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, 1999 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO -------------- -------------- ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) -------------------- DELAWARE 52-2126573 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 510 L. STREET, SUITE 500, ANCHORAGE, ALASKA 99501 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (907) 297-3000 - ------------------------------------------------------------------------------- FORMER NAME, FORMER ADDRESS AND FORMER THREE MONTHS, IF CHANGED SINCE LAST REPORT: Not Applicable INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES NO /X/ ----------------------- ------------------- APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: INDICATE BY CHECK MARK WHETHER THE REGISTRANT HAS FILED ALL DOCUMENTS AND REPORTS REQUIRED TO BE FILED BY SECTIONS 12, 13, OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 SUBSEQUENT TO THE DISTRIBUTION OF SECURITIES UNDER A PLAN CONFIRMED BY A COURT. YES NO ------------------------ ----------------------- APPLICABLE ONLY TO CORPORATE ISSUERS: THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK, AS OF NOVEMBER 18, 1999 WAS 21,829,273. TABLE OF CONTENTS PAGE PART I. FINANCIAL INFORMATION NUMBER ------- Item 1. Financial Statements: Consolidated Balance Sheets as of September 30, 1999........................................................................3 Consolidated Statements of Operations for the Three and Nine Month Periods Ended September 30, 1999...................................4 Consolidated Statement of Stockholders' Equity for the Nine Months Ended September 30, 1999....................................................5 Consolidated Statements of Cash Flows For the Nine Months Ended September 30, 1999....................................................6 Notes to Consolidated Financial Statements......................................................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................................14 PART II. OTHER INFORMATION Item 1 Legal Proceedings..............................................................................25 Item 2 Changes in Securities and Use of Proceeds......................................................25 Item 3 Defaults upon Senior Securities................................................................25 Item 4 Submission of Matters to a Vote of Security Holders............................................25 Item 5 Other Information; Risk Factors...............................................................25 Item 6. Exhibits and Reports on Form 8-K...............................................................25 SIGNATURE........................................................................................................27 2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. CONSOLIDATED BALANCE SHEET (UNAUDITED, IN THOUSANDS EXCEPT SHARE AMOUNTS) SEPTEMBER 30, ASSETS 1999 ----------------- Current assets: Cash and cash equivalents $ 1,554 Accounts receivable-trade 49,031 Materials and supplies 7,588 Prepayments and other current assets 5,269 ----------------- Total current assets 63,442 Investments 1,790 Property, plant and equipment: Telecommunications 839,627 Less: Accumulated depreciation 445,512 ----------------- 394,115 Construction work in progress 34,481 ----------------- Property, plant and equipment, net 428,596 Intangible Assets 28,020 Goodwill 244,209 Debt issuance cost 36,149 Deferred charges and other assets 2,266 ----------------- Total assets $ 804,472 ================= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 4,990 Notes payable 10,000 Accounts payable-trade 14,056 Accounts payable-affiliates 366 Income taxes payable 707 Advance billings and customer deposits 6,551 Accrued and other current liabilities 20,241 ----------------- Total current liabilities 56,911 Long-term debt, net of current portion 610,443 Deferred income taxes (986) Unamortized investment tax credits 522 Other deferred credits and long-term liabilities 8,491 Minority interest 1,422 Commitments and contingencies -- Stockholders' equity: Common stock, $.01 par value; 40,000,000 shares authorized, 21,790,276 shares issued and outstanding 218 Paid in capital in excess of par value 140,837 Notes receivable from officers (862) Unearned compensation (1,864) Retained earnings (deficit) (10,660) ----------------- Total stockholders' equity 127,669 ----------------- Total liabilities and stockholders' equity $ 804,472 ================= SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 3 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED, IN THOUSANDS EXCEPT PER SHARE AMOUNTS) Three months ended Nine months ended September 30, 1999 September 30, 1999 ----------------- ------------------ Operating revenues: Local telephone $ 63,265 $95,640 Cellular 10,167 14,735 Long distance 2,678 4,065 ----------------- ------------------ Total operating revenues 76,110 114,440 Cost of sales and operating expenses: Local telephone 40,363 63,612 Cellular 6,014 9,053 Long Distance 3,516 5,091 Depreciation and amortization 15,615 23,708 ----------------- ------------------ Total cost of sales and operating expenses 65,508 101,464 ----------------- ------------------ Operating income 10,602 12,976 Other income and expense: Interest expense (15,680) (23,532) Interest income 287 515 Other (297) (793) ----------------- ------------------ Other income and expense, net (15,690) (23,810) ----------------- ------------------ Income (loss) before income taxes (5,088) (10,834) Income tax provision (benefit) (174) (174) ----------------- ------------------ Net income (loss) $ (4,914) $ (10,660) ================= ================== Net loss per share - basic and diluted $ (0.23) $ (0.51) ================= ================== Shares used in computing net loss per share 21,598 21,085 ================= ================== SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, 1999 (UNAUDITED, IN THOUSANDS EXCEPT SHARE AMOUNTS) PAID IN NOTES CAPITAL IN RECEIVABLE TOTAL COMMON IN EXCESS OF FROM UNEARNED ACCUMULATED STOCKHOLDERS' STOCK PAR VALUE OFFICERS COMPENSATION DEFICIT EQUITY ------- ------------ ---------- ------------ ----------- ------------- Balance, December 31, 1998 $ - $ - $ - $ - $ - $ - Issuance of 21,789,176 shares of common stock, $.01 par 218 133,884 - - - 134,102 Discount on warrants issued in conjunction with long-term debt - 5,089 - - - 5,089 Officers loans in conjunction with the issuance of stock - - (862) - - (862) Unearned compensation - 1,864 - (1,864) - - Net loss for the period January 1, 1999 to September 30, 1999 - - - - (10,660) (10,660) -------- ---------- ---------- ----------- ---------- --------- Balance, September 30, 1999 $ 218 $ 140,837 $ (862) $ (1,864) $ (10,660) $ 127,669 ======== ========== ========== ========== ========== ========= SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED, IN THOUSANDS) NINE MONTHS ENDED SEPTEMBER 30, 1999 ------------------ CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (10,660) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation 20,997 Amortization of debt issuance costs 1,751 Amortization of intangibles 2,712 Deferred income taxes (947) Deferred credits (436) Accounts receivable and other current assets 3,711 Accounts payable and other current liabilities 545 Other 1,528 --------------- Net cash provided by operating activities 19,201 CASH FLOWS FROM INVESTING ACTIVITIES: Construction (excluding interest capitalized on equity funds) (46,218) Cost of acquisition, net of cash received (691,855) Organizational costs (2,385) --------------- Net cash used by investing activities (740,458) CASH FLOWS FROM FINANCING ACTIVITIES: Net change in short-term notes payable 10,000 Proceeds from the issuance of long-term debt, net of discounts 613,632 Payments on long-term debt (1,275) Debt issuance costs (37,900) Issuance of common stock/warrants 138,354 --------------- Net cash provided by financing activities 722,811 Increase in cash 1,554 Cash and equivalents at beginning of the period -- --------------- Cash and equivalents at end of the period $ 1,554 =============== SUPPLEMENTAL CASH FLOW DATA: Interest Paid $ 11,148 Income Taxes Paid -- SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED SEPTEMBER 30, 1999 (UNAUDITED, DOLLARS IN THOUSANDS) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements for Alaska Communications Systems Group, Inc. and Subsidiaries (the Company) represent the operating results of the following four legal entities (see Note 2, Acquisitions): Alaska Communications Systems Group, Inc. (formerly ALEC Holdings, Inc.) Alaska Communications Systems Holdings, Inc. (formerly ALEC Acquisition Corporation) ALEC Acquisition Sub Corp., Inc. which acquired the stock of the PTI Alaska companies at the closing of the acquisitions. Alaska Communications Systems, Inc. which acquired the stock of ATU Long Distance, ATU Communications, Inc. and MACtel Inc. (collectively, "ATU") on May 14, 1999 and purchased a majority interest in Alaska Choice Television on September 30, 1999. A summary of significant accounting policies followed by the Company is set forth below: BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements are as of and for the three and nine-month periods ended September 30, 1999 and include the operations of Alaska Communications Systems Holdings for the full nine month period and the PTI Alaska companies, ATU Long Distance, ATU Communications and MACtel since their acquisition on May 14, 1999. These financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month period ended September 30, 1999 are not necessarily indicative of the results that may be expected for the full fiscal year or for any future period. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. REGULATION The local telephone exchange activities of the Company are subject to rate regulation by the Federal Communications Commission (FCC) for interstate telecommunication service, and the Regulatory Commission of Alaska (RCA) for intrastate and local exchange telecommunication service. The Company, as required by the FCC, accounts for such activity separately. Long distance services are subject to rate regulation as a non-dominant interexchange carrier by the FCC for interstate telecommunication services 7 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED SEPTEMBER 30, 1999 (UNAUDITED, DOLLARS IN THOUSANDS) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) and the RCA for intrastate telecommunication services. Cellular operations are not subject to rate regulation. PROPERTY, PLANT AND EQUIPMENT TELEPHONE plant is stated substantially at original cost of construction. Telephone plant retired in the ordinary course of business, together with cost of removal, less salvage, is charged to accumulated depreciation with no gain or loss recognized. Renewals and betterments of telephone plant are capitalized while repairs, as well as renewals of minor items, are charged to operating expense. The Company provides for depreciation of telephone plant on the straight-line method, using rates approved by the regulatory authorities. NON-TELEPHONE plant is stated at purchase cost and, when sold or retired, a gain or loss is recognized. Depreciation of such property is provided on the straight-line method over its estimated service live ranging from three to 15 years. CELLULAR LICENSES Cellular licenses are stated at net book value. Amortization is computed on the straight-line method over an estimated useful life of 40 years. These licenses are renewable at our option in perpetuity. GOODWILL Goodwill associated with the purchase of rural telephone properties is amortized on the straight-line method over 40 years and 15 years for all other goodwill. REVENUE RECOGNITION Recurring revenues are billed one month in advance and are deferred until the month earned. Nonrecurring revenues are billed in arrears and are recognized when earned. IMPAIRMENT OF LONG-LIVED ASSETS The Company has adopted FASB Statement No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. Under the provisions of this statement, the Company has evaluated its long-lived assets for impairment and will continue to evaluate them if events or changes in circumstance indicate the carrying amount of such assets may not be fully recoverable on an undiscounted cash flow basis. EARNINGS PER SHARE Earnings per share for the three and nine-month periods ended September 30, 1999 is based on the weighted average number of shares of common stock outstanding from July 1, 1999 through September 30, 1999 and May 14, 1999 through September 30, 1999, respectively (basic earnings per share) and dilutive common equivalent shares from stock options and warrants, using the treasury stock method (dilutive earnings per share). The nine-month weighted average number of shares outstanding is calculated from May 14, 1999 because the Company had no significant operations or outstanding shares prior to that date. Common stock equivalent shares were antidilutive for the three and nine-month periods ended September 30. 1999. 8 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED SEPTEMBER 30, 1999 (UNAUDITED, DOLLARS IN THOUSANDS) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) COMPREHENSIVE INCOME (LOSS) The Company has adopted FASB Statement No. 130, COMPREHENSIVE INCOME. The Company's comprehensive loss is equal to its net loss. 2. ACQUISITIONS On May 14, 1999, Alaska Communications Systems Holdings, Inc. ("ACS") acquired Century's Alaska holdings (PTI properties), including Telephone Utilities of Alaska, Inc., Telephone Utilities of the Northland, Inc., PTI Communications of Alaska, Inc., Pacific Telecom of Alaska PCS, Inc., and Pacific Telecom Cellular of Alaska, Inc., excluding the assets, liabilities and equity of Alaska RSA#1. On the same date, ACS also acquired from the Municipality of Anchorage ATU Communications, Inc. and its subsidiaries, MACtel and ATU Long Distance (collectively, "ATU"). These holdings include local area exchanges, long distance service, Internet service and cellular operations throughout rural Alaska and Anchorage. Both acquisitions were accounted for under the purchase method of accounting. The financial statements reflect the allocation of the purchase price and assumption of certain liabilities and include the operating results of both ATU and PTI properties from the date of acquisition. In total, the Company paid Century Telephone Enterprise $411,784 for the PTI properties and the Municipality of Anchorage $265,115 for the assets acquired. Acquisition expenses totaling $14,079 were also allocated to the purchase price. The purchase price information presented is subject to final settlement adjustments, which management does not expect to be material. The following reflects the preliminary allocation of the purchase price and the sources of funds to finance the purchase (in thousands). PTI PROPERTIES ATU TOTAL ---------- --- ------ Current assets................................................. $20,905 $45,142 $66,047 Property, plant & equipment.................................... 153,181 247,694 400,875 Other assets................................................... 9,765 20,750 30,515 Less liabilities assumed....................................... (12,701) (38,518) (51,219) -------- -------- -------- Net assets acquired............................................ 171,150 275,068 446,218 Goodwill....................................................... 244,593 167 244,760 ------- -------- -------- Total cost of acquisition...................................... 415,743 275,235 690,978 Acquisition expenses........................................... (3,959) (10,120) (14,079) -------- -------- ------- Total purchase price paid...................................... $411,784 $265,115 $676,899 ======== ======== ======== 9 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED SEPTEMBER 30, 1999 (UNAUDITED, DOLLARS IN THOUSANDS) 2. ACQUISITIONS (CONTINUED) Net assets acquired were purchased for cash provided from the following sources (in thousands): Revolving credit facility (of ACS)........................................................... $6,700 Term loan facilities (of ACS)................................................................ 435,000 9 3/8 % Senior subordinated notes due 2009 (of ACS).......................................... 150,000 13% Senior discount debentures due 2011...................................................... 19,911 Issuance of common stock/warrants............................................................ 126,289 ------- Total sources................................................................................ $737,900 ======== These sources also provided $12,601 of working capital and entailed $48,400 of transaction fees and expenses. The goodwill acquired will be amortized on a straight line basis over 40 years. The following are the pro forma results for the nine month periods ended September 30, 1998 and 1999, giving effect to the acquisitions as if they had occurred at the beginning of the periods (in thousands, except net income (loss) per share amounts): 1998 1999 -------- -------- Revenues........................................................................ $208,037 $221,346 Net income (loss)............................................................... 1,457 (16,727) Net income (loss) per share..................................................... $ 0.07 $ (0.77) Weighted average shares outstanding............................................. 21,790 21,790 On September 30, 1999, the Company acquired a majority interest in Alaskan Choice Television ("ACTV"). The cash purchase price was approximately $1,900. Goodwill from the acquisition will be amortized over 15 years. 3. LONG-TERM OBLIGATIONS Long-term obligations consist of the following (in thousands): SEPTEMBER 30, 1999 ------------- Term Loan A Facility (of ACS)................................................................ $150,000 Term Loan B Facility (of ACS)................................................................ 150,000 Term Loan C Facility (of ACS)................................................................ 135,000 9 3/8 % Senior subordinated notes due 2009 (of ACS)......................................... 150,000 13% Senior discount debentures due 2011...................................................... 21,186 Capital Lease Obligations (of ACS)........................................................... 7,267 Note to Municipality of Fairbanks (of ACS)................................................... 1,602 Other........................................................................................ 378 -------- 615,433 Less current portion......................................................................... 4,990 -------- Total long-term obligations.................................................................. $610,443 -------- -------- 10 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED SEPTEMBER 30, 1999 (UNAUDITED, DOLLARS IN THOUSANDS) 3. LONG-TERM OBLIGATIONS (CONTINUED) The Company's senior discount debentures balance of $21,186 is the $25,000 issue price plus accrued interest of $1,221 minus unamortized original issue discount of $5,035. The original issue discount resulted from the issuance of detachable warrants in connection with the 13% senior discount debentures. These detachable warrants are exercisable into 828,261 shares of common stock at any time from May 14, 1999 through May 15, 2011 at $0.01 per share. The original issue discount represents the difference between the exercise price and the fair value of the underlying shares at the date of issue. The Company has three term loan facilities aggregating to $435,000 that bear interest at an annual rate equal to LIBOR plus 2.75%, 3.00% and 3.25%. We entered into a hedging transaction which fixed the interest rate for a three-year period at 5.99% for one-half, or $217,500, of the term loan borrowings. The remaining $217,500 of term loan debt is un-hedged and, therefore, subject to interest rate risk. Thirty day LIBOR was 5.38% at September 30, 1999. 4. STOCK OPTIONS At September 30, 1999, the Company has reserved a total 3,410,486 shares of authorized common stock for issuance under the 1999 Stock Incentive Plan ("the Plan"). At September 30, 1999, 3,328,000 options have been granted under the Plan at an exercise price of $6.1542 per share, generally vesting ratably over five years or after nine years subject to acceleration upon the attainment of certain performance goals. During May, June and July of 1999, 2,858,000 of these options were granted at an exercise price equivalent to the then fair value of the underlying stock as evidenced by sales to third parties. On September 28, 1999, 470,000 options were granted with exercise prices below the independently appraised fair value of the underlying stock at the time of issuance, which was $10.12. Additionally, the terms of the 470,000 options granted below fair value on September 28, 1999 call for immediate vesting upon the successful completion of an initial public offering ("IPO"). Of the options granted in May, 653,750 are performance vesting options granted to certain officers and management of the Company. The terms of these particular performance-vesting options call for vesting based upon the achievement of certain annual performance goals immediately upon successful completion of an IPO or on the ninth anniversary of their grant date. Included on the balance sheet at September 30, 1999 is unearned compensation of $1,864 related to the 470,000 options granted on September 28, 1999. This unearned compensation expense will be amortized as a non-cash expense over the vesting term of the options or immediately upon the successful completion of an IPO, whichever occurs first. The 653,760 options granted on May 14, 1999 will be recorded as compensation expense when vesting occurs. Compensation expense will be recorded upon the earlier of achieving the annual corporate level performance goals, the successful completion of an IPO or the ninth anniversary of their grant date. Compensation expense recorded will be the difference between the market price of the shares on the day vesting is determined and the exercise price of $ 6.1542. 5. BUSINESS SEGMENTS The Company has adopted FASB Statement No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. The Company has three reportable segments: local telephone 11 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED SEPTEMBER 30, 1999 (UNAUDITED, DOLLARS IN THOUSANDS) 5. BUSINESS SEGMENTS (CONTINUED) (consisting of local telephone service, directory advertising, deregulated revenue and other revenues), cellular and long distance. Each reportable segment is a strategic business under separate management and offering different services than those offered by the other segments. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company also incurs interest expense, interest income, equity in earnings of minority investments and other non operating income and expense at the parent company which are not allocated to the business segments, nor are they evaluated by the chief operating decision maker in analyzing the performance of the business segments. These non operating income and expense items are provided in the accompanying table under the caption "Other" in order to assist the users of these financial statements in reconciling the operating results and total assets of the business segments to the consolidated financial statements. The following tables illustrates selected financial data for each segment for the three and nine months ended September 30, 1999 (in thousands): THREE MONTHS ENDED SEPTEMBER 30, 1999 LOCAL LONG TELEPHONE CELLULAR DISTANCE OTHER TOTAL --------- -------- -------- ------- -------- Operating revenues............................................ $63,265 $10,167 $2,678 $ - $76,110 Operating income (loss)....................................... 8,528 3,292 (1,218) - 10,602 Depreciation and amortization................................. 12,094 861 299 2,361 15,615 Interest expense.............................................. (42) - - (15,638) (15,680) Interest income............................................... 173 38 - 76 287 Equity in earnings of minority investments.................... - - - (244) (244) Other non-operating, net...................................... (73) 27 - (7) (53) Income tax provision (benefit)................................ 4,603 1,199 - (5,976) (174) Net income (loss)............................................. 8,781 1,488 (1,218) (13,965) (4,914) Capital expenditures.......................................... 13,751 5,223 13 - 18,987 Investments under the equity method........................... - - - 1,790 1,790 Total assets.................................................. 706,156 73,491 21,831 2,994 804,472 NINE MONTHS ENDED SEPTEMBER 30, 1999 LOCAL LONG TELEPHONE CELLULAR DISTANCE OTHER TOTAL --------- -------- -------- ------- -------- Operating revenues............................................ $95,640 $14,735 $4,065 $ - $114,440 Operating income (loss)....................................... 10,005 4,445 (1,474) - 12,976 Depreciation and amortization................................. 19,743 1,237 367 2,361 23,708 Interest expense.............................................. (114) (1) - (23,417) (23,532) Interest income............................................... 318 54 - 143 515 Equity in earnings of minority investments.................... - - - (81) (81) Other non-operating, net...................................... (689) 28 - (51) (712) Income tax provision (benefit)................................ 6,497 1,869 - (8,540) (174) Net income (loss)............................................. 9,715 2,657 (1,474) (21,558) (10,660) Capital expenditures.......................................... 21,154 5,549 19,515 - 46,218 Investments under the equity method........................... - - - 1,790 1,790 Total assets.................................................. 706,156 73,491 21,831 2,994 804,472 12 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED SEPTEMBER 30, 1999 (UNAUDITED, DOLLARS IN THOUSANDS) 6. INCOME TAXES The tax benefit reported for the consolidated period ended September 30, 1999 is due to investment tax credits that the Company is eligible to take regardless of its net loss position for the period. In general, the provision for income taxes may differ from the federal statutory rate due to the effect of federal and state alternative minimum taxes and net operating losses incurred for the period that are not benefited. In the current period, operating losses were not benefited because its is not certain that the Company will be able to use the losses going forward. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS This Report may contain forward-looking statements that involve a number of risks and uncertainties including, without limitation, those set for in the "Risk Factors" section of the Company's recent filing on form S-1. The Company's actual results may differ materially from any future performance discussed in the forward-looking statements and this Management's Discussion and Analysis of Financial Condition and Results of Operations. The Company undertakes no obligation to update the information, including the forward-looking statements, if any, in this Report. INTRODUCTION We were formed in 1998 to acquire telecommunications properties in Alaska. In May 1999, we acquired Century's Alaska properties and ATU. Century's Alaska properties were the incumbent provider of local telephone services in Juneau, Fairbanks and more than 70 rural communities in Alaska and provided Internet services to customers statewide. ATU was the largest local exchange carrier in Alaska and provided local telephone and long distance services primarily in Anchorage and cellular services statewide. In addition, ATU held minority interests in companies that delivered wireless cable television, Internet access and wholesale long distance. On September 30, 1999, we acquired a two-thirds majority interest in Alaskan Choice Television, LLC, a wireless cable television company in which we had previously held a one-third minority interest. On October 6, 1999, we entered into an agreement to acquire the remaining one-third interest in Alaskan Choice Television, together with certain FCC licenses. The closing of this transaction is subject to the satisfaction of several conditions, including regulatory approval of the license transfers. Prior to the consummation of the acquisitions of Century's Alaska properties and ATU in May 1999, we had no operations. Accordingly, the following discussion should be read in conjunction with our consolidated financial statements and the related notes, the combined financial statements and the related notes of Century's Alaska properties and the financial statements and the related notes of ATU included in the Company's recent filing in Form S-1. Today, we generate revenue through: - the provision of local telephone services, including: - basic local service to retail customers within our service areas, - wholesale service to competitive local exchange carriers, - network access services to interexchange carriers for origination and termination of interstate and intrastate long distance phone calls, - enhanced services, - ancillary services, such as billing and collection, - universal service payments and - Internet and other services; 14 - the provision of wireless services; and - the provision of long distance services. We also recognize our proportionate share of the net income or loss of our minority-owned investments. Within the telecommunications industry, local exchange carriers have historically enjoyed stable revenue and cash flow from local exchange operations resulting from the need for basic telecommunications services, the highly regulated nature of the telecommunications industry and, in the case of rural local exchange carriers, the underlying cost recovery settlement and support mechanisms applicable to local exchange operations. Basic local service is generally provided at a flat monthly rate and allows the user to place unlimited calls within a defined local calling area. Access revenues are generated by providing interexchange carriers access to the local exchange carrier's local network and its customers. Universal service revenues are a subsidy paid to rural local exchange carriers to support the high cost of providing service in rural markets. Other service revenue is generated from ancillary services, enhanced services and Internet access. Changes in revenue are largely attributable to changes in the number of access lines, local service rates and minutes of use. Other factors can also impact revenue, including: - intrastate and interstate revenue settlement methodologies, - authorized rates of return for regulated services, - whether an access line is used by a business or residential subscriber, - intrastate and interstate calling patterns, - customers' selection of various local rate plan options, - selection of enhanced calling services, such as voice mail, or other packaged products, such as cellular and Internet and - other subscriber usage characteristics. Local exchange carriers have two basic tiers of customers: - end users located in the local exchanges that pay for local telephone service including, in our case, retail, resale and unbundled network elements end users and - interexchange carriers that pay the local exchange carrier for access to customers located within that local exchange carrier's local service area. Local exchange carriers provide access service to numerous interexchange carriers and may also bill and collect long distance charges from interexchange carrier customers on behalf of the interexchange carriers. The amount of access charge revenue associated with a particular interexchange carrier varies depending upon long distance calling patterns and the relative market share of each long distance carrier. Our local service rates for end users are authorized by the RCA. Authorized rates are set by the FCC and the RCA for interstate and intrastate access charges, respectively, and may change from time to time. 15 ATU has historically provided long distance service both through leased facilities and as a reseller of other carriers' long distance services. We recently purchased $19.5 million of long distance fiber capacity for high speed links within Alaska and for termination of traffic in the lower 48 states. We have migrated long distance traffic from leased circuits onto our own network infrastructure. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1998 The following unaudited table summarizes our consolidated operations for the three months ended September 30, 1999 and the historical combined operating results of PTI properties and ATU for the three months ended September 30, 1998. THREE MONTHS ENDED SEPTEMBER 30, ------------------- 1999 1998 ---- ---- (IN THOUSANDS) OPERATING REVENUES: Local telephone.................................................................... $ 63,265 $ 63,070 Cellular........................................................................... 10,167 9,088 Long distance...................................................................... 2,678 1,841 ----- ----- Total operating revenues..................................................... 76,110 73,999 OPERATING EXPENSES: Local telephone.................................................................... 40,363 36,869 Cellular........................................................................... 6,014 6,230 Long distance...................................................................... 3,516 2,767 Depreciation and amortization...................................................... 15,615 13,524 ------ ------ Total cost of sales and operating expenses................................... 65,508 59,390 ------ ------ Operating income................................................................... 10,602 14,609 Interest expense................................................................... (15,680) (3,250) Interest income.................................................................... 287 1,243 Other income (expense)............................................................. (297) (176) ----- ----- Income (loss) before taxes......................................................... (5,088) 12,426 Income tax expense (benefit)....................................................... (174) 3,132 ----- ----- Net income (loss).................................................................. $ (4,914) $9,294 ======= ====== OPERATING REVENUES Operating revenues increased 2.9%, for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998. Local telephone, cellular and long distance revenues increased. LOCAL TELEPHONE The following table summarizes each component of the Company's local telephone revenues for the three months ended September 30, 1999 and 1998: 16 Three Months Ended September 30, ----------------------------------- 1999 1998 --------------- ------------- Local service $ 24,063 $ 20,848 Network access 26,352 26,523 Other 12,850 15,699 --------------- ------------- Total local telephone $ 63,265 $ 63,070 =============== ============= Local telephone increased marginally for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998. For the three months ended September 30, 1998, other local telephone revenue includes $2.2 million resulting from a change in accounting estimate to 1997 and prior revenue accruals. As adjusted for the $2.2 million of 1997 and prior revenue recorded in the third quarter of 1998, local telephone revenue increased 3.5% for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998. This increase in local telephone revenues, as adjusted, is explained by an increase in access lines in service at September 30, 1999 or 7.8% over access lines in service at September 30, 1998 and flat performance in network access revenues from period to period. CELLULAR Cellular revenues increased $1.1 million, or 11.9%for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998, as cellular customers increased 11.9% from 63,309 to 70,856. LONG DISTANCE Long distance revenues increased $0.8 million, or 45.5%, for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998 due to a 47.8% increase in long distance minutes of use. OPERATING EXPENSES Operating expenses increased $6.1 million, or 10.3%, for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998. LOCAL TELEPHONE Local telephone expenses increased 9.5% for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998. Local telephone expense represents approximately 63.8% and 58.5% of local telephone revenues for the three months ended September 31, 1999 and 1998, respectively. As a percentage of sales, corporate operations expense represented the most significant increase in local telephone operating expenses. Corporate operations expense includes the costs associated with major system conversions that occurred during the current quarter. CELLULAR Cellular expenses decreased $0.2 million, or 3.5%, for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998. There were decreases in all expense categories except corporate expense as cellular operations benefited from the integration of acquisitions. 17 LONG DISTANCE Long distance expenses increased by $0.8 million, or 27.1%, but decreased as a percentage of sales as long distance operations benefited from economies of scale, particularly in general and administrative expenses. DEPRECIATION AND AMORTIZATION The increase of $2.1 million, or 15.5%, was due to increases in plant in and amortization of additional goodwill for the three months ended September 30, 1999. INTEREST EXPENSE Interest expense increased $12.4 million, or 382.5%, for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998 due to $611.6 million of debt incurred in connection with the acquisitions of Century's Alaska properties and ATU. OTHER INCOME (EXPENSE) Other income (expense) for the three months ended September 30, 1999 consists primarily of non-recurring income and expenses ancillary to telephone operations and losses in minority interests. The change in Other income (expense) was not material as compared to the three months ended September 30, 1998. NET INCOME The decrease in net income is primarily a result of the factors discussed above and, in particular, the increase in operating expense as a percentage of sales and the increase in interest expense. NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1998 The following unaudited table summarizes our combined operations for the nine-month periods ended September 30, 1999 and September 30, 1998. For the nine months ended September 30, 1999, the summary information represents the combined historical results of Century's Alaska properties and ATU from January 1, 1999 through acquisition on May 14, 1999 and our consolidated operating results for the period from May 15, 1999 to September 30, 1999. For the nine months ended September 30, 1998, the summary information represents the historical combined operating results of Century's Alaska properties and ATU for that nine-month period. 18 NINE MONTHS ENDED SEPTEMBER 30 ---------------------- 1999 1998 --------- ------- (IN THOUSANDS) OPERATING REVENUES: Local telephone....................................................................... $187,473 $180,284 Cellular.............................................................................. 25,943 23,210 Long distance......................................................................... 7,930 4,543 ------ ------- Total operating revenues........................................................ 221,346 208,037 OPERATING EXPENSES: Local telephone....................................................................... 120,037 107,855 Cellular.............................................................................. 17,446 16,012 Long distance......................................................................... 9,932 7,135 Depreciation and amortization......................................................... 44,516 40,099 ------- ------- Total operating expenses........................................................ 191,931 171,101 ------- ------- Operating income...................................................................... 29,415 36,936 Interest expense...................................................................... (28,058) (9,804) Interest income....................................................................... 1,902 3,530 Other income (expense)................................................................ (1,078) (843) ------- - ----- Income before taxes................................................................... 2,181 29,819 Income taxes.......................................................................... 3,770 7,436 ----- ----- Net income (loss)..................................................................... $(1,589) 22,383 ======= ====== OPERATING REVENUES Operating revenues increased $13.3 million, or 6.4%, for the nine months ended September 30, 1999 as compared to the nine months ended September 30, 1998. Local service, cellular and long distance revenues all increased as compared to the prior nine-month period. LOCAL TELEPHONE The following table summarizes each component of the Company local telephone revenues for the nine months ended September 30, 1999 and 1998: Nine Months Ended September 30, ---------------------------------- 1999 1998 --------------- ------------- Local service $ 71,248 $ 67,047 Network access 77,706 72,480 Other 38,519 40,757 --------------- --------------- Total local telephone $ 187,473 $ 180,284 =============== =============== Local telephone revenues increased $7.2 million for the nine months ended September 30, 1999 as compared to the nine months ended September 30, 1998. For the nine months ended September 30, 1998, other local telephone revenue includes $2.2 million resulting from a change in accounting estimate to 1997 and prior revenue accruals. As adjusted for the $2.2 million of 1997 and prior revenue recorded in the third quarter of 1998, local telephone revenue increased 5.3% for the nine months ended September 30, 1999 as compared to the nine months ended September 30, 1998. This increase in local telephone revenues, as adjusted, is explained by an increase in access lines in service at September 30, 1998 of 7.8% over access lines in service at September 30, 1998 offset by flat performance in other telephone revenues, as adjusted, from period to period. 19 CELLULAR Cellular revenues increased $2.7 million, or 11.8%, for the nine months ended September 30, 1999 as compared to the nine months ended September 30, 1998, as cellular customers increased 11.9%. LONG DISTANCE Long distance revenues increased $3.4 million, or 74.6%, for the nine months ended September 30, 1999 as compared to the nine months ended September 30, 1998 due to a 98.8% increase in long distance minutes of use. OPERATING EXPENSES Operating expenses increased $20.8 million, or 12.2%, for the nine months ended September 30, 1999 as compared to the nine months ended September 30, 1998. Operating expenses increased to 86.7% of revenues for the nine months ended September 30, 1999 as compared to 82.2% of revenues for the nine months ended September 30, 1998. Adjusted for one-time and transaction related costs associated with our acquisitions of PTI properties and ATU of approximately $7.7 operating expenses would have been 83.2% of revenues for the nine months ended September 30, 1999. LOCAL TELEPHONE Local telephone expenses increased $12.2 million, or 11.3%, for the nine months ended September 30, 1999 as compared to the nine months ended September 30, 1998. Plant expense, customer service expense and corporate operations represent $10.9 million of the $12.2 million increase. All three expense categories included one-time costs as described in the preceding paragraph. Without these non-recurring expenses, local telephone expense would have been $112.3 million which represents a 4.2% increase as compared to the nine months ended September 30, 1998. The increase in customer service expense includes marketing and sales expense which increased as the Company responded to competition in the local market. CELLULAR Cellular expenses increased $1.4 million, or 9.0%, for the nine months ended September 30, 1999 as compared to the nine months ended September 30, 1998, primarily due to the increased costs of supporting a larger customer base combined with the marketing expenses associated with customer sales and retention. Increased corporate expense was also a significant component of the increase. LONG DISTANCE Long distance increased by $2.8 million, or 39.2%, but decreased as a percentage of sales as long distance operations benefited from economies of scale, particularly in general and administrative expenses. DEPRECIATION AND AMORTIZATION The increase of $4.4 million, or 11.0%, was due to increases in plant in service for the nine months ended September 30, 1999 and amortization of additional goodwill from May 14, 1999 to September 30, 1999. 20 INTEREST EXPENSE Interest expense increased $18.3 million, or 186.2%, for the nine months ended September 30, 1999 as compared to the nine months ended September 30, 1998 due to $611.6 million of debt incurred in connection with the acquisitions of Century's Alaska properties and ATU. OTHER INCOME (EXPENSE) Other income (expense) for the nine months ended September 30, 1999 consists primarily of non-recurring income and expenses ancillary to telephone operations and losses in minority interests. Ancillary income and expense, net was approximately $0.4 million and loss in minority interests was approximately $1.5 million. This was a 27.9% increase in net expense as compared to the nine months ended September 30, 1998 and is primarily attributable to a greater loss in minority interests for the current nine-month period. NET INCOME The decrease in net income is primarily a result of the factors discussed above and, in particular, the increase in operating expense as a percentage of sales and the increase in interest expense. YEAR 2000 Some of our older computer programs identify years with two digits instead of four. This may cause problems because these programs may recognize the year 2000 as the year 1900. These problems could result in a system failure or miscalculations disrupting operations, including a temporary inability to process transactions, send invoices or engage in similar, normal business activities. In addition, we face the risk that suppliers of products, services and systems purchased by us do not have business systems or products that comply with the year 2000 requirements. While we believe that the conversions or installations of replacement systems will proceed smoothly, we cannot assure you that there will not be interruptions or failures in our systems or in the systems of our suppliers. The telecommunications industry is highly susceptible to the year 2000 issue. Should the year 2000 issue cause problems across our infrastructure, service could be interrupted. These events, if they occur, could materially adversely affect our financial condition and results of operations. In order to understand our vulnerability to the year 2000 issue, we conducted a comprehensive systems assessment of our year 2000 compliance during the process of evaluating the acquisitions of Century's Alaska properties and ATU. Many of our systems have also been represented by the respective vendors of these systems to be year 2000 compliant, and both Century's Alaska properties and ATU have initiatives in progress that we believe will address all outstanding year 2000 issues. As of January 1, 1999, ATU completed its installation of an integrated financial and accounting system. On March 12, 1999, ATU completed its installation of Saville, a state-of-the-art customer care and billing system. MACtel and ATU Long Distance will continue to operate their existing financial management and billing systems. With respect to carrier access billing, ATU has completed the transition to Century's Alaska properties' existing systems. Each of the foregoing systems has been represented by the vendor to be year 2000 compliant. We have recently converted Century's Alaska properties' customer care and billing systems to ATU's Saville platform. Century's Alaska properties recently completed their installation of Platinum, an integrated financial and accounting application. Facilities 21 management and repair support systems for Century's Alaska properties have also transitioned to ATU platforms, which have been represented by the vendors as year 2000 compliant. Since January 1, 1999, ATU and PTI have spent approximately $22.3 million to upgrade and maintain its information technology systems to make them year 2000 compliant. Additional costs required in order to make our information technology systems year 2000 compliant by the end of December 1999 are not expected to be material. Upgrades required to make ATU's network equipment year 2000 compliant are mostly complete, with remaining upgrades expected to be finished by mid-November 1999. All of ATU's central office switches have been upgraded to year 2000 certified release levels. Upgrades required to make Century's Alaska properties' network equipment year 2000 compliant are mostly complete with remaining upgrades expected to be finished by mid-November 1999. All of Century's Alaska properties' central office switches have been upgraded to year 2000 certified release levels. Upgrades required to Mactel's and Century's Alaska properties' company's switching networks are mostly complete with remaining upgrades schedules to be completed by our third party switching vendor by mid-December. Given the progress made to date, we do not anticipate delays in finalizing and implementing year 2000 readiness solutions by December 1999. We cannot accurately estimate the uncertainty of completing our year 2000 readiness plan, particularly as it relates to any failure by third parties that have material relationships with us and fail to achieve their own year 2000 readiness. We have in the past and will continue to obtain assurances from third parties that their systems are or will be year 2000 compliant no later than the end of December 1999. Any failures by these third parties to appropriately address their own year 2000 readiness challenges could materially adversely affect our financial condition and results of operations. We believe that the following several situations make up our most reasonably likely worst case scenario: FAILURE OF ELECTRICAL POWER SUPPLIES. Although most of our major switching and information systems have emergency standby power supplies, in the event of long-term power disruption we may be required to shut down our switching and computer equipment. We believe the larger electrical utilities that provide service to us are pursuing year 2000 readiness strategies. However, electric utilities serving smaller rural communities may be particularly exposed to year 2000 readiness issues. DISRUPTION OF SWITCHING AND INFORMATION TECHNOLOGY INFRASTRUCTURE. The most significant risks related to our switching and information technology systems are: - the inability of our customers to make and receive calls, - the inability of our cell sites, switching centers and other interfaces to process and record call details of local telephone, long distance and cellular traffic accurately and - the inability of our billing systems to report and bill customers for phone usage accurately. We believe that we have adequately addressed each of these risks in our year 2000 readiness plan. INABILITY OF LARGE CUSTOMERS TO PAY INVOICES. Our largest customers are interexchange carriers that are customers, vendors and competitors in some of our markets. If interexchange carriers 22 experience year 2000 readiness problems, we may experience delays in collection of outstanding receivables and a decrease in the cash available to fulfill our obligations. We are developing contingency plans for potential year 2000 disruptions. We are closely monitoring our year 2000 readiness plan and have developed preliminary contingency plans for the most critical aspects of our year 2000 readiness plan. Details of these plans will be further developed and will depend on our final assessment of the relevant situation and potential alternative strategies. LIQUIDITY AND CAPITAL RESOURCES We have funded our operations primarily from the sale of stock, debt financing and operations. The nine months ended September 30, 1999 include operations from acquired telephone operations for the period from May 15, 1999 to September 30, 1999. For this period, our cash flows from operating activities were $19.2 million. Significant cashflows from the issuance of debt and stock were used for the acquisitions of Century's Alaska properties and ATU and, to a lesser extent, for capital expenditures. At September 30, 1999, we had approximately $6.5 million in working capital, including approximately $1.6 million in cash and cash equivalents. We also have $59.0 million of remaining capacity under the $75.0 million revolving credit facility as of November 12, 1999. Our initial debt borrowings and equity contributions were sufficient to fund the consummation of the acquisitions of Century's Alaska properties and ATU and the purchase of fiber capacity. On May 14, 1999 Alaska Communications Systems Holdings entered into a $435.0 million credit agreement and issued $150.0 million aggregate principal amount of senior subordinated notes in a private placement, and we issued senior discount debentures and warrants for $25.0 million in gross proceeds in a private placement, and received an equity capital infusion in the amount of $121.2 million. As a result of the financing for these acquisitions, as of September 30, 1999 we had $615.4 million of long-term debt. Interest payments on borrowings under the senior credit facility, our senior discount debentures and the senior subordinated notes, as well as amortization of borrowings under the senior credit facility, represent significant obligations of ours and Alaska Communications Systems Holdings. Interest on our senior discount debentures and the senior subordinated notes is payable semiannually. Interest on borrowings under the senior credit facility is payable quarterly, and the senior credit facility requires annual principal payments commencing on May 14, 2002. The local telephone network requires the timely maintenance of plant and infrastructure. Our local network is of high quality and is technically advanced and will have relatively predictable annual capital needs. Our historical capital expenditures have been significant. The construction and geographic expansion of our cellular network required a substantial amount of capital. The implementation of our long distance and interexchange network strategy is also capital intensive. We recently purchased fiber capacity for $19.5 million, which was funded with monies borrowed to finance the acquisitions of Century's Alaska properties and ATU. This purchase will enable us to use our own leased facilities in developing our business. We also have agreed to purchase additional fiber capacity for $19.5 million in the second quarter of 2001. In addition to the purchase of fiber capacity, we anticipate, subject to effectiveness of an amendment to the credit agreement, entered into on October 19, 1999, that will become effective upon receipt of at least $140.0 million in gross proceeds from the currently contempleted initial public offering of our common stock, total capital expenditures of approximately $28.2 million for the remainder of 1999, and approximately $90.0 million in 2000, which we expect to fund through internally generated cash flow, a portion of the net proceeds from the offering and additional borrowings under our revolving credit facility. If we are unable to amend our credit agreement as expected, we anticipate capital expenditures of $18.8 million for the remainder of 1999 and of approximately $70 million in 2000. Our capital requirements may change, however, due to, among other things: - the availability of additional fiber capacity, 23 - our decision to pursue specific acquisition opportunities, - changes in technology, - the effects of competition or - changes in our business strategy. Any of these changes could require additional financing that might not be available or, if available, might not be on terms favorable to us. Our ability to satisfy our capital requirements will be dependent upon our future financial performance, which is, in turn, subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. Subsequent to the acquisition of ATU and Century's Alaska properties, we have sold 1,746,402 shares of our common Stock including 1,624,907 shares to Cook Inlet Region, Inc. for $10.0 million in cash. Proceeds of the stock sales were subsequently contributed to Alaska Communications Systems Holdings as additional equity capital. In connection with Cook Inlet's investment, it became a party to the stockholders' agreement, which is described under "Management - Stockholders' Agreement" in the Company's recent filing on form S-1. On July 24, 1999 we entered into a hedging transaction which fixed at 5.99% the underlying variable rate on one-half of the borrowings under the senior credit facility, or $217.5 million, for a three-year period. On September 30, 1999, we acquired an additional one-third interest in Alaska Choice Television for $1.9 million, increasing our ownership to a two-thirds majority interest. On October 6, 1999, we entered into an agreement to acquire the remaining one-third interest and expect that the acquisition will be completed by year-end 1999. We believe that we will have sufficient working capital provided by operations and borrowings under our existing revolving credit facility to fund our operations and capital expenditures over the next 12 months. EFFECT OF NEW ACCOUNTING STANDARDS SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, was issued in June 1998. SFAS No. 133 establishes standards for the recognition and measurement of derivatives and hedging activities. This statement, as amended, is effective for fiscal years beginning after June 15, 2000. We are currently analyzing the impact SFAS No. 133 will have on our financial statements. 24 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. Litigation The Company periodically becomes involved in litigation, regulatory process and other legal proceedings (formal and informal) that arise in the ordinary course of its business. While the ultimate outcome of such matters cannot be predicted with certainty, management believes that the results of such current proceedings will not have a material adverse effect on the financial results of the Company, taken as a whole. Regulatory Appeal In response to prior petitions of the Company for reconsideration, the Regulatory Commission of Alaska (RCA) on October 11, 1999 issued an order terminating the rural exemptions of Telephone Utilities of Alaska, Inc., Telephone Utilities of the Northland, Inc., and PTI Communications, Inc., with respect to defined study areas of those companies. Subsequently, on October 26, 1999, the RCA dismissed petitions of those companies seeking to establish open competitive markets in Fairbanks and Juneau, Alaska, through tariffed interconnection terms and conditions also filed with the RCA. On November 10, 1999, the Company filed a formal appeal of the RCA's order terminating the rural exemption in state Superior Court. On November 12, 1999, the Company filed a parallel appeal in state Superior Court of the RCA's order dismissing its petitions for tariffed interconnection. Although it believes the appeals well-founded, the Company cannot predict the timing and outcome of this litigation with any certainty. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. ( c ) The following is a summary of the transactions by the Registrant during the three months ended September 30, 1999 involving sales of the Registrant's securities that were not registered under the Securities Act: 1. Pursuant to a Stock Subscription Agreement, dated as of July 9, 1999, by and between the Registrant and Cook Inlet Region, Inc. ("CIRI"), CIRI purchased 1,624,907 shares of Common Stock for $10 million in cash. 2. Pursuant to a Stock Subscription Agreement, dated as of July 6, 1999, by and between the Registrant and Donn T. Wonnell, Mr.Wonnell purchased 16,249 shares of Common Stock for $100,000 in cash. 3. On September 27, 1999, John Ayers purchased 16,249 shares of Common Stock for $100,000 in cash. 4. The Registrant granted 50,000 shares of Common Stock to Donn T. Wonnell on July 31, 1999. In connection with this grant, Mr. Wonnell borrowed approximately 40% of the fair market value of this grant on a non-recourse basis to pay taxes on the income deemed received by virtue of such grant. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. NONE. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS. NONE. ITEM 5. OTHER INFORMATION. NONE. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 25 (a) EXHIBITS: EXHIBIT NUMBER EXHIBIT TITLE - -------- ------------- 2.1 Purchase Agreement, dated as of August 14, 1998, as amended, by and among ALEC Acquisition Sub Corp., CenturyTel of the Northwest, Inc. and CenturyTel Wireless, Inc.** 2.2 Asset Purchase Agreement, dated as of October 20, 1998, by and between Alaska Communications Systems, Inc. and the Municipality of Anchorage** 3.1 Certificate of Incorporation of the Registrant** 3.2 By-Laws of the Registrant** 4.2 Stockholders' Agreement, dated as of May 14, 1999, by and among the Registrant and the Investors listed on the signature pages thereto** 4.3 First Amendment to Stockholders' Agreement, dated as of July 6, 1999, by and among the Registrant and the Investors listed on the signature pages thereto** 4.4 Indenture, dated as of May 14, 1999, by and between Alaska Communications Systems Holdings, Inc., the Guarantors (as defined therein) and IBJ Whitehall Bank & Trust Company** 4.5 Purchase Agreement, dated as of May 11, 1999, by and among Alaska Communications Systems Holdings, Inc., the Guarantors, Chase Securities Inc., CIBC World Markets Corp. and Credit Suisse First Boston Corporation** 4.6 Indenture, dated as of May 14, 1999, by and between the Registrant and The Bank of New York** 4.7 First amendment, dated as of October 29, 1999, to indenture listed as exhibit No. 4.6 * 4.8 Purchase Agreement, dated as of May 11, 1999, by and among the Registrant, DLJ Investment Partners, L.P., DLJ Investment Funding, Inc. and DLJ ESC II, L.P.** 10.1 Exchange and Registration Rights Agreement, dated as of May 14,1999, by and among Alaska Communications Systems Holdings, Inc., the Guarantors, Chase Securities Inc., CIBC World Markets Corp. and Credit Suisse First Boston Corporation** 10.2 Exchange and Registration Rights Agreement, dated as of May 14, 1999, by and among the Registrant, DLJ Investment Partners, L.P., DLJ Investment Funding, Inc. and DLJ ESC II L.P.** 10.3 Credit Agreement, dated as of May 14, 1999, by and among Alaska Communications Systems Holdings, Inc., the Registrant, the financial institutions Lenders party thereto, The Chase Manhattan Bank, Credit Suisse First Boston and Canadian Imperial Bank of Commerce** 10.4 Amendment No.1, dated as of October 19, 1999, to credit agreement listed as exhibit No. 10.3. * 10.5 Employment Agreement, dated as of March 12, 1999, by and among Alaska Communications Systems Holdings, Inc., the Registrant and Charles E. Robinson** 10.6 Employment Agreement, dated as of March 12, 1999, by and among Alaska Communications Systems Holdings, Inc., the Registrant and Wesley E. Carson** 10.7 ALEC Holdings, Inc. 1999 Stock Incentive Plan** 21.1 Subsidiaries of the Registrant** 27.1 Financial Data Schedule ---- ------------------------- * Filed as an exhibit to the Registrant's Form 8-K filed on November 5, 1999. ** Filed as an exhibit to the Registrant's Registration Statement on Form S-4, File No. 333-82361 (b) REPORTS ON FORM 8-K: No reports on Form 8-K were filed during the quarter ended September 30, 1999. 26 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized. Date: November 15, 1999 ALASKA COMMUNICATIONS SYSTEMS GROUP, INC. /S/ MICHAEL E. HOLMSTROM ------------------------ Michael E. Holmstrom Senior Vice President and Chief Financial Officer signing both in his capacity as Senior Vice President on behalf of the Registrant and as Chief Financial Officer of the Registrant 27