As filed with the Securities and Exchange Commission on November 8, 2004
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, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-15279
GENERAL COMMUNICATION, INC.
(Exact name of registrant as specified in its charter)
STATE OF ALASKA 92-0072737
(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
Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (l) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No .
The number of shares outstanding of the registrant's classes of common stock
as of October 28, 2004 was:
54,205,376 shares of Class A common stock; and
3,865,686 shares of Class B common stock.
1
GENERAL COMMUNICATION, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
TABLE OF CONTENTS
Page No.
--------
Cautionary Statement Regarding Forward-Looking Statements.................................................3
PART I. FINANCIAL INFORMATION
Item l. Consolidated Balance Sheets as of September 30, 2004
(unaudited) and December 31, 2003..................................................6
Consolidated Statements of Income for the
three and nine months ended September 30, 2004
(unaudited) and 2003 (unaudited)...................................................8
Consolidated Statements of Stockholders' Equity
for the nine months ended September 30, 2004
(unaudited) and 2003 (unaudited)...................................................9
Consolidated Statements of Cash Flows for the nine
months ended September 30, 2004 (unaudited)
and 2003 (unaudited)...............................................................11
Notes to Interim Condensed Consolidated Financial
Statements.........................................................................12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................................................32
Item 3. Quantitative and Qualitative Disclosures About
Market Risk...........................................................................63
Item 4. Controls and Procedures...............................................................64
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.....................................................................65
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds...........................65
Item 6. Exhibits..............................................................................66
Other items are omitted, as they are not applicable.
SIGNATURES................................................................................................67
2
Cautionary Statement Regarding Forward-Looking Statements
You should carefully review the information contained in this Quarterly Report,
but should particularly consider any risk factors that we set forth in this
Quarterly Report and in other reports or documents that we file from time to
time with the Securities and Exchange Commission ("SEC"). In this Quarterly
Report, in addition to historical information, we state our future strategies,
plans, objectives or goals and our beliefs of future events and of our future
operating results, financial position and cash flows. In some cases, you can
identify those so-called "forward-looking statements" by words such as "may,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," "project," or "continue" or the negative of those words
and other comparable words. All forward-looking statements involve known and
unknown risks, uncertainties and other important factors that may cause our
actual results, performance, achievements, plans and objectives to differ
materially from any future results, performance, achievements, plans and
objectives expressed or implied by these forward-looking statements. In
evaluating those statements, you should specifically consider various factors,
including those outlined below. Those factors may cause our actual results to
differ materially from any of our forward-looking statements. For these
statements, we claim the protection of the safe harbor for forward-looking
statements provided by The Private Securities Litigation Reform Act of 1995.
Such risks, uncertainties and other factors include but are not limited to those
identified below and those further described in Part I, Item 1. Factors That May
Affect Our Business and Future Results of our annual report on Form 10-K for the
year ended December 31, 2003.
o Material adverse changes in the economic conditions in the markets we
serve and in general economic conditions, including the continuing
impact of the following on the communications industry: high levels of
competition in the long-distance market resulting in pressures to
reduce prices; an oversupply of long-haul capacity; excessive debt
loads; and several high-profile company failures and potentially
fraudulent accounting practices by some companies;
o The efficacy of laws enacted by Congress and the State of Alaska
legislature; rules and regulations to be adopted by the Federal
Communications Commission ("FCC") and state public regulatory agencies
to implement the provisions of the Telecommunications Act of 1996
("1996 Telecom Act"); the outcome of litigation relative thereto; and
the impact of regulatory changes relating to access reform;
o Our responses to competitive products, services and pricing, including
pricing pressures, technological developments, alternative routing
developments, and the ability to offer combined service packages that
include long-distance, local, cable, Internet, and wireless services;
o The extent and pace at which different competitive environments develop
for each segment of our business;
o The extent and duration for which competitors from each segment of the
communications industries are able to offer combined or full service
packages prior to our being able to do so;
o The degree to which we experience material competitive impacts to our
traditional service offerings prior to achieving adequate local service
entry;
o Competitor responses to our products and services and overall market
acceptance of such products and services;
3
o The outcome of our negotiations with Incumbent Local Exchange Carriers
("ILECs") and state regulatory arbitrations and approvals with respect
to interconnection agreements;
o Our ability to purchase network elements or wholesale services from
ILECs at a price sufficient to permit the profitable offering of local
telephone service at competitive rates;
o Success and market acceptance for new initiatives, many of which are
untested;
o The level and timing of the growth and profitability of existing and
new initiatives, particularly yellow page directories, local telephone
services expansion including deploying digital local phone service
("DLPS") and wireless services;
o Start-up costs associated with entering new markets, including
advertising and promotional efforts;
o Risks relating to the operations of new systems and technologies and
applications to support new initiatives;
o Local conditions and obstacles;
o The impact on our industry and indirectly on us of oversupply of
capacity resulting from excessive deployment of network capacity in
certain markets we do not serve;
o Uncertainties inherent in new business strategies, new product launches
and development plans, including local telephone services, wireless
services, and yellow page directories, and the offering of these
services in geographic areas with which we are unfamiliar;
o The risks associated with technological requirements, technology
substitution and changes and other technological developments;
o Prolonged service interruptions which could affect our business;
o Development and financing of communications, local telephone, wireless,
Internet and cable networks and services;
o Future financial performance, including the availability, terms and
deployment of capital; the impact of regulatory and competitive
developments on capital outlays, and the ability to achieve cost
savings and realize productivity improvements and the consequences of
increased leverage;
o Availability of qualified personnel;
o Changes in, or failure, or inability, to comply with, government
regulations, including, without limitation, regulations of the FCC, the
Regulatory Commission of Alaska ("RCA"), the SEC, and adverse outcomes
from regulatory proceedings;
o Changes in regulations governing unbundled network elements ("UNEs");
o Uncertainties in federal military spending levels and military base
closures in markets in which we operate;
o The ongoing global and domestic trend towards consolidation in the
communications industry, which may result in our competitors being
larger and better financed, and provide these competitors with
extensive resources and greater geographic reach, allowing them to
compete more effectively;
o Any continuing financial, credit and economic impacts of the MCI, Inc.
("MCI") bankruptcy filing on the industry in general and on us in
particular;
o The success of MCI's emergence from bankruptcy protection,
o A migration of MCI's or Sprint Corporation's ("Sprint") traffic off our
network without it being replaced by other common carriers that
interconnect with our network;
o The effect on us of pricing pressures, new program offerings and market
consolidation in the markets served by our significant customers, MCI
and Sprint;
4
o The effect on us of industry consolidation including the potential
acquisition of one or more of our large wholesale customers by a
company with commercial relationships with other providers;
o Under Statement of Financial Accounting Standard ("SFAS") No. 142,
"Goodwill and Other Intangible Assets," we must test our goodwill and
other intangible assets with indefinite lives for impairment at least
annually. Under the SEC Staff Announcement Topic "Use of the Residual
Method to Value Acquired Assets Other than Goodwill," we must apply a
direct value method to determine the fair value of our cable
certificates for purposes of impairment testing no later than January
1, 2005. Impairment testing may result in a material, non-cash
write-down of our cable certificate or goodwill assets and could have a
material adverse impact on our results of operations; and
o Other risks detailed from time to time in our periodic reports filed
with the SEC.
You should not place undue reliance on any such forward-looking statements.
Further, any forward-looking statement, and such risks, uncertainties and other
factors speak only as of the date on which they were originally made and we
expressly disclaim any obligation or undertaking to disseminate any updates or
revisions to any forward-looking statement to reflect any change in our
expectations with regard to those statements or any other change in events,
conditions or circumstances on which any such statement is based, except as
required by law. New factors emerge from time to time, and it is not possible
for us to predict what factors will arise or when. In addition, we cannot assess
the impact of each factor on our business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statements.
5
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands) (Unaudited)
September 30, December 31,
ASSETS 2004 2003
- ------------------------------------------------------------------------------------ ----------------- -------------------
Current assets:
Cash and cash equivalents $ 8,769 10,435
----------------- -------------------
Receivables 75,600 70,235
Less allowance for doubtful receivables 2,069 1,954
----------------- -------------------
Net receivables 73,531 68,281
Prepaid and other current assets 6,743 12,159
Deferred income taxes, net 5,621 7,195
Inventories 2,555 1,513
Property held for sale 1,046 2,173
Notes receivable from related parties 354 1,885
----------------- -------------------
Total current assets 98,619 103,641
----------------- -------------------
Property and equipment in service, net of depreciation 421,128 369,039
Construction in progress 19,940 33,618
----------------- -------------------
Net property and equipment 441,068 402,657
----------------- -------------------
Cable certificates 191,241 191,241
Goodwill 41,972 41,972
Other intangible assets, net of amortization of $2,087 and $1,656 at September 30,
2004 and December 31, 2003, respectively 5,078 4,195
Deferred loan and senior notes costs, net of amortization of $2,226 and $5,308 at
September 30, 2004 and December 31, 2003, respectively 9,102 5,757
Notes receivable from related parties 4,230 4,281
Other assets 9,315 9,276
----------------- -------------------
Total other assets 260,938 256,722
----------------- -------------------
Total assets $ 800,625 763,020
================= ===================
See accompanying notes to interim condensed consolidated financial statements.
6 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Continued)
(Amounts in thousands) (Unaudited)
LIABILITIES, REDEEMABLE PREFERRED STOCK, AND September 30, December 31,
STOCKHOLDERS' EQUITY 2004 2003
- -------------------------------------------------------------------------------- ------------------ -----------------
Current liabilities:
Current maturities of obligations under capital leases $ 6,313 5,139
Accounts payable 27,350 34,133
Accrued payroll and payroll related obligations 14,025 17,545
Deferred revenue 13,844 21,275
Accrued liabilities 7,389 8,156
Accrued interest 2,860 8,645
Subscriber deposits 471 651
------------------ -----------------
Total current liabilities 72,252 95,544
Long-term debt 377,060 345,000
Obligations under capital leases, excluding current maturities 34,244 38,959
Obligation under capital lease due to related party, excluding current maturity 680 677
Deferred income taxes, net of deferred income tax benefit 35,985 24,168
Other liabilities 6,811 6,366
------------------ -----------------
Total liabilities 527,032 510,714
------------------ -----------------
Redeemable preferred stock 19,244 25,664
------------------ -----------------
Stockholders' equity:
Common stock (no par):
Class A. Authorized 100,000 shares; issued 54,139 and 52,589 shares at
September 30, 2004 and December 31, 2003, respectively 211,012 202,362
Class B. Authorized 10,000 shares; issued 3,866 and 3,868 shares at
September 30, 2004 and December 31, 2003, respectively; convertible on a
share-per-share basis into Class A common stock 3,267 3,269
Less cost of 380 and 338 Class A common shares held in treasury at September
30, 2004 and December 31, 2003, respectively (2,284) (1,917)
Paid-in capital 13,617 12,836
Notes receivable with related parties issued upon stock option exercise (4,351) (4,971)
Retained earnings 33,088 15,371
Accumulated other comprehensive loss --- (308)
------------------ -----------------
Total stockholders' equity 254,349 226,642
------------------ -----------------
Commitments and contingencies
Total liabilities, redeemable preferred stock, and stockholders' equity $ 800,625 763,020
================== =================
See accompanying notes to interim condensed consolidated financial statements.
7
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
(Amounts in thousands, except per share amounts) 2004 2003 2004 2003
------------- ------------- --------------- --------------
Revenues $ 106,622 98,327 319,324 287,043
Cost of goods sold (exclusive of depreciation,
amortization and accretion shown separately below) 32,876 31,870 104,878 92,189
Selling, general and administrative expenses 37,324 35,262 108,830 102,549
Bad debt expense (recovery) (281) 533 (1,165) 1,932
Depreciation, amortization and accretion expense 15,297 13,067 46,759 39,368
------------- ------------- --------------- --------------
Operating income 21,406 17,595 60,022 51,005
------------- ------------- --------------- --------------
Other income (expense):
Interest expense (6,722) (8,845) (20,275) (27,137)
Loss on early extinguishment of debt --- --- (6,136) ---
Amortization and write-off of loan and senior
notes fees (400) (631) (3,414) (2,329)
Interest income 86 162 273 493
------------- ------------- --------------- --------------
Other expense, net (7,036) (9,314) (29,552) (28,973)
------------- ------------- --------------- --------------
Net income before income taxes and cumulative
effect of a change in accounting principle 14,370 8,281 30,470 22,032
Income tax expense 5,075 3,752 11,525 9,598
------------- ------------- --------------- --------------
Net income before cumulative effect of a change
in accounting principle 9,295 4,529 18,945 12,434
Cumulative effect of a change in accounting
principle, net of income tax benefit of $367 --- --- --- (544)
------------- ------------- --------------- --------------
Net income $ 9,295 4,529 18,945 11,890
============= ============= =============== ==============
Basic net income per common share:
Net income before cumulative effect of a change in
accounting principle $ 0.15 0.07 0.31 0.20
Cumulative effect of a change in accounting
principle, net of income tax benefit of $367 --- --- --- (0.01)
------------- ------------- --------------- --------------
Net income $ 0.15 0.07 0.31 0.19
============= ============= =============== ==============
Diluted net income per common share:
Net income before cumulative effect of a change in
accounting principle $ 0.15 0.07 0.30 0.19
Cumulative effect of a change in accounting
principle, net of income tax benefit of $367 --- --- --- (0.01)
------------- ------------- --------------- --------------
Net income $ 0.15 0.07 0.30 0.18
============= ============= =============== ==============
See accompanying notes to interim condensed consolidated financial statements.
8
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(Unaudited)
Notes
Class A Receivable Accumulated
Class A Class B Shares Issued to Other
Common Common Held in Paid-in Related Retained Comprehensive
(Amounts in thousands) Stock Stock Treasury Capital Parties Earnings Loss Total
----------------------------------------------------------------------------------------
Balances at December 31, 2002 $199,903 3,274 (1,836) 11,222 (5,650) 1,847 (540) 208,220
Components of comprehensive income:
Net income --- --- --- --- --- 11,890 --- 11,890
Change in fair value of cash flow
hedge, net of change in income tax
liability of $175 --- --- --- --- --- --- 118 118
-------
Comprehensive income 12,008
Tax effect of excess stock compensation
expense for tax purposes over amounts
recognized for financial reporting
purposes --- --- --- 222 --- --- --- 222
Shares issued under stock option plan 1,044 --- --- --- --- --- --- 1,044
Amortization of the excess of GCI stock
market value over stock option exercise
cost on date of stock option grant --- --- --- 393 --- --- --- 393
Class B shares converted to Class A 3 (3) --- --- --- --- --- ---
Purchase of treasury stock --- --- (81) --- --- --- --- (81)
Preferred stock dividends --- --- --- --- --- (1,533) --- (1,533)
----------------------------------------------------------------------------------------
Balances at September 30, 2003 $200,950 3,271 (1,917) 11,837 (5,650) 12,204 (422) 220,273
========================================================================================
See accompanying notes to interim condensed consolidated financial statements.
9 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(Unaudited)
(Continued)
Notes
Class A Receivable Accumulated
Class A Class B Shares Issued to Other
Common Common Held in Paid-in Related Retained Comprehensive
(Amounts in thousands) Stock Stock Treasury Capital Parties Earnings Loss Total
----------------------------------------------------------------------------------------
Balances at December 31, 2003 $202,362 3,269 (1,917) 12,836 (4,971) 15,371 (308) 226,642
Components of comprehensive income:
Net income --- --- --- --- --- 18,945 --- 18,945
Change in fair value of cash flow
hedge, net of change in income tax
benefit of $207 --- --- --- --- --- --- 308 308
-------
Comprehensive income 19,253
Tax effect of excess stock compensation
expense for tax purposes over amounts
recognized for financial reporting
purposes --- --- --- 534 --- --- --- 534
Class B shares converted to Class A 2 (2) --- --- --- --- --- ---
Shares issued under stock option plan 2,228 --- --- --- --- --- --- 2,228
Amortization of the excess of GCI stock
market value over stock option exercise
cost on date of stock option grant --- --- --- 247 --- --- --- 247
Conversion of Series B preferred stock to
Class A common stock 6,420 --- --- --- --- --- --- 6,420
Payments received on notes receivable
issued to related parties upon stock
option exercise --- --- --- --- 620 --- --- 620
Purchase of treasury stock --- --- (367) --- --- --- --- (367)
Preferred stock dividends --- --- --- --- --- (1,228) --- (1,228)
----------------------------------------------------------------------------------------
Balances at September 30, 2004 $211,012 3,267 (2,284) 13,617 (4,351) 33,088 --- 254,349
========================================================================================
See accompanying notes to interim condensed consolidated financial statements.
10
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(Unaudited)
(Amounts in thousands) 2004 2003
-------------- -------------
Cash flows from operating activities:
Net income $ 18,945 11,890
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation, amortization and accretion expense 46,759 39,368
Loss on early extinguishment of debt 6,136 ---
Deferred income tax expense 11,435 9,598
Amortization and write-off of loan and senior notes fees 3,414 2,329
Compensatory stock options 248 393
Bad debt expense (recovery), net of write-offs 115 (679)
Deferred compensation 427 331
Cumulative effect of a change in accounting principle, net --- 544
Other noncash income and expense items 654 (383)
Change in operating assets and liabilities (25,267) (13,990)
-------------- -------------
Net cash provided by operating activities 62,866 49,401
-------------- -------------
Cash flows from investing activities:
Purchases of property and equipment, including construction period interest (82,810) (34,393)
Purchases of other assets and intangible assets (2,297) (955)
Payments received on notes receivable from related parties 1,847 22
Proceeds from sales of assets 1,190 ---
Payment of deposits --- (3,221)
Refund of deposit 699 ---
Additions to property held for sale (128) ---
Notes receivable issued to related parties (27) (99)
-------------- -------------
Net cash used in investing activities (81,526) (38,646)
-------------- -------------
Cash flows from financing activities:
Issuance of new Senior Notes 245,720 ---
Repayment of old Senior Notes (180,000) ---
Borrowing on Senior Credit Facility 20,000 ---
Repayment of Senior Credit Facility (53,832) (7,700)
Repayments of capital lease obligations (3,538) (1,402)
Payment of debt issuance costs (6,659) (2,605)
Payment of bond call premiums (6,136) ---
Payment of preferred stock dividends (1,042) (1,171)
Proceeds from common stock issuance 2,228 1,044
Payment received on note receivable from related parties issued upon stock
option exercise 620 ---
Purchase of treasury stock (367) (81)
-------------- -------------
Net cash provided by (used in) financing activities 16,994 (11,915)
-------------- -------------
Net decrease in cash and cash equivalents (1,666) (1,160)
Cash and cash equivalents at beginning of period 10,435 11,940
-------------- -------------
Cash and cash equivalents at end of period $ 8,769 10,780
============== =============
See accompanying notes to interim condensed consolidated financial statements.
11
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
The accompanying unaudited interim condensed consolidated financial statements
include the accounts of General Communication, Inc. ("GCI") and its subsidiaries
and have been prepared in accordance with generally accepted accounting
principles for interim financial information. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally
accepted in the United States of America for complete financial statements. They
should be read in conjunction with our audited consolidated financial statements
for the year ended December 31, 2003, filed as part of our annual report on Form
10-K. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. The results of operations for interim periods are not necessarily
indicative of the results that may be expected for an entire year or any other
period.
(l) Business and Summary of Significant Accounting Principles
In the following discussion, GCI and its direct and indirect subsidiaries
are referred to as "we," "us" and "our."
(a) Business
GCI, an Alaska corporation, was incorporated in 1979. We offer the
following services:
o Long-distance telephone service between Alaska and the
remaining United States and foreign countries,
o Cable television services throughout Alaska,
o Facilities-based competitive local access services in
Anchorage, Fairbanks, and Juneau, Alaska,
o Internet access services,
o Origination and termination of traffic in Alaska for certain
common carriers,
o Private line and private network services,
o Managed services to certain commercial customers,
o Broadband services, including our SchoolAccess(TM) offering to
rural school districts and a similar offering to rural
hospitals and health clinics,
o Sales and service of dedicated communications systems and
related equipment,
o Lease and sales of capacity on our undersea fiber optic cable
system used in the transmission of interstate and intrastate
private line, switched message long-distance and Internet
services between Alaska and the remaining United States and
foreign countries, and
o Distribution of white and yellow pages directories to
residential and business customers in certain markets we serve
and on-line directory products.
(b) Principles of Consolidation
The consolidated financial statements include the consolidated
accounts of GCI and its wholly owned subsidiaries with all
significant intercompany transactions eliminated.
12 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
(c) Earnings per Common Share
Earnings per common share ("EPS") and common shares used to
calculate basic and diluted EPS consist of the following (amounts
in thousands, except per share amounts):
Three Months Ended September 30,
2004 2003
---------------------------------- ----------------------------------
Income Shares Income Shares
(Num- (Denom- Per-share (Num- (Denom- Per-share
erator) inator) Amounts erator) inator) Amounts
---------- ----------- ----------- ---------- ----------- -----------
Net income $ 9,295 $ 4,529
---------- ----------
Less preferred stock dividends:
Series B 230 361
Series C 151 151
---------- ----------
381 512
---------- ----------
Basic EPS:
Net income 8,914 58,031 $ 0.15 4,017 55,707 $ 0.07
Effect of Dilutive Securities:
Unexercised stock options --- 1,000 --- --- 1,163 ---
Series B redeemable preferred
stock 230 1,677 --- --- --- ---
---------- ----------- ----------- ---------- ----------- -----------
Diluted EPS:
Net income $ 9,144 60,708 $ 0.15 $ 4,017 56,870 $ 0.07
========== =========== =========== ========== =========== ===========
13 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Nine Months Ended September 30,
2004 2003
---------------------------------- ----------------------------------
Income Shares Income Shares
(Num- (Denom- Per-share (Num- (Denom- Per-share
erator) inator) Amounts erator) inator) Amounts
---------- ----------- ----------- ---------- ----------- -----------
Net income before cumulative
effect of a change in accounting
principle, net of deferred tax
benefit of $367 in 2003 $ 18,945 $ 12,434
----------- -----------
Less preferred stock dividends:
Series B 778 1,083
Series C 450 450
----------- -----------
1,228 1,533
----------- -----------
Basic EPS:
Net income before cumulative
effect of a change in accounting
principle, net of deferred tax
benefit of $367 in 2003,
available to common stockholders 17,717 57,027 $ 0.31 10,901 55,563 $ 0.20
Effect of Dilutive Securities:
Unexercised stock options --- 1,135 --- --- 531 ---
----------- ----------- ---------- ----------- ---------- -----------
Diluted EPS:
Net income before cumulative
effect of a change in accounting
principle, net of deferred tax
benefit of $367 in 2003,
available to common stockholders $ 17,717 58,162 $ 0.30 $ 10,901 56,094 $ 0.19
=========== =========== ========== =========== ========== ===========
14 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Common equivalent shares outstanding which are anti-dilutive for
purposes of calculating EPS for the three and nine months ended
September 30, 2004 and 2003 are not included in the diluted EPS
calculations and consist of the following (shares, in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
------------ ------------ ------------ ----------
Series B redeemable preferred stock --- 3,062 1,677 3,062
Series C redeemable preferred stock 833 833 833 833
------------ ------------ ------------ ----------
Anti-dilutive common equivalent shares outstanding 833 3,895 2,510 3,895
============ ============ ============ ==========
Weighted average shares associated with outstanding stock options
for the three and nine months ended September 30, 2004 and 2003
which have been excluded from the diluted EPS calculations because
the options' exercise price was greater than the average market
price of the common shares consist of the following (shares, in
thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
----------- ------------ ----------- -----------
Weighted average shares associated with outstanding
stock options 736 155 292 2,045
=========== ============ =========== ===========
(d) Common Stock
Following are the changes in common stock for the nine months ended
September 30, 2004 and 2003 (shares, in thousands):
Class A Class B
------------- ------------
Balances at December 31, 2002 51,795 3,875
Class B shares converted to Class A 4 (4)
Shares issued under stock option plan 216 ---
Shares issued per G.C. Cablevision, Inc.
acquisition agreement 223 ---
------------- ------------
Balances at September 30, 2003 52,238 3,871
============= ============
Balances at December 31, 2003 52,589 3,868
Class B shares converted to Class A 2 (2)
Shares issued under stock option plan 388 ---
Conversion of Series B preferred stock to Class A
common stock 1,160 ---
------------- ------------
Balances at September 30, 2004 54,139 3,866
============= ============
15 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
(e) Redeemable Preferred Stocks
Redeemable preferred stocks consist of the following (amounts in
thousands):
September 30, December 31,
2004 2003
---------------- -----------------
Series B $ 9,244 15,664
Series C 10,000 10,000
---------------- -----------------
$ 19,244 25,664
================ =================
We have 1,000,000 shares of preferred stock authorized with the
following shares issued (in thousands):
Series B Series C
------------- ------------
Shares at December 31, 2002 and
September 30, 2003 17 10
============= ============
Shares at December 31, 2003 16 10
Shares converted to GCI Class A common stock (7) ---
------------- ------------
Shares at September 30, 2004 9 10
============= ============
As of September 30, 2004, the combined aggregate amount of
preferred stock mandatory redemption requirements, including
dividends, follow (amounts in thousands):
Years Ending
September 30:
---------------
2005 $ 10,150
2006 ---
2007 ---
2008 ---
2009 ---
---------
$ 10,150
=========
Series B
The redemption amount of our Series B preferred stock at September
30, 2004 and December 31, 2003 was $9,653,000 and $15,887,000,
respectively. The difference between the carrying and redemption
amounts is due to accrued dividends that are included in Accrued
Liabilities.
Series C
The redemption amount of our convertible redeemable accreting
Series C preferred stock on September 30, 2004 and December 31,
2003 was $10,000,000.
16 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
(f) Asset Retirement Obligations
Upon adoption of SFAS No. 143, "Accounting for Asset Retirement
Obligations," we recorded the cumulative effect of accretion and
depreciation expense as a cumulative effect of a change in
accounting principle of approximately $544,000, net of income tax
benefit of $367,000, during the nine months ended September 30,
2003.
Following is a reconciliation of the beginning and ending aggregate
carrying amount of our asset retirement obligations at September
30, 2004 and 2003 (amounts in thousands):
Balance at December 31, 2002 $ ---
Liability recognized upon adoption
of SFAS No. 143 1,565
Accretion expense for the nine months ended
September 30, 2003 96
--------
Balance at September 30, 2003 $ 1,661
========
Balance at December 31, 2003 $ 2,005
Accretion expense for the nine months ended
September 30, 2004 134
Liability settled (6)
Other (43)
--------
Balance at September 30, 2004 $ 2,090
========
(g) Stock Option Plan
At September 30, 2004, we had one stock-based employee compensation
plan. We account for this plan under the recognition and
measurement principles of Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. We use the intrinsic-value method and
compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeds the exercise
price. We have adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," and SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure." We have elected to
continue to apply the provisions of APB Opinion No. 25 and provide
the pro forma disclosure as required by SFAS No. 148.
17 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Stock-based employee compensation cost is reflected over the
options' vesting period of generally five years and compensation
cost for options granted prior to January 1, 1996 is not
considered. The following table illustrates the effect on net
income and EPS for the three and nine months ended September 30,
2004 and 2003, if we had applied the fair-value recognition
provisions of SFAS No. 123 to stock-based employee compensation
(amounts in thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
----------- ---------- ----------- ----------
Net income, as reported $ 9,295 4,529 18,945 11,890
Total stock-based employee
compensation expense included in
reported net income, net of related
tax effects 53 66 129 225
Total stock-based employee
compensation expense under the
fair-value based method for all
awards, net of related tax effects (594) (653) (1,682) (1,641)
----------- ---------- ----------- ----------
Pro forma net income $ 8,754 3,942 17,392 10,474
=========== ========== =========== ==========
Basic net income per common share
after cumulative effect of a
change in accounting principle, as
reported $ 0.15 0.07 0.31 0.19
=========== ========== =========== ==========
Diluted net income per common share
after cumulative effect of a
change in accounting principle, as
reported $ 0.15 0.07 0.30 0.18
=========== ========== =========== ==========
Basic and diluted net income per
common share after cumulative
effect of a change in accounting
principle, pro forma $ 0.14 0.06 0.28 0.16
=========== ========== =========== ==========
The calculation of total stock-based employee compensation expense
under the fair-value based method includes weighted-average
assumptions of a risk-free interest rate, volatility and an
expected life.
(h) Variable Interest Entities
In December 2003, the Financial Accounting Standards Board ("FASB")
issued FASB Interpretation No. ("FIN") 46 (revised December 2003),
"Consolidation of Variable Interest
18 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Entities," which addresses how a business enterprise should
evaluate whether it has a controlling financial interest in an
entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R, which was issued in January
2003, replaces FIN 46. We were required to apply FIN 46R to
variable interests in Variable Interest Entities ("VIEs") created
after December 31, 2003. For variable interests in VIEs created
before January 1, 2004, the Interpretation will be applied
beginning on January 1, 2005. For any VIEs that must be
consolidated under FIN 46R that were created before January 1,
2004, the assets, liabilities and non-controlling interests of the
VIE initially would be measured at their carrying amounts with any
difference between the net amount added to the balance sheet and
any previously recognized interest being recognized as the
cumulative effect of an accounting change. If determining the
carrying amounts is not practicable, fair value at the date FIN 46R
first applies may be used to measure the assets, liabilities and
non-controlling interest of the VIE. At December 31, 2003, we did
not have VIEs. Adoption of this statement on January 1, 2004 did
not have a material effect on our results of operations, financial
position and cash flows.
(i) Use of the Residual Method to Value Acquired Assets Other than
Goodwill
On September 29, 2004, the SEC issued SEC Staff Announcement Topic
"Use of the Residual Method to Value Acquired Assets Other than
Goodwill," ("SEC Staff Announcement") requiring us to apply no
later than January 1, 2005 a direct value method to determine the
fair value of our intangible assets with indefinite lives other
than goodwill for purposes of impairment testing. We must also
recognize previously unrecognized intangible assets, if any, in the
determination of fair value for impairment testing purposes. Our
cable certificate assets are our only indefinite-lived assets other
than goodwill as of September 30, 2004. Our cable certificate
assets were originally valued and recorded using the residual
method. Impairment testing of our cable certificate assets in
future periods under SFAS No. 142 must use a direct value method
pursuant to the SEC Staff Announcement, which may result in a
material, non-cash write-down of our cable certificate assets and
could have a material adverse impact on our results of operations.
An impairment of our cable certificate assets, if any, recognized
upon the initial application of the direct value method will be
reported as a cumulative effect of a change in accounting
principle.
(j) Reclassifications
Reclassifications have been made to the 2003 financial statements
to make them comparable with the 2004 presentation.
19 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
(2) Consolidated Statements of Cash Flows Supplemental Disclosures
Changes in operating assets and liabilities consist of (amounts in
thousands):
Nine month periods ended September 30, 2004 2003
------------ ------------
Increase in accounts receivable $ (5,365) (9,315)
Increase in inventories (1,042) (137)
(Increase) decrease in prepaid and other current assets 5,416 (2,434)
Decrease in accounts payable (6,783) (2,802)
Increase (decrease) in deferred revenues (7,431) 2,211
Increase (decrease) in accrued payroll and payroll
related obligations (3,520) 3,745
Decrease in accrued interest (5,785) (4,977)
Increase (decrease) in accrued liabilities (252) 136
Decrease in subscriber deposits (180) (198)
Decrease in components of other long-term liabilities
(325) (219)
------------ ------------
$ (25,267) (13,990)
============ ============
We paid interest, including capitalized interest, totaling approximately
$27.1 million and $32.2 million during the nine months ended September
30, 2004 and 2003, respectively. We capitalized interest of approximately
$1.1 million and $0 during the nine months ended September 30, 2004 and
2003, respectively. Capitalized interest is recorded as an addition to
Property and Equipment.
In January and August 2004, 3,108 and 3,328 shares of our Series B
preferred stock, respectively, were converted to 560,000 and 599,640
shares of our Class A common stock, respectively, at the stated
conversion price of $5.55 per share.
We paid income taxes totaling $90,000 during the nine months ended
September 30, 2004. We paid no income taxes during the nine months ended
September 30, 2003.
(3) Intangible Assets
Cable certificates are allocated to our cable services segment. Goodwill
of approximately $41.0 million is allocated to the cable services segment
and approximately $1.0 million is allocated to the long-distance services
segment.
Amortization expense for amortizable intangible assets was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------- ----------- ------------- -----------
Amortization expense $ 224 195 575 527
============== =========== ============= ===========
20 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
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,
--------------
2004 $ 826
2005 806
2006 802
2007 740
2008 490
No indicators of impairment have occurred since the impairment testing
was performed as of December 31, 2003.
(4) MCI Settlement and Release Agreement
On July 21, 2002 MCI and substantially all of its active United States
subsidiaries filed voluntary petitions for reorganization under Chapter
11 of the United States Bankruptcy Code in the United States Bankruptcy
Court. On July 22, 2003, the United States Bankruptcy Court approved a
settlement agreement for pre-petition amounts owed to us by MCI and
affirmed all of our existing contracts with MCI. MCI emerged from
bankruptcy protection on April 20, 2004. The remaining pre-petition
accounts receivable balance owed by MCI to us after this settlement was
$11.1 million ("MCI credit") which we have used and will continue to use
as a credit against amounts payable for services purchased from MCI.
After settlement, we began reducing the MCI credit as we utilized it for
services otherwise payable to MCI. Uncertainties exist with respect to
the potential realization and the timing of our utilization of the MCI
credit. We have accounted for our use of the MCI credit as a gain
contingency and, accordingly, will recognize a reduction of bad debt
expense as services are provided by MCI and the credit is realized. The
use of the credit is recorded as a reduction of bad debt expense. We have
realized the following amounts of the MCI credit against amounts payable
for services received from MCI (amounts in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------- ----------- ------------- -----------
MCI credit realized $ 1,090 647 3,386 647
============== =========== ============= ===========
The remaining unused MCI credit totaled $4.5 million and $7.9 million at
September 30, 2004 and December 31, 2003, respectively. The credit
balance is not recorded on the Consolidated Balance Sheet as we are
recognizing recovery of bad debt expense as the credit is realized.
21 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
(5) Long-term Debt
Draws on New Senior Credit Facility
In 2004 we drew the following amounts under the revolving credit portion
of our new Senior Credit Facility (amounts in millions):
January 2004 $ 10
May 2004 5
August 2004 5
-----
$ 20
=====
We re-paid the $10 million draw in February 2004 from proceeds of our new
Senior Notes offering discussed below.
Senior Notes Refinancing
In February 2004 GCI's wholly owned subsidiary GCI, Inc. sold $250
million in aggregate principal amount of senior debt securities due in
2014 ("new Senior Notes"). The new Senior Notes are an unsecured senior
obligation. We pay interest of 7.25% on the new Senior Notes. The new
Senior Notes were sold at a discount of $4.3 million. The Senior Notes
are carried on our Consolidated Balance Sheet net of the unamortized
portion of the discount of $4.1 million at September 30, 2004, which is
being amortized to Interest Expense over the life of the new Senior
Notes.
The net proceeds of the offering were primarily used to repay our
existing $180.0 million 9.75% Senior Notes ("old Senior Notes") and to
repay approximately $43.8 million of the term portion and $10.0 million
of the revolving portion of our new Senior Credit Facility. A semi-annual
interest payment of approximately $9.1 million was paid on August 15,
2004. The next semi-annual interest payment will be due on February 15,
2005. In connection with the issuance, we paid fees and other expenses of
approximately $6.4 million which are being amortized over the life of the
new Senior Notes.
The new Senior Notes sold in February 2004 were offered only to qualified
institutional buyers pursuant to exemptions from registration under the
Securities Act. On July 7, 2004, GCI, Inc. commenced an offer to exchange
the privately issued new Senior Notes for a like amount of new Senior
Notes that have been registered under the Securities Act and have
otherwise identical terms to the privately issued new Senior Notes
(except for provisions relating to GCI, Inc.'s obligations to consummate
the exchange offer). The exchange offer closing occurred on August 11,
2004, at which time all $250.0 million in aggregate principal amount of
the privately issued new Senior Notes were tendered and exchanged for the
new Senior Notes that have been registered under the Securities Act.
22 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
The new Senior Notes are not redeemable prior to February 15, 2009. At
any time on or after February 15, 2009, the new Senior Notes are
redeemable at our option, in whole or in part, on not less than thirty
days nor more than sixty days notice, at the following redemption prices,
plus accrued and unpaid interest (if any) to the date of redemption:
If redeemed during the twelve month period
commencing February 1 of the year indicated: Redemption Price
-------------------------------------------- --------------------
2009 103.625%
2010 102.417%
2011 101.208%
2012 and thereafter 100.000%
We may, on or prior to February 17, 2007, at our option, use the net cash
proceeds of one or more underwritten public offerings of our qualified
stock to redeem up to a maximum of 35% of the initially outstanding
aggregate principal amount of our new Senior Notes at a redemption price
equal to 107.25% of the principal amount of the new Senior Notes,
together with accrued and unpaid interest, if any, thereon to the date of
redemption, provided that not less than 65% of the principal amount of
the new Senior Notes originally issued remain outstanding following such
a redemption.
The new Senior Notes restrict GCI, Inc. and certain of its subsidiaries
from incurring debt in most circumstances unless the result of incurring
debt does not cause our leverage ratio to exceed 6.0 to one. The new
Senior Notes do not allow debt under the new Senior Credit Facility to
exceed the greater of (and reduced by certain stated items):
o $250 million, reduced by the amount of any prepayments, or
o 3.0 times earnings before interest, taxes, depreciation, and
amortization for the last four full fiscal quarters of GCI, Inc.
and certain of its subsidiaries.
The new Senior Notes limit our ability to make cash dividend payments.
We conducted a Consent Solicitation and Tender Offer for the old Senior
Notes. Through February 13, 2004 we accepted for payment $114.6 million
principal amount of notes which were validly tendered. Such notes
accepted for payment received additional consideration as follows:
o $4.0 million based upon a payment of $1,035 per $1,000 principal
amount, consisting of the purchase price of $1,025 per $1,000
principal amount and the consent payment of $10 per $1,000
principal amount, and
o $497,000 in accrued and unpaid interest through February 16, 2004.
The remaining principal amount of $65.4 million was redeemed on March 18,
2004 for additional consideration as follows:
o $2.1 million based upon a payment of $1,032.50 per $1,000
principal amount, and
o $833,000 in accrued and unpaid interest through March 18, 2004.
23 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
The total redemption cost was $186.1 million. The premium to redeem our
old Senior Notes was $6.1 million (excluding interest cost of $1.3
million) and was recognized as a loss on early extinguishment of debt, a
component of Other Income (Expense), during the nine months ended
September 30, 2004.
Compliance with the redemption notice requirements in the Indenture
resulted in a delay before final payment of some of the old Senior Notes.
As a result of such delay, our total debt increased during the overlap
period between the redemption of the old Senior Notes and the issuance of
the new Senior Notes making us out of compliance with Section 6.11 of our
Credit, Guaranty, Security and Pledge Agreement, dated as of October 30,
2003. We received a waiver from compliance with Section 6.11 until April
30, 2004. After the final redemption payment on March 18, 2004 we were in
compliance with Section 6.11.
New Senior Credit Facility Amendment
On May 21, 2004 we amended our $220.0 million new Senior Credit Facility.
The amendment reduced the interest rate on the $170.0 million term
portion of the credit facility from LIBOR plus 3.25% to LIBOR plus 2.25%.
The amendment reduced the interest rate on the $50.0 million revolving
portion of the credit facility from LIBOR plus 3.25% to LIBOR plus a
margin dependent upon our Total Leverage Ratio (as defined) as follows:
Total Leverage Ratio
(as defined) LIBOR Plus:
---------------------- -------------------
>3.75 2.50%
-
>3.25 but <3.75 2.25%
-
>2.75 but <3.25 2.00%
-
< 2.75 1.75%
The commitment fee we are required to pay on the unused portion of the
commitment was amended as follows:
Total Leverage Ratio
(as defined) Commitment Fee
--------------------- ------------------
>3.75 0.625%
-
>2.75 but <3.75 0.500%
-
< 2.75 0.375%
Under certain circumstances the amendment allows for an increase in the
term and revolving commitments not to exceed an aggregate commitment
increase of $50.0 million. Any additional term and revolving credit
facility commitments are payable in full on October 31, 2007.
In connection with the May 21, 2004 amended Senior Credit Facility, we
paid bank fees and other expenses of approximately $103,000 and $253,000
during the three and nine months ended September 30, 2004, respectively.
24 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
(6) Industry Segments Data
Our reportable segments are business units that offer different products.
The reportable segments are each managed separately and offer distinct
products with different production and delivery processes.
We have four reportable segments as follows:
Long-distance services. We offer a full range of common carrier
long-distance services to commercial, government, other
telecommunications companies and residential customers, through our
networks of fiber optic cables, digital microwave, and fixed and
transportable satellite earth stations and our SchoolAccess(TM)
offering to rural school districts and a similar offering to rural
hospitals and health clinics.
Cable services. We provide cable television services to residential,
commercial and government users in the State of Alaska. Our cable
systems serve 35 communities and areas in Alaska, including the state's
four largest urban areas, Anchorage, Fairbanks, the Matanuska-Susitna
Valley, and Juneau. We offer digital cable television services in
Anchorage, the Matanuska-Susitna Valley, Fairbanks, Juneau, Ketchikan,
Kenai, Soldotna, Kodiak, Seward, Cordova, Valdez, and Nome and retail
cable modem service (through our Internet services segment) in all of
our locations in Alaska except Kotzebue.
Local access services. We offer facilities based competitive local
exchange services in Anchorage, Fairbanks and Juneau and plan to
provide similar competitive local exchange services in other locations
pending regulatory approval and subject to availability of capital.
Revenue, costs of sales and service and operating expenses for our new
phone directories are included in the local access services segment.
Internet services. We offer wholesale and retail Internet services to
both consumer and commercial customers. We offer cable modem service as
further described in Cable services above. Our undersea fiber optic
cable systems allow us to offer enhanced services with high-bandwidth
requirements.
Included in the "All Other" category in the tables that follow are our
managed services, product sales and cellular telephone services. None of
these business units has ever met the quantitative thresholds for
determining reportable segments. Also included in the All Other category
are corporate related expenses including information technology,
accounting, legal and regulatory, human resources, and other general and
administrative expenses.
We evaluate performance and allocate resources based on (1) earnings or
loss from operations before depreciation, amortization and accretion
expense, net other expense and income taxes, and (2) operating income or
loss. The accounting policies of the reportable segments are the same as
those described in the summary of significant accounting policies in note
1. Intersegment sales are recorded at cost plus an agreed upon
intercompany profit.
25 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
We earn all revenues through sales of services and products within the
United States. All of our long-lived assets are located within the United
States of America, except approximately 82% of our undersea fiber optic
cable systems which transit international waters.
Summarized financial information for our reportable segments for the nine
months ended September 30, 2004 and 2003 follows (amounts in thousands):
Reportable Segments
---------------------------------------------------------
Long- Local Total
Distance Cable Access Internet Reportable All
Services Services Services Services Segments Other Total
-------------------------------------------------------------------------------
2004
----
Revenues:
Intersegment $ 10,490 1,866 7,053 2,460 21,869 558 22,427
External 159,111 75,243 34,558 19,592 288,504 30,820 319,324
-------------------------------------------------------------------------------
Total revenues $ 169,601 77,109 41,611 22,052 310,373 31,378 341,751
===============================================================================
Earnings (loss) from
operations before
depreciation,
amortization, accretion,
net interest expense and
income taxes $ 91,010 33,190 (231) 6,409 130,378 (23,597) 106,781
===============================================================================
Operating income (loss) $ 71,368 19,118 (3,158) 3,669 90,997 (30,975) 60,022
===============================================================================
2003
----
Revenues:
Intersegment $ 10,139 1,900 7,277 1,792 21,108 558 21,666
External 153,248 71,009 27,211 14,302 265,770 21,273 287,043
-------------------------------------------------------------------------------
Total revenues $ 163,387 72,909 34,488 16,094 286,878 21,831 308,709
===============================================================================
Earnings (loss) from
operations before
depreciation,
amortization, accretion,
net interest expense and
income taxes $ 85,212 31,253 (3,182) 3,667 116,950 (26,577) 90,373
===============================================================================
Operating income (loss) $ 70,629 17,812 (5,794) 1,138 83,785 (32,780) 51,005
===============================================================================
26 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
A reconciliation of reportable segment revenues to consolidated revenues
follows (amounts in thousands):
Nine months ended September 30, 2004 2003
--------------- ---------------
Reportable segment revenues $ 310,373 286,878
Plus All Other revenues 31,378 21,831
Less intersegment revenues eliminated in consolidation 22,427 21,666
--------------- ---------------
Consolidated revenues $ 319,324 287,043
=============== ===============
A reconciliation of reportable segment earnings from operations before
depreciation, amortization and accretion expense, net other expense and
income taxes to consolidated net income before income taxes and
cumulative effect of a change in accounting principle follows (amounts in
thousands):
Nine months ended September 30, 2004 2003
-------------- ----------------
Reportable segment earnings from operations before
depreciation, amortization and accretion expense, net other
expense and income taxes $ 130,378 116,950
Less All Other loss from operations before depreciation,
amortization and accretion expense, net other expense and
income taxes 23,597 26,577
-------------- ----------------
Consolidated earnings from operations before
depreciation, amortization and accretion expense, net
other expense and income taxes 106,781 90,373
Less depreciation, amortization and accretion expense 46,759 39,368
-------------- ----------------
Consolidated operating income 60,022 51,005
Less other expense, net 29,552 28,973
-------------- ----------------
Consolidated net income before income taxes and
cumulative effect of a change in accounting principle $ 30,470 22,032
============== ================
27 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
A reconciliation of reportable segment operating income to consolidated
net income before income taxes and cumulative effect of a change in
accounting principle follows (amounts in thousands):
Nine months ended September 30, 2004 2003
--------------- ---------------
Reportable segment operating income $ 90,997 83,785
Less All Other operating loss 30,975 32,780
--------------- ---------------
Consolidated operating income 60,022 51,005
Less other expense, net 29,552 28,973
--------------- ---------------
Consolidated net income before income taxes and cumulative
effect of a change in accounting principle $ 30,470 22,032
=============== ===============
(7) Commitments and Contingencies
Litigation and Disputes
We are routinely involved in various lawsuits, billing disputes, legal
proceedings, and regulatory matters that have arisen in the normal course
of business. While the ultimate results of these items cannot be
predicted with certainty we do not expect at this time the resolution of
them to have a material adverse effect on our financial position, results
of operations or liquidity.
Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others Certain customers
have guaranteed levels of service. In the event we are unable to provide
the minimum service levels we may incur penalties or issue credits to
customers.
Fiber Optic Cable System Construction Commitment
In June 2003 we began work on the construction of a fiber optic cable
system connecting Seward, Alaska and Warrenton, Oregon, with leased
backhaul facilities to connect it to our switching and distribution
centers in Anchorage, Alaska and Seattle, Washington ("AULP West"). A
consortium of companies was selected to design, engineer, manufacture,
and install the undersea fiber optic cable system and a contract was
signed at a total cost to us of $35.2 million. In July 2004 we made our
final payment on the contract.
From inception through September 30, 2004 our capital expenditures for
this project have totaled approximately $50.1 million, most of which was
funded through our operating cash flows. We placed AULP West into service
in June 2004.
Fiber Optic Cable System Repair
Our undersea fiber optic cable system connecting Whittier, Valdez and
Juneau, Alaska and Seattle, Washington ("AULP East") experienced powering
irregularities during the first quarter of 2004. We completed the repair
of AULP East in July 2004 and recorded an estimate of the total repair
costs of approximately $400,000.
28 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Internal Revenue Service Examination
Our United States income tax return for 2000 was selected for examination
by the Internal Revenue Service during 2003. The examination was
completed in July 2004 and did not have a material adverse effect on our
financial position, results of operations, or our liquidity.
Our United States income tax return for 2001 was selected for examination
by the Internal Revenue Service during 2004. The examination began during
the second quarter of 2004. We believe this examination will not have a
material adverse effect on our financial position, results of operations,
or our liquidity.
Anchorage UNEs Arbitration
In June 2004 the RCA issued an order in our arbitration to revise the
rates, terms, and conditions that govern our access to UNEs in Anchorage.
The RCA's ruling set rates for numerous elements of Alaska Communications
Systems Group, Inc.'s ("ACS") network, the most significant being the
lease rate for local lines. The order increases the lease rate from
$14.92 to $18.64 per line per month. We estimate the ruling will increase
our local access services segment Cost of Goods Sold (exclusive of
depreciation, amortization and accretion shown separately) by as much as
approximately $1.7 million and $4.1 million during the years ended
December 31, 2004 and 2005, respectively. We have filed a petition for
reconsideration with the RCA. We cannot predict at this time the outcome
of the petition for reconsideration.
We and ACS have jointly filed an Anchorage Interconnection Agreement and
are awaiting approval from the RCA. The agreement, if approved, will have
a five-year term.
Rural Exemption
ACS, through subsidiary companies, provides local services in Fairbanks
and Juneau, Alaska. These ACS subsidiaries are classified as Rural
Telephone Companies under the 1996 Telecom Act, which entitles them to an
exemption of certain material interconnection terms of the 1996 Telecom
Act, until and unless such "rural exemption" is examined and discontinued
by the RCA. An April 2004 proceeding to decide the matter of rural
exemption was canceled upon our and ACS' joint settlement. The settlement
agreement includes the following terms, among others:
o ACS relinquishes all claims to exemptions from full local
telephone competition in Fairbanks and Juneau,
o New rates for unbundled loops in Fairbanks and Juneau will begin
January 1, 2005. We estimate the agreed upon rates will increase
our local services segment cost of sales and service
approximately $600,000 to $700,000 during the year ended
December 31, 2005,
o Extension of existing interconnection agreements between ACS and
us for Fairbanks and Juneau until January 1, 2008, and
o Resolution of UNE leasing issues for the Fairbanks and Juneau
markets.
29 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Galaxy XR
On August 3, 2004 Galaxy XR, our primary satellite used to provide voice,
data and Internet services to our rural Alaska customers, experienced a
failure of its secondary xenon ion propulsion system ("XIPS") that
maintains the satellite's proper orbital position. The primary XIPS had
previously failed in February 2004. The satellite is now using its backup
bi-propellant thrusters, which are a space flight proven technology, to
maintain its orbital position. The failure of the primary and secondary
XIPS had no impact on service to our customers. PanAmSat Corporation
("PanAmSat"), the owner and operator of Galaxy XR, believes there is
sufficient bi-propellant fuel on board the spacecraft to continue normal
operations until the first or second quarter of 2008. The term of our
Galaxy XR transponder purchase agreement extends through March 2012.
PanAmSat intends to replace the satellite prior to its estimated
end-of-life. We purchased a warranty as part of the original agreement to
cover a potential loss of this nature. We have an agreement in place that
provides backup transponder capacity on Galaxy XIII in the event of a
catastrophic failure of Galaxy XR. We do not believe failure of the
primary and secondary XIPS systems will have a material adverse effect on
our financial position, results of operations, or our liquidity.
Universal Service Administrative Company Account Receivable
The FCC directed the Universal Service Administrative Company ("USAC"),
the administrator of the Schools and Libraries and Rural Health Care
Universal Service Support Mechanisms, to change their accounting
methodology by October 1, 2004 to the same methodology that the Federal
Government uses. Among other things, USAC was informed that this required
them to change the rules that they use to account for various financial
transactions, including Funding Commitment Decision Letters ("FCDLs") in
those programs.
In the past, USAC allocated funds for accounting purposes to pay for
services in those programs at the time an invoice submitted by a service
provider was approved for payment. Under the new accounting rules,
however, it has been determined that issuance of the FCDL is the point at
which an "obligation" occurs for Federal Government accounting purposes.
Another significant change requires USAC to have cash or federal
securities on hand at least equal to the value of all its outstanding
FCDLs. Until this decision, USAC was only required to have money on hand
when the vendor sent an invoice to USAC for payment.
USAC suspended issuance of FCDLs in early August, 2004, but indicated
that it has sufficient funds on hand to cover all FCDLs it had previously
issued. USAC also indicated that new funding commitments could not be
issued until additional unobligated funds are made available. On November
3, 2004, USAC announced that it had determined the amount of unobligated
cash available and issuance of FCDLs had resumed up to that amount. In
the future FCDLs will be issued as further cash is available through
Universal Service Fund receipts.
At September 30, 2004 we had approximately $5.4 million in outstanding
funding requests for which FCDLs had been suspended by USAC. We believe
that Universal Service funds will become available to USAC to cover these
FCDLs. If we conclude that we will not be able to collect part or all of
the outstanding balance from USAC, the provision of an allowance for
doubtful accounts could have a material adverse effect on our financial
position, results of operations and liquidity.
30 (Continued)
GENERAL COMMUNICATION, INC. AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
Cable Services Property Acquisition
On August 24, 2004 we signed an Asset Purchase and Sale Agreement to
acquire the assets of Barrow Cable TV, Inc. We are awaiting the RCA's
approval of the acquisition. We expect to finalize the acquisition with a
cash payment of approximately $1.6 million during the first quarter of
2005.
31
PART I.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
In the following discussion, General Communication, Inc. and its direct and
indirect subsidiaries are referred to as "we," "us" and "our."
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and assumptions that affect the reported amounts of assets
and liabilities and the disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. On an on-going basis, we evaluate our
estimates and judgments, including those related to unbilled revenues, Cost of
Goods Sold (exclusive of depreciation, amortization and accretion shown
separately) ("Cost of Goods Sold") accruals, allowance for doubtful accounts,
depreciation, amortization and accretion periods, intangible assets, income
taxes, and contingencies and litigation. We base our estimates and judgments on
historical experience and on various other factors that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. See also our "Cautionary
Statement Regarding Forward-Looking Statements."
General Overview
Through our focus on long-term results, acquisitions, and strategic capital
investments, we strive to consistently grow our revenues and expand our margins.
We have historically met our cash needs for operations, regular capital
expenditures and maintenance capital expenditures through our cash flows from
operating activities. Historically, cash requirements for significant
acquisitions and major capital expenditures have been provided largely through
our financing activities. We funded the construction of a new fiber optic cable
system through our operating cash flows and, to the extent necessary, with draws
on our new Senior Credit Facility, as further discussed in Liquidity and Capital
Resources in this report.
32
Results of Operations
The following table sets forth selected Statement of Income data as a percentage
of total revenues for the periods indicated (underlying data rounded to the
nearest thousands):
Percentage Percentage
Change (1) Change (1)
Three Months Ended 2004 Nine Months Ended 2004
September 30, vs. September 30, vs.
(Unaudited) 2004 2003 2003 2004 2003 2003
---- ---- ---- ---- ---- ----
Statement of Income Data:
Revenues:
Long-distance services segment 51.2% 54.1% 2.6% 49.8% 53.4% 3.8%
Cable services segment 23.6% 24.1% 6.4% 23.6% 24.7% 6.0%
Local access services segment 10.8% 9.7% 21.0% 10.8% 9.5% 27.0%
Internet services segment 6.3% 5.0% 35.5% 6.1% 5.0% 37.0%
All other 8.1% 7.1% 23.9% 9.7% 7.4% 44.9%
--------------------------------------------------------------------------------
Total revenues 100.0% 100.0% 8.4% 100.0% 100.0% 11.2%
Selling, general and administrative
expenses 35.0% 35.9% 5.8% 34.1% 35.7% 6.1%
Bad debt expense (recovery) (0.3%) 0.5% (152.7%) (0.4%) 0.7% 160.3%
Depreciation, amortization and accretion
expense 14.3% 13.3% 17.1% 14.6% 13.7% 18.8%
Operating income 20.1% 17.9% 21.7% 18.8% 17.8% 17.7%
Net income before income taxes and
cumulative effect of a change in
accounting principle in 2003 13.5% 8.4% 73.5% 9.5% 7.7% 38.3%
Net income before cumulative effect of a
change in accounting principle in 2003 8.7% 4.6% 105.2% 5.9% 4.3% 52.4%
Net income 8.7% 4.6% 105.2% 5.9% 4.1% 59.3%
33
Percentage Percentage
Change (1) Change (1)
Three Months Ended 2004 Nine Months Ended 2004
September 30, vs. September 30, vs.
(Unaudited) 2004 2003 2003 2004 2003 2003
---- ---- ---- ---- ---- ----
Other Operating Data:
Long-distance services segment
operating income (2) 50.1% 45.7% 12.4% 44.9% 46.1% 1.0%
Cable services segment operating income (3) 23.6% 22.5% 11.5% 25.4% 25.1% 7.3%
Local access services segment operating
loss (4) (15.9%) (17.9%) (7.6%) (9.1%) (21.3%) 45.5%
Internet services segment operating
income (5) 22.1% 9.4% 219.3% 18.7% 8.0% 222.4%
<FN>
--------------------------
1 Percentage change in underlying data.
2 Computed by dividing total external long-distance services segment operating
income by total external long-distance services segment revenues.
3 Computed by dividing total external cable services segment operating income by
total external cable services segment revenues.
4 Computed by dividing total external local access services segment operating
loss by total external local access services segment revenues.
5 Computed by dividing total external Internet services segment operating income
by total external Internet services segment revenues.
--------------------------
</FN>
Three Months Ended September 30, 2004 ("2004") Compared To Three Months Ended
September 30, 2003 ("2003")
Overview of Revenues and Cost of Goods Sold
Total revenues increased 8.4% from $98.3 million in 2003 to $106.6 million in
2004. All of our segments and All Other Services contributed to the increase in
total revenues. See the discussion below for more information by segment.
Total Cost of Goods Sold increased 3.2% from $31.9 million in 2003 to $32.9
million in 2004. Our cable services, local access services and Internet services
segments and All Other Services contributed to the increase in total Cost of
Goods Sold, partially off-set by a decrease in long-distance services Cost of
Goods Sold. See the discussion below for more information by segment.
Long-Distance Services Segment Overview
Long-distance services segment revenue in 2004 represented 51.2% of consolidated
revenues. Our provision of interstate and intrastate long-distance services,
private line and leased dedicated capacity services, and broadband services
accounted for 91.1% of our total long-distance services segment revenues during
2004.
34
Factors that have the greatest impact on year-to-year changes in long-distance
services revenues include the rate per minute charged to customers, usage
volumes expressed as minutes of use, and the number of private line, leased
dedicated service and broadband products in use.
Due in large part to the favorable synergistic effects of our bundling strategy,
the long-distance services segment continues to be a significant contributor to
our overall performance, although the migration of traffic from voice to data
and from fixed to mobile wireless continues.
Our long-distance services segment faces significant competition from AT&T
Alascom, long-distance resellers, and local telephone companies that have
entered the long-distance market. We believe our approach to developing,
pricing, and providing long-distance services and bundling different business
segment services will continue to allow us to be competitive in providing those
services.
The initial term of our contract to provide interstate and intrastate
long-distance services to Sprint ends in March 2007 with two one-year automatic
extensions to March 2009. In June 2004 we amended the original agreement
resulting in new annual rate reductions beginning July 2004. Contractual rate
reductions will continue to occur annually through the end of the initial term
of the contract.
On July 21, 2002 MCI and substantially all of its active United States
subsidiaries filed voluntary petitions for reorganization under Chapter 11 of
the United States Bankruptcy Code in the United States Bankruptcy Court. On July
22, 2003, the United States Bankruptcy Court approved a settlement agreement for
pre-petition amounts owed to us by MCI and affirmed all of our existing
contracts with MCI. MCI emerged from bankruptcy protection on April 20, 2004.
The remaining pre-petition accounts receivable balance owed by MCI to us after
this settlement was $11.1 million ("MCI credit") which we have used and will
continue to use as a credit against amounts payable for services purchased from
MCI.
After settlement, we began reducing the MCI credit as we utilized it for
services otherwise payable to MCI. We have accounted for our use of the MCI
credit as a gain contingency, and, accordingly, are recognizing a reduction of
bad debt expense as services are provided by MCI and the credit is realized.
During 2004 and 2003 we realized approximately $1.1 million and $647,000,
respectively, of the MCI credit against amounts payable for services received
from MCI.
The remaining unused MCI credit totaled $4.5 million and $7.9 million at
September 30, 2004 and December 31, 2003, respectively. The credit balance is
not recorded on the Consolidated Balance Sheet as we are recognizing recovery of
bad debt expense as the credit is realized.
Other common carrier traffic routed to us for termination in Alaska is largely
dependent on traffic routed to MCI and Sprint by their customers. Pricing
pressures, new program offerings, business failures, and market and business
consolidations continue to evolve in the markets served by MCI and Sprint. If,
as a result, their traffic is reduced, or if their competitors' costs to
terminate or originate traffic in Alaska are reduced, our traffic will also
likely be reduced, and our pricing may be reduced to respond to competitive
pressures. Additionally, a protracted economic malaise in the 48 contiguous
states south of or below Alaska ("Lower 48 States") or a disruption in the
economy resulting from terrorist attacks and other attacks or acts of war could
affect our carrier customers. We are unable to predict the effect on us of such
changes, however given the materiality of other common carrier revenues to us, a
significant reduction in traffic or pricing could have a material adverse effect
on our financial position, results of operations and liquidity.
35
Long-distance Services Segment Revenues
Total long-distance services segment revenues increased 2.6% to $54.6 million in
2004. The components of long-distance services segment revenues are as follows
(amounts in thousands):
2004 2003 Percentage Change
-------------- ------------- -----------------
Common carrier message telephone services $ 21,046 24,643 (14.6%)
Residential, commercial and governmental message telephone
services 10,149 10,133 0.2%
Private line and private network services 10,973 9,167 19.7%
Broadband services 7,542 6,364 18.5%
Lease of fiber optic cable system capacity 4,840 2,884 67.8%
-------------- ------------- -----------------
Total long-distance services segment revenue $ 54,550 53,191 2.6%
============== ============= =================
Common Carrier Message Telephone Services Revenue
The 2004 decrease in message telephone service revenues from other common
carriers (principally MCI and Sprint) resulted from the following:
o A 8.7% decrease in the average rate per minute on minutes carried for
other common carriers primarily due to the decreased average rate per
minute as agreed to in the June 2004 amendment of our contract to
provide interstate and intrastate long-distance services to Sprint, and
o A 4.2% decrease in wholesale minutes carried to 233.5 million minutes.
Residential, Commercial, and Governmental Message Telephone Services Revenue
Selected key performance indicators for our offering of message telephone
service to residential, commercial, and governmental customers follow:
2004 2003 Percentage Change
------------------ ------------------ -----------------
Retail minutes carried 77.3 million 70.8 million 9.2%
Average rate per minute (1) $0.133 $0.140 (5.0%)
Number of active residential,
commercial and governmental
customers (2) 90,300 86,200 4.8%
<FN>
------------------------------------
1 Residential, commercial, and governmental message telephone services
revenues excluding plan fees associated with the carriage of data services
divided by the retail minutes carried.
2 All current subscribers who have had calling activity during September
2004 and 2003, respectively.
</FN>
The decrease in message telephone service revenues from residential, commercial,
and governmental customers in 2004 is primarily due to a decrease in the average
rate per minute. Our average rate per minute decrease is primarily due to our
promotion of and customers' enrollment in calling plans offering a certain
number of minutes for a flat monthly fee.
36
The decrease in message telephone service revenues from residential, commercial,
and governmental customers in 2004 is partially off-set by the following:
o Increased minutes carried for these customers primarily due to our
contract to provide services to the State of Alaska starting in the
first quarter of 2004, and
o An increase in the number of active residential, commercial, and
governmental customers billed primarily due to our promotion of and our
customers' enrollment in a new bundled offering to our residential
customers starting in the first quarter of 2004, partially off-set by
the effect of customers substituting cellular phone, prepaid calling
card, and email usage for direct dial minutes.
Broadband Services Revenue
The increase in revenues from our packaged telecommunications offerings to rural
hospitals and health clinics and our SchoolAccess(TM) offering to rural school
districts in 2004 is primarily due to the following:
o An increased number of circuits leased to rural hospitals, health
clinics, and rural school districts to both existing and a new customer
resulting in increased revenue of $334,000, and
o An $886,000 increase in special project revenue for services sold to
the federal government.
Fiber Optic Cable System Capacity Lease Revenue
The increase in revenues from the lease of fiber optic cable system capacity is
primarily due to a contract to lease capacity on the AULP East fiber optic cable
system resulting in increased monthly revenue of approximately $430,000 starting
in July 2004.
Long-distance Services Segment Cost of Goods Sold
Long-distance services segment Cost of Goods Sold decreased 16.9% to $12.0
million in 2004 primarily due to the following:
o A $472,000 credit received in 2004 from a vendor due to a rate
overcharge,
o A 4.2% decrease in wholesale minutes carried,
o Reductions in access costs due to distribution and termination of our
traffic on our own local access services network instead of paying
other carriers to distribute and terminate our traffic. The statewide
average cost savings is approximately $.010 and $.062 per minute for
interstate and intrastate traffic, respectively. We expect cost savings
to continue to occur as long-distance traffic originated, carried, and
terminated on our own facilities grows, and
o In the course of business we estimate unbilled long-distance services
Cost of Goods Sold based upon minutes of use processed through our
network and established rates. Such estimates are revised when
subsequent billings are received, payments are made, billing matters
are researched and resolved, tariffed billing periods lapse, or when
disputed charges are resolved. In 2004 and 2003, we had favorable
adjustments of $450,000 and $624,000, respectively.
The decrease in the long-distance services segment Cost of Goods Sold is
partially off-set by a 9.2% increase in retail minutes carried.
37
Long-distance Services Segment Operating Income
Long-distance services segment operating income increased 12.4% to $27.3 million
from 2003 to 2004 primarily due to the following:
o The 2.6% increase in long-distance services segment revenues to $54.6
million in 2004,
o The 16.9% decrease in long-distance services segment Cost of Goods Sold
to $12.0 million in 2004, and
o A $443,000 increase in bad debt recovery due to an increase in the
realization of the MCI credit in 2004 as compared to 2003, as further
discussed in the "Long Distance Service Segment Overview" above.
The increase in the long-distance services segment operating income was
partially off-set by a 3.7% increase in long-distance services segment selling,
general and administrative expenses to $9.8 million in 2004 as compared to 2003.
Cable Services Segment Overview
Cable services segment revenues in 2004 represented 23.6% of consolidated
revenues. Our cable systems serve 35 communities and areas in Alaska, including
the state's four largest population centers, Anchorage, Fairbanks, the
Matanuska-Susitna Valley and Juneau.
We generate cable services segment revenues from four primary sources: (1)
digital and analog programming services, including monthly basic and premium
subscriptions, pay-per-view movies and other one-time events, such as sporting
events; (2) equipment rentals and installation; (3) cable modem services (shared
with our Internet services segment); and (4) advertising sales. During 2004
programming services generated 71.9% of total cable services segment revenues,
cable services' allocable share of cable modem services accounted for 12.3% of
such revenues, equipment rental and installation fees accounted for 9.7% of such
revenues, advertising sales accounted for 5.2% of such revenues, and other
services accounted for the remaining 0.9% of total cable services segment
revenues.
The primary factors that contribute to year-to-year changes in cable services
segment revenues include average monthly subscription and pay-per-view rates,
the mix among basic, premium and pay-per-view services and digital and analog
services, the average number of cable television and cable modem subscribers
during a given reporting period, revenues generated from new product offerings,
and sales of cable advertising services.
We distribute local Anchorage programming to all of our cable systems. This
local programming provides additional value to our cable subscribers that not
all our Direct Broadcast Satellite ("DBS") competitors can provide. In the third
quarter of 2003 DBS service provider Dish Network (EchoStar Communications
Corporation) began providing, for an additional fee, Anchorage based broadcaster
programming in Anchorage and in other Alaska communities where there is not a
similar local broadcast affiliate.
38
Cable Services Segment Revenues and Cost of Goods Sold
Selected key performance indicators for our cable services segment follow:
September 30, Percentage
2004 2003 Change
------------- ------------- ----------------
Basic subscribers 134,300 135,300 (0.7%)
Digital special interest subscribers 42,600 34,800 22.4%
Cable modem subscribers 61,200 42,800 43.0%
Homes passed 206,000 201,100 2.4%
A basic cable subscriber is defined as one basic tier of service delivered to an
address or separate subunits thereof regardless of the number of outlets
purchased. A digital special interest subscriber is defined as one digital
special interest tier of service delivered to an address or separate subunits
thereof regardless of the number of outlets purchased.
A cable modem subscriber is defined by the purchase of cable modem service
regardless of the level of service purchased. If one entity purchases multiple
cable modem service access points, that entity is included in our cable modem
subscriber count at a rate equal to the number of access points purchased.
Total cable services segment revenues increased 6.4% to $25.2 million and
average gross revenue per average basic subscriber per month increased $4.78 or
8.0% in 2004.
The increase in cable services segment revenues is primarily due to the
following:
o A 14.3% increase to $3.1 million in 2004 in its share of cable modem
revenue (offered through our Internet services segment) due to an
increased number of cable modems deployed. Approximately 99% of our
cable homes passed are able to subscribe to our cable modem service,
and
o A 67.3% increase in advertising sales revenue to $1.3 million in 2004
primarily caused by an increase in Olympic and national and local
political advertising.
We now offer digital cable television service in Anchorage, the
Matanuska-Susitna Valley, Fairbanks, Juneau, Ketchikan, Kenai, Soldotna, Kodiak,
Seward, Cordova, Valdez, and Nome, representing approximately 94% of our total
homes passed at September 30, 2004. We launched digital cable television
services in the Ketchikan cable system in the third quarter of 2003, in the
Kodiak cable system in the first quarter of 2004, in the Cordova and Seward
cable systems in the second quarter of 2004, and in the Valdez and Nome cable
systems in the third quarter of 2004. Our digital service offering varies among
cable systems with the digital special interest programming tier only available
in Anchorage, the Matanuska-Susitna Valley, Fairbanks, Juneau, Ketchikan, Kenai
and Soldotna.
Cable services Cost of Goods Sold increased 4.4% to $6.9 million in 2004 due to
programming cost increases for most of our cable programming services offerings.
Cable Services Segment Operating Income
Cable services segment operating income increased 11.5% to $5.9 million from
2003 to 2004. Increased revenues of approximately $1.5 million were partially
off-set by increases in cable services segment Cost of Goods Sold of
approximately $293,000, selling, general, and administrative expenses
39
of approximately $211,000 to $7.4 million and depreciation, amortization and
accretion expense of approximately $323,000 to $4.7 million.
Local Access Services Segment Overview
We generate local access services revenues from three primary sources: (1)
business and residential basic dial tone services; (2) business private line and
special access services; and (3) business and residential features and other
charges, including voice mail, caller ID, distinctive ring, inside wiring and
subscriber line charges. During 2004 local access services revenues represented
10.8% of consolidated revenues.
The primary factors that contribute to year-to-year changes in local access
services revenues include the average number of business and residential
subscribers to our services during a given reporting period, the average monthly
rates charged for non-traffic sensitive services, the number and type of
additional premium features selected, the traffic sensitive access rates charged
to carriers and the Universal Service Program.
Our local access services segment faces significant competition in Anchorage,
Fairbanks, and Juneau from ACS, which is the largest ILEC in Alaska, and from
AT&T Alascom, Inc. in Anchorage for residential services. We believe our
approach to developing, pricing, and providing local access services and
bundling different business segment services will allow us to be competitive in
providing those services.
At September 30, 2004, 110,400 lines were in service as compared to
approximately 103,400 lines in service at September 30, 2003. We estimate that
our 2004 lines in service represents a statewide market share of approximately
24%. A line in service is defined as a revenue generating circuit or channel
connecting a customer to the public switched telephone network.
Our access line mix at September 30, 2004 follows:
o Residential lines represent approximately 61% of our lines,
o Business customers represent approximately 35% of our lines, and
o Internet access customers represent approximately 4% of our lines.
In April 2004 we successfully launched our Digital Local Phone Service ("DLPS")
deployment utilizing our Anchorage coaxial cable facilities. This service
delivery method allows us to utilize our own cable facilities to provide local
access service to our customers and avoid paying local loop charges to the ILEC.
To ensure the necessary equipment is available to us, we have committed to
purchase a certain number of outdoor, network powered multi-media adapters. At
September 30, 2004 we had approximately 4,000 DLPS lines in service.
Approximately 85% of our lines are provided on our own facilities and leased
local loops. Approximately 6% of our lines are provided using the UNE platform
delivery method.
In December 2003 we distributed our new phone directory and began recognizing
revenue and Cost of Goods Sold in the local access services segment. We
recognized one month of revenue and Cost of Goods Sold in the fourth quarter of
2003 and are recognizing the remaining eleven months of revenue and Cost of
Goods Sold in 2004.
40
In October 2004 we completed distribution our new Fairbanks and Juneau area
directories. We will recognize three months of revenue and Cost of Goods Sold in
2004 and will recognize the remaining nine months of revenue and Cost of Goods
Sold in 2005.
Local Access Services Segment Revenues and Cost of Goods Sold
Local access services segment revenues increased 21.0% in 2004 to $11.5 million
primarily due to the following:
o Growth in the average number of lines in service,
o $485,000 increase in support from the Universal Service Program, and
o Revenues of $468,000 from our new phone directory distributed in
December 2003.
The increase in local access services segment revenue is partially off-set by
access rate decreases.
Local access services segment Cost of Goods Sold increased 31.7% to $7.8 million
in 2004 primarily due to the growth in the average number of lines in service
and the increased costs resulting from the RCA's Anchorage UNE arbitration
settlement order in June 2004 which increased the UNE lease rate from $14.92 to
$18.64 per line per month beginning on June 25, 2004.
Local Access Services Segment Operating Loss
Local access services segment operating loss increased approximately $129,000 to
($1.8) million from 2003 to 2004. The increased operating loss is primarily due
to increased Cost of Goods Sold of approximately $1.9 million as previously
described and increased depreciation, amortization and accretion expense of
approximately $88,000 to $964,000. Partially off-setting the increased local
access services segment operating loss are increased revenues of approximately
$2.0 million as previously described.
The local access services segment operating results are negatively affected by
the allocation of the benefit of access cost savings to the long-distance
services segment. If the local access services segment received credit for the
access charge reductions recorded by the long distance services segment, the
local access services segment operating loss would have improved by
approximately $1.9 million and the long distance services segment operating
income would have been reduced by an equal amount in 2004. Avoided access
charges totaled approximately $1.6 million in 2003. The amount of allocated
access cost savings is affected by access rate decreases from 2003 to 2004.
Internet Services Segment Overview
We generate Internet services revenues from three primary sources: (1) access
product services, including commercial, Internet service provider, and retail
dial-up access; (2) network management services; and (3) Internet services'
allocable share of cable modem revenue (a portion of cable modem revenue is also
recognized by our cable services segment). During 2004 Internet services segment
revenues represented 6.3% of consolidated revenues.
The primary factors that contribute to year-to-year changes in Internet services
revenues include the average number of subscribers to our services during a
given reporting period, the average monthly subscription rates, the amount of
bandwidth purchased by large commercial customers, and the number and type of
additional premium features selected.
41
Marketing campaigns continue to be deployed targeting residential and commercial
customers featuring bundled products. Our Internet offerings are bundled with
various combinations of our long-distance, cable, and local access services
offerings and provide free or discounted basic or premium Internet services.
Value-added premium Internet features are available for additional charges.
We compete with a number of Internet service providers in our markets. We
believe our approach to developing, pricing, and providing Internet services
allows us to be competitive in providing those services.
Internet Services Segment Revenues and Cost of Goods Sold
Selected key performance indicators for our Internet services segment follow:
September 30, Percentage
2004 2003 Change
------------ ------------ ---------------
Total Internet subscribers 101,100 93,900 7.7%
Cable modem subscribers 61,200 42,800 43.0%
Dial-up subscribers 39,900 51,100 (21.9%)
Total Internet subscribers are defined by the purchase of Internet access
service regardless of the level of service purchased. If one entity purchases
multiple Internet access service points, that entity is included in our total
Internet subscriber count at a rate equal to the number of access points
purchased. A subscriber with both cable modem and dial-up service is included
once as a cable modem subscriber.
A dial-up subscriber is defined by the purchase of dial-up Internet service
regardless of the level of service purchased. If one entity purchases multiple
dial-up service access points, that entity is included in our dial-up subscriber
count at a rate equal to the number of access points purchased.
Total Internet services segment revenues increased 35.5% to $6.7 million in 2004
primarily due to the 30.1% increase in its allocable share of cable modem
revenues to $2.9 million in 2004 as compared to 2003. The increase in cable
modem revenues is primarily due to growth in cable modem subscribers.
The decrease in dial-up subscribers from 2003 to 2004 is primarily due to the
migration of existing dial-up subscribers to our cable modem access service.
Internet services segment Cost of Goods Sold increased 12.5% to $1.7 million in
2004 associated with increased Internet services segment revenues.
Internet Services Segment Operating Income
Internet services segment operating income increased $1.0 million to $1.5
million from 2003 to 2004. Increased revenues of approximately $1.7 million were
partially off-set by increased Cost of Goods Sold of approximately $189,000,
increased selling, general and administrative expenses of approximately $457,000
to $2.5 million and increased depreciation, amortization and accretion expense
of approximately $50,000 to $879,000.
42
All Other Overview
Revenues reported in the All Other category as described in note 6 in the
accompanying "Notes to Interim Condensed Consolidated Financial Statements"
include our managed services, product sales, and cellular telephone services.
Revenues included in the All Other category represented 8.1% of consolidated
revenues in 2004.
All Other Revenues and Cost of Goods Sold
All Other revenues increased 23.9% to $8.6 million in 2004. The increase is
primarily due to the following:
o Special project revenue for services sold to a certain customer,
o Revenue generated from our contract to provide services to the State of
Alaska starting in the first quarter of 2004.
All Other Cost of Goods Sold increased 30.9% to $4.5 million in 2004. The
increase is primarily due to costs associated with the special project revenue
described above.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 5.8% to $37.3 million in
2004 primarily due to a $1.2 million increase in contract labor and contract
services expenses associated with our Sarbanes-Oxley Act of 2002 ("SOX") Section
404 compliance efforts and other special projects, a $1.1 million write-off of
previously capitalized mobile wireless network costs upon finalization of a
long-term distribution agreement, and a $1.0 million increase in labor and
health insurance costs. The increases previously described are partially off-set
by a $1.3 million decrease in our company-wide success sharing bonus accrual. As
a percentage of total revenues, selling, general and administrative expenses
decreased to 35.0% in 2004 from 35.9% in 2003, primarily due to an increase in
revenues without a corresponding proportional increase in selling, general and
administrative expenses.
Bad Debt Expense (Recovery)
Bad debt expense decreased 152.7% to a net recovery of ($281,000) in 2004. The
2004 decrease is primarily due to realization of approximately $1.1 million of
the MCI credit through a reduction to bad debt expense in 2004, as further
discussed in the "Long Distance Service Segment Overview" above.
Depreciation, Amortization and Accretion Expense
Depreciation, amortization and accretion expense increased 17.1% to $15.3
million in 2004. The increase is primarily attributed to our $45.8 million
investment in equipment and facilities placed into service during the
twelve-month period ended December 31, 2003 for which a full year of
depreciation will be recorded in the twelve-month period ended December 31,
2004, and the $96.5 million investment in equipment and facilities placed into
service during nine-month period ended September 30, 2004 for which a partial
year of depreciation will be recorded in the twelve-month period ended December
31, 2004.
Other Expense, Net
Other expense, net of other income, decreased 24.5% to $7.0 million in 2004. The
decrease is primarily due to a $1.9 million decrease in interest expense in 2004
on our new Senior Credit Facility due to a decrease in the average outstanding
balance owed on our new Senior Credit Facility and a decreased new Senior Credit
Facility interest rate as compared to 2003.
43
Income Tax Expense
Income tax expense was $5.1 million in 2004 and $3.8 million in 2003. The change
was due to increased net income before income taxes in 2004 as compared to 2003.
Our effective income tax rate decreased from 45.3% in 2003 to 35.3% in 2004 due
to the decreasing proportion of items that are nondeductible for income tax
purposes and adjustment of deferred tax assets and liabilities in 2004.
At September 30, 2004, we have (1) tax net operating loss carryforwards of
approximately $173.9 million that will begin expiring in 2005 if not utilized,
and (2) alternative minimum tax credit carryforwards of approximately $2.0
million available to offset regular income taxes payable in future years. We
utilized net operating loss carryforwards of approximately $8.8 million during
the nine months ended September 30, 2004. Our utilization of certain net
operating loss carryforwards is subject to limitations pursuant to Internal
Revenue Code section 382.
Tax benefits associated with recorded deferred tax assets are considered to be
more likely than not realizable through future reversals of existing taxable
temporary differences and future taxable income exclusive of reversing temporary
differences and carryforwards. The amount of deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income during the carryforward period are reduced which would result in
additional income tax expense. We estimate that our effective annual income tax
rate for financial statement purposes will be 38% to 40% in 2004.
On October 22, 2004 the American Jobs Creation Act of 2004 was signed into law.
We believe this new law will not have a material effect on our results of
operations, financial position and cash flows.
Nine Months Ended September 30, 2004 ("2004") Compared To Nine Months Ended
September 30, 2003 ("2003")
Overview of Revenues and Cost of Goods Sold
Total revenues increased 11.2% from $287.0 million in 2003 to $319.3 million in
2004. All of our segments and All Other Services contributed to the increase in
total revenues. See the discussion below for more information by segment.
Total Cost of Goods Sold increased 13.8% from $92.2 million in 2003 to $104.9
million in 2004. All of our segments and All Other Services contributed to the
increase in total Cost of Goods Sold. See the discussion below for more
information by segment.
Long-Distance Services Segment Overview
Long-distance services revenue in 2004 represented 49.8% of consolidated
revenues. Our provision of interstate and intrastate long-distance services,
private line and leased dedicated capacity services, and broadband services
accounted for 92.8% of our total long-distance services segment revenues during
2004.
44
Long-distance Services Segment Revenues
Total long-distance services segment revenues increased 3.8% to $159.1 million
in 2004. The components of long-distance services segment revenues are as
follows (amounts in thousands):
2004 2003 Percentage Change
-------------- ------------- -----------------
Common carrier message telephone services $ 62,885 68,680 (8.4%)
Residential, commercial and governmental message telephone
services 30,406 30,526 (0.4%)
Private line and private network services 32,008 27,384 16.9%
Broadband services 22,382 18,380 21.8%
Lease of fiber optic cable system capacity 11,430 8,277 38.1%
-------------- ------------- -----------------
Total long-distance services segment revenue $ 159,111 153,247 3.8%
============== ============= =================
Common Carrier Message Telephone Services Revenue
The 2004 decrease in message telephone service revenues from other common
carriers (principally MCI and Sprint) resulted from the following:
o An 11.0% decrease in the average rate per minute on minutes carried for
other common carriers primarily due to the decreased average rate per
minute as agreed to in the June 2004 amendment of our contract to
provide interstate and intrastate long-distance services to Sprint and
in the July 2003 extension of our contract to provide interstate and
intrastate long-distance services to MCI, and
o A discount given to a certain other common carrier customer starting in
the third quarter of 2003.
The decrease in message telephone service revenues from other common carriers in
2004 was partially off-set by a 5.7% increase in wholesale minutes carried to
675.7 million minutes.
Residential, Commercial and Governmental Message Telephone Services Revenue
Selected key performance indicators for our offering of message telephone
service to residential, commercial and governmental customers follow:
2004 2003 Percentage Change
------------------ ------------------ -----------------
Retail minutes carried 230.3 million 215.3 million 7.0%
Average rate per minute (1) $0.132 $0.139 (5.0%)
Number of active residential,
commercial and governmental
customers (2) 90,300 86,200 4.8%
<FN>
------------------------------------
1 Residential, commercial and governmental message telephone services
excluding plan fees associated with the carriage of data services divided
by the retail minutes carried.
2 All current subscribers who have had calling activity during September
2004 and 2003, respectively.
</FN>
45
The decrease in message telephone service revenues from residential, commercial,
and governmental customers in 2004 is primarily due to a decrease in the average
rate per minute. Our average rate per minute decrease is primarily due to our
promotion of and customers' enrollment in calling plans offering a certain
number of minutes for a flat monthly fee.
The decrease in message telephone service to residential, commercial and
governmental customers in 2004 is partially off-set by the following:
o Increased minutes carried for these customers primarily due to our
contract to provide services to the State of Alaska starting in the
first quarter of 2004, and
o An increase in the number of active residential, commercial, and
governmental customers billed primarily due to our promotion of and our
customers' enrollment in a new bundled offering to our residential
customers, partially off-set by the effect of customers substituting
cellular phone, prepaid calling card, and email usage for direct dial
minutes.
Broadband Services Revenue
The increase in revenues from our packaged telecommunications offering to rural
hospitals and health clinics and our SchoolAccess(TM) offering to rural school
districts in 2004 is primarily due to the following:
o An increased number of circuits leased to rural hospitals, health
clinics, and rural school districts to both existing and a new customer
resulting in increased revenue of $1.8 million, and
o A $2.2 million increase in special project revenue for services sold to
the federal government.
Long-distance Services Segment Cost of Goods Sold
Long-distance services segment Cost of Goods Sold increased 2.8% to $40.6
million in 2004 primarily due to the following:
o A 7.0% increase in retail minutes carried,
o A 5.7% increase in wholesale minutes carried, and
o A $2.3 million refund ($1.9 million after deducting certain direct
costs) in 2003 from a local exchange carrier in respect of its earnings
that exceeded regulatory requirements that did not recur in 2004.
The increase in the long-distance services segment Cost of Goods Sold is
partially off-set by the following:
o A $472,000 credit received in 2004 from a vendor due to a rate
overcharge,
o In the course of business we estimate unbilled long-distance services
Cost of Goods Sold based upon minutes of use processed through our
network and established rates. Such estimates are revised when
subsequent billings are received, payments are made, billing matters
are researched and resolved, tariffed billing periods lapse, or when
disputed charges are resolved. In 2004 and 2003, we had favorable
adjustments of $450,000 and $1.4 million, respectively.
o Reductions in access costs due to distribution and termination of our
traffic on our own local access services network instead of paying
other carriers to distribute and terminate our traffic. The statewide
average cost savings is approximately $.010 and $.062 per minute for
interstate and intrastate traffic, respectively. We expect cost savings
to continue to occur as long-distance traffic originated, carried, and
terminated on our own facilities grows.
46
Long-distance Services Segment Operating Income
Long-distance services segment operating income increased 1.0% to $71.4 million
from 2003 to 2004 primarily due to the following:
o The 3.8% increase in long-distance services segment revenues to $159.1
million in 2004, and
o Realization of approximately $3.4 million of the MCI credit through a
reduction to bad debt expense in 2004, as further discussed in the
"Long Distance Service Overview" above. We realized approximately
$647,000 of the MCI credit through a reduction to bad debt expense in
2003.
The long-distance services segment operating income increase was partially
off-set by the following:
o The 2.8% increase in long-distance services segment costs of goods sold
to $40.6 million in 2004, as discussed above,
o An 8.7% increase in long-distance services segment selling, general and
administrative expenses to $29.9 million primarily due to an increase
of approximately $820,000 in promotion expenses and an increase of
approximately $925,000 in fiber repair expenses in 2004 and compared to
2003. The increase in fiber repair expenses is the result of the repair
of AULP East in July 2004 with an estimated total repair cost of
approximately $400,000 and an accrual reversal of $525,000 in 2003, and
o A 34.7% increase in long-distance services segment depreciation,
amortization and accretion expense to $19.6 million in 2004 as compared
to 2003 primarily due to our investment in long-distance services
segment equipment and facilities placed into service during the
twelve-month period ended December 31, 2003 for which a full year of
depreciation will be recorded in the twelve-month period ended December
31, 2004, and our investment in long-distance services segment
equipment and facilities placed into service during the nine-month
period ended September 30, 2004 for which a partial year of
depreciation will be recorded in the twelve-month period ended December
31, 2004.
Cable Services Segment Overview
Cable services segment revenues in 2004 represented 23.6% of consolidated
revenues. During 2004 programming services generated 72.9% of total cable
services segment revenues, cable services' allocable share of cable modem
services accounted for 12.8% of such revenues, equipment rental and installation
fees accounted for 9.5% of such revenues, advertising sales accounted for 3.9%
of such revenues, and other services accounted for the remaining 0.9% of total
cable services revenues.
Cable Services Segment Revenues and Cost of Goods Sold
Total cable services segment revenues increased 6.0% to $75.2 million and
average gross revenue per average basic subscriber per month increased $7.11 or
11.9% in 2004.
The increase in cable services segment revenues is primarily due to the
following:
o A 86.9% increase in digital set-top box rental revenue to $5.8 million
in 2004 primarily caused by the increased use of digital distribution
technology, and
o A 21.6% increase in its share of cable modem revenue (offered through
our Internet services segment) to $9.6 million in 2004 due to an
increased number of cable modems deployed. Approximately 99% of our
cable homes passed are able to subscribe to our cable modem service.
47
Cable services segment Cost of Goods Sold increased 4.5% to $20.3 million in
2004 due to programming cost increases for most of our cable programming service
offerings. The increase in Cable services segment Cost of Goods Sold is
partially off-set by a refund received in 2004 from a supplier retroactive to
August 2003 and an arrangement with a supplier in which we received a rebate in
2004 upon us meeting a specified goal.
Cable Services Segment Operating Income
Cable services segment operating income increased $1.3 million to $19.1 million
from 2003 to 2004 primarily due to the 6.0% increase in cable services segment
revenues to $75.2 million in 2004, partially off-set by the following:
o The 4.5% increase in cable services segment Costs of Goods Sold to
$20.3 million in 2004, as described above,
o A $1.3 million increase in cable services segment selling, general and
administrative expenses to $21.1 million primarily due to a $1.9
million increase in labor and employee benefits costs, and
o A 4.7% increase in cable services segment depreciation, amortization
and accretion expense to $14.1 million in 2004 as compared to 2003
primarily due to our investment in cable services segment equipment and
facilities placed into service during the twelve-month period ended
December 31, 2003 for which a full year of depreciation will be
recorded in the twelve-month period ended December 31, 2004, and our
investment in cable services segment equipment and facilities placed
into service during the nine-month period ended September 30, 2004 for
which a partial year of depreciation will be recorded in the
twelve-month period ended December 31, 2004.
Multiple System Operator ("MSO") Operating Statistics
Our operating statistics include capital expenditures and customer information
from our cable services segment and the components of our local access services
and Internet services segments which offer services utilizing our cable
services' facilities.
Our capital expenditures by standard reporting category for the nine month
periods ending September 30, 2004 and 2003 follows (amounts in thousands):
2004 2003
-------------- -------------
Customer premise equipment $ 12,136 6,880
Commercial 348 395
Scalable infrastructure 3,782 1,000
Line extensions 517 645
Upgrade/rebuild 6,516 1,816
Support capital 1,013 313
-------------- -------------
Sub-total 24,312 11,049
Remaining reportable segments and
All Other capital expenditures 58,498 23,344
-------------- -------------
$ 82,810 34,393
============== =============
48
The standardized definition of a customer relationship is the number of
customers that receive at least one level of service utilizing our cable
services segment's facilities, encompassing voice, video, and data services,
without regard to which services customers purchase. At September 30, 2004 and
2003 we had 122,100 and 122,400 customer relationships, respectively.
The standardized definition of a revenue generating unit is the sum of all
primary analog video, digital video, high-speed data, and telephony customers,
not counting additional outlets. At September 30, 2004 and 2003 we had 199,400
and 178,200 revenue generating units, respectively.
Local Access Services Segment Overview
During 2004 local access services revenues represented 10.8% of consolidated
revenues.
Local Access Services Segment Revenues and Cost of Goods Sold
Local access services segment revenues increased 27.0% in 2004 to $34.6 million
primarily due to the following:
o Growth in the average number of lines in service,
o $2.6 million increase in support from the Universal Service Program,
and
o Revenues of $1.6 million from our new phone directory distributed in
December 2003.
The increase in local access services segment revenues is partially off-set by
access rate decreases.
Local access services segment Cost of Goods Sold increased 21.4% to $21.2
million in 2004 primarily due to the growth in the average number of lines in
service and the increased costs resulting from the RCA's Anchorage UNE
arbitration settlement order in June 2004 which increased the lease rate from
$14.92 to $18.64 per line per month beginning on June 25, 2004.
Local Access Services Segment Operating Loss
Local access services segment operating loss decreased 45.5% to ($3.2) million
from 2003 to 2004 primarily due to the 27.0% revenue increase to $34.6 million
partially off-set by the 21.4% increase in Cost of Goods Sold to $21.2 million,
a $513,000 increase in local services segment selling, general and
administrative expenses to $13.4 million, and a 12.1% increase in local services
segment depreciation, amortization and accretion expense to $2.9 million in 2004
as compared to 2003.
The local access services segment operating results are negatively affected by
the allocation of the benefit of access cost savings to the long-distance
services segment. If the local access services segment received credit for the
access charge reductions recorded by the long distance services segment, the
local access services segment operating loss would have improved by
approximately $5.2 million and the long distance services segment operating
income would have been reduced by an equal amount in 2004. Avoided access
charges totaled approximately $5.1 million in 2003. The amount of allocated
access cost savings is affected by access rate decreases from 2003 to 2004.
Internet Services Segment Overview
During 2004 Internet services segment revenues represented 6.1% of consolidated
revenues.
49
Internet Services Segment Revenues and Cost of Goods Sold
Total Internet services segment revenues increased 37.0% to $19.6 million in
2004 primarily due to the 28.8% increase in its allocable share of cable modem
revenues to $8.4 million in 2004 as compared to 2003. The increase in cable
modem revenues is primarily due to growth in cable modem subscribers.
Internet services Cost of Goods Sold increased 21.5% to $5.3 million in 2004
associated with increased Internet services segment revenues.
Internet Services Segment Operating Income
Internet services segment operating income increased 222.4% to $3.7 million from
2003 to 2004 primarily due to the 37.0% increase in Internet services segment
revenues to $19.6 million in 2004 partially off-set by the 21.5% increase in
Internet services segment Cost of Goods Sold to $5.3 million in 2004, a $677,000
increase in selling, general and administrative expenses to $7.8 million. The
increase in selling, general and administrative expenses is primarily due to an
increase of approximately $612,000 in promotion expenses in 2004 as compared to
2003.
All Other Overview
Revenues reported in the All Other category as described in note 6 in the
accompanying "Notes to Interim Condensed Consolidated Financial Statements"
include our managed services, product sales, and cellular telephone services.
Revenues included in the All Other category represented 9.7% of total revenues
in 2004.
All Other Revenues and Cost of Goods Sold
All Other revenues increased 44.9% to $30.8 million in 2004. The increase is
primarily due to the following:
o $6.1 million in special project revenue earned from our fiber system
that transits the Trans Alaska oil pipeline corridor in 2004,
o Increased monthly revenue earned from our fiber system that transits
the Trans Alaska oil pipeline corridor,
o Revenue generated from our contract to provide services to the State of
Alaska starting in the first quarter of 2004, and
o Special project revenue for services sold to a certain customer.
The increase described above is partially off-set by a $693,000 decrease in
product sales revenue to $1.6 million in 2004. The decrease is due to sales of
product to two customers in 2003 that were not repeated in 2004.
All Other Cost of Goods Sold increased 52.6% to $17.5 million in 2004. The
increase in All Other Cost of Goods Sold is primarily due to the recognition of
$5.5 million in costs associated with special project revenue earned from our
fiber system that transits the Trans Alaska oil pipeline corridor in 2004, costs
associated with increased monthly revenue earned from our recurring service
contracts in 2004, and costs associated with the special project revenue
described above.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 6.1% to $108.8 million in
2004 primarily due to a $4.0 million increase in labor and health insurance
costs, a $2.3 million increase in contract labor
50
and contract services expenses associated with our SOX Section 404 compliance
efforts and other special projects, a $2.1 million increase in promotion
expenses in 2004 as compared to 2003, and a $1.1 million write-off of previously
capitalized mobile wireless network costs upon finalization of a long-term
distribution agreement,. The increases previously described are partially
off-set by a $2.8 million decrease in our company-wide success sharing bonus
accrual. As a percentage of total revenues, selling, general and administrative
expenses decreased to 34.1% in 2004 from 35.7% in 2003, primarily due to an
increase in revenues without a corresponding increase in selling, general and
administrative expenses.
Bad Debt Expense (Recovery)
Bad debt expense decreased 160.3% to a net recovery of ($1.2) million in 2004.
The 2004 decrease is primarily due to realization of approximately $3.4 million
of the MCI credit through a reduction to bad debt expense in 2004, as further
discussed in the "Long Distance Service Overview" above. We realized
approximately $647,000 of the MCI credit through a reduction to bad debt expense
in 2003.
Depreciation, Amortization and Accretion Expense
Depreciation, amortization and accretion expense increased 18.8% to $46.8
million in 2004. The increase is primarily attributed to our $45.8 million
investment in equipment and facilities placed into service during the
twelve-month period ended December 31, 2003 for which a full year of
depreciation will be recorded in the twelve-month period ended December 31,
2004, and the $96.5 million investment in equipment and facilities placed into
service during the nine-month period ended September 30, 2004 for which a
partial year of depreciation will be recorded in the twelve-month period ended
December 31, 2004.
Other Expense, Net
Other expense, net of other income, increased 2.0% to $29.6 million in 2004. The
increase is primarily due to the following:
o In 2004 we paid bond call premiums totaling $6.1 million to redeem our
old Senior Notes,
o As a result of redeeming our old Senior Notes in 2004 we recognized
$2.3 million in unamortized old Senior Notes fee expense, and
o A $1.0 million increase in interest expense on our new Senior Notes due
to an increase in the outstanding balance owed, partially off-set by a
decreased interest rate in 2004 as compared to 2003.
Partially offsetting the increases described above was a $7.1 million decrease
in interest expense in 2004 on our new Senior Credit Facility due to a decrease
in the average outstanding balance owed on our new Senior Credit Facility and a
decreased new Senior Credit Facility interest rate as compared to 2003.
Income Tax Expense
Income tax expense was $11.5 million in 2004 and $9.6 million in 2003. The
change was due to increased net income before income taxes and cumulative effect
of a change in accounting principle in 2004 as compared to 2003. Our effective
income tax rate decreased from 43.6% in 2003 to 37.8% in 2004 due to the
decreasing proportion of items that are nondeductible for income tax purposes
and adjustment of deferred tax assets and liabilities in 2004.
51
Cumulative Effect of a Change in Accounting Principle
On January 1, 2003 we adopted SFAS No. 143, "Accounting for Asset Retirement
Obligations," and recorded the cumulative effect of accretion and depreciation
expense as a cumulative effect of a change in accounting principle of
approximately $544,000, net of income tax benefit of $367,000.
Liquidity and Capital Resources
Cash flows from operating activities totaled $62.9 million in 2004 as compared
to $49.4 million in 2003. The 2004 increase is primarily due to increased cash
flow from all of our reportable segments and All Other Services, partially
off-set by a $4.3 million payment of our company-wide success sharing bonus in
2004, a $2.7 million increase in the MCI credit recovery, as further discussed
in the "Long Distance Service Overview" above, and a $2.3 million refund in 2003
from a local exchange carrier in respect of its earnings that exceeded
regulatory requirements.
Other sources of cash during 2004 include $245.7 million from the issuance of
our new Senior Notes, draws of $20.0 million under the revolving credit portion
of our new Senior Credit Facility, $2.2 million from the issuance of our Class A
common stock, and $1.8 million in payments of notes receivable from related
parties. Uses of cash during 2004 included expenditures of $82.8 million for
property and equipment, including construction in progress, the $180.0 million
repayment of our old Senior Notes, the $53.8 million repayment of the term and
revolving credit portions of our new Senior Credit Facility, payment of $6.7
million in fees associated with the new Senior Notes and new Senior Credit
Facility, payment of bond call premiums totaling $6.1 million to redeem our old
Senior Notes, and repayment of $3.5 million in capital lease obligations.
Net receivables increased $5.3 million from December 31, 2003 to September 30,
2004 primarily due to the timing of payments on trade receivables from certain
large customers and an increase in trade receivables for broadband services
provided to hospitals and health clinics. The increase in net receivables is
partially off-set by the February 2004 receipt of $5.6 million on a trade
receivable for broadband services provided to hospitals and health clinics.
Working capital totaled $26.4 million at September 30, 2004, an $18.3 million
increase as compared to $8.1 million at December 31, 2003. The increase is
primarily due to draws under the revolving credit portion of our new Senior
Credit Facility in January and May 2004 totaling $15.0 million primarily used to
fund our old Senior Notes interest payment in February 2004 and to pay an
accrued capital expenditure related to AULP West.
In February 2004 GCI's wholly owned subsidiary GCI, Inc. sold $250 million in
aggregate principal amount of senior unsecured debt securities due in 2014. We
pay interest of 7.25% on the new Senior Notes. The new Senior Notes were sold at
a discount of $4.3 million. The Senior Notes are carried on our Consolidated
Balance Sheet net of the unamortized portion of the discount, which is being
amortized to Interest Expense over the life of the new Senior Notes.
The net proceeds of the offering were primarily used to repay our existing
$180.0 million 9.75% Senior Notes and to repay approximately $43.8 million of
the term portion and $10.0 million of the revolving portion of our new Senior
Credit Facility. A semi-annual interest payment of approximately $9.1 million
was paid in August 2004; the next semi-annual interest payment will be made in
February 2004. In
52
connection with the issuance, we paid fees and other expenses of approximately
$6.4 million that are being amortized over the life of the new Senior Notes.
The new Senior Notes sold in February 2004 were offered only to qualified
institutional buyers pursuant to exemptions from registration under the
Securities Act. On July 7, 2004, GCI, Inc. commenced an offer to exchange the
privately issued new Senior Notes for a like amount of new Senior Notes that
have been registered under the Securities Act and have otherwise identical terms
to the privately issued new Senior Notes (except for provisions relating to GCI,
Inc.'s obligations to consummate the exchange offer). The exchange offer closing
occurred on August 11, 2004, at which time all $250.0 million in aggregate
principal amount of the privately issued new Senior Notes were tendered and
exchanged for the new Senior Notes that have been registered under the
Securities Act.
The new Senior Notes are not redeemable prior to February 15, 2009. At any time
on or after February 15, 2009, the new Senior Notes are redeemable at our
option, in whole or in part, on not less than thirty days nor more than sixty
days notice, at the following redemption prices, plus accrued and unpaid
interest (if any) to the date of redemption:
If redeemed during the twelve month period
commencing February 1 of the year indicated: Redemption Price
-------------------------------------------- ------------------
2009 103.625%
2010 102.417%
2011 101.208%
2012 and thereafter 100.000%
We may, on or prior to February 17, 2007, at our option, use the net
cash proceeds of one or more underwritten public offerings of our qualified
stock to redeem up to a maximum of 35% of the initially outstanding aggregate
principal amount of our new Senior Notes at a redemption price equal to 107.25%
of the principal amount of the new Senior Notes, together with accrued and
unpaid interest, if any, thereon to the date of redemption, provided that not
less than 65% of the principal amount of the new Senior Notes originally issued
remain outstanding following such a redemption.
The new Senior Notes restrict GCI, Inc. and certain of its subsidiaries from
incurring debt in most circumstances unless the result of incurring debt does
not cause our leverage ratio to exceed 6.0 to one. The new Senior Notes do not
allow debt under the new Senior Credit Facility to exceed the greater of (and
reduced by certain stated items):
o $250 million, reduced by the amount of any prepayments, or
o 3.0 times earnings before interest, taxes, depreciation and
amortization for the last four full fiscal quarters of GCI, Inc. and
certain of its subsidiaries.
The new Senior Notes limit our ability to make cash dividend payments.
53
We conducted a Consent Solicitation and Tender Offer for the old Senior Notes.
Through February 13, 2004 we accepted for payment $114.6 million principal
amount of notes which were validly tendered. Such notes accepted for payment
received additional consideration as follows:
o $4.0 million based upon a payment of $1,035 per $1,000 principal
amount, consisting of the purchase price of $1,025 per $1,000 principal
amount and the consent payment of $10 per $1,000 principal amount, and
o $497,000 in accrued and unpaid interest through February 16, 2004.
The remaining principal amount of $65.4 million was redeemed on March 18, 2004
for additional consideration as follows:
o $2.1 million based upon a payment of $1,032.50 per $1,000 principal
amount, and
o $833,000 in accrued and unpaid interest through March 18, 2004.
The total redemption cost was $186.1 million. The premium to redeem our old
Senior Notes was $6.1 million (excluding interest cost of $1.3 million) and was
recognized as a loss on early extinguishment of debt, a component of Other
Income (Expense), during the nine months ended September 30, 2004.
Compliance with the redemption notice requirements in the Indenture resulted in
a delay before final payment of some of the old Senior Notes. As a result of
such delay, our total debt increased during the overlap period between the
redemption of the old Senior Notes and the issuance of the new Senior Notes
making us out of compliance with Section 6.11 of our Credit, Guaranty, Security
and Pledge Agreement, dated as of October 30, 2003. We received a waiver from
compliance with Section 6.11 until April 30, 2004. After the final redemption
payment on March 18, 2004 we were in compliance with Section 6.11.
In 2004 we drew the following amounts under the revolving credit portion of our
new Senior Credit Facility (amounts in millions):
January 2004 $ 10.0
May 2004 5.0
August 2004 5.0
-------
$ 20.0
=======
Our ability to draw down on the revolving portion of our new Senior Credit
Facility could be diminished if we are not in compliance with all new Senior
Credit Facility covenants or have a material adverse change at the date of the
request for the draw. In February 2004 we used a portion of the proceeds from
the issuance of our new Senior Notes to repay approximately $43.8 million of the
term portion and $10.0 million of the revolving portion of our new Senior Credit
Facility.
54
On May 21, 2004 we amended our $220.0 million new Senior Credit Facility. The
amendment reduced the interest rate on the $170.0 million term portion of the
credit facility from LIBOR plus 3.25% to LIBOR plus 2.25%. The amendment reduced
the interest rate on the $50.0 million revolving portion of the credit facility
from LIBOR plus 3.25% to LIBOR plus a margin dependent upon our Total Leverage
Ratio (as defined) as follows:
Total Leverage Ratio
(as defined) LIBOR Plus:
---------------------- --------------------
>3.75 2.50%
-
>3.25 but <3.75 2.25%
-
>2.75 but <3.25 2.00%
-
< 2.75 1.75%
The commitment fee we are required to pay on the unused portion of the
commitment was amended as follows:
Total Leverage Ratio
(as defined) Commitment Fee
---------------------- --------------------
>3.75 0.625%
-
>3.25 but <3.75 0.50%
-
>2.75 but <3.25 0.50%
-
< 2.75 0.375%
Under certain circumstances the amendment allows for an increase in the term and
revolving commitments not to exceed an aggregate commitment increase of $50.0
million. Any additional term and revolving credit facility commitments are
payable in full on October 31, 2007.
In connection with the May 21, 2004 amended Senior Credit Facility, we paid bank
fees and other expenses of approximately $103,000 and $253,000 during the three
and nine months ended September 30, 2004, respectively.
We were in compliance with all loan covenants at September 30, 2004.
Our expenditures for property and equipment, including construction in progress,
totaled $82.8 million and $34.4 million during 2004 and 2003, respectively. Our
capital expenditures requirements in excess of approximately $25 million per
year, excluding the AULP West fiber optic cable system construction costs, are
largely success driven and are a result of the progress we are making in the
marketplace. We expect our 2004 expenditures for property and equipment for our
core operations, including construction in progress and excluding the AULP West
fiber optic cable system construction costs and other special projects described
below, to total approximately $65 million, depending on available opportunities
and the amount of cash flow we generate during 2004.
In June 2004 we placed into service our AULP West fiber optic cable system
connecting Seward, Alaska and Warrenton, Oregon, with leased backhaul facilities
connecting it to our switching and distribution centers in Anchorage, Alaska and
Seattle, Washington. The 1,544-statute mile cable system has a total design
capacity of 960 Gigabits per second access speed. The cable complements our
existing fiber optic cable system between Whittier, Alaska and Seattle,
Washington. The two cables provide physically diverse backup to each other in
the event of an outage. During 2004 our capital expenditures for this
55
project have totaled approximately $32.0 million, and from inception have
totaled $50.1 million, most of which have been funded through our operating cash
flows.
Planned capital expenditures over the next five years include those necessary
for continued expansion of our long-distance, local exchange and Internet
facilities, supplementing our existing network backup facilities, continuing
development of our Personal Communications Services ("PCS") network, continuing
deployment of DLPS, and upgrades to and expansions of our cable television
plant.
In April 2004 we successfully launched our DLPS service delivery method. To
ensure the necessary equipment is available to us we have entered into an
agreement to purchase a certain number of outdoor, network powered multi-media
adapters. The agreement has a remaining outstanding commitment at September 30,
2004 of $15.3 million.
A migration of MCI's or Sprint's traffic off our network without it being
replaced by other common carriers that interconnect with our network could have
a materially adverse impact on our financial position, results of operations and
liquidity.
Dividends accrued on our Series B preferred stock are payable in cash at the
semi-annual payment dates of April 30 and October 31 of each year. In January
2004, 3,108 shares of our Series B preferred stock were converted to 560,000
shares of our Class A common stock at the stated conversion price of $5.55 per
share. In August 2004, 3,328 shares of our Series B preferred stock were
converted to 599,640 shares of our Class A common stock at the stated conversion
price of $5.55 per share. The conversions will reduce our future semi-annual
cash dividends. In April 2004 we paid a Series B preferred stock dividend of
approximately $592,000. In October 2004 we will pay a Series B preferred stock
dividend of approximately $484,000.
Dividends accrued on our Series C preferred stock are payable quarterly in cash.
During the nine months ending September 30, 2004 we paid a Series C preferred
stock dividend of approximately $450,000.
GCI's board of directors has authorized the repurchase of up to $5.0 million per
quarter of our Class A and Class B common stock. We have obtained permission
from our lenders and preferred shareholders for the first $10.0 million of
repurchases. During the three and nine months ended September 30, 2004 we have
repurchased 28,000 shares of our Class A common stock at a cost of approximately
$252,000. We expect to continue the repurchases subject to the availability of
free cash flow, credit facilities, the price of our Class A and Class B common
stock and the requisite consents of lenders and preferred shareholders. The
repurchase will comply with the restrictions of SEC rule 10b-18.
The long-distance, local access, cable, Internet and wireless services
industries continue to experience substantial competition, regulatory
uncertainty, and continuing technological changes. Our future results of
operations will be affected by our ability to react to changes in the
competitive and regulatory environment and by our ability to fund and implement
new or enhanced technologies. We are unable to determine how competition,
economic conditions, and regulatory and technological changes will affect our
ability to obtain financing under acceptable terms and conditions.
We believe that we will be able to meet our current and long-term liquidity and
capital requirements, fixed charges and preferred stock dividends through our
cash flows from operating activities, existing cash, cash equivalents,
short-term investments, credit facilities, and other external financing and
equity
56
sources. Should cash flows be insufficient to support additional borrowings and
principal payments scheduled under our existing credit facilities, capital
expenditures will likely be reduced.
New Accounting Standards
In March 2004, the Emerging Issues Task Force ("EITF") reached final consensuses
on Issue No. 03-6, "Participating Securities and the Two-Class Method under FASB
Statement No. 128, Earnings per Share." EITF Issue No. 03-6 addresses the
computation of earnings per share by companies that have issued securities other
than common stock that contractually entitle the holder to participate in
dividends and earnings of the company when, and if, it declares dividends on its
common stock. The issue also provides further guidance in applying the two-class
method of calculating earnings per share. EITF Issue No. 03-6 is effective for
fiscal periods beginning after March 31, 2004, and prior period earnings per
share amounts presented for comparative purposes should be restated to conform
to the consensus guidance. We have not issued securities other than common stock
that contractually entitle the holder to participate in dividends and earnings
when, and if, we declare dividends on our common stock. We do not believe EITF
Issue No. 03-6 will have an effect on our EPS.
In October 2004, the FASB concluded that SFAS No. 123R, "Share-Based Payment,"
("SFAS No. 123R") which would require all companies to measure compensation cost
for all share-based payments (including employee stock options) at fair value,
would be effective for public companies for interim or annual periods beginning
after June 15, 2005. Retroactive application of the requirements of SFAS No. 123
(not SFAS No. 123R) to the beginning of the fiscal year that includes the
effective date would be permitted, but not required. The FASB plans to issue a
final statement on or around December 15, 2004. We are evaluating the impact of
SFAS No. 123R on our results of operations, financial position, and cash flows.
In October 2004, the FASB ratified the consensus reached by the EITF with
respect to EITF Issue No. 04-10, "Determining Whether to Aggregate Operating
Segments That Do Not Meet the Quantitative Thresholds," which clarifies the
guidance in paragraph 19 of SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." According to EITF Issue No. 04-10,
operating segments that do not meet the quantitative thresholds can be
aggregated only if aggregation is consistent with the objective and basic
principles of SFAS No. 131, the segments have similar economic characteristics,
and the segments share a majority of the aggregation criteria listed in items
(a)-(e) in paragraph 17 of SFAS No. 131. The consensus applies to fiscal years
ending after October 13, 2004. We do not believe EITF 04-10 will result in a
material change to our SFAS No. 131 disclosure.
Critical Accounting Policies
Our accounting and reporting policies comply with accounting principles
generally accepted in the United States of America. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions. The financial position and results
of operations can be affected by these estimates and assumptions, which are
integral to understanding reported results. Critical accounting policies are
those policies that management believes are the most important to the portrayal
of the Company's financial condition and results, and require management to make
estimates that are difficult, subjective or complex. Most accounting policies
are not considered by management to be critical accounting policies. Several
factors are considered in determining whether or not a policy is critical in the
preparation of financial statements. These factors include, among other things,
whether the estimates are significant to the
57
financial statements, the nature of the estimates, the ability to readily
validate the estimates with other information including third parties or
available prices, and sensitivity of the estimates to changes in economic
conditions and whether alternative accounting methods may be utilized under
accounting principles generally accepted in the United States of America. For
all of these policies, management cautions that future events rarely develop
exactly as forecast, and the best estimates routinely require adjustment.
Management has discussed the development and the selection of critical
accounting policies with the Company's Audit Committee.
Those policies considered to be critical accounting policies for the nine months
ended September 30, 2004 are described below.
o We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required
payments. We base our estimates on the aging of our accounts receivable
balances, financial health of specific customers, and our historical
write-off experience, net of recoveries. If the financial condition of
our customers were to deteriorate or if they are unable to emerge from
reorganization proceedings, resulting in an impairment of their ability
to make payments, additional allowances may be required. If their
financial condition improves or they emerge successfully from
reorganization proceedings, allowances may be reduced. Such allowance
changes could have a material effect on our consolidated financial
condition and results of operations.
o We record all assets and liabilities acquired in purchase acquisitions,
including goodwill and other intangibles, at fair value as required by
SFAS No. 141, "Business Combinations." Goodwill and indefinite-lived
assets such as our cable certificates are not amortized but are
subject, at a minimum, to annual tests for impairment and quarterly
evaluations of whether events and circumstances continue to support an
indefinite useful life as required by SFAS No. 142. Other intangible
assets are amortized over their estimated useful lives using the
straight-line method, and are subject to impairment if events or
circumstances indicate a possible inability to realize the carrying
amount as required by SFAS No. 142. The initial goodwill and other
intangibles recorded and subsequent impairment analysis requires
management to make subjective judgments concerning estimates of the
applicability of quoted market prices in active markets and, if quoted
market prices are not available and/or are not applicable, how the
acquired asset will perform in the future using a discounted cash flow
analysis. Estimated cash flows may extend beyond ten years and, by
their nature, are difficult to determine over an extended timeframe.
Events and factors that may significantly affect the estimates include,
among others, competitive forces, customer behaviors and attrition,
changes in revenue growth trends, cost structures and technology, and
changes in discount rates, performance compared to peers, material and
ongoing negative economic trends, and specific industry or market
sector conditions. In determining the reasonableness of cash flow
estimates, we review historical performance of the underlying asset or
similar assets in an effort to improve assumptions utilized in our
estimates. In assessing the fair value of goodwill and other
intangibles, we may consider other information to validate the
reasonableness of our valuations including third-party assessments.
These evaluations could result in a change in useful lives in future
periods and could result in write-down of the value of intangible
assets. The SEC Staff Announcement issued on September 29, 2004
requires us to value our indefinite-lived intangible assets other than
goodwill using the direct value method for impairment testing purposes
no later than January 1, 2005. Our cable certificate assets are our
only indefinite-lived intangible assets and were originally valued and
recorded using the residual method. Because of the significance of the
58
identified intangible assets and goodwill to our consolidated balance
sheet, our annual impairment analysis pursuant to the SEC Staff
Announcement and quarterly evaluation of remaining useful life will be
critical. Any changes in key assumptions about the business and its
prospects, changes in market conditions or other externalities, or
recognition of previously unrecognized intangible assets for impairment
testing purposes could result in an impairment charge and such a charge
could have a material adverse effect on our consolidated results of
operations. Refer to note 1(i) and note 3 in the accompanying "Notes to
Interim Condensed Consolidated Financial Statements" for additional
information regarding the SEC Staff Announcement and intangible assets,
respectively.
o We estimate unbilled long-distance services segment Cost of Goods Sold
based upon minutes of use carried through our network and established
rates. We estimate unbilled costs for new circuits and services, and
when network changes occur that result in traffic routing changes or a
change in carriers. Carriers that provide service to us regularly make
network changes that can lead to new, revised or corrected billings.
Such estimates are revised or removed when subsequent billings are
received, payments are made, billing matters are researched and
resolved, tariffed billing periods lapse, or when disputed charges are
resolved. Revisions to previous estimates could either increase or
decrease costs in the year in which the estimate is revised which could
have a material effect on our consolidated financial condition and
results of operations.
o Our income tax policy provides for deferred income taxes to show the
effect of temporary differences between the recognition of revenue and
expenses for financial and income tax reporting purposes and between
the tax basis of assets and liabilities and their reported amounts in
the financial statements in accordance with SFAS No. 109, "Accounting
for Income Taxes." We have recorded deferred tax assets of
approximately $71.0 million associated with income tax net operating
losses that were generated from 1990 to 2003, and that expire from 2007
to 2023. Pre-acquisition income tax net operating losses associated
with acquired companies are subject to additional deductibility limits.
We have recorded deferred tax assets of approximately $2.0 million
associated with alternative minimum tax credits that do not expire.
Significant management judgment is required in developing our provision
for income taxes, including the determination of deferred tax assets
and liabilities and any valuation allowances that may be required
against the deferred tax assets. In conjunction with certain 1996
acquisitions, we determined that approximately $20 million of the
acquired net operating losses would not be utilized for income tax
purposes, and elected with our December 31, 1996 income tax returns to
forego utilization of such acquired losses. Deferred tax assets were
not recorded associated with the foregone losses and, accordingly, no
valuation allowance was provided. We have not recorded a valuation
allowance on the deferred tax assets as of September 30, 2004 based on
management's belief that future reversals of existing taxable temporary
differences and estimated future taxable income exclusive of reversing
temporary differences and carryforwards, will, more likely than not, be
sufficient to realize the benefit of these assets over time. In the
event that actual results differ from these estimates or if our
historical trends change, we may be required to record a valuation
allowance on deferred tax assets, which could have a material adverse
effect on our consolidated financial position, results of operations or
liquidity.
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.
59
Policies related to revenue recognition and financial instruments require
difficult judgments on complex matters that are often subject to multiple
sources of authoritative guidance. Certain of these matters, including but not
limited to the requirement to account for the fair value of stock options as
compensation expense, are among topics currently under reexamination by
accounting standards setters and regulators. With the exception of accounting
for the cost of stock options, no specific conclusions reached by these standard
setters appear likely to cause a material change in our accounting policies,
although outcomes cannot be predicted with confidence. A complete discussion of
our significant accounting policies can be found in note 1 in the "Notes to
Consolidated Financial Statements" included in our December 31, 2003 annual
report on Form 10-K. A condensed discussion of our significant accounting
policies can be found in note 1 in the accompanying "Notes to Interim Condensed
Consolidated Financial Statements."
Geographic Concentration and the Alaska Economy
We offer voice and data telecommunication and video services to customers
primarily throughout Alaska. Because of this geographic concentration, growth of
our business and of our operations depends upon economic conditions in Alaska.
The economy of Alaska is dependent upon the natural resource industries, and in
particular oil production, as well as investment earnings, tourism, government,
and United States military spending. Any deterioration in these markets could
have an adverse impact on us. All of the federal funding and the majority of
investment revenues are dedicated for specific purposes, leaving oil revenues as
the primary source of general operating revenues. In fiscal 2003 the State's
actual results indicate that Alaska's oil revenues, federal funding and
investment revenues supplied 36%, 30% and 21%, respectively, of the state's
total revenues. In fiscal 2004 state economists forecast that Alaska's oil
revenues, federal funding and investment revenues will supply 23%, 25% and 44%,
respectively, of the state's total projected revenues.
The volume of oil transported by the TransAlaska Oil Pipeline System over the
past 20 years has been as high as 2.0 million barrels per day in fiscal 1988.
Production has been declining over the last several years with an average of
0.991 million barrels produced per day in fiscal 2003. The state forecasts the
production rate to decline from 0.985 million barrels produced per day in fiscal
2004 to 0.843 million barrels produced per day in fiscal 2015.
Market prices for North Slope oil averaged $28.15 in fiscal 2003 and are
forecasted to average $31.13 in fiscal 2004. The closing price per barrel was
$44.63 on November 3, 2004. To the extent that actual oil prices vary materially
from the state's projected prices the state's projected revenues and deficits
will change. When the price of oil is greater than $23.00 per barrel, every $1
change in the price per barrel of oil is forecasted to result in a $40.0 to
$70.0 million change in the state's fiscal 2004 revenue. The production policy
of the Organization of Petroleum Exporting Countries and its ability to continue
to act in concert represents a key uncertainty in the state's revenue forecast.
The State of Alaska maintains the Constitutional Budget Reserve Fund that is
intended to fund budgetary shortfalls. If the state's current projections are
realized, the Constitutional Budget Reserve Fund will be depleted in 2008. The
date the Constitutional Budget Reserve Fund is depleted is highly influenced by
the price of oil. If the fund is depleted, aggressive state action will be
necessary to increase revenues and reduce spending in order to balance the
budget. The governor of the State of Alaska and the Alaska legislature continue
to evaluate cost cutting and revenue enhancing measures.
60
Should new oil discoveries or developments not materialize or the price of oil
become depressed, the long term trend of continued decline in oil production
from the Prudhoe Bay area is inevitable with a corresponding adverse impact on
the economy of the state, in general, and on demand for telecommunications and
cable television services, and, therefore, on us, in particular. Periodically
there are renewed efforts to allow exploration and development in the Arctic
National Wildlife Refuge ("ANWR"). The United States Energy Information Agency
estimates it could take nine years to begin oil field drilling after approval of
ANWR exploration.
Deployment of a natural gas pipeline from the State of Alaska's North Slope to
the Lower 48 States has been proposed to supplement natural gas supplies. A
competing natural gas pipeline through Canada has also been proposed. The
economic viability of a natural gas pipeline depends upon the price of and
demand for natural gas. Either project could have a positive impact on the State
of Alaska's revenues and could provide a substantial stimulus to the Alaska
economy. In October 2004 both houses of Congress passed and the President signed
legislation allowing loan guarantees of up to $18.0 billion, certain favorable
income tax provisions and tax credits, and expedited permitting and judicial
review for the construction of an Alaska natural gas pipeline. To support the
construction of a natural gas pipeline, the governor of the State of Alaska has
announced that he believes the state must assume some level of shipper risk,
serve as an equity partner or both. The State of Alaska is actively negotiating
two applications to construct a natural gas pipeline. The governor of the State
of Alaska has indicated his desire to submit a contract from one or more of
these groups to the Alaska legislature in January 2005.
Development of the ballistic missile defense system project may have a
significant impact on Alaskan telecommunication requirements and the Alaska
economy. The system is a fixed, land-based, non-nuclear missile defense system
with a land and space based detection system capable of responding to limited
strategic ballistic missile threats to the United States. The system includes
deployment of up to 100 ground-based interceptor silos and battle management
command and control facilities at Fort Greely, Alaska.
The United States Army Corps of Engineers awarded a construction contract in
2002 for test bed facilities. The contract is reported to contain basic
requirements and various options that could amount to $250 million in
construction, or possibly more, if all items are executed. Construction began on
the Fort Greely test bed in 2002. The first ground-based missile interceptor was
placed in an underground silo on July 22, 2004. The Missile Defense Agency is
reported to expect to have up to ten more interceptors emplaced by the end of
2005.
Tourism, air cargo, and service sectors have helped offset the prevailing
pattern of oil industry downsizing that has occurred during much of the last
several years.
We have, since our entry into the telecommunication marketplace, aggressively
marketed our services to seek a larger share of the available market. The
customer base in Alaska is limited, however, with a population of approximately
644,000 people. The State of Alaska's population is distributed as follows:
o 42% are located in the Municipality of Anchorage,
o 13% are located in the Fairbanks North Star Borough,
o 10% are located in the Matanuska-Susitna Borough,
o 5% are located in the City and Borough of Juneau, and
o The remaining 30% are located in other communities across the State of
Alaska.
61
No assurance can be given that the driving forces in the Alaska economy, and in
particular, oil production, will continue at appropriate levels to provide an
environment for expanded economic activity.
No assurance can be given that oil companies doing business in Alaska will be
successful in discovering new fields or further developing existing fields which
are economic to develop and produce oil with access to the pipeline or other
means of transport to market, even with a reduced level of royalties. We are not
able to predict the effect of changes in the price and production volumes of
North Slope oil on Alaska's economy or on us.
Seasonality
Long-distance revenues (primarily those derived from our other common carrier
customers) have historically been highest in the summer months because of
temporary population increases attributable to tourism and increased seasonal
economic activity such as construction, commercial fishing, and oil and gas
activities. Cable television revenues are higher in the winter months because
consumers spend more time at home and tend to watch more television during these
months. Local access and Internet services do not exhibit significant
seasonality. Our ability to implement construction projects is also hampered
during the winter months because of cold temperatures, snow and short daylight
hours.
Schedule of Certain Known Contractual Obligations
The following table details future projected payments associated with our
certain known contractual obligations as of December 31, 2003, the date of our
most recent fiscal year-end balance sheet. Our schedule of certain known
contractual obligations has been updated to reflect our issuance of new Senior
Notes, redemption of our old Senior Notes, and conversion of shares of Series B
preferred stock to shares of GCI Class A common stock in January and August
2004.
Payments Due by Period
---------------------------------------------------------------
Less than 1 1 to 3 4 to 5 More Than 5
Total Year Years Years Years
------------- ----------- ---------- ------------ -------------
(Amounts in thousands)
Long-term debt $ 366,914 --- 32,168 89,002 245,744
Interest on long-term debt 190,026 17,838 36,250 36,250 99,688
Capital lease obligations, including
interest 61,902 8,448 19,201 15,775 18,478
Operating lease commitments 69,473 12,357 20,787 13,230 23,099
Redeemable preferred stock 22,659 --- 10,000 --- 12,659
Purchase obligations 71,038 45,024 20,303 5,711 ---
------------- ----------- ---------- ------------ -------------
Total contractual obligations $ 782,012 83,667 138,709 159,968 399,668
============= =========== ========== ============ =============
For long-term debt included in the above table, we have included principal
payments on our new Senior Credit Facility and on our new Senior Notes. Interest
on amounts outstanding under our new Senior Credit Facility is based on variable
rates and therefore the amount is not determinable. Our old Senior Notes
required semi-annual interest payments of approximately $8.8 million through
February 2004, after which they were repaid using funds from the issuance of our
new Senior Notes. Our new Senior
62
Notes require semi-annual interest payments of approximately $9.1 million
through February 2014. For a discussion of our long-term debt, including the
redemption of our old Senior Notes, issuance of new Senior Notes and the use of
proceeds from the issuance of new Senior Notes to pay down our new Senior Credit
Facility, see note 5 to the accompanying "Notes to Interim Condensed
Consolidated Financial Statements."
For a discussion of our capital and operating leases, see note 16 to the "Notes
to Consolidated Financial Statements" included in Part II of our December 31,
2003 annual report on Form 10-K.
We have included only the maturity redemption amounts on our Series B and C
preferred stock (cash dividends are excluded). Our Series B preferred stock is
convertible at $5.55 per share into GCI Class A common stock. Dividends are
payable in cash semi-annually at the rate of 8.5%, plus accrued but unpaid
dividends. Mandatory redemption is required 12 years from the date of closing.
In January and August 2004, a Series B preferred stockholder converted 3,108 and
3,328 shares of Series B preferred stock, respectively, to GCI Class A common
stock. Our Series C preferred stock is convertible at $12 per share into GCI
Class A common stock, is non-voting, and pays a 6% per annum quarterly cash
dividend. We may redeem the Series C preferred stock at any time in whole but
not in part. Mandatory redemption is required at any time after the fourth
anniversary date at the option of holders of 80% of the outstanding shares of
the Series C preferred stock. For more information about our redeemable
preferred stock, see notes 1(e) and 17 to the "Notes to Consolidated Financial
Statements" included in Part II of our December 31, 2003 annual report on Form
10-K.
Purchase obligations at December 31, 2003 are further described in note 16 to
the "Notes to Consolidated Financial Statements" included in Part II of our
December 31, 2003 annual report on Form 10-K and include the following:
o The remaining construction commitment for our fiber optic cable system
of $17.6 million,
o The remaining DLPS equipment purchase commitment of $17.4 million, and
o The remaining $16.0 million commitment for our Alaska Airlines
agreement.
The contracts associated with these commitments are non-cancelable. Purchase
obligations also include other commitments for goods and services for capital
projects and normal operations which are not included in our Consolidated
Balance Sheets at December 31, 2003, because the goods had not been received or
the services had not been performed at December 31, 2003.
PART I.
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various types of market risk in the normal course of business,
including the impact of interest rate changes. We do not hold derivatives for
trading purposes.
Our new Senior Credit Facility carries interest rate risk. Amounts borrowed
under this Agreement bear interest at Libor plus 2.25% or less depending upon
our Total Leverage Ratio (as defined). Should the Libor rate change, our
interest expense will increase or decrease accordingly. As of September 30,
2004, we have borrowed $131.2 million subject to interest rate risk. On this
amount, a 1% increase in the interest rate would result in $1,312,000 in
additional gross interest cost on an annualized basis.
63
The interest rate swap agreement to convert $25.0 million of variable interest
rate debt to 3.98% fixed rate debt plus applicable margin terminated on
September 21, 2004.
Our Satellite Transponder Capital Lease carries interest rate risk. Amounts
borrowed under this Agreement bear interest at Libor plus 3.25%. Should the
Libor rate change, our interest expense will increase or decrease accordingly.
As of September 30, 2004, we have borrowed $40.2 million subject to interest
rate risk. On this amount, a 1% increase in the interest rate would result in
$402,000 in additional gross interest cost on an annualized basis.
PART I.
ITEM 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation
of the effectiveness of the design and operation of our "disclosure controls and
procedures" (as defined in the Securities Exchange Act of 1934 ("Exchange Act")
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 upon that evaluation, our Chief Executive Officer and our Chief
Financial Officer concluded that our disclosure controls and procedures are
effective.
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in our reports
filed or submitted under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed in our
reports filed under the Exchange Act is accumulated and communicated to
management to allow timely decisions regarding required disclosure.
Changes in Internal Controls
There were no changes in our internal control over financial reporting during
the third quarter of 2004 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
There were no significant changes in our internal controls or, to our knowledge,
in other factors that could significantly affect our disclosure controls and
procedures subsequent to the date we carried out this evaluation.
We may enhance, modify, and supplement internal controls and disclosure controls
and procedures based on experience.
Sarbanes-Oxley Act of 2002 Section 404 Compliance
Section 404 of the Sarbanes Oxley Act of 2002 requires that we evaluate and
report on our system of internal controls over financial reporting and have our
auditor attest to such evaluation. We have prepared an internal plan of action
for compliance and we are in the
64
process of documenting, testing and remediating our system of internal controls
to provide the basis for our report. Due to ongoing evaluation and testing of
our internal controls and the uncertainties of the interpretation of these new
requirements, we cannot assure you that there may not be significant
deficiencies or material weaknesses that would be required to be reported.
PART II.
ITEM 1.
LEGAL PROCEEDINGS
Information regarding pending legal proceedings to which we are a party is
included in note 7 to the accompanying "Notes to Interim Condensed Consolidated
Financial Statements" and is incorporated herein by reference.
PART II.
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Not applicable. (b) Not applicable.
(c) Repurchase made in the quarter ended September 30, 2004.
Issuer Purchases of Equity Securities
------------------------------------------------------------------------------------------------
Period (a) Total (b) Average (c) Total Number (d) Maximum Number
Number of Price Paid of Shares (or approximate
Shares per Share Purchased as Part Dollar Value) of
Purchased of Publicly Shares that May Yet
Announced Plans Be Purchased Under
or Programs the Plans or Programs
--------------------- --------------- -------------- ------------------- -----------------------
September 1, 2004
to September 30,
2004 28,000 (1) $9.03 28,000 $9.747 million
--------------------- --------------- -------------- ------------------- -----------------------
<FN>
(1) Open-market purchase.
</FN>
65
PART II.
ITEM 6.
EXHIBITS
Exhibit No. Description
--------------------------------------------------------------------------------------------------------
31 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
66
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.
GENERAL COMMUNICATION, INC.
Signature Title Date
- -------------------------------------- -------------------------------------------- -----------------------
/s/ Ronald A. Duncan President and Director November 4, 2004
- -------------------------------------- -----------------------
Ronald A. Duncan (Principal Executive Officer)
/s/ John M. Lowber Senior Vice President, Chief Financial November 4, 2004
- -------------------------------------- -----------------------
John M. Lowber Officer, Secretary and Treasurer
(Principal Financial Officer)
/s/ Alfred J. Walker Vice President, Chief Accounting November 4, 2004
- -------------------------------------- -----------------------
Alfred J. Walker Officer
(Principal Accounting Officer)
67