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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(X) ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-5890
GCI, INC.
(Exact name of registrant as specified in its charter)
ALASKA 91-1820757
--------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2550 Denali Street Suite 1000 Anchorage, Alaska 99503
------------------------------------------------ -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (907) 868-5600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No .
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes No X
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(a) AND
(b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE
FORMAT.
1
GCI, INC.
A WHOLLY-OWNED SUBSIDIARY OF GENERAL COMMUNICATION, INC.
2004 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Glossary....................................................................................................................3
Cautionary Statement Regarding Forward-Looking Statements..................................................................11
Part I.....................................................................................................................13
Item 1. Business.......................................................................................................13
Item 2. Properties.....................................................................................................62
Item 3. Legal Proceedings..............................................................................................64
Item 4. Submissions of Matters to a Vote of Security Holders............................................................65
Part II....................................................................................................................65
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters......................................65
Item 6. Selected Financial Data........................................................................................66
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..........................66
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...................................................101
Item 8. Consolidated Financial Statements and Supplementary Data......................................................101
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure..........................102
Item 9A. Controls and Procedures......................................................................................102
Item 9B. Other Information............................................................................................102
Part III..................................................................................................................102
Items 10, 11, 12, 13 and 14 are omitted per General Instruction I(1)(a) and (b) of Form 10-K
Part IV...................................................................................................................103
Item 15. Exhibits, Consolidated Financial Statement Schedules.........................................................103
Item 15(b). Exhibits..................................................................................................147
SIGNATURES................................................................................................................154
This Annual Report on Form 10-K is for the year ending December 31, 2004. This
Annual Report modifies and supersedes documents filed prior to this Annual
Report. The Securities and Exchange Commission ("SEC") allows us to "incorporate
by reference" information that we file with them, which means that we can
disclose important information to you by referring you directly to those
documents. Information incorporated by reference is considered to be part of
this Annual Report. In addition, information that we file with the SEC in the
future will automatically update and supersede information contained in this
Annual Report.
2
Glossary
Access Charges -- Fees for accessing the local networks of the LECs in order to
originate and terminate long-distance calls and provide the customer connection
for Private Line services.
ACS -- Alaska Communications Systems Group, Inc., previously ALEC Holdings, Inc.
- -- ACS, one of our competitors, includes acquired properties from Century
Telephone Enterprises, Inc. and the Anchorage Telephone Utility ("ATU"). ATU
provided local telephone and long distance services primarily in Anchorage and
cellular telephone services in Anchorage and other Alaska markets.
Alaska United or AULP -- Alaska United Fiber System Partnership -- An Alaska
partnership, indirectly wholly owned by the Company. Alaska United was organized
to construct and operate fiber optic cable systems connecting various locations
in Alaska and the Lower 49 States and foreign countries through Seattle,
Washington.
AT&T -- AT&T Corp. -- A long distance carrier, parent company to AT&T Alascom.
AT&T Alascom -- Alascom, Inc. -- A wholly owned subsidiary of AT&T and one of
our competitors.
AULP East -- An undersea fiber optic cable system connecting Whittier, Valdez
and Juneau, Alaska and Seattle, Washington, which was placed into service in
February 1999.
AULP West -- A new undersea fiber optic cable system connecting Seward, Alaska
to Warrenton, Oregon which was placed into service in June 2004.
Basic Service -- The basic service tier includes, at a minimum, signals of local
television broadcast stations, any public, educational, and governmental
programming required by the franchise to be carried on the basic tier, and any
additional video programming service added to the basic tier by the cable
operator.
BOC -- Bell System Operating Company -- A LEC owned by any of the remaining
Regional Bell Operating Companies, which are holding companies established
following the AT&T Divestiture Decree to serve as parent companies for the BOCs.
Backbone -- A centralized high-speed network that interconnects smaller,
independent networks.
Bandwidth -- A range or band of the frequency spectrum, measured in Hertz (Hz).
It has become vogue, though strictly a misuse of the term, to say bandwidth is
the number of bits of data per second that can move through a communications
medium.
Broadband -- A high-capacity communications circuit/path, usually implying
speeds of 256 kilobits per second ("kbps") or better.
CAP -- Competitive Access Provider -- A company that provides its customers with
an alternative to the LEC for local transport of Private Line and special access
communications services.
Central Offices -- The switching centers or central switching facilities of the
LECs.
CLEC -- Competitive Local Exchange Carrier -- A company that provides its
customers with an alternative to the ILEC for local transport of communications
services, as allowed under the 1996 Telecom Act.
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Co-Carrier Status -- A regulatory scheme under which the ILEC is required to
integrate new, competing providers of local exchange service, into the systems
of traffic exchange, inter-carrier compensation, and other inter-carrier
relationships that already exist among LECs in most jurisdictions.
Collocation -- The ability of a CAP or CLEC to connect its network to the LEC's
central offices. Physical collocation occurs when a connecting carrier places
its network connection equipment inside the LEC's central offices. Virtual
collocation is an alternative to physical collocation pursuant to which the LEC
permits a CAP or CLEC to connect its network to the LEC's central offices on
comparable terms, even though the CAP's or CLEC's network connection equipment
is not physically located inside the central offices.
The Company -- GCI, Inc. and its direct and indirect subsidiaries, also referred
to as "we," "us" and "our."
Compression or Decompression -- A method of encoding, decoding and processing
signals that allows transmission (or storage) of more information than the
medium would otherwise be able to support. Both compression and decompression
require processing capacity, but with many products, the signal delay time due
to processing is not noticeable.
DAMA -- Demand Assigned Multiple Access -- The Company's digital satellite earth
station technology that allows calls to be made between remote villages using
only one satellite hop thereby reducing satellite delay and capacity
requirements while improving quality.
Dark Fiber -- An inactive fiber-optic strand without electronics or optronics.
Dark fiber is not connected to transmitters, receivers and regenerators.
DBS -- Direct Broadcast Satellite -- Subscription television service obtained
from satellite transmissions using frequency bands that are internationally
allocated to the broadcast satellite services. The major providers of DBS are
currently DirecTV and EchoStar (marketed as the DISH Network).
DS-0 -- A data communications circuit that carries data at the rate of 64 kbps.
DS-1 -- A data communications circuit that carries data at the rate of 1.544
Megabits per second (Mb/s), often interchangeably referred to as a T-1.
DS-3 -- A data communications circuit that is equivalent to 28 multiplexed T-1
channels capable of transmitting data at 44.736 Mbps (sometimes called a T-3).
Dedicated -- Communications lines dedicated or reserved for use by particular
customers.
Digital -- A method of storing, processing and transmitting information through
the use of distinct electronic or optical pulses that represent the binary
digits 0 and 1. Digital transmission and switching technologies employ a
sequence of these pulses to represent information as opposed to the continuously
variable analog signal. Digital transmission is advantageous in that it is more
resistant to the signal degrading effects of noise (such as graininess or snow
in the case of video transmission, or static or other background distortion in
the case of audio transmission).
DLC -- Digital Loop Carrier -- A digital transmission system designed for
subscriber loop plant. Multiplexes a plurality of circuits onto very few wires
or onto a single fiber pair.
DLPS -- Digital Local Phone Service -- A term we use referring to our deployment
of voice telephone service utilizing our hybrid-fiber coax cable facilities.
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DOCSIS 1.1 -- Data-Over-Cable Service Interface Specification 1.1 -- An industry
specification that provides for high-speed Internet service tiers, using
techniques known as data fragmentation and quality of service. Under this
specification, which is compatible with the existing DOCSIS 1.0 specification,
cable operators can deliver high-speed Internet services simultaneously over the
same plant and in a path parallel to core video services.
DSL -- Digital Subscriber Line -- Technology that allows Internet access and
other high-speed data services at data transmission speeds greater than those of
modems over conventional telephone lines.
Equal Access -- Connection provided by a LEC permitting a customer to be
automatically connected to the IXC of the customer's choice when the customer
dials "1". Also refers to a generic concept under which the BOCs must provide
access services to AT&T's competitors that are equivalent to those provided to
AT&T.
FCC -- Federal Communications Commission -- A federal regulatory body empowered
to establish and enforce rules and regulations governing public utility
companies and others, such as the Company.
Frame Relay -- A wideband (64 kilobits per second to 1.544 Mbps) packet-based
data interface standard that transmits bursts of data over WANs. Frame-relay
packets vary in length from 7 to 1024 bytes. Data oriented, it is generally not
used for voice or video.
FTC -- Federal Trade Commission -- A federal regulatory body empowered to
establish and enforce rules and regulations governing companies involved in
trade and commerce.
GCC -- GCI Communication Corp. -- An Alaska corporation and a wholly owned
subsidiary of Holdings.
GCI -- General Communication, Inc. -- An Alaska corporation and the parent of
GCI, Inc.
GCI, Inc. -- The Registrant, a wholly owned subsidiary of GCI, an Alaska
corporation and issuer of $320 million of senior notes.
GFCC -- GCI Fiber Communication Co., Inc. -- An Alaska corporation and a wholly
owned subsidiary of Holdings. Holdings acquired all minority ownership interests
in GFCC in the third and fourth quarters of 2002. GFCC owns and operates a fiber
optic cable system constructed along the trans-Alaska oil pipeline corridor
extending from Prudhoe Bay to Valdez, Alaska. See Kanas.
Holdings -- GCI Holdings, Inc. -- A wholly owned subsidiary of GCI, Inc., an
Alaska corporation and party to the Company's Senior Credit Facility.
HDTV -- High-Definition Television -- A digital television format delivering
theater-quality pictures and CD-quality sound. HDTV offers an increase in
picture quality by providing up to 1,920 active horizontal pixels by 1,080
active scanning lines, representing an image resolution of more than two million
pixels. In addition to providing improved picture quality with more visible
detail, HDTV offers a wide screen format and Dolby(R) Digital 5.1 surround
sound.
ILEC -- Incumbent Local Exchange Carrier -- With respect to an area, the LEC
that -- (A) on the date of enactment of the Telecommunications Act of 1996,
provided telephone exchange service in such area; and (B)(i) on such date of
enactment, was deemed to be a member of the exchange carrier association
pursuant to section 69.601(b) of the FCC's regulations (47 C.F.R. 69.601(b)); or
(ii) is a person or entity that, on or after such date of enactment, became a
successor or assign of a member described in clause (i).
Interexchange -- Communication between two different LATAs or, in Alaska,
between two different local exchange serving areas.
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IP -- Internet Protocol -- The method or protocol by which data is sent from one
computer to another on the Internet. Each computer (known as a host) on the
Internet has at least one IP address that uniquely identifies it from all other
computers on the Internet.
ISDN -- Integrated Services Digital Network -- A set of standards for
transmission of simultaneous voice, data and video information over fewer
channels than would otherwise be needed, through the use of out-of-band
signaling. The most common ISDN system provides one data and two voice circuits
over a traditional copper wire pair, but can represent as many as 30 channels.
Broadband ISDN extends the ISDN capabilities to services in the Gigabit per
second range.
ISP -- Internet Service Provider -- A company providing retail and/or wholesale
Internet services.
Internet -- A global collection of interconnected computer networks which use
TCP/IP, a common communications protocol.
IXC -- Interexchange Carrier -- A long-distance carrier providing services
between local exchanges.
Kanas -- Kanas Telecom, Inc. -- An Alaska corporation that was renamed GFCC in
2001.
LAN -- Local Area Network -- The interconnection of computers for sharing files,
programs and various devices such as printers and high-speed modems. LANs may
include dedicated computers or file servers that provide a centralized source of
shared files and programs.
LATA -- Local Access and Transport Area -- The approximately 200 geographic
areas defined pursuant to the AT&T Divestiture Decree. The BOCs were
historically prohibited from providing long-distance service between the LATA in
which they provide local exchange services, and any other LATA.
LEC -- Local Exchange Carrier -- A company providing local telephone services.
Each BOC is a LEC.
LMDS -- Local Multipoint Distribution System -- LMDS uses microwave signals
(millimeterwave signals) in the 28 GHz spectrum to transmit voice, video, and
data signals within small cells 3-10 miles in diameter. LMDS allows license
holders to control up to 1.3 GHz of wireless spectrum in the 28 GHz Ka-band. The
1.3 GHz can be used to carry digital data at speeds in excess of one gigabit per
second. The extremely high frequency used and the need for point to multipoint
transmissions limits the distance that a receiver can be from a transmitter.
This means that LMDS will be a "cellular" technology, based on multiple,
contiguous, or overlapping cells. LMDS is expected to provide customers with
multichannel video programming, telephony, video communications, and two-way
data services. ILECs and cable companies may not obtain the in-region 1150 MHz
license for three years following the date of the license grant. Within 10 years
following the date of the license grant, licensees will be required to provide
'substantial service' in their service regions.
Local Exchange -- A geographic area generally determined by a state regulatory
body, in which calls generally are transmitted without toll charges to the
calling or called party.
Local Number Portability -- The ability of an end user to change Local Exchange
Carriers while retaining the same telephone number.
Lower 48 States or Lower 48 -- Refers to the 48 contiguous states south of or
below Alaska.
Lower 49 States or Lower 49 -- Refers to Hawaii and the Lower 48 States.
MAN -- Metropolitan Area Network -- LANs interconnected within roughly a 50-mile
radius. MANs typically use fiber optic cable to connect various wire LANs.
Transmission speeds may vary from 2 to 100 Mbps.
6
Mat-Su Valley -- The Matanuska and Susitna valleys are located in south-central
Alaska, to the north of Anchorage, and include the communities of Palmer and
Wasilla and the immediately surrounding areas.
MCI, Inc. ("MCI") -- Owns approximately 2% of GCI's common stock at December 31,
2004, presently has two representatives on GCI's Board, and is a major customer.
Prior to May 1, 2000, the company was named MCI WorldCom, Inc. See also MWNS. On
July 21, 2002, MCI and substantially all of its active United States
subsidiaries filed voluntary petitions for reorganization under Chapter 11 of
the United States Bankruptcy Code in the United States Bankruptcy Court. On
December 7, 2004, we closed a transaction with MCI to repurchase 3,751,509
shares of GCI's Class A common stock at $8.33 per share (for a total purchase
price of approximately $31.3 million). In addition to the common stock
repurchase, the transaction included the redemption of all issued and
outstanding shares of GCI's Series C preferred stock held by MCI for an
aggregate redemption price of $10 million. MCI will retain its ownership of
almost 1.3 million shares of GCI's Class B common stock and will retain their
two seats on GCI's board of directors. You should see note 14 to the
accompanying "Notes to Consolidated Financial Statements" included in Part II of
this Report for more information.
MDU -- Multiple Dwelling Unit -- MDUs include multiple-family buildings, such as
apartment and condominium complexes.
MMDS -- Multichannel Multipoint Distribution Service -- Also known as wireless
cable. The FCC established the Multipoint Distribution Service (MDS) in 1972.
Originally, the FCC thought MDS would be used primarily to transmit business
data. However, the service became increasingly popular in transmitting
entertainment programming. Unlike conventional broadcast stations whose
transmissions are received universally, MDS programming is designed to reach
only a subscriber based audience. In 1983, the FCC reassigned eight channels
from the Instructional Television Fixed Service (ITFS) to MDS. These eight
channels make up the MMDS. Frequently, MDS and MMDS channels are used in
combination with ITFS channels to provide video entertainment programming to
subscribers.
MVPD -- Multi-channel Video Programming Distribution -- The distribution of
video programming over multiple platforms, such as cable and satellite.
MWNS -- MCI WorldCom Network Services -- A subsidiary of MCI, which had
previously entered into service agreements with the Company on behalf of MCI.
OCC -- Other Common Carrier -- A long-distance carrier other than the Company.
OC-n -- An optical communications circuit that optically signals at a data rate
of n times 51.84 Mbps, where n can be 1, 3, 12, 24, 48, 96, or 192.
Pay-per-view -- Offering television broadcasts to viewers in a manner whereby
they pay only for the programs they watch rather than having to subscribe to the
whole channel or station on a full-time basis.
PCS -- Personal Communication Services -- PCS encompasses a range of advanced
wireless mobile technologies and services. It promises to permit communications
to anyone, anywhere and anytime while on the move. The Cellular
Telecommunications Industry Association (CTIA) defines PCS as a "wide range of
wireless mobile technologies, chiefly cellular, paging, cordless, voice,
personal communications networks, mobile data, wireless PBX, specialized mobile
radio, and satellite-based systems." The FCC defines PCS as a "family of mobile
or portable radio communications services that encompasses mobile and ancillary
fixed communications services to individuals and businesses and can be
integrated with a variety of competing networks."
7
PBX -- Private Branch Exchange -- A customer premise communication switch used
to connect customer telephones (and related equipment) to LEC central office
lines (trunks), and to switch internal calls within the customer's telephone
system. Modern PBXs offer numerous software-controlled features such as call
forwarding and call pickup. A PBX uses technology similar to that used by a
central office switch (on a smaller scale). (The acronym PBX originally stood
for "Plug Board Exchange.")
POP -- Point of Presence -- The physical access location interface between a LEC
and an IXC network. The point to which the telephone company terminates a
subscriber's circuit for long-distance service or leased line communications.
PRI -- Primary Rate Interface -- An ISDN circuit transmitting at T-1 (DS-1)
speed (equivalent to 24 voice-grade channels). One of the channels ("D") is used
for signaling, leaving 23 ("B") channels for data and voice communication.
Private Line -- Uses dedicated circuits to connect customer's equipment at both
ends of the line. Does not provide any switching capability (unless supported by
customer premise equipment). Usually includes two local loops and an IXC
circuit.
Private Network -- A communications network with restricted (controlled) access
usually made up of Private Lines (with some PBX switching).
RCA -- Regulatory Commission of Alaska -- A state regulatory body empowered to
establish and enforce rules and regulations governing public utility companies
and others, such as the Company, within the State of Alaska (sometimes referred
to as Public Service Commissions, or PSCs, or Public Utility Commissions, or
PUCs). Previously known as the Alaska Public Utilities Commission (APUC).
Reciprocal Compensation -- The same compensation of a CLEC for termination of a
local call by the ILEC on its network, as the new competitor pays the ILEC for
termination of local calls on the ILEC network.
SchoolAccess(TM) -- The Company's Internet and related services offering to
schools in Alaska, and some sites in Arizona, Montana and New Mexico. The
federal mandate through the 1996 Telecom Act to provide universal service
resulted in schools across Alaska qualifying for varying levels of discounts to
support the provision of Internet services. The Universal Service Administrative
Company through its Schools and Libraries Division administers this federal
program.
SDN -- Software Defined Network -- A switched long-distance service for very
large users with multiple locations. Instead of putting together their own
network, large users can get special usage rates for calls carried on regular
switched long-distance lines.
Securities Reform Act -- The Private Securities Litigation Reform Act of 1995.
Senior Credit Facility -- Holding's $220.0 million credit facility. The Senior
Credit Facility includes a term loan of $170.0 million and a revolving credit
facility of $50.0 million. The new Senior Credit Facility matures on October 31,
2007 and bears interest at LIBOR plus 2.25%. You should see note 7 to the
accompanying "Notes to Consolidated Financial Statements" included in Part II of
this Report for more information.
SMATV -- Satellite Master Antenna Television -- (Also known as "private cable
systems") are multichannel video programming distribution systems that serve
residential, multiple-dwelling units ("MDUs"), and various other buildings and
complexes. A SMATV system typically offers the same type of programming as a
cable system, and the operation of a SMATV system largely resembles that of a
cable system -- a satellite dish receives the programming signals, equipment
processes the signals, and wires distribute the programming to individual
dwelling units. The primary difference between
8
the two is that a SMATV system typically is an unfranchised, stand-alone system
that serves a single building or complex, or a small number of buildings or
complexes in relatively close proximity to each other.
SONET -- Synchronous Optical Network -- A 1984 standard for optical fiber
transmission on the public network. 51.84 Mbps to 9.95 Gigabits per second,
effective for ISDN services including asynchronous transfer mode.
Sprint -- Sprint Corporation -- One of our significant customers.
T-1 -- A data communications circuit capable of transmitting data at 1.5 Mbps.
Tariff -- The schedule of rates and regulations set by communications common
carriers and filed with the appropriate federal and state regulatory agencies;
the published official list of charges, terms and conditions governing provision
of a specific communications service or facility, which functions in lieu of a
contract between the subscriber or user and the supplier or carrier.
TCP/IP -- Transmission Control Protocol/Internet Protocol -- A suite of network
protocols that allows computers with different architectures and operating
system software to communicate with other computers on the Internet.
TDM -- Time Division Multiplex -- A means by which multiple signals are combined
and carried on one transport medium by sequentially sharing the medium in slices
of time (time slots) for each of the various signals.
UNE -- Unbundled Network Element -- A discrete piece part of a telephone
network. Unbundled network elements are the basic network functions, i.e., the
piece parts needed to provide a full range of communications services. They are
physical facilities as well as all the features and capabilities provided by
those facilities.
VSAT -- Very Small Aperture Terminal -- A small, sometimes portable satellite
terminal that allows connection via a satellite link.
WAN -- Wide Area Network -- A remote computer communications system. WANs allow
file sharing among geographically distributed workgroups (typically at higher
cost and slower speed than LANs or MANs). WANs typically use common carriers'
circuits and networks. WANs may serve as a customized communication backbone
that interconnects all of an organization's local networks with communications
trunks that are designed to be appropriate for anticipated communication rates
and volumes between nodes.
World Wide Web or Web -- A collection of computer systems supporting a
communications protocol that permits multi-media presentation of information
over the Internet.
1984 Cable Act -- The Cable Communications Policy Act of 1984.
1992 Cable Act -- The Cable Television Consumer Protection and Competition Act
of 1992.
1996 Telecom Act -- The Telecommunications Act of 1996 -- The 1996 Telecom Act
was signed into law February 8, 1996. Under its provisions, BOCs were allowed to
immediately begin manufacturing, research and development; GTE Corp. could begin
providing interexchange services through its telephone companies nationwide;
laws in 27 states that foreclosed competition were pre empted; co-carrier status
for CLECs was ratified; and the physical collocation of competitors' facilities
in LECs central offices was allowed.
9
The purpose of the 1996 Telecom Act was to move from a regulated monopoly model
of telecommunications to a deregulatory competitive markets model. The act
eliminated the old barriers that prevented three groups of companies, the LECs,
including the BOCs, the long-distance carriers, and the cable TV operators, from
competing head-to-head with each other. The act requires LECs to let new
competitors into their business. It also requires the LECs to open up their
networks to ensure that new market entrants have a fair chance of competing. The
bulk of the act is devoted to establishing the terms under which the LECs, and
more specifically the BOCs, must open up their networks.
The 1996 Telecom Act substantially changed the competitive and regulatory
environment for telecommunications providers by significantly amending the
Communications Act of 1934 including certain of the rate regulation provisions
previously imposed by the Cable Television Consumer Protection and Competition
Act of 1992 (the "1992 Cable Act"). The 1996 Telecom Act eliminated rate
regulation of the cable programming service tier in 1999. Further, the
regulatory environment will continue to change pending, among other things, the
outcome of legal challenges, legislative activity, and FCC rulemaking and
enforcement activity in respect of the 1992 Cable Act and the completion of a
significant number of continuing FCC rulemakings under the 1996 Telecom Act.
10
Cautionary Statement Regarding Forward-Looking Statements
You should carefully review the information contained in this Annual Report, but
should particularly consider any risk factors that we set forth in this Annual
Report and in other reports or documents that we file from time to time with the
Securities and Exchange Commission ("SEC"). In this Annual Report, in addition
to historical information, we state our future strategies, plans, objectives or
goals and our beliefs of future events and of our future operating results,
financial position and cash flows. In some cases, you can identify those
so-called "forward-looking statements" by words such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential," "project," or "continue" or the negative of those words and other
comparable words. All forward-looking statements involve known and unknown
risks, uncertainties and other important factors that may cause our actual
results, performance, achievements, plans and objectives to differ materially
from any future results, performance, achievements, plans and objectives
expressed or implied by these forward-looking statements. In evaluating those
statements, you should specifically consider various factors, including those
outlined below. Those factors may cause our actual results to differ materially
from any of our forward-looking statements. For these statements, we claim the
protection of the safe harbor for forward-looking statements provided by the
Securities Reform Act. Such risks, uncertainties and other factors include but
are not limited to those identified below.
o Local and general market conditions and obstacles, including possible
material adverse changes in the economic conditions in the markets we
serve and in general economic conditions; the continuing impact of the
current stagnant communications industry due to high levels of
competition in the long-distance market resulting in continuing
pressures to reduce prices; and an oversupply of long-haul capacity and
high debt loads;
o The efficacy of laws enacted by Congress and the State of Alaska
legislature; rules and regulations to be adopted by the Federal
Communications Commission ("FCC") and state public regulatory agencies
to implement the provisions of the 1996 Telecom Act; the outcome of
litigation relative thereto; and the impact of regulatory changes
relating to access reform;
o The outcome of our negotiations with ILECs and state regulatory
arbitrations and approvals with respect to interconnection agreements;
o Changes in, or failure, or inability, to comply with, government
regulations, including, without limitation, regulations of the FCC, the
RCA, and adverse outcomes from regulatory proceedings;
o Changes in regulations governing UNEs;
o Changes in the treatment or classification of services using a
particular technology, including Internet protocol;
o Our responses to competitive products, services and pricing, including
pricing pressures, technological developments, alternative routing
developments, and the ability to offer combined service packages that
include long-distance, local, cable and Internet services;
o The extent and pace at which different competitive environments develop
for each segment of our business;
o The extent and duration for which competitors from each segment of the
communications industries are able to offer combined or full service
packages prior to our being able to do so;
o Competitor responses to our products and services and overall market
acceptance of such products and services;
o Our ability to purchase network elements or wholesale services from
ILECs at a price sufficient to permit the profitable offering of local
telephone service at competitive rates;
o Success and market acceptance for new initiatives, some of which are
untested;
o The level and timing of the growth and profitability of existing and
new initiatives, particularly local telephone services expansion
including deploying digital local telephone service, and wireless
services;
o Start-up costs associated with entering new markets, including
advertising and promotional efforts;
11
o Risks relating to the operations of new systems and technologies and
applications to support new initiatives;
o The risks associated with technological requirements, technology
substitution and changes and other
technological developments;
o Prolonged service interruptions which could affect our business;
o Development and financing of communications, local telephone, wireless,
Internet and cable networks and services;
o Future financial performance, including the availability, terms and
deployment of capital; the impact of regulatory and competitive
developments on capital outlays, and the ability to achieve cost
savings and realize productivity improvements and the consequences of
increased leverage;
o Availability of qualified personnel;
o Uncertainties in federal military spending levels in markets in which
we operate;
o Uncertainties surrounding the 2005 base realignment and closure program
and potential military base closures in markets in which we operate;
o The effect on us of industry consolidation including the potential
acquisition of one or more of our large wholesale customers by a
company with commercial relationships with other providers; and the
ongoing global and domestic trend towards consolidation in the
communications industry, which may result in our competitors being
larger and better financed, and provide these competitors with
extensive resources and greater geographic reach, allowing them to
compete more effectively;
o The effect on us of pricing pressures, new program offerings and
continuing market consolidation in the markets served by our
significant customers, MCI and Sprint; and
o Other risks detailed from time to time in our periodic reports filed
with the SEC.
You should not place undue reliance on any such forward-looking statements.
Further, any forward-looking statement, and such risks, uncertainties and other
factors speak only as of the date on which they were originally made and we
expressly disclaim any obligation or undertaking to disseminate any updates or
revisions to any forward-looking statement to reflect any change in our
expectations with regard to those statements or any other change in events,
conditions or circumstances on which any such statement is based, except as
required by law. New factors emerge from time to time, and it is not possible
for us to predict what factors will arise or when. In addition, we cannot assess
the impact of each factor on our business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statements.
12
Part I
Item 1. Business
General
In this Annual Report, "we," "us" and "our" refer to GCI, Inc. and its direct
and indirect subsidiaries.
GCI, Inc. was incorporated under the laws of the State of Alaska in 1997 to
effect the issuance of Senior Notes as further described in note 11 to the
accompanying "Consolidated Financial Statements" included in Part II of this
Report. GCI, Inc., as a wholly owned subsidiary of GCI, received through its
initial capitalization all ownership interests in subsidiaries previously held
by GCI. GCI, Inc. has its principal executive offices at 2550 Denali Street,
Suite 1000, Anchorage, AK 99503-2781 (telephone number 907-868-5600).
GCI, Inc. is primarily a holding company and together with its direct and
indirect subsidiaries, is a diversified communications provider with a leading
position in facilities-based long-distance service in the State of Alaska and is
Alaska's leading cable television and Internet services provider.
We are the leading integrated, facilities-based communications provider in
Alaska, offering local and long-distance voice, cable video, data and Internet
communications services to residential and business customers under our GCI
brand. A substantial number of our customers subscribe to product bundles that
include two or more of our services.
Since our founding in 1979, we have consistently expanded our product portfolio
to satisfy our customers' needs. We have benefited from the attractive and
unique demographic and economic characteristics of the Alaskan market. We are
pioneers of bundled communications services offerings, and believe our
integrated strategy of providing innovative bundles of voice, video and data
services provides us with an advantage over our competitors and will allow us to
continue to attract new customers, retain existing customers and expand our
addressable market. We hold leading market shares in long-distance, cable video
and Internet services and have gained significant market share in local access
against the incumbent provider.
Through our focus on long-term results and strategic capital investments, we
have consistently grown our revenues and expanded our margins. Our integrated
strategy provides us with competitive advantages in addressing the challenges of
converging telephony, video and broadband markets and has been a key driver of
our success. Today, using our extensive communications networks, we provide
customers with integrated communications services packages that we believe are
unmatched by any other competitor in Alaska.
Availability of Reports and Other Information
Internet users can access information about the Company and its services at
http://www.gci.com/, http://www.gcinetworksolutions.com/, and
http://www.alaskaunited.com/. The Company hosts Internet services at
http://www.gci.net/ and SchoolAccess(TM) services at http://www.gcisa.net/. Our
online telephone directory and yellow pages are hosted at
http://www.gcidirectory.com/. We make available on the http://www.gci.com/
website, free of charge, access to our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statement on Schedule
14A and amendments to those materials filed or furnished pursuant to Section
13(a) or 15(d) of the Securities and Exchange Act of 1934 as soon as reasonably
practicable after we electronically submit such material to the SEC. In
addition, the SEC's website is http://www.sec.gov/. The SEC makes available on
this website, free of charge, reports, proxy and information statements, and
other information regarding issuers, such as us, that file electronically with
the SEC. Information on our website or the SEC's website is not part of this
document.
13
Financial Information About Industry Segments
We have four reportable segments: long-distance services, cable services, local
access services and Internet services. For information required by this section,
you should see Part II, Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations. Also refer to Note 12 included in
Part II, Item 8, Consolidated Financial Statements and Supplementary Data.
Recent Developments
Intrastate Access Charge Ruling. On May 15, 2003, AT&T filed a petition with the
FCC requesting a declaratory ruling that intrastate access charges do not apply
to certain of its calling card offerings. When AT&T Alascom, a subsidiary of
AT&T, characterized calling card calls that originate and terminate in Alaska as
interstate, they shifted to us the charges for certain intrastate access payable
to Alaska LECs. In a proceeding before the RCA, the RCA had already declared
this AT&T Alascom practice to be improper. After AT&T petitioned the FCC, the
RCA stayed AT&T Alascom's obligations to make back payments of intrastate access
charges to Alaska LECs for the period prior to April, 2004, but ordered AT&T
Alascom to pay such charges on an ongoing basis from April 1, 2004. On February
23, 2005, the FCC also ruled against AT&T, consistent with the RCA's prior
findings. With this ruling, we can now seek to collect refunds for the
intrastate access charge amounts that AT&T Alascom improperly shifted to us
prior to April 1, 2004. We have not completed our calculations of the amounts
due to us and cannot predict at this time the ultimate amount to be refunded
pursuant to this gain contingency, however it could be material to our results
of operations, financial position and cash flows.
Barrow Cable TV Asset Purchase. We closed the asset purchase of Barrow Cable TV
in February 2005 for approximately $1.6 million, or approximately $1,700 per
subscriber. We plan to upgrade the plant of Barrow Cable TV in order to deliver
digital services as well as high-speed cable modem service. Upgrades are
scheduled to be implemented by the beginning of 2006. In January 2005, the RCA
approved the transfer of the Certificate of Public Convenience and Necessity to
us. We expect to add additional subscribers totaling approximately 950 and
additional homes passed totaling approximately 1,600 as a result of this asset
purchase.
Local Service Expansion Filing. In January 2005 we filed with the RCA to expand
our provision of competitive local telephone services into rural Alaska. We plan
to invest approximately $60 million dollars into local economies in
construction, technologies and facilities. We requested authorization to provide
service in competition with the existing service provider's entire service area
in the service area of Ketchikan Public Utilities, Cordova Telephone
Cooperative, Copper Valley Telephone Cooperative, Matanuska Telephone
Cooperative, and the "Glacier State" study area, including Delta Junction,
Homer, Kenai, Kodiak, Soldotna, Nenana, and North Pole. In addition, we are
seeking approval to offer local service in Wrangell, Petersburg, Sitka, Seward,
Bethel, and Nome. We are seeking certification in these markets for the area
covered by our cable facilities only.
We plan to offer service in these new areas using a combination of methods. To a
large extent, we will use our existing cable network to deliver local services.
Where we do not have cable plant, we may use wireless technologies and resale of
other carrier's services. We may lease portions of an existing carrier's network
or seek wholesale discounts, but our application is not dependent upon access to
either the incumbent's network or wholesale discount rates for resale of
services.
The RCA may only decide this application on the basis of whether or not we are
fit to provide the service. It has already been decided, under federal law, that
competition is permissible. Because we are not requesting use of the existing
carrier's network, there is no public interest issue for the RCA to decide. We
are requesting that the RCA decide this application as soon as possible, and in
any case, within six months.
14
MTA Rural Exemption Determination. By letter, submitted also to the RCA, on
January 12, 2004, we made a bona fide request for interconnection for the
purposes of local access competition with the Matanuska Telephone Association
("MTA"), under the provisions of the Telecommunications Act of 1996. We
submitted this request to MTA on the grounds that it waived its rural exemption
under the terms of Section 251(f)(1)(C) of the 1996 Telecom Act when it launched
its new video service through its wholly owned subsidiary MTA Vision, Inc. in
competition with our cable television service. MTA, however, refused to comply
with the negotiation and arbitration provisions under the 1996 Telecom Act
claiming that it still retains a rural exemption. We filed a complaint with the
RCA to resolve this dispute, and the RCA conducted a public hearing on the
matter on October 20, 2004. On February 22, 2005, the RCA released a ruling that
MTA's rural exemption for the areas served by MTA Vision, Inc. had been lifted
and that we may negotiate and arbitrate interconnection with MTA. We tendered a
new interconnection request to MTA on February 25, 2005 and are proceeding with
such negotiations. In the event negotiations are unsuccessful, an arbitration
will be requested which must be completed under the provisions of the 1996
Telecom Act by November 25, 2005. Following the entry into an Interconnection
Agreement, we intend to commence local service entry into the Mat-Su Valley
during 2007.
Cellular Service Expansion. We launched cellular services in the Southeast
Alaska cities of Petersburg and Wrangell in February 2005. This completes our
cellular services roll-out. Our cellular services are also provided in
Anchorage, Fairbanks, Homer, Juneau, Kenai/Soldotna, Ketchikan, Palmer/Wasilla,
Seward, Sitka, and Valdez.
Rural Internet Program Expansion. We expect to complete during the first quarter
of 2005 the last of the 50 wireless internet (WISP) sites that we began work on
in 2004. When these sites are completed, we will have provided internet services
to 150 remote communities in Alaska at faster speeds and lower rates than
they've experienced before.
AU East Capacity Expansion. We expect to complete a capacity expansion of our
AULP East fiber system during the first quarter of 2005. We are upgrading the
system using wavelength division multiplexing from its current five gigabit per
second ("Gbps") capacity to 20 Gbps.
Historical Development of our Business During the Past Fiscal Year
ConnectMD Services Expansion. We have developed an agreement with Alaska
Psychiatric Institute to expand our ConnectMD service to provide tele-psychiatry
services to health clinics across the state of Alaska. This new service will
triple the number of communities that have access to clinical staff via a video
link and we believe it will allow for better and more cost-efficient care for
patients. With this service, behavioral health patients in remote areas of
Alaska can now be treated in their own environment, instead of having to travel
to Anchorage for treatment.
Conversion to Digital Completed. In 2004 we completed the conversion of our
Anchorage and Fairbanks cable television systems from analog to digital service
delivery for service levels above basic. Digital service delivery allows us to
offer more programming content and advanced digital services, including digital
local phone service.
New Telephone Directories. We completed the distribution of our new telephone
directories to Fairbanks and Juneau areas homes and businesses. The directories
include an online version (http://www.gcidirectory.com/) so users can link to
advertisers' websites and e-mail addresses. They can also find arts, education,
government organizations and public safety information.
Galaxy XR Satellite Propulsion System Failure. Galaxy XR, our primary
satellite used to provide voice, data and internet services to our rural Alaska
customers, Galaxy XR, experienced a failure August 3, 2004 of its secondary
xenon ion propulsion system (XIPS) that maintains the satellite's proper orbital
position. The primary XIPS failed in February 2004. The satellite is now using
its backup bi-propellant thrusters to maintain its orbital position. These
thrusters are a space flight proven
15
technology. The failure of the primary and secondary XIPS had no short term
impact on service to our customers. PanAmSat, the owner and operator of Galaxy
XR, believes the satellite has sufficient fuel to continue normal operations
until November 2007. The terms of our Galaxy XR transponder purchase agreement
extends through March 2012. PanAmSat intends to replace the satellite before its
estimated end-of-life. We purchased a warranty with the original agreement to
cover a loss of this nature. We have had an agreement in place that provides
backup transponder capacity on the Galaxy XIII satellite in the event of a
catastrophic failure of Galaxy XR.
Cellular Services Distribution Agreement. We closed a 10-year distribution
agreement with a cellular service provider Dobson Communications ("Dobson") in
2004 that allows us to offer a full line of state-of-the-art voice and data
wireless products and services to our customers throughout Alaska. We are
marketing these products and services under our own brand as stand alone
wireless products and as additions to packaged offerings. The agreement also
allows us to develop new products and services combining both wireless and
wireline technologies. We will provide billing and all customer support services
for our wireless services. Under a separate agreement, Dobson will lease 10 MHz
of our 1900 MHz wireless spectrum and will expand services in existing and new
Alaska markets. Dobson's wireless spectrum is in the 800 MHz spectrum band. The
lease agreement enables us and Dobson to expand overall system capacity. This
will create a more efficient wireless system providing better service to
customers. Expansion of service under the terms of the agreement fulfills our
wireless buildout requirement to retain our PCS "B" block license.
Stock Repurchase Approvals. GCI's Board of Directors authorized us and we
obtained permission from our lenders and GCI's preferred shareholder to
repurchase up to $10 million of GCI's common stock during the six-month period
ended June 30, 2005. We expect to continue the purchases throughout 2005 subject
to the availability of free cash flow, credit facilities, the price of the stock
and the requisite consents of lenders and GCI's preferred shareholder. The
purchases will comply with the restrictions of Securities Exchange Commission
rule 10b-18.
AULP East Cable System Repair. Our AULP East system experienced powering
irregularities during the first quarter of 2004. We completed the repair of AULP
East in July 2004.
AULP West Cable System Completion. In June 2003 we began work on the
construction of a fiber optic cable system connecting Seward, Alaska and
Warrenton, Oregon, with leased backhaul facilities to connect it to our
switching and distribution centers in Anchorage, Alaska and Seattle, Washington.
A consortium of companies was selected to design, engineer, manufacture, and
install the undersea fiber optic cable system. We placed AULP West into service
in June 2004.
Anchorage Local Service Rates. The RCA released an order on June 28, 2004 that,
among other things, increased the Unbundled Network Element (UNE) rate we pay
ACS each month from $14.92 to $19.15 per line (subsequently reduced to $18.64
per line). In setting this rate, the RCA ruled on a variety of factors such as
depreciation, cost of capital, cost of the network, maintenance and
administrative overhead.
New Retail Store. In March 2004 we opened a new retail store in Eagle River that
serves our customers in Eagle River, Chugiak, and Peters Creek. Customers have a
more convenient opportunity to pay their bill, sign up for new services and
obtain answers to their questions from one of our customer service
representatives. HDTV and Digital Video Recorder Deployment. We began offering
HDTV programming in our Anchorage and Mat-Su Valley market areas in 2004. New
HDTV converters with digital video recorder capabilities were introduced to our
customers in these markets.
New Senior Notes and Senior Credit Facility Waiver and Amendment. In February
2004, GCI, Inc. issued $250 million principal amount of senior notes. These
senior notes bear interest at 7.25% and are due in February 2014. GCI, Inc. used
the proceeds from issuance of these senior notes to retire
16
or repay other indebtedness. In connection with the issuance of these senior
notes, GCI, Inc. offered to purchase all of its outstanding 9.75% Senior Notes
due 2007 (the "2007 Notes") for cash at 103.5% of the principal amount.
Approximately $114.6 million principal amount of the 2007 Notes were tendered
and accepted pursuant to this offer. GCI, Inc. called for redemption of the
remaining outstanding 2007 Notes at the redemption price of 103.25% of the
principal amount. In addition to the purchase and redemption of the 2007 Notes,
approximately $53.8 million of proceeds received from the issuance of the new
senior notes were used to repay indebtedness under our Senior Credit Facility.
Compliance with the redemption notice requirements in the 2007 Notes Indenture
resulted in a delay between the date the new senior notes were issued and the
final redemption date of the 2007 Notes. As a result of such delay, our total
debt temporarily increased during the overlap period between the redemption of
the outstanding 2007 Notes and the issuance of the new senior notes. This
temporary increase did not comply with certain provisions of our Senior Credit
Facility. We received a waiver of these provisions from the lenders under our
Senior Credit Facility until April 30, 2004.
On November 19, 2004, we entered into an Amendment No. 3 to our Senior Credit
Facility. The amendment modifies the terms of the existing credit facility to
permit the incurrence by GCI, Inc. of up to $100 million in aggregate principal
amount of additional senior notes due 2014. The amended credit facility permits
up to $70 million of the proceeds from such additional senior notes to be used
to purchase shares of GCI stock held by MCI and Toronto Dominion Investments,
Inc. (or the proceeds may be distributed to GCI for such purpose), so long as
there exists no default under the credit facility both before and after giving
effect to such transaction. The amended credit facility also permits the
proceeds to be used for additional capital expenditures.
Add-on Senior Notes and Stock Retirements. On December 7, 2004, we issued $70
million of additional 7.25% senior notes due 2014. In a private transaction
concurrent with the closing of the additional senior notes, we repurchased
3,751,509 of GCI's Class A common shares at $8.33 per share and $10 million face
value of GCI's Series C preferred stock from MCI. The aggregate amount of the
equity repurchase totaled $41.3 million. In addition, $10 million of the
proceeds of the additional senior notes were used to repay the outstanding
balance on our revolving credit facility. The remaining balance of the bond
proceeds of more than $17 million, after fees and expenses, will be used for
other general corporate purposes.
Fiber System Taken out of Service. We own a portion of the capacity of an
undersea fiber optic cable system linking Alaska to the Lower 48 states known as
the Alaska spur of the North Pacific Cable ("NPC"). The Alaska spur of the NPC
was removed from service in January 2004 by PT Cable, Inc. due to a dispute over
billings between PT Cable, Inc. and AT&T. We determined that the recorded value
for our NPC fiber asset was impaired at December 31, 2003 and recorded a $5.4
million charge in the fourth quarter in the financial statements included in
Part II of this report.
Free Cable Modem Service. On January 26, 2004, we began offering new and current
customers free LiteSpeed cable modem Internet service when they sign up for
certain of our other services. LiteSpeed uses cable modems and is designed for
dial-up Internet access customers who want more Internet download speed and
greater convenience. Cable modems transmit data reliably at a much faster rate
than dial-up connections and do not tie up the telephone line. Our cable modem
service is available to a high percentage of Alaska homes in Anchorage, Bethel,
Cordova, Fairbanks, Homer, Juneau, Kenai, Ketchikan, Kodiak, Nome, Palmer,
Petersburg, Seward, Sitka, Soldotna, Valdez, Wasilla, and Wrangell.
Alaska Supreme Court Decision and Settlement. ACS, through subsidiary companies,
provides local telephone services in Fairbanks and Juneau, Alaska. The ACS
subsidiaries are classified as Rural Telephone Companies under the 1996 Telecom
Act, which entitles them to an exemption of certain material interconnection
terms of the 1996 Telecom Act, until and unless such "rural exemption" is
examined and not continued by the RCA. On October 11, 1999, the RCA issued an
order terminating
17
rural exemptions for the ILECs operating in the Fairbanks and Juneau markets so
that we could compete with these companies in the provision of local telephone
service. Upon appeal by ACS, on December 12, 2003, the Alaska Supreme Court
issued a decision in which it reversed the RCA's rural exemption decision on the
procedural ground that the competitor, not the incumbent, must shoulder the
burden of proof. The Court remanded the matter to the RCA for reconsideration
with the burden of proof assigned to us. Additionally, the Court left it to the
RCA to decide as a matter of discretion whether to change the state of
competition during the remand period. In accordance with the Court's ruling, the
RCA re-opened the rural exemption dockets and scheduled a hearing to commence on
April 19, 2004. Additionally, the RCA issued a ruling on January 16, 2004, in
which the RCA determined that we can continue to rely on unbundled network
elements from ACS to serve our existing customers in Juneau and Fairbanks but
that we may not serve new customers through purchase of unbundled network
elements pending the completion of the remand proceeding.
On April 20, 2004, we announced that a joint settlement was reached that
substantially resolved a number of legal and regulatory proceedings between ACS
and us. Among other things, terms of the settlement are as follows:
o ACS relinquishes all claims to exemptions from full local telephone
competition in Fairbanks and Juneau,
o New rates for unbundled loops in Fairbanks and Juneau beginning January
1, 2005,
o Resolution of UNE loops provided with ILEC switching (UNE-Platform)
leasing issues for the Fairbanks and Juneau markets, and
o Extension of existing interconnection agreements between ACS and us for
Fairbanks and Juneau until January 1, 2008.
See "Part I -- Item 1 -- Business -- Regulation, Franchise Authorizations and
Tariffs -- Communications Operations -- Rural Exemption" for more information.
Narrative Description of our Business
General
We are the largest Alaska-based and operated integrated communications provider.
A pioneer in bundled service offerings, we provide facilities-based local and
long distance voice, cable video, Internet and data communications services, and
resell wireless telephone services, to residential and business customers under
our GCI brand.
We generated consolidated revenues of $424.8 million in 2004. We ended the year
with approximately 91,300 long-distance customers, 112,100 local access lines in
service, 134,700 basic cable subscribers, and 101,600 Internet subscribers,
including 65,500 cable modem subscribers. A substantial number of our customers
subscribe to product bundles that include two or more of our services. The
National Cable and Telecommunications Association ("NCTA") reports that we were
the 25th largest MSO in the U.S. as of September 30, 2004.
Since our founding in 1979, we have consistently expanded our product portfolio
to satisfy our customers' needs. We have benefited from the attractive and
unique demographic and economic characteristics of the Alaskan market. We
believe our integrated strategy of providing innovative bundles of voice, video
and data services provides us with an advantage over our competitors and will
allow us to continue to attract new customers, retain existing customers and
expand our addressable market. We hold leading market shares in long-distance,
cable video and Internet services and have gained significant market share in
local access against an incumbent provider.
Through our focus on long-term results and strategic capital investments, we
have consistently grown our revenues and expanded our margins. Our integrated
strategy provides us with competitive advantages in addressing the challenges of
converging telephony, video and broadband markets and has been a key driver of
our success. Today, using our extensive communications networks, we
18
provide customers with integrated communications services packages that we
believe are unmatched by any other competitor in Alaska.
We operate a broadband communications network that permits the delivery of a
seamless integrated bundle of communications, entertainment and information
services. We offer a wide array of consumer and business communications and
entertainment services -- including local telephone, long-distance and wireless
communications, cable television, consulting services, network and desktop
computing outsourced services, and dial-up, broadband (cable modem, wireless and
DSL) and dedicated Internet access services at a wide range of speeds -- all
under the GCI brand name.
We believe that the size and growth potential of the voice, video and data
market, the increasing deregulation of communications services, and the
increased convergence of telephony, wireless, and cable services offer us
considerable opportunities to continue to integrate our communications, Internet
and cable services and expand into communications markets both within and,
longer-term, possibly outside of Alaska.
Considerable deregulation has already taken place in the United States because
of the 1996 Telecom Act with the barriers to competition between long-distance,
local exchange and cable providers being lowered. We believe our acquisition of
cable television systems and our development of local exchange service, Internet
services, broadband services, and wireless services leave us well positioned to
take advantage of deregulated markets.
We are Alaska's leading provider of long-distance, cable television and data and
Internet services, as measured by revenues, and we are the second largest local
access provider, as measured by local access lines. We attribute our leadership
position to our commitment to provide our customers with high-quality products
in bundled offerings that maximize their satisfaction. We maintain a strong
competitive position, however there is active competition in the sale of
substantially all products and services we offer.
Competition in the Communications Industry
There is substantial competition in the communications industry. The traditional
dividing lines between providers offering long-distance telephone service, local
telephone service, wireless telephone service, Internet services and video
services are increasingly becoming blurred. Through mergers and various service
integration and product bundling strategies, major providers, including us, are
striving to provide integrated communications service offerings within and
across geographic markets.
Competitive Strengths
Market Leader. We are Alaska's leading provider of long-distance, cable
television and data and Internet services, as measured by revenues, and we are
the second largest local access provider, as measured by local access lines. We
attribute our leadership position to our commitment to provide our customers
with high-quality products in bundled offerings that maximize their
satisfaction.
Advanced Infrastructure and Robust Network Assets. We own and operate advanced
networks that provide integrated end-to-end solutions. Our hybrid-fiber coax
cable network enables us to offer last-mile broadband connectivity to our
customers. Our interstate and undersea fiber optic cable systems connect our
major markets in Alaska to the Lower 48 States. We employ satellite transmission
for rural intrastate and interstate traffic in markets where terrestrial based
network alternatives are not available. We have or expect to be able to obtain
satellite transponders to meet our long-term satellite capacity requirements. In
our local service markets, we offer services using our own facilities, unbundled
network elements and wholesale/resale.
19
Bundled Service Offerings. Ownership and control of our network and
communications assets have enabled us to effectively market bundled service
offerings. Bundling facilitates the integration of operations and administrative
support to meet the needs of our customers. Our product and service portfolio
includes stand-alone offerings and bundled combinations of local and
long-distance voice and data services, cable video, broadband (cable modem,
fixed wireless and DSL), dedicated Internet access services and other services.
Well-Recognized Brand Name. Our GCI brand is the oldest brand among major
communications providers in Alaska and positively differentiates our services
from those of our competitors. We believe our customers associate our brand name
with quality products. We continue to benefit from high name recognition and
strong customer loyalty, and the majority of our customers purchase multiple
services from us. We have been successful in selling new and enhanced products
to our customers based on perceived quality of products and brand recognition.
Favorable Alaskan Market Dynamics. The Alaskan communications market is
characterized by its large geographic size and isolated markets that include a
combination of major metropolitan areas and small, dense population clusters,
which create a deterrent to potential new entrants. Due to the remote nature of
its communities, the state's residents and businesses rely extensively on our
systems to meet their communications needs. We believe that, when compared to
national averages, Alaskan households spend more on communications services.
According to the United States Census Bureau, the median household income in
Alaska was 27% higher than the three-year United States national average from
2001 to 2003, and according to the Alaska Department of Revenue, in 2003,
federal spending in Alaska was up 4%, year over year. We believe there is a
positive outlook for continued growth.
Experienced Management Team. Our experienced management team has a proven track
record and has consistently expanded our business and improved our operations.
Our senior management averages more than 24 years of experience in the
communications industry and more than 19 years with our company.
Business Strategy
We intend to continue to increase revenues and cash flow using the following
strategies:
Continue to Offer Bundled Products. We offer innovative service bundles to
meet the needs of our residential and business customers. Bundling our
services significantly improves customer retention, increases revenue per
customer and reduces customer acquisition expenses. Our experience
indicates that our bundled customers are significantly less likely to
churn, and we experience less price erosion when we effectively combine our
offerings. Bundling improves our top line growth, provides operating cost
efficiencies that expand our margins and drives our overall business
performance. As a measure of success to date, substantially all of our
local customers subscribe to our long-distance service and approximately
one-half of our cable video subscribers also subscribe to our high-speed
Internet service.
Maximize Sales Opportunities. We successfully sell new and enhanced
services and products between and within our business segments to our
existing customer base to achieve increased revenues and penetration of our
services. Through close coordination of our customer service and sales and
marketing efforts, our customer service representatives cross sell and up
sell our products. Many calls into our customer service centers result in
sales of additional products and services. We actively seek to continue to
encourage our existing customers to acquire higher value, enhanced
services.
Deliver Industry Leading Customer Service. We have positioned ourselves as
a customer service leader in the Alaska communications market. We operate
our own customer service department and maintain and staff our own call
centers. We have empowered our customer service
20
representatives to handle most service issues and questions on a single
call. We prioritize our customer services to expedite handling of our most
valuable customers' issues, particularly for our largest business
customers. We believe our integrated approach to customer service,
including setting up the service, programming various network databases
with the customer's information, installation, and ongoing service, allows
us to provide a customer experience that fosters customer loyalty.
Leverage Communications Operations. We continue to expand and evolve our
integrated network for the delivery of our services. Our bundled strategy
and integrated approach to serving our customers creates efficiencies of
scale and maximizes network utilization. By offering multiple services, we
are better able to leverage our network assets and increase returns on our
invested capital. We periodically evaluate our network assets and
continually monitor technological developments that we can potentially
deploy to increase network efficiency and performance.
Expand Our Product Portfolio and Footprint in Alaska. Throughout our
history, we have successfully added and expect to continue to add new
products to our product portfolio. Management has a demonstrated history of
evaluating potential new products for our customers, and we will continue
to assess revenue-enhancing opportunities that create value for our
customers. In addition to new services such as digital video recorders,
HDTV and video-on-demand, we are also expanding the reach of our core
products to new markets. Where feasible and where economic analysis
supports geographic expansion of our network coverage, we expect to pursue
opportunities to increase the scale of our facilities, enhance our ability
to serve our existing customers' needs and attract new customers.
Alaska Voice, Video and Data Markets
The Alaskan voice, video and data markets are unique within the United States.
Alaska is geographically distant from the rest of the United States and is
generally characterized by large geographical size and relatively small, dense
population clusters (with the exception of population centers such as Anchorage,
Fairbanks and Juneau). It lacks a well-developed terrestrial transportation
infrastructure, and the majority of Alaska's communities are accessible only by
air or water. As a result, Alaska's communication networks are different from
those found in the Lower 49 States.
Alaskans continue to rely extensively on satellite-based long-distance
transmission for intrastate calling between remote communities where investment
in a terrestrial network would be uneconomic or impractical. Also, given the
geographic isolation of Alaska's communities and lack, in many cases, of major
civic institutions such as hospitals, libraries and universities, Alaskans are
dependent on communications services to access the resources and information of
large metropolitan areas in Alaska, the rest of the United States and elsewhere.
In addition to satellite-based communications, the communications services
infrastructure in Alaska includes fiber optic cables between Anchorage, Valdez,
Fairbanks, Prudhoe Bay, Seward, Kenai/Soldotna, Palmer/Wasilla, Homer and
Juneau, traditional copper wire, and digital microwave radio on the Kenai
Peninsula and other locations. For interstate and international communications,
Alaska is connected to the Lower 48 States by four fiber optic cables, one of
which was taken out of service in January 2004. See "Part I -- Item 1 --
Business -- Historical Development of our Business During the Past Fiscal Year
- -- Fiber System Taken out of Service" for more information.
Fiber optics is currently the preferred method of carrying Internet, voice,
video, and data communications over long-distances, eliminating the delay
commonly found in satellite connections. Widespread use of high capacity fiber
optic facilities is expected to allow continued expansion of business,
government, educational, and health care infrastructure in Alaska.
21
Long-Distance Services
Industry. Until the 1970s, AT&T had a virtual monopoly on long distance service
in the United States. In the 1970s, competitors such as MCI and Sprint began to
offer long distance service. With the gradual emergence of competition, basic
rates dropped, calling surged, and AT&T's dominance declined. More than 900
companies now offer wire-line long distance service. AT&T's 1984 toll revenues
were approximately 90% of those reported by all long distance carriers. The
FCC's regulation of AT&T as a "dominant" carrier ended in 1995. By 2003, AT&T's
revenues had declined to approximately 29% of all toll revenues. The two largest
market entrants, MCI and Sprint, have obtained a 28% combined market share
through 2003. BellSouth, Quest, SBC and Verizon have obtained a 15% combined
market share in 2003 as compared to 9% in 2000.
The FCC reports that approximately $78.6 billion was derived from toll services
in 2003 as compared to $109.6 billion in 2000. In 2002, residential customers
generated over 45% of toll revenues, and 35% of residential toll phone calls
were interstate as opposed to 47% of minutes. In 2002, approximately 31% of
total toll services revenue was derived from intrastate, 51% was derived from
domestic interstate, and 18% was derived from international toll services.
Interstate long distance toll revenues increased approximately 62% from $26
billion in 1984 to $43 billion in 2002, and intrastate toll revenues increased
approximately 23% from $21 billion in 1984 to $26 billion in 2002, despite
significant rate reductions in both categories during this period. Significant
decreases occurred in 2002 as compared to 2001, with interstate long distance
and intrastate toll revenues each decreasing approximately 13%.
The FCC reports that total interstate switched access minutes have declined
21.7% from 2000 to 2003; from 566.9 billion to 444.1 billion, respectively.
Average revenue per minute of long distance calling dropped from $0.32 in 1984,
when competitive discount and promotional long distance plans were introduced,
to $0.09 in 2002. This average price per minute represents a mix of
international calling (an average of 28 cents per minute) and domestic
interstate calling (an average of 7 cents per minute). The decline in prices
since 1984 is more than 80% after adjusting for the impact of inflation. The
annual rate of change in the consumer price index for all telephone services
between 2002 and 2003 was reported to be -2.7% as compared to 1.9% for all
services. Local residential services (based on monthly service charges, message
unit charges, leased equipment, installation, enhanced services, taxes,
subscriber line charges, and all other consumer expenditures associated with
telephone services except long distance charges) increased 2.6% in 2003 as
compared to 2002, while interstate toll service decreased 10.9% and intrastate
toll service decreased 9.4% during the same period. The average revenue per
minute for interstate and international calls in 1990 was $0.28 (adjusted for
inflation) as compared to $0.09 in 2002.
The FCC reports that approximately 2% of all consumer expenditures are devoted
to telephone service. This percentage has remained relatively constant over the
past 15 years, despite major changes in the industry and in telephone usage.
Average annual expenditures for telephone service increased from $877 per
household in 2000 to $996 in 2002.
The FCC reports that approximately 106 million U.S. households had telephone
services as of March 2004, an increase of 28 million households since 1983. An
estimated 93.8% of households and virtually all businesses in the United States
subscribed to telephone service in July 2004. Approximately 92.9% of households
subscribed to telephone service in 1980.
The FCC reports that primary lines in service in the United States have grown
over time, averaging approximately 3% per year, which, until 2000, had
historically reflected growth in the population and the economy. Since then, the
number of lines provided by wireline carriers has declined. The FCC reports that
consumer substitution of wireless service for wireline service, and consumer
elimination of second lines when they move from dial-up Internet service to
broadband service may explain the decrease. The percentage of additional
wirelines for households with telephone service has
22
increased significantly, from approximately 3% in 1988 to approximately 26% in
2000, and decreased back to 18% in 2002.
International communications continues to be an important segment of the
communications market. The FCC reports that the number of calls made from the
United States to other countries increased from 200 million in 1980 to 6.1
billion in 2002, and that Americans spent approximately $11.5 billion on
international telephone and private line services in 2002. Consistent with
domestic toll rates per minute, international toll rates per minute have
decreased significantly. On average, carriers billed 28 cents per minute for
international calls in 2002, a decline of more than 79% since 1980. Five
markets, Canada, Mexico, the United Kingdom, Germany, and India, accounted for
approximately 41% of the international calls billed in the United States in
2002. AT&T, MCI, and Sprint combined accounted for 82% of the international
service billed in the United States in 2002.
While the 1996 Telecom Act has facilitated competition and rapid growth in the
communications market, the last three years have been a tumultuous time for that
marketplace. Industry analysts believe that overly optimistic projections of
data growth spurred companies to invest large amounts of capital to boost
network capacity. While demand for communications services grew, it did not grow
at a sufficient pace to justify the substantial build-out of fiber capacity. A
wide gap developed between the supply of network capacity and the demand for
data transmission. Network owners refocused their efforts to demonstrate
profitability over a much shorter time horizon than initially projected. A
downward spiral ensued, as some communications carriers went out of business
after failing to generate sufficient revenues to service their accelerating debt
loads. The resultant slowdown in capital expenditures left equipment
manufacturers with surplus inventory and personnel. Excess capacity and new
technology is expected to enable more competition.
The communications industry stabilized in 2003, but remains stagnant. Intense
price competition continues, with continuing technological innovations
threatening established services.
Growth in demand for data services is expected to continue to be a key component
of industry revenue growth. We believe that the data communications business
will eventually rival and perhaps become larger than the traditional voice
telephony market. The continuing migration of voice and other traffic from
analog to digital transmission and the growth in data attributed to broadband
applications are expected to fuel the growth in data with inevitable industry
realignment expected to continue.
The FCC issued a Report and Order (FCC 03-197) in 2003 eliminating a policy that
prohibited the installation or operation of more than one satellite earth
station in any Alaska rural community for competitive carriage of interstate
message telephone service ("MTS") communications. The FCC found that through a
series of regulatory steps, the environment that once called for restrictions on
competitive facilities-based entry had changed. This policy change allows us to
install facilities and provide competitive interstate MTS and other
communications services over our own equipment and network in rural communities
where we presently have no facilities.
We believe that federal and state legislators, courts and regulators will
continue to influence the communications industry in 2005. Consummation of
mergers between and spin-offs from long-distance companies, local access
services companies, ISPs and cable television companies is expected to continue
to occur which blurs the distinction between product lines and competitors.
Industry analysts believe companies will be successful in the long-term if they
can achieve and maintain a superior operating cost position, minimize regulatory
battles, offer a full suite of integrated services to their customers using a
network that is largely under their control, and continue to offer new and
enhanced services that customers wish to purchase.
See "Part I -- Item I -- Business -- Regulation, Franchise Authorizations and
Tariffs -- Long-Distance Services" for more information.
23
General. We supply a full range of common carrier long-distance and other
communications products and services. We operate a modern, competitive
communications network employing the latest digital transmission technology
based upon fiber optic facilities within and between Anchorage, Fairbanks and
Juneau, Alaska. Our facilities include two self-constructed and financed
undersea digital fiber optic cables and additional owned capacity on another
undersea fiber optic cable (which was taken out of service in January 2004, (see
"Part I -- Item 1 -- Business -- Historical Development of our Business During
the Past Fiscal Year -- Fiber System Taken out of Service"), linking our Alaska
terrestrial networks to the networks of other carriers in the Lower 49 States.
We use satellite transponders to transmit voice and data traffic to remote areas
of Alaska. We operate digital microwave systems to link Anchorage with the Kenai
Peninsula, and our Prudhoe Bay Earth Station with Deadhorse. Digital microwave
facilities also are used to back up our fiber facilities from Anchorage to our
Eagle River earth station, and to our Fairbanks earth station from our Fairbanks
distribution center. Virtually all switched services are computer controlled,
digitally switched, and interconnected by a packet switched SS7 signaling
network.
We provide interstate and intrastate long-distance services throughout Alaska
using our own facilities or facilities leased from or swapped with other
carriers. We also provide (or join in providing with other carriers)
communications services to and from Alaska, Hawaii, the Lower 48 States, and
many foreign nations and territories.
We offer cellular services by reselling another cellular provider's services. We
offer wireless local access services over our own facilities, and have purchased
PCS and LMDS wireless broadband licenses in FCC auctions covering markets in
Alaska.
Products. Our long-distance services industry segment is engaged in the
transmission of interstate and intrastate-switched message telephone service and
Private Line and Private Network communications service between the major
communities in Alaska, and the remaining United States and foreign countries.
Our message toll services include intrastate, interstate and international
direct dial, toll-free 800, 888, 877 and 866 services, our calling card,
operator and enhanced conference calling, frame relay, SDN, ISDN technology
based services, as well as terminating northbound MTS traffic for MCI, Sprint
and several large resellers who do not have facilities of their own in Alaska.
We also provide origination of southbound calling card and toll-free 800, 888,
877 and 866 toll services for MCI, Sprint, and other IXCs. We offer our message
services to commercial, residential, and government subscribers. Subscribers
generally may cancel service at any time. Toll, Private Line, broadband and
related services account for approximately 45.7%, 49.6% and 53.5% of our 2004,
2003 and 2002 revenues, respectively. Broadband services include our
SchoolAccess(TM) and Rural Health initiatives. Private Line and Private Network
services utilize voice and data transmission circuits, dedicated to particular
subscribers, which link a device in one location to another in a different
location.
We have positioned ourselves as a price, quality, and customer service leader in
the Alaska communications market. The value of our long-distance services is
generally designed to be equal to or greater than that for comparable services
provided by our competitors.
In addition to providing communications services, we also design, sell, install,
service and operate, on behalf of certain customers, communications and computer
networking equipment and provide field/depot, third party, technical support,
communications consulting and outsourcing services through our Network Solutions
business. We also supply integrated voice and data communications systems
incorporating interstate and intrastate digital Private Lines, point-to-point
and multipoint Private Network and small earth station services. Our Network
Solutions sales and services revenue totaled $13.8 million, $11.9 million, and
$12.4 million in the years ended December 31, 2004, 2003 and 2002, respectively,
or approximately 3.2%, 3.0% and 3.4% of total revenues, respectively. Presently,
there are a number of competing companies in Alaska that actively sell and
maintain data and voice communications systems. Network Solutions' managed
services and product sales results
24
are reported in the All Other category in the Consolidated Financial Statements
included in Part IV of this report.
Our ability to integrate communications networks and data communications
equipment has allowed us to maintain our market position based on "value added"
support services rather than price competition. These services are blended with
other transport products into unique customer solutions, including managed
services and outsourcing.
Facilities. Our communication facilities include an undersea fiber optic cable
system connecting Whittier, Valdez and Juneau, Alaska and Seattle, Washington,
which was placed into service in February 1999.
We constructed a new undersea fiber optic cable system connecting Seward, Alaska
to Warrenton, Oregon that we placed into service in June 2004. This fiber optic
cable system is designated AULP West and the original undersea fiber optic cable
system is now designated AULP East. The Seward cable landing station connects to
our network in Anchorage and the Warrenton cable landing station connects to our
network in Seattle via long-term leased capacity. The combination of AULP West
and AULP East provides us with the ability to provide fully protected
geographically diverse routing of service between Alaska and the Lower 48
States.
These undersea fiber optic cable systems allow us to carry our military base
traffic and our Anchorage, Delta Junction, Eagle River, Fairbanks, Girdwood,
Glenallen, Healy, Juneau, Seward, Valdez, Wasilla, and Whittier, Alaska traffic
to and from the contiguous Lower 48 States and between these instate locations
over terrestrial circuits, eliminating the one-half second round trip delay
associated with satellite circuits.
Other facilities include major earth stations at Barrow, Bethel, Cordova,
Dillingham, Dutch Harbor, Eagle River, Ketchikan, King Salmon, Kodiak, Kotzebue,
Nome, Prudhoe Bay, and Sitka, all in Alaska, serving the communities in their
vicinity, and at Issaquah, Washington, which provides interconnection to Seattle
and the Lower 48 States for traffic to and from major Alaska earth stations. The
Eagle River earth station is linked to the Anchorage distribution center by
fiber optic facilities.
We use SONET as a service delivery method for our terrestrial metropolitan area
networks as well as our long-haul terrestrial and undersea fiber optic cable
networks. As of December 31, 2004 we have completed interconnection of
approximately 203 businesses and co-location facilities within the Anchorage,
Juneau and Fairbanks metropolitan areas, as well as the 800-mile long
TransAlaska Pipeline System pipeline right of way that connects Valdez to
Prudhoe Bay, Alaska. We currently connect Anchorage, Whittier, Juneau and
Seattle through our AULP East undersea fiber network. We use SONET-based next
generation multi-service nodes for purposes of delivering traditional TDM
services (at DS-0, DS-1 and DS-3 data rates) as well as next generation
services, such as optical OC-n and Ethernet. We have expanded our digital
cross-connect capacity through the addition of three large 3:1 cross connects
located in Anchorage and Seattle.
A fiber optic cable system from our Anchorage distribution center connects to
the MTA Eagle River central office and to our major hub earth station in Eagle
River. The Issaquah earth station is connected with the Seattle distribution
center by means of diversely routed leased fiber optic cable transmission
systems, each having the capability to restore the other in the event of
failure. The Juneau earth station and distribution centers are collocated. We
have digital microwave facilities serving the Kenai Peninsula communities. We
maintain earth stations in Fairbanks (linked by digital microwave to the
Fairbanks distribution center), Juneau (collocated with the Juneau distribution
center), Anchorage (Benson earth station), and in Prudhoe Bay as fiber network
restoration earth stations. Our Benson earth station also uplinks our statewide
video service; such service may be pre-empted if earth station capacity is
needed to restore our fiber network between Anchorage and Prudhoe Bay.
25
We constructed an earth station in Platinum, Alaska in 2004. This station was
constructed to support our telemedicine network. Two additional earth stations
in McGrath and Yakutat, Alaska are expected to be placed into service in the
first quarter of 2005.
We use our DAMA facilities to serve 57 additional locations throughout Alaska.
DAMA is a digital satellite earth station technology that allows calls to be
made between remote villages using only one satellite hop thereby reducing
satellite delay and capacity requirements while improving quality. In 1996, we
obtained the necessary RCA and FCC approvals waiving prohibitions against
construction of competitive facilities in certain rural Alaska communities,
allowing for deployment of DAMA technology in 56 sites in rural Alaska on a
demonstration basis. These prohibitions were removed by the FCC on August 6,
2003 allowing us to begin deploying earth stations in more locations in Alaska.
In addition, 72 (for a total of 129) C-band facilities provide dedicated
Internet access, Telehealth and Private Network services to rural public
schools, hospitals, health clinics, and natural resource development industries
throughout Alaska. Our Network of 86 Ku- band facilities provide dedicated
Internet access, Telehealth and private network services to rural public
schools, hospitals, health clinics, and natural resource development industries
throughout Alaska, and in 13 locations in the Lower 48 States.
Our Anchorage, Fairbanks, and Juneau distribution centers contain electronic
switches to route calls to and from local exchange companies and, in Seattle, to
obtain access to MCI, Sprint and other carriers to distribute our southbound
traffic to the remaining 49 states and international destinations. In Anchorage,
a Lucent Technologies Inc. ("Lucent") 5ESS digital host switch is connected by
fiber to seven remote facilities that are co-located in the ILEC switching
centers, to provide both local and long-distance service. Our extensive
metropolitan area fiber network in Anchorage supports cable television, Internet
and telephony services. The Anchorage, Fairbanks, and Juneau facilities also
include digital access cross-connect systems, frame relay data switches,
Internet platforms, and in Anchorage and Fairbanks, co-location facilities for
interconnecting and hosting equipment for other carriers. We also maintain an
operator and customer service center in Wasilla, Alaska.
We have constructed a switching center and ILEC collocation offices in
Fairbanks, and have installed a Lucent switch to enable the provisioning of
local telephone access services in that market. Substantially all toll traffic
originating in Fairbanks is routed to Anchorage. Fairbanks UNE loop provisioning
began in early 2002.
We installed a Lucent switch in our Juneau distribution center and collocation
offices at several of the Juneau ILEC central offices, enabling local services
to be launched in the Juneau market in 2002. Our collocation facilities enable
UNE loop access to a portion of the Juneau ILEC's loop facilities. See "Part I
- -- Item 1 -- Business -- Historical Development of our Business During the Past
Fiscal Year -- Alaska Supreme Court Decision and Settlement" for more
information.
We own and use Lucent 5ESS switches in Anchorage and Seattle. The Anchorage
switch serves as our primary long distance switch in Alaska, enabling additional
network efficiencies.
Our operator services traffic is processed by an integrated services platform
that also hosts answering services, directory assistance, and internal
conferencing services.
We employ satellite transmission for rural intrastate and interstate traffic and
certain other major routes. We acquired satellite transponders on PanAmSat
Corporation ("PanAmSat") Galaxy XR satellite in March 2000 to meet our long-term
satellite capacity requirements. We further augmented capacity on Galaxy XR with
the lease of a seventh C-band transponder in October, 2002. See "Part I -- Item
1 -- Business -- Historical Development of our Business During the Past Fiscal
Year -- Galaxy XR Satellite Propulsion System Failure" for more information.
As demand for redundant, geographically diverse capacity on our network
increases, we will need to further augment our facilities between Alaska and the
Lower 48 States. See "Part I -- Item 1 --
26
Business -- Historical Development of our Business During the Past Fiscal Year
- -- AU East Capacity Expansion" for more information.
In June 2004 we completed the construction of AULP West connecting Seward,
Alaska and Warrenton, Oregon, with leased backhaul facilities to connect it to
our switching and distribution centers in Anchorage, Alaska and Seattle,
Washington. Capital expenditures for this project totaled approximately $50.1
million, most of which was funded through our operating cash flows.
We employ a packet data satellite transmission technology for the efficient
transport of broadband data in support of our rural health and SchoolAccessTM
initiatives. We expect to further expand and upgrade this network during 2005.
An upgrade of the packet data satellite transmission equipment to a more
bandwidth efficient modulation scheme is expected to be completed during the
first quarter of 2005. In addition, our SchoolAccessTM and rural wireless
Internet service is partially provisioned over a satellite based digital video
broadcast carrier that is scheduled to convert to a more efficient modulation
scheme during the first quarter of 2005. These projects reduce the requirement
for new satellite transponder bandwidth to support expected growth in rural
health, distance learning and rural Internet services.
Emerging technology that facilitates more efficient transport of fixed assigned
point-to-point satellite transmissions is expected to become available during
the first quarter of 2005. This technology allows fixed point-to-point
transmissions between two earth stations to transmit at the same frequency.
Successful implementation of this new technology may reduce the requirement for
new satellite bandwidth to meet our needs as expected growth in demand for our
services occurs. We are investigating the possible use of this new technology to
further increase the efficiency of bandwidth utilization for a portion of our
satellite network.
We employ advanced digital transmission technologies to carry as many voice
circuits as possible through a satellite transponder without sacrificing voice
quality. Other technologies such as terrestrial microwave systems, metallic
cable, and fiber optics tend to be favored more for point-to-point applications
where the volume of traffic is substantial. With a sparse population spread over
a large geographic area, neither terrestrial microwave nor fiber optic
transmission technology is considered to be economically feasible in rural
Alaska in the foreseeable future.
Customers. We had approximately 91,300, 85,600 and 88,200 active Alaska
long-distance message telephone service subscribers at December 31, 2004, 2003
and 2002, respectively. Approximately 11,200, 11,300 and 11,600 of these were
business and government users at December 31, 2004, 2003 and 2002, respectively,
and the remainder were residential customers. Increases in our total customer
counts were primarily attributed to our successful efforts to acquire and retain
customers due to popular product bundle offerings. Decreases in our business and
government customer counts were primarily attributed to continuing competitive
pressures in Anchorage and other markets we serve. Message telephone service
revenues (excluding broadband, operator services and Private Line revenues)
averaged approximately $9.9 million per month during 2004.
Equal access conversions have been completed in all communities we serve with
owned facilities. We estimate that we carry nearly 50% of combined business and
residential traffic as a statewide average for both originating interstate and
intrastate message telephone service traffic.
27
A summary of our switched long-distance message telephone service traffic (in
minutes) follows:
Interstate Minutes
---------------------------------------
Combined
Interstate
Inter- and Inter- Intra-
South- North- Calling national national state Total
For Quarter ended bound bound Card Minutes Minutes Minutes Minutes
- -----------------------------------------------------------------------------------------------------------------------
(Amounts in thousands)
March 31, 2002 133,455 91,061 1,683 1,413 227,612 40,781 268,393
June 30, 2002 144,143 105,001 1,582 1,462 252,188 44,528 296,716
September 30, 2002 159,564 90,839 1,463 1,527 253,393 46,860 300,253
December 31, 2002 138,735 78,483 1,341 1,506 220,065 43,595 263,660
------------------------------------------------------------------------------------------
Total 2002 575,897 365,384 6,069 5,908 953,258 175,764 1,129,022
==========================================================================================
March 31, 2003 132,172 78,882 1,186 1,487 213,727 45,345 259,072
June 30, 2003 142,333 83,749 1,107 1,508 228,697 52,489 281,186
September 30, 2003 159,439 96,512 1,055 1,514 258,520 55,918 314,438
December 31, 2003 144,829 107,620 1,013 1,546 255,008 49,553 304,561
------------------------------------------------------------------------------------------
Total 2003 578,773 366,763 4,361 6,055 955,952 203,305 1,159,257
==========================================================================================
March 31, 2004 149,354 94,845 909 1,685 246,793 54,629 301,422
June 30, 2004 150,804 83,268 820 1,755 236,647 57,140 293,787
September 30, 2004 164,019 82,190 767 1,776 248,752 62,055 310,807
December 31, 2004 147,487 86,285 744 1,713 236,229 54,839 291,068
------------------------------------------------------------------------------------------
Total 2004 611,664 346,588 3,240 6,929 968,421 228,663 1,197,084
==========================================================================================
--------------------------
All minutes data were taken from our internal billing statistics reports.
---------------------------
We entered into a significant business relationship with MCI in 1993 that
included the following agreements, among others.
o We agreed to terminate all Alaska-bound MCI long-distance traffic and
MCI agreed to terminate all of our long-distance traffic terminating in
the Lower 49 States excluding Washington, Oregon and Hawaii.
o The parties agreed to share certain communications network resources
and various marketing, engineering and operating resources. We also
carry MCI's 800, 888, 877 and 866 traffic originating in Alaska and
terminating in the Lower 49 States and handle traffic for MCI's calling
card customers when they are traveling in Alaska.
Concurrently with these agreements, MCI purchased approximately 31% of GCI's
Common Stock and presently two representatives serve on GCI's Board. In
conjunction with our acquisition of cable television companies in 1996, MCI
purchased an additional two million shares of GCI's Common Stock at a premium to
the then current market price for $13 million or $6.50 per share. MCI sold 4.5
million shares of GCI Class A common stock in 2002. On December 7, 2004 we
repurchased 3,751,509 of GCI's Class A common shares at $8.33 per share and $10
million face value of GCI's Series C preferred stock from MCI. The aggregate
amount of the equity repurchase totaled $41.3 million. At December 31, 2004, MCI
owns approximately 2.0% of GCI's Common Stock.
Revenues attributed to MCI's message telephone traffic from these agreements
(excluding Private Line and other revenues) in 2004, 2003 and 2002 totaled $52.8
million, $57.8 million and $54.7 million, or 12.4%, 14.8% and 14.9% of total
revenues, respectively. The contract was amended in March 2001 extending its
term five years to March 2006. The amendment reduced the rate to be charged by
us for certain traffic over the extended term of the contract.
28
On July 21, 2002 MCI and substantially all of its active United States
subsidiaries filed voluntary petitions for reorganization under Chapter 11 of
the United States Bankruptcy Code in the United States Bankruptcy Court. Chapter
11 allows a company to continue operating in the ordinary course of business in
order to maximize recovery for the company's creditors and shareholders. On July
24, 2003, our contract to provide interstate and intrastate long-distance
services to MCI was extended for a minimum of five years to July 2008. The
agreement sets the terms and conditions under which we originate and terminate
certain types of long-distance and data services in Alaska on MCI's behalf. In
exchange for extending the term of this exclusive contract, MCI will receive a
series of rate reductions implemented in phases over the life of the contract.
On October 31, 2003, MCI's reorganization plan was approved by the United States
Bankruptcy Court and MCI emerged from bankruptcy protection on April 20, 2004.
On February 14, 2005 Verizon Communications Inc. announced it has agreed to
acquire MCI for $4.8 billion in equity and $488 million in cash. In addition,
MCI will pay its shareowners quarterly and special dividends of $4.50 per share,
worth $1.463 billion. In total, the transaction values MCI shares at $20.75 a
share, or $6.746 billion. The board of directors of both companies are reported
to have approved the agreement. In addition to MCI shareowner approval, the
acquisition requires regulatory approvals, which the companies are targeting to
obtain in about a year. Verizon has allowed MCI two weeks beginning in early
March 2005 to conduct additional talks with Quest Communications International,
Inc., another potential buyer. We are unable to predict the impact that a merger
with or an acquisition of MCI will have upon us in the long-term, however given
the materiality of MCI's revenues to us, a significant reduction in traffic or
pricing could have a material adverse effect on our financial position, results
of operations and liquidity.
In 1993 we entered into a long-term agreement with Sprint, pursuant to which we
agreed to terminate all Alaska-bound Sprint long-distance traffic and Sprint
agreed to handle substantially all of our international traffic. Services
provided pursuant to the contract with Sprint resulted in message telephone
service revenues (excluding Private Line and other revenues) in 2004, 2003 and
2002 of approximately $14.9 million, $18.3 million and $23.5 million, or
approximately 3.5%, 4.7% and 6.4% of total revenues, respectively. The contract
was amended in March 2002 extending its term five years to March 2007, with two
one-year automatic extensions thereafter. The amendment reduces the rate to be
charged by us for certain traffic over the extended term of the contract.
With the contracts and amendment described above, we believe that MCI and
Sprint, our two largest customers, will continue to make use of our services
during the extended term. MCI was a major customer of our long-distance services
industry segment through 2004. Sprint met the threshold for classification as a
major customer through 1998, and met the threshold again in 2001.
Other common carrier traffic routed to us for termination in Alaska is largely
dependent on traffic routed to our carrier customers by their customers. Pricing
pressures, new program offerings, revised business plans, and market
consolidation continue to evolve in the markets served by our carrier customers.
If, as a result, their traffic is reduced, or if their competitors' costs to
terminate or originate traffic in Alaska are reduced, our traffic will also
likely be reduced, and we may have to respond to competitive pressures,
consistent with federal law. We are unable to predict the effect of such changes
on our business; however the loss of one or both of MCI or Sprint as customers,
a material adverse change in our relationships with them or a material loss of
or reduction in their long-distance customers would have a material adverse
effect on our financial position, results of operations or liquidity.
We provide various services to the State of Alaska, BP Alaska, Wells Fargo Bank
Alaska, First National Bank of Alaska, and Alyeska Pipeline Service Company.
Although these customers do not meet the threshold for classification as major
customers, we do derive significant revenues and gross profit from them. There
are no other individual customers, the loss of which would have a material
impact on our revenues or gross profit.
29
We provided broadband, Private Line and Private Network communications products
and services, including SchoolAccessTM and rural health Private Line facilities,
to 452 commercial and government customers at the end of 2004. These products
and services generated approximately 17.2%, 15.9% and 14.8% of total revenues
during the years ended December 31, 2004, 2003 and 2002, respectively.
Although we have several agreements to facilitate the origination and
termination of international toll traffic, we have neither foreign operations
nor export sales. See "Part I -- Item 1 -- Business -- Financial Information
about our Foreign and Domestic Operations and Export Sales" for more
information.
Competition. The long-distance industry is intensely competitive and subject to
constant technological change. Competition is based upon price and pricing
plans, the type of services offered, customer service, billing services,
performance, perceived quality, reliability and availability. AT&T Alascom, as a
subsidiary of AT&T, has access to greater financial, technical and marketing
resources than we have. Future competitors could also be substantially larger
than we are, and have greater financial, technical and marketing resources than
we have.
In the long-distance market, we compete against AT&T Alascom, ACS, MTA, and
certain smaller rural local telephone carrier affiliates. There is also the
possibility that new competitors will enter the Alaska market. In addition,
wireless services continue to grow as an alternative to wireline services as a
means of reaching customers.
Historically, we have competed in the long-distance market by offering discounts
from rates charged by our competitors and by providing desirable packages of
services. Discounts have been eroded in recent years due to lowering of prices
by AT&T Alascom and entry of other competitors into the long-distance markets we
serve. In addition, our competitors have also begun to offer their own packages
of services. If competitors lower their rates further or develop more attractive
packages of services, we may be forced to reduce our rates or add additional
services, which would have a material adverse effect on our financial position,
results of operations or liquidity.
Under the terms of the acquisition of Alascom by AT&T Corp., AT&T Alascom rates
and services must mirror those offered by AT&T Corp., so changes in AT&T Corp.
prices indirectly affect our rates and services. AT&T Corp.'s and AT&T Alascom's
interstate prices are regulated under a price cap plan whereby their rate of
return is not regulated or restricted. Price increases by AT&T Corp. and AT&T
Alascom generally improve our ability to raise prices while price decreases
pressure us to follow. We believe we have, so far, successfully adjusted our
pricing and marketing strategies to respond to AT&T Corp. and other competitors'
pricing practices. However, if competitors significantly lower their rates, we
may be forced to reduce our rates, which could have a material adverse effect on
our financial position, results of operations or liquidity.
On January 31, 2005 SBC Communications Inc. ("SBC") and AT&T announced an
agreement for SBC to acquire AT&T. Under terms of the agreement, approved by the
boards of directors of both companies, shareholders of AT&T will receive total
consideration currently valued at $19.71 per share, or approximately $16
billion. The acquisition, which is subject to approval by AT&T's shareholders
and regulatory authorities, and other customary closing conditions, is expected
to close by the first half of 2006. We cannot predict how this transaction will
affect us at this time.
ACS and other LECs have entered the interstate and international long-distance
market, and pursuant to RCA authorization, entered the intrastate long-distance
market. ACS and other LECs generally lease or buy long-haul capacity on
long-distance carriers' facilities to provide their interstate and intrastate
long-distance services.
Another carrier completed construction of fiber optic facilities connecting
points in Alaska to the Lower 48 States in 1999. The additional fiber system
provides direct competition to services we
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provide on our owned fiber optic facilities, however this fiber system also
provides an alternative routing path for us in case of a major fiber outage in
our systems. This carrier filed for Chapter 11 bankruptcy in 2001 and its assets
were sold in 2002. We completed construction of the AULP West fiber optic cable
system in June 2004 that provides us with owned capacity for route diversity.
In the wireless communications services market, we closed a 10-year distribution
agreement with Dobson in 2004 allowing us to resell Dobson cellular services.
See "Part I -- Item 1 -- Business -- Historical Development of our Business
During the Past Fiscal Year -- Cellular Services Distribution Agreement" for
more information. We provide limited wireless local access and Internet services
using our own facilities. We compete against Dobson, ACS, Alaska DigiTel LLC,
and resellers of those services in Anchorage and other markets.
The wireless communications industry continues to experience significant
consolidation. In October 2004 Cingular Wireless LLC, a joint venture between
SBC Communications Inc. and BellSouth Corp., reported that it completed its
previously announced merger with AT&T Wireless Services Inc. Dobson acquired its
Anchorage wireless properties in a 2003 asset exchange with AT&T Wireless.
Dobson has acquired wireless companies and negotiated roaming arrangements that
give it a national presence. Mergers and joint ventures in the industry have
created large, well-capitalized competitors with substantial financial,
technical, marketing and other resources. These competitors may be able to offer
nationwide services and plans more quickly and more economically than we can,
and obtain roaming rates that are more favorable than those that we obtain.
Our long-distance services sales efforts are primarily directed toward
increasing the number of subscribers we serve, selling bundled services, and
generating incremental revenues through product and feature up-sale
opportunities. We sell our long-distance communications services through
telemarketing, direct mail advertising, door-to-door selling, up-selling by our
customer service personnel, and local media advertising.
We expect competition to increase as new technologies, products and services
continue to develop. We cannot predict which of many possible future
technologies, products or services will be important to maintain our competitive
position or what expenditures will be required to develop and provide these
technologies, products or services. Our ability to compete successfully will
depend on marketing and on our a