Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2002

OR

For the transition period from                      to

Commission file number 000-28167

Alaska Communications Systems Group, Inc.
(Exact name of registrant as specified in its charter)

(907) 297-3000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

     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 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 (§ 229.405 of this chapter) 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]

     The aggregate market value of the shares of all classes of voting stock of the registrant held by non-affiliates of the registrant on March 3, 2003, was approximately $19,906,035 computed upon the basis of the closing sales price of the Common Stock on that date. For purposes of this computation, shares held by directors (and shares held by any entities in which they serve as officers) and officers of the registrant have been excluded. Such exclusion is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the registrant.

     Indicate by check mark if whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.)

Yes [ ]  No [X]

     The aggregate market value of the shares of all classes of voting stock of the registrant held by non-affiliates of the registrant on June 28, 2002, was approximately $47,843,279 computed upon the basis of the closing sales price of the Common Stock on that date. For purposes of this computation, shares held by directors (and shares held by any entities in which they serve as officers) and officers of the registrant have been excluded. Such exclusion is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the registrant.

     As of March 3, 2003, there were outstanding 30,629,566 shares of Common Stock, $.01 par value, of the registrant.

Documents Incorporated by Reference

     Portions of the proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A for the registrant’s 2003 annual meeting of stockholders are incorporated by reference into Part III of this Form 10-K.

Table of Contents

ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2002

1

Table of Contents

Table of Contents

PART I

Item 1. Business

Forward Looking Statements and Analysts’ Reports

     This Form 10-K and future filings by Alaska Communications Systems Group, Inc. (“ACS Group” or the “Company”) on Forms 10-K, 10-Q and 8-K and future oral and written statements by the Company and its management may include certain “forward-looking statements” as defined under the Private Securities Litigation Reform Act of 1995, including (without limitation) statements with respect to anticipated future operating and financial performance, financial position and liquidity, growth opportunities and growth rates, pricing plans, acquisition and divestitive opportunities, business prospects, strategic alternatives, business strategies, regulatory and competitive outlook, investment and expenditure plans, financing needs and availability, and other similar forecasts and statements of expectation. Words such as “aims,” “anticipates,” “believes,” “could,” “estimates,” “expects,” “hopes,” “intends,” “may,” “plans,” “projects,” “seeks,” “should,” and “will,” and variations of these words and similar expressions, are intended to identify these forward-looking statements. These forward looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our Company’s historical experience and our present expectations or projections. Forward-looking statements by the Company and its management are based on estimates, projections, beliefs and assumptions of management and are not guarantees of future performance. The Company disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information, or otherwise.

     Actual future performance, outcomes and results may differ materially from those expressed in forward-looking statements made by the Company and its management as a result of a number of important factors. Examples of these factors include (without limitation) rapid technological developments and changes in the telecommunications industries; ongoing deregulation (and the resulting likelihood of significantly increased price and product/service competition) in the telecommunications industry as a result of the Telecommunications Act of 1996 (the “1996 Act”) and other similar federal and state legislation and the federal and state rules and regulations enacted pursuant to that legislation; regulatory limitations on the Company’s ability to change its pricing for communications services; the possible future unavailability of Statement of Financial Accounting Standards (“SFAS”) No. 71, Accounting for the Effects of Certain Types of Regulation, to the Company’s wireline subsidiaries; and possible changes in the demand for the Company’s products and services. In addition to these factors, actual future performance, outcomes and results may differ materially because of other, more general, factors including (without limitation) changes in general industry and market conditions and growth rates; changes in interest rates or other general national, regional or local economic conditions; governmental and public policy changes; changes in accounting policies or practices adopted voluntarily or as required by accounting principles generally accepted in the United States of America; and the continued availability of financing in the amounts, at the terms and on the conditions necessary to support the Company’s future business.

     Investors should also be aware that while ACS Group does, at various times, communicate with securities analysts, it is against the Company’s policy to disclose to them any material non-public information or other confidential information. Accordingly, investors should not assume that ACS Group agrees with any statement or report issued by an analyst irrespective of the content of the statement or report. To the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not the responsibility of ACS Group.

2

Table of Contents

Introduction

     ACS Group was formed in 1998 by Fox Paine & Company, members of the former senior management team of Pacific Telecom, Inc., and other experienced telecommunications industry executives. In May 1999, the Company acquired Century Telephone Enterprises, Inc.’s Alaska properties (“CenturyTel’s Alaska Properties”) and Anchorage Telephone Utility or ATU (collectively the “Predecessor Entities”). CenturyTel’s Alaska Properties were the incumbent provider of local telephone services in Juneau, Fairbanks and more than 70 rural communities in Alaska and provided Internet services to customers statewide. CenturyTel’s Alaska Properties included ACS of Fairbanks, Inc., ACS of Alaska, Inc., and ACS of the Northland, Inc. ATU was the largest local exchange carrier (“LEC”) in Alaska and provided local telephone and long distance services primarily in Anchorage and wireless services statewide. ATU provided long distance services through ATU Long Distance, Inc. and wireless services through MACtel, Inc. These companies are now known as ACS of Anchorage, Inc., ACS Long Distance, Inc. and ACS Wireless, Inc. On October 29, 1999, the Company changed its name from ALEC Holdings, Inc. to Alaska Communications Systems Group, Inc.

     On January 1, 2001, the Company established ACS InfoSource, Inc. as a separate operation and transferred to it the Company’s yellow pages directory advertising business and assets which were previously included as a component of four different local telephone exchange carriers operating in Alaska which are also wholly-owned subsidiaries of the Company.

     The consolidated financial statements for ACS Group represent the operations principally of the following entities:

	•		Alaska Communications Systems Group, Inc.
	•		Alaska Communications Systems Holdings, Inc. (“ACS Holdings”)
	•		ACS of Alaska, Inc. (“ACSAK”)
	•		ACS of the Northland, Inc. (“ACSN”)
	•		ACS of Fairbanks, Inc. (“ACSF”)
	•		ACS of Anchorage, Inc. (“ACSA”)
	•		ACS Wireless, Inc. (“ACSW”)
	•		ACS InfoSource, Inc. (“ACSIS”)
	•		ACS Internet, Inc. (“ACSI”)
	•		ACS Long Distance, Inc. (“ACSLD”)

     ACS Group is the leading diversified, facilities-based telecommunications provider in Alaska, offering local telephone, wireless, directory, Internet, and interexchange services to business and residential customers throughout the state. ACS Group is the largest telecommunications provider in Alaska using its own network facilities to provide full service end-to-end communications to its customers.

     At various times, ACS Group evaluates opportunities for establishing or acquiring other telecommunications businesses through acquisitions or otherwise in Alaska and elsewhere in the United States, and may make investments in such businesses in the future. ACS Group has focused its attention on local telephone, wireless, directory, Internet, and interexchange businesses.

     Local Telephone. With over 323,000 access lines, representing approximately 67% of the access lines provisioned in Alaska, ACS Group is the largest LEC in Alaska and the 14th largest in the U.S. The Company provides service to most of the state’s major population centers, including Anchorage, Juneau and Fairbanks.

     Wireless. ACS Group is the largest and only statewide provider of wireless services in Alaska, currently serving over 82,000 subscribers. Its wireless network covers over 478,000 residents, including all major population centers and highway corridors. The Company has upgraded to a fully digital network in substantially all of its service areas.

3

Table of Contents

     Directory. ACS Group, through its subsidiary ACSIS, is the largest provider of published directory advertising in Alaska. The Company serves over 13,500 customers through its yellow page directory books tailored to serve the needs of each of its local exchange markets, with many customers advertising in multiple books. During 2002, ACSIS published ten different yellow pages, white pages or combined directory books covering approximately 95% of the State of Alaska’s population. ACSIS publishes the white pages directories under a publishing agreement with its affiliated LECs. ACSIS also provides an online directory product and other specialized advertising vehicles to its customers.

     Internet. ACS Group is the second largest provider of Internet access services in Alaska with approximately 46,000 customers. ACS Group offers dedicated and dial-up Internet access and digital subscriber line, (“DSL”) Internet access to its customers.

     Interexchange. ACS Group provides long distance and other interexchange services to approximately 70,000 customers in Alaska. ACS Group has migrated long distance traffic from leased circuits onto its own network infrastructure where possible, principally between its major markets of Anchorage, Fairbanks and Juneau.

Products, Services and Revenue Sources

     ACS Group offers a broad portfolio of telecommunications services to residential and business customers in its markets. The Company believes that, as the communications marketplace continues to converge and competition continues to enter the market, the ability to offer an integrated package of communications products will provide a distinct competitive advantage, as well as increase customer loyalty, and thereby decrease customer turnover. The Company complements its local telephone services by actively marketing its wireless, directory, Internet, interexchange and other service offerings.

     Profit or loss and total assets for each of the Company’s segments is disclosed in Note 16 “Business Segments” of the Alaska Communications Systems Group, Inc. Consolidated Financial Statements. The following table sets forth the components of ACS Group’s consolidated revenues for the years ended December 31, 2002, 2001 and 2000 (dollars in millions).

Local Telephone

     The Company provides local telephone service through its four LECs. Local telephone revenue consists of local network service, network access (including universal service revenue), and deregulated and other revenue, each of which is described below.

4

Table of Contents

Local Network Service

     Basic Local Network Service. Basic local network service enables customers to originate and receive telephone calls within a defined “exchange” area. The Company provides basic local services on a retail basis to residential and business customers, generally for a fixed monthly charge. The maximum amount that can be charged to a customer for basic local services is determined by rate proceedings involving the Regulatory Commission of Alaska (“RCA”). The Company charges business customers higher rates to recover a portion of the costs of providing local service to residential customers, as is customary in the industry. On average, U.S. business rates for basic local services have been over two times the rates of residential customers. Basic local service also includes non-recurring charges to customers for the installation of new products and services and recurring charges for enhanced features such as call waiting and caller identification.

     At December 31, 2002, approximately 53% of ACS Group’s retail access lines served residential customers and 47% served business customers. Currently, monthly charges for basic local service for residential customers range from $9.42 to $16.30 in ACS Group’s service areas compared to the national average for urban areas of $14.11. Monthly charges for business customers range from $17.65 to $35.00 in ACS Group’s service areas compared to the national average for urban areas of $33.84. In November 2001, the Company was authorized by the RCA to increase on an interim basis certain rates in its largest market, Anchorage, by 24%. As a result, the Company increased residential service rates in Anchorage from $9.70 to $12.05 per month. See “Business — Regulation” for further discussion of regulatory matters including the Company’s local network service rate proceedings.

     The table below sets forth the annual growth in access lines for ACS Group and its Predecessor Entities from December 31, 1998 to December 31, 2002. The number of access lines shown represents all revenue producing access lines connected to both retail and wholesale customers.

     On June 1, 1999, as part of the consolidation of its operating and billing systems, ACS Group conformed the methodology by which the number of access lines is calculated across all of its local exchanges to that previously used for CenturyTel’s Alaska Properties. In the table above, for the year ended December 31, 1999, the Company shows ATU’s number of access lines calculated using this method. If the number of ATU’s access lines in service at December 31, 1998 was computed under this same method, the number of access lines at ATU would increase by 4,940 and the total number of access lines would equal 305,334 and the combined growth percentage would be 7.8% for 1999.

     Management believes that future access line growth is dependent on, among other things, the economic outlook in Alaska and the United States, the impact of technology and competition on line demand and population growth in the Company’s service areas.

     Competitive Local Network Service. The Company also provides interconnection through wholesale access to its basic local service and through leasing unbundled network elements (“UNEs”) to its competitors as required by the 1996 Act. Revenues for these services are included in local network service revenues. In November of 2001 the Company was authorized by the RCA to implement an interim and refundable rate increase of $1.07 per UNE loop for its Anchorage serving area, increasing the total rate to $14.92 from $13.85. The RCA has also lifted the Company’s rural exemption for the Fairbanks and Juneau serving areas and awarded interconnection rates to a competitor on a UNE basis of $19.19 and $16.71, respectively. The Company provided 86,859 lines to competitors in the Anchorage, Fairbanks and Juneau service areas on either a wholesale or UNE basis as of December 31, 2002. The Company believes the UNE rates in place in all of its

5

Table of Contents

markets are below its embedded and forward looking cost and are therefore non-compensatory. See “Business — Regulation” for further discussion of regulatory matters, including interconnection under the 1996 Act.

     While there is some seasonality in local network service, represented primarily by reduced line demand in the Alaskan winter as seasonal workers leave the state, operating results for local telephone services are not materially impacted by seasonal factors.

     Network Access

     Network access services arise in connection with the origination and termination of long distance, or toll, calls and typically involve more than one company in the provision of such long distance service on an end-to-end basis. Since toll calls are generally billed to the customer originating the call, a mechanism is required to compensate each company providing services relating to the call. This mechanism is the access charge, which the Company bills to each interexchange carrier for the use of its facilities to access the customer. The Company also receives universal service revenue, which it includes in its reported network access revenue. These components of network access revenue are described below.

     Intrastate Access Charges. ACS Group generates intrastate access revenue when an intrastate long distance call that involves an ACS Group LEC and an interexchange carrier is originated and terminated within the same state. The interexchange carrier pays the Company an intrastate access payment for either terminating or originating the call. The Company records the details of the call through its carrier access billing system and receives the access payment from the interexchange carrier. The Company also provides billing and collection (“B&C”) services for interexchange carriers through negotiated B&C agreements for certain types of toll calls placed by the Company’s local customers. ACS Group’s LECs in competitive areas are under their own stand-alone tariffs for intrastate access. In non-competitive areas, ACS Group’s LECs participate in a statewide tariff and access charge pooling arrangement that is administered by the Alaska Exchange Carriers Association (“AECA”). The access charge for ACS Group’s intrastate service is regulated by the RCA.

     Interstate Access Charges. ACS Group generates interstate access revenue when an interstate long distance call is originated from an Alaskan local calling area served by an ACS Group LEC and is terminated in a local calling area in another state, and vice versa. The Company bills interstate access charges in a manner similar to intrastate access charges. However, interstate access charges are regulated by the Federal Communications Commission (“FCC”) rather than the RCA. ACS Group’s LECs participate in a nationwide tariff and access charge pooling arrangement that is administered by the National Exchange Carrier Association (“NECA”) for all ACS Group’s LECs except ACSA. ACSA participates in the NECA common line tariff, but has its own interstate access tariff for traffic sensitive and special access services.

     Universal Service Revenue. Universal service revenue supplements the amount of local service revenue the Company receives to ensure that basic local service rates for customers in high cost rural areas are not significantly higher than rates charged in lower cost urban and suburban areas. The 1996 Act prescribed new standards applicable to universal service, including mechanisms for defining the types of services to be provided as part of a universal service program, specific goals or criteria applicable to universal service programs, new qualifications for receipt of universal service funding and new requirements for contributions to universal service funding. The FCC, in conjunction with a federal-state joint board composed of FCC and state commission members, has been working since passage of the 1996 Act to implement these new statutory provisions. The FCC has chosen to address universal service matters, initially for non-rural telephone companies, and subsequently for rural telephone companies. While new cost-identification models for non-rural local carriers were adopted effective on January 1, 2000, similar models for rural carriers were rejected by the FCC, leaving previous Universal Service Fund (“USF”) calculations in place for the Federal High-Cost Fund. In accordance with the 1996 Act’s requirement to eliminate implicit subsidies, the FCC has created additional USF support mechanisms to compensate for support that had previously been provided implicitly through access revenue. While the joint board and the FCC continue to examine modifications to the universal service funding mechanisms, it is unlikely that any changes will have a near-term impact on ACS Group’s revenue.

6

Table of Contents

     Interstate access, intrastate access, and universal service funding are all influenced by both LEC cost levels and by competitive local market penetration. Toll traffic originating or terminating on a competitors network does not generate access billings to interexchange carriers for ACS Group. Many of the underlying factors in jurisdictional cost separations studies that allow network costs to be recovered through access charges are diminished as competitive market penetration increases. Universal service funding may also diminish as a result of competitive local market penetration. Under FCC rules, when a competitive local exchange carrier (“CLEC”) is named an “eligible telecommunications carrier” as General Communication, Inc. (“GCI”) has been in Anchorage, Fairbanks and Juneau, universal service funding becomes portable to the CLEC on a per-line basis, further eroding the incumbent local exchange carriers (“ILECs”) revenue.

     Operating results for network access services are not materially impacted by seasonal factors.

     Deregulated and Other Revenue

     Deregulated and other revenues consist of B&C contracts, space and power rents, pay telephone service, customer premise equipment (“CPE”) sales, and other miscellaneous revenues generated by the Company’s LECs. ACS Group seeks to capitalize on its local presence and network infrastructure by offering these additional services to customers and interexchange carriers. Deregulated and other revenue is generally not subject to seasonal impacts on operating results.

     Wireless

     ACS Group’s wireless business is currently managed separately from its LEC business and is subject to a different regulatory framework and cost structure. Wireless services are provided statewide under the ACS Wireless brand name. The primary sources of wireless revenue include subscriber access charges, airtime usage, toll charges, connection fees, roaming revenues, and enhanced features, such as caller identification and call waiting. A subscriber may purchase services separately or may purchase rate plans that package these services in different ways to fit different calling patterns and desired features.

     The table below sets forth the annual growth in the number of wireless subscribers served and total covered population for ACS Group and its Predecessor Entities from December 31, 1998 to December 31, 2002.

     Management believes there are opportunities to improve the penetration rates of its wireless operations in Southeastern Alaska, and in particular, Juneau. Management also believes that the market for wireless services will continue to grow with the expansion of the wireless industry as a whole.

     ACS Group also owns 10 megahertz E Block PCS licenses covering Anchorage, Fairbanks and Juneau which were purchased by CenturyTel’s Alaska Properties in 1997 and acquired by the Company when it purchased CenturyTel’s Alaska Properties on May 14, 1999. During 2002, the Company purchased 10 megahertz F Block PCS licenses. In 2002, ACS Wireless in accordance with FCC requirements, deployed a limited turn up of its CDMA 1X services in all E and F Block markets. Management is analyzing the further build out of these services to enhance the Company’s offerings in its overall business.

     Wireless revenue declines in the winter months and increases in the summer months due to Alaska’s northern latitude and the wide swing in available daylight and changes in weather patterns between summer and winter and their effect on business, tourism and subscriber calling patterns. However, operating results for wireless services are not materially impacted by seasonal factors.

7

Table of Contents

     Directory

     ACS Group provides directory advertising services, commonly known as yellow pages advertising, to its customers in the State of Alaska. During 2002, ACSIS published ten different yellow pages, white pages or combined directory books covering approximately 95% of the State of Alaska’s population. ACSIS publishes the white pages directories under a publishing agreement with its affiliated LECs. Additionally, ACSIS provides internet-based directory advertising services. The Company provides these services under a contractual arrangement with a directory publishing company. Directory advertising is billed in conjunction with local telephone service under a B&C agreement. Directory revenues are not materially affected by seasonality.

     The Company has been authorized by its Board of Directors to evaluate the possible disposition of its directory business, ACSIS. This transaction, if completed, would result in a de-leveraging of the Company’s balance sheet and generate cash for other corporate objectives. The Company expects to file on or about March 6, 2003, a preliminary prospectus with Canadian securities regulators relating to a proposed public offering in Canada of ACSIS through a Canadian income fund. Any prospective sale of ACSIS is subject to the approval of the Company’s Board of Directors, which is dependent upon terms and pricing. Any such sale is also contingent upon a number of conditions including approval by securities regulators, the approval of an amendment of certain terms and conditions of the Company’s senior credit facility and market conditions. There can be no assurance that the Company will consummate any transaction to sell ACSIS.

     Internet

     ACS Group provides Internet access services to approximately 46,000 customers as of December 31, 2002. In order to offer Internet access, the Company provides local dial-up telephone numbers for its customers. ACS Group also offers high speed DSL to its customers in its major LEC service territories. These local dial-up numbers and dedicated DSL connections allow customers access, through a modem connection on their computer, to a series of computer servers ACS Group owns and maintains. These servers allow customers to access their e-mail accounts and to be routed to local access points that connect customers to the Internet. ACS Group charges customers either a flat rate for unlimited Internet usage or a usage sensitive rate. Operating results for Internet access services are not materially impacted by seasonal factors.

     Interexchange

     ACS Group’s predecessors began offering long distance services on a resale basis in October 1997, primarily in Anchorage. The Company currently has approximately 70,000 long distance customers and less than 10% of total interexchange revenues in Alaska. Before August 1998, CenturyTel’s Alaska Properties were precluded from entering the long distance business by a non-competition agreement with AT&T Alascom which was signed when Pacific Telecom sold Alascom, Inc. to AT&T in 1995.

     In April 1999, ACS Group entered into a settlement agreement with GCI under which the Company agreed to enter into a number of new business arrangements and to settle a number of outstanding disputes, including GCI’s opposition to ACS Group’s acquisitions of CenturyTel’s Alaska Properties and ATU. As part of this agreement and to support other aspects of the Company’s business strategy, ACS Group purchased from GCI $19.5 million of fiber capacity for high-speed links within Alaska and for termination of traffic in the lower 49 states. Subsequently, the Company entered into an amendment to the purchase agreement with GCI, whereby, among other things, ACS Group agreed to purchase additional capacity for $19.5 million. The Company fulfilled this commitment to purchase additional capacity on January 12, 2001.

     ACS Group is subject to numerous conditions imposed by the RCA and, to a lesser degree, by the FCC on the manner in which the Company conducts its long distance operations. The restrictions are intended to prohibit cross-subsidization from the regulated LEC to the long distance affiliate and discrimination against other long distance providers in favor of a LEC’s long distance affiliate. Among the conditions applied to ACS Group’s long distance affiliate are those which:

8

Table of Contents

	•		require the Company to hold all books and records, management, employees and administrative services separate, except that services may be provided among affiliates through arm’s length affiliated interest agreements,
	•		prohibit ACSA, ACSAK, ACSN and ACSF from bundling local and intra-state long distance services until competition develops in their local markets and
	•		prevent the Company from joint ownership of telephone transmission or switching facilities with the LEC and from using the LEC’s assets as collateral for its own indebtedness.

     Although there is some seasonal impact on customer usage patterns for long distance, operating results are not materially impacted by seasonal factors.

Network Facilities

     As of December 31, 2002, ACS Group owned 65 host switches serving over 323,000 access lines. All of the Company’s access lines are served by digital switches provided predominately by Nortel Networks. ACS Group’s switches are linked through a combination of extensive aerial, underground and buried cable, including 640 sheath miles of fiber optic cable, as well as digital microwave and satellite links. The Company has 100% single-party services (one customer per access line), and believes substantially all of its major switches have current generic software upgrades installed, allowing for the full range of enhanced customer features.

     ACS Group has integrated numerous network elements to offer a variety of services and applications that meet the increasingly sophisticated needs of customers. These elements include Signal System 7 signaling networks, voice messaging platforms, digital switching, DSL and, in some communities, integrated service digital network access. As the telecommunications industry experiences significant changes in technology, customer demand and competition, the Company intends to introduce additional enhancements.

     Network operations and monitoring are provided by ACS Group’s network operating control center located in Anchorage. The network operating control center has technicians staffed seven days a week, 24 hours a day. The Company also has customer care call center facilities in Anchorage and Fairbanks along with additional customer care facilities in Juneau, Sitka, Kenai/Soldotna and Kodiak. All of these facilities offer extended business hours to efficiently handle customer inquiries and orders for service.

     ACS Group’s wireless operations consist of four digital switching centers, 111 cell sites and three repeaters covering substantially all major population centers and highway corridors in Alaska plus one analog switch and cell site covering Barrow, Alaska. The Company’s switching and cell site infrastructure is linked by fiber and digital microwave. ACS Group’s network operating control center located in Anchorage also supports all wireless switches in ACS Group’s markets. Customer care centers are located in Anchorage, Fairbanks, Juneau, North Pole, Homer and Kenai/Soldotna.

     The Company has enhanced its network to accommodate developing products and technology. The Company completed its Multi-Protocol Label Switching over Asynchronous Transfer Mode network or MPLS/ATM network in early 2002. Core MPLS/ATM nodes were installed in Anchorage, Fairbanks, Kenai, Juneau, the Mat-Su valley and Seattle. ACS Group believes the MPLS/ATM network enhances its capability to provide a complete suite of converged telecommunications, data and video services and achieve significant operating efficiencies. ACS Group currently offers a variety of products and services and is able to converge them all over its MPLS core network:

	•		virtual private networks and lines,
	•		voice over Internet Protocol (“IP”) services,
	•		transparent local area networks (LAN) and proprietary LANs and wide area networks (WAN),
	•		high speed Internet access,
	•		managed services and
	•		video and video conferencing.

9

Table of Contents

Customers

     ACS Group has three basic types of customers for the services of its LECs:

	•		business and residential customers located in their local service areas that pay for local phone service,
	•		interexchange carriers that pay for access to long distance calling customers located within the Company’s local service areas and
	•		CLECs that pay for wholesale access to the Company’s network in order to provide competitive local service on either a wholesale or UNE basis as prescribed under the 1996 Act.

     Approximately 53% of ACS Group’s retail access lines served residential customers, while 47% served business customers.

     ACS Group also has approximately 82,000 wireless subscribers, 13,500 directory advertising customers, 46,000 Internet subscribers and 70,000 long-distance subscribers consisting substantially of retail residential and business consumers.

     During 2002 one customer accounted for 11% of consolidated revenues and no other customers accounted for more than 10% of consolidated revenue.

Competition

     Local Telephone Service

     ILECs may be subject to any of several types of competition:

	•		facilities-based competition from providers with their own local service network,
	•		resale competition from resale interconnection, or providers who purchase local service from the ILEC at wholesale rates and resell these services to their customers,
	•		competition from UNE interconnection, that is, providers who lease UNEs from the ILEC, and
	•		alternatives to local service networks, including wireless, IP, satellite, and cable telephony.

     The geographic characteristics of rural areas presently make the entrance of most facilities-based competitors uneconomical because of the significant capital investment required and the limited market size. Therefore, ACS Group believes competition is likely to come from resale interconnection or UNE interconnection. However, in the future, competition though other means, such as cable or wireless telephony may become economically feasible. There are no regional Bell operating companies in Alaska.

     In September 1997, GCI and AT&T Alascom, the two largest long distance carriers in Alaska, began providing competitive local telephone services in Anchorage. GCI competes principally through UNE interconnection with ACSA facilities, while AT&T Alascom competes primarily by reselling ACSA’s services. Competition is based upon price and pricing plans, types of services offered, customer service, billing services, and quality and reliability of service. GCI has focused principally on advertising discount plans for bundled services. AT&T Alascom’s strategy has been to resell ACSA’s service as part of a package of local and long distance services. As a result, ACSA now has approximately 50% competitive market penetration as of December 31, 2002. The Company expects GCI and AT&T Alascom to continue to compete for local telephone business.

     As “rural telephone companies” under the 1996 Act, ACS Group’s rural LECs have historically been exempt from the obligation to lease their facilities or resell their services on a wholesale discount basis to CLECs seeking interconnection. However, on June 30, 1999 the Alaska Public Utilities Commission (“APUC”)

10

Table of Contents

ordered these exemptions terminated for certain rural service areas of ACS Group, and on October 11, 1999, the RCA, which replaced the APUC on July 1, 1999, sustained the APUC’s order. As a result, ACS Group’s rural LECs entered into interconnection arbitration with GCI. This arbitration resulted in interconnection agreements for certain rural service areas of ACS Group. See “Business – Regulation” for further discussion.

     In October 2000, the RCA approved interconnection agreements under the 1996 Act between ACSF, ACSN and ACSAK and GCI for its Fairbanks and Juneau markets. Commencing in April 2001, the Company received its first orders for resale of local services in Fairbanks. As of December 31, 2002, ACS Group estimates that it now has approximately 75% market share in Fairbanks. Through December 31, 2002, GCI has competed in Fairbanks primarily through reselling services and through UNE interconnection. Similar trends are being experienced by ACSAK in its Juneau market where, as of December 31, 2002, the Company has approximately 85% market share. While GCI claims the right to resell local service in portions of the ACSN territory, it has yet to place any orders to do so.

     ACS Group expects increasing competition from providers of various services that provide users the means to bypass its network. Long distance companies may construct, modify or lease facilities to transmit traffic directly from a user to a long distance company. Cable television companies also may be able to modify their networks to partially or completely bypass the Company’s local network. GCI, the dominant cable operator in Alaska and a CLEC, is currently testing cable telephony service and recently announced plans to start switching its local phone service customers in Anchorage over to its cable system in 2004.

     In addition, while wireless telephone services have historically complemented traditional LEC services, the Company anticipates that existing and emerging wireless technologies may increasingly compete with LEC services. For example, AT&T had introduced its fixed wireless product to the Anchorage market. Although AT&T’s fixed wireless product was subsequently abandoned, communications technology manufacturers continue to work on alternatives to traditional LEC service. At this time it is not possible to predict the impact of this product on the Company’s share of the local market. Technological developments in wireless telephone features, personal communications services, digital microwave and other wireless technologies are expected to further permit the development of alternatives to traditional wireline services.

     Wireless Services

     The wireless telecommunications industry is experiencing significant technological change, as evidenced by the increasing pace of improvements in the capacity and quality of digital technology, shorter cycles for new products and enhancements, and changes in consumer preferences and expectations. ACS Group believes that the demand for wireless telecommunications services is likely to increase significantly as equipment costs and service rates continue to decline and equipment becomes more convenient and functional. Competition is based on price, quality, network coverage, packaging features and brand reputation. In addition, there are six PCS licensees in each of the Company’s wireless service areas. ACS Group holds PCS licenses covering Anchorage, Fairbanks and Juneau. ACS Group currently competes with at least one other wireless provider in each of its wireless service areas, including AT&T Wireless Services, Alaska DigiTel, and Dobson Communications. Recently, Dobson Communications and AT&T Wireless announced a property swap which the Company anticipates will remove AT&T Wireless from direct competition and give Dobson Communications a statewide competition position. The Company believes that the unique and vast terrain and the high cost of PCS system buildout make entrance into markets outside Anchorage uneconomical at this time.

     As the market for simple wireless voice services approaches maturity, providers are experiencing downward pressure on price. ACS Group is positioning itself to offset this impact by bringing new higher margin services to market. By developing products for targeted market segments, the Company is leveraging the advantage in market share and geographical coverage to attract new customers and increase monthly revenues from existing customers. The Company continuously evaluates new service offerings in order to differentiate it from its competitors, produce additional revenues and increase margins.

11

Table of Contents

     Directory

     The Alaskan directory advertising industry is competitive. ACSIS competes in Alaska with other directory businesses and other forms of advertising media, including newspapers, radio, television, the Internet, billboards and direct mail. The other directory publishers in Alaska include Phone Directories Company, Inc., which is an independent directory publisher based in Utah and GTE Directories Corporation, which is a directory publisher based in Texas. ACSIS also competes with Alltel Publishing Corporation, which publishes directories for an incumbent telephone company operating in the region to the Northwest of Anchorage, known as Matanuska Telephone Association. Alltel also recently announced that it will publish a directory in Anchorage for GCI, the dominant cable operator in Alaska and a CLEC, which is expected to be published in December 2003. Management believes that ACSIS competes effectively against these providers and that it has a leading market share in each of the areas it serves.

     Internet-based directories have emerged as a new medium for customers. Although advertising on the Internet still represents only a small part of the total advertising market, it may become increasingly important as an advertising medium. Most major yellow pages publishers operate an Internet-based directory business. ACSIS competes through its Internet site, acsyellowpages.com, with these publishers, with other Internet sites providing classified directory information, such as Anchoragedailynews.com, alaskayellowpages.com, and with search engines such as Yahoo!, Alta Vista and Excite, some of which have entered into affiliate agreements with other major directory publishers.

     Internet Services

     The market for Internet access services is highly competitive in most markets in the state. There are few significant barriers to entry, and the Company expects that competition will intensify in the future. ACS Group currently competes with a number of established online services companies, interexchange carriers, LECs with Internet subsidiaries, satellite service providers and cable television companies. The Company believes that its ability to compete successfully will depend upon a number of factors, including the reliability and security of its network infrastructure, the ease of access to the Internet, the availability of broadband ISP access and the pricing policies of its competitors. During 2002, the Company continued to feature its DSL services in Anchorage, Fairbanks, Juneau, Kenai/Soldotna, Homer and Sitka, Alaska for both residential and business applications.

     Long Distance Services

     The long distance telecommunications market is highly competitive. Competition in the long distance business is based primarily on price, although service bundling, branding, customer service, billing services and quality play a role in customer’s choices to some extent. The Company currently offers long distance service to customers located primarily in the more populous communities within its service territory. AT&T Alascom and GCI are currently the two major competing long distance providers in Alaska. The Company currently has less than 10% of total interexchange revenues in Alaska. The Company provides traditional “1+” direct distance dialing (DDD), toll-free services, calling cards and private line services for data and voice applications. In Spring 2001, the Company discontinued its long distance “Infinite Minutes” program, and introduced several new flat-fee programs marketed as “Easy Choices.” The new programs allow customers to purchase interstate minutes of use in blocks of time for a single monthly fee. ACS Group expects to continue offering innovative products of this nature in the future.

Sales and Marketing

     The Predecessor Entities have historically conducted their sales and marketing operations for each of their respective products on a stand-alone basis, with each product line having its own sales force and marketing department. ACS Group has consolidated its product and service offerings under the “Alaska Communications Systems” and “ACS” brands, subject to regulatory and strategic business considerations.

12

Table of Contents

     Key components of the Company’s sales and marketing strategy include:

	•		establishing name recognition of the ACS brand across all product and service offerings,
	•		marketing current and future service offerings aggressively,
	•		providing simplified packaged service offerings,
	•		centralizing marketing functions,
	•		improving quality, reliability and customer service,
	•		developing and delivering to the market new products and services in line with strategic goals, and
	•		enhancing direct sales efforts.

     ACS Group believes that it can leverage its position as an integrated, one-stop provider of telecommunications services with strong positions in local access, wireless, directory, Internet, and interexchange long distance and data markets. By pursuing, within the bounds of any applicable regulatory constraints, a marketing strategy that takes advantage of these characteristics and that facilitates cross-selling and packaging of its products and services, the Company believes it can increase penetration of new product offerings, improve customer retention rates, increase its share of its customers’ overall telecommunications expenditures, and achieve continued revenue and operating cash flow growth.

     ACS Group has begun, to a limited extent, within regulatory bounds, marketing local telephone services in attractively priced, packaged service offerings with wireless, long distance and Internet services. ACS Group believes packaged offerings are popular with customers because they allow customers to enjoy pricing for a number of services at a discount to a la carte pricing of individual services. Subject to regulatory limitations, the Company intends to expand this strategy, which it expects will increase the average revenue per customer, and result in a more loyal and satisfied customer base and in reduced churn.

     The Company has established a sales and marketing organization where marketing strategies are centralized and sales functions are based locally. To enhance its direct selling efforts, the Company has established additional customer and retail service centers in its larger service areas, such as Juneau and Kenai/Soldotna, and intends to enhance its call center operations through a combination of technology investments, training, and incentive compensation programs for call center employees.

Employees

     ACS Group considers employee relations to be good. As of December 31, 2002, the Company employed a total of 1,103 regular full-time employees, 869 of whom were represented by the International Brotherhood of Electrical Workers, Local 1547 (“IBEW”). On November 2, 1999, the IBEW membership for ACS Group ratified the terms of a master collective bargaining agreement that governs the terms and conditions of employment for all IBEW represented employees working for ACS Group in the State of Alaska. The master agreement embraces a labor-management relationship that is founded on trust, cooperation and shared goals. The November 1999 agreement, which expires December 31, 2006, provides for wage increases up to 4% in specified years based on the annual increases in the consumer price index for Anchorage as reported by the U.S. Department of Labor CPI-U. The last wage increase under the agreement was implemented in July 2001 and the next scheduled wage review is in January 2003. The master agreement also limits ACS Group’s health and welfare contributions for represented employees to 4% annually. There have been no work stoppages or strikes, and none are anticipated.

     ACS Group also enjoys good relations with the non-represented employee group. Non-represented employees qualify for wage increases based on individual and Company performance, and key employees are also eligible for performance-based incentives. ACS Group provides a total benefits package, including health, welfare, and retirement components, that is competitive in ACS Group’s market.

13

Table of Contents

Website Access to Reports

     ACS Group makes its periodic and current reports available, free of charge, on its investor website, www.ALSK.com, as soon as practicable after such material is electronically filed with, or furnished to, the SEC.

Regulation

     Overview

     The Company’s local telephone operating subsidiaries, ACSA, ACSF, ACSAK, and ACSN, are each “telecommunications carriers” and ILECs under the Communications Act of 1934 (the “Communications Act”), which was amended by the 1996 Act, and are subject to the jurisdiction of the FCC and the RCA. ACSLD, ACS Group’s long distance subsidiary, is also subject to both the FCC and RCA’s regulatory jurisdiction. ACS Group’s wireless operations are also subject to FCC jurisdiction because they are telecommunications carriers and because they hold FCC-issued licenses.

     Federal Regulation

     Under the federal regulatory scheme, ILECs are required to comply with the Communications Act and the applicable rules and regulations of the FCC. In substantially overhauling the Communications Act, the 1996 Act was intended to, among other things, eliminate unproductive regulatory burdens and promote competition. Despite this, telecommunications carriers are still subject to extensive ongoing regulatory requirements. For instance, ACS Group’s ILEC subsidiaries are required to maintain accounting records in accordance with the Uniform System of Accounts, to structure interstate access charges according to FCC rules, and to charge for interstate services at a rate of return not to exceed a rate prescribed by the FCC. The FCC also must give prior consent to transfers of control and assignments of radio frequency licenses. The FCC requires ILECs providing interstate access services to file tariffs with the FCC reflecting the rates, terms and conditions of those services. These tariffs are subject to review and potential objection by the FCC or third parties. Additionally, all of the Company’s LECs are “ILECs” within the meaning of the 1996 Act. As such, they are subject to various additional requirements under the 1996 Act, including specific interconnection duties such as providing requesting telecommunications carriers with UNEs and wholesale discounted end user services for resale.

     Long distance companies are now precluded from filing tariffs for interstate domestic and international services. Federal tariffing has been replaced with Internet web site posting of offers, terms and prices.

     State Regulation

     Telecommunications companies subject to the RCA’s jurisdiction are required to obtain certificates of public convenience and necessity prior to operating as a public utility in Alaska. The RCA is responsible for approving new certificates and any transfers of existing certificates. In addition, the RCA is responsible for implementing a portion of the competitive requirements of the 1996 Act, as well as for regulating intrastate access and rates for local and other services of local telephone companies. After passage of the 1996 Act, the RCA’s predecessor, APUC, adopted a plan to address competition issues across Alaska. The APUC established multiple dockets to investigate different competition-related issues, including revising local and long distance market structures, reforming its intrastate access charge system and establishing a state universal service fund. In addition to its preliminary actions to mandate access charge depooling for ILECs operating in competitive markets, the RCA made operational the new Alaska Universal Service Fund (“AUSF”). In a subsequent rulemaking, the RCA revised its eligibility standards for companies receiving high-cost switching support from the AUSF. These rules resulted in a loss of support to ACS Group’s rural affiliates. Rather than seeking interim local relief for this cost recovery shift, ACS Group has opted to include consideration of this issue in the more comprehensive rate proceedings described below.

14

Table of Contents

     In connection with regulatory approval of ACS Group’s acquisitions of CenturyTel’s Alaska Properties and ATU in 1999, the APUC imposed several conditions on its operating companies. Among those conditions was a requirement that ACSA, ACSF, ACSAK, and ACSN each file revenue requirement, cost of service and rate design studies no later than July 2001. All of these companies except ACSF were also required to file updated depreciation analyses concurrently with the rate case filings. The revenue requirement studies were subsequently bifurcated from the cost of service and rate design studies. In conformance with RCA orders, all revenue requirement studies and testimonies have been filed. Following a hearing and decisions as to revenue requirements, the companies will file their cost of service and rate design studies and testimony. In addition, restrictions were placed on the ability of ACS Group’s LECs to bundle intrastate service offerings with ACSLD.

     Having secured both LEC certification and interconnection agreements to serve the local exchange markets in Juneau and Fairbanks, Alaska, and numerous smaller communities in Alaska, GCI’s CLEC operation has been designated an “Eligible Telecommunications Carrier” (“ETC”) by the RCA for Anchorage, Juneau, Fairbanks and Fort Wainwright. ETC designation is an essential first step in securing “portable” or shared universal service support. ACS Group’s operating companies are currently designated as ETCs in the same markets for which GCI has received this designation.

     Under existing FCC regulations, ILECs may seek, through filings with state commissions, the disaggregation of study areas into multiple zones for purposes of universal service support. Filings reflecting two-zone disaggregation plans have already been made by ACSF and ACSN for its Glacier State study area.

     Cost Recovery and Revenue Recognition

     As regulated common carriers, the operating subsidiary companies of ACS Group have the right to an opportunity to set maximum rates at a level that allows the Company to recover the reasonable costs incurred in the provision of regulated telecommunications services and to earn a reasonable rate of return on the investment required to provide these services.

     These costs are recovered through:

	•		monthly charges to end users for basic local telephone services and enhanced service offerings,
	•		access charges to interexchange carriers for originating and terminating interstate and intrastate interexchange calls, along with an end-user access charge referred to as a Subscriber Line Charge
	•		interconnection charges, wholesale service charges, UNE charges, and other rates to competing carriers interconnecting with the Company’s networks or reselling its services and
	•		high-cost support mechanisms, such as USF and AUSF.

     In conjunction with the recovery of costs and establishment of rates for regulated services, a LEC must first determine its aggregate costs and then allocate those costs between regulated and nonregulated services. After identifying the regulated costs of providing local telephone service, a LEC must allocate those costs between state and federal jurisdictions and among its various interstate and intrastate services. This process is complicated by the necessity to allocate specific pieces of plant and equipment to a particular service because a LEC’s plant and equipment are utilized for different jurisdictional services, such as local telephone and interstate and intrastate access. This process is referred to as “separations” and is governed primarily by the FCC’s rules and regulations. The underlying legal purpose of separations rules is to define how a carrier’s expenses are allocated and recovered from federal and state jurisdictions. The FCC is considering whether to modify or eliminate the current separations process. This decision could indirectly increase or reduce earnings of carriers subject to separations rules by reallocating costs between the federal and state jurisdictions. However, maximum rates for regulated services and the amount of high-cost support are set by the FCC with respect to interstate services and by the RCA with respect to intrastate services.

15

Table of Contents

     Interstate End-User Rates

     The deployment of the local telephone network from the switching facility to the customer is known as the “local loop” and is one of the most significant costs incurred by a LEC in providing telephone service. The FCC has established a rate structure that provides for the recovery of a portion of the cost of the local loop allocated to the interstate jurisdiction directly from the end user customer through the assessment of a subscriber line charge. The remaining portion of the local loop costs are recovered from interstate access charges to an interexchange carrier or, in some circumstances, from the federal USF. The FCC recently increased the cap for subscriber line charges assessed by the Company’s LECs as part of a comprehensive review of its rules that also lowered carrier-paid interstate access charges and created explicit universal service support for interstate-allocated local loop costs.

     As a result of the market and geographic conditions in rural areas, the costs of providing local loop and switching services are often higher than in urban areas. In the absence of an accommodation in the FCC rules to address this fact, a substantial portion of the costs of smaller LECs would remain allocated to the intrastate jurisdiction placing substantial pressure on such carriers to charge higher rates for intrastate services. Accordingly, the FCC provides for additional interstate cost recovery by eligible telecommunications carriers through the federal USF. The federal USF is available to carriers whose local loop costs are significantly above the national average as calculated pursuant to FCC rules. Recent FCC rulings have made this high-cost support available to a competitive carrier, on an averaged per line basis, for those lines serving customers switching to the competitive carrier. See “Promotion of Universal Service,” below.

     Interstate Access Rates

     Interstate access rates are developed on the basis of a LEC’s measurement of its interstate costs for the provision of access service to interexchange carriers divided by its projected demand for access service. The resulting rates are published in a company’s interstate access tariff and filed with the FCC, at which time they are subject to challenge by third parties and to review by the FCC.

     The FCC recognized that this rate making and tariff filing process may be administratively burdensome for small LECs. Accordingly, the FCC established NECA, in 1983 to, among other things, develop common interstate access service rates, terms and conditions. NECA develops interstate access rates on the basis of data that are provided individually by participating LECs and blended to yield average rates. These rates are intended to generate revenue equal to the aggregate costs plus a return on the investment of all of the participants. Currently, the authorized maximum rate of return used in setting interstate access rates is 11.25%.

     On August 24, 2000, GCI filed a formal complaint with the FCC under various provisions of the Communications Act (as amended), alleging that ACSA (formerly known as ATU) exceeded its federally authorized rates of return related to the 1997-1998 monitoring period. The principal issue raised in the complaint focuses on the proper jurisdictional recognition (federal versus state) of minutes of use associated with Internet service provider traffic. On January 24, 2001, the FCC issued an order finding for GCI on the matter and ordering the Company to pay GCI approximately $2.7 million plus interest. The Company appealed this order in the United States Court of Appeals for the District of Columbia Circuit and the FCC issued a stay concerning the obligation to pay GCI during the pendency of the appeal. On March 4, 2002, the District of Columbia Circuit Court of Appeals heard oral argument in the matter. On May 21, 2002, the court issued its decision finding that the FCC could rule that ISP traffic is intrastate in nature, but that the FCC could not order refunds for those periods during which the Company’s tariffs were deemed lawful. The matter was remanded back to the FCC for recalculation of any refunds that may be appropriate given the tariffs that have been deemed lawful and for reconsideration of the interest rate imposed in the FCC’s original order on any refunds that may eventually be ordered. In March 2003, ACS entered into a settlement agreement with GCI covering both the 1997-1998 monitoring period and similar issues GCI had raised with respect to the 1999-2000 monitoring period.

16

Table of Contents

     Individual participating LECs are likely to have costs of providing service that are either higher or lower than the revenues generated by applying the overall NECA tariff rate. To rectify this result, the revenues generated by applying the NECA rates are pooled from all of the participating companies and redistributed on the basis of each individual company’s costs. The result of this process not only eliminates the burden of individual tariff filing, but also produces a system in which small companies can share and spread risk. For example, if a smaller LEC filed its own tariff and subsequently suffered the loss of major customers that utilize interstate access service, the LEC could suffer significant under-recovery of its costs. In the NECA pool environment, the impact of this loss is reduced because it is spread over all of the pool participants.

     NECA operates separate pools for traffic sensitive costs, which are primarily switching costs, and non-traffic sensitive costs, which are primarily loop costs. Companies are also free to develop and administer their own interstate access charges if they choose not to participate in the pools. ACS Group’s rural LECs participate in both the traffic sensitive and non-traffic sensitive NECA pools. ACSA files its own traffic sensitive access tariffs with the FCC but participates in the NECA non-traffic sensitive pool.

     End User Local Rates

     The levels of rates charged to end-users for the provision of basic local service are generally subject to rate-of-return regulation administered by the RCA. Local rates have historically been set at a level that will allow recovery of embedded costs for local service divided by the number of services and customers. Competitive forces, however, may prevent local rates from being sufficient to recover costs for local service in the future. Recognized costs include an allowance for a rate of return on investment in plant used to provide local service. Rate cases are typically infrequent, carrier-initiated and require the carrier to meet substantial burdens of proof. All ACS Group’s affiliate LECs filed revenue requirement studies on July 1, 2001. A hearing commenced on the revenue requirement for these LECs on March 4, 2002. While a final decision has yet to be rendered on the LEC’s revenue requirements, it appears that ACSF and ACSN will face revenue requirement reductions while ACSAK will have an increased revenue requirement. The likely revenue requirement for ACSA can not be determined at this time. The ACS LECs will file cost of service and rate design studies and testimony, and have a second hearing, to arrive at final adjudicated rates following the final rulings on revenue requirements.

     Competitive Local Exchange Regulations

     The former APUC adopted regulations to govern competition in the local exchange marketplace. The transitional regulations provide for, among other things:

	•		initial classification of all ILECs, including the Company’s rural properties and ACSA, as dominant carriers,
	•		symmetrical requirements that all carriers, both dominant and nondominant, offer all retail services for resale at wholesale rates,
	•		substantial dominant carrier pricing flexibility in competitive areas, under which carriers may reduce retail rates, offer new or repackaged services and implement special contracts for retail service upon 30 days’ notice. Only rate increases affecting existing services are subject to full cost support showings for LECs in areas with local competition and
	•		application limited initially to the ACSA market, and in 2002, extended to the ACSF and ACSAK markets. ACSN anticipates filing a petition with the RCA to extend application upon the commencement of facilities-based competition.

     Intrastate Access Rates

     In the past, the APUC had required all local companies in Alaska to pool their access costs and has set an annual statewide average price for access service. Each LEC charges interexchange carrier fees for originating or terminating long distance calls on its network based on the statewide average cost of access rather than on its individual costs of access. Access revenues are collected in a pool administered by the AECA and

17

Table of Contents

then redistributed to the LECs based on their actual costs. With the passage of the 1996 Act and increased competition in the local exchange market, the APUC began a process of reforming intrastate access charges.

     Under recent revisions to the Alaska access system, LECs not yet subject to local competition continue to participate in the AECA pool. Participants in this pool recover their costs based on the embedded cost of services most recently authorized by the RCA. In the event of competitive entry into a dominant incumbent carrier’s service area, these revisions also require the dominant LEC to exit the pool and initiate separate access charge tariffs. Dominant LECs subjected to competitive entry have the right to propose that their access charges be based on market rates. The only ACS LEC remaining in the AECA pool as of December 31, 2002 is ACSN. The RCA is currently advancing a proceeding to examine whether changes to the current annual process for establishing access charges are warranted. The RCA issued a new access charge reform Notice of Inquiry in early 2001 which will target further substantive changes in access charge derivation.

     An additional consequence of this access reform is the continued removal of subsidies implicit in access pricing. The RCA, for example, has adopted regulations which limit switching support to local companies with access lines of 20,000 or less. This change has reduced the amount of AUSF which the Company’s rural LECs receive and the resulting cost recovery shift will be addressed in the local service rate cases commenced in 2001.

     The AUSF serves as a complement to the federal USF, but must meet federal statutory criteria concerning consistency with federal rules and regulations. Currently, the AUSF subsidizes a portion of higher cost carriers’ switching costs, the costs of lifeline service, which supports rates of low income customers, and a portion of the cost of Public Interest Pay Telephones. Recent proposals have targeted the AUSF as a source of funding for cost shifts that are likely to occur as a result of in-state access charge reform. It is unclear the degree to which the AUSF might be used to absorb cost shifts that result if federal universal service support is scaled back in the future.

     The Telecommunications Act of 1996

     Among other things, the 1996 Act was enacted to enhance competition without jeopardizing the availability of nationwide universal service at affordable rates. These two objectives have resulted in a complex set of rules intended to promote competitive entry in the provision of local telephone services except where entry would adversely affect the provision of universal service or the public interest.

     Promotion of Local Service Competition and Rural Exemptions

     The 1996 Act made competitive entry into the local telephone business more attractive to other carriers by removing barriers to competition. In order to promote competition, the 1996 Act established new interconnection rules generally requiring LECs to allow competing carriers to interconnect with their local networks. Congress recognized, however, that when the desire to promote competition conflicted with the ability of existing carriers to provide universal service to higher cost customers, LECs classified as “Rural Telephone Companies” should be exempted from interconnection requirements until the continuation of the exemption was no longer required by the public interest, as defined in the 1996 Act.

     Under the 1996 Act, all LECs, including both ILECs and new competitive carriers, are required to:

	•		offer reasonable and nondiscriminatory resale of their telecommunications services,
	•		ensure that customers can keep their telephone numbers when changing carriers,
	•		ensure that competitors’ customers can use the same number of digits when dialing and receive nondiscriminatory access to telephone numbers, operator service, directory assistance and directory listing,
	•		provide access to telephone poles, ducts, conduits and rights of way, to the extent required by the Communications Act, and

18

Table of Contents

•

compensate competitors for the costs of transporting and terminating telecommunications traffic.

     The 1996 Act also requires ILECs to:

	•		negotiate in good faith the terms and conditions of interconnection with any competitive carrier making a request for same,
	•		interconnect their facilities and equipment with any requesting telecommunications carrier at any technically feasible point,
	•		unbundle and provide nondiscriminatory access to UNEs, such as local loops, switches and transport facilities, at nondiscriminatory rates and on nondiscriminatory terms and conditions, unless such carriers are exempt as rural telephone companies,
	•		offer resale interconnection at wholesale rates,
	•		provide reasonable notice of changes in the information necessary for transmission and routing of services over the ILEC’s facilities or in the information necessary for interoperability and
	•		provide for the physical collocation of equipment necessary for interconnection or access to UNEs at the premises of the ILEC, at rates, terms and conditions that are just, reasonable and nondiscriminatory.

     In order to implement interconnection requirements, ILECs generally enter into negotiated interconnection arrangements with competing carriers. Competitors are required to compensate a LEC for the cost of providing interconnection services. In the case of resale interconnection, the rules provide that the rates charged should be on a wholesale basis and reflect the current retail rates of the ILEC, excluding the portion of costs avoided by the ILEC. In the case of UNE interconnection, rates are based on costing methodologies that employ a forward-looking economic cost pricing methodology known as Total Element Long Run Incremental Cost (“TELRIC”).

     On January 25, 1999, in AT&T Corp. et al. v. Iowa Utilities Board et al. 525 U.S. 366 (1999) (“Iowa I”), the U.S. Supreme Court affirmed the FCC’s authority to develop national pricing guidelines, but the Supreme Court did not evaluate the substance of these rules. The Supreme Court did hold, however, that the FCC had not properly applied the statutory “necessary and impair” standard for determining which elements of their networks the ILECs must unbundle. The Supreme Court remanded the case to the FCC for further consideration of the unbundling standard, and remanded the remainder of the issues to the Eighth Circuit.

     On remand, some ILECs argued that the FCC improperly placed upon them the burden of proof in rural exemption proceedings and improperly defined the meaning of the term “not unduly economically burdensome” as used in the 1996 Act. In addition, some ILECs argued that the FCC’s forward-looking TELRIC pricing methodology does not allow adequate compensation for the provision of UNEs. On July 18, 2000, in Iowa Utilities Board, et al. v. Federal Communications Commission 219 F.3d 744 (8th Cir. 2000) (“Iowa II”), the Eighth Circuit Court of Appeals ordered some of these FCC rules to be vacated on the grounds they were inconsistent with the 1996 Act. The Eighth Circuit said the FCC’s rural exemption rules were contrary to the plain language of the 1996 Act. On March 5, 2001, the ACS Group’s rural LECs petitioned the FCC to adopt a new national rule consistent with the Iowa II decision, placing the burden of proof on CLECs in proceedings to terminate a company’s rural exemption. On August 27, 2001, the FCC denied the petition, explaining it was unnecessary as the FCC is already bound by the Iowa II decision. The ACS Group rural companies requested reconsideration of that decision on September 26, 2001 and the matter is still pending.

     As to the FCC’s TELRIC pricing methodology, the Eighth Circuit in Iowa II upheld the use of a forward-looking economic model but vacated the FCC’s rule requiring the pricing model to assume a hypothetical network based upon the most efficient technology currently available and the lowest cost network configuration.

     On September 22, 2000, the Eighth Circuit stayed that portion of its mandate which vacated the FCC hypothetical network rule (set out at 47 C.F.R. §51.505(b)(1)). This suspension was ordered by the Court to

19

Table of Contents

permit parties to the proceeding to seek review of its Iowa II decision by the U.S. Supreme Court. On January 22, 2001, the U.S. Supreme Court granted certiorari to review the Eighth Circuit’s decision requiring the FCC to vacate its hypothetical network rule. The Eighth Circuit did not suspend other portions of its decision, including those portions vacating FCC rules addressing the “rural exemption” provisions of 47 U.S.C. §251(f)(1), and the U.S. Supreme Court declined to review the Eighth Circuit’s rural exemption decision. On May 13, 2002, the U.S. Supreme Court upheld the FCC’s TELRIC regulations in Verizon Communications, Inc. v. Federal Communications Commission, 535 U.S. 467 (2002)

     In November, 1999, the FCC issued an order addressing the issues the Supreme Court remanded in Iowa I. In May, 2002, the United States Court of Appeals for the District of Columbia Circuit held that the FCC again had improperly applied the statutory unbundling standard, and remanded the unbundling rules to the FCC for further consideration. In February, 2003, the FCC adopted a further order governing the network elements that an ILEC must unbundle, and delegating significant authority to make such determinations to state public utility commissions. The FCC’s order is likely to be the subject of further appeals.

     The 1996 Act also specifies that resale and UNE rates are to be negotiated among the parties, or, if the parties fail to reach an agreement, arbitrated by the relevant state regulatory commission. Once the parties have come to agreement, the proposed rates are subject to final approval by the state regulatory commission.

     In January 1997, ACSA’s predecessor, ATU, entered into an interconnection agreement with GCI, which provides for resale and UNE interconnection, and with AT&T Alascom, which provides for resale interconnection. Neither interconnection agreement contained a defined term or a termination date. Near the end of 1999, the Company notified GCI and AT&T of its view that the interconnection agreements pertaining to ACSA had reached the end of a reasonable period of availability. In January of 2000, the Company filed a motion with the RCA to reopen the original GCI arbitration proceedings involving ACSA for the purpose of establishing an appropriate forward looking cost model and the re-pricing various interconnection services and UNEs in the Anchorage market. The RCA subsequently granted the essence of the Company’s motion and has reopened the docket for such purposes. No action was taken in 2000. On October 25, 2001, the RCA granted ACSA an interim UNE rate increase of $1.07, bringing the UNE rate up from $13.85 to $14.92. At present time there is no schedule for the RCA to complete its adjudication of Anchorage UNE rates.

     Certain of ACS Group’s local operating utilities, ACSAK, ACSN, and ACSF, are defined as “rural telephone companies” under the 1996 Act. As rural telephone companies, they were granted rural exemptions from the requirements relating to both resale interconnection and UNE interconnection. The rural exemptions were to continue until the APUC or the RCA determined that interconnection was technically feasible, not unduly economically burdensome and consistent with the 1996 Act’s universal service provisions.

     On June 30, 1999, the APUC issued an order terminating the rural exemptions of ACSN, ACSAK and ACSF. On October 11, 1999, the RCA affirmed the APUC’s order. As a result, these rural LECs are no longer exempt from the 1996 Act’s interconnection requirements applicable to ILECs, and the Company’s competitors immediately requested interconnection agreements.

     On November 10, 1999, the Company filed a formal appeal of the RCA’s order terminating the rural exemptions in the Alaska Superior Court. The issues in the case were fully briefed during the year 2000. The court denied the Company’s request to stay the RCA’s order terminating the rural exemptions on February 9, 2001 and subsequently upheld the RCA’s orders on November 26, 2001. The Company filed an appeal with the Alaska Supreme Court on December 26, 2001 and the Court heard oral argument in the matter on February 11, 2003. Although ACS Group believes that the appeals are well founded, it cannot predict the timing and outcome of this litigation.

     Subsequent to terminating the rural exemptions for the Fairbanks, Juneau-Douglas and ACSN’s Glacier State study area markets, the Company entered into unsuccessful negotiations for interconnection agreements with GCI. Interconnection issues, including the pricing for UNEs, were subject to an RCA arbitration during the year 2000. On September 5, 2000, the RCA issued orders largely ratifying the findings of the arbiter in these

20

Table of Contents

interconnection arbitration proceedings involving the Company and GCI. On September 25, 2000, the Company filed a protective appeal in the State Superior Court and a complaint in the Federal District Court for the District of Alaska, alleging various errors in the RCA orders. On October 5, 2000, the RCA issued final orders affirming the interconnection agreements arbitrated in these proceedings. The RCA also sought to dismiss the claims against it on the basis of sovereign immunity, and when its request was denied, it appealed the issue to the Ninth Circuit Court of Appeals. The Ninth Circuit has yet to render a decision on the RCA’s sovereign immunity claims. No court has ever ruled on the merits of ACS’ claims. Although ACS Group believes that its appeal and complaint are well founded, it cannot predict the timing and outcome of this litigation. The Company has and will continue to vigorously defend its proposed cost models and interconnection charges but it cannot be certain that it will be able to charge rates that provide fair compensation for providing UNEs and/or schedule discounted resale services.

     Since 1999, the Company has also entered into interconnection agreements with Alaska Fiber Star, LLC, TelAlaska Long Distance, Inc., Level 3, and other entities.

     The rural exemption previously enjoyed by ACS Group’s ACSF, ACSAK and ACSN have been lifted by the RCA, with the exception of the Company’s Sitka study area within ACSN. The loss of the rural exemptions, absent compensating measures, such as rate increases or market structure reforms, including the replacement of implicit subsidies by explicit support mechanisms, rate deaveraging, or regulatory flexibility, could adversely affect the Company’s operating results.

     Promotion of Universal Service

     While the 1996 Act promoted Congress’ policy of ensuring that affordable service is provided to consumers universally in rural, high-cost areas of the country, the 1996 Act altered the framework for providing universal service by:

	•		providing for the identification of those services eligible for universal service support,
	•		requiring the FCC to make implicit subsidies explicit,
	•		expanding the types of communications carriers required to pay universal service contributions and
	•		allowing CLECs to be eligible for funding.

     These and other provisions were intended to make provision of universal service support compatible with a competitive market.

     Pursuant to the 1996 Act, federal USF payments are only available to carriers that are designated as eligible telecommunications carriers by a state public utilities commission. In areas served by rural LECs, the 1996 Act provides that a state public utilities commission may designate more than one eligible telecommunications carrier, in addition to the ILEC, only after determining that the designation of an additional eligible telecommunications carrier is consistent with the public interest. As a result, an incumbent rural LEC has an opportunity to maintain its status as the sole recipient of federal USF payments in its service area, even if it is subsequently subjected to competition. The RCA, however, has granted GCI’s request that it be designated an eligible telecommunications carrier in Fairbanks, Juneau, and Fort Wainwright, all of which are currently served by the Company’s subsidiaries. The addition of a second eligible telecommunications carrier in the service areas of ACS Group’s properties could have the effect of reducing the amount of funds available from the federal USF and could materially adversely affect the Company’s ability to achieve a reasonable rate of return on the capital invested in its network.

     Rules for rural telephone companies are still being developed by the FCC, in consultation with a Federal-State Joint Board on Universal Service (“Joint Board”). The RCA Chairman is a member of this Joint Board, and the Company’s remaining LEC subsidiaries are rural telephone companies as defined in the 1996 Act. On May 23, 2001, after considering recommendations from the Joint Board and a Rural Task Force formed to study universal service issues, the FCC issued rules that, for an interim period of five years, will: (1) increase

21

Table of Contents

the overall funding of the universal service support fund for high-cost rural carriers; (2) permit disaggregation of universal service support so that greater amounts of support would be targeted to the highest-cost areas the rural carrier serves; and (3) create additional support for significant investments in rural telecommunications plant and equipment.

     Because the operating subsidiary companies of ACS Group provide interstate and international services, they are required to contribute to the federal USF a percentage of their revenue earned from their interstate and international services. Although the Company’s rural LECs receive subsidies from the federal USF, they cannot be certain of how, in the future, the Company’s contributions to the fund will compare to the subsidies they receive from the fund.

     FCC Regulation of Wireless Services

     The FCC regulates the licensing, construction, operation, acquisition and sale of personal communications services and cellular systems in the United States. All cellular and personal communications services licenses have a 10-year term, at the end of which they must be renewed. Licenses may be revoked for cause, and license renewal applications may be denied if the FCC determines that renewal would not serve the public interest. In addition, all personal communications services licensees must satisfy certain coverage requirements. Licensees that fail to meet the coverage requirements may be subject to forfeiture of the license.

     The FCC has restricted the amount of wireless spectrum that a single entity may hold in a market. The FCC’s rule prohibited an entity from holding more than 55 MHz of spectrum in any particular market, however, this rule did sunset on January 1, 2003.

     The Communications Act preempts state and local regulation of the entry of, or the rates charged by, any provider of Commercial Mobile Radio Service (“CMRS”) which includes personal communications services and cellular services and the FCC does not regulate such rates. The FCC imposes, however, a variety of additional regulatory requirements on CMRS operators. For example CMRS operators must be able to transmit 911 calls from any qualified handset without credit check or validation, are required to provide the location of the 911 caller, within an increasingly narrow geographic tolerance over time, and in the future, will be required to provide 911 service for individuals with speech and hearing disabilities.

     FCC Regulation of Interstate Long Distance Services

     The Company’s interstate long distance services are currently not subject to rate regulation by the FCC, and the Company is not required to obtain FCC authorization for the installation, acquisition or replacement of its domestic interexchange network facilities. However, the Company must comply with the requirements of common carriage under the Communications Act. ACSLD is subject to the general requirement that its charges and terms for its telecommunications services be “just and reasonable” and that it not make any “unjust or unreasonable discrimination” in its charges or terms, as well as to a number of other requirements of the Communications Act and the FCC’s rules. The FCC has jurisdiction to act upon complaints against any common carrier for failure to comply with its statutory obligations, and it has recently levied substantial fines on carriers that have engaged in “slamming,” which is the industry term for unauthorized switching of a customer’s telecommunications service provider.

     In 1996, the FCC issued an order that required nondominant interexchange carriers, like ACSLD, to cease filing tariffs for its domestic interexchange services. The order required mandatory detariffing and gave carriers nine months to withdraw federal tariffs and move into contractual relationships with their customers. This order subsequently was upheld by the United States Court of Appeals for the District of Columbia Circuit. As a result, all interstate interexchange carriers, including ACSLD, were required to detariff contract-type interstate, interexchange services by January 31, 2001, and were required to detariff interstate consumer long distance services by April 30, 2001. These rules also require ACSLD to post the rates, terms, and conditions of its service on its Internet web site, and engage in other public disclosure activities. The FCC has recently

22

Table of Contents

adopted rules that require nondominant international carriers to detariff international services. ACSLD timely complied with these FCC requirements.

     FCC Policy on Internet Services

     The 1996 Act establishes a distinction between telecommunications services, which are regulated by the FCC, and information services, which remain unregulated. ACS Group’s Internet services are considered information services and are not regulated by the FCC. Because the regulatory boundaries in this area are somewhat unclear and subject to dispute, however, the FCC could seek to characterize some of the Company’s information services as “telecommunications services.” If that happens, those services would become subject to FCC regulations. The impact of a reclassification of ACS Group’s Internet services is difficult to predict.

     In June 2000, the United States Court of Appeals for the Ninth Circuit held that AT&T’s high-speed Internet access service, delivered using cable television facilities, constituted both a “telecommunications” and an “information” service. In response to this holding, in September 2000, the FCC launched a proceeding to examine whether providers of high-speed Internet access over such cable facilities should be required to provide “open access” to their facilities to competing Internet service providers on a nondiscriminatory basis. If the FCC implements such a requirement, the Company may be able to supplement its own high-speed Internet access offerings by obtaining access to GCI’s high-speed Internet access cable lines for its own Internet service provider.

     Other Regulatory Proceedings

     In addition to the foregoing matters, a number of other FCC, state and judicial proceedings are currently pending or may be initiated in the future which could materially affect the Company’s business.

     The Company cannot predict the outcome of these proceedings before the FCC, the RCA or the courts.

Environmental Regulations

     ACS Group’s operations are subject to federal, state and local laws and regulations governing the use, storage, disposal of, and exposure to, hazardous materials, the release of pollutants into the environment and the remediation of contamination. As an owner or operator of property and a generator of hazardous wastes, the Company could be subject to environmental laws that impose liability for the entire cost of cleanup at contaminated sites, regardless of fault or the lawfulness of the activity that resulted in contamination. The Company believes, however, that its operations are in substantial compliance with applicable environmental laws and regulations.

     Many of ACS Group’s properties formerly contained, or currently contain, underground and above ground storage tanks used for the storage of fuel or wastes. Some of these tanks have leaked. The Company believes that known contamination caused by these leaks has been, or is being, investigated or remediated. The Company cannot be sure, however, that it has discovered all contamination or that the regulatory authorities will not request additional remediation at sites that have previously undergone remediation.

     ACS Group’s wireless and television operations are also subject to regulations and guidelines that impose a variety of operational requirements relating to radio frequency emissions. The potential connection between radio frequency emissions and negative health effects, including some forms of cancer, has been the subject of substantial study by the scientific community in recent years. To date, the results of these studies have been inconclusive. Although the Company has not been named in any lawsuits alleging damages from radio frequency emissions, it is possible it could be in the future, particularly if scientific studies conclusively determine that radio frequency emissions are harmful.

23

Table of Contents

Item 2. Properties

     At December 31, 2002, ACS Group’s telecommunications network includes over 640 sheath miles of fiber optic cable, over 188 switching facilities and a statewide wireless network. In addition, the Company purchased fiber capacity in May of 1999 and in January of 2001 for high-speed links within Alaska and for termination of traffic in the lower 49 states. The Company plans to continue enhancing its network to meet customer demand for increased bandwidth and advanced services. See “Business — Network Facilities.”

     Local Telephone. ACS Group’s primary local telephone properties consist of 188 switching facilities. The Company owns most of its administrative and maintenance facilities, customer service center, central office and remote switching platforms and transport and distribution network facilities. The Company’s local telephone assets are located in Alaska.

     ACS Group’s transport and distribution network facilities include a fiber optic backbone and copper wire distribution facilities that connect customers to remote switch locations or to the central office and to points of presence or interconnection with interexchange carriers. These facilities are located on land pursuant to permits, easements, right of ways or other agreements.

     Wireless. ACS Group has four digital switching centers, 111 cell sites and three repeaters covering substantially all major population centers and highway corridors in Alaska plus one analog switch and cell site covering Barrow, Alaska. In most cases, the Company leases the land on which these sites are located.

     Internet. ACS Group has point of presence facilities in over 34 communities serving the majority of Alaska’s populated areas. These communities are linked over both owned and leased facilities to the Internet at Seattle, Washington.

     Interexchange. ACS Group is a facilities based interexchange carrier. The Company has invested in fiber optic capacity through an indefeasible right of use that provides bandwidth between the Company’s Anchorage, Fairbanks, and Juneau locations and Seattle, Washington. The Company also leases transport facilities and has arrangements with other interexchange carriers to terminate traffic in the lower 49 states.

     Substantially all of the Company’s assets (including those of its subsidiaries) are pledged as collateral for its senior obligations. See Note 7 “Long-term Obligations” to the Alaska Communications Systems Group, Inc. Consolidated Financial Statements for further discussion.

Item 3. Legal Proceedings

     The Company is involved in various claims, legal actions and regulatory proceedings arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

     Some of the legal proceedings involving regulatory matters are described under “Business — Regulation.” In addition, a class action lawsuit was filed against the Company on March 14, 2001. The litigation alleges various contract and tort claims concerning the Company’s decision to terminate its Infinite Minutes long distance plan. Although the Company believes this suit is without merit and intends to vigorously defend its position, it is impossible to determine at this time the actual number of plaintiffs or the claims that will actually continue to be in dispute.

Item 4. Submission of Matters to a Vote of Security Holders

     There were no matters submitted to a vote of security holders during the fourth quarter of 2002.

24

Table of Contents

PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

     ACS Group’s common stock, $.01 par value, was first listed on the NASDAQ National Market on November 18, 1999 under the symbol “ALSK.” Prior to November 18, 1999, there was no public market for ACS Group’s Common Stock. The following table sets forth quarterly market price ranges for ACS Group’s Common Stock in 2002 and 2001:

     The approximate number of holders of record of Common Stock as of March 3, 2003 was 38. Management believes that actual holders exceed 1,000, including those held in the broker/dealers name on behalf of their clients.

Dividends

     ACS Group has never declared or paid any cash dividends on its common stock. The Company intends to retain its earnings, if any, to finance the development and expansion of its business, and, therefore, it does not anticipate paying any cash dividends in the foreseeable future. Moreover, the Company’s ability to declare and pay cash dividends on its common stock is restricted by covenants in its bank credit agreement and in the indentures governing its senior discount debentures and senior subordinated notes.

Securities Authorized for Issuance Under Equity Compensation Plans

     The number of securities remaining available for future issuance under equity compensation plans includes 1,767,685 shares under the Alaska Communications Systems Group, Inc. 1999 Stock Incentive Plan, 39,907 under the ACS Group, Inc. 1999 Non-Employee Director Stock Compensation Plan, and 632,309 under the Alaska Communications Systems Group, Inc. 1999 Employee Stock Purchase Plan. See Note 14 “Stock

25

Table of Contents

Incentive Plans” to the Alaska Communications Systems Group, Inc. Consolidated Financial Statements for further information on the Company’s equity compensation plans.

Stock Offerings

     On December 3, 1999 the Company registered 6,021,489 shares under various employee and non-employee stock option plans and an employee stock purchase plan (File # 333-92091) on Form S-8 under the Securities Act of 1933. As of March 3, 2003, 3,365,462 option grants are outstanding under the employee stock option plans and 441,305 options have been exercised and converted into shares of the Company’s common stock. As of March 3, 2003, 110,093 shares have been awarded under the non-employee stock plan, of which 55,846 were elected to be deferred. As of March 3, 2003, 367,693 shares have been issued under the employee stock purchase plan. See Note 14, “Stock Incentive Plans” to the Alaska Communications Systems Group, Inc. Consolidated Financial Statements for further discussion.

Item 6. Selected Financial Data

SELECTED HISTORICAL FINANCIAL DATA

     The following table sets forth selected historical condensed consolidated financial data of ACS Group. Consider the following points in connection with the table:

	•		Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets. Upon adoption and completion of the analysis required under SFAS No, 142, a transitional impairment loss of $105,350 was recognized as the cumulative effect of a change in accounting principle in the first quarter of 2002. The Company performed its required annual goodwill impairment test as of October 1, 2002 and recognized an impairment loss of $64.8 million in operating expenses for the year ended December 31, 2002.
	•		On March 30, 2002, the Company approved a plan to sell its wireless cable television service segment. As a result of this decision, the operating revenue and expense of this segment has been classified as discontinued operations for all periods presented.
	•		Certain reclassifications have been made to the 2001 and 2000 financial statements to make them conform to the current year’s presentation.
	•		The selected historical consolidated operating data for the year ended December 31, 1999 represents the consolidated results of ACS Group from May 15, 1999 through December 31, 1999. Certain reclassifications have been made to the 1999 consolidated operations to conform to the current presentation of ACS Group’s consolidated operations.

The selected historical consolidated financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited consolidated financial statements of ACS Group and the related notes. See Index to Consolidated Financial Statements and Schedule which appears on page F-1 hereof.

26

Table of Contents

ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. AND SUBSIDIARIES
For the Years Ended December 31, 2002, 2001, 2000, and 1999
(dollars in thousands, except per share amounts)

27

Table of Contents

SELECTED HISTORICAL FINANCIAL DATA—ATU AND CENTURYTEL’S ALASKA PROPERTIES

     The following table sets forth selected historical combined financial data of CenturyTel’s Alaska Properties and ATU for the year ended December 31, 1998 and as of December 31, 1998 (dollars in thousands).

     The Company derived the selected historical combined financial data for CenturyTel’s Alaska Properties from the audited combined financial statements and the related notes of CenturyTel’s Alaska Properties and is presented on CenturyTel’s basis of accounting.

     ACS Group derived the selected historical financial data for ATU from the audited financial statements and the related notes of ATU. Consider the following points for ATU in connection with the table:

	•		“Other income (expense)” includes the equity in earnings (losses) from minority investments.
	•		During the periods presented, ATU was a public utility of the Municipality of Anchorage and was exempt from federal and state taxes on income.
	•		Net cash data includes information from ATU financial statements prepared in accordance with governmental accounting standards. Under Governmental Accounting Standards Board (“GASB”) Statement No. 20, Accounting And Financial Reporting For Proprietary Funds And Other Governmental Entities That Use Proprietary Fund Accounting, ATU applied all applicable GASB pronouncements and all Financial Accounting Standards Board (“FASB”) Statements and Interpretations, Accounting Principles, Board Opinions and Accounting Research Bulletins, unless they conflict with or contradict GASB pronouncements. ATU followed the provisions of GASB Statement No. 27 to account for pension and post-retirement costs, which differs from FASB Statement No. 87 and FASB Statement No. 106 regarding the methodology for calculation of such costs and how they are recorded and disclosed. It is not practicable to quantify the differences between the statements without an additional complete actuarial valuation because the actuarial calculations for FASB Statement No. 87 purposes require different assumptions and represent different measurement basis. Other differences between GASB and FASB have been evaluated and have been determined not to be material for the periods presented.

28

Table of Contents

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements and Analysts’ Reports

     This Form 10-K and future filings by the Company on Forms 10-K, 10-Q and 8-K and future oral and written statements by the Company and its management may include, certain “forward-looking statements” as defined under the Private Securities Litigation Reform Act of 1995, including (without limitation) statements with respect to anticipated future operating and financial performance, financial position and liquidity, growth opportunities and growth rates, pricing plans, acquisition and divestitive opportunities, business prospects, strategic alternatives, business strategies, regulatory and competitive outlook, investment and expenditure plans, financing needs and availability, and other similar forecasts and statements of expectation. Words such as “aims,” “anticipates,” “believes,” “could,” “estimates,” “expects,” “hopes,” “intends,” “may,” “plans,” “projects,” “seeks,” “should,” and “will,” and variations of these words and similar expressions, are intended to identify these forward-looking statements. These forward looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our Company’s historical experience and our present expectations or projections. Forward-looking statements by the Company and its management are based on estimates, projections, beliefs and assumptions of management and are not guarantees of future performance. The Company disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information, or otherwise.

     Actual future performance, outcomes and results may differ materially from those expressed in forward-looking statements made by the Company and its management as a result of a number of important factors. Examples of these factors include (without limitation) rapid technological developments and changes in the telecommunications industries; ongoing deregulation (and the resulting likelihood of significantly increased price and product/service competition) in the telecommunications industry as a result of the 1996 Act and other similar federal and state legislation and the federal and state rules and regulations enacted pursuant to that legislation; regulatory limitations on the Company’s ability to change its pricing for communications services; the possible future unavailability of SFAS No. 71, Accounting for the Effects of Certain Types of Regulation, to the Company’s wireline subsidiaries; and possible changes in the demand for the Company’s products and services. In addition to these factors, actual future performance, outcomes and results may differ materially because of other, more general, factors including (without limitation) changes in general industry and market conditions and growth rates; changes in interest rates or other general national, regional or local economic conditions; governmental and public policy changes; changes in accounting policies or practices adopted voluntarily or as required by accounting principles generally accepted in the United States of America; and the continued availability of financing in the amounts, at the terms and on the conditions necessary to support the Company’s future business.

     Investors should also be aware that while ACS Group does, at various times, communicate with securities analysts, it is against the Company’s policy to disclose to them any material non-public information or other confidential information. Accordingly, investors should not assume that ACS Group agrees with any statement or report issued by an analyst irrespective of the content of the statement or report. To the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not the responsibility of ACS Group.

29

Table of Contents

Introduction

     This discussion and analysis should be read in conjunction with the financial statements and related notes and the other financial information included elsewhere in this Form 10-K.

Alaska Communications Systems Group

     ACS Group was formed in 1998 by Fox Paine & Company, members of the former senior management team of Pacific Telecom, Inc., and other experienced telecommunications industry executives. In May 1999, the Company acquired CenturyTel’s Alaska Properties and Anchorage Telephone Utility or ATU. CenturyTel’s Alaska Properties were the incumbent provider of local telephone services in Juneau, Fairbanks and more than 70 rural communities in Alaska and provided Internet services to customers statewide. CenturyTel’s Alaska Properties included ACS of Fairbanks, Inc., ACS of Alaska, Inc., and ACS of the Northland, Inc. ATU was the largest LEC in Alaska and provided local telephone and long distance services primarily in Anchorage and wireless services statewide. ATU provided long distance services through ATU Long Distance, Inc. and wireless services through MACtel, Inc. These companies are now known as ACS of Anchorage, Inc., ACS Long Distance, Inc. and ACS Wireless, Inc. On October 29, 1999, the Company changed its name from ALEC Holdings, Inc. to Alaska Communications Systems Group, Inc.

     On January 1, 2001, the Company established ACS InfoSource, Inc. as a separate operation and transferred to it the Company’s yellow pages directory advertising business and assets which were previously included as a component of four different local telephone exchange carriers operating in Alaska which are also wholly-owned subsidiaries of the Company.

     The consolidated financial statements for ACS Group represent the operations principally of the following entities:

	•		Alaska Communications Systems Group, Inc.
	•		Alaska Communications Systems Holdings, Inc.
	•		ACS of Alaska, Inc.
	•		ACS of the Northland, Inc.
	•		ACS of Fairbanks, Inc.
	•		ACS of Anchorage, Inc.
	•		ACS Wireless, Inc.
	•		ACS Long Distance, Inc.
	•		ACS Television, L.L.C.
	•		ACS Internet, Inc.
	•		ACS InfoSource, Inc.

     Prior to the consummation of the acquisitions of CenturyTel’s Alaska Properties and ATU in May 1999, ACS Group had no operations.

     Today, ACS Group generates revenue primarily through:

	•		the provision of local telephone services, including:
			• basic local service to retail customers within ACS Group’s service areas,
			• wholesale service to CLECs,
			• network access services to interexchange carriers for origination and termination of interstate and intrastate long distance phone
			calls,
			• enhanced services,
			• ancillary services, such as B&C, and
			• universal service payments;
	•		the provision of wireless services;
	•		the provision of yellow pages directory advertising;

30

Table of Contents

	•		the provision of Internet services; and
	•		the provision of interexchange network long-distance and data services.

     ACS Group also recognizes its proportionate share of the net income or loss of its minority-owned investments.

     Within the telecommunications industry, LECs have historically enjoyed stable revenue and cash flow from local exchange operations resulting from the need for basic telecommunications services, the highly regulated nature of the telecommunications industry and, in the case of rural LECs, the underlying cost recovery settlement and support mechanisms applicable to local exchange operations. Basic local service is generally provided at a flat monthly rate and allows the user to place unlimited calls within a defined local calling area. Access revenues are generated by providing interexchange carriers access to the LEC’s local network and its customers. Universal service revenues are a subsidy paid to rural LECs to support the high cost of providing service in rural markets. Other service revenue is generated from ancillary services and enhanced services.

     Changes in revenue are largely attributable to changes in the number of access lines, local service rates and minutes of use. Other factors can also impact revenue, including:

	•		intrastate and interstate revenue settlement methodologies,
	•		authorized rates of return for regulated services,
	•		whether an access line is used by a business or residential subscriber,
	•		intrastate and interstate calling patterns,
	•		customers’ selection of various local rate plan options,
	•		selection of enhanced calling services, such as voice mail
	•		other subscriber usage characteristics.

     LECs have three basic tiers of customers:

	•		business and residential customers located in their local service areas that pay for local phone service,
	•		interexchange carriers that pay for access to long distance calling customers located within its local service areas and
	•		CLEC’s that pay for wholesale access to the Company’s network in order to provide competitive local service on either a wholesale or UNE basis as prescribed under the 1996 Act.

     LECs provide access service to numerous interexchange carriers and may also bill and collect long distance charges from interexchange carrier customers on behalf of the interexchange carriers. The amount of access charge revenue associated with a particular interexchange carrier varies depending upon long distance calling patterns and the relative market share of each long distance carrier.

     ACS Group’s local service rates for end users are authorized by the RCA. Authorized rates are set by the FCC and the RCA for interstate and intrastate access charges, respectively, and may change from time to time.

Critical Accounting Policies and Accounting Estimates

     Management is responsible for the financial statements presented elsewhere in this 10-K and has evaluated the accounting policies used in their preparation. Management believes these policies to be reasonable and appropriate. The Company’s significant accounting policies are described in Note 1 in the Notes to the Consolidated Financial Statements elsewhere in this 10-K. The following discussion identifies those accounting policies that management believes are critical in the preparation of the Company’s financial statements, the

31

Table of Contents

judgements and uncertainties affecting the application of those policies, and the possibility that materially different amounts would be reported under different conditions or using different assumptions.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Among the significant estimates affecting the financial statements are those related to the realizable value of accounts receivable, long-lived assets, income taxes and network access revenue reserves. Actual results may differ from those estimates.

     Access revenue is recognized when earned. The Company participates in toll revenue pools with other telephone companies. Such pools are funded by toll revenue and/or access charges regulated by the RCA within the intrastate jurisdiction and the FCC within the interstate jurisdiction. Much of the interstate access revenue is initially recorded based on estimates. These estimates are derived from interim financial statements, available separations studies and the most recent information available about achieved rates of return. These estimates are subject to adjustment in future accounting periods as additional operational information becomes available. To the extent that disputes arise over revenue settlements, the Company’s policy is to defer revenue collected until settlement methodologies are resolved and finalized. At December 31, 2002, the Company had recorded liabilities of $20.5 million related to its estimate of refundable access revenue. Actual results could vary from this estimate.

     The Company utilizes the liability method of accounting for income taxes. Under the liability method, deferred taxes reflect the temporary differences between the financial and tax bases of assets and liabilities using the enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent that it is more likely than not that such deferred tax assets will not be realized. If the Company thought it was more likely than not that all of its deferred tax assets would be realized in future periods, the Company’s previously reported net losses for the three years ended December 31, 2002 would decrease by up to $92.1 million and its accumulated deficit would decrease from $247.2 million to $155.1 million.

     The local telephone exchange operations of the Company account for costs in accordance with the accounting principles for regulated enterprises prescribed by SFAS No. 71, Accounting for the Effects of Certain Types of Regulation. This accounting recognizes the economic effects of rate regulation by recording cost and a return on investment as such amounts are recovered through rates authorized by regulatory authorities. Accordingly, under SFAS No. 71, plant and equipment is depreciated over lives approved by regulators and certain costs and obligations are deferred based upon approvals received from regulators to permit recovery of such amounts in future years. Historically, lives approved for regulatory purposes have approximated economically useful lives. On July 21, 2002, the Company received an order from the RCA which appears to extend lives approved for rate-making purposes beyond the economically useful lives of the underlying assets. Management petitioned for reconsideration, and the RCA has agreed to take additional testimony. A final order on the matter is not expected until the second quarter of 2003. As of December 31, 2002 the Company has deferred as a regulatory asset $0.9 million of costs incurred in connection with regulatory rate making proceedings, which will be amortized in future periods. If the Company were not following SFAS No. 71, these costs would have been charged to expense as incurred.

     Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets. In accordance with the guidelines of this accounting principle, goodwill and indefinite-lived intangible assets are no longer amortized but will be assessed for impairment on at least an annual basis. SFAS No. 142 requires that goodwill be tested for impairment at the reporting unit level upon adoption and at least annually thereafter, utilizing a two-step methodology. The initial step requires the Company to determine the fair value of each reporting unit and compare it to the carrying value, including goodwill, of such unit. If the fair value exceeds the carrying value, no impairment loss would be recognized. However, if the carrying value of the reporting unit

32

Table of Contents

for purposes of this test primarily by using a discounted cash flow valuation technique. Significant estimates used in the valuation include estimates of future cash flows, both future short-term and long-term growth rates, and estimated cost of capital for purposes of arriving at a discount factor. At December 31, 2002, the Company had recorded goodwill of $77.2 million and had recorded a transitional impairment loss of $105.4 million and an impairment loss of $64.8 million based on the annual impairment test.

Results of Operations

     The following table summarizes ACS Group’s operations for the years ended December 31, 2002, 2001, and 2000. Certain reclassifications have been made to 2001 and 2000 to conform to the current presentation of ACS Group’s consolidated operations.