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EX-32.2 - EXHIBIT 32.2 - GCI, LLCinc09302016exhibit32-2.htm
EX-32.1 - EXHIBIT 32.1 - GCI, LLCinc09302016exhibit32-1.htm
EX-31.2 - EXHIBIT 31.2 - GCI, LLCinc09302016exhibit31-2.htm
EX-31.1 - EXHIBIT 31.1 - GCI, LLCinc09302016exhibit31-1.htm
EX-10.1 - EXHIBIT 10.1 - TOWER MASTER LEASE AGREEMENT - GCI, LLCexhibit101-towersalemla052.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q

(Mark One)
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2016
 
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from           to
 Commission File No. 0-5890
 
GCI, INC.
 
 
(Exact name of registrant as specified in its charter)
 
 
State of Alaska
 
91-1820757
 
 
(State or other jurisdiction of
 
(I.R.S Employer
 
 
incorporation or organization)
 
Identification No.)
 
 
2550 Denali Street
 
 
 
 
Suite 1000
 
 
 
 
Anchorage, Alaska
 
99503
 
 
(Address of principal
executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code: (907) 868-5600
 
Not Applicable
 
 
Former name, former address and former fiscal year, if changed since last report
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) x Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer", "accelerated filer” and "smaller reporting company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer x (Do not check if a smaller reporting company)
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
¨ Yes x No


1



GCI, INC.
WHOLLY OWNED SUBSIDIARY OF GENERAL COMMUNICATION, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2016

TABLE OF CONTENTS

 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
 
 
 
Item 1A.
 
 
 
 
 
Item 6.
 
 
 
 
 
Other items are omitted, as they are not applicable.
 
 
 
 
 

2



Cautionary Statement Regarding Forward-Looking Statements

You should carefully review the information contained in this Quarterly Report, but should particularly consider any risk factors that we set forth in this Quarterly Report and in other reports or documents that we file from time to time with the Securities and Exchange Commission (“SEC”). In this Quarterly Report, in addition to historical information, we state our future strategies, plans, objectives or goals and our beliefs of future events and of our future operating results, financial position and cash flows. In some cases, you can identify these so-called “forward-looking statements” by words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “project,” or “continue” or the negative of these words and other comparable words. All forward-looking statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance, achievements, plans and objectives to differ materially from any future results, performance, achievements, plans and objectives expressed or implied by these forward-looking statements. In evaluating these statements, you should specifically consider various factors, including those identified under “Risk Factors” in Item 1A of our annual report on Form 10-K for the year ended December 31, 2015.  Those factors may cause our actual results to differ materially from any of our forward-looking statements. For these forward looking statements, we claim the protection of the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995.

You should not place undue reliance on any such forward-looking statements. Further, any forward-looking statement, and the related risks, uncertainties and other factors speak only as of the date on which they were originally made and we expressly disclaim any obligation or undertaking to update or revise any forward-looking statement to reflect any change in our expectations with regard to these statements or any other change in events, conditions or circumstances on which any such statement is based. New factors emerge from time to time, and it is not possible for us to predict what factors will arise or when. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

3



PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
 
 
 
 
GCI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Amounts in thousands)
 
 
 
 
September 30,
 
December 31,
ASSETS
2016
 
2015
Current assets:
 
 
 
Cash and cash equivalents
$
92,622

 
26,528

 
 
 
 
Receivables
200,294

 
208,384

Less allowance for doubtful receivables
4,436

 
3,630

Net receivables
195,858

 
204,754

 
 
 
 
Prepaid expenses
16,253

 
12,862

Inventories
7,966

 
11,322

Other current assets
173

 
3,129

Total current assets
312,872

 
258,595

 
 
 
 
Property and equipment
2,505,753

 
2,384,530

Less accumulated depreciation
1,412,540

 
1,290,149

Net property and equipment
1,093,213

 
1,094,381

 
 
 
 
Goodwill
239,263

 
239,263

Cable certificates
191,635

 
191,635

Wireless licenses
92,347

 
86,347

Other intangible assets, net of amortization
70,062

 
69,290

Other assets
32,560

 
27,429

Total other assets
625,867

 
613,964

Total assets
$
2,031,952

 
1,966,940

 
 
 
 
See accompanying condensed notes to interim consolidated financial statements.
 
 

 
(Continued)

4



GCI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Continued)
(Amounts in thousands)
 
 
 
 
September 30,
 
December 31,
LIABILITIES AND STOCKHOLDER'S EQUITY
2016
 
2015
Current liabilities:
 
 
 
  Current maturities of obligations under long-term debt,
capital leases, and tower obligation
$
13,046

 
12,050

Accounts payable
51,551

 
63,014

Deferred revenue
33,115

 
34,128

Accrued payroll and payroll related obligations
29,251

 
31,337

Accrued interest
21,747

 
8,523

Accrued liabilities
17,002

 
22,822

Subscriber deposits
876

 
1,242

Total current liabilities
166,588

 
173,116

 
 
 
 
Long-term debt, net
1,274,042

 
1,274,586

Obligations under capital leases, excluding current maturities (including $1,785 and $1,824 due to a related party at September 30, 2016 and December 31, 2015, respectively)
52,713

 
59,651

Deferred income taxes
118,532

 
108,073

Long-term deferred revenue
120,875

 
93,427

Tower obligation
88,060

 

Other liabilities
47,222

 
47,992

Total liabilities
1,868,032

 
1,756,845

 
 
 
 
Commitments and contingencies


 


Stockholder's equity:
 

 
 

Class A common stock (no par). Authorized 10 shares; issued and outstanding 0.1 shares at September 30, 2016 and December 31, 2015
206,622

 
206,622

Paid-in capital
172,682

 
164,508

Retained deficit
(246,032
)
 
(192,033
)
Total GCI, Inc. stockholder's equity
133,272

 
179,097

Non-controlling interests
30,648

 
30,998

Total stockholder's equity
163,920

 
210,095

Total liabilities and stockholder's equity
$
2,031,952

 
1,966,940

 
 
 
 
See accompanying condensed notes to interim consolidated financial statements.
 
 

5



GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
 
 
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(Amounts in thousands)
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Non-related party
$
236,655

 
258,573

 
701,519

 
731,907

Related party

 

 

 
5,283

Total revenues
236,655

 
258,573

 
701,519

 
737,190

 
 
 
 
 
 
 
 
Cost of goods sold (exclusive of depreciation and amortization shown separately below):
 
 
 
 
 
 
 
Non-related party
73,494

 
82,717

 
227,926

 
235,860

Related party

 

 

 
881

Total cost of goods sold
73,494

 
82,717

 
227,926

 
236,741

 
 
 
 
 
 
 
 
Selling, general and administrative expenses:
 
 
 
 
 
 
 
Non-related party
88,974

 
82,579

 
264,642

 
248,885

Related party

 

 

 
540

Total selling, general and administrative expenses
88,974

 
82,579

 
264,642

 
249,425

 
 
 
 
 
 
 
 
Depreciation and amortization expense
47,819

 
45,157

 
143,033

 
135,563

Software impairment charge

 
2,571

 

 
29,839

Operating income
26,368

 
45,549

 
65,918

 
85,622

 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
Interest expense (including amortization of deferred loan fees)
(19,666
)
 
(19,260
)
 
(58,199
)
 
(59,713
)
Loss on extinguishment of debt

 

 

 
(27,700
)
Impairment of equity method investment

 

 

 
(12,593
)
Other
613

 
1,202

 
1,702

 
2,445

Other expense, net
(19,053
)
 
(18,058
)
 
(56,497
)
 
(97,561
)
 
 
 
 
 
 
 
 
Income (loss) before income taxes
7,315

 
27,491

 
9,421

 
(11,939
)
Income tax expense
(8,288
)
 
(7,689
)
 
(10,490
)
 
(681
)
Net income (loss)
(973
)
 
19,802

 
(1,069
)
 
(12,620
)
 
 
 
 
 
 
 
 
Net income (loss) attributable to non-controlling interests
(116
)
 
(116
)
 
(350
)
 
330

Net income (loss) attributable to GCI, Inc.
$
(857
)
 
19,918

 
(719
)
 
(12,950
)
 
 
 
 
 
 
 
 
See accompanying condensed notes to interim consolidated financial statements.

6



GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015
(Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares of Class A Common Stock
 
Class A Common Stock
 
Paid-in
Capital
 
Retained
Deficit
 
Non-
controlling
Interests
 
Total
Stockholder's
Equity
 
(Amounts in thousands)
Balances at January 1, 2015
0.1

 
$
206,622

 
$
88,802

 
$
(128,068
)
 
$
299,866

 
$
467,222

Net income (loss)

 

 

 
(12,950
)
 
330

 
(12,620
)
Distribution to General Communication, Inc.

 

 

 
(49,360
)
 

 
(49,360
)
Contribution from General Communication, Inc.

 

 
83,277

 

 

 
83,277

Distribution to non-controlling interest

 

 

 

 
(765
)
 
(765
)
Purchase of AWN NCI

 

 
(35,467
)
 

 
(268,364
)
 
(303,831
)
Other

 

 
(230
)
 

 

 
(230
)
Balances at September 30, 2015
0.1

 
$
206,622

 
$
136,382

 
$
(190,378
)
 
$
31,067

 
$
183,693

 
 
 
 
 
 
 
 
 
 
 
 
Balances at January 1, 2016
0.1

 
$
206,622

 
$
164,508

 
$
(192,033
)
 
$
30,998

 
$
210,095

Net loss

 

 

 
(719
)
 
(350
)
 
(1,069
)
Distribution to General Communication, Inc.

 

 

 
(53,280
)
 

 
(53,280
)
Contribution from General Communication, Inc.

 

 
8,174

 

 

 
8,174

Balances at September 30, 2016
0.1

 
$
206,622

 
$
172,682

 
$
(246,032
)
 
$
30,648

 
$
163,920

 
 
 
 
 
 
 
 
 
 
 
 
See accompanying condensed notes to interim consolidated financial statements.

7



GCI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015
(Unaudited)
(Amounts in thousands)
 
 
 
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net loss
$
(1,069
)
 
(12,620
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 

 
 

Depreciation and amortization expense
143,033

 
135,563

Deferred income tax expense
10,459

 
632

Share-based compensation expense
7,820

 
8,074

Loss on extinguishment of debt

 
27,700

Software impairment charge

 
29,839

Impairment of equity method investment

 
12,593

Other noncash income and expense items
10,647

 
8,060

Change in operating assets and liabilities
25,340

 
17,245

Net cash provided by operating activities
196,230

 
227,086

Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(149,842
)
 
(134,275
)
Purchases of other assets and intangible assets
(10,226
)
 
(7,191
)
Note receivable payment from an equity method investee
3,000

 

Proceeds from sale of investment
1,377

 
7,551

Grant proceeds

 
14,007

Note receivable issued to an equity method investee

 
(3,000
)
Purchase of business, net of cash received

 
(10,569
)
Other
(1,591
)
 
(4,711
)
Net cash used for investing activities
(157,282
)
 
(138,188
)
Cash flows from financing activities:
 

 
 

Proceeds from tower sale
90,795

 

Borrowing on Amended Senior Credit Facility
60,000

 
295,000

Repayment of debt and capital lease obligations
(69,013
)
 
(492,068
)
Net contribution from (distribution to) General Communication, Inc.
(53,084
)
 
25,935

Issuance of 2025 notes

 
445,973

Purchase of non-controlling interests

 
(280,505
)
Payment of bond call premium

 
(20,244
)
Payment of debt issuance costs

 
(13,979
)
Distribution to non-controlling interest

 
(4,932
)
Other
(1,552
)
 
203

Net cash provided by (used for) financing activities
27,146

 
(44,617
)
Net increase in cash and cash equivalents
66,094

 
44,281

Cash and cash equivalents at beginning of period
26,528

 
15,402

Cash and cash equivalents at end of period
$
92,622

 
59,683

 
 
 
 
See accompanying condensed notes to interim consolidated financial statements.

8



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)



The accompanying unaudited interim consolidated financial statements include the accounts of GCI, Inc. and its direct and indirect subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. They should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2015, filed with the SEC on March 3, 2016, as part of our annual report on Form 10-K.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for interim periods are not necessarily indicative of the results that may be expected for an entire year or any other period.

(1)
Business and Summary of Significant Accounting Principles
In the following discussion, GCI, Inc. and its direct and indirect subsidiaries are referred to as “we,” “us” and “our.”

Basis of Presentation
We were incorporated in Alaska in 1997 to affect the issuance of Senior Notes. As a wholly owned subsidiary of General Communication, Inc. ("GCI"), we received through our initial capitalization all ownership interest in subsidiaries previously held by GCI. The GCI and GCI, Inc. interim consolidated financial statements include substantially the same operating activities.

(a)
Business
We provide a full range of wireless, data, video, voice, and managed services to residential customers, businesses, governmental entities, and educational and medical institutions primarily in Alaska.
(b)
Principles of Consolidation
Our consolidated financial statements include the consolidated accounts of GCI, Inc. and its wholly owned subsidiaries, The Alaska Wireless Network, LLC ("AWN") of which we owned a two-third interest through February 2, 2015 when we purchased the remaining one-third interest, and four variable interest entities (“VIEs”) for which we are the primary beneficiary after providing certain loans and guarantees.  These VIEs are Terra GCI Investment Fund, LLC (“TIF”), Terra GCI 2 Investment Fund, LLC (“TIF 2”), Terra GCI 2-USB Investment Fund, LLC (“TIF 2-USB”) and Terra GCI 3 Investment Fund, LLC (“TIF 3”).  We also include in our consolidated financial statements non-controlling interests in consolidated subsidiaries for which our ownership is less than 100 percent.  All significant intercompany transactions between non-regulated affiliates of our company are eliminated.  Intercompany transactions generated between regulated and non-regulated affiliates of our company are not eliminated in consolidation.

(c)
Non-controlling Interests
Non-controlling interests represent the equity ownership interests in consolidated subsidiaries not owned by us.  Non-controlling interests are adjusted for contributions, distributions, and income and loss attributable to the non-controlling interest partners of the consolidated entities.  Income and loss is allocated to the non-controlling interests based on the respective governing documents.


9



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


(d)
Acquisition
On February 2, 2015, we purchased Alaska Communications Systems Group, Inc.'s (“ACS”) interest in AWN ("AWN NCI Acquisition") and substantially all the assets of ACS and its affiliates related to ACS’s wireless operations (“Acquired ACS Assets”) (collectively the "Wireless Acquisition"). Under the terms of the agreement, we paid ACS $293.2 million, excluding working capital adjustments and agreed to terminate certain agreements related to the use of ACS network assets that were included as part of the original transaction that closed in July 2013. The Acquired ACS Assets include substantially all of ACS’s wireless subscriber assets, including subscriber contracts, and certain of ACS’s CDMA network assets, including fiber strands and associated cell site electronics and microwave facilities and associated electronics. We assumed from ACS post-closing liabilities of ACS and its affiliates under contracts assumed by us and liabilities with respect to the ownership by ACS of its equity interest in AWN to the extent accruing and related to the period after closing. All other liabilities were retained by ACS and its affiliates.

We have accounted for the AWN NCI Acquisition as the acquisition of a non-controlling interest in accordance with Accounting Standards Codification ("ASC") 810, Consolidation, and the Acquired ACS Assets as the acquisition of assets that do not constitute a business in accordance with ASC 805-50, Business Combinations - Related Issues. Total consideration transferred to ACS in the transaction consisted of the cash payment, settlement of working capital, and the fair market value of certain rights to receive future capacity terminated as part of the Wireless Acquisition agreement. The future capacity receivable assets transferred as consideration were adjusted to fair value as of the acquisition date resulting in a gain of $1.2 million recorded in Other Income (Expense) in our Consolidated Statements of Operations for the nine months ended September 30, 2015. We allocated the total consideration transferred to ACS between the AWN NCI Acquisition and the Acquired ACS Assets based on the relative fair values of the assets and non-controlling interest received.

The following table summarizes the allocation of total consideration transferred to ACS between the AWN NCI Acquisition and the Acquired ACS Assets excluding working capital adjustments (amounts in thousands):
Total consideration transfered to ACS
 
$
304,838

 
 
 
Allocation of consideration between wireless assets and non-controlling interest acquired:
 
 
AWN non-controlling interest
 
$
303,831

Property and equipment
 
746

Other intangible assets
 
261

Total consideration
 
$
304,838


We have accounted for the AWN NCI Acquisition as an equity transaction, with the carrying amount of the non-controlling interest adjusted to reflect the change in ownership of AWN. The difference between the fair value of consideration paid and the total of the additional deferred taxes incurred as a result of the transaction and the carrying amount of the non-controlling interest has been recognized as additional paid-in capital in our Consolidated Statement of Stockholder's Equity. The impact of the AWN NCI Acquisition is summarized in the following table (amounts in thousands):
Reduction of non-controlling interest
 
$
268,364

Increase in deferred tax assets
 
24,028

Additional paid-in capital
 
11,439

Fair value of consideration paid for acquisition of equity interest
 
$
303,831


Pursuant to the accounting guidance in ASC 805-50, we determined that the Acquired ACS Assets did not meet the criteria necessary to constitute a business combination and was therefore accounted for as an

10



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


asset purchase. We recognized the assets acquired in our Consolidated Balance Sheets at their allocated cost on the day of acquisition.

In conjunction with the Wireless Acquisition, we amended certain agreements related to the right to use ACS network assets. We adjusted the related right to use asset to fair value as of the acquisition date resulting in a loss of $3.8 million recorded in Other Income (Expense) in our Consolidated Statements of Operations for the nine months ended September 30, 2015.

Other Acquisitions
During the year ended December 31, 2015, we completed three business acquisitions for total cash consideration of $12.7 million, net of cash received. We accounted for the transactions using the acquisition method of accounting under ASC 805, Business Combinations. Accordingly, the assets received, liabilities assumed and any non-controlling interests were recorded at their estimated fair value as of the acquisition date. We determined the estimated fair values using a combination of the discounted cash flows method and estimates made by management.

(e)
Recently Issued Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers. This new standard provides guidance for the recognition, measurement and disclosure of revenue resulting from contracts with customers and will supersede virtually all of the current revenue recognition guidance under GAAP. In August 2015, the FASB issued ASU 2015-14, which deferred the effective date to fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. In March 2016, the FASB issued ASU 2016-08, which amended the guidance in the new standard in order to clarify the principal versus agent assessment and is intended to make the guidance more operable and lead to more consistent application. In April 2016, the FASB issued ASU 2016-10, which clarifies the identification of performance obligations and the licensing implementation guidance in ASU 2014-09. In May 2016, the FASB issued ASU 2016-11, which rescinds SEC paragraphs pursuant to SEC staff announcements regarding ASU 2014-09. These rescissions include changes to topics pertaining to accounting for shipping and handling fees and costs and accounting for consideration given by a vendor to a customer. In May 2016, the FASB issued ASU 2016-12, which provides clarifying guidance in certain narrow areas and adds some practical expedients to ASU 2014-09. The standard permits the use of either the retrospective or cumulative effect transition method. Early adoption is permitted for annual periods beginning after December 15, 2016, however, we do not plan to early adopt this standard. We are currently evaluating the impact of the provisions of this new standard and we expect to have our assessment of the impact on our financial position and results of operations to be completed by December 31, 2016.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The update addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted only for certain portions of the ASU related to financial liabilities. We are currently evaluating the impact of the provisions of this new standard on our financial position and results of operations.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The new standard establishes a right-of-use ("ROU") model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. Lease accounting by the lessor remains largely unchanged by the new standard. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and is required to be adopted using the modified retrospective approach. We are currently evaluating the impact of the provisions of this new standard on our financial position and results of operations, but we expect that adoption will have a material impact on our long-term assets and liabilities.


11



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


In March 2016, the FASB issued ASU No. 2016-07, Simplifying the Transition to the Equity Method of Accounting. The update eliminates the requirement to apply the equity method of accounting retrospectively when a reporting entity obtains significant influence over a previously held investment. Instead, the equity method of accounting should be applied prospectively from the date significant influence is obtained and investors should add the cost of acquiring the additional interest to the current basis of their previously held interest. For available-for-sale securities that become eligible for the equity method of accounting, any unrealized gain or loss recorded within accumulated other comprehensive income should be recognized in earnings at the date the investment initially qualifies for the use of the equity method. ASU 2016-07 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is permitted and should be applied prospectively. The adoption of this guidance is not expected to have a material effect on our financial position or results of operations.

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC 718, Compensation - Stock Compensation. The update includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. ASU 2016-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is permitted with any adjustments reflected as of the beginning of the fiscal year of adoption. We are currently evaluating the impact of the provisions of this new standard on our financial position and results of operations.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The update introduces a new forward-looking approach, based on expected losses, to estimate credit losses on certain types of financial instruments, including trade receivables. The estimate of expected credit losses will require entities to incorporate consideration of historical information, current information and reasonable and supportable forecasts. This ASU also expands the disclosure requirements to enable users of financial statements to understand the entity’s assumptions, models and methods for estimating expected credit losses. ASU 2016-13 is effective for annual and interim reporting periods beginning after December 15, 2019, and is required to be adopted using the modified retrospective approach. Early adoption is permitted for annual and interim reporting periods beginning after December 15, 2018. We are currently evaluating the impact of the provisions of this new standard on our financial position and results of operations.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This update addresses eight specific cash flow issues with the objective of reducing diversity in practice. The issues identified within the ASU include: debt prepayments or extinguishment costs; contingent consideration made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identified cash flows and application of the predominance principle. ASU 2016-15 is effective for annual and interim reporting periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted for annual and interim reporting periods. The adoption of this guidance is not expected to have a material effect on our statement of cash flows.

(f)
Recently Adopted Accounting Pronouncements
In April 2015, the FASB issued ASU No. 2015-03, Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 requires an entity to present debt issuance costs related to a recognized debt liability in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. In August 2015, the FASB issued ASU No. 2015-15, Interest - Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements which clarifies that the guidance in ASU 2015-03 does not apply to line-of-credit arrangements. According to ASU 2015-15, line-of-credit arrangements will continue to defer and present debt issuance costs as an asset and subsequently amortize the deferred debt issue costs ratably over the term of the arrangement. We adopted ASU 2015-03 retrospectively as of January 1, 2016, and have reclassified $15.4 million of the December 31, 2015,

12



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


Deferred Loan and Senior Note Costs, Net of Amortization balance included in Total Other Assets to Long-Term Debt, Net included in Total Liabilities.

In April 2015, the FASB issued ASU 2015-05, Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement. The ASU provides guidance in evaluating whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the software license element of the arrangement should be accounted for as an acquisition of a software license. If the arrangement does not contain a software license, it should be accounted for as a service contract. We adopted ASU 2015-05 prospectively as of January 1, 2016. The adoption of this standard did not have a significant effect on our financial position or results of operations.

In June 2015, the FASB issued ASU No. 2015-10, Technical Corrections and Updates. The amendments in this update cover a wide range of topics in the codification and are generally categorized as follows: Amendments Related to Differences between Original Guidance and the Codification; Guidance Clarification and Reference Corrections; Simplification; and, Minor Improvements. We adopted ASU 2015-10 as of January 1, 2016. The adoption of this standard did not have a significant effect on our financial position or results of operations.

In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory. Under ASU 2015-11, inventory will be measured at the “lower of cost and net realizable value” and options that currently exist for “market value” will be eliminated. The ASU defines net realizable value as the “estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.” No other changes were made to the current guidance on inventory measurement. We adopted ASU 2015-11 prospectively as of April 1, 2016. The adoption of this standard did not have a significant effect on our financial position or results of operations.

In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. The update requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, including the cumulative effect of the change in provisional amount as if the accounting had been completed at the acquisition date. The adjustments related to previous reporting periods since the acquisition date must be disclosed by income statement line item either on the face of the income statement or in the notes. We adopted ASU 2015-16 as of January 1, 2016. The adoption of this standard did not have a significant effect on our financial position or results of operations.

(g)
Regulatory Accounting
We account for the regulated operations of our incumbent local exchange carriers in accordance with the accounting principles for regulated enterprises.  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, 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.  Our cost studies and depreciation rates for our regulated operations are subject to periodic audits that could result in a change to recorded revenues.

(h)
Earnings (Loss) per Common Share
We are a wholly owned subsidiary of GCI and, accordingly, are not required to present earnings per share. Our common stock is not publicly traded.

(i)
Accounts Receivable and Allowance for Doubtful Receivables
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful receivables is our best estimate of the amount of probable credit losses in our existing accounts receivable. We base our estimates on the aging of our accounts receivable balances, financial health of specific customers, regional economic data, changes in our collections process, regulatory requirements and our customers’ compliance with Universal Service Administrative Company rules. We review our allowance for doubtful receivables methodology at least annually.

13



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)



Depending upon the type of account receivable, our allowance is calculated using a pooled basis for all accounts greater than 120 days past due, a pooled basis using a percentage of related accounts, or a specific identification method.  When a specific identification method is used, potentially uncollectible accounts due to bankruptcy or other issues are reviewed individually for collectability.  Account balances are charged off against the allowance when we believe it is probable the receivable will not be recovered. We do not have any off-balance-sheet credit exposure related to our customers.

Wireless Equipment Installment Plan ("EIP") Receivables
We offer new and existing wireless customers the option to participate in Upgrade Now, a program that provides eligible customers with the ability to purchase certain wireless devices in installments over a period of up to 24 months. Participating customers have the right to trade-in the original equipment for a new device after making the equivalent of 12 monthly installment payments, provided their handset is in good working condition. Upon upgrade, the outstanding balance of the EIP is exchanged for the used handset.

At the time of sale, we impute interest on the receivables associated with Upgrade Now. We record the imputed interest as a reduction to the related accounts receivable. Interest income, which is included in Other Income and (Expense) in our Consolidated Statements of Operations, is recognized over the financed installment term.

We assess the collectability of our EIP receivables based upon a variety of factors, including payment trends and other qualitative factors. The credit profiles of our customers with an Upgrade Now plan are similar to those of our customers with a traditional subsidized plan. Customers with a credit profile which carries a higher risk are required to make a down payment for equipment financed through Upgrade Now.

(j)
Guarantees
We offer a device trade-in program, "Upgrade Now", which provides eligible customers a specified-price trade-in right to upgrade their device. Participating customers must have purchased a financed device using an equipment installment plan from us and have a qualifying monthly wireless service plan. Upon qualifying for an Upgrade Now device trade-in, the customer's remaining EIP balance is settled provided they trade in their eligible used device in good working condition and purchase a new device from us on a new EIP.

For customers who enroll in Upgrade Now, we defer the portion of equipment sales revenue which represents the estimated value of the trade-in right guarantee. The estimated value of the guarantees are based on various economic and customer behavioral assumptions, including the customer's estimated remaining EIP balance at trade-in, the expected fair value of the used handset at trade-in and the probability and timing of a trade-in.

We assess facts and circumstances at each reporting date to determine if we need to adjust the guarantee liability. The recognition of subsequent adjustments to the guarantee liability as a result of these assessments are recorded as adjustments to revenue. When customers upgrade their devices, the difference between the trade-in credit to the customer and the fair value of the returned devices is recorded against the guarantee liabilities.

(k)
Revenue Recognition
As an Eligible Telecommunications Carrier ("ETC"), we receive support from the Universal Service Fund ("USF") to support the provision of wireline local access and wireless service in high cost areas. On August 31, 2016, the Federal Communications Commission ("FCC") published a Report and Order to reform the methodology for distributing USF high cost support for both wireline and wireless voice and broadband service (“Alaska High Cost Order”).  The Alaska High Cost Order was a significant program change that required a reassessment of our high cost support revenue recognition.

Remote High Cost Support
Prior to the Alaska High Cost Order, we accrued estimated program revenue based on current line counts and the frozen per-line rates, reduced as needed by our estimate of the impact of the Statewide Support

14



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


Cap. Additionally, we also considered our assessment of the impact of current FCC regulations and of the potential outcome of FCC proceedings.

As of January 1, 2017, Remote high cost support payments to Alaska High Cost participants will be frozen on a per-company basis at adjusted December 2014 levels for a ten-year term in exchange for meeting individualized performance obligations to offer voice and broadband services meeting the service obligations at specified minimum speeds by five-year and ten-year service milestones to a specified number of locations. Remote high cost support is no longer dependent upon line counts and line count filings are no longer required.

As a result of the Alaska High Cost Order, we apply the proportional performance revenue recognition method to account for the transition from accruals based on line counts to a fixed payment stream while our level of service provided and associated costs remain constant. Included in the calculation are the scheduled Remote high cost support payments from September 2016 through January 2027 net of our Remote accounts receivable balance at August 31, 2016. In 2022, the FCC may redistribute support in areas with duplicative LTE service. We will account for any changes made by the FCC to redistribute support prospectively.

Urban High Cost Support
Prior to the Alaska High Cost Order, Urban high cost support payments were frozen and had phased down to 60% of the monthly average of the 2011 annual support. The Alaska High Cost Order mandates that as of January 1, 2017, Urban high cost support for 2017 and 2018 will be two-thirds and one-third of the December 2014 level of support received, respectively.

We apply the proportional performance revenue recognition method to account for the impact of the declining payments while our level of service provided and associated costs remain constant. Included in the calculation are the scheduled Urban high cost support payments from September 2016 through January 2018 net of our Urban accounts receivable balance at August 31, 2016. An equal amount of this result is recognized as Urban support revenue each period.

For both Remote and Urban high cost support revenue, our ability to collect our accrued USF support is contingent upon continuation of the USF program and upon our eligibility to participate in that program, which are subject to change by future regulatory, legislative or judicial actions. We adjust revenue and the account receivable in the period the FCC makes a program change or we assess the likelihood that such a change has increased or decreased revenue. We do not recognize revenue related to a particular service area until our ETC status has been approved by the RCA.

We recorded high cost support revenue under the Universal Service Fund (“USF”) program of $15.9 million and $16.5 million for the three months ended September 30, 2016 and 2015, respectively, and $48.4 million and $50.6 million for the nine months ended September 30, 2016 and 2015, respectively.  At September 30, 2016, we have $44.7 million in high cost support accounts receivable.

(l)
Use of Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant items subject to estimates and assumptions include the allowance for doubtful receivables, unbilled revenues, accrual of the USF high cost program support, share-based compensation, inventory at lower of cost and net realizable value, reserve for future customer credits, liability for incurred but not reported medical insurance claims, valuation allowances for deferred income tax assets, depreciable and amortizable lives of assets, the carrying value of long-lived assets including goodwill, cable certificates, wireless licenses,and broadcast licenses, the fair value of equity method investments evaluated for impairment, our effective tax rate, imputed interest rate, purchase price allocations, deferred lease expense, asset retirement obligations, the accrual of cost of goods sold (exclusive of depreciation and amortization expense), depreciation, guarantees, and the accrual of contingencies and litigation. Actual results could differ from those estimates.

15



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


(m)
Income Taxes
GCI, Inc., as a wholly owned subsidiary and member of the GCI controlled group of corporations, files its income tax returns as part of the consolidated group of corporations under GCI. Accordingly, all discussions regarding income taxes reflect the consolidated group's activity. Our income tax expense and deferred income tax assets and liabilities are presented herein using the separate-entity method.

(n)
Classification of Taxes Collected from Customers
We report sales, use, excise, and value added taxes assessed by a governmental authority that is directly imposed on a revenue-producing transaction between us and a customer on a net basis in our Consolidated Statements of Operations.  The following are certain surcharges reported on a gross basis in our Consolidated Statements of Operations (amounts in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Surcharges reported gross
$
951

 
1,426

 
2,973

 
3,960


(o)
Reclassifications
Reclassifications have been made to the 2015 financial statements to make them comparable with classifications used in the current year.

(2)
Tower Sale and Leaseback
In August 2016, we sold to Vertical Bridge Towers II, LLC (“VBT”) 276 cell sites (“VBT Tower Sites”) in exchange for net proceeds of $90.8 million (“Tower Transaction”). The sale included, where applicable, the towers, the land on which the towers were situated if owned by us, the obligation to pay land leases, and other executory costs.
We entered into a master lease agreement in which we lease back space at the VBT Tower Sites for an initial term of ten years, followed by the option to renew for eight additional five year periods, for a total possible lease term of 50 years. Each lease is subject to a 2% annual increase in lease payments throughout the life of the initial lease and all subsequent lease renewals.
Prior to the Tower Transaction, we had the legal obligation to remove the towers upon termination of the land lease agreements. The obligation is now reduced to the removal of our equipment from the towers. Therefore, we have reduced our asset retirement obligation related to the VBT Tower Sites by $3.4 million.
Per the master lease agreement, we have the right to cure land lease defaults on behalf of VBT and have negotiated fixed rate lease renewals as described above. Due to this continuing involvement with the VBT Tower Sites, we determined we were precluded from applying sale-leaseback accounting. We recorded a long-term financial obligation (“Tower Obligation”) in the amount of the net proceeds received and recognize interest on the tower obligation at a rate of 7.1% using the effective interest method. The Tower Obligation is increased by interest expense and amortized through contractual leaseback payments made by us to VBT. Our historical tower site asset costs continue to be depreciated and reported in Net Property and Equipment.
The following table summarizes the impacts to the Consolidated Balance Sheets (amounts in thousands):
 
September 30, 2016
Property and equipment (1)
$
19,159

Tower obligation(2)
$
88,060

(1) Property conveyed to VBT as part of the Tower Transaction, but remains on our Consolidated Balance Sheets.
(2) Excluding current portion and net of deferred transaction costs.


16



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


Future minimum payments related to the Tower Obligation, including expected renewals and excluding deferred transaction costs, are summarized below (amounts in thousands):
Years ending December 31,
Total
2016
$
1,735

2017
6,996

2018
7,136

2019
7,279

2020
7,425

2021 and thereafter
157,690

Total minimum payments
188,261

Less amount representing interest
98,118

Tower obligation
$
90,143

(3)
Consolidated Statements of Cash Flows Supplemental Disclosures
Changes in operating assets and liabilities consist of (amounts in thousands):
Nine Months Ended September 30,
2016
 
2015
Decrease in accounts receivable, net
$
3,129

 
17,016

Increase in prepaid expenses
(3,636
)
 
(885
)
Decrease in inventories
3,356

 
6,957

(Increase) decrease in other current assets
(44
)
 
17

Increase in other assets
(3,990
)
 
(7,886
)
Increase (decrease) in accounts payable
4,155

 
(7,743
)
Increase (decrease) in deferred revenues
(1,013
)
 
1,532

Decrease in accrued payroll and payroll related obligations
(2,227
)
 
(3,783
)
Increase (decrease) in accrued liabilities
(5,758
)
 
2,496

Increase in accrued interest
13,224

 
16,321

Decrease in subscriber deposits
(366
)
 
(590
)
Increase (decrease) in long-term deferred revenue
18,178

 
(6,437
)
Increase in components of other long-term liabilities
332

 
230

Total change in operating assets and liabilities
$
25,340

 
17,245


The following item is for the nine months ended September 30, 2016 and 2015 (amounts in thousands):
Net cash paid or received:
2016
 
2015
Interest paid including capitalized interest
$
45,164

 
45,393


The following items are non-cash investing and financing activities for the nine months ended September 30, 2016 and 2015 (amounts in thousands):
 
2016
 
2015
Non-cash additions for purchases of property and equipment
$
11,372

 
17,683

Net asset retirement obligation additions (deletions) to property and equipment
$
(2,279
)
 
1,730

Non-cash consideration for Wireless Acquisition
$

 
23,326



17



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


(4)
Intangible Assets and Goodwill
Amortization expense for amortizable intangible assets was as follows (amounts in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Amortization expense
$
3,147

 
2,701

 
9,183

 
7,919


Amortization expense for amortizable intangible assets for each of the five succeeding fiscal years is estimated to be (amounts in thousands):
Years Ending December 31,
 
2016
$
12,141

2017
$
10,352

2018
$
8,388

2019
$
5,872

2020
$
4,474


(5)
Fair Value Measurements

Recurring Fair Value Measurements
Assets measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 are as follows (amounts in thousands):
September 30, 2016
Level 1 (1)
 
Level 2 (2)
 
Level 3 (3)
 
Total
Assets:
 
 
 
 
 
 
 
Deferred compensation plan assets (mutual funds)
$
1,462

 

 

 
1,462

 
 
 
 
 
 
 
 
December 31, 2015
Level 1 (1)
 
Level 2 (2)
 
Level 3 (3)
 
Total
Assets:
 
 
 
 
 
 
 
Deferred compensation plan assets (mutual funds)
$
1,728

 

 

 
1,728

 
 
 
 
 
 
 
 
(1) Quoted prices in active markets for identical assets or liabilities
(2) Observable inputs other than quoted prices in active markets for identical assets and liabilities
(3) Inputs that are generally unobservable and not corroborated by market data

The fair value of our mutual funds is determined using quoted market prices in active markets utilizing market observable inputs.

Current and Long-Term Debt
The carrying amounts and approximate fair values of our current and long-term debt, excluding capital leases, at September 30, 2016 and December 31, 2015 are as follows (amounts in thousands):
 
September 30,
2016
 
December 31,
2015
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
Current and long-term debt
$
1,277,378

 
1,316,241

 
1,293,296

 
1,314,864


The following methods and assumptions were used to estimate fair values:
The fair values of the 6.75% Senior Notes due 2021 and the 6.875% Senior Notes due 2025 are based upon quoted market prices for the same or similar issues (Level 2).

18



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


The fair value of our Amended Senior Credit Facility and Wells Fargo note payable are estimated to approximate their carrying value because the instruments are subject to variable interest rates (Level 2).

(6)
Stockholder's Equity

Share-based Compensation
GCI's Amended and Restated 1986 Stock Option Plan ("Stock Option Plan"), provides for the grant of options and restricted stock awards (collectively "award") for a maximum of 15.7 million shares of GCI Class A common stock, subject to adjustment upon the occurrence of stock dividends, stock splits, mergers, consolidations or certain other changes in corporate structure or capitalization. We have issued only restricted stock awards since 2010. If an award expires or terminates, the shares subject to the award will be available for further grants of awards under the Stock Option Plan. The Compensation Committee of GCI’s Board of Directors administers the Stock Option Plan. Substantially all restricted stock awards granted vest over periods of up to three years.  The requisite service period of our awards is generally the same as the vesting period.  New shares of GCI Class A common stock are issued when restricted stock awards are granted.  We have 1.6 million shares available for grant under the Stock Option Plan at September 30, 2016.

A summary of nonvested restricted stock award activity under the Stock Option Plan as of September 30, 2016 and changes during the period then ended is presented below:
 
Shares (in thousands)
 
Weighted
Average
Grant Date
Fair Value
Nonvested at December 31, 2015
1,495

 
$
11.08

Granted
580

 
$
17.68

Vested
(284
)
 
$
10.41

Forfeited
(3
)
 
$
15.93

Nonvested at September 30, 2016
1,788

 
$
13.32


The weighted average grant date fair value of awards granted during the nine months ended September 30, 2016 and 2015, were $17.68 and $14.70, respectively. The total fair value of awards vesting during the nine months ended September 30, 2016 and 2015 were $4.5 million and $5.1 million, respectively. We have recorded share-based compensation expense of $7.8 million and $8.0 million for the nine months ended September 30, 2016 and 2015, respectively. Share-based compensation expense is classified as Selling, General and Administrative Expense in our Consolidated Statements of Operations.  Unrecognized share-based compensation expense was $11.2 million as of September 30, 2016.  We expect to recognize share-based compensation expense over a weighted average period of 1.4 years for restricted stock awards.

(7)
Segments
Our reportable segments are business units that offer different products and are each managed separately. A description of our reportable segments follows:

Wireless - We offer wholesale wireless services.  

Wireline - We provide a full range of wireless, data, video, voice, and managed services to residential customers, businesses, governmental entities, and educational and medical institutions primarily in Alaska.

We evaluate performance and allocate resources based on Adjusted EBITDA, which is defined as earnings plus imputed interest on financed devices before:
Net interest expense,
Income taxes,
Depreciation and amortization expense,
Loss on extinguishment of debt,
Software impairment charge,

19



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


Share-based compensation expense,
Accretion expense,
Loss attributable to non-controlling interest resulting from NMTC transactions,
Gains and impairment losses on equity and cost method investments, and
Other non-cash adjustments.

Management believes that this measure is useful to investors and other users of our financial information in understanding and evaluating operating performance as an analytical indicator of income generated to service debt and fund capital expenditures.  In addition, multiples of current or projected Adjusted EBITDA are used to estimate current or prospective enterprise value.  

In the first quarter of 2016, we added an adjustment to Adjusted EBITDA, our measure of segment profitability, for cash received in excess of revenue recognized for long-term roaming arrangements ("Roaming Adjustment"). In the third quarter of 2016, we reevaluated our measure of segment profitability and decided to eliminate this adjustment due to the fact that this adjustment is not appropriate to include in non-GAAP metrics, which resulted in differences between our measure of segment profitability and disclosures of non-GAAP metrics.

The effect of removing the Roaming Adjustment from Adjusted EBITDA for the three months ended March 31, 2016 and the three and six months ended June 30, 2016 follows (amounts in thousands):
 
Wireless Segment Adjusted EBITDA
 
Adjusted EBITDA as Previously Defined
Removal of Roaming Adjustment
Adjusted EBITDA
First Quarter 2016
$
40,064

(7,500
)
32,564

Second Quarter 2016
$
40,334

(7,500
)
32,834

Six Months Ended June 30, 2016
$
80,398

(15,000
)
65,398


The accounting policies of the reportable segments are the same as those described in Note 1, “Business and Summary of Significant Accounting Policies” of this Form 10-Q.  We have no intersegment sales.

We earn all revenues through sales of services and products within the United States. All of our long-lived assets are located within the United States of America, except the majority of our undersea fiber optic cable systems which transit international waters and all of our satellite transponders.

Summarized financial information for our reportable segments for the three and nine months ended September 30, 2016 and 2015 follows (amounts in thousands):
 
Three Months Ended
 
Nine Months Ended
 
Wireless
 
Wireline
 
Total Reportable Segments
 
Wireless
 
Wireline
 
Total Reportable Segments
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
52,327

 
184,328

 
236,655

 
$
157,664

 
543,855

 
701,519

Adjusted EBITDA
$
32,018

 
46,167

 
78,185

 
$
97,416

 
122,915

 
220,331

 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 

Revenues
$
80,424

 
178,149

 
258,573

 
$
207,568

 
529,622

 
737,190

Adjusted EBITDA
$
57,404

 
39,198

 
96,602

 
$
140,518

 
119,517

 
260,035



20



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


A reconciliation of reportable segment Adjusted EBITDA to consolidated income (loss) before income taxes follows (amounts in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Reportable segment Adjusted EBITDA
$
78,185

 
96,602

 
220,331

 
260,035

Less depreciation and amortization expense
(47,819
)
 
(45,157
)
 
(143,033
)
 
(135,563
)
Less share-based compensation expense
(2,810
)
 
(2,660
)
 
(7,820
)
 
(8,074
)
Less imputed interest on financed devices
(651
)
 
(268
)
 
(1,885
)
 
(438
)
Less accretion expense
(406
)
 
(191
)
 
(1,240
)
 
(992
)
Less software impairment charge

 
(2,571
)
 

 
(29,839
)
Other
(131
)
 
(206
)
 
(435
)
 
493

Consolidated operating income
26,368

 
45,549

 
65,918

 
85,622

Less other expense, net
(19,053
)
 
(18,058
)
 
(56,497
)
 
(97,561
)
Consolidated income (loss) before income taxes
$
7,315

 
27,491

 
9,421

 
(11,939
)
 
(8)
Related Party Transactions
We entered into a long-term capital lease agreement in 1991 with the wife of GCI’s President and CEO for property occupied by us.  The leased asset was capitalized in 1991 at the owner’s cost of $0.9 million and the related obligation was recorded.  The lease agreement was amended in April 2008 and our existing capital lease asset and liability increased by $1.3 million to record the extension of this capital lease.  The amended lease terminates on September 30, 2026.

In January 2001 we entered into an aircraft operating lease agreement with a company owned by GCI’s President and CEO.  The lease was amended several times, most recently in May 2011.  The lease term of the aircraft may be terminated at any time by us upon 12 months written notice.  The monthly lease rate of the aircraft is $132,000.  In 2001, we paid a deposit of $1.5 million in connection with the lease.  The deposit will be repaid to us no later than six months after the agreement terminates.

ACS was a related party for financial statement reporting purposes through the date of the Wireless Acquisition on February 2, 2015. Included in our related party disclosures were ACS' provision to us of local service lines and network capacity in locations where we do not have our own facilities, our provision to ACS of wholesale wireless services for their use of our network to sell services to their respective retail customers, and our receipt of ACS' high cost support from USF for its wireless customers. For the period January 1, 2015 to February 2, 2015, we paid ACS $6.2 million and received $8.1 million in payments from ACS. We also have long-term capacity exchange agreements with ACS for which no money is exchanged.

(9)
Variable Interest Entities

New Markets Tax Credit Entities
We have entered into several arrangements under the NMTC program with US Bancorp to help fund a project that extended terrestrial broadband service for the first time to rural Northwestern Alaska communities via a high capacity hybrid fiber optic and microwave network (“TERRA-NW”).  The NMTC program was provided for in the Community Renewal Tax Relief Act of 2000 (the “Act”) to induce capital investment in qualified lower income communities.  The Act permits taxpayers to claim credits against their federal income taxes for up to 39% of qualified investments in the equity of community development entities (“CDEs”).  CDEs are privately managed investment institutions that are certified to make qualified low-income community investments.

On August 30, 2011, we entered into the first arrangement (“NMTC #1”).  In connection with the NMTC #1 transaction we loaned $58.3 million to TIF, a special purpose entity created to effect the financing arrangement, at 1% interest due August 30, 2041.  Simultaneously, US Bancorp invested $22.4 million in TIF.  TIF then contributed US Bancorp’s contribution and the loan proceeds to certain CDEs.  The CDEs, in turn, loaned the

21



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


$76.8 million in funds less payment of placement fees, at interest rates varying from 1% to 3.96%, to Unicom, as partial financing for TERRA-NW.

On October 3, 2012, we entered into the second arrangement (“NMTC #2”). In connection with the NMTC #2 transaction we loaned $37.7 million to TIF 2 and TIF 2-USB, special purpose entities created to effect the financing arrangement, at 1% interest due October 2, 2042.  Simultaneously, US Bancorp invested $17.5 million in TIF 2 and TIF 2-USB.  TIF 2 and TIF 2-USB then contributed US Bancorp’s contributions and the loan proceeds to certain CDEs.  The CDEs, in turn, loaned the $55.2 million in funds less payment of placement fees, at interest rates varying from 0.7099% to 0.7693%, to Unicom, as partial financing for TERRA-NW.

On December 11, 2012, we entered into the third arrangement (“NMTC #3”).  In connection with the NMTC #3 transaction we loaned $8.2 million to TIF 3, a special purpose entity created to effect the financing arrangement, at 1% interest due December 10, 2042.  Simultaneously, US Bancorp invested $3.8 million in TIF 3.  TIF 3 then contributed US Bancorp’s contributions and the loan proceeds to a CDE.  The CDE, in turn, loaned the $12.0 million in funds less payment of placement fees, at an interest rate of 1.35%, to Unicom, as partial financing for TERRA-NW.

US Bancorp is the sole investor in TIF, TIF 2, TIF 2-USB and TIF 3, and as such, is entitled to substantially all of the benefits derived from the NMTCs.  All of the loan proceeds to Unicom net of syndication and arrangement fees, were restricted for use on TERRA-NW.  We completed construction of TERRA-NW and placed the final phase into service in 2014.

These transactions include put/call provisions whereby we may be obligated or entitled to repurchase US Bancorp’s interests in TIF, TIF 2, TIF 2-USB and/or TIF 3. We believe that US Bancorp will exercise the put options in August 2018, October 2019 and December 2019, at the end of the compliance periods for NMTC #1, NMTC #2 and NMTC #3, respectively.  The NMTCs are subject to 100% recapture for a period of seven years as provided in the Internal Revenue Code.  We are required to be in compliance with various regulations and contractual provisions that apply to the NMTC arrangements.  Non-compliance with applicable requirements could result in projected tax benefits not being realized by US Bancorp.  We have agreed to indemnify US Bancorp for any loss or recapture of NMTCs until such time as our obligation to deliver tax benefits is relieved.  There have been no credit recaptures as of September 30, 2016.  The value attributed to the puts/calls is nominal.

We have determined that TIF, TIF 2, TIF 2-USB and TIF 3 are VIEs.  The consolidated financial statement of TIF, TIF 2, TIF 2-USB and TIF 3 include the CDEs discussed above. The ongoing activities of the VIEs – collecting and remitting interest and fees and NMTC compliance – were all considered in the initial design and are not expected to significantly affect economic performance throughout the life of the VIEs.  Management considered the contractual arrangements that obligate us to deliver tax benefits and provide various other guarantees to US Bancorp; US Bancorp’s lack of a material interest in the underlying economics of the project; and the fact that we are obligated to absorb losses of the VIEs.  We concluded that we are the primary beneficiary of each and consolidated the VIEs in accordance with the accounting standard for consolidation.

US Bancorp’s contributions, net of syndication fees and other direct costs incurred in structuring the NMTC arrangements, are included in Non-controlling Interests on the Consolidated Balance Sheets.  Incremental costs to maintain the structure during the compliance period are recognized as incurred to selling, general and administrative expense.


22



GCI, INC. AND SUBSIDIARIES
Condensed Notes to Interim Consolidated Financial Statements
(Unaudited)


The assets and liabilities of our consolidated VIEs were $140.9 million and $104.2 million, respectively, as of September 30, 2016 and December 31, 2015.

Equity Method Investment
We own a 40.8% interest in a next generation carrier-class communications services firm. We account for our investment using the equity method. Due to declining economic conditions in the sector in which it operates, additional financing was needed for the company to maintain its business plan. In March 2015, the existing owners provided financial support in the form of a loan of which our portion was $3.0 million. We determined that the additional financing provided to the company was a reconsideration event under ASC 810 and subsequently determined that the entity is a VIE due to insufficient equity to finance its operations as a result of the decline in economic conditions.

We concluded that the company's board has the power to direct the significant activities of the entity. The board is comprised of five members of which we may choose two of the board members. As we do not control the board, we concluded that we do not have the power to direct the significant activities of the entity and are not the primary beneficiary.

During the second quarter of 2015, it became apparent that we would not recover the carrying value of our investment and we subsequently wrote-off the entire value of our investment. We received full payment on the $3.0 million note receivable in January 2016 and we do not have a contractual obligation to provide additional financing. We currently have no exposure to loss related to our involvement with the VIE.

(10)
Software Impairment
During the years ended December 31, 2013 and 2014, we internally developed computer software in our Wireline segment to replace our wireless, Internet, video, local service, and long distance customer billing systems. During the first quarter of 2015, we completed a detailed assessment of our progress to date and determined it was no longer probable that the computer software being developed would be completed and placed in service. Our assessment concluded that the cost of continuing the development would be much higher than originally estimated, and the timing and scope risks were substantial. We identified development work, hardware, and software recorded as Construction in Progress through September 30, 2015, that may be applicable to our replacement customer billing solution, future internally developed software, and other system needs and therefore should remain capital assets. We considered the remaining capital expenditures for this billing system to have a fair value of $0 and recorded an impairment charge of $20.7 million during the nine months ended September 30, 2015 by recording an expense which is included in Software Impairment Charge in our Consolidated Statements of Operations.

During the first quarter of 2015, we reassessed our plans for our internally developed machine-to-machine billing system in our Wireline segment, and decided to no longer market this system to third parties. Accordingly we recognized an impairment charge of $0.5 million and $7.1 million during the three and nine months ended September 30, 2015 by recording an expense which is included in Software Impairment Charge in our Consolidated Statements of Operations.

During the third quarter of 2015, we evaluated user management software we purchased in 2014 and
determined that we would not be able to use the software. Accordingly we recognized an impairment of $1.0 million during the three and nine months ended September 30, 2015 by recording an expense which is included
in Software Impairment Charge in our Consolidated Statement of Operations.

(11)
Commitments and Contingencies
On July 29, 2016, we executed a Membership Interest Purchase Agreement to acquire Kodiak Kenai Cable Company, the owner of the Kodiak Kenai Fiber Link ("KKFL") for consideration of $20.0 million.  KKFL is the only low latency redundant fiber link between Anchorage, the Kenai Peninsula and Kodiak and it will ensure we have diverse, protected network capacity to these markets to support our current and future broadband requirements.  Closing is subject to the consent of the Federal Communications Commission.


23



Part I

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

In the following discussion, GCI, Inc. and its direct and indirect subsidiaries are referred to as “we,” “us” and “our.”
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our interim consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those described in Note 1 in the accompanying "Condensed Notes to Interim Consolidated Financial Statements" included in Part I of this quarterly report on Form 10-Q. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. See also our “Cautionary Statement Regarding Forward-Looking Statements.”

GCI, Inc. was incorporated under the laws of the State of Alaska in 1997 to affect the issuance of Senior Notes. GCI, Inc., a wholly owned subsidiary of General Communication, Inc. ("GCI"), received through its initial capitalization all ownership interests in subsidiaries previously held by GCI. Shares of GCI's Class A common stock are traded on the Nasdaq National Market tier of the Nasdaq Stock Market under the symbol of GNCMA. Shares of GCI's Class B common stock are traded on the Over-the-Counter market. Shares of GCI, Inc.'s common stock are wholly owned by GCI and are not publicly traded. The GCI and GCI, Inc. interim consolidated financial statements include substantially the same operating activities.

Emerging Growth Company
We qualify as an “emerging growth company” under the Jumpstart Our Business Startups Act (the “JOBS
Act”) enacted on April 5, 2012. As a result, we are permitted to rely on exemptions from certain disclosure requirements that are applicable to companies that are not emerging growth companies.

In addition, Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we are choosing to “opt out” of such extended transition period, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

Update on Economic Conditions
We offer wireless and wireline telecommunication services, data services, video services, and managed services to customers primarily throughout Alaska. Because of this geographic concentration, growth of our business and operations depends upon economic conditions in Alaska.  The economy of Alaska is dependent upon the oil
industry, state government spending, United States military spending, investment earnings and tourism.  Prolonged periods of low oil prices will adversely impact the Alaska economy, which in turn could have an adverse impact on the demand for our products and services and on our results of operations and financial condition.

Oil prices have continued to remain low which has put significant pressure on the Alaska state government budget since the majority of its revenues come from the oil industry. While the Alaska state government has significant reserves that we believe will help fund the state government for the next couple of years, major structural budgetary reforms will need to be implemented in order to offset the impact of declining oil prices. The State of Alaska failed to pass a workable long-term fiscal plan during the recent legislative session. As a result, we plan to reduce our 2017 Alaska capital expenditure budget by 20% to 25% of the 2016 target of $210.0 million due substantially to the continued uncertainty of the ability of the State of Alaska to adopt and implement a workable long-term fiscal plan.


24



General Overview
Through our focus on long-term results, acquisitions, and strategic capital investments, we strive to consistently grow our Adjusted EBITDA, as defined in Note 7 in "Part I - Item 1 - Condensed Notes to Interim Consolidated Financial Statements."  We have historically met our cash needs for operations and regular and maintenance capital expenditures through our cash flows from operating activities.  Historically, cash requirements for significant acquisitions and major capital expenditures have been provided largely through our financing activities.

On August 31, 2016, the Federal Communications Commission ("FCC") published a Report and Order to reform the methodology for distributing Universal Service Fund ("USF") high cost support for both wireline and wireless voice and broadband service (“Alaska High Cost Order”).  The Alaska High Cost Order was a significant program change that required a reassessment of our high cost support revenue recognition. See Note 1(k) in "Part I - Item 1 - Condensed Notes to Interim Consolidated Financial Statements" for additional information. As a result of the Alaska High Cost Order, we expect high cost support revenue under the USF program to be less than the $66.2 million of high cost support revenue recognized in 2015 by approximately $2.5 million in 2016, $5.0 million in each of 2017 and 2018, and $15.0 million annually from 2019 through 2026, the date the Alaska High Cost Order ends.

On February 2, 2015, we purchased Alaska Communications Systems Group, Inc.'s (“ACS”) interest in The Alaska Wireless Network, LLC ("AWN") and substantially all the assets of ACS and its affiliates related to ACS’s wireless operations (“Acquired ACS Assets”) (collectively the "Wireless Acquisition"). Under the terms of the agreement, we transfered to ACS a cash payment of $293.2 million excluding working capital adjustments and agreed to terminate or amend certain agreements related to the use of ACS network assets that were included as part of the original transaction that closed in July 2013. The Acquired ACS Assets include substantially all of ACS’s wireless subscriber assets, including subscriber contracts, and certain of ACS’s CDMA network assets, including fiber strands and associated cell site electronics and microwave facilities and associated electronics. We assumed from ACS post-closing liabilities of ACS and its affiliates under contracts assumed by us and liabilities with respect to the ownership by ACS of its equity interest in AWN to the extent accruing and related to the period after closing. All other liabilities were retained by ACS and its affiliates.

Results of Operations
The following table sets forth selected financial data as a percentage of total revenues for the periods indicated (underlying data rounded to the nearest thousand):
 
Three Months Ended September 30,
Percentage Change
2016
 
Nine Months Ended September 30,
Percentage Change
2016
 
2016
2015
vs. 2015
 
2016
2015
vs. 2015
Statements of Operations Data:
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
Wireless segment
22%
31%
(35)%
 
22%
28%
(24)%
Wireline segment
78%
69%
3%
 
78%
72%
3%
Total revenues
100%
100%
(8)%
 
100%
100%
(5)%
Selling, general and administrative expenses
38%
32%
8%
 
38%
34%
6%
Depreciation and amortization expense
20%
17%
6%
 
20%
18%
6%
Software impairment charge
—%
1%
(100)%
 
—%
4%
(100)%
Operating income
11%
18%
(42)%
 
9%
12%
(23)%
Other expense, net
8%
7%
6%
 
8%
13%
42%
Income (loss) before income taxes
3%
11%
(73)%
 
1%
(2)%
179%
Net income (loss)
—%
8%
(105)%
 
—%
(2)%
92%
Net income (loss) attributable to non-controlling interests
—%
—%
—%
 
—%
—%
(206)%
Net income (loss) attributable to GCI, Inc.
—%
8%
(104)%
 
—%
(2)%
94%
 
 
 
 
 
 
 
 
1Percentage change in underlying data
 
 

25




We evaluate performance and allocate resources based on Adjusted EBITDA, which is defined as earnings plus imputed interest on financed devices before:
Net interest expense,
Income taxes,
Depreciation and amortization expense,
Loss on extinguishment of debt,
Software impairment charge,
Share-based compensation expense,
Accretion expense,
Loss attributable to non-controlling interest resulting from NMTC transactions,
Gains and impairment losses on equity and cost method investments, and
Other non-cash adjustments.

Management believes that this measure is useful to investors and other users of our financial information in understanding and evaluating operating performance as an analytical indicator of income generated to service debt and fund capital expenditures. In addition, multiples of current or projected Adjusted EBITDA are used to estimate current or prospective enterprise value. See Note 7 in "Part I - Item 1 - Condensed Notes to Interim Consolidated Financial Statements" for a reconciliation of total Adjusted EBITDA to consolidated income (loss) before income taxes.

Overview of Revenues and Cost of Goods Sold
Total revenue, cost of goods sold (exclusive of depreciation and amortization expense) ("Cost of Goods Sold"), and Adjusted EBITDA for the three and nine months ended September 30, 2016 and 2015 are as follows (amounts in thousands):
 
Three Months Ended 
 September 30,
 
Percentage
 
Nine Months Ended September 30,
 
Percentage
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Revenue
$
236,655

 
258,573

 
(8
)%
 
$
701,519

 
737,190

 
(5
)%
Cost of Goods Sold
$
73,494

 
82,717

 
(11
)%
 
$
227,926

 
236,741

 
(4
)%
Adjusted EBITDA
$
78,185

 
96,602

 
(19
)%
 
$
220,331

 
260,035

 
(15
)%

See the discussion below for more information by segment.

Wireless Segment Overview
The Wireless segment was impacted by the Wireless Acquisition discussed above in the General Overview section. From the formation of AWN in 2013 to the close of the Wireless Acquisition on February 2, 2015, AWN provided wholesale services to GCI and ACS and roaming services to other wireless carriers. During that time, AWN received a portion of its revenue from GCI and ACS' retail wireless customers. Additionally, AWN paid an incentive to GCI and ACS for the sale of wireless handsets to their respective retail customers. Following the close of the Wireless Acquisition, the Wireless segment continues to provide roaming services to other wireless carriers and provides wholesale services to the Wireline segment for which it receives a portion of its revenue from wireless retail customers. Additionally, the Wireless segment started recording a portion of the wireless equipment costs to encourage the Wireline segment to transition customers from our CDMA network to our GSM network.

Wireless segment revenue, Cost of Goods Sold, and Adjusted EBITDA for the three and nine months ended September 30, 2016 and 2015 are as follows (amounts in thousands):
 
Three Months Ended 
 September 30,
 
Percentage
 
Nine Months Ended September 30,
 
Percentage
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Revenue
$
52,327

 
80,424

 
(35
)%
 
$
157,664

 
207,568

 
(24
)%
Cost of Goods Sold
$
15,313

 
18,031

 
(15
)%
 
$
47,426

 
53,897

 
(12
)%
Adjusted EBITDA
$
32,018

 
57,404

 
(44
)%
 
$
97,416

 
140,518

 
(31
)%


26



Wireless Segment Revenues
The decrease in revenue for the three and nine months ended September 30, 2016 when compared to the same periods in 2015 is primarily due to the following:
A $24.9 million or 61% and $44.9 million or 50% decrease in roaming revenue for the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively, due to long-term roaming agreements we have entered into with our largest roaming partners (please see "Liquidity and Capital Resources" below for additional discussion of the long-term roaming agreements), and
A $4.3 million or 21% and $12.2 million or 19% decrease in plan fee revenue for the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively, primarily due to a decrease in subscribers and discounts given to customers who finance or bring their own device.

Wireless Segment Cost of Goods Sold
The decrease in Cost of Goods Sold for the three and nine months ended September 30, 2016 when compared to the same periods in 2015 is primarily due to the following:
A $2.4 million or 52% and $8.0 million or 56% decrease in roaming costs for the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively, primarily due to renegotiated roaming agreements, and
A $1.7 million or 100% and $6.3 million or 100% decrease in wireless equipment costs for the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively. Through the February 2, 2015 close of the Wireless Acquisition, the Wireless segment gave a wireless equipment subsidy to the Wireline segment in accordance with the AWN agreements. Following the close of the Wireless Acquisition, this subsidy was discontinued but the Wireless segment started recording a portion of the wireless equipment costs to encourage the Wireline segment to transition customers from our CDMA network to our GSM network which partially offset the decrease. All wireless equipment costs are recorded in the Wireline segment in 2016.

The decreases above are partially offset by a $0.4 million or 10% and $3.9 million or 34% increase for the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively, primarily due to an increase in network maintenance costs primarily due to the expansion of our network and an increase in utility and operating costs. Additionally, the release of a reserve during the first quarter of 2015 contributed to the increase for the nine months ended September 30, 2016 when compared to the same period in 2015.

Wireless Segment Adjusted EBITDA
The decrease in Adjusted EBITDA for the three and nine months ended September 30, 2016 when compared to the same periods in 2015 is primarily due to a decrease in revenues as described above in "Wireless Segment Revenues, partially offset by decreased Cost of Goods Sold as described above in "Wireless Segment Cost of Goods Sold."

Wireline Segment Overview
Our Wireline segment offers services and products under two major customer groups as follows:
 
 
Customer Group
Wireline Segment Services and Products
Consumer
Business
 
 
 
 
Retail wireless
X
X
 
 
 
 
Data:
 
 
 
Internet
X
X
 
Data networks
 
X
 
Managed services
 
X
 
 
 
 
Video
X
X
 
 
 
 
Voice:
 
 
 
Long-distance
X
X
 
Local access
X
X

27




Consumer – we offer a full range of retail wireless, data, video and voice services to residential customers.
Business – we offer a full range of wireless, data, video, voice, and managed services to businesses, governmental entities, and educational institutions and wholesale data and voice services to common carrier customers and regulated voice services to residential and commercial customers in rural communities primarily in Southwest Alaska.

The components of Wireline segment revenue for the three and nine months ended September 30, 2016 and 2015 are as follows (amounts in thousands):
 
Three Months Ended 
 September 30,
 
Percentage
 
Nine Months Ended 
 September 30,
 
Percentage
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Consumer
 
 
 
 
 
 
 
 
 
 
 
Wireless
$
19,866

 
19,451

 
2
 %
 
$
50,055

 
56,566

 
(12
)%
Data
35,255

 
32,465

 
9
 %
 
105,033

 
95,771

 
10
 %
Video
26,134

 
28,483

 
(8
)%
 
81,294

 
86,629

 
(6
)%
Voice
6,551

 
7,420

 
(12
)%
 
20,357

 
22,950

 
(11
)%
Business
 
 
 
 
 

 
 
 
 
 
 

Wireless
2,205

 
2,036

 
8
 %
 
6,787

 
6,077

 
12
 %
Data
74,777

 
67,780

 
10
 %
 
219,977

 
199,815

 
10
 %
Video
4,636

 
4,476

 
4
 %
 
14,530

 
13,511

 
8
 %
Voice
14,904

 
16,038

 
(7
)%
 
45,822

 
48,303

 
(5
)%
Total Wireline segment revenue
$
184,328

 
178,149

 
3
 %
 
$
543,855

 
529,622

 
3
 %

Wireline segment Cost of Goods Sold and Adjusted EBITDA for the three and nine months ended September 30, 2016 and 2015 are as follows (amounts in thousands):
 
Three Months Ended 
 September 30,
 
Percentage
 
Nine Months Ended 
 September 30,
 
Percentage
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Wireline segment Cost of Goods Sold
$
58,181

 
64,686

 
(10
)%
 
$
180,500

 
182,844

 
(1
)%
Wireline segment Adjusted EBITDA
$
46,167

 
39,198

 
18
 %
 
$
122,915

 
119,517

 
3
 %

Selected key performance indicators for our Wireline segment follow:
 
September 30,

Percentage
 
2016
 
2015

Change
Consumer
 

 

 
Data:
 

 

 
Cable modem subscribers
127,000


124,300


2
 %
Video:
 
 
 
 
 

Basic subscribers
108,900

 
113,600

 
(4
)%
Digital programming tier subscribers
54,400

 
59,500

 
(9
)%
HD/DVR converter boxes
117,300

 
110,700

 
6
 %
Homes passed
250,200

 
251,200

 
 %
Video ARPU - quarter-to-date5
$
79.63

 
$
80.85

 
(2
)%
Video ARPU - year-to-date6
$
81.19

 
$
83.24

 
(2
)%
Voice:
 
 
 
 
 

Total local access lines in service7
49,000

 
51,000

 
(4
)%
Business
 
 
 
 
 


28



Data:
 
 
 
 
 

Cable modem subscribers
13,200

 
14,200

 
(7
)%
Voice:
 
 
 
 
 

Total local access lines in service7
46,100

 
47,100

 
(2
)%
Combined Consumer and Business
 
 
 
 
 

Wireless
 
 
 
 
 

Consumer Lifeline wireless lines in service8
28,700

 
28,100

 
2
 %
Consumer prepaid wireless lines in service9
29,600

 
27,100

 
9
 %
Consumer postpaid wireless lines in service10
141,000

 
146,700

 
(4
)%
Business postpaid wireless lines in service10
27,100

 
30,000

 
(10
)%
Total wireless lines in service
226,400

 
231,900

 
(2
)%
Wireless ARPU - quarter-to-date11
$
37.21

 
$
44.24

 
(16
)%
Wireless ARPU - year-to-date12
$
38.82

 
$
46.60

 
(17
)%
Cable Modem ARPU - quarter-to-date13
$
88.54

 
$
84.87

 
4
 %
Cable Modem ARPU - year-to-date14
$
88.23

 
$
84.27

 
5
 %
A cable modem subscriber is defined by the purchase of cable modem service regardless of the level of service purchased. If one entity purchases multiple cable modem service access points, each access point is counted as a subscriber.
A basic subscriber is defined as one basic tier of service delivered to an address or separate subunits thereof regardless of the number of outlets purchased.
A digital programming tier subscriber is defined as one digital programming tier of service delivered to an address or separate subunits thereof regardless of the number of outlets or digital programming tiers purchased. Digital programming tier subscribers are a subset of basic subscribers.
A high-definition/digital video recorder ("HD/DVR") converter box is defined as one box rented by a digital programming or basic tier subscriber. A digital programming or basic tier subscriber is not required to rent an HD/DVR converter box to receive service.
Applicable average monthly video revenues divided by the average number of basic subscribers at the beginning and end of each month in the period ("Video ARPU") for the three months ended September 30, 2016 and 2015.
6 Video ARPU for the nine months ended September 30, 2016 and 2015.
A local access line in service is defined as a revenue generating circuit or channel connecting a customer to the public switched telephone network.
A Lifeline wireless line in service is defined as a revenue generating wireless device that is eligible for Lifeline support. The Universal Service Fund's Lifeline program is administered by the Universal Service Administrative Company and is designed to ensure that quality telecommunications services are available to low-income customers at affordable rates.
8 A prepaid wireless line in service is defined as a revenue generating wireless device where service is purchased in advance of use. The purchased credit is used to pay for wireless services at the point the service is accessed or consumed.
10 A postpaid wireless line in service is defined as a revenue generating wireless device where service is provided by a prior arrangement with a subscriber and the subscriber is billed after the fact according to their use of wireless services at the end of each month.
11 Average monthly wireless revenues, excluding those from common carrier customers, divided by the average number of wireless subscribers at the beginning and end of each month in the period ("Wireless ARPU") for the three months ended September 30, 2016 and 2015. Revenue used for this calculation includes Wireline segment - Consumer - Wireless, Wireline segment - Business - Wireless and wholesale wireless revenues earned from GCI retail subscribers included in the Wireless segment.
12 Wireless ARPU for the nine months ended September 30, 2016. Average of the monthly wireless revenues, excluding those from common carrier customers, divided by the number of wireless subscribers at the end of each month for each of the months in the nine months ended September 30, 2015. Revenue used for this calculation includes Wireline segment - Consumer - Wireless, Wireline segment - Business - Wireless and wholesale wireless revenues earned from GCI retail subscribers included in the Wireless segment.
13 Applicable average monthly cable modem revenues divided by the average number of subscribers at the beginning and end of each month in the period ("Cable Modem ARPU") for the three months ended September 30, 2016 and 2015.
14 Cable Modem ARPU for the nine months ended September 30, 2016 and 2015.


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Wireline Segment Revenues

Consumer
The increase in wireless revenue for the three months ended September 30, 2016 when compared to the same period in 2015 is primarily due to a $4.1 million adjustment to lower the guarantee liability for our Upgrade Now program (please see Note 1(i) in "Part I - Item 1 - Condensed Notes to Interim Consolidated Financial Statements" for additional information on the guarantee liability). Based on a review of historical information, we determined that our customers were not trading their devices in as early and frequently as originally estimated. Additionally, we found that we were able to resell the used handsets for prices higher than originally estimated. Based on this new information, we determined that it was appropriate to reduce the guarantee liability recorded for financed devices in our Upgrade Now program. The increase in wireless revenue discussed above was partially offset by a decrease in the number of subscribers, discounts given to customers who finance or bring their own device, and a decrease in equipment sales revenue in the three months ended September 30, 2016 when compared to the same period in 2015. The decrease in wireless revenue for the nine months ended September 30, 2016 when compared to the same period in 2015, respectively, is primarily due to a decrease in the number of subscribers, discounts given to customers who finance or bring their own device, and a decrease in equipment sales revenue in the nine months ended September 30, 2016 when compared to the same period in 2015. The decreases were partially offset by the $4.1 million adjustment discussed above that was recorded during the three months ended September 30, 2016 to lower the guarantee liability for our Upgrade Now program.

The increase in data revenue is primarily due to a $2.5 million or 8% and $9.0 million or 10% increase in cable modem revenue for the three and nine months ended September 30, 2016 when compared to the same periods in 2015 due to an increase in the number of subscribers and our subscribers’ selection of plans that offer higher speeds and higher included usage amounts.

The decrease in Consumer video revenue for the three months ended September 30, 2016 when compared to the same period in 2015 is primarily due to a decrease in the number of subscribers. Consumer video revenue faces challenges as more customers choose to have their video content delivered via the Internet. However, as a major Internet-provider ourselves, this selection may result in additional data service revenue to the extent we grow average cable modem revenue per subscriber.

We expect Consumer voice revenue to continue to decrease due to a growing number of customers using wireless service as their primary voice phone service for local and long distance calling.

Business
Business data revenue is comprised of monthly recurring charges for data transport and storage services and charges billed on a time and materials basis largely for personnel providing on-site customer support.  The time and materials revenue can vary significantly based on project activity. This revenue faces challenges due to the continued decline of oil prices which negatively impacts certain of our customers.

The increase in data revenue for the three and nine months ended September 30, 2016 when compared to the same periods in 2015 is primarily due to a $10.6 million or 20% and $24.6 million or 15% increase in data transport and storage revenue due to new customers and increased purchases by our existing customers partially offset by decreases due to rate compression. The increase in data revenue was partially offset by a $2.0 million or 17% and $4.1 million or 12% decrease in time and materials revenue due to a decrease in special project work for the three and nine months ended September 30, 2016 when compared to the same periods in 2015.

Wireline Segment Cost of Goods Sold
The decrease in Wireline segment Cost of Goods Sold for the three and nine months ended September 30, 2016 when compared to the same periods in 2015 is primarily due to the following:
A $2.7 million or 21% and $3.3 million or 10% decrease for the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively, due to a decrease in the number of handsets sold, and
A $2.2 million or 22% decrease for the three months ended September 30, 2016 when compared to the same period in 2015 due to a decrease in time and materials Cost of Goods Sold related to the decreased special project work described above in "Wireline Segment Revenues - Business Services."

The decrease for the nine months ended September 30, 2016 is partially offset by a $3.7 million or 14% increase in transport and storage Cost of Goods Sold primarily due to an increase in circuit costs in satellite served locations

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related to the increased data transport and storage revenue described above in "Wireline Segment Revenues - Business Services."

Wireline Segment Adjusted EBITDA
The increase in Adjusted EBITDA for the three and nine months ended September 30, 2016 when compared to the same periods in 2015 is primarily due to an an increase in revenue as described in "Wireline Segment Revenues" and a decrease in Cost of Goods Sold as described above in "Wireline Segment Cost of Goods Sold" partially offset by an increase in selling, general and administrative expense.

Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 8% to $89.0 million and 6% to $264.6 million for the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively. Items contributing to the increase include:

A $1.4 million and $8.7 million increase in labor and health insurance costs for the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively,
A $2.7 million and $6.0 million increase in professional and contract services costs for the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively,
A $2.4 million and $1.5 million increase in our allowance for doubtful accounts for the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively, primarily due to growth in our financed device allowance,
A $3.1 million increase in software contracts with subscription licenses instead of perpetual licenses for the nine months ended September 30, 2016 when compared to the same period in 2015, respectively, and
A $2.2 million increase to support a campaign to encourage public action related to the State of Alaska budget for the nine months ended September 30, 2016 when compared to the same period in 2015.

The increases above are partially offset by the absence of $1.9 million and $10.5 million for costs related to the acquisition of ACS' wireless subscribers and its non-controlling interest in AWN in the three and nine months ended September 30, 2016 when compared to the same periods in 2015, respectively.

As a percentage of total revenues, selling, general and administrative expenses increased from 32% and 34% for the three and nine months ended September 30, 2015, respectively, to 38% for the three and nine months ended September 30, 2016.

Depreciation and Amortization Expense
Depreciation and amortization expense increased $2.7 million to $47.8 million and $7.5 million to $143.0 million in the three and nine months ended September 30, 2016 compared to the same periods in 2015.  The increase is primarily due to new assets placed in service in the last three months of 2015 and in the first nine months of 2016, partially offset by assets which became fully depreciated during the last three months of 2015 and in the first nine months of 2016.

Software Impairment Charge
Software impairment charge decreased $2.6 million and $29.8 million in the three and nine months ended September 30, 2016 when compared to the same periods in 2015 primarily due to the absence of an impairment charge as discussed below.

During the years ended December 31, 2013 and 2014, we internally developed computer software to replace our wireless, Internet, video, local service, and long distance customer billing systems. During the first quarter of 2015, we completed a detailed assessment of our progress to date and determined it was no longer probable that the computer software being developed would be completed and placed in service. Our assessment concluded that the cost of continuing the development would be much higher than originally estimated, and the timing and scope risks were substantial. We identified development work, hardware, and software recorded as Construction in Progress through September 30, 2015, that may be applicable to our replacement customer billing solution, future internally developed software, and other system needs and therefore should remain capital assets. We considered the remaining capital expenditures for this billing system to have a fair value of $0 and recorded an impairment charge of $20.7 million during the nine months ended September 30, 2015, by recording an expense which is included in Software Impairment Charge in our Consolidated Statements of Operations. We have signed a contract with an established billing solution provider and have begun the multi-year implementation.

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During the first quarter of 2015, we reassessed our plans for our internally developed machine-to-machine billing system and decided to no longer market this system to third parties. Accordingly we recognized an impairment of $0.5 million and $7.1 million during the three and nine months ended September 30, 2015, by recording an expense which is included in Software Impairment Charge in our Consolidated Statements of Operations.

During the third quarter of 2015, we evaluated user management software we purchased in 2014 and determined that we would not be able to use the software. Accordingly we recognized an impairment of $1.0 million during the three and nine months ended September 30, 2015 by recording an expense which is included in Software Impairment Charge in our Consolidated Statement of Operations.

Other Expense, Net
Other expense, net of other income, increased $1.0 million to $19.1 million for the three months ended September 30, 2016 when compared to the same period in 2015. Other expense, net of other income decreased $41.1 million to $56.5 million in the nine months ended September 30, 2016 when compared to the same period in 2015. Items contributing to the change include:
The absence of a $27.7 million loss on extinguishment of debt for the nine months ended September 30, 2015,
The absence of a $12.6 million impairment charge for the nine months ended September 30, 2015 to reflect an other than temporary decline in fair value for one of our equity investments,
The absence of a $4.7 million gain for the nine months ended September 30, 2015 recorded upon the sale of one of our cost method investments, and
The absence of a $2.6 million net loss for the nine months ended September 30, 2015, from adjusting to fair value the assets included in the consideration transfered in the Wireless Acquisition and adjusting to fair value amendments to certain agreements related to the right to use ACS network assets.

Income Tax Expense
GCI, Inc. as a wholly owned subsidiary and member of the GCI controlled group of corporations, files its income tax returns as part of the consolidated group of corporations under GCI. Accordingly, all discussions regarding income taxes reflect the consolidated group's activity. Our income tax expense and deferred income tax assets and liabilities are presented herein using the separate-entity method.

Income tax expense totaled $8.3 million and $10.5 million and our effective income tax rate was 113% and 111% in the three and nine months ended September 30, 2016, respectively. Income tax expense totaled $7.7 million and $0.7 million and our effective income tax rate was 28% and (6)% in the three and nine months ended September 30, 2015, respectively. Our effective income tax rate is impacted by the amount of expected permanent differences in a year as compared to our expected net income before income taxes.

At September 30, 2016, we have income tax net operating loss carryforwards of $324.8 million that will begin expiring in 2020 if not utilized, and alternative minimum tax credit carryforwards of $1.7 million available to offset regular income taxes payable in future years.

We have recorded deferred tax assets of $133.5 million associated with income tax net operating losses that were generated from 2000 to 2015 and that expire from 2020 to 2035, respectively, and with charitable contributions that were converted to net operating losses in 2004 through 2007, 2013, and 2014 and that expire in 2024 through 2027, 2033, and 2034, respectively.

Tax benefits associated with recorded deferred tax assets are considered to be more likely than not realizable through future reversals of existing taxable temporary differences and future taxable income exclusive of reversing temporary differences and carryforwards.  The amount of deferred tax assets considered realizable, however, could be reduced if estimates of future taxable income during the carryforward period are reduced which would result in additional income tax expense.  We estimate that our effective annual income tax expense rate for financial statement purposes will be 108% to 113% in the year ending December 31, 2016.
  
Liquidity and Capital Resources
Our principal sources of current liquidity are cash and cash equivalents.  We believe, but can provide no assurances, that we will be able to meet our current and long-term liquidity, capital requirements and fixed charges through our cash flows from operating activities, existing cash, cash equivalents, and credit facilities, and other external financing and equity sources.  Should operating cash flows be insufficient to support additional borrowings

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and principal payments scheduled under our existing credit facilities, capital expenditures will likely be reduced, which would likely reduce future revenues.

On August 1, 2016, we received $90.8 million for the initial closing to sell the majority of our urban wireless rooftop and tower sites to Vertical Bridge ("Tower Sale"). Additionally, we entered into a Master Lease Agreement with Vertical Bridge to lease collocation space on communications towers and facilities that were sold to Vertical Bridge.

In the first quarter of 2016, we entered into new long-term roaming and backhaul agreements with our largest roaming partners. The revenue recognized for these contracts was determined by calculating the cumulative minimum cash payments and recognizing the amount evenly over the life of the contracts. In the early years of the contracts, the cash received is in excess of the revenue recognized resulting in a significant increase in long-term deferred revenue; in the later years the cash received will be less than the revenue recognized and will lower long-term deferred revenue.

As discussed in the General Overview section of this Item 2, on February 2, 2015, we completed the Wireless Acquisition to purchase ACS' wireless subscriber base and its one-third ownership interest in AWN for $293.2 million excluding working capital adjustments and the termination or amendment of certain agreements related to the use of ACS network assets that were included as part of the original transaction that closed in July 2013. Following the close of the transaction, AWN is our wholly owned subsidiary and we are entitled to 100% of the future cash flows from AWN.

To fund the purchase from ACS, on February 2, 2015, our wholly owned subsidiary, GCI Holdings, Inc., entered into a Fourth Amended and Restated Credit and Guarantee Agreement with Credit Agricole Corporate and Investment Bank, as administrative agent, that included a $275.0 million Term B loan ("Senior Credit Facility"). The Senior Credit Facility was subsequently amended on August 3, 2015 ("First Amendment"). The interest rate under the Term B loan is London Interbank Offered Rate (“LIBOR”) plus 3.25%, with a 0.75% LIBOR floor. The Term B loan will mature on February 2, 2022 or December 3, 2020, if our Senior Notes due 2021 are not refinanced prior to such date.

While our short-term and long-term financing abilities are believed to be adequate as a supplement to internally generated cash flows to fund capital expenditures and acquisitions as opportunities arise, turmoil in the global financial markets may negatively impact our ability to further access the capital markets in a timely manner and on attractive terms, which may have a negative impact on our ability to grow our business.

We monitor the third-party depository institutions that hold our cash and cash equivalents. Our emphasis is primarily on safety of principal and secondarily on maximizing yield on those funds.

Investing Activities
Net cash used for investing activities consists primarily of cash paid for capital expenditures.  Our most significant recurring investing activity has been capital expenditures and we expect that this will continue in the future.  A significant portion of our capital expenditures is based on the level of customer growth and the technology being deployed.

Our cash expenditures for property and equipment, including construction in progress, totaled $149.8 million and $134.3 million during the nine months ended September 30, 2016 and 2015, respectively.  Depending on available opportunities and the amount of cash flow we generate during 2016, we expect our 2016 capital expenditures to total approximately $210.0 million. This estimate is based on purchases in 2016 regardless of the timing of cash payments.

The State of Alaska failed to pass a workable long-term fiscal plan during the recent legislative session. As a result, we plan to reduce our 2017 Alaska capital expenditure budget by 20% to 25% of the 2016 target of $210.0 million due substantially to the continued uncertainty of the ability of the State of Alaska to adopt and implement a workable long-term fiscal plan.


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Financing Activities
Net cash provided by financing activities for the nine months ended September 30, 2016, consists primarily of cash received from the Tower Sale partially offset by repurchases of GCI's stock and payments on our Senior Credit Facility net of borrowings. Net cash used by financing activities during the nine months ended September 30, 2015, consists primarily of cash paid for the Wireless Acquisition, repurchases of GCI's stock, and payments related to the issuance of $450.0 million of new 6.875% Senior Notes due 2025 partially offset by borrowings on our Senior Credit Facility and a contribution from GCI.

Proceeds from borrowings fluctuate from year to year based on our liquidity needs. We may use excess cash to make optional repayments on our debt or repurchase our common stock depending on various factors, such as market conditions.

Available Borrowings Under Amended Senior Credit Facility
Our Senior Credit Facility includes a $150.0 million revolving credit facility with a $50.0 million sublimit for letters of credit.  Under the revolving portion of the Senior Credit Facility we have $22.0 million of letters of credit outstanding, which leaves $128.0 million available for borrowing as of September 30, 2016.

Debt Covenants
We are subject to covenants and restrictions under our long-term debt agreements.  We are in compliance with the covenants, and we believe that neither the covenants nor the restrictions in our long-term debt agreements will limit our ability to operate our business.

Share Repurchases
GCI’s Board of Directors has authorized a common stock buyback program for the repurchase of GCI Class A and Class B common stock in order to reduce the outstanding shares of Class A and Class B common stock.  Under this program, GCI is currently authorized to make up to $64.0 million of repurchases as of September 30, 2016.  GCI is authorized to increase its repurchase limit $5.0 million per quarter indefinitely and to use stock option exercise proceeds to repurchase additional shares.  If stock repurchases are less than the total approved quarterly amount the difference may be carried forward and applied against future stock repurchases.  During the nine months ended September 30, 2016 we repurchased 3.0 million shares of GCI common stock, on GCI's behalf, under the stock buyback program at a cost of $46.5 million.  The common stock buyback program is expected to continue for an indefinite period dependent on leverage, liquidity, company performance, and market conditions and subject to continued oversight by GCI’s Board of Directors. The open market repurchases have and will continue to comply with the restrictions of Securities Exchange Act of 1934 Rule 10b-18.

Critical Accounting Policies and Estimates
Our accounting and reporting policies comply with GAAP.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions.  The financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding reported results.  Critical accounting policies are those policies that management believes are the most important to the portrayal of our financial condition and results, and require management to make estimates that are difficult, subjective or complex.  Most accounting policies are not considered by management to be critical accounting policies.  Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements.  These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under GAAP.  For all of these policies, management cautions that future events rarely develop exactly as forecast, and the best estimates routinely require adjustment.  Management has discussed the development and the selection of critical accounting policies with GCI's Audit Committee.

Those policies considered to be critical accounting policies for 2016 are revenue recognition related to revenues from the Remote high cost, rural health, and schools and libraries USF programs, the allowance for doubtful receivables, impairment and useful lives of intangible assets, and the valuation allowance for net operating loss deferred tax assets.  A complete discussion of our critical accounting policies can be found in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our December 31, 2015 annual report on Form 10-K.

Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. A complete discussion of our significant accounting policies can be found in Note 1 in "Part I - Item 1 - Condensed Notes to Interim Consolidated

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Financial Statements" and in Part IV of our annual report on Form 10-K for the fiscal year ended December 31, 2015.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to various types of market risk in the normal course of business, including the impact of interest rate changes. Market risk is the potential loss arising from adverse changes in market rates and prices. We do not hold or issue financial instruments for trading purposes.

Interest Rate Risk
Our Senior Credit Facility and Wells Fargo note payable carry interest rate risk.  Our Senior Credit Facility consists of a term loan, Term B loan, and revolving credit facility. Amounts borrowed under the term loan and revolving credit facility bear interest at LIBOR plus 3.00% or less depending upon our Total Leverage Ratio (as defined in the Senior Credit Facility agreement).  Amounts borrowed under the Term B loan bear interest at LIBOR plus 3.25%. Amounts borrowed under the Wells Fargo note payable bear interest at LIBOR plus 2.25%. Should the LIBOR rate change, our interest expense will increase or decrease accordingly.  As of September 30, 2016, we have borrowed $519.6 million subject to interest rate risk.  On this amount, each 1% increase in the LIBOR interest rate would result in $5.2 million of additional gross interest cost on an annualized basis.  All of our other material borrowings have a fixed interest rate.

Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized, accumulated and communicated to our management, including our principal executive and financial officers, to allow timely decisions regarding required financial disclosure, and reported as specified in the SEC’s rules and forms.  As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation of the effectiveness of the design and operation of our “disclosure controls and procedures” (as defined in Exchange Act Rule 13a - 15(e)) under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer.  Based on that evaluation, our management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of September 30, 2016.

The certifications attached as Exhibits 31 and 32 to this report should be read in conjunction with the disclosures set forth herein.

Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) identified in connection with the evaluation of our controls performed during the quarter ended September 30, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.  A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures.  Internal control over financial reporting also can be circumvented by collusion or improper management override.  Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting.  However, these inherent limitations are known features of the financial reporting process.  Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.


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We may enhance, modify, and supplement internal controls and disclosure controls and procedures based on experience.

PART II. OTHER INFORMATION

Item 1A. Risk Factors

Our business is geographically concentrated in Alaska.  Any deterioration in the economic conditions in Alaska could have a material adverse effect on our financial position, results of operations and liquidity.

We offer wireless and wireline telecommunication services, data services, video services, and managed services to customers primarily throughout Alaska. Because of this geographic concentration, growth of our business and operations depends upon economic conditions in Alaska.  The economy of Alaska is dependent upon the oil
industry, state government spending, United States military spending, investment earnings and tourism.  Oil prices have continued to remain low which has put significant pressure on the Alaska state government budget since the majority of its revenues come from the oil industry. While the Alaska state government has significant reserves that we believe will help fund the state government for the next couple of years, major structural budgetary reforms will need to be implemented in order to offset the impact of declining oil prices. Prolonged periods of low oil prices will adversely impact the Alaska economy, which in turn could have an adverse impact on the demand for our products and services and on our results of operations and financial condition. The State of Alaska failed to pass a workable long-term fiscal plan during the recent legislative session. As a result, we plan to reduce our 2017 Alaska capital expenditure budget by 20% to 25% of the 2016 target of $210.0 million due substantially to the continued uncertainty of the ability of the State of Alaska to adopt and implement a workable long-term fiscal plan.

Additionally, the customer base in Alaska is limited and we have already achieved significant market penetration with respect to our service offerings in Anchorage and other locations in Alaska. We may not be able to continue to increase our market share of the existing markets for our services, and no assurance can be given that the Alaskan economy will grow and increase the size of the markets we serve or increase the demand for the services we offer.  As a result, the best opportunities for expanding our business may arise in other geographic areas such as the lower 49 states.  There can be no assurance that we will find attractive opportunities to grow our businesses outside of Alaska or that we will have the necessary expertise to take advantage of such opportunities.  The markets in Alaska for wireless and wireline telecommunications and video services are unique and distinct within the United States due to Alaska’s large geographical size, its sparse population located in a limited number of clusters, and its distance from the rest of the United States.  The expertise we have developed in operating our businesses in Alaska may not provide us with the necessary expertise to successfully enter other geographic markets.

We may not meet our performance plan milestones under the Alaska High Cost Order.

As an Eligible Telecommunications Carrier ("ETC"), we receive support from the USF to support the provision of wireline local access and wireless service in high cost areas. On August 31, 2016, the FCC published the Alaska High Cost Order which requires us to submit to the FCC a performance plan with five-year and ten-year commitments.  If we are unable to meet the final performance plan milestones approved by the FCC we will be required to repay 1.89 times the average amount of support per location received over the ten-year term for the relevant number of locations that we failed to deploy to, plus ten percent of our total Alaska High Cost Order support received over the ten-year term.

We may lose USF high cost support if another carrier adds 4G LTE service in an area where we currently provide 4G LTE service.

Under the Alaska High Cost Order, the FCC adopted a process for revisiting after five years whether and to what extent there is duplicative support for 4G LTE service in rural Alaska and to take steps to eliminate such duplicative support levels in the second half of the 10-year term. As a result, if another carrier builds 4G LTE service in an area where we are the sole provider and the FCC decides to redistribute the support then our high cost support may be reduced.

Item 6. Exhibits

Listed below are the exhibits that are filed as a part of this Report (according to the number assigned to them in Item 601 of Regulation S-K):

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Exhibit No.
Description
10.1
Master Lease Agreement among the Alaska Wireless Network, LLC, AWN Tower Company, LLC, and General Communication, Inc effective August 1, 2016 *
31.1
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by our President and Director *
31.2
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by our Chief Financial Officer, Secretary and Treasurer *
32.1
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by our President and Director *
32.2
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by our Chief Financial Officer, Secretary and Treasurer *
101
The following materials from GCI, Inc.'s Quarterly Report on Form
10-Q for the quarter ended September 30, 2016, formatted in XBRL (eXtensible Business
Reporting Language): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Stockholder's Equity; (iv) Consolidated Statements of Cash Flows; and (v) Condensed Notes to Interim Consolidated Financial Statements *
 
 
 
 
*
Filed herewith.
 
 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

GCI, INC.


Signature
 
Title
 
Date
 
 
 
 
 
 
 
 
 
 
/s/ Gregory F. Chapados
 
President and Director
 
November 3, 2016
Gregory F. Chapados
 
(Principal Executive Officer)
 
 
 
 
 
 
 
/s/ Peter J. Pounds
 
Chief Financial Officer, Secretary,
 
November 3, 2016
Peter J. Pounds
 
Treasurer and Director
(Principal Financial Officer)
 
 
 
 
 
 
 
/s/ Lynda L. Tarbath
 
Vice President, Chief Accounting
 
November 3, 2016
Lynda L. Tarbath
 
Officer (Principal Accounting Officer)
 
 


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