revenues are dedicated for specific purposes, leaving oil revenues as
the primary source of general operating revenues. In fiscal 2004 the State's
actual results indicate that Alaska's oil revenues, federal funding and
investment revenues supplied 28%, 22% and 40%, respectively, of the state's
total revenues. In fiscal 2005 state economists forecast that Alaska's oil
revenues, federal funding and investment revenues will supply 34%, 32% and 23%,
respectively, of the state's total projected revenues.
The volume of oil transported by the TransAlaska Oil Pipeline System over the
past 20 years has been as high as 2.0 million barrels per day in fiscal 1988.
Production has been declining over the last several years with an average of
0.980 million barrels produced per day in fiscal 2004. The state forecasts the
production rate to decline from 0.934 million barrels produced per day in fiscal
2005 to 0.850 million barrels produced per day in fiscal 2015.
Market prices for North Slope oil averaged $31.74 in fiscal 2004 and are
forecasted to average $43.61 in fiscal 2005. The closing price per barrel was
$42.76 on February 14, 2005. To the extent that actual oil prices vary
materially from the state's projected prices the state's projected revenues and
deficits will change. When the price of oil is greater than $25.00 per barrel
and production of oil is between 0.9 and 1.0 million barrels per day, every $1
change in the price per barrel of oil is forecasted to result in a $40.0 million
to $140.0 million change in the state's fiscal 2005 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 2010. 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 evaluate cost cutting and revenue enhancing measures.
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. Periodically
there are renewed efforts to allow exploration and development in the Arctic
National Wildlife Refuge ("ANWR"). The United States 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
98
Alaska's revenues and could provide a substantial stimulus to the Alaska
economy. In October 2004 both houses of Congress passed and the President signed
legislation allowing loan guarantees of up to $18.0 billion, certain favorable
income tax provisions and tax credits, and expedited permitting and judicial
review for the construction of an Alaska natural gas pipeline. To support the
construction of a natural gas pipeline, the governor of the State of Alaska has
announced that he believes the state must assume some level of shipper risk,
serve as an equity partner or both. The State of Alaska is actively negotiating
two applications to construct a natural gas pipeline. The governor of the State
of Alaska has indicated his desire to submit a contract from one or more of
these groups to the Alaska legislature during the legislative session beginning
in January 2005.
Development of the ballistic missile defense system may have a significant
impact on Alaskan communication requirements and the Alaska economy. The system
is 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 system includes deployment of up to
100 ground-based interceptor silos and battle management command and control
facilities at Fort Greely, Alaska.
The United States 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. Construction began on
the Fort Greely test bed in 2002. The first ground-based missile interceptor was
placed in an underground silo in July 2004 and a total of eight were in place at
the end of 2004. The Missile Defense Agency is reported to expect to have
activated the first missile interceptors in 2005.
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.
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
649,000 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 11% are located in the Mat-Su Borough,
o 8% are located in the Kenai Peninsula Borough,
o 5% are located in the City and Borough of Juneau, and
o The remaining 21% 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 are higher in the winter months because
99
consumers spend more time at home and tend to watch more television during these
months. Local access and Internet services do not exhibit significant
seasonality. Our ability to implement construction projects is also hampered
during the winter months because of cold temperatures, snow and short daylight
hours.
Off-Balance Sheet Arrangements
We have not created, and are not party to, any special-purpose or off-balance
sheet entities for the purpose of raising capital, incurring debt or operating
parts of our business that are not consolidated into our financial statements.
We do not have any arrangements or relationships with entities that are not
consolidated into our financial statements that are reasonably likely to
materially affect our liquidity or the availability of our capital resources.
Schedule of Certain Known Contractual Obligations
The following table details future projected payments associated with our
certain known contractual obligations as of December 31, 2004.
Payments Due by Period
----------------------------------------------------------------
More
Less than 1 1 to 3 4 to 5 Than 5
Total Year Years Years Years
------------- ----------- ------------ ------------ ------------
(Amounts in thousands)
Long-term debt $ 441,168 168 121,000 --- 320,000
Interest on long-term debt 220,400 23,200 46,400 46,400 104,400
Capital lease obligations, including
interest 53,560 9,461 17,849 25,798 452
Operating lease commitments 72,771 14,564 21,080 15,070 22,057
Redeemable preferred stock 4,249 --- --- --- 4,249
Purchase obligations 43,168 24,076 15,183 3,909 ---
------------- ----------- ------------ ------------ ------------
Total contractual obligations $ 835,316 71,469 221,512 91,177 451,158
============= =========== ============ ============ ============
For long-term debt included in the above table, we have included principal
payments on our new Senior Credit Facility and on our new Senior Notes. Interest
on amounts outstanding under our new Senior Credit Facility is based on variable
rates and therefore the amount is not determinable. Our new Senior Notes require
semi-annual interest payments of $11.6 million through August 2014. For a
discussion of our long-term debt see note 7 to the accompanying "Notes to
Consolidated Financial Statements."
For a discussion of our capital and operating leases, see note 15 to the
accompanying "Notes to Consolidated Financial Statements."
We have included only the maturity redemption amount on GCI's Series B preferred
stock (cash dividends are excluded). GCI's Series B preferred stock is
convertible at $5.55 per share into GCI's Class A common stock and the dividends
are payable semi-annually at the rate of 8.5%, plus accrued but unpaid
dividends, in cash. Mandatory redemption is required 12 years from the date of
closing. For more information about GCI's redeemable preferred stock, see GCI's
annual report on Form 10-K for the fiscal year ended December 31, 2004.
Purchase obligations include the remaining DLPS equipment purchase commitment of
$13.5 million and the remaining $13.9 million commitment for our Alaska Airlines
agreement as further described in note 15 to the accompanying "Notes to
Consolidated Financial Statements" and a $411,000 maintenance contract
commitment. The contracts associated with these commitments are non-cancelable.
Purchase obligations also includes open purchase orders for goods and services
for capital projects and normal operations totaling $15.4 million which are not
included in our
100
Consolidated Balance Sheets at December 31, 2004, because the goods had not been
received or the services had not been performed at December 31, 2004. The open
purchase orders are cancelable.
Regulatory Developments
You should see "Part I -- Item 1 -- Business, Regulation, Franchise
Authorizations and Tariffs" for more information about regulatory developments
affecting us.
Inflation
We do not believe that inflation has a significant effect on our operations.
Audit Committee
GCI's Audit Committee, composed entirely of independent directors, meets
periodically with our independent auditors and management to review the
Company's financial statements and the results of audit activities. GCI's Audit
Committee, in turn, reports to GCI's Board of Directors on the results of its
review and recommends the selection of independent auditors.
GCI's 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 GCI's registration
statements, accounting consultations);
o Audit-related (employee benefit plan audits and accounting consultation
on proposed transactions);
o Income tax services (review of corporate and partnership income tax
returns, and consultations regarding income tax matters); and
o Professional services (planning, scoping and documentational assistance
of internal controls over financial reporting).
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various types of market risk in the normal course of business,
including the impact of interest rate changes. We do not hold derivatives for
trading purposes.
Our new Senior Credit Facility carries interest rate risk. Amounts borrowed
under this Agreement bear interest at Libor plus 2.25% or less depending upon
our Total Leverage Ratio (as defined). Should the Libor rate change, our
interest expense will increase or decrease accordingly. As of December 31, 2004,
we have borrowed $121.2 million subject to interest rate risk. On this amount, a
1% increase in the interest rate would result in $1,212,000 in additional gross
interest cost on an annualized basis. The interest rate swap agreement to
convert $25.0 million of variable interest rate debt to 3.98% fixed rate debt
plus applicable margin terminated on September 21, 2004.
Our Satellite Transponder Capital Lease carries interest rate risk. Amounts
borrowed under this Agreement bear interest at Libor plus 3.25%. Should the
Libor rate change, our interest expense will increase or decrease accordingly.
As of December 31, 2004, we have borrowed $38.7 million subject to interest rate
risk. On this amount, a 1% increase in the interest rate would result in
$387,000 in additional gross interest cost on an annualized basis.
Item 8. Consolidated Financial Statements and Supplementary Data
Our consolidated financial statements are filed under this Item, beginning on
page 103.
101
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Annual Report on Form 10-K, 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 - 15(e)) 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 changes in our internal control over financial reporting during
the fourth quarter of 2004 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
We may enhance, modify, and supplement internal controls and disclosure controls
and procedures based on experience.
Item 9B. Other Information
None
Part III
Items 10, 11, 12, 13 and 14 are omitted per General Instruction I(1)(a) and (b)
of Form 10-K.
102
Part IV
Item 15. Exhibits, Consolidated Financial Statement Schedules
(l) Consolidated Financial Statements Page No.
--------
Included in Part II of this Report:
Independent Auditors' Report..................................................104
Consolidated Balance Sheets, December 31, 2004 and 2003.......................105 -- 106
Consolidated Statements of Operations,
Years ended December 31, 2004, 2003 and 2002...............................107
Consolidated Statements of Stockholder's Equity,
Years ended December 31, 2004, 2003 and 2002...............................108
Consolidated Statements of Cash Flows,
Years ended December 31, 2004, 2003 and 2002...............................109
Notes to Consolidated Financial Statements....................................110 -- 146
(2) Consolidated Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts is included in note 3 in Notes to Consolidated Financial
Statements included in Part II of this report.
Other schedules are omitted, as they are not required or are not applicable, or the required information is
shown in the applicable financial statements or notes thereto.
(3) Exhibits...............................................................................147
103
INDEPENDENT AUDITORS' REPORT
The Board of Directors
GCI, Inc.
We have audited the accompanying consolidated balance sheets of GCI, Inc. and
subsidiaries as of December 31, 2004 and 2003, and the related consolidated
statements of operations, stockholder's equity, and cash flows for each of the
years in the three-year period ended December 31, 2004. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards
as established by the Auditing Standards Board (United States) and in accordance
with the auditing standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. The Company is not required to have, nor were we engaged
to perform, an audit of its internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of GCI, Inc. and
subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for the each of the years in the three-year
period ended December 31, 2004 in conformity with accounting principles
generally accepted in the United States of America.
(signed) KPMG LLP
March 11, 2005
104
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands) December 31,
ASSETS 2004 2003
- ----------------------------------------------------------------------------------------- ------------ ------------
Current assets:
Cash and cash equivalents $ 31,452 10,435
------------ ------------
Receivables 74,429 70,235
Less allowance for doubtful receivables 2,317 1,954
------------ ------------
Net receivables 72,112 68,281
Deferred income taxes, net 13,893 7,195
Prepaid expenses 7,907 10,436
Property held for sale 2,282 2,173
Inventories 1,215 1,513
Notes receivable from related parties 475 1,885
Other current assets 2,429 1,723
------------ ------------
Total current assets 131,765 103,641
------------ ------------
Property and equipment in service, net of depreciation 432,249 369,039
Construction in progress 22,505 33,618
------------ ------------
Net property and equipment 454,754 402,657
------------ ------------
Cable certificates 191,241 191,241
Goodwill 41,972 41,972
Other intangible assets, net of amortization of $1,625 and $1,656 at December 31, 2004
and 2003, respectively 6,265 4,195
Deferred loan and senior notes costs, net of amortization of $2,602 and $5,308 at
December 31, 2004 and 2003, respectively 10,341 5,757
Notes receivable from related parties 3,345 4,281
Other assets 9,508 9,276
------------ ------------
Total other assets 262,672 256,722
------------ ------------
Total assets $ 849,191 763,020
============ ============
See accompanying notes to consolidated financial statements.
105 (Continued)
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Continued)
(Amounts in thousands)
December 31,
LIABILITIES AND STOCKHOLDER'S EQUITY 2004 2003
----------------------------------------------------------------------------------------- ------------- -----------
Current liabilities:
Current maturities of obligations under capital leases and long-term debt $ 6,407 5,139
Accounts payable 28,742 34,133
Deferred revenue 16,253 21,275
Accrued payroll and payroll related obligations 15,350 17,545
Due to related party 10,004 6,258
Accrued interest 8,747 8,645
Accrued liabilities 6,760 7,933
Subscriber deposits 437 651
------------- -----------
Total current liabilities 92,700 101,579
Long-term debt 436,969 345,000
Obligations under capital leases, excluding current maturities 32,750 38,959
Obligation under capital lease due to related party, excluding current maturity 672 677
Deferred income taxes, net of deferred income tax benefit 49,111 24,168
Other liabilities 8,385 6,366
------------- -----------
Total liabilities 620,587 516,749
------------- -----------
Stockholder's equity:
Class A common stock. Authorized 10 shares; issued .01 shares at December 31, 2004
and December 31, 2003 206,622 206,622
Paid-in capital 5,677 44,904
Retained earnings (deficit) 16,305 (4,947)
Accumulated other comprehensive loss --- (308)
------------- -----------
Total stockholder's equity 228,604 246,271
------------- -----------
Commitments and contingencies
Total liabilities and stockholder's equity $ 849,191 763,020
============= ===========
See accompanying notes to consolidated financial statements.
106
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Amounts in thousands) 2004 2003 2002
------------- ------------ -------------
Revenues $ 424,826 390,797 367,842
Cost of goods sold (exclusive of depreciation, amortization and
accretion shown separately below) 139,563 125,383 123,564
Selling, general and administrative expenses 147,360 138,693 129,029
Bad debt expense (recovery) (1,074) (178) 13,124
Impairment charge --- 5,434 ---
Depreciation, amortization and accretion expense 63,113 53,388 56,400
------------- ------------ -------------
Operating income 75,864 68,077 45,725
------------- ------------ -------------
Other income (expense):
Interest expense (27,586) (34,745) (29,316)
Loss on early extinguishment of debt (6,136) --- ---
Amortization of loan and senior notes fees (3,790) (7,732) (4,612)
Interest income 363 560 525
------------- ------------ -------------
Other expense, net (37,149) (41,917) (33,403)
------------- ------------ -------------
Net income before income taxes and cumulative effect of a
change in accounting principle 38,715 26,160 12,322
Income tax expense 17,463 10,074 5,659
------------- ------------ -------------
Net income before cumulative effect of a change in
accounting principle 21,252 16,086 6,663
Cumulative effect of a change in accounting principle, net of
income tax benefit of $367 --- (544) ---
------------- ------------ -------------
Net income $ 21,252 15,542 6,663
============= ============ =============
See accompanying notes to consolidated financial statements.
107
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Shares of Accumulated
Class A Class A Retained Other
Common Common Paid-in Earnings 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 --- --- --- 6,663 --- 6,663
Change in fair value of cash flow hedge, net of
change in income tax effect of $459 --- --- --- --- (548) (548)
-----------
Comprehensive income 6,115
Contribution from General Communication, Inc. --- --- 2 --- --- 2
-----------------------------------------------------------------------------
Balances at December 31, 2002 100 206,622 44,904 (20,489) (540) 230,497
Components of comprehensive income:
Net income --- --- --- 15,542 --- 15,542
Change in fair value of cash flow hedge, net of
change in income tax effect of $175 --- --- --- --- 232 232
-----------
Comprehensive income 15,774
-----------------------------------------------------------------------------
Balances at December 31, 2003 100 206,622 44,904 (4,947) (308) 246,271
Components of comprehensive income:
Net income --- --- --- 21,252 --- 21,252
Change in fair value of cash flow hedge, net of
change in income tax effect of $207 --- --- --- --- 308 308
-----------
Comprehensive income 21,560
Contribution to General Communication, Inc. --- --- (39,227) --- --- (39,227)
-----------------------------------------------------------------------------
Balances at December 31, 2004 100 $ 206,622 5,677 16,305 --- 228,604
=============================================================================
See accompanying notes to consolidated financial statements.
108
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Amounts in thousands) 2004 2003 2002
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 21,252 15,542 6,663
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation, amortization and accretion expense 63,113 53,388 56,400
Deferred income tax expense 18,245 9,673 5,754
Loss on early extinguishment of debt 6,136 --- ---
Amortization of loan and senior notes fees 3,790 7,732 4,612
Deferred compensation 657 689 430
Compensatory stock options 390 1,076 548
Bad debt expense (recovery), net of write-offs 363 (1,084) 9,844
Impairment charge --- 5,434 ---
Cumulative effect of a change in accounting principle, net --- 544 ---
Employee Stock Purchase Plan expense funded with General Communication,
Inc.'s issuance of its Class A common stock --- --- 791
Other noncash income and expense items 791 99 90
Change in operating assets and liabilities (12,143) (5,990) (10,943)
----------- ----------- ------------
Net cash provided by operating activities 102,594 87,103 74,189
----------- ----------- ------------
Cash flows from investing activities:
Purchases of property and equipment, including construction period interest (111,804) (62,479) (65,140)
Purchases of other assets and intangible assets (4,692) (6,249) (1,657)
Payments received on notes receivable from related parties 2,607 74 946
Proceeds from sales of assets 1,190 --- ---
Refund of deposit 699 --- ---
Purchases of and additions to property held for sale (626) (138) (38)
Notes receivable issued to related parties (52) (99) (3,055)
----------- ----------- ------------
Net cash used in investing activities (112,678) (68,891) (68,944)
----------- ----------- ------------
Cash flows from financing activities:
Issuance of new Senior Notes 315,720 --- ---
Repayment of old Senior Notes (180,000) --- ---
Repayment of Senior Credit Facility (63,832) (12,700) (15,575)
Contribution to General Communication, Inc. (41,263) (1,632) (1,537)
Borrowings on Senior Credit Facility 20,000 --- 14,766
Payment of debt issuance costs (8,274) (3,528) (352)
Payment of bond call premiums (6,136) --- ---
Repayments of capital lease obligations (5,114) (1,857) (1,704)
----------- ----------- ------------
Net cash provided by (used in) financing activities 31,101 (19,717) (4,402)
----------- ----------- ------------
Net increase (decrease) in cash and cash equivalents 21,017 (1,505) 843
Cash and cash equivalents at beginning of year 10,435 11,940 11,097
----------- ----------- ------------
Cash and cash equivalents at end of year $ 31,452 10,435 11,940
=========== =========== ============
See accompanying notes to consolidated financial statements.
109
GCI, INC.
Notes to Consolidated Financial Statements
(l) Business and Summary of Significant Accounting Principles
In the following discussion, GCI, Inc. and its direct and indirect
subsidiaries are referred to as "we," "us" and "our".
Basis of Presentation
We were incorporated in Alaska in 1997 to affect 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 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 Origination and 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 our undersea fiber optic cable
systems 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, and
o Distribution of white and yellow pages directories to
residential and business customers in certain markets we serve
and on-line directory products.
(b) Principles of Consolidation
The consolidated financial statements include the consolidated
accounts of GCI, Inc. and all wholly owned subsidiaries with all
significant intercompany transactions eliminated.
(c) Earnings per Common Share
We are a wholly owned subsidiary of GCI and, accordingly, are not
required to present earnings per share. Our common stock is not
publicly traded.
(d) Cash Equivalents
Cash equivalents consist of repurchase interest investments and
certificates of deposit which are short-term and readily
convertible into cash.
(e) Accounts Receivable and Allowance for Doubtful Receivables
Trade accounts receivable are recorded at the invoiced amount and
do not bear interest. The allowance for doubtful accounts is our
best estimate of the amount of probable credit losses in our
existing accounts receivable. We base our estimates on our
historical collections experience, industry standards, regulatory
requirements, regional economic data, and our collections process.
We review our allowance for doubtful accounts methodology at least
annually. During the review process we consider a change to our
methodology if there are any changes to these factors.
Depending upon the type of account receivable our allowance is
calculated using a pooled basis with an allowance for all accounts
greater than 120 days past due, a specific identification method,
or a combination of the two methods. When a specific identification
method is used past due balances over 90 days and balances less
than 90 days old but potentially uncollectible due to bankruptcy or
other issues are reviewed individually for collectibility. Account
balances are charged
110 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
off against the allowance when we feel it is probable the
receivable will not be recovered. We do not have any
off-balance-sheet credit exposure related to our customers.
(f) Inventories
Inventory of merchandise for resale and parts is stated at the
lower of cost or market. Cost is determined using the average cost
method.
(g) Property and Equipment
Property and equipment is stated at cost. Construction costs of
facilities are capitalized. Equipment financed under capital leases
is recorded at the lower of fair market value or the present value
of future minimum lease payments. Construction in progress
represents distribution systems and support equipment not placed in
service on December 31, 2004; management intends to place this
equipment in service during 2005.
Depreciation is computed on a straight-line basis based upon the
shorter of the estimated useful lives of the assets or the lease
term, if applicable, in the following ranges:
Asset Category Asset Lives
-------------------------------------------------------- -----------------
Telephony distribution and fiber optic cable systems 10-20 years
Cable television distribution systems 10 years
Support equipment 3-10 years
Transportation equipment 5-10 years
Property and equipment under capital leases 12-15 years
Amortization of property and equipment under capital leases is
included in Depreciation, Amortization, and Accretion Expense on
the Consolidated Statements of Operations.
Repairs and maintenance are charged to expense as incurred.
Expenditures for major renewals and betterments are capitalized.
Accumulated depreciation is removed and gains or losses are
recognized at the time of retirements, sales or other dispositions
of property.
(h) Long-lived Assets to be Disposed of
Long-lived assets to be disposed of by sales, including those of
discontinued operations, are measured at the lower of carrying
amount or fair value less cost to sell, if applicable. We classify
a long-lived asset to be disposed of other than by sale as held and
used until it is disposed of. We classify a long-lived asset to be
sold as held for sale in the period in which all of certain
criteria established by SFAS 144, "Accounting for the Impairment or
Disposal of Long-lived Assets" are met. We do not depreciate or
amortize long-lived assets to be sold.
A loss is recognized for any initial or subsequent write-down to
fair value less cost to sell. A gain is recognized for any
subsequent increase in fair value less cost to sell, but not in
excess of the cumulative loss previously recognized (for a
write-down to fair value less cost to sell). The loss or gain
adjusts only the carrying amount of a long-lived asset, whether
classified as held for sale individually or as part of a disposal
group. A gain or loss not previously recognized that results from
the sale of a long-lived asset (disposal group) is recognized at
the date of sale.
(i) Intangible Assets
Goodwill and cable certificates (certificates of convenience and
public necessity) are not amortized. Cable certificates represent
certain perpetual operating rights to provide cable services.
Goodwill represents the excess of cost over fair value of net
assets acquired. Cable certificates are allocated to our cable
services reportable segment. Goodwill is primarily allocated to the
cable services segment and the remaining amount is not allocated to
a reportable segment, but is included in the All Other Category in
note 12.
111 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
The cost of our Personal Communication Services license and related
financing costs were capitalized as an amortizable intangible
asset. The associated assets were placed into service during 2000
and the recorded cost of the license and related financing costs
are being amortized over a 40-year period using the straight-line
method. All other amortizable intangible assets are being amortized
over 5-20 year periods using the straight-line method.
(j) Impairment of Intangibles, Goodwill, and Long-lived Assets
Cable certificates are tested annually for impairment, and are
tested for impairment more frequently if events and circumstances
indicate that the asset might be impaired. The impairment test
consists of a comparison of the fair value of the asset with its
carrying amount. If the carrying amount of the cable certificates
asset exceeds its fair value, an impairment loss is recognized in
an amount equal to that excess. After an impairment loss is
recognized, the adjusted carrying amount of the asset is its new
accounting basis.
On September 29, 2004, the Securities and Exchange Commission
("SEC") issued SEC Staff Announcement Topic "Use of the Residual
Method to Value Acquired Assets Other than Goodwill," ("SEC Staff
Announcement") requiring us to apply no later than January 1, 2005
a direct value method to determine the fair value of our intangible
assets with indefinite lives other than goodwill for purposes of
impairment testing. We adopted the SEC Staff Announcement on
December 31, 2004. Our cable certificate assets are our only
indefinite-lived assets other than goodwill as of December 31,
2004. Our cable certificate assets were originally valued and
recorded using the residual method. Impairment testing of our cable
certificate assets as of December 31, 2004 used a direct value
method pursuant to the SEC Staff Announcement.
Goodwill is tested annually for impairment, and is tested for
impairment more frequently if events and circumstances indicate
that the asset might be impaired. An impairment loss is recognized
to the extent that the carrying amount exceeds the asset's fair
value. This determination is made at the reporting unit level and
consists of two steps. First, we determine the fair value of a
reporting unit and compare it to its carrying amount. Second, if
the carrying amount of a reporting unit exceeds its fair value, an
impairment loss is recognized for any excess of the carrying amount
of the reporting unit's goodwill over the implied fair value of
that goodwill. The implied fair value of goodwill is determined by
allocating the fair value of the reporting unit in a manner similar
to a purchase price allocation, in accordance with SFAS No. 141,
"Business Combinations." The residual fair value after this
allocation is the implied fair value of the reporting unit
goodwill.
Long-lived assets, such as property, plant, and equipment, and
purchased intangibles subject to amortization, are reviewed for
impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to estimated
undiscounted future cash flows expected to be generated by the
asset. If the carrying amount of an asset exceeds its estimated
future cash flows, an impairment charge is recognized by the amount
by which the carrying amount of the asset exceeds the fair value of
the asset.
(k) Amortization of Loan and Senior Notes Fees
Debt issuance costs are deferred and amortized using the
straight-line method, which approximates the interest method, over
the term of the related debt and notes. Amortization costs are
reported as a component of Other Income (Expense) in the
Consolidated Statements of Operations.
(l) Other Assets
Other Assets primarily include long-term deposits and prepayments,
a performance bond, and non-trade accounts receivable.
112 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(m) Accounting for Derivative Instruments and Hedging Activities
We record derivatives on the balance sheet as assets or
liabilities, measured at fair value and establish criteria for
designation and effectiveness of hedging relationships consistent
with SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended.
In 2003 we adopted SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends
and clarifies financial accounting and reporting for 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."
(n) Accounting for Certain Financial Instruments with Characteristics
of Both Liabilities and Equity
We classify and measure certain financial instruments with
characteristics of both liabilities and equity according to SFAS
No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." SFAS No. 150
requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some
circumstances).
(o) Asset Retirement Obligations
On January 1, 2003 we adopted SFAS No. 143, "Accounting for Asset
Retirement Obligations." We record the fair value of a liability
for an asset retirement obligation in the period in which it is
incurred in Other Liabilities on the Consolidated Balance Sheets.
When the liability is initially recorded, we capitalize 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, we
either settle the obligation for its recorded amount or incur a
gain or loss upon settlement. Upon adoption of SFAS No. 143,
"Accounting for Asset Retirement Obligations" on January 1, 2003,
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.
The majority of our asset retirement obligation is the estimated
cost to remove telephony distribution equipment and support
equipment from leased property.
Following is a reconciliation of the beginning and ending aggregate
carrying amount of our liability for asset retirement obligations
at December 31, 2004 (amounts in thousands):
Balance at December 31, 2002 $ ---
Liability recognized upon adoption of SFAS No. 143 1,565
Liability incurred during the year ended December 31, 2003 277
Accretion expense for the year ended December 31, 2003 163
----------
Balance at December 31, 2003 2,005
Liability incurred during the year ended December 31, 2004 775
Accretion expense for the year ended December 31, 2004 242
Liability settled (6)
Other (45)
----------
Balance at December 31, 2004 $ 2,971
==========
If SFAS No. 143 had been applied at December 31, 2002 the liability
for asset retirement obligations would have been $1,565,000.
At the date of adoption we recorded additional capitalized costs of
$654,000 in Property and Equipment in Service, Net of Depreciation.
During the years ended December 31, 2004 and 2003
113 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
we recorded additional capitalized costs of $775,000 and $277,000,
respectively, in Property and Equipment in Service, Net of
Depreciation.
(p) Alaska Airlines, Inc. ("Alaska Airlines") Contract
Our contract with Alaska Airlines provides that we purchase a
specific minimum number of mileage awards in the Alaska Airlines
Mileage Plan each year at a specific price per mile. If we exceed
the minimum purchase commitment in any of the specified periods,
the excess miles are priced at a reduced fixed cost per mile.
Alaska Airlines invoices us for all mileage credited during the
prior month. Our contractual cost for purchased miles is not tied
or related in any way to our customers' usage of the awarded miles.
Use of the miles is a transaction between our customers and Alaska
Airlines and does not involve us in any way. Accordingly we do not
account for or record our customers' usage of miles purchased.
We have recorded a liability for the estimated obligation under the
contract as of December 31, 2004 and 2003. We estimated the amount
of the obligation based on the amount of mileage awards purchased
through December 31, 2004 and 2003 in comparison to the required
minimum commitment. We have recorded the expense for the miles
purchased from Alaska Airlines in Selling, General and
Administrative expenses for each of our benefiting segments.
(q) Revenue Recognition
All revenues are recognized when the earnings process is complete
in accordance with SEC Staff Accounting Bulletins No. 101 and No.
104, "Revenue Recognition" as follows:
o Revenues generated from long-distance and managed services
are recognized when the services are provided,
o Cable television service, local access service, Internet
service and private line telecommunication revenues are
billed in advance, recorded as Deferred Revenue on the
balance sheet, and are recognized as the associated service
is provided,
o The majority of our equipment sale transactions involve the
sale of communications equipment with no other services
involved. Such equipment is subject to standard
manufacturer warranties and we do not manufacture any of
the equipment we sell. In such instances the customer takes
title to the equipment generally upon delivery. We
recognize revenue for such transactions when title passes
to the customer and the revenue is earned and realizable
pursuant to the provisions of SAB 101 and SAB 104. On
certain occasions we enter into agreements to sell and
satisfactorily install or integrate telecommunications
equipment for a fixed fee. Customers may have refund rights
if the installed equipment does not meet certain
performance criteria. We defer revenue recognition until we
have received customer acceptance per the contract or
agreement, and all other required revenue recognition
elements have been achieved. Revenues from contracts with
multiple element arrangements, such as those including
installation and integration services, are recognized as
each element is earned based on objective evidence
regarding the relative fair value of each element and when
there are no undelivered elements that are essential to the
functionality of the delivered elements,
o Technical services revenues are derived primarily from
maintenance contracts on equipment and are recognized on a
prorated basis over the term of the contracts,
o Revenues from telephone and yellow-page directories are
recognized ratably during the period following publication,
which typically begins with distribution and is complete in
the month prior to publication of the next directory,
o Other revenues are recognized when the service is provided,
and
o We recognize unbilled revenues when the service is provided
based upon minutes of use processed or established rates,
net of credits and adjustments.
114 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(r) Payments Received from Suppliers
In 2003 we adopted Emerging Issues Task Force ("EITF") Issue No.
02-16, "Accounting by a Reseller for Cash Consideration Received
from a Vendor." 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 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.
(s) Advertising Expense
We expense advertising costs in the year during which the first
advertisement appears. Advertising expenses were approximately
$3,281,000, $3,727,000 and $2,967,000 for the years ended December
31, 2004, 2003 and 2002, respectively.
(t) Leases
We account for capital and operating leases as lessee as required
by SFAS No. 13, "Accounting for Leases" and in subsequently issued
amendments and interpretations of SFAS No. 13. Scheduled rent
increases are amortized over the lease term on a straight-line
basis. Contingent rent expense results from increases in the
Consumer Price Index. Rent holidays are recognized on a
straight-line basis over the lease term.
Leasehold improvements are amortized over the shorter of their
economic lives or the lease term. We may amortize a leasehold
improvement over a term that includes assumption of a lease renewal
if the renewal is reasonably assured. Leasehold improvements made
by us and funded by landlord incentives or allowances under an
operating lease are recorded as deferred rent and amortized as
reductions to lease expense over the lease term.
(u) Interest Expense
Interest costs incurred during the construction period of
significant capital projects, such as construction of an undersea
fiber optic cable system, are capitalized. We capitalized interest
cost of approximately $1.1 million and $403,000 during the years
ended December 31, 2004 and 2003, respectively, during the
construction of the AULP West fiber optic cable system. No interest
was capitalized during the year ended December 31, 2002.
(v) Income Taxes
Income taxes are accounted for using the asset and liability
method. Deferred tax assets and liabilities are recognized for
their future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply
to taxable earnings in the years in which those temporary
differences are expected to be recovered or settled. Deferred tax
assets are recognized to the extent that the benefits are more
likely to be realized than not. GCI, Inc. and its wholly-owned
subsidiaries file corporate income tax returns as part of the GCI
consolidated group of companies.
115 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(w) Costs Associated with Exit or Disposal Activities
In 2003 we adopted SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." We record exit or disposal costs
when they are incurred and can be measured at fair value. The
recorded liability is subsequently adjusted for changes in
estimated cash flows.
(x) Incumbent Local Exchange Carrier ("ILEC") Over-earnings Refunds
We receive refunds from time to time from ILECs with which we do
business in respect of their earnings that exceed regulatory
requirements. Telephone companies that are rate regulated by the
Federal Communications Commission ("FCC") using the rate of return
method are required by the FCC to refund earnings from interstate
access charges assessed to long-distance carriers when their
earnings exceed their authorized rate of return. Such refunds are
computed based on the regulated carrier's earnings in several
access categories. Uncertainties exist with respect to the amount
of their earnings, the refunds (if any), their timing, and their
realization. We account for such refundable amounts as gain
contingencies, and, accordingly, do not recognize them until
realization is a certainty upon receipt.
(y) Stock Option Plan
At December 31, 2004, we had one stock-based employee compensation
plan, which is described more fully in note 11. We account for this
plan under the recognition and measurement principles of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. We use the
intrinsic-value method and compensation expense is recorded on the
date of grant only if the current market price of the underlying
stock exceeds the exercise price. We have adopted SFAS 123,
"Accounting for Stock-Based Compensation," which permits entities
to recognize as expense over the vesting period the fair value of
all stock-based awards on the date of grant. Alternatively, SFAS
123 also allows entities to continue to apply the provisions of APB
Opinion No. 25.
We have adopted SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure." This Statement amends SFAS
No. 123 to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results.
We have elected to continue to apply the provisions of APB Opinion
No. 25 and provide the pro forma disclosure as required by SFAS
148.
116 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
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 for the years ended December 31, 2004, 2003 and 2002, if we
had applied the fair-value recognition provisions of SFAS 123 to
stock-based employee compensation (amounts in thousands):
2004 2003 2002
------------ ------------ ------------
Net income after cumulative effect of a change in $ 21,252 15,542 6,663
accounting principle in 2003, as reported
Total stock-based employee compensation expense
included in reported net income, net of related tax
effects 215 630 257
Total stock-based employee compensation expense
under the fair-value based method for all awards,
net of related tax effects (2,047) (1,981) (2,504)
------------ ------------ ------------
Pro forma net income after cumulative effect of
a change in accounting principle in 2003 $ 19,420 14,191 4,416
============ ============ ============
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.
(z) Stock Options and Stock Warrants Issued for Non-employee Services
We account for stock options and warrants issued in exchange for
non-employee services pursuant to the provisions of SFAS 123, EITF
96-3 and EITF 96-18, wherein such transactions are accounted for at
the fair value of the consideration or services received or the
fair value of the equity instruments issued, whichever is more
reliably measurable.
When a stock option or warrant is issued for non-employee services
where the fair value of such services is not stated, we estimate
the value of the stock option or warrant issued using the Black
Scholes method.
The fair value determined using these principles is charged to
operating expense over the shorter of the term for which
non-employee services are provided, if stated, or the stock option
or warrant vesting period.
(aa) Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principles requires us to make
estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Significant items subject to estimates and assumptions
include allowance for doubtful receivables, valuation allowances
for deferred income tax assets, depreciable lives of assets, the
carrying value of long-lived assets including goodwill, and the
accrual of cost of sales and services. Actual results could differ
from those estimates.
(ab) Concentrations of Credit Risk
Financial instruments that potentially subject us to concentrations
of credit risk are primarily cash and cash equivalents and accounts
receivable. Excess cash is invested in high quality short-term
liquid money instruments issued by highly rated financial
institutions. At December 31, 2004 and
117 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
2003, substantially all of our cash and cash equivalents were
invested in short-term liquid money instruments at one highly rated
financial institution.
We have one major customer, MCI (see note 14). 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, 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.
(ac) Software Capitalization Policy
Internally used software, whether purchased or developed, is
capitalized and amortized using the straight-line method over an
estimated useful life of five years. In accordance with Statement
of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," we capitalize
certain costs associated with internally developed software such as
payroll costs of employees devoting time to the projects and
external direct costs for materials and services. Costs associated
with internally developed software to be used internally are
expensed until the point the project has reached the development
stage. Subsequent additions, modifications or upgrades to
internal-use software are capitalized only to the extent that they
allow the software to perform a task it previously did not perform.
Software maintenance and training costs are expensed in the period
in which they are incurred. The capitalization of software requires
judgment in determining when a project has reached the development
stage.
(ad) Rescission of Financial Accounting Standard Board ("FASB")
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13,
and Technical Corrections
In accordance with SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections," unamortized bank fees and other expenses totaling
approximately $2.3 million associated with the November 2002
refinancing of debt instruments were not classified as an
extraordinary item and were charged to Amortization of Loan and
Senior Notes Fees during the year ended December 31, 2002.
(ae) Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others
Certain of our customers have guaranteed levels of service and we
account for these guarantees according to FASB Interpretation
("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." We accrue for guarantees as they become probable and
estimable.
(af) Aggregate Operating Segments That Do Not Meet the Quantitative
Thresholds
In October 2004, the FASB ratified the consensus reached by the
EITF with respect to EITF Issue No. 04-10, "Determining Whether to
Aggregate Operating Segments That Do Not Meet the Quantitative
Thresholds," which clarifies the guidance in paragraph 19 of SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related
Information." According to EITF Issue No. 04-10, operating segments
that do not meet the quantitative thresholds can be aggregated only
if aggregation is consistent with the objective and basic
principles of SFAS No. 131, the segments have similar economic
characteristics, and the segments share a majority of the
aggregation criteria listed in items (a)-(e) in paragraph 17 of
SFAS No. 131. The consensus applies to fiscal years ending after
October 13, 2004. EITF 04-10 has not resulted in a change to our
SFAS No. 131 disclosure.
118 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(ag) New Accounting Standards
In December 2004, the FASB issued SFAS No. 123R, "Share-Based
Payment," requiring all companies to measure compensation cost for
all share-based payments (including employee stock options) at fair
value. SFAS No. 123R is effective for public companies for interim
or annual periods beginning after June 15, 2005. As of July 1,
2005, all public entities will apply SFAS No. 123R using a modified
version of prospective application. Under that transition method,
compensation cost is recognized on or after July 1, 2005 for the
portion of outstanding awards for which the requisite service has
not yet been rendered, based on the grant-date fair value of those
awards calculated under SFAS 123 for either recognition or pro
forma disclosures. We estimate the application of SFAS No. 123R
will result in an increase in our compensation cost for all
share-based payments of approximately $1.4 million during the year
ended December 31, 2005.
In December 2004, the FASB issued SFAS 153, "Exchanges of
Nonmonetary Assets," which amends APB Opinion No. 29, "Accounting
for Nonmonetary Transactions." The guidance in APB Opinion No. 29
is based on the principle that exchanges of nonmonetary assets
should be measured based on the fair value of the assets exchanged.
The guidance in that Opinion, however, included certain exceptions
to that principle. SFAS No. 153 amends APB Opinion No. 29 to
eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for
exchanges of nonmonetary assets that do not have commercial
substance. A nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change
significantly as a result of the exchange. We will adopt this
statement July 1, 2005 and do not expect it to have a material
effect on our results of operations, financial position and cash
flows.
In November 2004, the FASB ratified the consensus reached by the
EITF with respect to EITF Issue No. 03-13, "Applying the Conditions
in Paragraph 42 of FASB Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," in Determining
Whether to Report Discontinued Operations." A number of issues have
arisen in practice in applying the criteria in paragraph 42, and
the following broad categories of issues related to the application
of both criteria in that paragraph have been identified: (a)
whether the intent of the paragraph is that all operations and cash
flows of the disposal component be eliminated from the ongoing
operations of the entity or whether some minor level of operations
or cash flows may remain; (b) if some insignificant level of
operations or cash flows of the disposal component can continue
without precluding discontinued operations reporting, the level at
which "significance" should be measured; and (c) in applying the
paragraph, the factors to consider in determining whether the
selling entity has retained "significant continuing involvement" in
the disposed component. At December 31, 2004 we do not have a
component that has been identified for disposal. We will adopt this
EITF January 1, 2005 and do not expect it to have a material effect
on our results of operations, financial position and cash flows.
(ah) Reclassifications
Reclassifications have been made to the 2003 financial statements
to make them comparable with the 2004 presentation.
119 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(2) Consolidated Statements of Cash Flows Supplemental Disclosures
Changes in operating assets and liabilities consist of (amounts in
thousands):
Year ended December 31, 2004 2003 2002
------------- ------------- ------------
Increase in accounts receivable $ (4,976) (16,549) (5,476)
(Increase) decrease in prepaid expenses 2,529 (1,830) (5,623)
(Increase) decrease in inventories 298 (1,113) 446
Increase in other current assets (706) (1,158) (382)
Increase (decrease) in accounts payable (5,391) 2,465 (2,859)
Increase (decrease) in deferred revenue (5,022) 2,985 6,161
Increase (decrease) in accrued payroll and payroll
related obligations (2,195) 5,724 (3,468)
Increase (decrease) in due to related party 3,746 1,387 (289)
Increase (decrease) in accrued interest 102 707 (111)
Increase (decrease) in accrued liabilities (659) 1,927 825
Decrease in subscriber deposits (214) (238) (232)
Increase (decrease) in components of other long-term
liabilities 345 (297) 65
------------- ------------- ------------
$ (12,143) (5,990) (10,943)
============= ============= ============
We paid interest totaling approximately $28,581,000, $34,441,000 and
$29,427,000 during the years ended December 31, 2004, 2003 and 2002,
respectively.
GCI, Inc., as a wholly-owned subsidiary and member of the GCI controlled
group of corporations, files its income tax returns as part of the
consolidated group of corporations under GCI. Accordingly, the following
discussion of an income tax payment and refund reflects the consolidated
group's activity. We paid income taxes totaling $205,000 during the year
ended December 31, 2004. We paid no income taxes during the years ended
December 31, 2003 and 2002. Net income tax refunds received totaled
$283,700 during the year ended December 31, 2002. We received no income
tax refunds during the years ended December 31, 2004 and 2003.
We recorded $1,730,000, $538,000 and $319,000 during the years ended
December 31, 2004, 2003 and 2002, respectively, in paid-in capital in
recognition of the income tax effect of excess stock compensation expense
for tax purposes over amounts recognized for financial reporting
purposes.
During the year ended December 31, 2004 our President and CEO tendered
70,028 shares of his GCI Class A common stock to us at an agreed-upon
value of $10.71 per share for a total value of $750,000. The stock tender
was in lieu of a cash payment on a note receivable with related parties
issued upon stock option exercise.
During the year ended December 31, 2002 we funded the employer match
portion of Employee Stock Purchase Plan contributions by GCI's issuance
of its Class A common stock valued at $791,000 and by purchasing GCI
Class A common stock on the open market. During the years ended December
31, 2004 and 2003 all employer match shares were purchased on the open
market.
We financed the acquisition of approximately $1.0 million of telephony
distribution equipment pursuant to a long-term capital lease arrangement
with a leasing company during the year ended December 31, 2002.
We acquired all minority shareholders' ownership interests in GCI Fiber
Communication Co., Inc., a wholly-owned subsidiary of GCI Holdings, Inc.
("Holdings") by GCI's issuance of 15,000 shares of its Class A common
stock in 2002. Holdings is a wholly-owned subsidiary of GCI, Inc.
120 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(3) Receivables and Allowance for Doubtful Receivables
Receivables consist of the following at December 31, 2004 and 2003
(amounts in thousands):
2004 2003
------------- -------------
Trade $ 71,034 67,186
Employee 277 284
Other 3,118 2,765
------------- -------------
Total receivables $ 74,429 70,235
============= =============
Following are the changes in the allowance for doubtful receivables
during the years ended December 31, 2004, 2003 and 2002 (amounts in
thousands):
Additions Deductions
----------------------- ------------
Balance at Charged to Charged to Write-offs
beginning costs and Other net of Balance at
Description of year expenses Accounts recoveries end of year
------------------------------ ------------ ------------ ---------- ------------ -----------
December 31, 2004 $ 1,954 3,136 --- 2,773 2,317
============ ============ ========== =========== ===========
December 31, 2003 $ 14,010 2,640 --- 14,696 1,954
============ ============ ========== =========== ===========
December 31, 2002 $ 4,166 13,124 --- 3,280 14,010
============ ============ ========== =========== ===========
As further described in note 12, during the year ended December 31, 2003
we reached a settlement agreement for pre-petition amounts owed to us by
MCI. The remaining pre-petition accounts receivable balance owed by MCI
after this settlement was removed from our Consolidated Balance Sheets in
2003. During the years ended December 31, 2004 and 2003 we utilized
approximately $4.2 million and $2.8 million, respectively, of the MCI
credit against amounts otherwise payable for services received from MCI.
The Allowance for Doubtful Receivables at December 31, 2002 includes the
provision of $11.6 million of bad debt expense for estimated
uncollectible accounts due from MCI.
(4) Net Property and Equipment in Service
Net property and equipment in service consists of the following at
December 31, 2004 and 2003 (amounts in thousands):
2004 2003
------------ ------------
Land and buildings $ 4,061 3,151
Telephony distribution systems 440,050 345,984
Cable television distribution systems 170,843 161,054
Support equipment 50,211 46,219
Transportation equipment 6,648 5,500
Property and equipment under capital leases 50,992 51,214
------------ ------------
722,805 613,122
Less accumulated depreciation 269,626 227,071
Less accumulated amortization 20,930 17,012
------------ ------------
Net property and equipment in service $ 432,249 369,039
============ ============
(5) Intangible Assets
As of December 31, 2004 cable certificates and goodwill were tested for
impairment and the fair values were greater than the carrying amounts,
therefore these intangible assets were determined not to be impaired at
121 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
December 31, 2004. The remaining useful lives of our cable certificates
and goodwill were evaluated as of December 31, 2004 and events and
circumstances continue to support an indefinite useful life.
No intangible assets subject to amortization have been impaired based
upon impairment testing performed as of December 31, 2004.
No indicators of impairment have occurred since the impairment testing
was performed.
Amortization expense for amortizable intangible assets for the years
ended December 31, 2004, 2003 and 2002 follow (amounts in thousands):
Years Ended December 31,
2004 2003 2002
---------- ----------- ----------
Amortization expense for amortizable intangible assets $ 856 660 790
========== =========== ==========
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,
------------
2005 $ 1,100
2006 $ 1,095
2007 $ 1,034
2008 $ 784
2009 $ 504
Following are the changes in Other Intangible Assets (amounts in
thousands):
Balance, December 31, 2002 $ 3,460
Asset additions 1,395
Less amortization expense 660
---------
Balance, December 31, 2003 4,195
Asset additions 2,926
Less amortization expense 856
----------
Balance, December 31, 2004 $ 6,265
==========
122 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(6) Notes Receivable from Related Parties
Notes receivable from related parties consist of the following (amounts
in thousands):
December 31,
2004 2003
--------------- -------------
Notes receivable from officers bearing interest up to 6.5%
or at the rate paid by us on our senior indebtedness,
unsecured, due through December 31, 2006 $ 2,436 3,029
Notes receivable from officers bearing interest at the rate
paid by us on our senior indebtedness, secured by GCI
common stock, due through December 1, 2006 350 919
Notes receivable from other related parties bearing
interest up to 7.6% or at the rate paid by us on our
senior indebtedness, unsecured and secured by property,
due through December 31, 2007 185 606
Interest receivable 849 1,612
--------------- -------------
Total notes receivable from related parties 3,820 6,166
Less current portion, including current interest receivable 475 1,885
--------------- -------------
Long-term portion, including long-term interest receivable $ 3,345 4,281
=============== =============
(7) Long-term Debt
Long-term debt consists of the following (amounts in thousands):
December 31,
2004 2003
-------------- -------------
Senior Notes, net of unamortized bond discount of $4,031 (a) $ 315,969 180,000
Senior Credit Facility (b) 121,000 165,000
-------------- -------------
Long-term debt $ 436,969 345,000
============== =============
(a) In February 2004 we sold $250.0 million in aggregate principal amount
of senior unsecured debt securities due in 2014 ("February Senior
Notes"). In December 2004 we sold $70.0 million in aggregate
principal amount of senior unsecured debt securities due in 2014
("December Senior Notes"). The February and December Senior Notes are
treated as a single class ("new Senior Notes").
February Senior Notes
The February Senior Notes were sold at a discount of $4.3 million.
The February Senior Notes are carried on our Consolidated Balance
Sheet net of the unamortized portion of the discount, which is being
amortized to Interest Expense over the life of the new Senior Notes.
The net proceeds of the offering were primarily used to repay our
existing $180.0 million 9.75% Senior Notes and to repay approximately
$43.8 million of the term portion and $10.0 million of the revolving
portion of our original Senior Credit Facility. In connection with
the issuance, we paid fees and other expenses of approximately $6.5
million that are being amortized over the life of the new Senior
Notes.
123 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
The February Senior Notes were offered only to qualified
institutional buyers pursuant to exemptions from registration under
the Securities Act. On July 7, 2004, we commenced an offer to
exchange the privately issued February Senior Notes for a like amount
of February Senior Notes that have been registered under the
Securities Act and have otherwise identical terms to the privately
issued original Senior Notes (except for provisions relating to our
obligations to consummate the exchange offer). The exchange offer
closing occurred on August 11, 2004, at which time all $250.0 million
in aggregate principal amount of the privately issued February Senior
Notes were tendered and exchanged for the February Senior Notes that
have been registered under the Securities Act.
December Senior Notes
The December Senior Notes were sold at face value.
The net proceeds of the offering were primarily used to repurchase
3,751,509 of GCI's Class A common shares at $8.33 per share and $10.0
million of GCI's Series C preferred stock from MCI. The aggregate
amount of the equity repurchase totaled $41.3 million. In addition we
used the proceeds to repay $10.0 million of the revolving portion of
our new Senior Credit Facility. In connection with the issuance, we
paid fees and other expenses of approximately $1.6 million that are
being amortized over the life of the new Senior Notes.
The December Senior Notes were offered only to qualified
institutional buyers pursuant to Rule 144A and non-United States
persons pursuant to Regulation S. The December Senior Notes have not
been registered under the Securities Act and, unless so registered,
may not be offered or sold except pursuant to an exemption from, or
in a transaction not subject to, the registration requirements of the
Securities Act and applicable state securities laws. Beginning April
6, 2005, we plan to commence an offer to exchange the privately
issued December Senior Notes that have been registered under the
Securities Act and have otherwise identical terms to the privately
issued original Senior Notes (except for provisions relating to GCI
Inc.'s obligations to consummate the exchange offer).
New Senior Notes
We pay interest of 7.25% on the new Senior Notes.
The new Senior Notes are not redeemable prior to February 15, 2009.
At any time on or after February 15, 2009, the new Senior Notes are
redeemable at our option, in whole or in part, on not less than
thirty days nor more than sixty days notice, at the following
redemption prices, plus accrued and unpaid interest (if any) to the
date of redemption:
If redeemed during the twelve month period
commencing February 1 of the year indicated: Redemption Price
-------------------------------------------- ----------------
2009 103.625%
2010 102.417%
2011 101.208%
2012 and thereafter 100.000%
We may, on or prior to February 17, 2007, at our option, use the net
cash proceeds of one or more underwritten public offerings of our
qualified stock to redeem up to a maximum of 35% of the initially
outstanding aggregate principal amount of our new Senior Notes at a
redemption price equal to 107.25% of the principal amount of the new
Senior Notes, together with accrued and unpaid interest, if any,
thereon to the date of redemption, provided that not less than 65% of
the principal amount of the new Senior Notes originally issued remain
outstanding following such a redemption.
124 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
The new Senior Notes restrict GCI, Inc. and certain of its
subsidiaries from incurring debt in most circumstances unless the
result of incurring debt does not cause our leverage ratio to exceed
6.0 to one. The new Senior Notes do not allow debt under the new
Senior Credit Facility to exceed the greater of (and reduced by
certain stated items):
o $250 million, reduced by the amount of any prepayments, or
o 3.0 times earnings before interest, taxes, depreciation and
amortization for the last four full fiscal quarters of GCI,
Inc. and certain of its subsidiaries.
The new Senior Notes limit our ability to make cash dividend
payments.
We conducted a Consent Solicitation and Tender Offer for the old
Senior Notes. Through February 13, 2004 we accepted for payment
$114.6 million principal amount of notes which were validly tendered.
Such notes accepted for payment received additional consideration as
follows:
o $4.0 million based upon a payment of $1,035 per $1,000
principal amount, consisting of the purchase price of $1,025
per $1,000 principal amount and the consent payment of $10
per $1,000 principal amount, and
o $497,000 in accrued and unpaid interest through February 16,
2004.
The remaining principal amount of $65.4 million was redeemed on March
18, 2004 for additional consideration as follows:
o $2.1 million based upon a payment of $1,032.50 per $1,000
principal amount, and
o $833,000 in accrued and unpaid interest through March 18,
2004.
The total redemption cost was $186.1 million. The premium to redeem
our old Senior Notes was $6.1 million (excluding interest cost of
$1.3 million) and was recognized as a loss on early extinguishment of
debt, a component of Other Income (Expense), during the year ended
December 31, 2004.
Compliance with the redemption notice requirements in the Indenture
resulted in a delay before final payment of some of the old Senior
Notes. As a result of such delay, our total debt increased during the
overlap period between the redemption of the old Senior Notes and the
issuance of the February Senior Notes making us out of compliance
with Section 6.11 of our Credit, Guaranty, Security and Pledge
Agreement, dated as of October 30, 2003. We received a waiver from
compliance with Section 6.11 until April 30, 2004. After the final
redemption payment on March 18, 2004 we were in compliance with
Section 6.11.
A semi-annual interest payment of approximately $9.0 million was paid
in August 2004. We will make semi-annual interest payments of $11.6
million in February and August 2005.
The new Senior Notes are subordinate to our new Senior Credit
Facility.
We were in compliance with all loan covenants at December 31, 2004.
125 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(b) On May 21, 2004 we amended our $220.0 million new Senior Credit
Facility. The amendment reduced the interest rate on the $170.0
million term portion of the credit facility from LIBOR plus 3.25% to
LIBOR plus 2.25%. The amendment reduced the interest rate on the
$50.0 million revolving portion of the credit facility from LIBOR
plus 3.25% to LIBOR plus a margin dependent upon our Total Leverage
Ratio (as defined) as follows:
Total Leverage Ratio
(as defined) LIBOR Plus:
---------------------- --------------------
>3.75 2.50%
-
>3.25 but <3.75 2.25%
-
>2.75 but <3.25 2.00%
-
< 2.75 1.75%
The commitment fee we are required to pay on the unused portion of
the commitment was amended as follows:
Total Leverage Ratio
(as defined) Commitment Fee
------------------------ --------------------
>3.75 0.625%
-
>2.75 but <3.75 0.50%
-
< 2.75 0.375%
Under certain circumstances the amendment allows for an increase in
the term and revolving commitments not to exceed an aggregate
commitment increase of $50.0 million. Any additional term and
revolving credit facility commitments are payable in full on October
31, 2007.
In connection with the May 21, 2004 amended Senior Credit Facility,
we paid bank fees and other expenses of approximately $215,000 during
the year ended December 31, 2004.
On November 17, 2004 we amended our $220.0 million new Senior Credit
Facility. The amendment allowed us to repurchase up to $10.0 million
of GCI's common stock each year and to complete the repurchase of
3,751,509 of GCI's Class A common shares and $10.0 million of GCI's
Series C preferred stock from MCI as described in note 11.
The November 2004 amendment reduced our leverage ratio requirements
for certain periods as follows:
Period Total Leverage Ratio
------ --------------------
December 31, 2003 through December 30, 2004 4.25:1
December 31, 2004 through December 30, 2005 4.00:1
December 31, 2005 through June 29, 2006 3.75:1
June 30, 2006 through June 29, 2007 3.50:1
June 30, 2007 through September 29, 2007 3.25:1
September 30, 2007 through final maturity date 3.00:1
The November amendment also increased our allowable capital
expenditures during the year ended December 31, 2004 by the $18.8
million excess proceeds from the December Senior Notes.
In connection with the November 17, 2004 amended Senior Credit
Facility, we paid bank fees and other expenses of approximately
$129,000 during the year ended December 31, 2004.
126 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
The term loan is fully drawn and we have letters of credit totaling
$4.7 million, which left $45.3 million available at December 31, 2004
to draw under the revolving credit facility if needed. Ability to
draw down on the revolver portion of our new Senior Credit Facility
could be diminished if we are not in compliance with all new Senior
Credit Facility covenants or have a material adverse change at the
date of the request for the draw.
Our new Senior Notes are subordinate to our new Senior Credit
Facility.
Substantially all of Holdings' assets collateralize the new Senior
Credit Facility. The capital lease is secured by the leased satellite
transponders.
We were in compliance with all loan covenants at December 31, 2004.
In October 2003 we amended our Senior Credit Facility, a portion of
which was a substantial modification of the previous Senior Credit
Facility agreement. We therefore recognized approximately $5.0
million in Amortization of Loan and Senior Notes Fees during the year
ended December 31, 2003. The $2.2 million in amended Senior Credit
Facility deferred loan costs associated with the portion that was not
a substantial modification continues to be amortized over the life of
the new Senior Credit Facility.
As of December 31, 2004 maturities of long-term debt were as follows
(amounts in thousands):
Years ending December 31,
2005 $ 168
2006 32,000
2007 89,000
2008 ---
2009 ---
2010 and thereafter 320,000
------------
441,168
Less unamortized bond discount paid on February
Senior Notes (4,031)
Less current portion of long-term debt (168)
------------
Long-term debt, at December 31, 2004 $ 436,969
============
(8) Impairment Charge
In 2003, we reported an impairment charge of $5.4 million which equaled
the remaining net book value recorded for our North Pacific Cable asset.
In 1991 GCI purchased one DS-3 of capacity on a fiber optic cable system
owned by AT&T. This fiber optic cable system is a spur off of a
trans-Pacific fiber optic cable system owned by another group. We used
our owned capacity to carry traffic to and from Alaska and the Lower 48
States. The section of the North Pacific Cable in which we owned capacity
was taken out of service in January 2004 due to a billing dispute between
AT&T and the owner of the trans-Pacific cable system causing us to
re-route certain of our traffic. We were relieved of all future
obligations required by our purchase agreement and ceased payment of
maintenance and vessel standby costs totaling approximately $324,000 per
year that would otherwise be payable over the remaining life of the
system. The AULP West fiber optic cable system we built was put into
service in June 2004 and provides us with route diversity and redundancy
in excess of that previously provided by the North Pacific Cable.
(9) Comprehensive Income (Loss)
During the years ended December 31, 2004, 2003 and 2002 we had other
comprehensive income (loss) of approximately $308,000, 232,000 and
($548,000), respectively. Total comprehensive income during the years
ended December 31, 2004, 2003 and 2002 was $21,560,000, $15,774,000 and
$6,115,000, respectively.
127 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(10) Income Taxes
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.
Total income tax (expense) benefit was allocated as follows (amounts in
thousands):
Years ended December 31,
2004 2003 2002
-------------- ------------- ------------
Net income before cumulative effect of a change in $ (17,463) (10,074) (5,659)
accounting principle
Cumulative effect of a change in accounting principle --- 367 ---
-------------- ------------- ------------
Net income from continuing operations (17,463) (9,707) (5,659)
Stockholder's equity, for stock option compensation
expense for tax purposes in excess of amounts
recognized for financial reporting purposes 1,730 538 319
-------------- ------------- ------------
$ (15,733) (9,169) (5,340)
============== ============= ============
Income tax (expense) benefit consists of the following (amounts in
thousands):
Years ended December 31,
2004 2003 2002
-------------- ------------- ------------
Current tax expense:
Federal taxes $ 606 (297) (1,754)
State taxes 176 (104) (536)
-------------- ------------- ------------
782 (401) (2,290)
-------------- ------------- ------------
Deferred tax expense:
Federal taxes (14,151) (7,169) (2,580)
State taxes (4,094) (2,504) (789)
-------------- ------------- ------------
(18,245) (9,673) (3,369)
-------------- ------------- ------------
$ (17,463) (10,074) (5,659)
============== ============= ============
Total income tax expense differed from the "expected" income tax expense
determined by applying the statutory federal income tax rate of 35% for
2004 and 2003 and 34% for 2002 as follows (amounts in thousands):
Years ended December 31,
2004 2003 2002
----------------- -------------- --------------
"Expected" statutory tax expense $ (13,550) (9,156) (4,189)
State income taxes, net of federal benefit (2,439) (1,695) (873)
Income tax effect of goodwill amortization,
nondeductible expenditures and other items, net (668) (568) (597)
Adjustments to ending temporary difference and other
balances, net (806) 1,345 ---
----------------- -------------- --------------
$ (17,463) (10,074) (5,659)
================= ============== ==============
128 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 2004 and 2003 are presented below (amounts in thousands):
December 31,
2004 2003
-------------- ---------------
Current deferred tax assets:
Net operating loss carryforwards $ 8,344 ---
Accounts receivable, principally due to allowance for
doubtful accounts 2,450 4,117
Compensated absences, accrued for financial reporting
purposes 2,186 2,062
Workers compensation and self insurance health reserves,
principally due to accrual for financial reporting
purposes 854 801
Other 59 215
-------------- ---------------
Total current deferred tax assets $ 13,893 7,195
============== ===============
December 31,
2004 2003
-------------- ---------------
Long-term deferred tax assets:
Net operating loss carryforwards $ 63,524 77,534
Alternative minimum tax credits 1,892 1,892
Deferred compensation expense for financial reporting
purposes in excess of amounts recognized for tax
purposes 1,729 1,531
Asset retirement obligations in excess of amounts
recognized for tax purposes 1,218 825
Employee stock option compensation expense for financial
reporting purposes in excess of amounts recognized for
tax purposes 601 727
Sweepstakes award in excess of amounts recognized for tax
purposes 178 179
Charitable contributions expense for financial reporting
in excess of amount recognized for tax purposes 405 672
Cost of sales and services for financial reporting in
excess of amounts recognized for tax purposes --- 185
Cash flow hedge expense for financial reporting
purposes in excess of amounts recognized for tax
purposes --- 212
Other 118 ---
-------------- ---------------
Total long-term deferred tax assets 69,665 83,757
-------------- ---------------
Long-term deferred tax liabilities:
Plant and equipment, principally due to differences in
depreciation 101,603 93,928
Amortizable assets 17,173 13,997
-------------- ---------------
Total gross long-term deferred tax liabilities 118,776 107,925
-------------- ---------------
Net combined long-term deferred tax liabilities $ 49,111 24,168
============== ===============
129 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
We recorded net deferred tax assets of $15.8 million in 2002 associated
with the Rogers American Cablesystems, Inc. and Kanas Telecom, Inc.
acquisitions in 2001, resulting in adjustments to the recorded financial
statement cost basis of associated goodwill and property and equipment.
In conjunction with the 1996 Cable Companies acquisition, GCI incurred a
net deferred income tax liability of $24.4 million and acquired net
operating losses totaling $57.6 million. GCI determined that
approximately $20 million of the acquired net operating losses would not
be utilized for income tax purposes, and elected with its December 31,
1996 income tax returns to forego utilization of such acquired losses
under Internal Revenue Code section 1.1502-32(b)(4). Deferred tax assets
were not recorded associated with the foregone losses and, accordingly,
no valuation allowance was provided. At December 31, 2004, we have (1)
tax net operating loss carryforwards of approximately $175.6 million that
will begin expiring in 2007 if not utilized, and (2) alternative minimum
tax credit carryforwards of approximately $1.9 million available to
offset regular income taxes payable in future years. We utilized tax net
operating loss carryforwards of approximately $5.6 million in 2004.
The following schedule shows our tax net operating loss carryforwards by
year of expiration (amounts in thousands):
Years ending December 31, Federal State
------------ ------------
2007 $ 705 17
2008 6,435 6,434
2009 11,767 11,767
2010 9,134 9,134
2011 6,919 6,919
2018 19,995 18,253
2019 27,910 26,516
2020 44,747 43,799
2021 29,614 28,998
2022 14,080 13,796
2023 3,967 3,909
2024 362 362
------------ ------------
Total tax net operating loss carryforwards $ 175,635 169,904
============ ============
Our utilization of remaining acquired net operating loss carryforwards is
subject to annual limitations pursuant to Internal Revenue Code section
382 which could reduce or defer the utilization of these losses.
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.
Our United States income tax return for 2000 was selected for examination
by the Internal Revenue Service during 2003. The examination was
completed in July 2004 and did not have a material adverse effect on our
financial position, results of operations, or our liquidity.
Our United States income tax return for 2001 was selected for examination
by the Internal Revenue Service during 2004. The examination was
completed in December 2004 and did not have a material adverse effect on
our financial position, results of operations, or our liquidity.
130 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
(11) Stockholder's Equity
Common Stock
We were incorporated in 1997 and issued 100 shares of our no par Class A
common stock to GCI in our initial capitalization. We received all
ownership interests in subsidiaries previously held by GCI and proceeds
from GCI's August 1, 1997 common stock offering. We recorded $206,622,000
associated with our initial capitalization. All of our issued and
outstanding Class A common stock is owned by GCI.
Stock Option Plan
In December 1986, GCI adopted a Stock Option Plan (the "Option Plan") in
order to provide a special incentive to our officers, non-employee
directors, and employees by offering them an opportunity to acquire an
equity interest in GCI. The Option Plan, as amended, provides for the
grant of options for a maximum of 13.2 million shares of GCI Class A
common stock, subject to adjustment upon the occurrence of stock
dividends, stock splits, mergers, consolidations or certain other changes
in corporate structure or capitalization. If an option expires or
terminates, the shares subject to the option will be available for
further grants of options under the Option Plan. The Compensation
Committee of GCI's Board of Directors administers the Option Plan.
The Option Plan provides that all options granted under the Option Plan
must expire not later than ten years after the date of grant. If at the
time an option is granted the exercise price is less than the market
value of the underlying common stock, the difference in these amounts at
the time of grant is expensed ratably over the vesting period of the
option. Options granted pursuant to the Option Plan are only exercisable
if at the time of exercise the option holder is our employee,
non-employee director, or a consultant or advisor working on our behalf.
Our employees and employees of our subsidiaries are eligible to
participate in the Option Plan. Expenses associated with the grant of
options to employees are recorded pursuant to the provisions of APB
Number 25 and Interpretative Releases 1 and 2 of SAB Topic 1B1, which
amounts were not material in 2004, 2003 and 2002. We believe the
allocation method used is reasonable.
131 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Information for the years 2004, 2003 and 2002 with respect to the Option
Plan follows:
Weighted
Average
Shares Exercise Price
---------------- ---------------
Outstanding at December 31, 2001 5,100,131 $6.11
Granted 1,995,700 $6.90
Exercised (583,888) $5.78
Forfeited (223,177) $7.42
----------------
Outstanding at December 31, 2002 6,288,766 $6.34
Granted 963,200 $6.24
Exercised (377,487) $4.95
Forfeited (98,200) $5.93
----------------
Outstanding at December 31, 2003 6,776,279 $6.41
Granted 881,500 $8.19
Exercised (1,116,704) $5.49
Forfeited (104,200) $7.07
----------------
Outstanding at December 31, 2004 6,436,875 $6.81
================
Available for grant at December 31, 2004 1,745,457
================
Our stock options and warrants expire at various dates through December
2013. At December 31, 2004, 2003, and 2002, the weighted-average
remaining contractual lives of options outstanding were 6.16, 6.47, and
6.93 years, respectively.
At December 31, 2004, 2003, and 2002, the number of exercisable shares
under option was 3,473,340, 3,495,361, and 3,187,618, respectively, and
the weighted-average exercise price of those options was $6.45, $6.11,
and $5.87, respectively.
The per share weighted-average fair value of stock options granted during
2004 was $4.65 per share for compensatory and $4.48 for non-compensatory
options; for 2003 was $4.30 per share for compensatory and $2.99 for
non-compensatory options; and for 2002 was $3.05 per share for
compensatory and $0.61 for non-compensatory options. The amounts were
determined as of the options' grant dates using a Black-Scholes
option-pricing model with the following weighted-average assumptions:
2004 - risk-free interest rate of 3.62%, volatility of 0.52 and an
expected life of 5.69 years; 2003 - risk-free interest rate of 3.45%,
volatility of 0.53 and an expected life of 5.26 years; and 2002 -
risk-free interest rate of 3.08%, volatility of 0.68 and an expected life
of 6.18 years.
132 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Summary information about our stock options outstanding at December 31,
2004 follows:
Options Outstanding Options Exercisable
-------------------------------------------------------------------------- --------------------------------------
Weighted
Average
Remaining Weighted
Range of Number Contractual Average Number Weighted Average
Exercise Prices outstanding Life Exercise Price Exercisable Exercise Price
-------------------------------------------------------------------------- --------------------------------------
$3.11-$5.69 671,542 5.01 $4.65 514,342 $4.49
$5.77-$5.77 2,000 8.14 $5.77 400 $5.77
$6.00-$6.00 1,028,030 6.73 $6.00 466,190 $6.00
$6.05-$6.35 58,000 6.27 $6.14 40,600 $6.13
$6.50-$6.50 1,817,610 5.46 $6.50 1,323,150 $6.50
$6.94-$7.00 680,300 3.69 $7.00 531,366 $6.99
$7.25-$7.25 1,150,000 7.11 $7.25 151,665 $7.25
$7.40-$8.40 794,893 7.16 $7.98 363,687 $7.70
$8.50-$10.98 463,500 8.74 $9.15 57,940 $9.48
$11.25-$11.25 36,000 6.50 $11.25 24,000 $11.25
-------------- ---------------
$3.11-$11.25 6,701,875 6.16 $6.80 3,473,340 $6.45
============== ===============
Stock Warrants Not Pursuant to a Plan
We entered into a stock warrant agreement in exchange for services in
December 1998 with certain of our legal counsel which provides for the
purchase of 16,667 shares of GCI Class A common stock, vesting in
December 1999, with an exercise price of $3.00 per share, and expiring
December 2003. The fair value of the stock warrant when issued was
approximately $23,000. The warrant was exercised in November 2003 prior
to its expiration.
We entered into a stock warrant agreement in exchange for services in
June 1999 with certain of our legal counsel which provides for the
purchase of 25,000 shares of GCI Class A common stock, vesting through
December 2001, with an exercise price of $3.00 per share, and expiring
December 2003. The fair value of the stock warrant when issued was
approximately $94,000. The warrant was exercised in October 2003 prior to
its expiration.
Employee Stock Purchase Plan
In December 1986, GCI adopted an Employee Stock Purchase Plan ("Plan")
qualified under Section 401 of the Internal Revenue Code of 1986
("Code"). The Plan provides for acquisition of GCI's Class A and Class B
common stock at market value. The Plan permits each employee who has
completed one year of service to elect to participate in the Plan.
Through December 31, 2004, eligible employees could elect to reduce their
compensation in any even dollar amount up to 50 percent of such
compensation (subject to certain limitations) up to a maximum of $13,000.
Beginning January 1, 2005, eligible employees can elect to reduce their
compensation in any even dollar amount up to 50 percent of such
compensation (subject to certain limitations) up to a maximum of $14,000.
Eligible employees may contribute up to 10 percent of their compensation
with after-tax dollars, or they may elect a combination of salary
reductions and after-tax contributions.
Eligible employees were allowed to make catch-up contributions of no more
than $3,000 during the year ended December 31, 2004 and will be able to
make such contributions limited to $4,000 during the year ended December
31, 2005. We do not match employee catch-up contributions.
133 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
We may match employee salary reductions and after tax contributions in
any amount, elected by GCI's Board of Directors each year, but not more
than 10 percent of any one employee's compensation will be matched in any
year. Matching contributions vest over the initial six years of
employment. For the years ended December 31, 2003 and 2002 the
combination of salary reductions, after tax contributions and matching
contributions could not exceed the lesser of 100 percent of an employee's
compensation or $40,000 (determined after salary reduction) for any year.
For the year ended December 31, 2004, the combination of salary
reductions, after tax contributions and matching contributions could not
exceed the lesser of 100 percent of an employee's compensation or $41,000
(determined after salary reduction).
Employee contributions may be invested in GCI class A common stock, AT&T
common stock, Comcast Corporation common stock, or various mutual funds.
As of April 1, 2004 employee contributions receive up to 100% matching,
as determined by GCI's Board of Directors each year, in GCI common stock.
Prior to April 1, 2004 employee contributions invested in GCI common
stock received up to 100% matching, as determined by GCI's Board of
Directors each year, in GCI common stock and employee contributions
invested in other than GCI common stock received up to 50% matching, as
determined by GCI's Board of Directors each year, in GCI common stock.
Our matching contributions allocated to participant accounts totaled
approximately $4,858,000, $4,035,000, and $3,665,000 for the years ended
December 31, 2004, 2003, and 2002, respectively. The Plan may, at its
discretion, purchase shares of GCI common stock from GCI at market value
or may purchase GCI's common stock on the open market. In 2004 and 2003
we funded all of our employer-matching contributions through market
purchases. In 2002 we funded a portion of our employer-matching
contributions through GCI's issuance of new shares of its common stock
rather than market purchases.
(12) 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 35 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, Ketchikan,
Kenai, Soldotna, Kodiak, Seward, Cordova, Valdez, and Nome and retail
cable modem service (through our Internet services segment) in all of
our locations in Alaska except Kotzebue.
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.
Revenue, costs of sales and service and operating expenses for our new
phone directories are included in the local access services segment.
134 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Internet services. We offer wholesale and retail Internet services to
both consumer and commercial customers. We offer cable modem service as
further described in Cable services above. Our undersea fiber optic
cable systems allow 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.
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. All of our long-lived assets are located within the United
States of America, except approximately 82% of our undersea fiber optic
cable systems which transit international waters.
Summarized financial information for our reportable segments for the
years ended December 31, 2004, 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
--------------------------------------------------------------------------------
2004
----
Revenues:
Intersegment $ 14,447 2,596 9,436 3,731 30,210 794 31,004
External 210,135 101,437 46,957 25,969 384,498 40,328 424,826
--------------------------------------------------------------------------------
Total revenues 224,582 104,033 56,393 29,700 414,708 41,122 455,830
--------------------------------------------------------------------------------
Cost of goods sold (exclusive
of depreciation, amortization
and accretion shown separately
below) ("Cost of goods sold"):
Intersegment 20,441 1 2,624 4,322 27,388 482 27,870
External 54,143 26,959 29,088 6,991 117,181 22,382 139,563
--------------------------------------------------------------------------------
Total cost of good sold 74,584 26,960 31,712 11,313 144,569 22,864 167,433
--------------------------------------------------------------------------------
Contribution:
Intersegment (5,994) 2,595 6,812 (591) 2,822 312 3,134
External 155,992 74,478 17,869 18,978 267,317 17,946 285,263
--------------------------------------------------------------------------------
Total contribution 149,998 77,073 24,681 18,387 270,139 18,258 288,397
Selling, general and
administrative expenses 40,065 28,100 18,316 9,377 95,858 51,502 147,360
Bad debt expense (recovery) (2,962) 932 279 154 (1,597) 523 (1,074)
--------------------------------------------------------------------------------
Earnings (loss) from
operations before
depreciation, amortization,
net interest expense and
income taxes 118,889 45,446 (726) 9,447 173,056 (34,079) 138,977
135 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Reportable Segments
----------------------------------------------------------
Long- Local Total
Distance Cable Access Internet Reportable All
Services Services Services Services Segments Other Total
--------------------------------------------------------------------------------
Depreciation, amortization
and accretion expense 25,519 19,038 4,941 3,984 53,482 9,631 63,113
--------------------------------------------------------------------------------
Operating income (loss) $ 93,370 26,408 (5,667) 5,463 119,574 (43,710) 75,864
================================================================================
Total assets $ 310,820 328,887 55,120 30,101 724,928 124,263 849,191
================================================================================
Capital additions $ 46,892 20,350 19,280 9,085 95,607 16,972 112,579
================================================================================
2003
----
Revenues:
Intersegment $ 13,648 2,504 9,763 2,423 28,338 744 29,082
External 204,567 96,004 38,998 19,842 359,411 31,386 390,797
--------------------------------------------------------------------------------
Total revenues 218,215 98,508 48,761 22,265 387,749 32,130 419,879
--------------------------------------------------------------------------------
Cost of goods sold:
Intersegment 19,242 1 2,121 4,484 25,848 860 26,708
External 53,377 25,988 23,761 5,862 108,988 16,395 125,383
--------------------------------------------------------------------------------
Total cost of good sold 72,619 25,989 25,882 10,346 134,836 17,255 152,091
--------------------------------------------------------------------------------
Contribution:
Intersegment (5,594) 2,503 7,642 (2,061) 2,490 (116) 2,374
External 151,190 70,016 15,237 13,980 250,423 14,991 265,414
--------------------------------------------------------------------------------
Total contribution 145,596 72,519 22,879 11,919 252,913 14,875 267,788
Selling, general and
administrative expenses 37,692 27,101 17,718 8,589 91,100 47,593 138,693
Bad debt expense (recovery) (1,104) 651 119 60 (274) 96 (178)
Impairment charge 5,434 --- --- --- 5,434 --- 5,434
--------------------------------------------------------------------------------
Earnings (loss) from
operations before
depreciation, amortization,
net interest expense and
income taxes 109,168 42,264 (2,600) 5,331 154,163 (32,698) 121,465
Depreciation, amortization
and accretion expense 20,209 17,296 3,553 3,708 44,766 8,622 53,388
--------------------------------------------------------------------------------
Operating income (loss) $ 88,959 24,968 (6,153) 1,623 109,397 (41,320) 68,077
================================================================================
Total assets $ 274,519 326,435 40,763 26,262 667,979 95,041 763,020
================================================================================
Capital additions $ 30,331 15,223 3,608 2,993 52,155 10,324 62,479
================================================================================
2002
----
Revenues:
Intersegment $ 21,297 2,094 9,723 2,026 35,140 744 35,884
External 204,930 88,688 32,071 15,584 341,273 26,569 367,842
--------------------------------------------------------------------------------
Total revenues 226,227 90,782 41,794 17,610 376,413 27,313 403,726
--------------------------------------------------------------------------------
Cost of goods sold:
Intersegment 16,942 --- 2,100 14,988 34,030 752 34,782
External 60,053 23,649 20,205 4,792 108,699 14,865 123,564
--------------------------------------------------------------------------------
Total cost of good sold 76,995 23,649 22,305 19,780 142,729 15,617 158,346
--------------------------------------------------------------------------------
136 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Reportable Segments
----------------------------------------------------------
Long- Local Total
Distance Cable Access Internet Reportable All
Services Services Services Services Segments Other Total
--------------------------------------------------------------------------------
Contribution:
Intersegment 4,355 2,094 7,623 (12,962) 1,110 (8) 1,102
External 144,877 65,039 11,866 10,792 232,574 11,704 244,278
--------------------------------------------------------------------------------
Total contribution 149,232 67,133 19,489 (2,170) 233,684 11,696 245,380
Selling, general and
administrative expenses 36,378 25,264 16,600 8,855 87,097 41,932 129,029
Bad debt expense 12,388 428 162 54 13,032 92 13,124
--------------------------------------------------------------------------------
Earnings (loss) from
operations before
depreciation and
amortization, net interest
expense and income taxes 96,111 39,347 (4,896) 1,883 132,445 (30,320) 102,125
Depreciation and
amortization expense 22,167 15,882 3,466 3,524 45,039 11,361 56,400
--------------------------------------------------------------------------------
Operating income (loss) $ 73,945 23,465 (8,362) (1,641) 87,407 (41,682) 45,725
================================================================================
Total assets $ 261,978 322,899 35,276 28,102 648,255 90,527 738,782
================================================================================
Capital additions $ 22,832 17,395 10,388 4,215 54,830 10,310 65,140
================================================================================
Long-distance services, local access services and Internet services are
billed utilizing a unified accounts receivable system and are not
reported separately by business segment. All such accounts receivable are
included above in the long-distance services segment for all periods
presented.
A reconciliation of reportable segment revenues to consolidated revenues
follows (amounts in thousands):
Years ended December 31, 2004 2003 2002
--------------- --------------- --------------
Reportable segment revenues $ 414,708 387,749 376,413
Plus All Other revenues 41,122 32,130 27,313
Less intersegment revenues eliminated in consolidation 31,004 29,082 35,884
--------------- --------------- --------------
Consolidated revenues $ 424,826 390,797 367,842
=============== =============== ==============
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):
Years ended December 31, 2004 2003 2002
-------------- ---------------- --------------
Reportable segment earnings from operations before
depreciation, amortization and accretion expense, net other
expense and income taxes $ 173,056 154,163 132,445
Less All Other loss from operations before depreciation,
amortization and accretion expense, net other expense and
income taxes 34,079 32,698 30,320
-------------- ---------------- --------------
Consolidated earnings from operations before
depreciation, amortization and accretion expense, net
other expense and income taxes 138,977 121,465 102,125
137 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2004 2003 2002
-------------- ---------------- --------------
Less depreciation, amortization and accretion expense $ 63,113 53,388 56,400
-------------- ---------------- --------------
Consolidated operating income 75,864 68,077 45,725
Less other expense, net 37,149 41,917 33,403
-------------- ---------------- --------------
Consolidated net income before income taxes and cumulative
effect of a change in accounting principle $ 38,715 26,160 12,322
============== ================ ==============
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):
Years ended December 31, 2004 2003 2002
--------------- --------------- --------------
Reportable segment operating income $ 119,574 109,397 84,483
Less All Other operating loss 43,710 41,320 38,758
--------------- --------------- --------------
Consolidated operating income 75,864 68,077 45,725
Less other expense, net 37,149 41,917 33,403
--------------- --------------- --------------
Consolidated net income before income taxes and cumulative
effect of a change in accounting principle $ 38,715 26,160 12,322
=============== =============== ==============
We earn revenues included in the long-distance services segment from MCI,
a major customer. We earned revenues from MCI, net of discounts, of
approximately $81,741,000, $81,996,000 and $84,641,000 for the years
ended December 31, 2004, 2003 and 2002, respectively. Revenues earned
from MCI include approximately $11,004,000 for the year ended December
31, 2002 earned from a certain MCI customer who considered itself to be a
third party obligor that was ultimately liable for services provided by
us to the third party under a contract that had been assigned to MCI.
Beginning January 1, 2003 we have billed this customer directly for
services provided. Revenues earned from MCI net of amounts earned from
the third party obligor were approximately $73,637,000 for the year ended
December 31, 2002. As a percentage of total revenues, MCI revenues, net
of amounts earned from the third party obligor, totaled 19.2%, 21.0% and
20.0% for the years ended December 31, 2004, 2003 and 2002, respectively.
On July 21, 2002 MCI and substantially all of its active United States
subsidiaries filed voluntary petitions for reorganization under Chapter
11 of the United States Bankruptcy Code in the United States Bankruptcy
Court. On July 22, 2003, the United States Bankruptcy Court approved a
settlement agreement for pre-petition amounts owed to us by MCI and
affirmed all of our existing contracts with MCI. MCI emerged from
bankruptcy protection on April 20, 2004. The remaining pre-petition
accounts receivable balance owed by MCI to us after this settlement was
$11.1 million ("MCI credit") which we have used and will continue to use
as a credit against amounts payable for services purchased from MCI.
After settlement, we began reducing the MCI credit as we utilized it for
services otherwise payable to MCI. We have accounted for our use of the
MCI credit as a gain contingency, and, accordingly, are recognizing a
reduction of bad debt expense as services are provided by MCI and the
credit is realized. During the years ended December 31, 2004 and 2003 we
realized approximately $4.2 million and $2.8 million, respectively, of
the MCI credit against amounts payable for services received from MCI.
During the year ended December 31, 2002 we recorded bad debt expense of
approximately $11.0 million associated with MCI's bankruptcy.
138 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
The remaining unused MCI credit totaled $3.7 million and $7.9 million at
December 31, 2004 and 2003, respectively. The credit balance is not
recorded on the Consolidated Balance Sheet as we are recognizing recovery
of bad debt expense as the credit is realized.
(13) Financial Instruments
Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing
parties. At December 31, 2004 and 2003 the fair values of cash and cash
equivalents, net receivables, current portion of notes receivable from
related parties, current maturities of capital lease obligations and
long-term debt, accounts payable, accrued payroll and payroll related
obligations, due from related party, accrued interest, accrued
liabilities, and subscriber deposits approximate their carrying value due
to the short-term nature of these financial instruments. The carrying
amounts and estimated fair values of our financial instruments at
December 31, 2004 and 2003 follows (amounts in thousands):
2004 2003
------------------------------ ---------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------------------ ---------------------------
Notes receivable with related parties $ 3,345 3,345 3,443 3,443
Long-term debt and capital lease obligations $ 470,391 474,422 384,636 401,987
Cash flow hedge liability $ --- --- 515 515
Other liabilities $ 8,108 8,108 5,931 5,931
The following methods and assumptions were used to estimate fair values:
Notes receivable from related parties: Substantially all of the
carrying value of the long-term portion of notes receivable from
related parties is estimated to approximate fair value because these
instruments are subject to variable interest rates.
Long-term debt and capital lease obligations: The fair value of our
Senior Notes is estimated based on the quoted market price for the
same issue. The fair value of our Senior Credit Facility and
obligations under capital leases is estimated to approximate the
carrying value because these instruments are subject to variable
interest rates.
Other Liabilities: Deferred compensation liabilities have no defined
maturity dates therefore the fair value is the amount payable on
demand as of the balance sheet date. Asset retirement obligations are
recorded at their fair value and, over time, the liability is
accreted to its present value each period.
Derivative Instruments and Hedging Activities
Effective January 3, 2001, we entered into an interest rate swap
agreement to convert $50 million of 9.75% fixed rate debt to a variable
interest rate equal to the 90 day LIBOR rate plus 334 basis points. This
interest rate swap was cancelled by the counterparty on August 1, 2002.
The differential paid to us was recorded as a decrease in Interest
Expense in the Consolidated Statements of Operations in the period in
which it was recognized. During the year ended December 31, 2002 we
recognized approximately $1.2 million as a reduction of interest expense.
Effective September 21, 2001, we entered into an interest rate swap
agreement to convert $25.0 million of variable interest rate debt equal
to the 90 day LIBOR rate plus 334 basis points to 3.98% fixed rate debt
plus applicable margins. Terms of the interest rate swap mirror the
underlying variable rate
139 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
debt, except the interest rate swap terminated on September 21, 2004. We
entered into the transaction to help insulate us from future increases in
interest rates. Under SFAS No. 133, the interest rate swap was accounted
for as a cash flow hedge. The change in the fair value of the interest
rate swap net of income taxes was recorded as an increase or decrease in
Accumulated Other Comprehensive Loss in the Consolidated Statements of
Stockholder's Equity. The associated cost was recognized in Interest
Expense in the Consolidated Statements of Operations. During the years
ended December 31, 2004, 2003 and 2002 we recognized approximately
$526,000, $681,000 and $555,000, respectively, in incremental interest
expense resulting from this transaction.
(14) Related Party Transactions
MCI
MCI was a related party through December 7, 2004 and during the years
ended December 31, 2003 and 2002. In December 2004 we repurchased from
MCI 3,751,509 shares of GCI's Class A common stock after which MCI no
longer qualifies as a related party. We earned revenues from MCI, net of
discounts, of approximately $81,741,000, $81,996,000 and $84,641,000 for
the years ended December 31, 2004, 2003 and 2002, respectively. Revenues
earned from MCI include approximately $11,004,000 for the year ended
December 31, 2002 earned from a certain MCI customer who considered
itself to be a third party obligor that was ultimately liable for
services provided by GCI to the third party under a contract that had
been assigned to MCI. Beginning January 1, 2003 we have billed this
customer directly for services provided. Revenues earned from MCI net of
amounts earned from the third party obligor were approximately
$73,637,000 for the year ended December 31, 2002. As a percentage of
total revenues, MCI revenues, net of amounts earned from the third party
obligor, totaled 19.2%, 21.0% and 20.0% for the years ended December 31,
2004, 2003 and 2002, respectively.
Amounts receivable, net of accounts payable, from MCI totaled $25,585,000
at December 31, 2003. We paid MCI to distribute our traffic in the
contiguous 48 states and Hawaii approximately $4,174,000, $4,570,000 and
$4,911,000 for the years ended December 31, 2004, 2003 and 2002,
respectively.
Other
GCI is a related party due to its 100% ownership of our Class A common
stock. We pay the dividends on GCI's preferred stock and in 2004 we
funded the redemption of GCI's Series C preferred stock, the purchase of
MCI's 3,751,509 shares of GCI's Class A common stock, and the buyback
program of GCI's common stock. During the years ended December 31, 2004,
2003 and 2002 we paid GCI's preferred stock dividends of $1,637,000,
$2,036,000 and $2,045,000, respectively. During the year ended December
31, 2004 we paid $31.3 million, $10.0 million, and $2.4 million to
purchase MCI's ownership of GCI's Class A common stock, to redeem GCI's
Series C preferred stock, and to repurchase GCI's common stock,
respectively.
GCI entered into a long-term capital lease agreement in 1991 with the
wife of our President and CEO for property occupied by us. The leased
asset was capitalized in 1991 at the owner's cost of $900,000 and the
related obligation was recorded in the accompanying financial statements.
The lease agreement was amended in September 2002. The amended lease
terminates on September 30, 2011. Through September 30, 2003 our monthly
payment was $20,000, increasing to $20,860 per month October 1, 2003
through September 30, 2006 and increasing to $21,532 per month October 1,
2006 through September 30, 2011. Since the property was not sold prior to
the tenth year of the lease, the owner was required to pay us the greater
of one-half of the appreciated value of the property over $900,000, or
$500,000. Accordingly, we received a $500,000 payment in 2002. The owner
paid us $135,000 in 2002 as additional consideration for the execution of
the September 2002 amendment.
In January 2001 we entered into an aircraft operating lease agreement
with a company owned by our President and CEO. The lease was amended
effective January 1, 2002. The lease is month-to-month
140 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
and may be terminated at any time upon one hundred and twenty days
written notice. The monthly lease rate is $50,000. Upon signing the
lease, the lessor was granted an option to purchase 250,000 shares of GCI
Class A common stock at $6.50 per share, all of which are exercisable. We
paid a deposit of $1.5 million in connection with the lease. The deposit
will be repaid to us upon the earlier of six months after the agreement
terminates, or nine months after the date of a termination notice. The
lessor may sell to us the stock arising from the exercise of the stock
option or surrender the right to purchase all or a portion of the stock
option to repay the deposit, if allowed by our debt and GCI's preferred
stock instrument in effect at such time.
(15) Commitments and Contingencies
Leases
Operating Leases as Lessee. We lease business offices, have entered into
site lease agreements and use satellite transponder capacity and certain
equipment pursuant to operating lease arrangements. Rental costs,
including immaterial amounts of contingent rent expense, under such
arrangements amounted to approximately $18,146,000, $15,899,000 and
$13,795,000 for the years ended December 31, 2004, 2003 and 2002,
respectively.
Satellite Transponder Capacity Capital Lease
We lease satellite transponder capacity through a capital lease
arrangement with a leasing company. The capital lease was entered into in
March 2000. The effective term of the lease is nine years from the
closing date, the lease matures through March 2009 and a final payment of
$16.1 million is due March 31, 2009. The interest rate is Libor plus
3.25%. The lease is subordinate to our new Senior Notes and new Senior
Credit Facility. The capital lease includes certain covenants requiring
maintenance of specific levels of operating cash flow to indebtedness and
limitations on additional indebtedness. We were in compliance with all
covenants during the year ending December 31, 2004.
We began operating the satellite transponders on April 1, 2000. The
satellite transponders are recorded at a cost of $48.0 million and are
being depreciated over twelve years. We have financed $38.7 million and
$43.5 million under this capital lease at December 31, 2004 and 2003,
respectively.
We entered into a long-term capital lease agreement in 1991 with the wife
of our President and CEO for property occupied by us as further described
in note 14.
141 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
A summary of future minimum lease payments for all leases follows
(amounts in thousands):
Years ending December 31: Operating Capital
------------ -------------
2005 $ 14,564 9,461
2006 11,676 9,232
2007 9,404 8,617
2008 8,362 7,706
2009 6,708 18,092
2010 and thereafter 22,057 452
------------ -------------
Total minimum lease payments $ 72,771 53,560
============
Less amount representing interest (13,899)
Less current maturities of obligations under capital
leases (6,239)
-------------
Subtotal - long-term obligations under capital leases 33,422
Less long-term obligations under capital leases due to
related party, excluding current maturities (672)
-------------
Long-term obligations under capital leases, excluding
related party, excluding current maturities $ 32,750
=============
The leases generally provide that we pay the taxes, insurance and
maintenance expenses related to the leased assets. Several of our leases
include renewal options, escalation clauses and immaterial amounts of
contingent rent expense. We have no leases that include rent holidays. We
expect that in the normal course of business leases that expire will be
renewed or replaced by leases on other properties.
Telecommunication Services Agreements
We lease a portion of our 800-mile fiber optic system capacity that
extends from Prudhoe Bay to Valdez via Fairbanks, and provide management
and maintenance services for this capacity to a customer. In December
2001 we signed a letter of agreement with our customer in which we
agreed, amongst other things, to upgrade the 800-mile fiber optic system,
install multiple earth stations, and potentially provide other services.
We completed the projects outlined in the letter of agreement and our
work was accepted by the customer in 2004. The contract was amended in
2004 consistent with the terms of the letter of agreement. The
telecommunications service agreement is for fifteen years and may be
extended for up to two successive three-year periods and, upon expiration
of the extensions, one additional year. The agreement may be canceled by
either party with 180 days written notice.
We lease a portion of our AULP East fiber optic system capacity to a
customer. The lease agreement is for five years and may be extended on a
month-to-month basis following the expiration of the initial term in June
2009.
142 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
A summary of minimum future service revenues, assuming the agreement for
a portion of our 800-mile fiber optic system capacity is not terminated
pursuant to contract provisions, follows (amounts in thousands):
Years ending December 31,
2005 $ 18,360
2006 18,360
2007 18,360
2008 18,360
2009 15,780
2010 and thereafter 85,276
------------
Total minimum future service revenues $ 174,496
============
Letters of Credit
We have letters of credit totaling $4,750,000 as follows:
o $3.0 million of the new Senior Credit Facility has been used to
provide a letter of credit to secure payment of certain access
charges associated with our provision of telecommunications
services within the State of Alaska,
o $1.5 million of the new Senior Credit Facility has been used to
provide a letter of credit in lieu of a deposit for the
self-insured portion of our workers compensation insurance,
o $150,000 of the new Senior Credit Facility has been used to
provide a letter of credit to secure general liability
insurance, and
o $100,000 of the new Senior Credit Facility has been used to
provide a letter of credit to secure right of way access.
Digital Local Phone Service ("DLPS") Equipment Purchase Commitment
To ensure the necessary equipment is available to us to provision DLPS
service delivery, we have entered into an agreement to purchase a certain
number of outdoor, network powered multi-media adapters. During the year
ended December 31, 2004 we purchased adapters totaling $6.0 million
pursuant to our commitment. The agreement has a remaining outstanding
commitment at December 31, 2004 of $13.5 million of which approximately
$5.5 million and $8.0 million will be paid during the years ended
December 31, 2005 and 2006, respectively.
Alaska Airline Miles Agreement
In August 2003 we entered into an agreement with Alaska Airlines, Inc.
("Alaska Airlines") to offer our residential and business customers who
make qualifying purchases from us the opportunity to accrue mileage
awards in the Alaska Airlines Mileage Plan. The agreement was amended in
October 2004. The agreement as amended requires the purchase of Alaska
Airlines miles during the year ended December 31, 2004 and in future
years. The agreement has a remaining commitment at December 31, 2004
totaling approximately $13.9 million.
Deferred Compensation Plan
During 1995, we adopted a non-qualified, unfunded deferred compensation
plan to provide a means by which certain employees may elect to defer
receipt of designated percentages or amounts of their compensation and to
provide a means for certain other deferrals of compensation. We may
contribute matching deferrals at a rate selected by us. Participants
immediately vest in all elective deferrals and all income and gain
attributable thereto. Matching contributions and all income and gain
attributable thereto vest over a six-year period. Participants may elect
to be paid in either a single lump sum payment or annual installments
over a period not to exceed 10 years. Vested balances are payable upon
termination of employment, unforeseen emergencies, death and total
disability. Participants are general creditors of us with respect to
deferred compensation plan benefits. Compensation deferred
143 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
pursuant to the plan totaled approximately $37,000, $0 and $82,000 for
the years ended December 31, 2004, 2003 and 2002, respectively.
Performance Based Incentive Compensation Plan
During 2003 we adopted a non-qualified, performance based incentive
compensation plan. The incentive compensation plan provides additional
compensation to certain officers and key employees based upon the
Company's achievement of specified financial performance goals. The
Compensation Committee of GCI's Board of Directors establishes goals on
which executive officers are compensated, and management establishes the
goals for other covered employees. Awards may be payable in cash or GCI's
Class A common stock. Under this plan we recognized expenses of $673,000
and $672,000 during the years ended December 31, 2004 and 2003,
respectively.
Guaranteed Service Levels
Certain customers have guaranteed levels of service with varying terms.
In the event we are unable to provide the minimum service levels we may
incur penalties or issue credits to customers.
Self-Insurance
We are self-insured for losses and liabilities related primarily to
health and welfare claims up to $150,000 per incident and $1.0 million
per lifetime per beneficiary above which third party insurance applies. A
reserve of $2.0 million and $1.7 million was recorded at December 31,
2004 and 2003, respectively, to cover estimated reported losses,
estimated unreported losses based on past experience modified for current
trends, and estimated expenses for investigating and settling claims.
Beginning January 1, 2003, we were self-insured for losses and
liabilities related to workers' compensation claims up to $500,000 and
$250,000 during the years ended December 31, 2004 and 2003, respectively,
above which third party insurance applies. A reserve of $122,000 and
$141,000 was recorded at December 31, 2004 and 2003, respectively, to
cover estimated reported losses and estimated expenses for investigating
and settling claims. Actual losses will vary from the recorded reserves.
While we use what we believe is pertinent information and factors in
determining the amount of reserves, future additions to the reserves may
be necessary due to changes in the information and factors used.
We are self-insured for damage or loss to certain of our transmission
facilities, including our buried, under sea, and above-ground
transmission lines. If we become subject to substantial uninsured
liabilities due to damage or loss to such facilities, our financial
position, results of operations or liquidity may be adversely affected.
Anchorage Unbundled Network Elements ("UNEs") Arbitration
On June 25, 2004 the Regulatory Commission of Alaska ("RCA") issued an
order in our arbitration with Alaska Communications Systems Group, Inc.
("ACS") to revise the rates, terms, and conditions that govern access to
UNEs in the Anchorage market. The RCA's ruling set rates for numerous
elements of ACS' network, the most significant being the lease rate for
local loops. The order initially increased the loop rate from $14.92 to
$19.15 per loop per month. We immediately filed a petition for
reconsideration with the RCA to correct computational errors and raise
other issues. On August 20, 2004, the RCA ruled on the petition and
retroactively lowered the loop rate to $18.64 per month. We estimate the
ruling will increase our local access services segment Cost of Goods Sold
by as much as approximately $4.0 million during the year ended December
31, 2005. In January 2005 GCI appealed the RCA ruling to the Federal
Circuit Court arguing that the pricing and methodology used by ACS and
approved by the RCA was flawed and in violation of federal law. We cannot
predict at this time the outcome of the lawsuit.
144 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Rural Exemption
ACS, through subsidiary companies, provides local services in Fairbanks
and Juneau, Alaska. These ACS subsidiaries were classified as Rural
Telephone Companies under the 1996 Telecom Act, which entitled them to an
exemption of certain material interconnection terms of the 1996 Telecom
Act, until and unless such "rural exemption" were examined and
discontinued by the RCA. An April 2004 proceeding to decide the matter of
rural exemption was canceled upon our and ACS' joint settlement. The
settlement agreement includes the following terms, among others:
o ACS relinquishes all claims to exemptions from full local
telephone competition in Fairbanks and Juneau,
o New rates for unbundled loops in Fairbanks and Juneau began on
January 1, 2005. We estimate the agreed upon rates will increase
our local services segment cost of sales and service
approximately $600,000 to $700,000 during the year ended
December 31, 2005,
o Extension of existing interconnection agreements between ACS and
us for Fairbanks and Juneau until January 1, 2008, and
o Resolution of UNE leasing issues for the Fairbanks and Juneau
markets.
Cable Service Rate Reregulation
Federal law permits regulation of basic cable programming services rates.
However, Alaska law provides that cable television service is exempt from
regulation by the RCA unless 25% of a system's subscribers request such
regulation by filing a petition with the RCA. At December 31, 2004, only
the Juneau system is subject to RCA regulation of its basic service
rates. No petition requesting regulation has been filed for any other
system. (The Juneau system serves 7.3% of our total basic service
subscribers at December 31, 2004.) A cable rate increase in the Juneau
system effective February 1, 2003, did not affect basic programming
service and therefore did not require RCA approval.
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.
(16) Subsequent Events
Acquisition of Barrow Cable TV, Inc. Assets
On February 1, 2005 we acquired all of the assets of Barrow Cable TV,
Inc. ("BCTV") for approximately $1.6 million. We expect the BCTV asset
purchase to result in additional subscribers totaling approximately 950
and additional homes passed totaling approximately 1,600.
Intrastate Access Refund
On May 15, 2003, AT&T filed a petition with the FCC requesting a
declaratory ruling that intrastate access charges do not apply to certain
of its calling card offerings. When AT&T Alascom, a subsidiary of AT&T,
characterized calling card calls that originate and terminate in Alaska
as interstate, they shifted certain intrastate access charges payable to
Alaska LECs to us. In a proceeding before the RCA, the RCA had already
declared this AT&T Alascom practice to be improper. After AT&T petitioned
the FCC, the RCA stayed AT&T Alascom's obligations to make back payments
for the period prior to April, 2004, but ordered AT&T Alascom to pay on
an ongoing basis from April 1, 2004. On February 23, 2005, the FCC also
ruled against AT&T, consistent with the RCA's prior findings. With this
ruling, we can now seek to collect refunds for the intrastate access
charge amounts that AT&T Alascom unlawfully shifted to us prior to April
1, 2004. We have not completed our calculations of the amounts due to us
and cannot predict at this time the ultimate amount to be refunded
pursuant to this gain contingency, however it could be material to our
results of operations, financial position and cash flows.
145 (Continued)
GCI, INC.
Notes to Consolidated Financial Statements
Amended Related Party Lease
On February 25, 2005 we amended the aircraft operating lease agreement
with a company owned by our President and CEO. The lease was amended to
accommodate the lessor's purchase of a replacement aircraft. The
amendment increases the monthly lease rate from $50,000 to $75,000 upon
the earlier of the sale of the aircraft covered by the original lease
agreement or May 25, 2005. Prior to the sale of the aircraft covered by
the original lease agreement or May 25, 2005 we pay a monthly lease rate
of $125,000. Other terms of the lease were not changed.
146
Item 15(b). Exhibits
Listed below are the exhibits that are filed as a part of this Report
(according to the number assigned to them in Item 601 of Regulation S-K):
Exhibit No. Description
--------------------------------------------------------------------------------------------------------------------------
3.1 Restated Articles of Incorporation of the Registrant (18)
3.2 Amended and Restated Bylaws of the Registrant (18)
10.3 Westin Building Lease (5)
10.4 Duncan and Hughes Deferred Bonus Agreements (6)
10.5 Compensation Agreement between General Communication, Inc. and William C. Behnke dated January 1,
1997 (19)
10.6 Order approving Application for a Certificate of Public Convenience and Necessity to operate as a
Telecommunications (Intrastate Interexchange Carrier) Public Utility within Alaska (3)
10.7 1986 Stock Option Plan, as amended (21)
10.13 MCI Carrier Agreement between MCI Telecommunications Corporation and General Communication, Inc.
dated January 1, 1993 (8)
10.14 Contract for Alaska Access Services Agreement between MCI Telecommunications Corporation and
General Communication, Inc. dated January 1, 1993 (8)
10.15 Promissory Note Agreement between General Communication, Inc. and Ronald A. Duncan, dated August
13, 1993 (9)
10.16 Deferred Compensation Agreement between General Communication, Inc. and Ronald A. Duncan, dated
August 13, 1993 (9)
10.17 Pledge Agreement between General Communication, Inc. and Ronald A. Duncan, dated August 13, 1993
(9)
10.19 Summary Plan Description pertaining to Qualified Employee Stock Purchase Plan of General
Communication, Inc., as amended and restated January 1, 2003 (37)
10.20 The GCI Special Non-Qualified Deferred Compensation Plan (11)
10.21 Transponder Purchase Agreement for Galaxy X between Hughes Communications Galaxy, Inc. and GCI
Communication Corp. (11)
10.25 Licenses: (5)
10.25.1 214 Authorization
10.25.2 International Resale Authorization
10.25.3 Digital Electronic Message Service Authorization
10.25.4 Fairbanks Earth Station License
10.25.5 Fairbanks (Esro) Construction Permit for P-T-P Microwave Service
10.25.6 Fairbanks (Polaris) Construction Permit for P-T-P Microwave Service
10.25.7 Anchorage Earth Station Construction Permit
10.25.8 License for Eagle River P-T-P Microwave Service
10.25.9 License for Juneau Earth Station
10.25.10 Issaquah Earth Station Construction Permit
10.26 ATU Interconnection Agreement between GCI Communication Corp. and Municipality of Anchorage,
executed January 15, 1997 (18)
10.29 Asset Purchase Agreement, dated April 15, 1996, among General Communication, Inc., ACNFI, ACNJI
and ACNKSI (12)
10.30 Asset Purchase Agreement, dated May 10, 1996, among General Communication, Inc., and Alaska
Cablevision, Inc. (12)
10.31 Asset Purchase Agreement, dated May 10, 1996, among General Communication, Inc., and McCaw/Rock
Homer Cable System, J.V. (12)
10.32 Asset Purchase Agreement, dated May 10, 1996, between General Communication, Inc., and McCaw/Rock
Seward Cable System, J.V. (12)
10.33 Amendment No. 1 to Securities Purchase and Sale Agreement, dated October 31, 1996, among General
Communication, Inc., and the Prime Sellers Agent (13)
10.34 First Amendment to Asset Purchase Agreement, dated October 30, 1996, among
147 (Continued)
Exhibit No. Description
--------------------------------------------------------------------------------------------------------------------------
General Communication, Inc., ACNFI, ACNJI and ACNKSI (13)
10.36 Order Approving Arbitrated Interconnection Agreement as Resolved and Modified by Order U-96-89(8)
dated January 14, 1997 (18)
10.37 Amendment to the MCI Carrier Agreement executed April 20, 1994 (18)
10.38 Amendment No. 1 to MCI Carrier Agreement executed July 26, 1994 (16)
10.39 MCI Carrier Addendum--MCI 800 DAL Service effective February 1, 1994 (16)
10.40 Third Amendment to MCI Carrier Agreement dated as of October 1, 1994 (16)
10.41 Fourth Amendment to MCI Carrier Agreement dated as of September 25, 1995 (16)
10.42 Fifth Amendment to the MCI Carrier Agreement executed April 19, 1996 (18)
10.43 Sixth Amendment to MCI Carrier Agreement dated as of March 1, 1996 (16)
10.44 Seventh Amendment to MCI Carrier Agreement dated November 27, 1996 (20)
10.45 First Amendment to Contract for Alaska Access Services between General Communication, Inc. and
MCI Telecommunications Corporation dated April 1, 1996 (20)
10.46 Service Mark License Agreement between MCI Communications Corporation and General
Communication, Inc. dated April 13, 1994 (19)
10.47 Radio Station Authorization (Personal Communications Service License), Issue Date June 23,
1995 (19)
10.50 Contract No. 92MR067A Telecommunications Services between BP Exploration (Alaska), Inc. and
GCI Network Systems dated April 1, 1992 (20)
10.51 Amendment No. 03 to BP Exploration (Alaska) Inc. Contract No. 92MRO67A effective August 1,
1996 (20)
10.52 Lease Agreement dated September 30, 1991 between RDB Company and General Communication, Inc.
(3)
10.54 Order Approving Transfer Upon Closing, Subject to Conditions, and Requiring Filings dated
September 23, 1996 (19)
10.55 Order Granting Extension of Time and Clarifying Order dated October 21, 1996 (19)
10.58 Employment and Deferred Compensation Agreement between General Communication, Inc. and John
M. Lowber dated July 1992 (19)
10.59 Deferred Compensation Agreement between GCI Communication Corp. and Dana L. Tindall dated
August 15, 1994 (19)
10.60 Transponder Lease Agreement between General Communication Incorporated and Hughes Communications
Satellite Services, Inc., executed August 8, 1989 (9)
10.61 Addendum to Galaxy X Transponder Purchase Agreement between GCI Communication Corp. and
Hughes Communications Galaxy, Inc. dated August 24, 1995 (19)
10.62 Order Approving Application, Subject to Conditions; Requiring Filing; and Approving Proposed
Tariff on an Inception Basis, dated February 4, 1997 (19)
10.66 Supply Contract Between Submarine Systems International Ltd. And GCI Communication Corp.
dated as of July 11, 1997. (23)
10.67 Supply Contract Between Tyco Submarine Systems Ltd. And Alaska United Fiber System Partnership
Contract Variation No. 1 dated as of December 1, 1997. (23)
10.71 Third Amendment to Contract for Alaska Access Services between General Communication, Inc.
and MCI Telecommunications Corporation dated February 27, 1998 (25)
10.77 General Communication, Inc. Preferred Stock Purchase Agreement (26)
10.78 Qualified Employee Stock Purchase Plan of General Communication, Inc., as amended and restated January
01, 2003 (37)
10.79 Statement of Stock Designation (Series B) (26)
10.80 Fourth Amendment to Contract for Alaska Access Services between General Communication, Inc.
and its wholly owned subsidiary GCI Communication Corp., and MCI WorldCom. (27)
10.82 Lease Intended for Security between GCI Satellite Co., Inc. and General Electric Capital
Corporation (29)
148 (Continued)
Exhibit No. Description
--------------------------------------------------------------------------------------------------------------------------
10.89 Fifth Amendment to Contract for Alaska Access Services between General Communication, Inc.
and its wholly owned subsidiary GCI Communication Corp., and MCI WorldCom Network Services,
Inc., formerly known as MCI Telecommunications Corporation dated August 7, 2000 # (31)
10.90 Sixth Amendment to Contract for Alaska Access Services between General Communication, Inc.
and its wholly owned subsidiary GCI Communication Corp., and MCI WorldCom Network
Services, Inc., formerly known as MCI Telecommunications Corporation dated February 14,
2001 # (31)
10.91 Seventh Amendment to Contract for Alaska Access Services between General Communication, Inc.
and its wholly owned subsidiary GCI Communication Corp., and MCI WorldCom Network Services,
Inc., formerly known as MCI Telecommunications Corporation dated March 8, 2001 # (31)
10.99 Statement of Stock Designation (Series C) (34)
10.100 Contract for Alaska Access Services between Sprint Communications Company L.P. and General
Communication, Inc. and its wholly owned subsidiary GCI Communication Corp. dated March
12, 2002 # (35)
10.101 Credit, Guaranty, Security and Pledge Agreement between GCI Holdings, Inc. and Credit
Lyonnais New York Branch as Administrative Agent, Issuing Bank, Co-Bookrunner and
Co-Arranger, General Electric Capital Corporation as Documentation Agent, Co-Arranger and
Co-Bookrunner and CIT Lending Services Corporation as Syndication Agent, dated as of
November 1, 2002. (36)
10.102 First Amendment to Lease Agreement dated as of September 2002 between RDB Company and GCI
Communication Corp. as successor in interest to General Communication, Inc. (37)
10.103 Agreement and plan of merger of GCI American Cablesystems, Inc. a Delaware corporation and
GCI Cablesystems of Alaska, Inc. an Alaska corporation each with and into GCI Cable, Inc.
an Alaska corporation, adopted as of December 10, 2002 (37)
10.104 Articles of merger between GCI Cablesystems of Alaska, Inc. and GCI Cable, Inc., adopted as
of December 10, 2002 (37)
10.105 Aircraft lease agreement between GCI Communication Corp., and Alaska corporation and 560
Company, Inc., an Alaska corporation, dated as of January 22, 2001 (37)
10.106 First amendment to aircraft lease agreement between GCI Communication Corp., and Alaska
corporation and 560 Company, Inc., an Alaska corporation, dated as of February 8, 2002
(37)
10.107 Amendment No. 1 to Credit, Guaranty, Security and Pledge Agreement between GCI Holdings,
Inc. and Credit Lyonnais New York Branch as Administrative Agent, Issuing Bank,
Co-Bookrunner and Co-Arranger, General Electric Capital Corporation as Documentation
Agent, Co-Arranger and Co-Bookrunner and CIT Lending Services Corporation as Syndication
Agent, dated as of November 1, 2002 (38)
10.108 Bonus Agreement between General Communication, Inc. and Wilson Hughes (39)
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. # (39)
10.110 Settlement and Release Agreement between General Communication, Inc. and WorldCom, Inc. (39)
10.111 Credit, Guaranty, Security and Pledge Agreement between GCI Holdings, Inc. and Credit
Lyonnais New York Branch as Administrative Agent,
Issuing Bank, Co-Bookrunner and Co-Arranger,
General Electric Capital Corporation as
Documentation Agent, Co-Arranger and Co-Bookrunner
and CIT Lending Services Corporation as
Syndication Agent, dated as of October 30, 2003
(40)
10.112 Waiver letter agreement dated as of February 13, 2004 for Credit, Guaranty,
149 (Continued)
Exhibit No. Description
--------------------------------------------------------------------------------------------------------------------------
Security and Pledge Agreement (41)
10.113 Indenture dated as of February 17, 2004 between GCI, Inc. and The Bank of New York, as
trustee (41)
10.114 Registration Rights Agreement dated as of February 17, 2004, among GCI, Inc., and Deutsche
Bank Securities Inc., Jefferies & Company, Inc., Credit Lyonnais Securities (USA), Inc.,
Blaylock & Partners, L.P., Ferris, Baker Watts, Incorporated, and TD Securities (USA),
Inc., as Initial Purchasers (41)
10.115 Amended and Restated 1986 Stock Option Plan of General Communication, Inc. as of June 7,
2002 (filed as an exhibit to the Company's Proxy Statement dated April 30, 2004) (44)
10.116 Audit Committee Charter (filed as Appendix I to the Company's Proxy Statement dated April
30, 2004) (42)
10.117 Nominating and Corporate Governance Committee Charter (42)
10.119 Amendment No. 1 dated February 2, 2004 to the Credit, Guaranty, Security and Pledge
Agreement between GCI Holdings, Inc. and Credit Lyonnais New York Branch as
administrative agent for the Lenders, issuing bank, co-bookrunner and co-arranger (the
"Administrative Agent"), General Electric Capital Corporation as documentation agent,
co-arranger and co-bookrunner and CIT Lending Services Corporation as Syndication Agent
(43)
10.120 Amendment No. 2 dated May 21, 2004 to the Credit, Guaranty, Security and Pledge
Agreement between GCI Holdings, Inc. and Calyon New York Branch (successor-in-interest to
Credit Lyonnais New York Branch) as administrative agent for the Lenders, issuing bank,
co-bookrunner and co-arranger (the "Administrative Agent"), General Electric Capital
Corporation as documentation agent, co-arranger and co-bookrunner and CIT Lending Services
Corporation as Syndication Agent (43)
10.121 First amendment to contract for Alaska Access Services between Sprint Communications Company
L.P. and General Communication, Inc. and its wholly owned subsidiary GCI Communication
Corp. dated July 24, 2002 # (43)
10.122 Second amendment to contract for Alaska Access Services between Sprint Communications
Company L.P. and General Communication, Inc. and its wholly owned subsidiary GCI
Communication Corp. dated December 31, 2003 (43)
10.123 Third amendment to contract for Alaska Access Services between Sprint Communications
Company L.P. and General Communication, Inc. and its wholly owned subsidiary GCI
Communication Corp. dated February 19, 2004 # (43)
10.124 Fourth amendment to contract for Alaska Access Services between Sprint Communications
Company L.P. and General Communication, Inc. and its wholly owned subsidiary GCI
Communication Corp. dated June 30, 2004 # (43)
10.125 Amendment No. 3 dated November 17, 2004 to the Credit, Guaranty, Security and Pledge
Agreement between GCI Holdings, Inc. and Calyon New York Branch (successor-in-interest to
Credit Lyonnais New York Branch) as administrative agent for the Lenders, issuing bank,
co-bookrunner and co-arranger (the "Administrative Agent"), General Electric Capital
Corporation as documentation agent, co-arranger and co-bookrunner and CIT Lending Services
Corporation as Syndication Agent *
14 Code Of Business Conduct and Ethics (originally reported as exhibit 10.118) (42)
21.1 Subsidiaries of the Registrant *
31 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 *
32 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 *
99 Additional Exhibits:
99.1 The Articles of Incorporation of GCI Communication Corp. (2)
99.2 The Bylaws of GCI Communication Corp. (2)
150 (Continued)
Exhibit No. Description
--------------------------------------------------------------------------------------------------------------------------
99.7 The Bylaws of GCI Cable, Inc. (14)
99.8 The Articles of Incorporation of GCI Cable, Inc. (14)
99.15 The Bylaws of GCI Holdings, Inc. (19)
99.16 The Articles of Incorporation of GCI Holdings, Inc. (19)
99.19 The Bylaws of GCI Transport, Inc. (23)
99.20 The Articles of Incorporation of GCI Transport, Inc. (23)
99.21 The Bylaws of Fiber Hold Co., Inc. (23)
99.22 The Articles of Incorporation of Fiber Hold Co., Inc. (23)
99.23 The Bylaws of GCI Fiber Co., Inc. (23)
99.24 The Articles of Incorporation of GCI Fiber Co., Inc. (23)
99.25 The Bylaws of GCI Satellite Co., Inc. (23)
99.26 The Articles of Incorporation of GCI Satellite Co., Inc. (23)
99.27 The Partnership Agreement of Alaska United Fiber System (23)
99.28 The Bylaws of Potter View Development Co., Inc. (32)
99.29 The Articles of Incorporation of Potter View Development Co., Inc. (32)
99.30 The Bylaws of GCI American Cablesystems, Inc. (34)
99.31 The Articles of Incorporation of GCI American Cablesystems, Inc. (34)
99.32 The Bylaws of GCI Cablesystems of Alaska, Inc. (34)
99.33 The Articles of Incorporation of GCI Cablesystems of Alaska, Inc. (34)
99.34 The Bylaws of GCI Fiber Communication, Co., Inc. (34)
99.35 The Articles of Incorporation of GCI Fiber Communication, Co., Inc. (34)
99.37 The Articles of Incorporation of Wok 1, Inc. (38)
99.38 The Bylaws of Wok 1, Inc. (38)
99.39 The Articles of Incorporation of Wok 2, Inc. (38)
99.40 The Bylaws of Wok 2, Inc. (38)
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# Certain information has been redacted from this
document which we desire to keep undisclosed.
* Filed herewith.
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Exhibit
Reference Description
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2 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1990
3 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1991
5 Incorporated by reference to GCI's Registration Statement on Form 10 (File No.
0-15279), mailed to the Securities and Exchange Commission on December 30, 1986
6 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1989.
8 Incorporated by reference to GCI's Current Report on Form 8-K dated June 4, 1993.
9 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1993.
10 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1994.
11 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1995.
12 Incorporated by reference to GCI's Form S-4 Registration Statement dated October 4, 1996.
13 Incorporated by reference to GCI's Current Report on Form 8-K dated November 13, 1996.
151
Exhibit
Reference Description
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14 Incorporated by reference to GCI's Annual Report on Form 10-K for the year ended
December 31, 1996.
16 Incorporated by reference to GCI's Current Report on Form 8-K dated March 14, 1996,
filed March 28, 1996.
18 Incorporated by reference to GCI's Form S-3 Registration Statement (File No. 333-28001)
dated May 29, 1997.
19 Incorporated by reference to GCI's Amendment No. 1 to Form S-3/A Registration Statement
(File No. 333-28001) dated July 8, 1997.
20 Incorporated by reference to GCI's Amendment No. 2 to Form S-3/A Registration Statement
(File No. 333-28001) dated July 21, 1997.
21 Incorporated by reference to GCI's Amendment No. 3 to Form S-3/A Registration Statement
(File No. 333-28001) dated July 22, 1997.
23 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 1997.
24 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 1998.
25 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 1998.
26 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended March 31, 1999.
27 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 1999.
28 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 1999.
29 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 2000.
30 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 2000.
31 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended March 31, 2001.
32 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 2001.
33 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended September 30, 2001.
34 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 2001.
35 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 2002.
36 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended September 30, 2002.
37 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 2002.
38 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended March 31, 2003.
152
Exhibit
Reference Description
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39 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 2003.
40 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended September 30, 2003.
41 Incorporated by reference to The Company's Annual Report on Form 10-K for the year ended
December 31, 2003.
42 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended March 31, 2004.
43 Incorporated by reference to The Company's Quarterly Report on Form 10-Q for the period
ended June 30, 2004.
44 Incorporated by reference to GCI's Annual Definitive Proxy Statement on Form 14A filed
on April 30, 2004.
153
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
GCI, INC.
By: /s/
Ronald A. Duncan, President
(Chief Executive Officer)
Date: March 11, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
Signature Title Date
- ------------------------------------- ------------------------------------------ -------------------
/s/ President and Director March 11, 2005
Ronald A. Duncan (Principal Executive Officer)
/s/ Vice President and Director March 11, 2005
G. Wilson Hughes
/s/ Secretary, Treasurer and Director March 11, 2005
John M. Lowber (Principal Financial and Accounting
Officer)
154