Item 1. Business
General
In this Annual Report, “we,” “us,” “our,” and “the Company” refer to GCI, Inc. and its direct and indirect subsidiaries.
GCI, Inc. was incorporated in 1997 to effect the issuance of Senior Notes as further described in note 6 to the accompanying "Consolidated Financial Statements" included in Part IV of this Report. GCI, Inc. as a wholly owned subsidiary of General Communication, Inc. ("GCI"), received through its initial capitalization all ownership interests in subsidiaries previously held by GCI. GCI was incorporated in 1979 under the laws of the State of Alaska and 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 operations primarily in the state of 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.gci-industrialtelecom.com, http://www.unicom-alaska.com/ and http://www.alaskaunited.com/. The Company hosts Internet services at http://www.gci.net/, broadband delivery of ConnectMD® services at http://www.connectmd.com, and SchoolAccess® services at http://www.schoolaccess.net/. The Company hosts information about our TERRA-Southwest (“TERRA-SW”) and TERRA-Northwest (“TERRA-NW”) projects at http://terra.gci.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, GCI’s 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 websites or the SEC’s website is not part of this document.
Financial Information about Industry Segments
Our five reportable segments are Consumer, Network Access, Commercial, Managed Broadband, and Regulated Operations.
For financial information about our reportable segments, see “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Also refer to note 10 included in “Part II - Item 8 - Consolidated Financial Statements and Supplementary Data.”
Narrative Description of our Business
General
We are the largest Alaska-based communications provider as measured by revenues. We offer facilities-based wireless telephone services, data services, Internet access, video services and local and long-distance voice services, to residential and business customers across the state under our GCI brand. Due to the unique nature of the markets we serve, including harsh winter weather and remote geographies, our customers rely extensively on our systems to meet their communication and entertainment needs. We benefit from the attractive demographic and economic characteristics of Alaska.
Since GCI’s founding in 1979 as a competitive long distance provider, we have consistently expanded our product portfolio and facilities to become the leading integrated communication services provider in our markets. Our facilities include redundant and geographically diverse digital undersea fiber optic cable systems linking our Alaska terrestrial networks to the networks of other carriers in the lower 48 contiguous states. In recent years, we expanded our efforts in wireless and presently operate the only statewide wireless network. Our network provides access for both global system for mobile communications (“GSM”) and code division multiple access (“CDMA”) based devices, and fourth generation evolved high-speed packet access (“HSPA+”) based wireless communications. As of December 31, 2012, our cable systems passed 78% of Alaska’s households, and we have achieved 50% basic cable penetration of the homes we reach. We believe we offer superior video services relative to direct broadcast satellite (“DBS”), which is limited by Alaska’s geographic location, challenging climate and terrain features. At December 31, 2012, 80% of the local access lines we served were carried on our own last mile facilities.
Our Consumer segment serves residential customers. Our Network Access segment serves other common carriers. Our Commercial segment serves local, national and global businesses, governmental entities, and public and private educational institutions. Our Managed Broadband segment serves rural school districts, hospitals and health clinics. The financial results of the long-distance and local access sold to consumer and commercial customers that we serve in the Bethel, Alaska area are reported in the Regulated Operations segment.
For the year ended December 31, 2012, we generated consolidated revenues of $710.2 million. We ended the period with 140,000 wireless subscribers, 128,900 cable modem subscribers, 140,000 basic video subscribers and 129,600 local access lines in service.
Development of our Business During the Past Fiscal Year
The Alaska Wireless Network. On June 4, 2012, we entered into an Asset Purchase and Contribution Agreement (“Wireless Agreement”) by and among Alaska Communications Systems Group, Inc. (“ACS”), GCI, ACS Wireless, Inc., a wholly owned subsidiary of ACS (“ACS Member”), GCI Wireless Holdings, LLC, a wholly owned subsidiary of GCI, and The Alaska Wireless Network, LLC (“AWN”), a wholly owned subsidiary of GCI, pursuant to which the parties have agreed to contribute the respective wireless network assets of GCI, ACS and their affiliates to AWN. We entered into this agreement to provide a robust, statewide network with the spectrum mix, scale, advanced technology and cost structure necessary to compete with Verizon Wireless (“Verizon”) and AT&T Mobility, LLC (“AT&T Mobility”) in Alaska. After the transaction closes AWN will provide wholesale services to GCI and ACS. GCI and ACS will use the AWN network in order to continue to sell services to their respective retail customers. GCI and ACS will continue to compete against each other and other wireless providers in the retail market.
Under the terms of the Wireless Agreement, we agreed to purchase certain wireless network assets from ACS and its affiliates for $100.0 million and we will contribute the purchased assets, our wireless network assets and certain rights to use capacity to AWN. ACS also agreed to contribute its remaining wireless network assets and certain rights to use capacity to AWN. Upon the contribution of assets to AWN, ACS Member will own one-third of AWN and we will own two-thirds of AWN. ACS Member will be entitled to receive preferential cash distributions totaling $190.0 million over the first four years of AWN’s operations and we will be entitled to all remaining cash distributions during that period. We anticipate that the $190.0 million preferential distributions to ACS will constitute approximately $80.0 million in distributions over the distributions otherwise attributable to their ownership percentage during such period. Following the initial four year period, we and ACS Member will receive distributions proportional to our ownership interests. We are evaluating the accounting treatment for this transaction.
The closing of the transactions is subject to the satisfaction of customary closing conditions, including the receipt of required governmental and third party consents and approvals and the expiration of any applicable waiting periods under competition laws. The waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 has expired without any objections. The transactions are expected to close in the second quarter of 2013.
TERRA-NW Project Funding. In August 2011, we entered into our first financing arrangement under the New Markets Tax Credit (“NMTC”) program that provided $16.5 million in net cash to our wholly owned subsidiary, Unicom, Inc. (“Unicom”), to help fund the extension of terrestrial broadband service for the first time to rural Northwestern Alaska communities via a high capacity hybrid fiber optic and microwave network. This project, called TERRA-NW, connects to our TERRA-SW network and provides a high capacity backbone connection from the served communities to the Internet. In October 2012 and December 2012, we entered into our second and third financing arrangements, respectively, under the NMTC program. The second and third NMTC transactions provided $12.9 million and $2.9 million, respectively, in net cash to Unicom.
In September 2011, the Regulatory Commission of Alaska (“RCA”) approved our application for a $5.3 million grant to help fund TERRA-NW. The grant was increased to $6.3 million in January 2012.
The NMTC arrangements and grant award discussed above partially fund backbone network facilities that we would not otherwise be able to construct within our return-on-investment requirements. We plan to fund an additional $20.7 million for TERRA-NW. We began construction on TERRA-NW in 2012 and expect to complete all current phases of the project in 2014. We began offering service on Phase 1 of this new facility on January 3, 2013.
Universal Service Fund Lifeline Support. On February 6, 2012, the Federal Communications Commission (“FCC”) released its Report and Order and Further Notice of Proposed Rulemaking to comprehensively reform and modernize the Universal Service Fund’s (“USF”) Lifeline program. The Lifeline program is administered by the Universal Service Administrative Company (“USAC”) and is designed to ensure that quality telecommunications services are available to low-income customers at affordable rates. The order adopted several reforms but the only reform with a significant 2012 impact was a requirement for annual recertification of all Lifeline subscribers enrolled as of June 1, 2012, to be completed by the end of 2012 subject to the waiver to perfect early recertifications by January 31, 2013. The completion of the annual recertification process was the primary reason for our loss of approximately 10,000 Lifeline subscribers from December 31, 2011 to December 31, 2012.
Mobility Fund Grant. On October 3, 2012, the FCC announced our winning bids in the Mobility Fund I auction for a $3.2 million grant to partially fund expansion of our 3G wireless network to high cost rural locations in Alaska. Upon review we agreed to accept $2.3 million. Upon FCC authorization of our final application submission, which is currently pending, we plan to begin construction in 2013 and expect to complete the project in 2014.
Denali Media Holdings. On November 9, 2012, we entered into asset purchase agreements, pursuant to which Denali Media Holdings, a wholly owned subsidiary of GCI, through its wholly owned subsidiaries, Denali Media Anchorage, Corp. and Denali Media Southeast, Corp., agreed to purchase three Alaska broadcast stations: CBS affiliate KTVA-TV of Anchorage and NBC affiliates KATH-TV in Juneau and KSCT-TV of Sitka, for a total of $7.6 million (“Media Agreements”). We entered into these agreements as the first step toward providing a new statewide platform for news and information as well as a method to provide unique content and value to our video subscribers. The Media Agreements are subject to the satisfaction of customary closing conditions, including the receipt of required governmental approvals from the FCC. The transactions are expected to close in the second half of 2013.
You should see “Part I - Item 1. Business - Regulation” for regulatory developments.
Business Strategy
We intend to continue to increase revenues using the following strategies:
Offer Bundled Products. We offer innovative service bundles to meet the needs of our consumer and commercial customers. We believe that 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 revenue growth, provides operating cost efficiencies that expand our margins and drives our overall business performance. As a measure of success to date, over 85,000 of our residential customers subscribe to one of our service bundles that include two or more services.
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 suggest to our customers other services they can purchase or enhanced versions of services they already purchase. Many calls into our customer service centers or visits into one of our 41 retail stores result in sales of additional services and products.
Deliver Industry Leading Customer Service. We have positioned ourselves as a customer service leader in the Alaska communications market. We have organized our operations to effectively focus on our customers. We operate our own customer service department and have empowered our customer service 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 commercial customers. We believe our integrated approach to customer service, including service set-up, 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. We have a demonstrated history of new product evaluation, development and deployment for our customers, and we continue to assess revenue-enhancing opportunities that create value for our customers. In addition to new services such as additional high definition television ("HDTV") channels, 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 are currently pursuing or expect to pursue opportunities to increase the scale of our facilities, enhance our ability to serve our existing customers’ needs and attract new customers.
Make Strategic Acquisitions. We have a history of making and integrating acquisitions of in-state telecommunications providers. Our management team will continue to actively pursue and buy companies that we believe fit with our strategy and networks and that enhance earnings.
Description of our Business by Reportable Segment
Overview
Our five reportable segments are Consumer, Network Access, Commercial, Managed Broadband, and Regulated Operations. Following are our segments and the services and products each offers to its customers:
Many of our networks and facilities are utilized by more than one segment to provide services and products to our customers. The following description of our business by reportable segment includes a comprehensive discussion within the Consumer segment section with references to that section if such common network and facility use exists in another segment. Similarly, many of the same services and products are sold to our customers in different segments.
The following discussion includes information about significant services and products, sales and marketing, facilities, competition and seasonality for each of our five reportable segments. For a discussion and analysis of financial condition and results of operations please see “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Consumer Segment
Consumer segment revenues for 2012, 2011 and 2010 are summarized as follows (amounts in thousands):
1 See “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” and note 10 included in “Part II - Item 8 - Consolidated Financial Statements and Supplementary Data” for more information regarding the financial performance of our Consumer segment.
Services and Products
Our Consumer segment offers a full range of wireless, data, video and voice services and products to residential customers.
Wireless Services and Products
Revenues derived from Consumer segment wireless services and products in 2012, 2011, and 2010 totaled $109.8 million, $109.9 million, and $105.7 million, respectively, or 15%, 16%, and 16% of our total revenues, respectively.
We offer facilities-based mobile wireless voice and data services to our customers in the state’s largest population centers and many other small Alaska communities. We offer our customers a variety of post-paid and prepaid wireless rate plans so they can choose the plan that best fits their expected needs.
Wireless voice service is generally offered on a contract basis for one or two year periods. Under the terms of these contracts, service is billed and provided on a monthly basis according to the applicable rate plan chosen. Our offerings include regional and national rate plans at a variety of pricing tiers. Our wireless voice plans generally combine a fixed monthly access charge, a designated number of minutes-of-use, per minute usage charges for minutes in excess of the included amount and additional charges for certain custom-calling features. Most of our plans include basic features such as voice messaging, caller ID, call forwarding and call waiting, and two-way text messaging.
Wireless data service is included in certain plans or can be purchased as a feature to a plan. Wireless data services include mobile productivity applications, such as Internet access, messaging and email services; wireless photo and video offerings; location-based capabilities, including navigation tools; and mobile entertainment applications, including the ability to view live television, listen to satellite radio, download and listen to music, and game play with full-color graphics and polyphonic and real-music sounds from a wireless handset. Our wireless data plans generally combine a fixed monthly access charge, a designated number of megabytes-of-use and per megabyte usage charges for megabytes in excess of the included amount. In 2012 we began offering our wireless data subscribers access to our high speed Wi-Fi product we call TurboZone. This access is complimentary through March 31, 2013.
We sell a variety of wireless handsets and data cards manufactured by various suppliers for use with our wireless services. We also sell accessories, such as carrying cases, hands-free devices, batteries, battery chargers and other items. We provide contract subscribers substantial equipment subsidies to initiate, continue or upgrade service.
Data Services and Products
Revenues derived from Consumer segment data services and products in 2012, 2011, and 2010 totaled $86.5 million, $72.0 million, and $61.4 million, respectively, or 12%, 11%, and 9% of our total revenues, respectively.
Internet
We primarily offer high-speed cable modem service. Our consumer high-speed cable modem Internet service offers up to 50 Mbps download and 5 Mbps upload speeds.
Consumer Internet service is billed and provided on a monthly basis according to the applicable rate plan chosen. Our Internet plans generally combine a fixed monthly access charge, a designated number of megabytes-of-use, per megabyte usage charges for megabytes in excess of the included amount and additional charges for value-added features such as e-mail virus prevention, personal web site and domain hosting, and additional e-mail accounts.
Video Services and Products
Revenues derived from Consumer segment video services and products in 2012, 2011, and 2010 totaled $115.3 million, $118.6 million, and $118.5 million, respectively, or 16%, 17%, and 18% of our total revenues, respectively.
Our video systems serve 41 communities and areas in Alaska, including the state’s five largest population centers, Anchorage, Fairbanks, the Matanuska-Susitna Valley, the Kenai Peninsula, and Juneau.
We offer a full range of video services over our broadband cable systems. Our video service offerings include the following:
Basic video. Our basic video service consists of digital basic service with access of up to 21 channels of programming and an expanded digital basic service with access of up to 109 additional channels of programming. These services generally consist of programming provided by national and local broadcast networks, national and regional cable networks, and governmental and public access programming. We transmit an entirely digital signal for all cable television channels in all markets we serve.
High-definition television. Our HDTV service provides our subscribers with improved, high-resolution picture quality, improved audio quality and a wide-screen, theater-like display. Our HDTV service offers a broad selection of high-definition programming with access to up to 115 high-definition channels including most major broadcast networks, leading national cable networks, premium channels and national sports networks.
Digital video recorder. Our advanced digital video recorder ("DVR") service lets digital video subscribers select, record and store programs and play them at whatever time is convenient. DVR service also provides the ability to pause and rewind “live” television. During 2012 we introduced our Whole Home DVRs which allow the subscriber to watch recordings from any room, not just the room where it was recorded.
Premium channel programming. Our premium channel programming service, which includes cable networks such as Home Box Office, Showtime, Starz and Cinemax, generally offers, without commercial interruption, feature motion pictures, original programming, live and taped sporting events, concerts and other special features.
Video on demand. Our video on demand service permits our video subscribers to order at their convenience and for a separate fee, individual feature motion pictures and special event programs, on an unedited, commercial-free basis.
Pay-per-view programming. Our pay-per-view service permits our video subscribers to order, for a separate fee, scheduled individual feature motion pictures and special event programs, such as professional boxing, professional wrestling and concerts, on an unedited, commercial-free basis.
Voice Services and Products
Revenues derived from Consumer segment voice services and products in 2012, 2011, and 2010 totaled $41.4 million, $52.1 million, and $57.3 million, respectively, or 6%, 8%, and 9% of our total revenues, respectively.
Long-Distance
We are a full-service long-distance provider including intrastate, interstate and international calling.
Local Access
We offer local access services in many communities and areas in Alaska, including the state’s five largest population centers, Anchorage, Fairbanks, the Matanuska-Susitna Valley, the Kenai Peninsula, and Juneau. Our own digital local phone service (“DLPS”) facilities and collocated remote facilities that access the incumbent local exchange carrier (“ILEC”) unbundled network element ("UNE") loops allow us to offer full featured local service products to customers. In areas where we do not have our own DLPS facilities or access to ILEC UNE loop facilities, we offer service using total service resale of the ILEC’s local service or UNE platform.
Bundled Services and Products
We combine one or more of our individual service and product offerings into bundles that we sell to our Consumer segment customers at attractive prices. Our most popular bundled offering includes cable modem Internet access, video service, long-distance and local access services. In addition to several other bundled offerings, we also offer a bundle of wireless services, cable modem Internet access and video service.
Sales and Marketing
Our Consumer segment 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-sell opportunities.
Facilities
We operate a modern, competitive communications network employing digital transmission technology over our fiber optic facilities within Alaska and between Alaska and the lower 48 states. Our facilities include three self-constructed digital undersea fiber optic cable systems linking our Alaska terrestrial networks to the networks of other carriers in the lower 48 states:
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Alaska United East was placed into service in 1999 and connects Whittier, Valdez and Juneau, Alaska and Seattle, Washington,
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Alaska United West was placed into service in 2004 and connects Seward, Alaska to Warrenton, Oregon, and
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Alaska United Southeast was placed into service in 2008 and connects Ketchikan, Wrangell, Petersburg, Angoon and Sitka, Alaska to Alaska United West and Alaska United East.
The combination of our Alaska United East, Alaska United West and Alaska United Southeast systems provides us with the ability to provide fully protected geographically diverse routing of service between Alaska and the lower 48 states.
Our Alaska United Northwest self-constructed terrestrial fiber optic cable system connects Anchorage and Fairbanks, Alaska along the Parks Highway corridor and we own a terrestrial fiber optic cable system that extends from Prudhoe Bay, Alaska to Valdez, Alaska via Fairbanks, Alaska.
We have Indefeasible Right to Use ("IRU") capacity in the Kodiak-Kenai Cable Company, LLC’s undersea fiber optic cable system linking Anchorage to Kenai, Homer, Kodiak, Narrow Cape on Kodiak Island, and Seward, Alaska.
We serve many rural and remote Alaska locations solely via satellite communications. Each of our C-band and Ku-band satellite transponders is backed up on alternate spacecraft with multiple backup transponders. The primary spacecraft we use to provide voice, data and Internet services to our rural Alaska customers are Intelsat’s Galaxy 18 for C-band and Intelsat's Horizons 1 for Ku-band, but we also lease capacity on two other spacecraft, SES Americom’s AMC-7 and AMC-8.
We lease one 36 MHz transponder on SES Americom's AMC-7 spacecraft. We use this transponder to distribute multi-channel, digitally encoded video programming and other services to remote locations within Alaska. We may use this transponder along with four others that we reserve on AMC-7 to restore service during any fiber outage that may occur in our network.
We operate digital microwave systems to link Anchorage with the Kenai Peninsula, and our Prudhoe Bay Earth Station with Deadhorse, Alaska. Virtually all switched services are computer controlled, digitally switched, and interconnected by a packet switched SS7 signaling network.
We operate a hybrid fiber optic cable and digital microwave system (“TERRA”) linking Anchorage with the Bristol Bay and Yukon-Kuskokwim regions of the state. This system serves 67 communities with interstate Ethernet and TDM services. The network is computer controlled, centrally monitored and supports multiple services.
Other facilities include major earth stations at Adak, Barrow, Bethel, Dillingham, Dutch Harbor, Eagle River, Fairbanks, Galena, King Salmon, Kodiak, Kotzebue, McGrath, Nome, Prudhoe Bay, Sitka, Unalakleet, and Yakutat, all in Alaska, serving the communities in their vicinity. The Eagle River earth station is linked to the Anchorage distribution center by fiber optic facilities.
We use a synchronous optical network ("SONET") and Optical Ethernet as service delivery methods for our terrestrial metropolitan area networks and long-haul terrestrial and undersea fiber optic cable systems.
A fiber optic cable system from our Anchorage distribution center connects to the Matanuska Telephone Association (“MTA”), Eagle River central office and to our major hub earth station in Eagle River. We have digital microwave and fiber IRU facilities serving the Kenai Peninsula communities. We maintain earth stations in Fairbanks (connected via SONET fiber facilities), Anchorage (Benson earth station), and in Prudhoe Bay, Unalakleet and Bethel as terrestrial 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, and Anchorage and TERRA-SW communities.
We use our demand assigned multiple access ("DAMA") facilities to serve 56 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 addition, 89 (for a total of 145) C-band facilities provide dedicated Internet access and private network services to rural public schools, hospitals, health clinics, and natural resource development industries throughout Alaska. Our network of 213 Ku-band facilities provides dedicated Internet access and private network services to rural public schools, hospitals, health clinics, and natural resource development industries throughout Alaska, and in ten 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 other long-distance carriers and, in Seattle, to obtain access to other carriers to distribute our southbound traffic to the remaining 49 states and international destinations. Our digital switching systems also provide local service in Anchorage, Fairbanks, Juneau and 14 smaller communities throughout Alaska. Our extensive metropolitan area fiber network in Anchorage supports video, Internet and telephony services. The Anchorage, Fairbanks, and Juneau facilities also include digital access cross-connect systems, Internet platforms, frame relay, optical ethernet and multi-protocol label switching (“MPLS”) data switches. The Anchorage and Fairbanks facilities also include collocation facilities for interconnecting and hosting equipment for other carriers and commercial entities.
We utilize our coaxial cable facilities for DLPS. This delivery method allows us to utilize our own cable facilities to provide local access service to our customers and avoid paying local loop charges to the ILEC.
Our statewide cable systems consist of 3,234 miles of installed cable plant having 450 to 860 MHz of channel capacity. Our video businesses are located throughout Alaska and serve 41 communities and areas in Alaska, including the state’s five largest population centers, Anchorage, Fairbanks, the Matanuska-Susitna Valley, the Kenai Peninsula, and Juneau. Our facilities include cable plant and head-end distribution equipment. Some of our locations on the fiber routes are served from the head-end distribution equipment in Anchorage. All of our cable systems are completely digital.
We provide access to the Internet using a platform that includes many of the latest advancements in technology. The physical platform is concentrated in Anchorage and is extended into many remote areas of the state. Our Internet platform includes the following:
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Our Anchorage facilities are connected to multiple Internet access points in Seattle through multiple, diversely routed networks;
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We use multiple routers on each end of the circuits to control the flow of data and to provide resiliency; and
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Our Anchorage facility consists of routers, a bank of servers that perform support and application functions, database servers providing authentication and user demographic data, layer two and layer three gigabit, 10 gigabit and 100 gigabit switch networks for intercommunications and broadband services.
Our dedicated Internet access and Internet protocol ("IP") data services are delivered to routers located at the multiple service points throughout our service area. Our Internet management platform constantly monitors these routers and continual communications are maintained with all of the core and distribution devices in the network. The availability and quality of service, as well as statistical information on traffic loading, are continuously monitored for quality assurance. The manage­ment platform has the capability to remotely access routers, servers and layer two switches, permitting changes in configuration without the need to be physically located at the service point.
We own statewide wireless facilities that cover most of the population providing service to urban and rural Alaska communities and we will continue to expand these networks throughout the terrestrially and satellite served portions of Alaska in 2013. We own GSM/HSPA+ and CDMA/EVDO wireless facilities serving urban Alaska locations. Our urban network includes Ericsson and Nortel wireless switches located in Anchorage and 218 cell sites that serve the following areas of Alaska: Anchorage and Eagle River, the Matanuska-Susitna Valley, Kenai Peninsula, Southeast, Kodiak and Fairbanks. Our rural network consists of 164 GSM facilities that are located throughout Alaska’s rural villages and communities. We extend our network coverage through roaming arrangements with other GSM and CDMA carriers. In addition, under an agreement with ACS, we have integrated all of our GSM/HSPA+ sites with all 48 of their Long Term Evolution (“LTE”) network sites to enhance the speed of our data traffic. These integrated sites are located in Anchorage, Fairbanks, Juneau and the Kenai Peninsula.
We own 1,212 wireless access points in Anchorage, Fairbanks, Juneau, Kodiak, Ketchikan, Kenai-Soldotna, Matanuska-Susitna valley, and other areas of the State to support our TurboZone product.
Competition
A discussion of competition by product and service in our Consumer segment follows.
Wireless Services and Products Competition
We compete against AT&T Mobility, ACS, MTA, and resellers of those services in Anchorage and other markets. In November 2010, Verizon acquired a license for 700 MHz wireless spectrum covering Alaska. We expect Verizon will complete their build of a LTE network in 2013 and subsequently they will be an additional competitor where our markets overlap.
Regulatory policies favor robust competition in wireless markets. Wireless local number portability helps to maintain a high level of competition in the industry. Number portability allows subscribers to switch carriers without having to change their telephone numbers.
The communications industry continues to experience significant technological changes, as evidenced by the increasing pace of improvements in the capacity and quality of digital technology, shorter cycles for new products and enhancements and changes in consumer preferences and expectations. Accordingly, we expect competition in the wireless communications industry to continue to be dynamic and intense as a result of the development of new technologies, services and products.
The national wireless carriers against whom we compete or expect to compete, AT&T Mobility and Verizon, have resources that are substantially greater than ours. These companies have significantly greater spectrum, capital, financial, marketing, human capital, distribution and other resources than we do. Specifically, as a regional wireless carrier we may not have immediate access to some wireless handsets that are available to these national wireless carriers. In 2012, along with other regional wireless carriers in Alaska, we gained access to, and began offering, the iPhone-series of wireless handsets to our subscribers. In addition, as discussed in Development of Our Business During the Past Fiscal Year section of this Item 1, we have entered into an agreement with ACS to create AWN, which will allow us to compete better against the national carriers on all resource fronts.
We compete for customers based principally upon price, bundled services, the services and enhancements offered, network quality, customer service, network coverage and capacity, the type of wireless handsets offered, and the availability of differentiated features and services. Our ability to compete successfully will depend, in part, on our marketing efforts and our ability to anticipate and respond to various competitive factors affecting the industry.
Data Services and Products Competition
The Internet industry is highly competitive, rapidly evolving and subject to constant technological change. Competition is based upon price and pricing plans, service bundles, the types of services offered, the technologies used, customer service, billing services, and perceived quality, reliability and availability. We compete with other Alaska based Internet providers and domestic, non-Alaska based providers that provide national service coverage. Several of the providers headquartered outside of Alaska have substantially greater financial, technical and marketing resources than we do.
With respect to our high-speed cable modem service, ACS and other Alaska telephone service providers are providing competitive high-speed data subscriber line services over their telephone lines in direct competition with our high-speed cable modem service. DBS providers and local fixed wireless providers supply wireless high-speed Internet service in competition with our high-speed cable modem services.
Niche providers in the industry, both local and national, compete with certain of our Internet service products, such as web hosting, list services and e-mail.
We expect to continue to provide, at reasonable prices and in competitive bundles, a greater variety of data services than are available through other alternative delivery sources. Additionally, we believe we offer superior technical performance and speed, and responsive community-based customer service. Increased competition, however, may adversely affect our market share and results of operations from our data services product offerings.
Video Services and Products Competition
Our video systems face competition from online services and devices that offer Internet video streaming and distribution of movies, television shows and other video programming, as well as alternative methods of receiving and distributing television signals, including DBS, digital video over telephone lines, broadband IP-based services, wireless and satellite master antenna television ("SMATV") systems, and from other sources of news, information and entertainment such as off-air television broadcast programming, newspapers, movie theaters, live sporting events, interactive computer services, and home video products, including video discs. Our video systems also face competition from potential overbuilds of our existing cable systems by other cable television operators and municipally-owned cable systems, and alternative methods of receiving and distributing television signals. The extent to which our video systems are competitive depends, in part, upon our ability to provide quality programming and other services at competitive prices.
Online video services via the Internet are a major growing source of competition for our video services. However, as a major Internet-provider ourselves, the competition may result in additional data service subscriber revenue to the extent we grow Internet average revenue per subscriber.
We believe that the greatest source of external competition for our video services comes from the DBS industry. Two major companies, DIRECTV and DISH DBS Corporation, are currently offering nationwide high-power DBS services. The ILECs in the Matanuska-Susitna Valley and Ketchikan offer digital video service over telephone lines in limited areas. Their product offerings and price points are similar to our product offerings. With the addition of Anchorage local broadcast stations, increased marketing, ILEC and DBS alliances, and emerging technologies creating new opportunities, competition from these sources has increased and will likely continue to increase.
Competitive forces will be counteracted by offering expanded programming through digital services. Digital delivery technology is being utilized in all of our systems. We have retransmission agreements with Anchorage broadcasters and provide for the uplink/downlink of their signals into all our systems, and local programming for our customers. Additionally, in November 2012 we entered into the Media Agreements as a method to provide unique content and value to video subscribers.
Other new technologies may become competitive with non-entertainment services that video systems can offer. The FCC has authorized television broadcast stations to transmit textual and graphic information useful to both consumers and businesses. The FCC also permits commercial and non-commercial FM radio stations to use their subcarrier frequencies to provide non-broadcast services including data transmissions. The FCC established an over-the-air interactive video and data service that will permit two-way interaction with commercial and educational programming along with informational and data services. ILECs and other common carriers also provide facilities for the transmission and distribution to homes and businesses of interactive computer-based services, including the Internet, as well as data and other non-video services. The FCC has conducted spectrum auctions for licenses to provide personal communication services (“PCS”) as well as other services. PCS and other services will enable license holders, including cable operators, to provide voice and data services. We own a statewide PCS license in Alaska.
Video systems generally operate pursuant to franchises granted on a non-exclusive basis. The 1992 Cable Act gives local franchising authorities jurisdiction over basic video service rates and equipment in the absence of “effective competition.” The 1992 Cable Act also prohibits franchising authorities from unreasonably denying requests for additional franchises and permits franchising authorities to operate video systems. Well-financed businesses from outside the video industry (such as the public utilities that own certain of the poles on which cable is attached) may become competitors for franchises or providers of competing services.
We expect to continue to provide, at reasonable prices and in competitive bundles, a greater variety of communication services than are available off-air or through other alternative delivery sources. Additionally, we believe we offer superior technical performance and responsive community-based customer service. Increased competition, however, may adversely affect our market share and results of operations from our video services product offerings.
Voice Services and Products Competition
Local Access
We compete against ACS, the ILEC in Anchorage, Juneau, Fairbanks and the Kenai Peninsula area; MTA, the ILEC in the Matanuska-Susitna Valley, and other smaller ILECs in other communities.
In the local telephone services market, the 1996 Telecom Act, judicial decisions, state and federal legislative and regulatory developments, and new technologies have increased the overall likelihood that barriers to local telephone competition will be substantially reduced or removed. These initiatives include requirements that ILECs negotiate with entities, including us, to provide interconnection to the existing local telephone network, to allow the purchase, at cost-based rates, of access to UNEs, to establish dialing parity, to obtain access to rights-of-way and to resell services offered by the ILEC. We have been able to obtain interconnection, access and related services from the ILECs, at rates that allow us to offer competitive services. However, if we are unable to continue to obtain these services and access at acceptable rates, our ability to offer local access services, and our revenues and net income, could be materially adversely affected. To date, we have been successful in capturing a significant portion of the local telephone market in the locations where we are offering these services. However, there can be no assurance that we will continue to be successful in attracting or retaining these customers. In addition, wireless and VoIP services continue to grow as an alternative to wireline services as a means of reaching customers. Wireless local number portability allows consumers to retain the same phone number as they change service providers allowing for interchangeable and portable fixed-line and wireless numbers. A growing number of consumers now use wireless service as their primary voice phone service for local calling.
Long-Distance
The long-distance industry is intensely competitive, with service offerings based upon price and bundling.
In the intrastate, interstate and international long-distance market, we compete against ACS, MTA, long-distance resellers, and certain smaller rural local telephone companies. There is also the possibility that new competitors will enter the Alaska market. In addition, wireless and voice over Internet protocol ("VoIP") services continue to grow as an alternative to wireline services as a means of reaching customers. Wireless local number portability allows consumers to retain the same phone number as they change service providers allowing for interchangeable and portable fixed-line and wireless numbers. A growing number of consumers now use wireless service as their primary voice phone service for long-distance calling.
We have competed in the long-distance market by offering discounts from rates charged by our competitors and by providing desirable bundles of services.
Our ability to compete successfully will depend on our ability to anticipate and respond to various competitive factors affecting the industry, including new services that may be introduced, changes in consumer preferences, demographic trends, economic conditions and pricing strategies.
We believe that we have certain advantages over ILECs in providing communications services, including awareness by Alaskan customers of the GCI brand name, our facilities-based communications network, and our prior experience in, and knowledge of, the Alaskan market.
See “Regulation - Wireline Voice Services and Products” below for more information.
Seasonality
Our Consumer segment services and products do not exhibit significant seasonality. Our ability to implement construction projects is hampered during the winter months because of cold temperatures, snow and short daylight hours.
Network Access Segment
Network Access segment revenues for 2012, 2011 and 2010 are summarized as follows (amounts in thousands):
1 See “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” and note 10 included in “Part II - Item 8 - Consolidated Financial Statements and Supplementary Data” for more information regarding the financial performance of our Network Access segment.
Services and Products
Our Network Access segment offers wholesale wireless, data and voice services and products to other common carrier customers. We provide network transport, billing services and access to our network to other common carriers. These services allow other common carriers to provide services to their customers that originate or terminate on our network, or on the networks of other communication companies to which we connect.
Wireless Services and Products
Revenues derived from Network Access segment wireless services and products in 2012, 2011, and 2010 totaled $26.8 million, $19.4 million, and $16.7 million, respectively, or 4%, 3%, and 3% of our total revenues, respectively. We provide roaming services on our wireless network within Alaska to other GSM and CDMA wireless carriers.
Data Services and Products
Revenues derived from Network Access segment data services and products in 2012, 2011, and 2010 totaled $56.2 million, $62.5 million, and $61.5 million, respectively, or 8%, 9%, and 9% of our total revenues, respectively.
Data network services include MPLS, frame relay, private line and dedicated Internet service.
Voice Services and Products
Revenues derived from Network Access segment voice services and products in 2012, 2011, and 2010 totaled $22.5 million, $23.6 million, and $29.0 million, respectively, or 3%, 3%, and 4% of our total revenues, respectively.
We are engaged in the transmission of interstate and intrastate-switched message telephone service. We terminate northbound message telephone service traffic for several large resellers who do not have facilities of their own in Alaska. We also provide origination of southbound calling card, toll-free services, and toll services for interexchange carriers. Services are generally provided pursuant to contracts.
Sales and Marketing
Our Network Access segment sales and marketing efforts are primarily directed toward increasing the number of other common carriers we serve, the number of billable minutes of wireless and long-distance traffic, and the number of billable megabytes of wireless data traffic we carry over our network and the number of voice and data transmission circuits leased. We sell our voice, data and wireless services primarily through direct contact marketing.
Facilities
Our Network Access segment shares common facilities used for wireless, data and voice services by other segments. You should refer to “Consumer Segment - Facilities” above for additional information.
Major Customer
We had no major customer in 2012, 2011 or 2010.
Competition
Our Network Access segment competes against AT&T Alascom, ACS, and certain smaller rural local telephone carriers. There is also the possibility that new competitors will enter the Alaska market.
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. We are unable to predict the effect of such changes on our business.
Historically, we have competed in the Network Access segment market by offering rates comparable to or less than our competitors, by providing a comprehensive service model to meet the complete needs of our carrier customers, and by providing responsive customer service.
Another carrier operates a pair of fiber optic cable facilities connecting points in Alaska to the lower 48 states. This additional fiber system provides direct competition to services we provide on our owned fiber optic cable facilities.
Seasonality
Network Access segment long-distance and wireless services revenues derived from our other common carrier customers have historically been highest in the summer months because of temporary population increases attributable to tourism and increased seasonal economic activity such as construction, commercial fishing, and oil and gas activities. Our Network Access segment data services do not exhibit significant seasonality.
Commercial Segment
We offer a full range of communications services and products to commercial and governmental customers. Commercial segment revenues for 2012, 2011 and 2010 are summarized as follows (amounts in thousands):
1 See “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” and note 10 included in “Part II - Item 8 - Consolidated Financial Statements and Supplementary Data” for more information regarding the financial performance of our Commercial segment.
Services and Products
Our Commercial segment offers a full range of wireless, data, video and voice services and products to local, national and global businesses, governmental entities, and public and private educational institutions.
Wireless Services and Products
Revenues derived from Commercial segment wireless services and products in 2012, 2011, and 2010 totaled $9.9 million, $9.8 million, and $8.7 million, respectively, or 1% of our total revenues for each year.
Wireless services and products offered to our Commercial segment customers are the same as those described in the Consumer Wireless Services and Products section above. You should refer to “Consumer Segment - Services and Products” above for additional information.
Data Services and Products
Revenues derived from Commercial segment data services and products in 2012, 2011, and 2010 totaled $93.4 million, $86.0 million, and $76.8 million, respectively, or 13%, 13% and 12% of our total revenues, respectively.
Internet
We currently offer several Internet service packages for commercial use. Our business high-speed cable modem Internet service offers access of up to 50 Mbps download and 5 Mbps upload speeds, and free 24-hour customer service and technical support. We also provide dedicated Internet access service to commercial and public organizations in Alaska.
Data Networks
Data 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. Private IP, private lines, metro Ethernet and frame relay offer a secure solution for frequent communication of large amounts of data between sites.
Managed Services
We 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. We supply integrated voice and data communications systems incorporating private IP, interstate and intrastate digital data networks, point-to-point and multipoint data network and small earth station services. In 2012 we began offering hosting services to customers wishing to have data-center technology in a secure location with redundant space, power and bandwidth.
Video Services and Products
Revenues derived from Commercial segment video services and products in 2012, 2011, and 2010 totaled $12.8 million, $11.6 million, and $11.2 million, respectively, or 2% of our total revenues for each year.
Commercial segment subscribers such as hospitals, hotels and motels are charged negotiated monthly service fees. Our video on demand platform is available to hotels in Anchorage that are connected using our fiber facilities. Programming services offered to our video systems subscribers differ by system as described in the Consumer segment Video Services and Products section above. You should refer to “Consumer Segment - Services and Products” above for additional information.
Commercial segment also manages our advertising sales. As part of our programming license agreements with programming networks, we generally receive an allocation of scheduled advertising time that we may sell to local, regional and national advertisers. In most cases, the available advertising time is sold by our sales force.
Voice Services and Products
Revenues derived from Commercial segment voice services and products in 2012, 2011, and 2010 totaled $27.4 million, $28.7 million, and $31.7 million, respectively, or 4%, 4% and 5% of our total revenues, respectively.
Long-Distance
We are engaged in the transmission of interstate and intrastate-switched message telephone service between the major communities in Alaska, the remaining 49 states, and foreign countries. Our message toll services include intrastate, interstate and international direct dial, toll-free services, calling card, operator and enhanced conference calling services. Small business subscribers generally may cancel long-distance service at any time. Certain small business and most large business, governmental and educational institution customers generally contract with us for service over one to five year periods.
Local Access
We offer full featured local access service to our Commercial segment customers using our own fiber and coax facilities and collocated remote facilities that access the ILEC’s UNE loops and wholesale facilities. In areas where we do not have our own facilities or access to ILEC loop facilities, we offer service using total service resale of the ILEC’s local service or UNE platform.
Our package offerings are competitively priced and include popular features, including caller ID, voice messaging, three-way calling, call forwarding, and call waiting. Small business subscribers generally may cancel local access service at any time. Certain small business and most large business, governmental and educational institution customers generally contract with us for service over one to five year periods.
Bundled Services and Products
We combine one or more of our individual service or product offerings into bundles that we sell to our Commercial segment customers at attractive prices as described further in the Consumer segment Services and Products section above. You should refer to “Consumer Segment - Services and Products” above for additional information. Additionally, we use master service agreements with larger enterprise customers to capture the overall relationship.
Sales and Marketing
Our Commercial segment sales and marketing efforts focus on increasing the number of subscribers we serve, selling bundled services, and generating incremental revenues through product and feature up-sell opportunities. We sell our Commercial segment services and products primarily through direct contact marketing.
Facilities
Our Commercial segment uses many facilities to provide services and products that are common to the Consumer segment. You should refer to “Consumer Segment - Facilities” above for additional information.
We provide our own facilities-based local access services to many of Anchorage’s larger business customers through expansion and deployment of SONET, optical ethernet, and passive optical network fiber transmission facilities, digital loop carrier facilities, and leased facilities.
Our dedicated Internet access and Internet protocol/MPLS data services are delivered to an Ethernet port located at the service point. Our management platform constantly monitors this port and continual communications are maintained with all of the core and distribution elements in the network. The availability and quality of service, as well as statistical information on traffic loading, are continuously monitored for quality assurance. The manage­ment platform has the capability to remotely access routers, servers and layer two switches, permitting changes in configuration without the need to physically be at the service point. This management platform allows us to offer network monitoring and management services to businesses and governmental entities. Many of the largest commercial networks in Alaska use this service, including the State of Alaska government.
Beginning in 2012 we provide a hosting center in Alaska designed to support the emerging trends in virtualized servers and cloud-based systems. Our Data Services Center brings data-center technologies and services together by offering space, power and bandwidth in a redundant and secure location.
Competition
Many of our Commercial segment wireless, data, video and voice services and products are also common to the Consumer segment. You should refer to “Consumer Segment - Competition” above for additional information.
We expect continued competition in commercial customer wireless, data, Internet access and telephone access markets. Competition is based upon price and pricing plans, the type of services offered, customer service, billing services, performance, and perceived quality, reliability and availability.
Presently, there are a number of competing companies in Alaska that actively sell and maintain data and voice communications systems. Our ability to integrate communications networks and data communications equipment has allowed us to maintain our market position based on customer support services rather than price competition alone. These services are blended with other transport products into unique customer solutions, including managed services and outsourcing.
Seasonality
Our Commercial segment wireless, data, video, and voice services do not exhibit significant seasonality. Our ability to implement construction projects to expand our outside plant facilities is hampered during the winter months because of cold temperatures, snow and short daylight hours.
Managed Broadband Segment
Managed Broadband segment revenues for 2012, 2011 and 2010 are summarized as follows (amounts in thousands):
1 See “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” and note 10 included in “Part II - Item 8 - Consolidated Financial Statements and Supplementary Data” for more information regarding the financial performance of our Managed Broadband segment.
Services and Products
Our Managed Broadband segment offers Internet access, data network and managed services to rural schools and health organizations.
SchoolAccess® is a suite of services designed to advance the educational opportunities of students in underserved regions of the country. Our SchoolAccess® division provides Internet and distance learning services designed exclusively for the school environment. The Schools and Libraries Program of the USF makes discounts available to eligible rural school districts for telecommunication services and monthly Internet service charges. The program is intended to ensure that rural school districts have access to affordable services.
Our network, Internet and software application services provided through our Managed Broadband segment’s Medical Services division are branded as ConnectMD®. The Rural Health Care Program of the USF makes discounts available to eligible rural health care providers for telecommunication services and monthly Internet service charges. The program is intended to ensure that rural health care providers pay no more for telecommunication services in the provision of health care services than their urban counterparts. Customers utilize ConnectMD® services to securely move data and images, and for voice traffic and real time multipoint interactive video.
We offer a managed video conferencing product for use in distance learning, telemedicine and group communication and collaboration environments. The product is designed to offer customers enhanced communication services that support video, audio and data presentation. Our product benefits customers by reducing travel costs, improving course equity in education and increasing the quality of health services available to patients. The product bundles our data products, video conferencing services and optional rental of video conferencing endpoint equipment. Our video conferencing services include multipoint conferencing, integrated services digital network gateway and transcoding services, online scheduling and conference control, and videoconference recording, archiving and streaming. We provide 24-hour technical support via telephone or online.
Our videoconferencing network is the largest in Alaska with additional sites in several other states. The network supports all H.323 IP videoconferencing standards including the newer H.264 standard, and supports call data rates from 128 Kb per second up to and including multi-megabit high definition calls.
Sales and Marketing
Our Managed Broadband segment sales and marketing efforts focus on increasing the number of subscribers we serve, selling bundled services, and generating incremental revenues through product and feature up-sell opportunities. We sell our Managed Broadband segment services and products primarily through direct contact marketing followed by competitive bidding.
Facilities
Our Managed Broadband segment services and products are delivered using a platform including many of the latest advancements in technology through a locally available circuit, our existing lines, and/or satellite earth stations. Our Internet services are partially provisioned over a satellite based digital video broadcast carrier that reduces the requirement for new satellite transponder bandwidth to support growth in ConnectMD®, SchoolAccess® and other broadband services.
We employ a packet data satellite transmission technology for the efficient transport of broadband data in support of our ConnectMD® and SchoolAccess® initiatives. Our SchoolAccess® Internet service is delivered as follows:
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In communities where we have terrestrial interconnects or provide existing service over regional earth stations, we have configured intermediate distribution facilities. Schools that are within these service boundaries are connected locally to one of those facilities;
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In communities where we have extended communications services via our DAMA earth station program, SchoolAccess® is provided via a satellite circuit to an intermediate distribution facility at the Eagle River earth station; and
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In communities or remote locations to which we have not extended communications services, SchoolAccess® is provided via a dedicated (usually on premise) very small aperture terminal ("VSAT") satellite station. The VSAT connects to an intermediate distribution facility located in Anchorage.
Our facilities include TERRA-SW, a middle mile long haul broadband network. TERRA-SW provides terrestrial telecommunication service to 65 remote rural Alaska communities located in southwest Alaska through a hybrid microwave and fiber optic network. TERRA-SW includes 395 miles of fiber optic cable stretching from Homer, Alaska to Levelock, Alaska, microwave towers in certain communities and four remote mountaintop microwave repeaters. We utilize TERRA-SW to support growth in wireless and broadband services including ConnectMD® and SchoolAccess®.
You should refer to “Consumer Segment - Facilities” above for additional information.
Competition
There are several competing companies in Alaska that actively sell broadband services. Our ability to provide end-to-end broadband services solutions has allowed us to maintain our market position based on “value added” services and products rather than solely based on price competition. These services are blended with other transport and software products into unique customer solutions, including SchoolAccess® and ConnectMD® applications such as video conferencing and unique web content services.
Seasonality
Our Managed Broadband segment does not exhibit seasonality.
Regulated Operations Segment
Regulated Operations segment revenues for 2012, 2011 and 2010 are summarized as follows (amounts in thousands):
1 See “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” and note 10 included in “Part II - Item 8 - Consolidated Financial Statements and Supplementary Data” for more information regarding the financial performance of our Regulated Operations segment.
Services and Products
Our Regulated Operations segment offers wireline communications services, including local access and long-distance, to our residential and commercial customers in 61 rural communities primarily in Southwest Alaska, under our United Utilities, Inc. (“UUI”) and United-KUC, Inc. (“United-KUC”) brands.
Sales and Marketing
Our Regulated Operations segment sales efforts are primarily directed toward increasing the number of subscribers we serve. We sell our Regulated Operations segment services through local media advertising, retail stores, and through our website.
Facilities
Our Regulated Operations segment services are delivered by switching, outside plant, terrestrial microwave, and satellite facilities. Our outside plant is primarily aerial and buried copper and fiber optic cables.
Competition
Our Regulated Operations segment’s competition results from a growing number of consumers using wireless service as the primary source for their voice phone service. However, the only wireless provider in their service area is ourselves, and thus the competition source is internal as our Consumer and Commercial segment subscriber revenue replaces Regulated Operations segment subscriber revenue.
Seasonality
Our Regulated Operations segment services do not exhibit significant seasonality.
Sales and Marketing - Company-wide
Our sales and marketing strategy hinges on our ability to leverage (i) our unique position as an integrated provider of multiple communications, Internet and video services, (ii) our well-recognized and respected brand names in the Alaskan marketplace and (iii) our leading market positions in the services and products we offer. By continuing to pursue a marketing strategy that takes advantage of these characteristics, we believe we can increase our customer market penetration and retention rates, increase our share of our customers’ aggregate voice, video, data and wireless services expenditures and achieve continued growth in revenues and operating cash flow.
Environmental Regulations
We may undertake activities that, under certain circumstances, may affect the environment. Accordingly, they are subject to federal, state, and local regulations designed to preserve or protect the environment, including the Clean Water Act and the Clean Air Act. The FCC, Bureau of Land Management, U.S. Forest Service, U.S. Fish and Wildlife Service, U.S. Army Corps of Engineers, and National Park Service are among the federal agencies required by the National Environmental Policy Act of 1969 to consider the environmental impact of actions they authorize, including facility construction.
We believe that compliance with such regulations has had no material effect on our consolidated operations. The principal effect of our facilities on the environment would be in the form of construction of facilities and networks at various locations in Alaska and between Alaska, Seattle, Washington, and Warrenton, Oregon. Our facilities have been constructed in accordance with federal, state and local building codes and zoning regulations whenever and wherever applicable. Some facilities may be on wetlands that may be subject to state and/or federal regulation.
Most of our facilities are on leased property, and, with respect to all of these facilities, we are unaware of any violations of lease terms or federal, state or local regulations pertaining to preservation or protection of the environment.
The engineered routes of our projects to construct terrestrial and undersea fiber optic cable facilities pass over wetlands and other environmentally sensitive areas. We believe our construction methods used for buried cable have a minimal impact on the environment. The agencies, among others, that are involved in permitting and oversight of our cable deployment efforts are the U.S. Army Corps of Engineers, National Marine Fisheries Service, U.S. Fish and Wildlife Service, U.S. Coast Guard, National Oceanic and Atmospheric Administration, and the Alaska Department of Natural Resources. We are unaware of any violations of federal, state or local regulations or permits pertaining to preservation or protection of the environment.
In the course of operating our video and communications systems, we have used various materials defined as hazardous by applicable governmental regulations. These materials have been used for insect repellent, paint used to mark the location of our facilities, and pole treatment, and as heating fuel, transformer oil, cable cleaner, batteries, diesel fuel, and in various other ways in the operation of those systems. We do not believe that these materials, when used in accordance with manufacturer instructions, pose an unreasonable hazard to those who use them or to the environment. Where present at levels above applicable thresholds, we submit annual reports detailing hazardous substance quantities and locations to emergency responders under the Emergency Planning & Community Right-to-Know Act.
Our construction activities and operations include transporting fuel via helicopter to remote locations within Alaska. To any extent not covered by our insurance or that of our contractors, we could incur cleanup costs and third-party claims for property damage if fuel were to be released to underlying lands or water while in flight. New laws and regulations, more stringent enforcement of existing laws and regulations, or the discovery of previously unknown contamination could result in additional costs.
Patents, Trademarks, and Licenses
We do not hold patents, franchises (with the exception of video services as described below) or concessions for communications services or local access services. We do hold federally registered service marks, used by each of our reportable segments, for the marks GCI®, SchoolAccess®, Alaska United Fiber Optic Cable System®, GCI ConnectMD®, ConnectMD®, GCI Hypernet®, My GCI®, MyGCI®, Keep Talking Alaska®, Unicom®, and United-KUC®. The original deadline to renew the registration for the mark Unicom® for a new 10-year term has expired; however, the registration is in a “grace period” and our intention is to renew the registration before the end of the grace period. We also own two pending applications to register the mark GCI TurboZone. Both applications have been approved for publication. The Communications Act of 1934, as amended, gives the FCC the authority to license and regulate the use of the electromagnetic spectrum for radio communications. We hold licenses through our subsidiary GCI Communication Corp. (“GCICC”) for our satellite and microwave transmission facilities for provision of long-distance services provided by our Consumer, Commercial and Network Access segments.
We hold the following licenses, among others:
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Two licenses for use of a 30 MHz block of spectrum, which together authorize provision of PCS services in Alaska. Both licenses have an expiration date of June 23, 2015. Licenses may be revoked and license renewal applications may be denied for cause. We expect the PCS licenses will be renewed in due course when, at the end of the license period, a renewal application will be filed,
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A local multipoint distribution system ("LMDS") license which we acquired in 1998 for use of a 150 MHz block of spectrum in the 28 GHz Ka-band for providing wireless services. The LMDS license was renewed in 2008 for an additional 10-year term, following the grant of an extension until June 1, 2012, of the requirement to provide “substantial service” in the service region. We timely satisfied this condition, as reflected in the required FCC filing on June 1, 2012.
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25 MHz cellular licenses for sites located in the Wade Hampton AK-1 portion of CMA315 (A and B blocks) and in the Bethel AK-2 portion of CMA 316 (A block), and
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Several 25 MHz cellular B licenses are held by our subsidiary Unicom for sites located in the Wade Hampton AK-1 portion of CMA 315 and the Bethel AK-2 portion of CMA 316, and operated by GCICC pursuant to a de facto long-term spectrum lease.
Earth stations are licensed generally for fifteen years. The FCC also issues a single blanket license for a large number of technically identical earth stations (e.g., VSATs). Our operations may require additional licenses in the future.
We are certified through the RCA to provide video service by Certificates of Public Convenience and Necessity (“CPCN”). These CPCNs are nonexclusive certificates issued for each community. Although CPCNs have no stated expiration date, they may be revoked due to cause.
Regulation
Our businesses are subject to substantial government regulation and oversight. The following summary of regulatory issues does not purport to describe all existing and proposed federal, state, and local laws and regulations, or judicial and regulatory proceedings that affect our businesses. Existing laws and regulations are reviewed frequently by legislative bodies, regulatory agencies, and the courts and are subject to change. We cannot predict at this time the outcome of any present or future consideration of proposed changes to governing laws and regulations.
Wireless Services and Products
General. The FCC regulates the licensing, construction, interconnection, operation, acquisition, and transfer of wireless network systems in the United States pursuant to the Communications Act. As a licensee of PCS, LMDS, and other wireless services, we are subject to regulation by the FCC, and must comply with certain build-out and other license conditions, as well as with the FCC’s specific regulations governing wireless services, including the PCS and LMDS services (as discussed above in the Patents, Trademarks and Licenses section of this Item 1). The FCC does not currently regulate rates for services offered by commercial mobile radio service providers (the official legal description for wireless service providers).
Commercial mobile radio service wireless systems are subject to Federal Aviation Administration and FCC regulations governing the location, lighting, construction, and registration of antenna structures on which our antennas and associated equipment are located and are also subject to regulation under federal environmental laws and the FCC’s environmental regulations, including limits on radio frequency radiation from wireless handsets and antennas on towers.
Universal Service. The USF pays Eligible Telecommunications Carriers ("ETCs") to support the provision of facilities-based wireless telephone service in high cost areas. A wireless carrier may seek ETC status so that it can receive support from the USF. Under FCC regulations and RCA orders, we are an authorized ETC for purposes of providing wireless telephone service in Anchorage, Juneau, Fairbanks, and the MTA study area (which includes the Matanuska-Susitna Valley) and other small areas throughout Alaska. Without ETC status, we would not qualify for USF support in these areas or other rural areas where we propose to offer facilities-based wireless telephone services, and our net cost of providing wireless telephone services in these areas would be materially adversely affected.
On November 29, 2011, the FCC published a final rule to reform the methodology for distributing USF high cost support for voice and broadband services, as well as to the access charge regime for terminating traffic between carriers. Support for competitive eligible telecommunications carriers (“CETCs”) serving areas that generally include Anchorage, Fairbanks, and Juneau followed national reforms and had support per provider per service area capped as of January 1, 2012, and a five-step phase-down commenced on July 1, 2012. In addition to broader reforms, the FCC tailored revisions specifically for CETCs serving Remote Alaska, intended to address the unique challenges for serving these areas. Support to these locations is capped and distributed on a per-line basis until the later of July 1, 2014, or the implementation of a successor funding mechanism. A further rulemaking to consider successor funding mechanisms is underway. We cannot predict at this time the outcome of this proceeding or its effect on Remote high cost support available to us, but our revenue for providing local services in these areas would be materially adversely affected by a substantial reduction of USF support.
On February 6, 2012, the FCC released its Report and Order and Further Notice of Proposed Rulemaking to comprehensively reform and modernize the USF’s Lifeline program. The Lifeline program is administered by the USAC and is designed to ensure that quality telecommunications services are available to low-income customers at just, reasonable, and affordable rates. The order adopted several reforms, but the only reform with a significant 2012 impact was a requirement for annual recertification of all Lifeline subscribers enrolled as of June 1, 2012 to be completed by the end of 2012. In an order released on December 27, 2012, the FCC’s Wireline Competition Bureau granted GCI a waiver to permit early recertification of subscribers (those recertified prior to June 1, 2012), subject to the condition that certain address information be verified for a subset of those subscribers by January 31, 2013.
Interconnection. We have completed negotiation and the RCA has approved current direct wireless interconnection agreements between GCI and all of the major Alaska ILECs. These are in addition to indirect interconnection arrangements utilized elsewhere.
See “Description of Our Business by Reportable Segment - Regulation - Wireline Voice Services and Products - Universal Service and Regulatory Regime Applicable to IP-based Networks” for more information.
Emergency 911. The FCC has imposed rules requiring carriers to provide emergency 911 services, including enhanced 911 (“E911”) services that provide to local public safety dispatch agencies the caller’s phone number and approximate location. Providers are required to transmit the geographic coordinates of the customer’s location, either by means of network-based or handset-based technologies, within accuracy parameters recently revised by the FCC, to be implemented over a phase-in period. Due to Alaska’s relatively low population and low cell-site densities, we have excluded certain areas from E911 coverage where cell triangulation is not feasible, pursuant to FCC rule. We have also filed for a waiver, which remains pending, for remaining areas where triangulation may be technically feasible, but where the cell-site densities are insufficient to reach the FCC’s standard. Providers may not demand cost recovery as a condition of providing E911, although they are permitted to negotiate cost recovery if it is not mandated by the state or local governments.
State and Local Regulation. While the Communications Act generally preempts state and local governments from regulating the entry of, and the rates charged by, wireless carriers, it also permits a state to petition the FCC to allow it to impose commercial mobile radio service rate regulation when market conditions fail to adequately protect customers and such service is a replacement for a substantial portion of the telephone wireline exchange service within a state. No state currently has such a petition on file, and all prior efforts have been rejected. In addition, the Communications Act does not expressly preempt the states from regulating the “terms and conditions” of wireless service.
Several states have invoked this “terms and conditions” authority to impose or propose various consumer protection regulations on the wireless industry. State attorneys general have also become more active in enforcing state consumer protection laws against sales practices and services of wireless carriers. States also may impose their own universal service support requirements on wireless and other communications carriers, similar to the contribution requirements that have been established by the FCC.
States have become more active in attempting to impose new taxes and fees on wireless carriers, such as gross receipts taxes. Where successful, these taxes and fees are generally passed through to our customers and result in higher costs to our customers.
At the local level, wireless facilities typically are subject to zoning and land use regulation. Neither local nor state governments may categorically prohibit the construction of wireless facilities in any community or take actions, such as indefinite moratoria, which have the effect of prohibiting construction. Nonetheless, securing state and local government approvals for new tower sites has been and is likely to continue to be difficult, lengthy and costly.
Internet-based Services and Products
General. There is no one entity or organization that governs the Internet. Each facilities-based network provider that is interconnected with the global Internet controls operational aspects of their own network. Certain functions, such as IP addressing, domain name routing, and the definition of the TCP/IP protocol, are coordinated by an array of quasi-governmental, intergovernmental, and non-governmental bodies. The legal authority of these bodies is not precisely defined.
Although the FCC does not regulate the prices charged by Internet service providers or Internet backbone providers, the vast majority of users connect to the Internet over facilities of existing communications carriers. Those communications carriers are subject to varying levels of regulation at both the federal and state level. Thus, non-Internet-specific regulatory decisions exercise a significant influence over the economics of the Internet market.
Many aspects of the coordination and regulation of Internet activities and the underlying networks over which those activities are conducted are evolving. Internet-specific and non-Internet-specific changes in the regulatory environment, including changes that affect communications costs or increase competition from ILECs or other communications services providers, could adversely affect the prices at which we sell Internet-based services.
On November 20, 2011, the FCC issued rules governing the activities of cable operators and other Internet service providers in connection with the provision of Internet service. The rules generally prohibit blocking lawful content and prohibiting unreasonable discrimination, outside of reasonable network management, as well as imposing transparency and related disclosure requirements. We do not believe at this time that these requirements represent significant federal regulation of cable system delivery of Internet services. In addition, these rules are subject to court appeals. Further legislative proposals under the banner of “net neutrality,” if adopted, could interfere with our ability to reasonably manage and invest in our broadband network, and could adversely affect the manner and price of providing service.
Video Services and Products
General. Because video communications systems use local streets and rights-of-way, they generally are operated pursuant to franchises (which can take the form of certificates, permits or licenses) granted by a municipality or other state or local government entity. The RCA is the franchising authority for all of Alaska. We believe that we have generally met the terms of our franchises, which do not require periodic renewal, and have provided quality levels of service. Military franchise requirements also affect our ability to provide video services to military bases.
The RCA is also certified under federal law to regulate rates for the Basic Service tier on our video systems. Under state law, however, video service is exempt from regulation unless subscribers petition the RCA. At present, regulation of basic video rates takes place only in Juneau. The RCA does not regulate rates for cable modem service.
Must Carry/Retransmission Consent. The 1992 Cable Act contains broadcast signal carriage requirements that allow local commercial television broadcast stations to elect once every three years to require a cable system to carry the station, subject to certain exceptions, or to negotiate for “retransmission consent” to carry the station.
The FCC has adopted rules to require cable operators to carry the digital programming streams of broadcast television stations. The FCC requirement that cable operators carry both the analog and digital programming streams of broadcast television stations while broadcasters are transitioning from analog to digital transmission does not apply to all-digital systems like ours. Further, the FCC has declined to require any cable operator to carry multiple digital programming streams from a single broadcast television station, but should the FCC change this policy, we would be required to devote additional cable capacity to carrying broadcast television programming streams, a step that could require the removal of other programming services.
Cable System Delivery of Internet Service. The FCC has defined high-speed Internet over cable as an “information service” not subject to local cable franchise fees, as video service may be, or any explicit requirements for “open access.” The Supreme Court affirmed the FCC’s position in a decision issued in 2005.
Although there is at present no significant federal regulation of cable system delivery of Internet services, proposals previously have been advanced at the FCC and before Congress to require cable operators to provide access to unaffiliated Internet service providers and online service providers and to govern the terms under which content providers and applications are delivered by all broadband network operators. If such requirements were imposed on cable operators, it could burden the capacity of cable systems and frustrate our plans for providing expanded Internet access services. These access obligations could adversely affect our financial position, results of operations or liquidity.
Segregated Security for Set-top Devices. The FCC mandated, effective July 1, 2007, that all new set-top video navigation devices must segregate the security function from the navigation function. The new devices are more expensive than existing equipment, and compliance would increase our cost of providing video services. Subject to a waiver granted by the FCC on May 4, 2007, we may continue providing low-cost integrated set-top boxes to consumers to facilitate our all-digital cable networks.
AllVid Proceeding. On April 21, 2010, the FCC adopted a Notice of Inquiry to consider ways to develop a standardized interface for accessing video content, as an alternative to set-top boxes. Adoption of new rules or standards in this area could affect the manner in which we deliver video products to our customers. We do not know if the FCC will propose rules for further consideration.
Pole Attachments. The Communications Act requires the FCC to regulate the rates, terms and conditions imposed by public utilities for cable systems’ use of utility pole and conduit space unless state authorities can demonstrate that they adequately regulate pole attachment rates. In the absence of state regulation, the FCC administers pole attachment rates on a formula basis. This formula governs the maximum rate certain utilities may charge for attachments to their poles and conduit by companies providing communications services, including cable operators. The RCA, however, does not use the federal formula and instead has adopted its own formula that has been in place since 1987. This formula could be subject to further revisions upon petition to the RCA. In addition, on April 7, 2011, the FCC adopted an order to rationalize different pole attachment rates among types of services. The United States Court of Appeals, D.C. Circuit, recently upheld the FCC’s rules, denying challenges from several utility companies. Though the general purpose of rule changes was to ensure pole attachment rates as low and as uniform as possible, we do not expect the rules to have an immediate impact on the terms under which we access poles.
Copyright. Cable television systems are subject to federal copyright licensing covering carriage of television and radio broadcast signals. In exchange for filing certain reports and contributing a percentage of their revenues to a federal copyright royalty pool that varies depending on the size of the system, the number of distant broadcast television signals carried, and the location of the cable system, cable operators can obtain blanket permission to retransmit copyrighted material included in broadcast signals. The possible modification or elimination of this compulsory copyright license is the subject of continuing legislative review. We cannot predict the outcome of this legislative review, which could adversely affect our ability to obtain desired broadcast program­ming. Copyright clearances for non-broadcast programming services are arranged through private negotiations.
Wireline Voice Services and Products
General. As an interexchange carrier, we are subject to regulation by the FCC and the RCA as a non-dominant provider of interstate, international, and intrastate long-distance services. As a state-certificated competitive local exchange carrier, we are subject to regulation by the RCA and the FCC as a non-dominant provider of local communications services. Military franchise requirements also affect our ability to provide communications services to military bases.
Universal Service. The USF pays ETCs to support the provision of facilities-based wireline telephone service in high cost areas. Under FCC regulations and RCA orders, we are an authorized ETC for purposes of providing wireline local exchange service in Anchorage, Juneau, Fairbanks, and the MTA study area (which includes the Matanuska-Susitna Valley) and other small areas throughout Alaska. Without ETC status, we would not qualify for USF support in these areas or other rural areas where we propose to offer facilities-based wireline telephone services, and our net cost of providing local telephone services in these areas would be materially adversely affected.
On November 29, 2011, the FCC published a final rule to reform the methodology for distributing USF high cost support for voice and broadband services, as well as to the access charge regime for terminating traffic between carriers. Support for CETCs serving areas that generally include Anchorage, Fairbanks, and Juneau followed national reforms and had support per provider per service area capped as of January 1, 2012, and a five-step phase-down commenced on July 1, 2012. In addition to broader reforms, the FCC tailored revisions specifically for CETCs serving Remote Alaska, intended to address the unique challenges for serving these areas. Support to these locations is capped and distributed on a per-line basis until the later of July 1, 2014, or the implementation of a successor funding mechanism. A further rulemaking to consider successor funding mechanisms is underway. We cannot predict at this time the outcome of this proceeding or its effect on Remote high cost support available to us, but our revenue for providing local services in these areas would be materially adversely affected by a substantial reduction of USF support.
On February 6, 2012, the FCC released its Report and Order and Further Notice of Proposed Rulemaking to comprehensively reform and modernize the USF’s Lifeline program. The Lifeline program is administered by the USAC and is designed to ensure that quality telecommunications services are available to low-income customers at just, reasonable, and affordable rates. The order adopted several reforms, but the only reform with a significant 2012 impact was a requirement for annual recertification of all Lifeline subscribers enrolled as of June 1, 2012 to be completed by the end of 2012. In an order released on December 27, 2012, the FCC’s Wireline Competition Bureau granted GCI a waiver to permit early recertification of subscribers (those recertified prior to June 1, 2012), subject to the condition that certain address information be verified for a subset of those subscribers by January 31, 2013.
Rural Exemption and Interconnection. A Rural Telephone Company is exempt from compliance with certain material interconnection requirements under Section 251(c) of the 1996 Telecom Act, including the obligation to negotiate Section 251(b) and (c) interconnection requirements in good faith, unless and until a state regulatory commission lifts such “rural exemption” or otherwise finds it not to apply. All ILECs in Alaska are Rural Telephone Companies except ACS in its Anchorage study area. We have had to participate in numerous proceedings regarding the rural exemptions of various ILECs, including ACS for its Fairbanks and Juneau operating companies, MTA and Ketchikan Public Utilities, in order to achieve the necessary interconnection agreements with the remaining ILECs. In other cases the interconnection agreements were reached by negotiation without regard to the implications of the ILEC’s rural exemption.
We have completed negotiation and/or arbitration of the necessary interconnection provisions and the RCA has approved current wireline Interconnection Agreements between GCI and all of the major ILECs. We have entered all of the major Alaskan markets with local access services.
See “Description of Our Business by Reportable Segment - Consumer - Competition - Voice Services and Products Competition” for more information.
Access Charges and Other Regulated Fees. The FCC regulates the fees that local telephone companies charge long-distance companies for access to their local networks. On November 29, 2011, the FCC published a final rule to restructure and reduce over time originating interstate access charges, along with a proposal to adopt similar reforms applicable to terminating interstate access charges. We do not anticipate that the adopted changes, for which implementation began in 2012, will have a material impact, except that the reduction of interstate access rates generally will result in a cost savings on access charges to us. However, the details of implementation in general and between different classes of technology continue to be addressed, and they could affect the economics of some aspects of our business. We cannot predict at this time the impact of this implementation or future implementation of adopted reforms, but we do not expect it to have a material impact on our operations.
Carriers also pay fees for switched wholesale transport services in and out of Alaska. The rates for such services offered by and to any provider were governed by a federal law that was effective through December 31, 2009. The expiration of the applicable federal law has resulted in a decrease in the rates for services, resulting in a reduction of revenues, which may continue over time.
Access to Unbundled Network Elements. The ability to obtain UNEs is an important element of our local access services business. We cannot predict the extent to which existing FCC rules governing access to and pricing for UNEs will be sustained in the face of additional legal action and the impact of any further rules that are yet to be determined by the FCC. Moreover, the future regulatory classification of services that are transmitted over facilities may impact the extent to which we will be permitted access to such facilities. Changes to the applicable regulations could result in a change in our cost of serving new and existing markets.
Recurring and non-recurring charges for UNE loops and other UNEs may increase based on the rates adopted in RCA proceedings to establish new Interconnection Agreements or renew existing agreements. These increases could have an adverse effect on our financial position, results of operations or liquidity.
Local Regulation. We may be required to obtain local permits for street opening and construction permits to install and expand our networks. Local zoning authorities often regulate our use of towers for microwave and other communications sites. We also are subject to general regulations concerning building codes and local licensing. The 1996 Telecom Act requires that fees charged to communications carriers be applied in a competitively neutral manner, but there can be no assurance that ILECs and others with whom we will be competing will bear costs similar to those we will bear in this regard.
Regulatory Regime Applicable to IP-based Networks. In recent months, AT&T and the National Telecommunications Cooperative Association have petitioned the FCC to consider revisions to the regulatory regime governing interconnection and other policies related to the transition of networks from TDM-based to IP-based technologies. These proceedings are in early stages, and we cannot predict any resulting proceedings or their effect on us; however, a change in regulatory obligation or classification that interfered with our ability to exchange traffic with other providers, that raised the cost of doing so, or that adversely affected eligibility for USF support could materially affect our net cost of and revenue from providing local services.
Rural Health Care Program. On December 12, 2012, the FCC created the Healthcare Connect Fund to supplement the existing Rural Health Care Program of the USF. Healthcare providers can choose to participate under either the existing Rural Health Care Program or the new Healthcare Connect Fund. We cannot predict at this time the impact of this change but we do not expect it to have a material impact on our operations.
Other
Conflict Minerals. Recently, the SEC adopted new rules pursuant to Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act setting forth new disclosure requirements concerning the use of certain minerals that are mined from the Democratic Republic of Congo and adjoining countries. These new disclosure requirements begin in May 2014. We are still completing our review of the requirements as they pertain to us but do not believe complying with these disclosure requirements will have a material effect on our financial position, results of operations or liquidity.
Financial Information about our Foreign and Domestic Operations and Export Sales
Although we have several agreements to originate and terminate international toll traffic, we do not have foreign operations or export sales. We conduct our operations throughout the western contiguous United States and Alaska and believe that any subdivision of our operations into distinct geographic areas would not be meaningful.
Company-Sponsored Research
We have not expended material amounts during the last three fiscal years on company-sponsored research activities.
Geographic Concentration and the Alaska Economy
The national economy continues to see persistent unemployment and slow economic growth and even once stabilized is not expected to return quickly to a period of strong growth. Should the national economy deteriorate further, it could lead to reductions in consumer spending which could impact our revenue growth. However, we offer wireless, data and voice telecommunication services and video services to customers primarily throughout Alaska. Because of this geographic concentration, growth of our business and operations depends upon economic conditions in Alaska, and we believe the Alaska economy continues to perform well compared to most other states at the current time. The economy of Alaska is dependent upon the natural resource industries, and in particular oil production, as well as government spending, investment earnings and tourism. The government spending is comprised of state government and United States military spending. Any deterioration in these markets could have an adverse impact on us.
State Government Spending
A significant part of the Alaska economy is the state government. All of the State’s federal funding and the majority of investment revenues are dedicated for specific purposes, leaving oil revenues as the primary source of general operating revenues for the State of Alaska. The State of Alaska reported in fiscal 2012 that oil revenues supplied 93% of the State's unrestricted revenues. In fiscal 2013 state economists forecast that Alaska’s oil revenues will supply 92% of the State’s projected unrestricted revenues.
The volume of oil transported by the TransAlaska Oil Pipeline System over its life to date has been as high as 2.011 million barrels per day in fiscal 1988. Production has been declining over the last several years with an average of 579,000 barrels produced per day in fiscal 2012. The State forecasts the production rate to decline from 553,000 barrels produced per day in fiscal 2013 to 339,000 barrels produced per day in fiscal 2022.
Market prices for North Slope oil averaged $112.65 in fiscal 2012 and are forecasted to average $108.67 in fiscal 2013. The closing price per barrel was $106.93 on March 1, 2013. To the extent that actual oil prices vary materially from the State’s projected prices, the State’s projected revenues and deficits will change.
Should new oil discoveries or developments not materialize or the price of oil become depressed, the long term trend of continued decline in oil production from the Prudhoe Bay area is inevitable with a corresponding adverse impact on the economy of the State, in general, and on demand for telecommunications and video services, and, therefore, on us, in particular. During 2012 Royal Dutch Shell plc secured all the required permits to begin drilling for oil in the Chukchi Sea but announced in early 2013 that they would delay exploration until 2014. Periodically there are renewed efforts to allow exploration and development in the Arctic National Wildlife Refuge (“ANWR”). The United States Energy Information Agency has estimated that it could take nine years to begin oil field drilling after approval of ANWR exploration.
No assurance can be given that the driving forces in the Alaska economy, and in particular, oil production, will continue at appropriate levels to provide an environment for expanded economic activity. The Governor of the State of Alaska and the Alaska Legislature continue to evaluate the State’s oil tax structure which may also affect the oil production industry in Alaska.
No assurance can be given that oil companies doing business in Alaska will be successful in discovering new fields or further developing existing fields which are economic to develop and produce oil with access to the pipeline or other means of transport to market. We are not able to predict the effect of changes in the price and production volumes of North Slope oil on Alaska’s economy or on us.
Deployment of a natural gas pipeline from the State of Alaska’s North Slope to the lower 48 states has been proposed to supplement natural gas supplies. Companies that have been studying the economic viability of a natural gas pipeline, which depends upon the price of and demand for natural gas, have not been able to secure adequate shipping bids to date. Production of natural gas supplies, whether through a pipeline or other means, continues to be studied by government regulators and the involved parties.
The State of Alaska maintains the Constitutional Budget Reserve Fund (“CBRF”) that is intended to fund budgetary shortfalls. If the State’s current projections are realized and no surpluses are deposited into the CBRF it is projected that the fund would not be depleted before 2021. The date the CBRF is depleted is highly influenced by the price of oil. If the fund is depleted, aggressive state action will be necessary to increase revenues and reduce spending in order to balance the budget. The Governor of the State of Alaska and the Alaska Legislature continue to evaluate cost cutting and revenue enhancing measures.
We have, since our entry into the telecommunication marketplace, aggressively marketed our services to seek a larger share of the available market. The customer base in Alaska is limited, however, with a population of approximately 732,000 people. The State of Alaska’s population is distributed as follows:
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41% are located in the Municipality of Anchorage,
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14% are located in the Fairbanks North Star Borough,
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13% are located in the Matanuska-Susitna Borough,
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8% are located in the Kenai Peninsula Borough,
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4% are located in the City and Borough of Juneau, and
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The remaining 20% are located in other communities across the State of Alaska.
United States Military Spending
In August 2011, Congress enacted the Budget Control Act which committed the United States government to significantly reducing the federal deficit over ten years, including substantial automatic spending cuts, known as "sequestration," split between defense and non-defense programs. These spending cuts went into effect beginning March 1, 2013. We are not able to predict the effect that sequestration or any form of spending cuts will have on Alaska’s economy or on us.
Employees
We employed 1,734 persons as of December 31, 2012, and we are not subject to any collective bargaining agreements with our employees. We believe our future success will depend upon our continued ability to attract and retain highly skilled and qualified employees. We believe that relations with our employees are satisfactory.
Other
No material portion of our business is subject to renegotiation of profits or termination of contracts at the election of the federal government.
Item 1A.
Item 1A. Risk Factors.
Factors That May Affect Our Business and Future Results
Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business operations. Any of the following risks could materially and adversely affect our business, financial position, results of operations or liquidity.
We face competition that may reduce our market share and harm our financial performance.
There is substantial competition in the telecommunications and entertainment industries. Through mergers and various service integration strategies, major providers are striving to provide integrated communications services offerings within and across geographic markets. We face increasing wireless services competition from the expected entrance of Verizon into the Alaska market and increasing video services competition from DBS providers.
We expect competition to increase as a result of the rapid development of new technologies, services and products. 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 ability to anticipate and respond to various competitive factors affecting the industry, including new services that may be introduced, changes in consumer preferences, economic conditions and pricing strategies by competitors. To the extent we do not keep pace with technological advances or fail to timely respond to changes in competitive factors in our industry and in our markets, we could lose market share or experience a decline in our revenue and net income. Competitive conditions create a risk of market share loss and the risk that customers shift to less profitable lower margin services. Competitive pressures also create challenges for our ability to grow new businesses or introduce new services successfully and execute our business plan. Most of our business segments also face the risk of potential price cuts by our competitors that could materially adversely affect our market share and gross margins.
For more information about competition by segment, see the sections titled “Competition” included in “Item 1 - Business - Narrative Description of our Business - Description of our Business by Reportable Segment.”
If we experience low or negative rates of subscriber acquisition or high rates of turnover, our financial performance will be impaired.
We are in the business of selling communications and entertainment services to subscribers, and our economic success is based on our ability to retain current subscribers and attract new subscribers. If we are unable to retain and attract subscribers, our financial performance will be impaired. Our rates of subscriber acquisition and turnover are affected by a number of competitive factors including the size of our service areas, network performance and reliability issues, our device and service offerings, subscribers’ perceptions of our services, and customer care quality. Managing these factors and subscribers’ expectations is essential in attracting and retaining subscribers. Although we have implemented programs to attract new subscribers and address subscriber turnover, we cannot assure you that these programs or our strategies to address subscriber acquisition and turnover will be successful. A high rate of turnover or low or negative rate of new subscriber acquisition would reduce revenues and increase the total marketing expenditures required to attract the minimum number of subscribers required to sustain our business plan which, in turn, could have a material adverse effect on our business, financial condition and results of operations.
We may be unable to obtain or maintain the roaming services we need from other carriers to remain competitive.
AT&T Wireless and Verizon, who is expected to be a competitor starting in 2013, have national networks which enable them to offer automatic roaming services to their subscribers at a lower cost than we can offer. The networks we operate do not, by themselves, provide national coverage and we must pay fees to other carriers who provide roaming services to us. We currently rely on roaming agreements with several carriers for the majority of our roaming services. We believe that the rates charged to us by some of these carriers are higher than the rates they charge to certain other roaming partners. We do not currently have LTE data agreements with any carriers that are currently providing these services.
The FCC has adopted rules requiring commercial mobile radio service providers to provide automatic roaming, upon request, for voice and SMS text messaging services on just, reasonable and non-discriminatory terms. The FCC has also adopted rules generally requiring carriers to offer data roaming services. The United States Court of Appeals for the District of Columbia Circuit recently upheld the FCC’s data roaming order from a challenge by Verizon Wireless. These orders, however, do not provide or mandate any specific mechanism for determining the reasonableness of roaming rates for voice, SMS text messaging or data services and require that roaming complaints be resolved on a case-by-case basis, based on a non-exclusive list of factors that can be taken into account in determining the reasonableness of particular conduct or rates. If we were unexpectedly to lose the benefit of one or more key roaming or wholesale agreements, we may be unable to obtain similar replacement agreements and as a result may be unable to continue providing nationwide voice and data roaming services for our customers or may be unable to provide such services on a cost-effective basis. Our inability to obtain new or replacement roaming services on a cost-effective basis may limit our ability to compete effectively for wireless customers, which may increase our turnover and decrease our revenues, which in turn could materially adversely affect our business, financial condition and results of operations.
We may be unable to complete our pending transactions or if completed we may not be able to successfully manage the new operations.
The formation, with ACS, of AWN is crucial to our strategy to remain competitive in wireless services against the national wireless carriers. We anticipate being granted approval by the FCC and having the ability to close on the transactions contemplated in the Wireless Agreement by the end of the second quarter of 2013. A delay or failure to gain FCC approval or the occurrence of any other event delaying or causing a failure to complete the AWN transaction may cause us to incur additional and unforeseen expenses and may have an adverse effect on our business, financial condition, or results of operations.
If we complete the AWN transaction we may not be able to successfully integrate the network facilities or recognize the expected synergies which may cause interruptions of or loss of momentum in our business and financial performance. The diversion of management’s attention and any delays or difficulties encountered in connection with this transaction may have an adverse effect on our business, financial condition, or results of operations. We may also incur additional and unforeseen expenses in connection with the integration efforts. There can be no assurance that the expense savings and synergies that we anticipate from the transaction will be realized fully or will be realized within the expected timeframe.
If we complete the Denali Media transaction we may not be able to successfully manage the broadcast stations or recognize the expected synergies with our video services business which may cause interruptions of or loss of momentum in our business and financial performance. The diversion of management’s attention and any delays or difficulties encountered in connection with this transaction may have an adverse effect on our business, financial condition, or results of operations. We may also incur additional and unforeseen expenses in connection with the management efforts. There can be no assurance that the expense savings and synergies that we anticipate from the transaction will be realized fully or will be realized within the expected timeframe.
Our business is subject to extensive governmental legislation and regulation. Applicable legislation and regulations and changes to them could adversely affect our business, financial position, results of operations or liquidity.
Wireless Services. The licensing, construction, operation, sale and interconnection arrangements of wireless communications systems are regulated by the FCC and, depending on the jurisdiction, state and local regulatory agencies. In particular, the FCC imposes significant regulation on licensees of wireless spectrum with respect to:
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How radio spectrum is used by licensees;
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The nature of the services that licensees may offer and how such services may be offered; and
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Resolution of issues of interference between spectrum bands.
The Communications Act of 1934, as amended, preempts state and local regulation of market entry by, and the rates charged by, commercial mobile radio service providers, except that states may exercise authority over such things as certain billing practices and consumer-related issues. These regulations could increase the costs of our wireless operations. The FCC grants wireless licenses for terms of generally ten years that are subject to renewal and revocation. FCC rules require all wireless licensees to meet certain build-out requirements and substantially comply with applicable FCC rules and policies and the Communications Act of 1934, as amended, in order to retain their licenses. Failure to comply with FCC requirements in a given license area could result in revocation of the license for that license area. There is no guarantee that our licenses will be renewed.
The FCC has initiated a number of proceedings to evaluate its rules and policies regarding spectrum licensing and usage. Changes proposed by the FCC could adversely impact our utilization of our licensed spectrum and our operation costs.
Commercial mobile radio service providers must implement E911 capabilities in accordance with FCC rules. Failure to deploy E911 service consistent with FCC requirements could subject us to significant fines.
The FCC, together with the Federal Aviation Administration, also regulates tower marking and lighting. In addition, tower construction is affected by federal, state and local statutes addressing zoning, environmental protection and historic preservation. The FCC adopted significant changes to its rules governing historic preservation review of projects, which makes it more difficult and expensive to deploy antenna facilities. The FCC has adopted rule changes that require local notice in any community in which it is seeking FCC Antenna Structure Registration to build a tower. Local notice provides members of the community with an opportunity to comment on or challenge the tower construction for environmental or other reasons. This rule change could cause delay for certain tower construction projects.
Internet Services. Proposals may be made before Congress and the FCC to mandate cable operators provide “open access” over their cable systems to Internet service providers. As of the date of this report, the FCC has declined to impose such requirements. If the FCC or other authorities mandate additional access to our cable systems, we cannot predict the effect that this would have on our Internet service offerings.
Changes in the regulatory environment relating to the Internet access market, including changes in legislation, FCC regulation, judicial action or local regulation that affect communications costs or increase competition from the ILEC or other communications services providers, could adversely affect the prices at which we sell Internet services.
Video Services. The cable television industry is subject to extensive regulation at various levels, and many aspects of such regulation are currently the subject of judicial proceedings and administrative or legislative proposals. The law permits certified local franchising authorities to order refunds of rates paid in the previous 12-month period determined to be in excess of the reasonable rates. It is possible that rate reductions or refunds of previously collected fees may be required of us in the future. Currently, pursuant to Alaska law, the basic video rates in Juneau are the only rates in Alaska subject to regulation by the local franchising authority; the rates in Juneau were reviewed and approved by the RCA in July 2010.
Other existing federal regulations, currently the subject of judicial, legislative, and administrative review, could change, in varying degrees, the manner in which video systems operate. Neither the outcome of these proceedings nor their impact upon the cable television industry in general, or on our activities and prospects in the cable television business in particular, can be predicted at this time. There can be no assurance that future regulatory actions taken by Congress, the FCC or other federal, state or local government authorities will not have a material adverse effect on our business, financial position, results of operations or liquidity.
Local Access Services. Our success in the local telephone market depends on our continued ability to obtain interconnection, access and related services from local exchange carriers on terms that are reasonable and that are based on the cost of providing these services. Our local telephone services business faces the risk of unfavorable changes in regulation or legislation or the introduction of new regulations. Our ability to provide service in the local telephone market depends on our negotiation or arbitration with local exchange carriers to allow interconnection to the carrier’s existing local telephone network, to establish dialing parity, to obtain access to rights-of-way, to resell services offered by the local exchange carrier, and in some cases, to allow the purchase, at cost-based rates, of access to UNEs. In some Alaska markets, it also depends on our ability to gain interconnection at economic costs. Future negotiations or arbitration proceedings with respect to new or existing markets could result in a change in our cost of serving these markets via the facilities of the ILEC or via wholesale offerings.
For more information about Regulations affecting our operations, see “Competition” contained in “Item 1 - Business - Regulation.”
Loss of our ETC status would disqualify us for USF support.
The USF pays support to ETCs to support the provision of facilities-based wireline and wireless telephone service in high cost areas. If we were to lose our ETC status in any of the study areas where we are currently an authorized ETC, we would be ineligible to receive USF support for providing service in that area. Loss of our ETC status could have an adverse effect on our business, financial position, results of operations or liquidity.
Revenues and accounts receivable from USF support may be reduced or lost.
We receive support from each of the various USF programs: high cost, low income, rural health care, and schools and libraries. This support was 19%, 19%, and 18% of our revenue for the years ended December 31, 2012, 2011 and 2010, respectively. We had USF net receivables of $70.1 million and $69.8 million at December 31, 2012 and 2011, respectively. The programs are subject to change by regulatory actions taken by the FCC or legislative actions. For example, on November 29, 2011, the FCC published a final rule to reform the methodology for distributing USF high cost support for voice and broadband services, as well as to the access charge regime for terminating traffic between carriers. As described further in “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” the reform changes reduced our current and future high cost support revenue. Changes to any of the USF programs that we participate in could result in a material decrease in revenue and accounts receivable, which could have an adverse effect on our business, financial position, results of operations or liquidity.
See “Description of Our Business by Reportable Segment - Regulation - Wireless Services and Products - Universal Service” and “Description of Our Business by Reportable Segment - Regulation - Wireline Voice Services and Products - Universal Service” for more information.
Programming expenses for our video services are increasing, which could adversely affect our business.
We expect programming expenses for our video services to continue to increase in the foreseeable future. The multichannel video provider industry has continued to experience an increase in the cost of programming, especially sports programming. In addition, as we add programming to our video services or if we choose to distribute existing programming to our customers through additional delivery platforms, we may incur increased programming expenses. We are not making payments on a per subscriber basis to local broadcast television stations in exchange for their required consent for the retransmission of broadcast network programming to our video services customers but there can be no assurance that we will continue to avoid such payment. We expect to continue to be subject to demands for payment and other concessions from local broadcast television stations. If we are unable to raise our customers’ rates or offset such programming cost increases through the sale of additional services, the increasing cost of programming could have an adverse impact on our business, financial condition, or results of operations. Moreover, as our contracts with content providers expire, there can be no assurance that they will be renewed on acceptable terms or that they will be renewed at all, in which case we may be unable to provide such content as part of our video services and our business could be adversely affected.
The decline in our Consumer, Network Access and Commercial voice services’ results of operations, which include long-distance and local access services, may accelerate.
We expect our Consumer, Network Access and Commercial voice services’ results of operations, which include long-distance and local access services, will continue to decline. As competition from wireless carriers, such as ourselves, increases we expect our local access services and long-distance subscribers will continue to decline and possibly accelerate. Additionally, we do not expect to increase the rates charged to our remaining subscribers resulting in decreasing results of operations. We expect to continue to strategically use certain marketing and bundling strategies to slow the decline but we do not expect these strategies will significantly impact or stop the decline.
We may not be able to satisfy the requirements of our participation in a New Markets Tax Credit program for funding our TERRA-NW project.
As of December 31, 2012, we have entered into three separate arrangements under the NMTC program with US Bancorp to help fund various phases of our TERRA-NW project. In connection with the NMTC transactions we received proceeds which are restricted for use on TERRA-NW. The NMTCs are subject to 100% recapture of the tax credit for a period of seven years as provided in the Internal Revenue Code. We are required to be in compliance with various regulations and contractual provisions that apply to the NMTC arrangements. We have agreed to indemnify US Bancorp for any loss or recapture of its $56.0 million in NMTCs until such time as our obligation to deliver tax benefits is relieved. Non-compliance with applicable requirements could result in projected tax benefits not being realized by US Bancorp and could have an adverse effect on our financial position, results of operations or liquidity.
Failure to complete development, testing and deployment of a new technology that supports new services could affect our ability to compete in the industry. In addition, the technology we use may place us at a competitive disadvantage.
We develop, test and deploy various new technologies and support systems intended to enhance our competitiveness by both supporting new services and features and reducing the costs associated with providing those services or features. Successful development and implementation of technology upgrades depend, in part, on the willingness of third parties to develop new applications in a timely manner. We may not successfully complete the development and rollout of new technology and related features or services in a timely manner, and they may not be widely accepted by our customers or may not be profitable, in which case we could not recover our investment in the technology. Deployment of technology supporting new service offerings may also adversely affect the performance or reliability of our networks with respect to both the new and existing services. Any resulting customer dissatisfaction could affect our ability to retain customers and may have an adverse effect on our financial position, results of operations, or liquidity. In addition to introducing new technologies and offerings, we must phase out outdated and unprofitable technologies and services. If we are unable to do so on a cost-effective basis, we could experience reduced profits.
Unfavorable general economic conditions in the United States could have a material adverse effect on our financial position, results of operations and liquidity.
Unfavorable general economic conditions, including the current continued economic slowdown in the United States, could negatively affect our business. While it is often difficult for us to predict the impact of general economic conditions on our business, these conditions could adversely affect the affordability of and demand for some of our products and services and could cause customers to shift to lower priced products and services or to delay or forgo purchases of our products and services. One or more of these circumstances could cause our revenue to decline. Also, our customers may not be able to obtain adequate access to credit, which could affect their ability to make timely payments to us. If that were to occur, we could be required to increase our allowance for doubtful accounts, and the number of days outstanding for our accounts receivable could increase. The government has taken various measures in an attempt to help improve the economy, however, we are unable to predict the success or outcome of such programs. For these reasons, among others, if the current economic conditions persist or decline, this could adversely affect our financial position, results of operations, or liquidity, as well as our ability to service debt, pay other obligations and enhance shareholder returns.
Our business is geographically concentrated in Alaska. Any deterioration in the economic conditions in Alaska could have a material adverse effect on our financial position, results of operations and liquidity.
We offer voice, data and wireless communication and video services to customers primarily in Alaska. Because of this geographic concentration, our growth and operations depend upon economic conditions in Alaska. The economy of Alaska is dependent upon natural resource industries, in particular oil production, as well as tourism, and government spending, including substantial amounts for the United States military. Any deterioration in these markets or the occurrence of a single disruptive event, such as a shut-down of the TransAlaska Pipeline System, could have an adverse impact on the demand for communication and video services and on our results of operations and financial condition. In addition, the customer base in Alaska is limited. Alaska has a population of approximately 732,000 people, 54% of whom are located in the Anchorage and Matanuska-Susitna Borough region. We have already achieved significant market penetration with respect to our service offerings in Anchorage and in other locations in Alaska.
We may not be able to continue to increase our market share of the existing markets for our services, and no assurance can be given that the Alaskan economy will continue to grow and increase the size of the markets we serve or increase the demand for the services we offer. As a result, the best opportunities for expanding our business may arise in other geographic areas such as the lower 49 states. There can be no assurance that we will find attractive opportunities to grow our businesses outside of Alaska or that we will have the necessary expertise to take advantage of such opportunities. The markets in Alaska for voice, data and wireless communications and video services are unique and distinct within the United States due to Alaska’s large geographical size, its sparse population located in a limited number of clusters, and its distance from the rest of the United States. The expertise we have developed in operating our businesses in Alaska may not provide us with the necessary expertise to successfully enter other geographic markets.
See the section “Item 1 - Business - Geographic Concentration and the Alaska Economy” for more information.
Natural disasters, terrorist attacks or breaches of network or information technology security could have an adverse effect on our business.
Our technical infrastructure (including our communications network infrastructure and ancillary functions supporting our network such as service activation, billing and customer care) is vulnerable to damage or interruption from technology failures, power surges or outages, natural disasters, fires, human error, terrorism, intentional wrongdoing or similar events. Unanticipated problems at our facilities or with our technical infrastructure, system or equipment failures, hardware or software failures or defects, computer viruses or hacker attacks could affect the quality of our services and cause network service interruptions. Unauthorized access to or use of customer or account information, including credit card or other personal data, could result in harm to our customers and legal actions against us, and could damage our reputation. In addition, earthquakes, floods, fires and other unforeseen natural disasters or events could materially disrupt our business operations or our provision of service in one or more markets. Costs we incur to restore, repair or replace our network or technical infrastructure, as well as costs associated with detecting, monitoring or reducing the incidence of unauthorized use, may be substantial and increase our cost of providing service. Any failure in or interruption of systems that we or third parties maintain to support ancillary functions, such as billing, point of sale, inventory management, customer care and financial reporting, could materially impact our ability to timely and accurately record, process and report information important to our business. If any of the above events were to occur, we could experience higher churn, reduced revenues and increased costs, any of which could harm our reputation and have a material adverse effect on our business, financial condition or results of operations.
Prolonged service interruptions could affect our business.
We rely heavily on our network equipment, communications providers, data and software to support all of our functions. We rely on our networks and the networks of others for substantially all of our revenues. We are able to deliver services only to the extent that we can protect our network systems against damage from power or communication failures, computer viruses, natural disasters, unauthorized access and other disruptions. While we endeavor to provide for failures in the network by providing back-up systems and procedures, we cannot guarantee that these back-up systems and procedures will operate satisfactorily in an emergency. Should we experience a prolonged failure, it could seriously jeopardize our ability to continue operations. In particular, should a significant service interruption occur, our ongoing customers may choose a different provider, and our reputation may be damaged, reducing our attractiveness to new customers.
If failures occur in our undersea fiber optic cable systems or our TERRA-SW facility and its extensions, our ability to immediately restore the entirety of our service may be limited and we could incur significant costs, which could lead to a material adverse effect on our business, financial position, results of operations or liquidity.
Our communications facilities include undersea fiber optic cable systems that carry a large portion of our traffic to and from the contiguous lower 48 states one of which provides an alternative geographically diverse backup communication facility to the other. Our facilities also include TERRA-SW and its extensions which are an unringed facility operating in a remote environment and are at times difficult to access for repairs. If a failure of both sides of the ring of our undersea fiber optic facilities or of our unringed TERRA-SW facility and its extensions occurs and we are not able to secure alternative facilities, some of the communications services we offer to our customers could be interrupted which could have a material adverse effect on our business, financial position, results of operations or liquidity. Damage to an undersea fiber optic cable system or TERRA-SW and its extensions could result in significant unplanned expense which could have a material adverse effect on our business, financial position, results of operations or liquidity.
If a failure occurs in our satellite communications systems, our ability to immediately restore the entirety of our service may be limited.
Our communications facilities include satellite transponders that we use to serve many rural and remote Alaska locations. Each of our C-band and Ku-band satellite transponders is backed up using on-board transponder redundancy. In the event of a complete spacecraft failure the services are restored using capacity on other spacecraft that are held in reserve. If a failure of our satellite transponders occurs and we are not able to secure alternative facilities, some of the communications services we offer to our customers could be interrupted which could have a material adverse effect on our business, financial position, results of operations or liquidity.
We depend on a limited number of third-party vendors to supply communications equipment. If we do not obtain the necessary communications equipment, we will not be able to meet the needs of our customers.
We depend on a limited number of third-party vendors to supply wireless, Internet, video and other telephony-related equipment. If our providers of this equipment are unable to timely supply the equipment necessary to meet our needs or provide them at an acceptable cost, we may not be able to satisfy demand for our services and competitors may fulfill this demand. Due to the unique characteristics of the Alaska communications markets (i.e., remote locations, rural, satellite-served, low density populations, and our leading edge services and products), in many situations we deploy and utilize specialized, advanced technology and equipment that may not have a large market or demand. Our vendors may not succeed in developing sufficient market penetration to sustain continuing production and may fail. Vendor bankruptcy, or acquisition without continuing product support by the acquiring company, may require us to replace technology before its otherwise useful end of life due to lack of on-going vendor support and product development.
The suppliers and vendors on which we rely may also be subject to litigation with respect to technology on which we depend, including litigation involving claims of patent infringement. Such claims have been growing rapidly in the communications industry. We are unable to predict whether our business will be affected by any such litigation. We expect our dependence on key suppliers to continue as they develop and introduce more advanced generations of technology.
We do not have insurance to cover certain risks to which we are subject, which could lead to the incurrence of uninsured liabilities that adversely affect our financial position, results of operations or liquidity.
As is typical in the communications industry, we are self-insured for damage or loss to certain of our transmission facilities, including our buried, undersea and above-ground fiber optic cable systems. If we become subject to substantial uninsured liabilities due to damage or loss to such facilities, our financial position, results of operations or liquidity may be adversely affected.
Our significant debt and capital lease obligations could adversely affect our business and prevent us from fulfilling our obligations under our Senior Notes, Senior Credit Facility, other debt or capital leases.
We have and will continue to have a significant amount of debt and capital lease obligations. On December 31, 2012, we had total debt of $877.1 million and total capital lease obligations of $80.6 million. We expect to fund our $100.0 million purchase of certain wireless assets from ACS and the $50.0 million working capital line of credit to AWN according to the Wireless Agreement by increasing our total debt. Our high level of debt and capital lease obligations could have important consequences, including the following:
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Use of a large portion of our cash flow to pay principal and interest on our Senior Notes, Senior Credit Facility, other debt and capital leases, which will reduce the availability of our cash flow to fund working capital, capital expenditures and other business activities;
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Increase our vulnerability to general adverse economic and industry conditions;
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Limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
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Restrict us from making strategic acquisitions or exploiting business opportunities;
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Make it more difficult for us to satisfy our obligations with respect to the Senior Notes, Senior Credit Facility, other debt and capital lease obligations;
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Place us at a competitive disadvantage compared to our competitors that have less debt and capital lease obligations; and
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Limit, along with the financial and other restrictive covenants in our debt, among other things, our ability to borrow additional funds, dispose of assets or pay cash dividends on GCI’s common stock.
We will require a significant amount of cash to service our debt and to meet other obligations. Our ability to generate cash depends on many factors beyond our control. If we are unable to meet our future capital needs it may be necessary for us to curtail, delay or abandon our business growth plans. If we incur significant additional indebtedness to fund our plans, it could cause a decline in our credit rating and could increase our borrowing costs or limit our ability to raise additional capital.
We will continue to require a significant amount of cash to satisfy our debt service requirements and to meet other obligations. Our ability to make payments on and to refinance our debt and to fund planned capital expenditures and acquisitions will depend on our ability to generate cash and to arrange additional financing in the future. These abilities are subject to, among other factors, our credit rating, our financial performance, general economic conditions, prevailing market conditions, the state of competition in our market, the outcome of certain legislative and regulatory issues and other factors that may be beyond our control. Our business may not generate sufficient cash flow from operations and future borrowings may not be available to us in an amount sufficient to enable us to pay our debt or to fund our other liquidity needs. We may need to refinance all or a portion of our debt on or before maturity. We may not be able to refinance any of our debt on commercially reasonable terms or at all.
We may be unable to obtain additional financing as needed to close our AWN transaction.
We expect to fund our $100.0 million purchase of certain wireless assets from ACS and the $50.0 million working capital line of credit to AWN according to the Wireless Agreement by increasing our total debt. It is difficult to predict future debt market conditions and whether we will be able to obtain additional financing on terms acceptable to us or at all. Depending upon market conditions, any additional financing we might seek could be with rates and terms significantly less favorable than those contained in our outstanding debt instruments. Other factors, such as a rating downgrade, could further impact our potential access to financing sources. The failure to raise sufficient funds on reasonable terms could cause us to not close our AWN Transaction which could have an adverse effect on our business, financial condition, or results of operations.
The terms of our debt impose restrictions on us that may affect our ability to successfully operate our business and our ability to make payments on the Senior Notes.
The indentures governing our Senior Notes and/or the credit agreements governing our Senior Credit Facility and other loans contain various covenants that could materially and adversely affect our ability to finance our future operations or capital needs and to engage in other business activities that may be in our best interest.
All of these covenants may restrict our ability to expand or to pursue our business strategies. Our ability to comply with these covenants may be affected by events beyond our control, such as prevailing economic conditions and changes in regulations, and if such events occur, we cannot be sure that we will be able to comply. A breach of these covenants could result in a default under the indentures governing our Senior Notes and/or the Senior Credit Facility. If there were an event of default under the indentures for the Senior Notes and/or the Senior Credit Facility, holders of such defaulted debt could cause all amounts borrowed under these instruments to be due and payable immediately. Additionally, if we fail to repay the debt under the Senior Credit Facility when it becomes due, the lenders under the Senior Credit Facility could proceed against certain of our assets and capital stock of our subsidiaries that we have pledged to them as security. Our assets or cash flow may not be sufficient to repay borrowings under our outstanding debt instruments in the event of a default thereunder.
Any significant impairment of our indefinite-lived intangible assets would lead to a decrease in our assets and a reduction in our net operating performance.
We had $294.9 million of indefinite-lived intangible assets at December 31, 2012, consisting of cable certificates of $191.6 million, goodwill of $77.3 million and wireless licenses of $26.0 million. Our cable certificates are our largest indefinite-lived intangible asset and represent agreements with government entities to construct and operate a video business. Our wireless licenses are from the FCC and give us the right to provide wireless service within a certain geographical area. Goodwill represents the excess of cost over fair value of net assets acquired in connection with a business acquisition.
If we make changes in our business strategy or if market or other conditions adversely affect our operations, we may be forced to record an impairment charge, which would lead to a decrease in our assets and a reduction in our net operating performance. Our indefinite-lived intangible assets are tested annually for impairment during the fourth quarter and at any time upon the occurrence of certain events or substantive changes in circumstances that indicate the assets might be impaired. If the testing performed indicates that impairment has occurred, we are required to record an impairment charge for the difference between the carrying value of the goodwill and/or the indefinite-lived intangible assets, as appropriate, and the fair value of the goodwill and/or indefinite-lived intangible assets, in the period in which the determination is made. The testing of goodwill and indefinite-lived intangible assets for impairment requires us to make significant estimates about our future performance and cash flows, as well as other assumptions. These estimates can be affected by numerous factors, including changes in economic, industry or market conditions, changes in underlying business operations, future operating performance, changes in competition, or changes in technologies. Any changes to key assumptions, or actual performance compared with those assumptions, about our business and its future prospects or other assumptions could affect the fair value, resulting in an impairment charge.
Our ability to use net operating loss carryforwards to reduce future tax payments could be negatively impacted if there is an “ownership change” as defined under Section 382 of the Internal Revenue Code.
At December 31, 2012, we have tax net operating loss carryforwards of $293.3 million for U.S. federal income tax purposes and, under the Internal Revenue Code, we may carry forward these net operating losses in certain circumstances to offset any current and future taxable income and thus reduce our federal income tax liability, subject to certain requirements and restrictions. If GCI experiences an “ownership change,” as defined in Section 382 of the Internal Revenue Code and related Treasury regulations at a time when its market capitalization is below a certain level, our ability to use the net operating loss carryforwards could be substantially limited. This limit could impact the timing of the usage of the net operating loss carryforwards, thus accelerating cash tax payments or causing net operating loss carryforwards to expire prior to their use, which could affect the ultimate realization of that deferred tax asset.
Concerns about health risks associated with wireless equipment may reduce the demand for our wireless services.
Portable communications devices have been alleged to pose health risks, including cancer, due to radio frequency emissions from these devices. Purported class actions and other lawsuits have been filed from time to time against other wireless companies seeking not only damages but also remedies that could increase the cost of doing business. We cannot be sure of the outcome of any such cases or that the industry will not be adversely affected by litigation of this nature or public perception about health risks. The actual or perceived risk of mobile communications devices could adversely affect us through a reduction in subscribers. Further research and studies are ongoing, with no linkage between health risks and mobile phone use established to date by a credible public source. However, we cannot be sure that additional studies will not demonstrate a link between radio frequency emissions and health concerns.
Additionally, new government regulations on the use of a wireless device while driving may affect us through a reduction in usage revenue. Studies have indicated that using wireless devices while driving may impair a driver’s attention. Many state and local legislative bodies, including Alaska’s, have passed legislation to restrict the use of wireless telephones while driving vehicles. In Alaska all drivers are banned from texting while driving. Concerns over safety and the effect of additional future legislation, if adopted and enforced in the areas we serve, could limit our ability to market and sell our wireless services. Litigation relating to accidents, deaths or serious bodily injuries allegedly incurred as a result of wireless telephone use while driving could result in adverse publicity and further governmental regulation. Any of these results could have a material adverse effect on our financial position, results of operations or liquidity.
A significant percentage of GCI’s voting securities are owned by a small number of shareholders and these shareholders can control shareholder decisions on very important matters.
As of December 31, 2012, our executive officers and directors and their affiliates owned 11% of GCI’s combined outstanding Class A and Class B common stock, representing 22% of the combined voting power of that stock. These shareholders can significantly influence, if not control, our management policy and all fundamental corporate actions, including mergers, substantial acquisitions and dispositions, and election of directors to GCI’s Board.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties
Our properties do not lend themselves to description by location of principal units. The majority of our properties are located in Alaska. It is not practicable to allocate our properties to our reportable segments since many of our properties are employed by more than one segment to provide common services and products. Additionally our properties are managed at the consolidated company level rather than at the segment level.
We lease our executive, corporate and administrative facilities and business offices. Our operating, executive, corporate and administrative properties are in good condition. We consider our properties suitable and adequate for our present needs and they are being fully utilized.
Our properties consist primarily of undersea and terrestrial fiber optic cable networks, switching equipment, satellite transponders and earth stations, microwave radio, cable and wire facilities, cable head-end equipment, wireless towers and equipment, coaxial distribution networks, connecting lines (aerial, underground and buried cable), routers, servers, transportation equipment, computer equipment, general office equipment, land, land improvements, landing stations and other buildings. Substantially all of our properties are located on or in leased real property or facilities. Substantially all of our properties secure our Senior Credit Facility. See note 6 included in “Part II - Item 8 - Consolidated Financial Statements and Supplementary Data” for more information.
Item 3.
Item 3. Legal Proceedings
We are involved in various lawsuits, billing disputes, legal proceedings, and regulatory matters that have arisen from time to time in the normal course of business. The range of possible losses from asserted and unasserted claims recorded and possibly recorded in the future do not have a material adverse effect on our financial position, results of operations or liquidity. In addition, in August 2010 a GCI-owned aircraft was involved in an accident resulting in five fatalities and injuries to the remaining four passengers on board. We had aircraft and liability insurance coverage in effect at the time of the accident. During 2012 final payments on all resolved claims were made with the exception of any potential claims for environmental remediation. All paid claims related to the accident have been resolved within insurance policy limits and were recorded net of these recoveries in our Consolidated Income Statements. We cannot predict the likelihood or nature of any potential claims for environmental remediation.
Item 4.
Item 4. Mine Safety Disclosures
Not Applicable.
Part II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information for Common Stock
All issued and outstanding shares of GCI, Inc's Class A common stock are held by GCI and are not publicly traded. GCI's Class A and Class B common stock are publicly traded.
Dividends
GCI and GCI, Inc. have never paid cash dividends on GCI’s common stock, and we have no present intention of doing so. Payment of cash dividends in the future, if any, will be determined by GCI’s Board of Directors in light of our earnings, financial condition and other relevant considerations. Our existing debt agreements contain provisions that limit payment of dividends on common stock, other than stock dividends (see note 6 included in “Part II - Item 8 - Consolidated Financial Statements and Supplementary Data” for more information).
Stock Transfer Agent and Registrar
Computershare is GCI’s stock transfer agent and registrar.
Item 6.
Item 6. Selected Financial Data
The following table presents selected historical information relating to financial condition and results of operations over the past five years.
The Selected Financial Data should be read in conjunction with “Part II - Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
In the following discussion, GCI, Inc. and its direct and indirect subsidiaries are referred to as “we,” “us” and “our.”
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to the allowance for doubtful receivables, unbilled revenues, accrual of the Universal Service Fund (“USF”) high cost Remote area program support, share-based compensation, inventory at lower of cost or market, reserve for future customer credits, liability for incurred but not reported medical insurance claims, valuation allowances for deferred income tax assets, depreciable and amortizable lives of assets, the carrying value of long-lived assets including goodwill, cable certificates and wireless licenses, our effective tax rate, purchase price allocations, deferred lease expense, asset retirement obligations, the accrual of cost of goods sold (exclusive of depreciation and amortization expense) ("Cost of Goods Sold"), depreciation, and accrual of contingencies and litigation. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. See also our “Cautionary Statement Regarding Forward-Looking Statements.”
GCI, Inc. was incorporated under the laws of the State of Alaska in 1997 to affect the issuance of Senior Notes. GCI, Inc., a wholly owned subsidiary of GCI, received through its initial capitalization all ownership interests in subsidiaries previously held by GCI. Shares of GCI’s Class A common stock are traded on the Nasdaq National Market tier of the Nasdaq Stock Market under the symbol of GNCMA. Shares of GCI’s Class B common stock are traded on the Over-the-Counter market. Shares of GCI, Inc.’s common stock are wholly owned by GCI and are not publicly traded. The GCI and GCI, Inc. consolidated financial statements include substantially the same account activity.
The following discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated financial statements and supplementary data as presented in Part IV of this Form 10-K.
General Overview
Through our focus on long-term results, acquisitions, and strategic capital investments, we strive to consistently grow our revenues and expand our margins. We have historically met our cash needs for operations, regular capital expenditures and maintenance capital expenditures through our cash flows from operating activities. Historically, cash requirements for significant acquisitions and major capital expenditures have been provided largely through our financing activities.
The national economy continues to see persistent unemployment and slow economic growth and even once stabilized is not expected to return quickly to a period of strong growth. Should the national economy deteriorate further, it could lead to reductions in consumer spending which could impact our revenue growth. As discussed earlier in “Item 1 - Business - Geographic Concentration and the Alaska Economy,” we believe the Alaska economy continues to perform well compared to most other states at the current time. The State of Alaska has large cash reserves that should enable it to maintain its budget for at least the short-term. This cash reserve is important for Alaska’s economy as the State is the largest employer and second largest source of gross state product. The majority of our revenue is driven by the strength of the Alaska economy which appears to have weathered the economic pressures relatively well to date. Nonetheless we cannot predict the impact the nation’s future economic situation may have on us in the future.
On June 4, 2012, we entered into an Asset Purchase and Contribution Agreement (“Wireless Agreement”) by and among Alaska Communications Systems Group, Inc. (“ACS”), GCI, ACS Wireless, Inc., a wholly owned subsidiary of ACS (“ACS Member”), GCI Wireless Holdings, LLC, a wholly owned subsidiary of GCI, and The Alaska Wireless Network, LLC (“AWN”), a wholly owned subsidiary of GCI, pursuant to which the parties have agreed to contribute the respective wireless network assets of GCI, ACS and their affiliates to AWN. We entered into this agreement to provide a robust, statewide network with the spectrum mix, scale, advanced technology and cost structure necessary to compete with Verizon Wireless (“Verizon”) and AT&T in Alaska. After the transaction closes AWN will provide wholesale services to GCI and ACS. GCI and ACS will use the AWN network in order to continue to sell services to their respective retail customers. GCI and ACS will continue to compete against each other and other wireless providers in the retail market.
Under the terms of the Wireless Agreement, we agreed to purchase certain wireless network assets from ACS and its affiliates for $100.0 million and we will contribute the purchased assets, our wireless network assets and certain rights to use capacity to AWN. ACS also agreed to contribute its remaining wireless network assets and certain rights to use capacity to AWN. Upon the contribution of assets to AWN, ACS Member will own one-third of AWN and we will own two-thirds of AWN. ACS Member will be entitled to receive preferential cash distributions totaling $190.0 million over the first four years of AWN’s operations and we will be entitled to all remaining cash distributions during that period. We anticipate that the $190.0 million preferential distributions to ACS will constitute approximately $80.0 million in distributions over the distributions otherwise attributable to their ownership percentage during such period. Following the initial four year period, we and ACS Member will receive distributions proportional to our ownership interests. We are evaluating the accounting treatment for this transaction.
The closing of the transactions is subject to the satisfaction of customary closing conditions, including the receipt of required governmental and third party consents and approvals and the expiration of any applicable waiting periods under competition laws. The waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 has expired without any objections. The transactions are expected to close by the second quarter of 2013.
As an eligible telecommunications carrier (“ETC”), we receive support from the USF to support the provision of wireline local access and wireless services in high cost areas. On November 29, 2011, the Federal Communications Commission (“FCC”) published a final rule to reform the methodology for distributing USF high cost support for voice and broadband services, as well as to the access charge regime for terminating traffic between carriers (“High Cost Order”). The High Cost Order defined Urban and Remote areas and divided support to Alaska between these two areas. Support for competitive eligible telecommunications carriers (“CETCs”) serving Urban areas that generally include Anchorage, Fairbanks, and Juneau will follow national reforms, had support per provider per service area capped as of January 1, 2012, and a five-step phase-down commenced on July 1, 2012. In addition to broader reforms, the FCC tailored revisions specifically for CETCs serving Remote Alaska, intended to address the unique challenges for serving these areas. Support to these locations will continue to be distributed on a per-line basis until the later of July 1, 2014, or the implementation of a successor funding mechanism. A further rulemaking to consider successor funding mechanisms is underway. We cannot predict at this time the outcome of this proceeding or its effect on Remote high cost support available to us, but our revenue for providing local access and wireless services in these areas would be materially adversely affected by a substantial reduction of USF support.
The High Cost Order Remote and Urban program changes primarily impacted our Consumer segment. The High Cost Order Remote and Urban program changes resulted in decreased Consumer segment voice revenue of approximately $1.6 million and decreased Consumer segment wireless revenue of approximately $1.7 million for the year ended December 31, 2012, as compared to the year ended December 31, 2011. At December 31, 2012, we have $32.0 million and $3.6 million in Remote and Urban high cost accounts receivable, respectively.
On February 6, 2012, the FCC released its Report and Order and Further Notice of Proposed Rulemaking to comprehensively reform and modernize the USF’s Lifeline program. The Lifeline program is administered by the Universal Service Administrative Company (“USAC”) and is designed to ensure that quality telecommunications services are available to low-income customers at affordable rates. The order adopted several reforms but the only reform with a significant 2012 impact was a requirement for annual recertification of all Lifeline subscribers enrolled as of June 1, 2012, to be completed by the end of 2012 subject to the waiver to perfect early recertification by January 31, 2013. The completion of the annual recertification process was the primary reason for our loss of approximately 10,000 Lifeline subscribers from December 31, 2011 to December 31, 2012.
We have recognized $14.2 million in Consumer wireless Lifeline revenue for the year ended December 31, 2012. The Lifeline program changes resulted in decreased Consumer segment wireless revenue of approximately $700,000 for the year ended December 31, 2012, as compared to the year ended December 31, 2011, and estimated decreased Consumer segment revenue in the range of $1.3 million to $1.5 million for the year ending December 31, 2013, as compared to the year ended December 31, 2012.
As a related matter, in April 2012 the Regulatory Commission of Alaska (“RCA”) issued a notice of inquiry to consider whether to modify the state-funded component of Lifeline support, which is currently $3.50 per month. In May 2012, we responded in favor of preserving the current level of support. We cannot predict the outcome of the support review proceedings or the impact on our income statement, financial position or cash flows.
In November 2010, Verizon acquired a license for 700 MHz wireless spectrum covering Alaska. Verizon began building a Long Term Evolution (“LTE”) network in 2012 and subsequently we expect they will be an additional competitor where our markets overlap. We cannot predict the potential impact this new competition may have on us in the future.
As part of an agreement signed in December 2007 with AT&T Mobility, AT&T Mobility provided to us a large block of wireless network usage at no charge that we used for roaming. This block of minutes was depleted in January 2012 and our wireless Cost of Goods Sold for the year ended December 31, 2012, increased approximately $5.1 million as compared to the year ended December 31, 2011, before factoring in the impact of 2012 non-Lifeline subscriber growth. Our future wireless Cost of Goods Sold will depend on several factors including the impact and timing of our wireless network build-out, the pattern of usage by our wireless subscribers, and negotiated rates with our roaming partners.
On October 3, 2012, we entered into a second arrangement under the New Markets Tax Credit (“NMTC”) program with US Bancorp for $12.9 million to fund the further extension of terrestrial broadband service to rural Northwestern Alaska communities via a high capacity hybrid fiber optic and microwave network (“Phase 3 of TERRA-Northwest”) (“NMTC #2”). In connection with this NMTC #2 transaction we loaned $37.7 million to two special purpose entities created to effect the financing arrangement, at 1.0% interest due October 2, 2042. Simultaneously, US Bancorp invested $17.5 million in these special purpose entities, and as such, is entitled to substantially all of the benefits derived from the NMTCs. The special purpose entities then contributed US Bancorp’s contribution and the loan proceeds to certain community development entities (“CDEs”) less payment of placement fees of $3.2 million. The CDEs, in turn, loaned $52.0 million, at interest rates varying from 0.7099% to 0.7693%, to Unicom, Inc. (“Unicom”), our wholly owned subsidiary, as partial financing for Phase 3 of TERRA-Northwest (“TERRA-NW”). The loan proceeds to Unicom, net of syndication and arrangement fees, are restricted for use on Phase 3 of TERRA-NW. Restricted cash of $12.9 million was received by Unicom on October 3, 2012.
On December 11, 2012, we entered into a third arrangement under the NMTC program with US Bancorp for $2.9 million for additional funding of Phase 3 of TERRA-NW (“NMTC #3”). In connection with this NMTC #3 transaction we loaned $8.2 million to a special purpose entity created to effect the financing arrangement, at 1.0% interest due December 10, 2042. Simultaneously, US Bancorp invested $3.8 million in this special purpose entity, and as such, is entitled to substantially all of the benefits derived from the NMTCs. The special purpose entity then contributed US Bancorp’s contribution and the loan proceeds to certain CDEs less payment of placement fees of $240,000. The CDEs, in turn, loaned $11.8 million, at 1.3472% interest rate, to Unicom as partial financing for Phase 3 of TERRA-NW. The loan proceeds to Unicom, net of syndication and arrangement fees, are restricted for use on Phase 3 of TERRA-NW. Restricted cash of $2.9 million was received by Unicom on December 11, 2012. We plan to begin construction on Phase 3 of TERRA-NW in 2013 and expect to complete the project in 2014.
Results of Operations
The following table sets forth selected financial data as a percentage of total revenues for the periods indicated (underlying data rounded to the nearest thousand):
We evaluate performance and allocate resources based on earnings before depreciation and amortization expense, net interest expense, income taxes, share-based compensation expense, accretion expense, loss attributable to non-controlling interest and non-cash contribution adjustment (“Adjusted EBITDA”). Management believes that this measure is useful to investors and other users of our financial information in evaluating operating profitability as an analytical indicator of income generated to service debt and fund capital expenditures. In addition, multiples of current or projected earnings before depreciation and amortization expense, net interest expense and income taxes (“EBITDA”) are used to estimate current or prospective enterprise value. See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Year Ended December 31, 2012 (“2012”) Compared to Year Ended December 31, 2011 (“2011”)
Overview of Revenues and Cost of Goods Sold
Total revenues increased 5% from $679.4 million in 2011 to $710.2 million in 2012. Revenue increases in our Consumer, Commercial and Managed Broadband segments were partially offset by decreased revenue in our Network Access and Regulated Operations segments. See the discussion below for more information by segment.
Total Cost of Goods Sold increased 9% from $227.4 million in 2011 to $247.5 million in 2012. Cost of Goods Sold increases in our Consumer, Commercial, Managed Broadband and Regulated Operations segments were partially offset by decreased Cost of Goods Sold in our Network Access segment. See the discussion below for more information by segment.
Consumer Segment Overview
Consumer segment revenue represented 50% of 2012 consolidated revenues. The components of Consumer segment revenue are as follows (amounts in thousands):
Consumer segment Cost of Goods Sold represented 52% of 2012 consolidated Cost of Goods Sold. The components of Consumer segment Cost of Goods Sold are as follows (amounts in thousands):
Consumer segment Adjusted EBITDA, representing 39% of 2012 consolidated Adjusted EBITDA, is as follows (amounts in thousands):
See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Selected key performance indicators for our Consumer segment follow:
1 A local access line in service is defined as a revenue generating circuit or channel connecting a customer to the public switched telephone network.
2 A basic subscriber is defined as one basic tier of service delivered to an address or separate subunits thereof regardless of the number of outlets purchased.
3 A digital programming tier subscriber is defined as one digital programming tier of service delivered to an address or separate subunits thereof regardless of the number of outlets or digital programming tiers purchased. Digital programming tier subscribers are a subset of basic subscribers.
4 A high-definition/digital video recorder ("HD/DVR") converter box is defined as one box rented by a digital programming or basic tier subscriber. A digital programming or basic tier subscriber is not required to rent an HD/DVR converter box to receive service.
5 Average monthly consumer video revenues divided by the average number of consumer basic subscribers at the beginning and end of each month in the period.
6 A cable modem subscriber is defined by the purchase of cable modem service regardless of the level of service purchased. If one entity purchases multiple cable modem service access points, each access point is counted as a subscriber. Cable modem subscribers may also be video basic subscribers though basic video service is not required to receive cable modem service.
7 A Lifeline wireless line in service is defined as a revenue generating wireless device that is eligible for Lifeline support.
8 A non-Lifeline wireless line in service is defined as a revenue generating wireless device that is not eligible for Lifeline support.
9 Average monthly consumer wireless revenues divided by the average of consumer wireless subscribers at the beginning and end of each month in the period.
Consumer Segment Revenues
The decrease in voice revenue is primarily due to:
·
A 21% decrease in local service plan fee revenue to $15.9 million due to decreased subscribers and a February 2012 rate decrease to one of our popular plans,
·
A 21% decrease in local service high cost support to $8.3 million due to the changes in the high cost support program as discussed above in the General Overview section of this Item 7 and a decrease in subscribers, and
·
A 39% decrease in long-distance usage to $2.4 million due to the lower rates mandated by the Intrastate Access Reform Act (“Intrastate Access Reform”) which went into effect in July 2011, along with our introduction of a popular new plan offering unlimited interstate and intrastate calling which went into effect in August 2011.
The increase in data revenue is primarily due to:
·
An 18% increase in cable modem revenue to $75.0 million due to increased subscribers and our subscribers’ selection of plans that offer higher speeds, and
·
A 57% increase in excess usage revenue to $7.9 million due to customers moving from plans with unlimited usage to plans with limited usage.
The increase in wireless revenue is primarily due to a 10% increase in plan fee revenue to $46.8 million due to our subscribers’ selection of plans that offer more data and an increase in non-Lifeline subscribers. This increase was partially offset by:
·
A 10% decrease in wireless high cost support to $31.9 million due to the changes in the high cost support program as discussed above in the General Overview section of this Item 2 and decreased subscribers, and
·
A 16% decrease in Lifeline support to $14.2 million primarily due to decreased subscribers primarily resulting from the recertification program started in June 2012 and discussed above in the General Overview section of this Item 2.
Consumer Segment Cost of Goods Sold
The wireless Cost of Goods Sold increase is primarily due to increased costs for wireless handset equipment and roaming. Our wireless handset equipment costs have increased because a higher percentage of our handsets sold have been premium smartphones which have a higher cost. Additionally, we have experienced an increase in handset sales due to an increased number of handsets issued to new customers and those extending their service. The increase in roaming costs is due to the end of free network usage as discussed above in the General Overview section of this Item 7 and an increase in data usage by our customers. The increase in smartphones resulted in an increase in data usage.
Consumer Segment Adjusted EBITDA
The decrease in Adjusted EBITDA is primarily due to increased Cost of Goods Sold as described above in “Consumer Segment Cost of Goods Sold” and an increase in the selling, general and administrative expense that was allocated to our Consumer segment due to an increase in consolidated selling, general and administrative expense.
Network Access Segment Overview
Network access segment revenue represented 15% of 2012 consolidated revenues. The components of Network Access segment revenue are as follows (amounts in thousands):
Network Access segment Cost of Goods Sold represented 10% of 2012 consolidated Cost of Goods Sold. The components of Network Access segment Cost of Goods Sold are as follows (amounts in thousands):
Network Access segment Adjusted EBITDA, representing 24% of 2012 consolidated Adjusted EBITDA, is as follows (amounts in thousands):
See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Network Access Segment Revenues
The increase in wireless revenue is primarily due to an increase in data usage by our roaming partners’ customers.
Network Access Segment Cost of Goods Sold
The decrease in voice Cost of Goods Sold is primarily due to Intrastate Access Reform which went into effect in July 2011 and eliminated the incumbent local exchange carrier’s (“ILEC”) ability to bill long distance carriers for certain intrastate line charges.
Network Access Segment Adjusted EBITDA
The Adjusted EBITDA increase is primarily due to decreased Cost of Goods Sold as described above in “Network Access Segment Cost of Goods Sold.”
Commercial Segment Overview
Commercial segment revenue represented 20% of 2012 consolidated revenues. Commercial segment data revenue is comprised of monthly recurring charges for data services and charges billed on a time and materials basis largely for personnel providing on-site customer support. This latter category can vary significantly based on project activity. The components of Commercial segment revenue are as follows (amounts in thousands):
Commercial segment Cost of Goods Sold represented 27% of 2012 consolidated Cost of Goods Sold. The components of Commercial segment Cost of Goods Sold are as follows (amounts in thousands):
Commercial segment Adjusted EBITDA, representing 16% of 2012 consolidated Adjusted EBITDA, is as follows (amounts in thousands):
See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Selected key performance indicators for our Commercial segment follow:
Commercial Segment Revenues
The increase in data revenue is primarily due to:
·
A 9% increase in managed services project revenue to $50.2 million due to special project work, and
·
A 9% increase in internet revenue to $22.3 million primarily due to increased subscribers and increased excess usage.
Commercial Segment Cost of Goods Sold
The decrease in voice Cost of goods Sold is primarily due to Intrastate Access Reform which went into effect July 2011 and eliminated the ILECs’ ability to bill long distance carriers for certain intrastate line charges.
The increase in data Cost of Goods Sold is primarily due to a $3.4 million or 10% increase in managed services project Cost of Goods Sold related to the increased revenue described above in “Commercial Segment Revenues.”
Commercial Segment Adjusted EBITDA
The Adjusted EBITDA increase is primarily due to increased revenue as described above in “Commercial Segment Revenues.” This increase was partially offset by increased Cost of Goods Sold as described above in “Commercial Segment Cost of Goods Sold” and by an increase in the selling, general and administrative expense that was allocated to our Commercial segment primarily due to an increase in consolidated selling, general and administrative expense.
Managed Broadband Segment Overview
Managed Broadband segment revenue, Cost of Goods sold and Adjusted EBITDA represented 12%, 9% and 19% of 2012 consolidated revenues, Cost of Goods Sold and Adjusted EBITDA, respectively.
Managed Broadband Segment Revenues
Managed Broadband segment revenue, which includes data products only, increased 37% to $86.6 million in 2012 as compared to 2011. The increase is primarily due to:
·
An $18.6 million increase in monthly contract revenue due to new ConnectMD® and SchoolAccess® customers and increased data network capacity purchased by our existing ConnectMD® and SchoolAccess® customers,
·
A $3.1 million increase in product sales to our customers, and
·
Recognition of $1.6 million in previously denied funding from the USAC for one ConnectMD® customer for the funding year July 2008 to June 2009. We had appealed the funding denial and received notice during the second quarter of 2012 that our appeal was successful and the funding was reinstated.
Managed Broadband Segment Cost of Goods Sold
Managed Broadband segment Cost of Goods Sold increased from $17.0 million in 2011 to $21.3 million in 2012 primarily due to Cost of Goods Sold associated with the product sales revenue described above in “Managed Broadband Segment Revenues.”
Managed Broadband Segment Adjusted EBITDA
Managed Broadband segment Adjusted EBITDA increased 49% to $42.8 million in 2012 primarily due to an increase in revenue as described above in "Managed Broadband Segment Revenues," partially offset by an increase in the Cost of Goods Sold as described above in “Managed Broadband Segment Cost of Goods Sold,” and an increase in the selling, general and administrative expense that was allocated to our Managed Broadband segment. The increase in selling, general and administrative expense is primarily due to an increase in the 2011 segment margin upon which the selling, general and administrative expense allocation is based and an increase in consolidated selling, general and administrative expense.
See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Regulated Operations Segment Overview
Regulated Operations segment revenue, Cost of Goods Sold and Adjusted EBITDA represented 3%, 2% and 2% of 2012 consolidated revenues, Cost of Goods Sold and Adjusted EBITDA, respectively.
A selected key performance indicator for our Regulated Operations segment follows:
1 A local access line in service is defined as a revenue generating circuit or channel connecting a customer to the public switched telephone network.
Regulated Operations Segment Revenues
Regulated Operations segment revenues decreased from $22.0 million in 2011 to $21.6 million in 2012.
Regulated Operations Segment Cost of Goods Sold
Regulated Operations segment Cost of Goods Sold increased from $5.8 million in 2011 to $6.6 million in 2012.
Regulated Operations Segment Adjusted EBITDA
Regulated Operations segment Adjusted EBITDA increased 37% to $3.9 million in 2012 primarily due to a decrease in selling, general and administrative expense. The decrease in selling, general and administrative expense is primarily due to non-capitalizable TERRA-Southwest (“TERRA-SW”) expenses recorded in 2011 that did not recur in 2012.
See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $7.7 million to $243.2 million in 2012. Individually significant items contributing to the increase include:
·
A $4.2 million increase in labor costs, and
·
$2.9 million in transaction costs related to the transactions described in the Wireless Agreement as discussed in the General Overview section of this Item 7.
As a percentage of total revenues, selling, general and administrative expenses decreased to 34% in 2012 from 35% in 2011, primarily due to increased revenues.
Depreciation and Amortization Expense
Depreciation and amortization expense increased $4.5 million to $130.5 million in 2012 primarily due to new assets placed in service in 2012 partially offset by assets which became fully depreciated during 2012.
Other Expense, Net
Other expense, net of other income, decreased 13% to $67.7 million in 2012 primarily due to the absence of a $9.1 million loss on extinguishment of debt recognized in 2011. On May 23, 2011, GCI, Inc., our wholly owned subsidiary, completed an offering of $325.0 million in aggregate principal amount of 6.75% Senior Notes due 2021 (“2021 Notes”). We used the net proceeds from this offering to repay and retire all of our outstanding senior unsecured notes due 2014.
Income Tax Expense
GCI, Inc., as a wholly owned subsidiary and member of the GCI controlled group of corporations, files its income tax return as part of the consolidated group of corporations under GCI. Accordingly, all discussions regarding income taxes reflect the consolidated group's activity. Our income tax expense and deferred income tax assets and liabilities are presented herein using the separate-entity method.
Income tax expense totaled $12.1 million and $7.4 million in 2012 and 2011, respectively. Our effective income tax rate was 57% in 2012 and 2011.
At December 31, 2012, we have income tax net operating loss carryforwards of $293.3 million that will begin expiring in 2020 if not utilized, and alternative minimum tax credit carryforwards of $1.9 million available to offset regular income taxes payable in future years.
We have recorded deferred tax assets of $120.0 million associated with income tax net operating losses that were generated from 2000 to 2011 and that expire from 2020 to 2031, and with charitable contributions that were converted to net operating losses in 2004 through 2007, and that expire in 2024 through 2027, respectively.
Tax benefits associated with recorded deferred tax assets are considered to be more likely than not realizable through future reversals of existing taxable temporary differences and future taxable income exclusive of reversing temporary differences and carryforwards. The amount of deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carryforward period are reduced which would result in additional income tax expense. We estimate that our effective annual income tax rate for financial statement purposes will be 55% to 59% in the year ending December 31, 2013, primarily due to the large amount of permanent differences expected in 2013 as compared to our net income before income tax expense.
Year Ended December 31, 2011 (“2011”) Compared to Year Ended December 31, 2010 (“2010”)
Overview of Revenues and Cost of Goods Sold
Total revenues increased 4% from $651.3 million in 2010 to $679.4 million in 2011. Revenue increases in our Consumer, Commercial and Managed Broadband segments were partially offset by decreased revenue in our Network Access and Regulated Operations segments. See the discussion below for more information by segment.
Total Cost of Goods Sold increased 9% from $207.8 million in 2010 to $227.4 million in 2011. Cost of Goods Sold increased in all of our segments. See the discussion below for more information by segment.
Consumer Segment Overview
Consumer segment revenue represented 52% of 2011 consolidated revenues. The components of Consumer segment revenue are as follows (amounts in thousands):
Consumer segment Cost of Goods Sold represented 49% of 2011 consolidated Cost of Goods Sold. The components of Consumer segment Cost of Goods Sold are as follows (amounts in thousands):
Consumer segment Adjusted EBITDA, representing 50% of 2011 consolidated Adjusted EBITDA, is as follows (amounts in thousands):
See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Selected key performance indicators for our Consumer segment follow:
4 A HD/DVR converter box is defined as one box rented by a digital programming or basic tier subscriber. A digital programming or basic tier subscriber is not required to rent an HD/DVR converter box to receive service.
5 Average monthly consumer video revenues divided by the average number of consumer basic subscribers at the beginning and end of each month in the period.
6 A cable modem subscriber is defined by the purchase of cable modem service regardless of the level of service purchased. If one entity purchases multiple cable modem service access points, each access point is counted as a subscriber. Cable modem subscribers may also be video basic subscribers though basic video service is not required to receive cable modem service.
7 A Lifeline wireless line in service is defined as a revenue generating wireless device that is eligible for Lifeline support.
8 A non-Lifeline wireless line in service is defined as a revenue generating wireless device that is not eligible for Lifeline support.
9 Average monthly consumer wireless revenues divided by the average of consumer wireless subscribers at the beginning and end of each month in the period.
Consumer Segment Revenues
The increase in data revenue is primarily due to a 19% increase in cable modem revenue to $63.4 million due to increased subscribers, rate increases in May and August 2010 and in May 2011, and our subscribers’ selection of plans that offer higher speeds.
Consumer Segment Cost of Goods Sold
The increase in video Cost of Goods Sold is primarily due to increased channels offered to our subscribers, increased rates paid to programmers and increased costs associated with delivery of digital services offered through our HD/DVR converter boxes. This increase was partially offset by decreased costs due to a decrease in subscribers.
The wireless Cost of Goods Sold increase is primarily due to increased costs for wireless handset equipment sales and a change in the allocation of network maintenance costs. The increased wireless handset equipment sale costs are associated with an increased number of premium wireless handsets which have higher costs and an increased number of handsets issued to new customers and those extending their service. The change in allocation of network maintenance costs resulted in an increase to our Consumer segment and a decrease to our Network Access, Commercial and Managed Broadband segments.
Consumer Segment Adjusted EBITDA
The decrease in Adjusted EBITDA is primarily due to increased Cost of Goods Sold as described above in “Consumer Segment Cost of Goods Sold” and an increase in the selling, general and administrative expense that was allocated to our Consumer segment due to an increase in the 2010 segment margin upon which the selling, general and administrative expense allocation is based and an increase in consolidated selling, general and administrative expense. These increases are partially offset by increased revenue as described above in "Consumer Segment Revenues.”
Network Access Segment Overview
Network access segment revenue represented 16% of 2011 consolidated revenues. The components of Network Access segment revenue are as follows (amounts in thousands):
Network Access segment Cost of Goods Sold represented 13% of 2011 consolidated Cost of Goods Sold. The components of Network Access segment Cost of Goods Sold are as follows (amounts in thousands):
Network Access segment Adjusted EBITDA, representing 22% of 2011 consolidated Adjusted EBITDA, is as follows (amounts in thousands):
See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Network Access Segment Cost of Goods Sold
The decrease in voice Cost of Goods Sold is primarily due to a $5.3 million Cost of Goods Sold classification change. Prior to 2011 certain Cost of Goods Sold were classified as Network Access segment voice Cost of Goods Sold. Beginning in 2011 these Cost of Goods Sold were reclassified to data Cost of Goods Sold for a more accurate presentation.
The increase in data Cost of Goods Sold is primarily due to:
·
A $5.3 million Cost of Goods Sold classification change. Prior to 2011 certain Cost of Goods Sold were classified as Network Access segment voice Cost of Goods Sold. Beginning in 2011 these Cost of Goods Sold were reclassified to data Cost of Goods Sold for a more accurate presentation, and
·
$1.8 million in Cost of Goods Sold related to special project work.
Network Access Segment Adjusted EBITDA
The Adjusted EBITDA decrease is primarily due to decreased revenue and increased Cost of Goods Sold as described above in “Network Access Segment Cost of Goods Sold.” These changes are partially offset by a decrease in the selling, general and administrative expense that was allocated to our Network Access segment primarily due to a decrease in the 2010 segment margin upon which the selling, general and administrative expense allocation is based.
Commercial Segment Overview
Commercial segment revenue represented 20% of 2011 consolidated revenues. Commercial segment data revenue is comprised of monthly recurring charges for data services and charges billed on a time and materials basis largely for personnel providing on-site customer support. This latter category can vary significantly based on project activity. The components of Commercial segment revenue are as follows (amounts in thousands):
Commercial segment Cost of Goods Sold represented 29% of 2011 consolidated Cost of Goods Sold. The components of Commercial segment Cost of Goods Sold are as follows (amounts in thousands):
Commercial segment Adjusted EBITDA, representing 14% of 2011 consolidated Adjusted EBITDA, is as follows (amounts in thousands):
See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Selected key performance indicators for our Commercial segment follow:
Commercial Segment Revenues
The increase in data revenue is primarily due to a $5.1 million or 13% increase in managed services project revenue due to special project work.
Commercial Segment Cost of Goods Sold
The increase in data Cost of Goods Sold is primarily due to a $4.7 million or 15% increase in managed services project Cost of Goods Sold related to the increased revenue described above in “Commercial Segment Revenues.”
Commercial Segment Adjusted EBITDA
The Adjusted EBITDA increase is primarily due to increased revenue as described above in “Commercial Segment Revenues.” This increase was partially offset by increased Cost of Goods Sold as described above in “Commercial Segment Cost of Goods Sold” and an increase in the selling, general and administrative expense that was allocated to our Commercial segment primarily due to an increase in consolidated selling, general and administrative expense.
Managed Broadband Segment Overview
Managed Broadband segment revenue, Cost of Goods Sold and Adjusted EBITDA represented 9%, 7% and 13% of 2011 consolidated revenues, Cost of Goods Sold and Adjusted EBITDA, respectively.
Managed Broadband Segment Revenues
Managed Broadband segment revenue, which includes data products only, increased 27% to $63.2 million in 2011 as compared to 2010. The increase is primarily due to increased monthly contract revenue due to increased data network capacity purchased by our ConnectMD® and SchoolAccess® customers and absence of $1.7 million in denied funding from the USAC for one ConnectMD® customer for the funding year July 2008 to June 2009. We received the funding commitment letter, which outlined the denied portion, in the second quarter of 2010. The denial was appealed to the FCC and we received notice during the second quarter of 2012 that our appeal was successful. We subsequently recognized $1.6 million in 2012.
Managed Broadband Segment Cost of Goods Sold
Managed Broadband segment Cost of Goods Sold increased from $14.0 million in 2010 to $17.0 million in 2011 primarily due to the increase in data network capacity described above in “Managed Broadband Segment Revenues.”
Managed Broadband Segment Adjusted EBITDA
Managed Broadband segment Adjusted EBITDA increased 49% to $28.6 million in 2011 primarily due to an increase in revenue as described above in "Managed Broadband Segment Revenues," partially offset by an increase in the Cost of Goods Sold as described above in “Managed Broadband Segment Cost of Goods Sold,” and an increase in the selling, general and administrative expense that was allocated to our Managed Broadband segment. The increase in selling, general and administrative expense is primarily due to an increase in the consolidated selling, general and administrative expense.
See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Regulated Operations Segment Overview
Regulated Operations segment revenue, Cost of Goods Sold and Adjusted EBITDA represented 3%, 2% and 1% of 2011 consolidated revenues, Cost of Goods Sold and Adjusted EBITDA, respectively.
A selected key performance indicator for our Regulated Operations segment follows:
Regulated Operations Segment Revenues
Regulated Operations segment revenues decreased from $22.7 million in 2010 to $22.0 million in 2011.
Regulated Operations Segment Cost of Goods Sold
Regulated Operations segment Cost of Goods Sold increased from $4.4 million in 2010 to $5.8 million in 2011. Beginning July 1, 2011, our Regulated Segment began purchasing access to carry its traffic in certain regions from our Network Access Segment. Prior to this the traffic in these regions was carried on its own network plant. Under regulatory accounting these intercompany transactions are not eliminated from the consolidated financial statements.
Regulated Operations Segment Adjusted EBITDA
Regulated Operations segment Adjusted EBITDA decreased 55% to $2.8 million in 2011 primarily due to a decrease in revenue, an increase in Cost of Goods Sold as described above in “Regulated Operations Segment Cost of Goods Sold” and an increase in the selling, general and administrative expense that was recorded in our Regulated Operations segment. The increase in selling, general and administrative expense is primarily due to non-capitalizable TERRA-SW expenses recorded in 2011.
See note 10 in the "Notes to Consolidated Financial Statements" included in Part IV of this annual report on Form 10-K for a reconciliation of consolidated Adjusted EBITDA, a non-GAAP financial measure, to consolidated income before income taxes.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $6.7 million to $235.5 million in 2011. Individually significant items contributing to the increase include:
·
A $1.6 million increase in labor costs,
·
A $1.2 million increase in health benefit costs, and
·
A $1.2 million increase in bad debt expense primarily due to absence of settlements which resulted in the release of credit reserves in the third quarter of 2010.
These increases were partially offset by a $3.8 million decrease in our company-wide success sharing bonus accrual. The remainder of the increase is comprised of individually insignificant items.
As a percentage of total revenues, selling, general and administrative expenses were 35% in 2011 and 2010.
Depreciation and Amortization Expense
Depreciation and amortization expense decreased $762,000 to $125.9 million in 2011.
Other Expense, Net
Other expense, net of other income, increased 11% to $77.6 million in 2011 primarily due to a $9.1 million loss on extinguishment of debt. On May 23, 2011, GCI, Inc., our wholly owned subsidiary, completed an offering of $325.0 million in aggregate principal amount of 2021 Notes. We used the net proceeds from this offering to repay and retire all of our outstanding 2014 Notes. This increase was partially offset by a $2.1 million decrease in interest expense to $68.3 million. The interest expense decrease is primarily due to the issuance of the 2021 Notes, which have a lower interest rate than the interest rate paid on our 2014 Notes.
Income Tax Expense
GCI, Inc., as a wholly owned subsidiary and member of the GCI controlled group of corporations, files its income tax return as part of the consolidated group of corporations under GCI. Accordingly, all discussions regarding income taxes reflect the consolidated group's activity. Our income tax expense and deferred income tax assets and liabilities are presented herein using the separate-entity method.
Income tax expense totaled $7.4 million and $9.2 million in 2011 and 2010, respectively. Our effective income tax rate increased from 52% in 2010 to 57% in 2011.
Multiple System Operator (“MSO”) Operating Statistics
Our operating statistics include capital expenditures and customer information from our Consumer and Commercial segments which offer services utilizing our cable services’ facilities.
The standardized definition of a customer relationship is the number of customers that receive at least one level of service utilizing our cable service facilities, encompassing voice, video, and data services, without regard to which services customers purchase. At December 31, 2012, 2011 and 2010 we had 126,700, 129,400, and 134,400 customer relationships, respectively.
The standardized definition of a revenue generating unit is the sum of all primary digital video, high-speed data, and telephony customers, not counting additional outlets. At December 31, 2012, 2011 and 2010 we had 343,900, 345,900, and 350,100 revenue generating units, respectively.
Liquidity and Capital Resources
Our principal sources of current liquidity are cash and cash equivalents. We believe, but can provide no assurances, that we will be able to meet our current and long-term liquidity, capital requirements and fixed charges through our cash flows from operating activities, existing cash, cash equivalents, credit facilities, and other external financing and equity sources. Should operating cash flows be insufficient to support additional borrowings and principal payments scheduled under our existing credit facilities, capital expenditures will likely be reduced, which would likely reduce future revenues.
As discussed in the General Overview section of this Item 7, in June 2012 we entered into a Wireless Agreement with ACS. Under the terms of the Wireless Agreement, we agreed to purchase certain wireless network assets from ACS and its affiliates for $100.0 million and we will contribute the purchased assets, our wireless network assets and certain rights to use capacity to AWN. We have also agreed to provide AWN a $50.0 million working capital line of credit. We expect to finance the asset purchase and working capital line of credit by refinancing our Senior Credit Facility.
ACS Member will be entitled to receive preferential cash distributions totaling $190.0 million over the first four years of AWN’s operations and we will be entitled to all remaining cash distributions during that period. We anticipate that the $190.0 million preferential distributions to ACS will constitute approximately $80.0 million in excess of the distributions otherwise attributable to their ownership percentage during such period. Currently we do not expect the preference payments will result in a significant decrease in our liquidity but should the payments cause a significant decrease our non-wireless capital expenditures will likely be reduced, which would likely reduce future revenues. Following the initial four year period, we and ACS Member will receive distributions proportional to our ownership interests.
We will manage AWN and receive a management fee of 4% of free cash flow as defined in the Wireless Agreement in the first two years of operations. The management fee will increase to 6% in the third and fourth years of the agreement and 8% after the fourth year of the agreement. The management fee will be paid before distributions to the owners.
In July 2012, we received payment for the sale of a $4.5 million IRU.
On August 30, 2011, we entered into a financing arrangement under the NMTC program (“NMTC #1”) which provided $16.5 million in net cash to help fund the extension of terrestrial broadband service for the first time to rural Northwestern Alaska communities via a high capacity hybrid fiber optic and microwave network. When completed, the project, called TERRA-NW, will connect to our TERRA-SW network and provide a high capacity backbone connection from the served communities to the Internet. On October 3, 2012, and December 11, 2012, we entered into NMTC #2 and NMTC #3, respectively, which provided $12.9 million and $2.9 million, respectively, in net cash to help fund additional phases of our TERRA-NW project. We began construction on TERRA-NW in 2012 and expect to complete the project in 2014 or earlier if possible. The total net cash received under NMTC #1, NMTC #2 and NMTC #3 is recorded as Restricted Cash on our Consolidated Balance Sheets. We have used $10.6 million of Restricted Cash to fund TERRA-NW capital expenditures through December 31, 2012.
In September 2011, the RCA approved our application for a $5.3 million grant to help fund TERRA-NW. The grant was increased to $6.3 million in January 2012. We received $5.7 million in grant funds during 2012. The NMTC arrangements discussed above and this grant award partially fund backbone network facilities that we would not otherwise be able to construct within our return-on-investment requirements. We plan to fund an additional $20.7 million for TERRA-NW.
On October 3, 2012, the FCC announced our winning bids in the Mobility Fund I auction for a $3.2 million grant to partially fund expansion of our 3G wireless network to high cost rural locations in Alaska. Upon review we agreed to accept $2.3 million. Upon FCC authorization of our final application submission, which is currently pending, we plan to begin construction in 2013 and expect to complete the project in 2014.
As discussed in the General Overview section of this Item 7, in November 2012 we entered into the Media Agreements pursuant to which we agreed to purchase three Alaska broadcast stations for a total of $7.6 million. The Media Agreements are subject to the satisfaction of customary closing conditions, including the receipt of required governmental approvals from the FCC. The transactions are expected to close in the second half of 2013.
While our short-term and long-term financing abilities are believed to be adequate as a supplement to internally generated cash flows to fund capital expenditures and acquisitions as opportunities arise, turmoil in the global financial markets may negatively impact our ability to further access the capital markets in a timely manner and on attractive terms, which may have a negative impact on our ability to grow our business.
We monitor the third-party depository institutions that hold our cash and cash equivalents. Our emphasis is primarily on safety of principal and secondarily on maximizing yield on those funds.
Our net cash flows provided by and (used for) operating, investing and financing activities, as reflected in the Consolidated Statements of Cash Flows for 2012 and 2011, are summarized as follows (amounts in thousands):
Operating Activities
The increase in cash flows provided by operating activities from 2011 to 2012 is due primarily to:
·
A decrease in accounts receivable due to timing of payments,
·
An increase in accounts payable due to timing of payments, and
·
A decrease in accrued interest in 2011 due to a change in due dates for semi-annual interest payments on our 2021 Notes as compared to the senior unsecured notes due 2014 that were retired.
Investing Activities
Net cash used in investing activities consists primarily of cash paid for capital expenditures. Our most significant recurring investing activity has been capital expenditures and we expect that this will continue in the future. A significant portion of our capital expenditures is based on the level of customer growth and the technology being deployed.
Our cash expenditures for property and equipment, including construction in progress, totaled $146.0 million and $177.1 million during 2012 and 2011, respectively. Our capital expenditures decreased in 2012 primarily due to our TERRA-SW project which was placed into service December 30, 2011. Depending on available opportunities and the amount of cash flow we generate during 2013, we expect our 2013 expenditures from unrestricted cash for property and equipment, including construction in progress, for our core and non-core operations, to total approximately $150.0 million and $15.0 million, respectively.
Under our TERRA-SW Rural Utilities Service (“RUS”) award, we had total available grant funds of $44.0 million. We have received $4.7 million in grant funds in 2012 for a total receipt of $39.8 million in grant funds under this award through December 31, 2012, leaving $4.3 million remaining grant funds available as of December 31, 2012. We have a $959,000 grant fund receivable recorded as of December 31, 2012.
Under our TERRA-NW RCA award, we had total available grant funds of $6.3 million. We have received $5.7 million in grant funds in 2012 for a total receipt of $5.7 million in grant funds under this award through December 31, 2012, leaving $600,000 remaining grant funds available as of December 31, 2012. We have a $600,000 grant fund receivable recorded as of December 31, 2012.
In 2012, we received $15.8 million in restricted cash from participating in NMTC#2 and NMTC#3 financing transactions. The cash is restricted for construction of TERRA-NW.
Financing Activities
Net cash provided by financing activities in 2012 consists primarily of proceeds from the issuance of our Supplement No. 3 under our Senior Credit Facility, borrowing under the revolving portion of our Senior Credit Facility, borrowing under our TERRA-SW RUS loan and investments by US Bancorp, a non-controlling interest. These proceeds were offset by repayments under the revolving portion of our Senior Credit Facility, repayments of RUS debt and repurchases of GCI’s common stock. Proceeds from borrowings fluctuate from year to year based on our liquidity needs. We may use excess cash to make optional repayments on our debt or repurchase GCI’s common stock depending on various factors, such as market conditions.
Available Borrowings Under Senior Credit Facility
We have a facility which includes an $80.0 million term loan and a $75.0 million revolving credit facility with a $25.0 million sublimit for letters of credit (“Senior Credit Facility”). The term loan is fully drawn at December 31, 2012. Under the revolving portion of the Senior Credit Facility we have borrowed $10.0 million and have $349,000 of letters of credit outstanding, which leaves $64.7 million available for borrowing as of December 31, 2012. A total of $90.0 million is outstanding as of December 31, 2012.
On February 15, 2013, we borrowed $10.0 million under the revolving portion of our Senior Credit Facility. After consideration of this transaction, we have $54.7 million available for borrowing under the revolving portion of our Senior Credit Facility.
Available TERRA-SW Borrowings Under RUS
Under our TERRA-SW RUS award, we had total available loan funds of $44.2 million. We have borrowed $4.8 million in loan funds in 2012 for a total borrowing of $40.0 million in loan funds under this award through December 31, 2012, leaving $4.2 million remaining loan funds available as of December 31, 2012.
Debt Covenants
We are subject to covenants and restrictions applicable to our 2021 Notes, our $425.0 million in aggregate principal amount of 8.63% Senior Notes due 2019, our Senior Credit Facility, our RUS loans, and our CoBank loans. We are in compliance with the covenants, and we believe that neither the covenants nor the restrictions in our indentures or loan documents will limit our ability to operate our business.
Share Repurchases
GCI’s Board of Directors has authorized a common stock buyback program for the repurchase of GCI Class A and Class B common stock in order to reduce the outstanding shares of Class A and Class B common stock. Under this program, GCI is currently authorized to make up to $101.0 million of repurchases as of December 31, 2012. GCI is authorized to increase its repurchase limit $5.0 million per quarter indefinitely and to use stock option exercise proceeds to repurchase additional shares. If stock repurchases are less than the total approved quarterly amount the difference may be carried forward and applied against future stock repurchases. During 2012 we repurchased, on GCI’s behalf, 1.5 million shares of GCI common stock under the stock buyback program at a cost of $14.0 million. The common stock buyback program is expected to continue for an indefinite period dependent on leverage, liquidity, company performance, and market conditions and subject to continued oversight by GCI’s Board of Directors. The open market repurchases have and will continue to comply with the restrictions of SEC Rule 10b-18.
Schedule of Certain Known Contractual Obligations
The following table details future projected payments associated with certain known contractual obligations as of December 31, 2012 (amounts in thousands):
Long-term debt listed in the table above includes principal payments on our Senior Credit Facility, 2019 and 2021 Notes, Rural Utilities Services debt and CoBank Mortgage note payable. Interest on the amount outstanding under our Senior Credit Facility is based on variable rates. We used the current rate paid on the Senior Credit Facility to estimate our future interest payments. Our 2019 Notes require semi-annual interest payments of $18.3 million through November 2019 and our 2021 Notes require semi-annual interest payments of $11.0 million through June 2021. Our Rural Utilities Services debt and CoBank Mortgage note payable have fixed interest rates ranging from 2.4% to 4.5%. For a discussion of our 2019 and 2021 Notes, Senior Credit Facility, Rural Utilities Services debt and CoBank Mortgage note payable see note 6 in the accompanying “Notes to Consolidated Financial Statements.”
Capital lease obligations include our obligation to lease transponder capacity on Galaxy 18. For a discussion of our capital and operating leases, see note 13 in the accompanying “Notes to Consolidated Financial Statements.”
Purchase obligations include cancelable open purchase orders for goods and services for capital projects and normal operations totaling $31.7 million which are not included in our Consolidated Balance Sheets at December 31, 2012, because the goods had not been received or the services had not been performed at December 31, 2012.
Off-Balance Sheet Arrangements
We have not created, and are not party to, any special-purpose and off-balance sheet entities for the purpose of raising capital, incurring debt or operating parts of our business that are not consolidated into our financial statements. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of our capital resources.
New Accounting Standards
Accounting Standards Update (“ASU”) 2012-02, “Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” allows an entity to assess qualitative factors (such as changes in management, key personnel, strategy, key technology or customers) to determine if it is more likely than not that an indefinite-lived intangible asset is impaired and thus whether it is necessary to perform the quantitative impairment test in accordance with GAAP. The updated guidance is effective for the quarter ending March 31, 2013. Early adoption was permitted. The adoption of this guidance is not expected to have a material effect on our income statements, financial position or cash flows.
ASU 2012-04, “Technical Corrections and Improvements” includes amendments that cover a wide range of topics in the Accounting Standards Codification (“ASC”). These amendments include technical corrections and improvements to the ASC and conforming amendments related to fair value measurements. The amendments in this update will be effective for fiscal periods beginning after December 15, 2012. The adoption of ASU 2012-04 is not expected to have a material impact on our income statements, financial position or cash flows.
Critical Accounting Policies and Estimates
Our accounting and reporting policies comply with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of our financial condition and results, and require management to make estimates that are difficult, subjective or complex. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements. These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under GAAP. For all of these policies, management cautions that future events rarely develop exactly as forecast, and the best estimates routinely require adjustment. Management has discussed the development and the selection of critical accounting policies with GCI’s Audit Committee.
Those policies and estimates considered to be critical for the year ended December 31, 2012 are described below.
Revenue Recognition
The accounting estimates related to revenues from the Remote high cost, rural health and schools and libraries USF programs are dependent on various inputs including our estimate of the statewide support cap, our assessment of the impact of new FCC regulations, the potential outcome of FCC proceedings and the potential outcome of USAC contract reviews. Some of the inputs are subjective and based on our judgment regarding the outcome of certain variables and are subject to upward or downward adjustment in subsequent periods. Significant changes to our estimates could result in material changes to the revenues we have recorded and could have a material effect on our financial condition and results of operations.
Allowance for Doubtful Receivables
We maintain allowances for doubtful receivables for estimated losses resulting from the inability of our customers to make required payments. We also maintain an allowance for doubtful receivables based on notification that a customer may not have satisfactorily complied with rules necessary to obtain supplemental funding from the USAC for services provided by us under our packaged communications offerings to rural hospitals, health clinics and school districts. We base our estimates on the aging of our accounts receivable balances, financial health of specific customers, regional economic data, changes in our collections process, regulatory requirements, and our customers’ compliance with USAC rules. If the financial condition of our customers were to deteriorate or if they are unable to emerge from reorganization proceedings, resulting in an impairment of their ability to make payments, additional allowances may be required. If their financial condition improves, or they emerge successfully from reorganization proceedings, allowances may be reduced. Such allowance changes could have a material effect on our financial condition and results of operations.
Impairment and Useful Lives of Intangible Assets
We had $294.9 million of indefinite-lived intangible assets at December 31, 2012, consisting of cable certificates of $191.6 million, goodwill of $77.3 million and wireless licenses of $26.0 million. Our indefinite-lived intangible assets are tested annually for impairment during the fourth quarter and at any time upon the occurrence of certain events or substantive changes in circumstances that indicate the assets might be impaired.
In our annual test over goodwill we are allowed to first assess qualitative factors (“Step Zero”) to determine whether it is more likely than not that goodwill is impaired. We chose not to apply Step Zero and instead went straight to assessing for goodwill impairment using the traditional quantitative two-step process. The first step of the quantitative goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill that would be recognized in a business combination.
We chose not to early adopt ASU No. 2012-02, “Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment,” which would have allowed us to apply a Step Zero in our annual test over our indefinite-lived intangible assets other than goodwill. The impairment test for identifiable indefinite-lived intangible assets other than goodwill consists of a comparison of the estimated fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
Our cable certificates are our largest indefinite-lived intangible asset and represent agreements with government entities to construct and operate a video business. The value of our cable certificates is derived from the economic benefits we receive from the right to solicit new customers and to market new services. The amount we have recorded for cable certificates is primarily from cable system acquisitions. The cable certificates are valued under a direct discounted cash flow method whereby the cash flow associated with existing customers is isolated after appropriate contributory asset charges and then projected based on an analysis of customer churn and attrition characteristics.
Our wireless licenses are from the FCC and give us the right to provide wireless service within a certain geographical area. The amount we have recorded is from acquisitions of wireless companies and auctions of wireless spectrum. We use comparable market transactions from recent FCC auctions, as appropriate, and a hypothetical build-up method to value our wireless licenses.
Goodwill represents the excess of cost over fair value of net assets acquired in connection with a business acquisition. We use an income approach to determine the fair value of our reporting units for purposes of our goodwill impairment test. In addition, a market-based approach is used where possible to corroborate the fair values determined by the income approach.
The direct discounted cash flow, hypothetical build-up, and income approach valuation methods require us to make estimates and assumptions including projected cash flows, discount rate, customer churn, and customer behaviors and attrition. These estimates and assumptions could have a significant impact on whether an impairment charge is recognized and the magnitude of any such impairment charge. Fair value estimates are made at a specific point in time, based on relevant information. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Events and factors that may be out of our control that could affect the estimates include such things as competitive forces, customer behaviors, change in revenue growth trends, cost structures and technology, and changes in discount rates, performance compared to peers, material and ongoing negative economic trends, and specific industry or market sector conditions. Our company is operated and managed with two balance sheets, however, our impairment tests must be performed at the reporting unit level, which requires us to allocate one of our balance sheets. These allocations are subjective and require a significant amount of judgment. Changes to the assumptions and allocation methodologies could significantly change our estimates. We may also record impairments in the future if there are changes in long term market conditions, expected future operating results, or laws and regulations that may prevent us from recovering the carrying value of our goodwill, cable certificates, and wireless licenses.
We have allocated all of the goodwill to our reporting units and based on our annual impairment test as of October 31, 2012, the fair value of each reporting unit exceeded the book value by a range between 15% and 123%. The reporting unit that exceeded the book value by 15% passed the goodwill impairment test by $97.9 million, which we believe is a large margin. We believe none of our reporting units were close to failing step one of the goodwill impairment test.
Based on our annual impairment test as of October 31, 2012, the fair value of our cable certificates exceeded the book value by 29% and $55.4 million, which we believe is a large margin. The fair value of our wireless licenses exceeded the book value by 8% and $2.0 million as of October 31, 2012. The fair value of our wireless licenses was negatively affected by increases in our forecasted wireless Cost of Goods Sold for handset and data roaming costs.
Valuation Allowance for Net Operating Loss Deferred Tax Assets
Our income tax policy provides for deferred income taxes to show the effect of temporary differences between the recognition of revenue and expenses for financial and income tax reporting purposes and between the tax basis of assets and liabilities and their reported amounts in the financial statements. We have recorded deferred tax assets of $120.0 million associated with income tax net operating losses that were generated from 2000 to 2011, and that primarily expire from 2020 to 2031, and with charitable contributions that were converted to net operating losses in 2004 to 2007, and that expire in 2024 to 2027, respectively. We have recorded deferred tax assets of $1.9 million associated with alternative minimum tax credits that do not expire. Significant management judgment is required in developing our provision for income taxes, including the determination of deferred tax assets and liabilities and any valuation allowances that may be required against the deferred tax assets. We have not recorded a valuation allowance on the deferred tax assets as of December 31, 2012, based on management’s belief that future reversals of existing taxable temporary differences and estimated future taxable income exclusive of reversing temporary differences and carryforwards will, more likely than not, be sufficient to realize the benefit of these assets over time. In the event that actual results differ from these estimates or if our historical trends change, we may be required to record a valuation allowance on deferred tax assets, which could have a material adverse effect on our consolidated financial position or results of operations.
Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. A complete discussion of our significant accounting policies can be found in note 1 in the accompanying “Notes to Consolidated Financial Statements.”
Regulatory Developments
See “Part I - Item 1 - Business - Regulation” for more information about regulatory developments affecting us.
Inflation
We do not believe that inflation has a significant effect on our operations.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to various types of market risk in the normal course of business, including the impact of interest rate changes. Our Senior Credit Facility carries interest rate risk. Amounts borrowed under our Senior Credit Facility bear interest at the London Interbank Offered Rate (“LIBOR”) plus 4.0% or less depending upon our Total Leverage Ratio (as defined in the Senior Credit Facility) for the revolving portion and LIBOR plus 2.5% for the term portion. Should the LIBOR rate change, our interest expense will increase or decrease accordingly. As of December 31, 2012, we have borrowed $90.0 million subject to interest rate risk. On this amount, each 1% increase in the LIBOR interest rate would result in $900,000 of additional gross interest cost on an annualized basis. All of our other material borrowings have a fixed interest rate. We do not hold derivatives.
Item 8.
Item 8. Consolidated Financial Statements and Supplementary Data
Our consolidated financial statements are filed under this Item, beginning on page 67. Our supplementary data is filed under Item 7, beginning on page 42.
Item 9.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized, accumulated and communicated to our management, including our principal executive and financial officers, to allow timely decisions regarding required financial disclosure, and reported as specified in the SEC’s rules and forms. As of the end of the period covered by this Annual Report on Form 10-K, we carried out an evaluation of the effectiveness of the design and operation of our “disclosure controls and procedures” (as defined in Exchange Act Rule 13a - 15(e)) under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer. Based on that evaluation and as described below under “Management’s Report on Internal Control Over Financial Reporting", our management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of December 31, 2012.
The certifications attached as Exhibits 31 and 32 to this report should be read in conjunction with the disclosures set forth herein.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations (COSO).
Based on our evaluation of the effectiveness of our internal control over financial reporting, our management concluded that as of December 31, 2012, we maintained effective internal control over financial reporting.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) identified in connection with the evaluation of our controls performed during the quarter ended December 31, 2012, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
We may enhance, modify, and supplement internal controls and disclosure controls and procedures based on experience.
Item 9B.
Item 9B. Other Information
None.
Part III
Items 10, 11, 12, 13 and 14 are omitted per General Instruction I(1)(a) and (b) of Form 10-K.
Part IV
Item 15.
Item 15. Exhibits, Consolidated Financial Statement Schedules
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholder
GCI, Inc.
We have audited the accompanying consolidated balance sheets of GCI, Inc. (an Alaska corporation) and subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated income statements and statements of stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of GCI, Inc. and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.
(signed) Grant Thornton LLP
Seattle, Washington
March 8, 2013
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Business and Summary of Significant Accounting Principles
In the following discussion, GCI, Inc. and its direct and indirect subsidiaries are referred to as “we,” “us” and “our.”
Basis of Presentation
We were incorporated in Alaska in 1997 to affect the issuance of Senior Notes. As a wholly owned subsidiary of General Communication, Inc. ("GCI"), we received through our initial capitalization all ownership interests in subsidiaries previously held by GCI. The GCI and GCI, Inc. consolidated financial statements include substantially the same account activity.
(a)
Business
We offer the following services primarily in Alaska:
·
Postpaid and prepaid wireless telephone services and sale of wireless telephone handsets and accessories,
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Video services throughout Alaska,
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Internet access services,
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Wireless roaming for certain wireless carriers and origination and termination of wireline traffic in Alaska for certain common carriers,
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Competitive and incumbent local access services throughout Alaska,
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Long-distance telephone service,
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Data network services,
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Broadband services, including our SchoolAccess® offering to rural school districts, our ConnectMD® offering to rural hospitals and health clinics, and managed video conferencing,
·
Managed services to certain commercial customers,
·
Sales and service of dedicated communications systems and related equipment, and
·
Lease, service arrangements and maintenance of capacity on our fiber optic cable systems used in the transmission of services within Alaska and between Alaska and the remaining United States and foreign countries.
(b)
Principles of Consolidation
Our consolidated financial statements include the consolidated accounts of GCI, Inc. and its wholly owned subsidiaries, as well as four variable interest entities (“VIEs”) for which we are the primary beneficiary after
providing certain loans and guarantees. These VIEs are Terra GCI Investment Fund, LLC (“TIF”), Terra GCI 2 Investment Fund, LLC (“TIF 2”), Terra GCI 2-USB Investment Fund, LLC (“TIF 2-USB”) and Terra GCI 3
Investment Fund, LLC (“TIF 3”). TIF became a VIE on August 30, 2011. TIF 2 and TIF 2-USB became VIEs on October 3, 2012. TIF 3 became a VIE on December 11, 2012. We also include in our consolidated financial
statements non-controlling interests in consolidated subsidiaries for which our ownership is less than 100 percent. All significant intercompany transactions between non-regulated affiliates of our company are
eliminated. Intercompany transactions generated between regulated and non-regulated affiliates of our company are not eliminated in consolidation.
(c)
Non-controlling Interests
Non-controlling interests represent the equity ownership interests in consolidated subsidiaries not owned by us. Non-controlling interests are adjusted for contributions, distributions, and earnings (loss) attributable to
the non-controlling interest partners of the consolidated entities. Income and loss is allocated to the non-controlling interests based on the respective partnership agreements.\
(d)
Recently Issued Accounting Pronouncements
Accounting Standards Update (“ASU”) 2012-02, “Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” allows an entity to assess qualitative factors (such as changes in management, key personnel, strategy, key technology or customers) to determine if it is more likely than not that an indefinite-lived intangible asset is impaired and thus whether it is necessary to perform the quantitative impairment test in accordance with generally accepted accounting principles in the United States of America (“GAAP”). The updated guidance is effective for the quarter ending March 31, 2013. Early adoption was permitted. The adoption of this guidance is not expected to have a material effect on our income statements, financial position or cash flows.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
ASU 2012-04, “Technical Corrections and Improvements” includes amendments that cover a wide range of topics in the Accounting Standards Codification (“ASC”). These amendments include technical corrections and improvements to the ASC and conforming amendments related to fair value measurements. The amendments in this update will be effective for fiscal periods beginning after December 15, 2012. The adoption of ASU 2012-04 is not expected to have a material impact on our income statements, financial position or cash flows.
(e)
Recently Adopted Accounting Pronouncements
ASU 2012-03, “Technical Amendments and Corrections to SEC Sections: Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (“SAB”) No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22 (SEC Update)” amends various Securities and Exchange Commission (“SEC”) paragraphs pursuant to the issuance of SAB No. 114. The adoption of ASU 2012-03 on August 27, 2012, did not have a material impact on our income statements, financial position or cash flows.
ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment” allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under these amendments, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The adoption of ASU 2011-08 on January 1, 2012, did not have a material impact on our income statements, financial position or cash flows.
ASU 2011-04 “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”)” amended current guidance to achieve common fair value measurement and disclosure requirements in GAAP and IFRS. The amendments generally represent clarification of Financial Accounting Standards Board ASC Topic 820, but also include instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. The adoption of ASU 2011-04 on January 1, 2012, did not have a material impact on our income statements, financial position or cash flows.
(f)
Regulatory Accounting
We account for our regulated operations in accordance with the accounting principles for regulated enterprises. This accounting recognizes the economic effects of rate regulation by recording cost and a return on investment as such amounts are recovered through rates authorized by regulatory authorities. Accordingly, plant and equipment is depreciated over lives approved by regulators and certain costs and obligations are deferred based upon approvals received from regulators to permit recovery of such amounts in future years. Our cost studies and depreciation rates for our regulated operations are subject to periodic audits that could result in a change to recorded revenues.
(g)
Earnings per Common Share
We are a wholly owned subsidiary of GCI and, accordingly, are not required to present earnings
per share. Our common stock is not publicly traded.
(h)
Cash Equivalents
Cash equivalents consist of certificates of deposit which have an original maturity of three months or less at the date acquired and are readily convertible into cash.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(i)
Accounts Receivable and Allowance for Doubtful Receivables
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful receivables is our best estimate of the amount of probable credit losses in our existing accounts
receivable. We base our estimates on the aging of our accounts receivable balances, financial health of specific customers, regional economic data, changes in our collections process, regulatory requirements and our
customers’ compliance with Universal Service Administrative Company ("USAC") rules. We review our allowance for doubtful receivables methodology at least annually.
Depending upon the type of account receivable our allowance is calculated using a pooled basis with an allowance for all accounts greater than 120 days past due or a specific identification method. When a specific
identification method is used, potentially uncollectible accounts due to bankruptcy or other issues are reviewed individually for collectability. Account balances are charged off against the allowance when we feel it is
probable the receivable will not be recovered. We do not have any off-balance-sheet credit exposure related to our customers.
(j)
Inventories
Wireless handset inventories are stated at the lower of cost or market (net realizable value). Cost is determined using the average cost method. Handset costs in excess of the revenues generated from handset sales, or
handset subsidies, are expensed at the time of sale. We do not recognize the expected handset subsidies prior to the time of sale because the promotional discount decision is made at the point of sale and/or because we
expect to recover the handset subsidies through service revenue.
Inventories of other merchandise for resale and parts are stated at the lower of cost or market. Cost is determined using the average cost method.
(k)
Property and Equipment
Property and equipment is stated at cost. Construction costs of facilities are capitalized. Equipment financed under capital leases is recorded at the lower of fair market value or the present value of future minimum lease
payments at inception of the lease. Construction in progress represents transmission equipment and support equipment and systems not placed in service on December 31, 2012, that management intends to place in
service during 2013 and 2014.
Depreciation is computed using the straight-line method based upon the shorter of the estimated useful lives of the assets or the lease term, if applicable, in the following ranges:
Amortization of property and equipment under capital leases is included in Depreciation and Amortization Expense on the Consolidated Income Statements.
Repairs and maintenance are charged to expense as incurred. Expenditures for major renewals and betterments are capitalized. Accumulated depreciation is removed and gains or losses are recognized at the time of sales
or other dispositions of property and equipment.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(l)
Intangible Assets and Goodwill
Goodwill, cable certificates (certificates of convenience and public necessity) and wireless licenses are not amortized. Cable certificates represent certain perpetual operating rights to provide cable services. Wireless
licenses represent the right to utilize certain radio frequency spectrum to provide wireless communications services. Goodwill represents the excess of cost over fair value of net assets acquired in connection with a
business acquisition. Goodwill is not allocated to our reportable segments as our Chief Operating Decision Maker does not review a balance sheet by reportable segment to make decisions about resource allocation or
evaluate reportable segment performance, however, goodwill is allocated to our reporting units for the sole purpose of the annual impairment test.
All other amortizable intangible assets are being amortized over 2 to 20 year periods using the straight-line method.
(m)
Impairment of Intangibles, Goodwill, and Long-lived Assets
Cable certificates and wireless license assets are treated as indefinite-lived intangible assets and are tested annually for impairment or more frequently if events and circumstances indicate that the asset might be impaired. We chose not to early adopt ASU No. 2012-02, “Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment,” which would have allowed us first to assess qualitative factors (“Step Zero”) in our annual test over our indefinite-lived intangible assets other than goodwill. The impairment test for identifiable indefinite-lived intangible assets other than goodwill consists of a comparison of the estimated fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. After an impairment loss is recognized, the adjusted carrying amount of the asset becomes its new accounting basis. Impairment testing of our cable certificate and wireless license assets as of October 31, 2012 and 2011, used a direct discounted cash flow method. This approach requires us to make estimates and assumptions including projected cash flows and discount rates. These estimates and assumptions could have a significant impact on whether an impairment charge is recognized and also the magnitude of any such impairment charge.
Our goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the assets might be impaired. In our annual test over goodwill we are allowed to use Step Zero to determine whether it is more likely than not that goodwill is impaired. We chose not to apply Step Zero and instead went straight to assessing for goodwill impairment using the traditional quantitative two-step process. The first step of the quantitative goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill that would be recognized in a business combination. We use an income approach to determine the fair value of our reporting units for purposes of our goodwill impairment test. In addition, a market-based approach is used where possible to corroborate the fair values determined by the income approach. The income approach requires us to make estimates and assumptions including projected cash flows and discount rates. These estimates and assumptions could have a significant impact on whether an impairment charge is recognized and also the magnitude of any such impairment charge.
We completed our annual review and no impairment charge was recorded for the years ended December 31, 2012, 2011 or 2010.
Long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount
of an asset group may not be recoverable. Recoverability of an asset group to be held and used is measured by a comparison of the carrying amount of an asset group to estimated undiscounted future cash flows
expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying
amount of the asset group exceeds the fair value of the asset group.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(n)
Amortization and Write-off of Loan Fees
Debt issuance costs are deferred and amortized using the effective interest method. If a refinancing or amendment of a debt instrument is a substantial modification, all or a portion of the applicable debt issuance costs are
written off. If a debt instrument is repaid prior to the maturity date we will write-off a proportional amount of debt issuance costs.
(o)
Other Assets
Other Assets primarily include long-term deposits, prepayments, and non-trade accounts receivable.
(p)
Asset Retirement Obligations
We record the fair value of a liability for an asset retirement obligation in the period in which it is incurred in Other Liabilities on the Consolidated Balance Sheets if the fair value of the liability can be reasonably estimated.
When the liability is initially recorded, we capitalize a cost by increasing the carrying amount of the related long-lived asset. In periods subsequent to initial measurement, period-to-period changes in the liability for an
asset retirement obligation resulting from revisions to either the timing or the amount of the original estimate of undiscounted cash flows are recognized. Over time, the liability is accreted to its present value each period,
and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, we either settle the obligation for its recorded amount or incur a gain or loss upon settlement.
The majority of our asset retirement obligations are the estimated cost to remove telephony transmission equipment and support equipment from leased property. Following is a reconciliation of the beginning and ending
aggregate carrying amounts of our liability for asset retirement obligations (amounts in thousands):
During the years ended December 31, 2012 and 2011, we recorded additional capitalized costs of $660,000 and $613,000, respectively, in Property and Equipment in Service, Net of Depreciation.
Certain of our network facilities are on property that requires us to have a permit and the permit contains provisions requiring us to remove our network facilities in the event the permit is not renewed. We expect to continually renew our permits and therefore cannot estimate any liabilities associated with such agreements. A remote possibility exists that we would not be able to successfully renew a permit, which could result in us incurring significant expense in complying with restoration or removal provisions.
(q)
Revenue Recognition
All revenues are recognized when the earnings process is complete. Revenue recognition is as follows:
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
·
Revenues generated from long-distance service usage and plan fees, Internet service excess usage, and managed services are recognized when the services are provided,
·
We recognize unbilled revenues when the service is provided based upon minutes of use processed, and/or established rates, net of credits and adjustments,
·
Video service package fees, local access and Internet service plan fees, and data network revenues are billed in advance, recorded as Deferred Revenue on the balance sheet, and are recognized as the associated service is provided,
·
Certain of our wireless services offerings have been determined to be revenue arrangements with multiple deliverables. Revenues are recognized as each element is earned based on objective evidence regarding the relative fair value of each element and when there are no undelivered elements that are essential to the functionality of the delivered elements. Revenues generated from wireless service usage and plan fees are recognized when the services are provided. Revenues generated from the sale of wireless handsets and accessories are recognized when title to the handset and accessories passes to the customer. As the non-refundable, up-front activation fee charged to the customer does not meet the criteria as a separate unit of accounting, we allocate the additional arrangement consideration received from the activation fee to the handset (the delivered item) to the extent that the aggregate handset and activation fee proceeds do not exceed the fair value of the handset. Any activation fees not allocated to the handset would be deferred upon activation and recognized as service revenue on a straight-line basis over the expected customer relationship period,
·
The majority of our equipment sale transactions involve the sale of communications equipment with no other services involved. Such equipment is subject to standard manufacturer warranties and we do not manufacture any of the equipment we sell. In such instances the customer takes title to the equipment generally upon delivery. We recognize revenue for such transactions when title passes to the customer and the revenue is earned and realizable. On certain occasions we enter into agreements to sell and satisfactorily install or integrate telecommunications equipment for a fixed fee. Customers may have refund rights if the installed equipment does not meet certain performance criteria. We defer revenue recognition until we have received customer acceptance per the contract or agreement, and all other required revenue recognition elements have been achieved. Revenues from contracts with multiple element arrangements, such as those including installation and integration services, are recognized as each element is earned based on objective evidence regarding the relative fair value of each element and when there are no undelivered elements that are essential to the functionality of the delivered elements,
·
Technical services revenues are derived primarily from maintenance contracts on equipment and are recognized on a prorated basis over the term of the contracts,
·
We account for fiber capacity Indefeasible Right to Use ("IRU") agreements as an operating lease or service arrangement and we defer the revenue and recognize it ratably over the life of the IRU or as service is rendered,
·
Access revenue is recognized when earned. We participate in access revenue pools with other telephone companies. Such pools are funded by toll revenue and/or access charges regulated by the Regulatory Commission of Alaska ("RCA") within the intrastate jurisdiction and the Federal Communications Commission (“FCC”) within the interstate jurisdiction. Much of the interstate access revenue is initially recorded based on estimates. These estimates are derived from interim financial information, available separation studies and the most recent information available about achieved rates of return. These estimates are subject to adjustment in future accounting periods as additional information becomes available. To the extent that a dispute arises over revenue settlements, our policy is to defer revenue recognition until the dispute is resolved,
·
We receive grant revenue for the purpose of building communication infrastructure in rural areas. We defer the revenue and recognize it over the life of the asset that was constructed using grant funds, and
·
Other revenues are recognized when the service is provided.
As an Eligible Telecommunications Carrier ("ETC"), we receive support from the Universal Service Fund ("USF") to support the provision of wireline local access and wireless service in high cost areas. On November 29, 2011, the FCC published a final rule to reform the methodology for distributing USF high cost support for voice and broadband services, as well as to the access charge regime for terminating traffic between carriers (“High Cost Order”). The High Cost Order defined the division of support to Alaska between Urban and Remote areas. The High Cost Order was a significant program change that required a reassessment of our high cost support revenue recognition.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Prior to the High Cost Order program changes we accrued Remote and Urban estimated program revenue quarterly based on current line counts, the most current rates paid to us, our assessment of the impact of current FCC regulations, and our assessment of the potential outcome of FCC proceedings. Our estimated accrued revenue was subject to our judgment regarding the outcome of many variables and was subject to upward or downward adjustments in subsequent periods.
Remote High Cost Support
The High Cost Order mandated that as of January 1, 2012, the annual available Remote high cost support is based upon the total 2011 support disbursed to all subject Competitive Eligible Telecommunications Carriers (“CETCs”) (“Statewide Support Cap”). On January 1, 2012, the per line rates paid in the Remote areas were mandated and frozen by the USF and cannot exceed $250 per line per month on a study area basis. Line count growth that causes the Statewide Support Cap to be exceeded triggers a pro rata support payment reduction to all subject Alaska CETCs until the support is reduced to the Statewide Support Cap amount.
In the Third Order on Reconsideration issued in May 2012 the FCC determined that Remote support will continue to be based on line counts until June 30, 2014, or the last full month prior to the establishment of a successor funding mechanism. If a successor funding mechanism is operational on July 1, 2014, a 20% annual phase down will commence decreasing support 20% each annual period until no support is paid starting July 1, 2018. If a successor funding mechanism is not operational on July 1, 2014, the phase down will not begin and the subject CETCs will continue to receive per-line based support (subject to the Statewide Support Cap) until a successor funding mechanism is operational. A subject CETC may not receive both phase down support and support from a successor funding mechanism; one program or the other must be selected. At this time we cannot predict the likelihood of a successor funding mechanism being operational on July 1, 2014, nor can we predict whether we can or will participate in a successor funding mechanism.
As a result of the High Cost Order program changes for the areas designated Remote by the FCC, beginning in the fourth quarter of 2011 we accrue estimated program revenue based on current line counts and the rates mandated and frozen by the FCC, reduced as needed by our estimate of the impact of the Statewide Support Cap. When determining the estimated program revenue accrual we also consider our assessment of the impact of current FCC regulations and of the potential outcome of FCC proceedings. Our estimated accrued revenue is subject to our judgment regarding the outcome of many variables and is subject to upward or downward adjustment in subsequent periods.
Urban High Cost Support
The High Cost Order mandated that as of January 1, 2012, Urban high cost support payments are frozen at the monthly average of the subject CETC’s 2011 annual support. A 20% annual phase down commenced July 1, 2012, decreasing support 20% each annual period until no support is paid starting July 1, 2016. If a successor funding mechanism is not operational on July 1, 2014, the phase down will stop at 60% and the subject CETCs will continue to receive annual support payments at the 60% level until a successor funding mechanism is operational. Urban high cost support is no longer dependent upon line counts.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As a result of the High Cost Order program changes for the areas designated as Urban by the FCC we apply the proportional performance revenue recognition method to account for the impact of the declining payments while our level of service provided and associated costs remain constant. Included in the calculation are the scheduled Urban high cost support payments from October 2011 through June 2014 net of our Urban accounts receivable balance at September 30, 2011. An equal amount of this result is recognized as Urban support revenue each period. At this time we cannot predict the likelihood of a successor funding mechanism being operational on July 1, 2014; therefore we have not included projected support payments beyond June 2014.
For both Remote and Urban high cost support revenue our ability to collect our accrued USF support is contingent upon continuation of the USF program and upon our eligibility to participate in that program, which is subject to change by future regulatory, legislative or judicial actions. We adjust revenue and the account receivable in the period the FCC makes a program change or we assess the likelihood that such a change has increased or decreased revenue. We do not recognize revenue until our ETC status has been approved by the RCA.
We recorded high cost support revenue under the USF program of $42.8 million, $48.8 million and $51.7 million for the years ended December 31, 2012, 2011 and 2010, respectively. At December 31, 2012, we have $32.0 million and $3.6 million in Remote and Urban high cost accounts receivable, respectively.
(r)
Advertising Expense
We expense advertising costs in the period during which the first advertisement appears. Advertising expenses were $4.9 million, $4.2 million and $4.3 million for the years ended December 31, 2012, 2011 and 2010,
respectively.
(s)
Leases
Scheduled operating lease rent increases are amortized over the expected lease term on a straight-line basis. Rent holidays are recognized on a straight-line basis over the operating lease term (including any rent holiday
period).
Leasehold improvements are amortized over the shorter of their economic lives or the lease term. We may amortize a leasehold improvement over a term that includes assumption of a lease renewal if the renewal is
reasonably assured. Leasehold improvements acquired in a business combination are amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to
be reasonably assured at the date of acquisition. Leasehold improvements that are placed in service significantly after and are not contemplated at or near the beginning of the lease term are amortized over the shorter of
the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date the leasehold improvements are purchased. Leasehold improvements made by
us and funded by landlord incentives or allowances under an operating lease are recorded as deferred rent and amortized as reductions to lease expense over the lease term.
(t)
Interest Expense
Material interest costs incurred during the construction period of non-software capital projects are capitalized. Interest costs incurred during the development period of a software capital project are capitalized. Interest is capitalized in the period commencing with the first expenditure for a qualifying capital project and ending when the capital project is substantially complete and ready for its intended use. We capitalized interest costs of $2.8 million, $3.7 million and $1.1 million during the years ended December 31, 2012, 2011 and 2010, respectively.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(u)
Income Taxes
GCI, Inc., as a wholly owned subsidiary and member of the GCI controlled group of corporations, files its income tax returns as part of the consolidated group of corporations under GCI. Accordingly, all discussions
regarding income taxes reflect the consolidated group's activity. Our income tax expense and deferred income tax assets and liabilities are presented herein using the separate-entity method.
Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for their future tax consequences attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable earnings in the years in which those temporary
differences are expected to be recovered or settled. A valuation allowance is recognized if it is more likely than not that some portion or the entire deferred tax asset will not be realized.
(v)
Share-based Payment Arrangements
We currently use the Black-Scholes-Merton option-pricing model to value stock options granted to employees. We use these values to recognize stock compensation expense for stock options. Compensation expense is
recognized in the financial statements for share-based awards based on the grant date fair value of those awards. Share-based compensation expense includes an estimate for pre-vesting forfeitures and is recognized over
the requisite service periods of the awards on a straight-line basis, which is generally commensurate with the vesting term. See Note 9, “Stockholder’s Equity” of this Form 10-K for information on the assumptions we used
to calculate the fair value of share-based compensation.
We are required to report the benefits associated with tax deductions in excess of recognized compensation cost as a financing cash flow rather than as an operating cash flow.
(w)
Stock Awards Issued for Non-employee Services
Stock awards issued in exchange for non-employee services are accounted for based upon the fair value of the consideration or services received or the fair value of the equity instruments issued using the Black-Scholes- Merton method, whichever is more reliably measurable.
The fair value determined using these principles is charged to operating expense over the shorter of the term for which non-employee services are provided, if stated, or the stock award vesting period.
(x)
Use of Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to estimates and assumptions include the allowance for doubtful
receivables, unbilled revenues, accrual of the USF high cost Remote area program support, share-based compensation, inventory at lower of cost or market, reserve for future customer credits, liability for incurred but not
reported medical insurance claims, valuation allowances for deferred income tax assets, depreciable and amortizable lives of assets, the carrying value of long-lived assets including goodwill, cable certificates and wireless
licenses, our effective tax rate, purchase price allocations, deferred lease expense, asset retirement obligations, the accrual of Cost of Goods Sold, depreciation and the accrual of contingencies and litigation. Actual results
could differ from those estimates.
The accounting estimates related to revenues from the USF high cost Remote area program are dependent on various inputs including our estimate of the Statewide Support Cap, our assessment of the impact of new FCC
regulations, and the potential outcome of FCC proceedings. These inputs are subjective and based on our judgment regarding the outcome of certain variables and are subject to upward or downward adjustment in
subsequent periods. Effective in the fourth quarter of 2011, we changed our high cost support revenue recognition methodology due to the High Cost Order. See Note 1(t) “Revenue Recognition,” of this Form 10-K for
information.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Effective in the second quarter of 2010, we changed our USF high cost area program support accrual methodology due to a change in our estimate of the current amounts expected to be paid to us. The effect of this change in estimate was a revenue increase of $4.7 million, a net income increase of $3.1 million and a basic and diluted net income per share increase of $0.06 for the year ended December 31, 2010.
(y)
Concentrations of Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk are primarily cash and cash equivalents and accounts receivable. Excess cash is invested in high quality short-term liquid money
instruments. At December 31, 2012 and 2011, substantially all of our cash and cash equivalents were invested in short-term liquid money instruments. At December 31, 2012 and 2011, cash balances were in excess of
Federal Deposit Insurance Corporation insured limits.
We do not have any major customers for the year ended December 31, 2012, see Note 10, “Industry Segment Data” of this Form 10-K. Our customers are located primarily throughout Alaska. Because of this geographic
concentration, our growth and operations depend upon economic conditions in Alaska.
(z)
Software Capitalization Policy
Internally used software, whether purchased or developed, is capitalized and amortized using the straight-line method over an estimated useful life of five years. We capitalize certain costs associated with internally
developed software such as payroll costs of employees devoting time to the projects and external direct costs for materials and services. Costs associated with internally developed software to be used internally are
expensed until the point the project has reached the development stage. Subsequent additions, modifications or upgrades to internal-use software are capitalized only to the extent that they allow the software to perform a
task it previously did not perform. Software maintenance and training costs are expensed in the period in which they are incurred. The capitalization of software requires judgment in determining when a project has reached
the development stage.
(aa)
Guarantees
Certain of our customers have guaranteed levels of service. If an interruption in service occurs we do not recognize revenue for any portion of the monthly service fee that will be refunded to the customer or not billed to the customer due to these service level agreements.
Additionally, we have provided certain guarantees to U.S. Bancorp Community Development Corporation (“US Bancorp”), our tax credit investor in our four VIEs. We have guaranteed the delivery of $56.0 million of New Markets Tax Credits (“NMTC”) to US Bancorp, as well as certain loan and management fee payments between our subsidiaries and the VIEs, for which we are the primary beneficiary. In the event that the tax credits are not delivered or certain payments not made, we are obligated to provide prompt and complete payment of these obligations. Please refer to Note 12, Non-controlling Interests, of this Form 10-K, for more information about our NMTC transactions.
(ab)
Classification of Taxes Collected from Customers
We report sales, use, excise, and value added taxes assessed by a governmental authority that is directly imposed on a revenue-producing transaction between us and a customer on a net basis in our Consolidated
Income Statements. The following are certain surcharges reported on a gross basis in our Consolidated Income Statements (amounts in thousands):
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(ac)
Immaterial Error Correction
During the first quarter of 2012, we identified an error in the depreciable life of one fixed asset. The error resulted in a $146,000 quarterly or $585,000 annual understatement of depreciation expense in 2007 through 2009 and a corresponding overstatement of net property and equipment in service for the same periods. For the years ended December 31, 2011 and 2010, the error resulted in a $195,000 and $585,000, respectively, understatement to depreciation expense and corresponding overstatement of net property and equipment in service for the same periods. In order to assess materiality of this error we considered SAB 99, “Materiality” and SAB 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” and determined that the impact of this error on prior period consolidated financial statements was immaterial. Although the error was and continues to be immaterial to prior periods, because of the significance of the cumulative error in the first quarter of 2012, we revised our prior period financial statements. The impact of the immaterial error correction adjustment for the periods presented is as follows (amounts in thousands):
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(2) Consolidated Statements of Cash Flows Supplemental Disclosures
Changes in operating assets and liabilities consist of (amounts in thousands):
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following items are for the years ended December 31, 2012, 2011 and 2010 (amounts in thousands):
The following items are non-cash investing and financing activities for the years ended December 31, 2012, 2011 and 2010 (amounts in thousands):
(3) Receivables and Allowance for Doubtful Receivables
Receivables consist of the following at December 31, 2012 and 2011 (amounts in thousands):
As described in Note 1(q), Revenue Recognition, we receive support from each of the various USF programs: high cost, low income, rural health care, and schools and libraries. This support was 19%, 19% and 18% of our revenue for the years ended December 31, 2012, 2011 and 2010, respectively. We had USF net receivables of $70.1 million and $69.8 million at December 31, 2012 and 2011, respectively.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Changes in the allowance for doubtful receivables during the years ended December 31, 2012, 2011 and 2010 are summarized below (amounts in thousands):
Charged to other accounts during the year ended December 31, 2010, includes a $1.6 million reserve for a customer that participates in the Rural Health Care Division support program that is operated by the USAC. We provided service to this customer pursuant to a contract from July 2008 to June 2009. In 2010 we received a funding commitment letter from USAC for the year from July 2008 to June 2009 committing funding for all but $1.7 million of that particular year. USAC denied funding of $1.7 million based on the timing of customer-owned equipment placed in service in relation to service charges. In August 2010, we filed with the FCC a request for review of the denial. We recorded a reserve by reducing revenue $1.7 million in the year ended December 31, 2010. During the second quarter of 2011, we decreased the allowance by $100,000 to true up 2008 and 2009’s funding amounts. After recording the adjustment in 2011, the allowance related to this customer was $1.6 million at December 31, 2011. In 2012 we received notice our appeal was successful and received payment of the $1.6 million, allowing us to recognize revenue and reduce our allowance and this amount is included in charged to other accounts during the year ended December 31, 2012.
(4) Net Property and Equipment in Service
Net property and equipment in service consists of the following at December 31, 2012 and 2011 (amounts in thousands):
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(5) Intangible Assets and Goodwill
As of October 31, 2012, cable certificates, wireless licenses and goodwill were tested for impairment and the fair values were greater than the carrying amounts, therefore these intangible assets were determined not to be impaired at December 31, 2012. The remaining useful lives of our cable certificates, wireless licenses, and goodwill were evaluated as of October 31, 2012, and events and circumstances continue to support an indefinite useful life. There are no indicators of impairment of our intangible assets subject to amortization as of December 31, 2012.
Other Intangible Assets subject to amortization include the following at December 31, 2012 and 2011 (amounts in thousands):
Changes in Other Intangible Assets are as follows (amounts in thousands):
Goodwill increased $2.4 million at December 31, 2012, as compared to December 31, 2011, and $951,000 at December 31, 2011, as compared to December 31, 2010, due to contingent payments to the former shareholders of United Utilities, Inc. (“UUI”), our wholly owned subsidiary. The amount recorded at December 31, 2012, is the final contingent payment under this agreement.
Amortization expense for amortizable intangible assets for the years ended December 31, 2012, 2011 and 2010 follow (amounts in thousands):
Amortization expense for amortizable intangible assets for each of the five succeeding fiscal years is estimated to be (amounts in thousands):
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(6) Long-Term Debt
Long-term debt consists of the following at December 31, 2012 and 2011 (amounts in thousands):
(a)
On May 20, 2011 (“Closing Date”), we completed an offering of $325.0 million in aggregate principal amount of 6 3/4% Senior Notes due 2021 (“2021 Notes”) at an issue price of 100% to qualified institutional buyers
in reliance on Rule 144A under the Securities Act of 1933, as amended (“Securities Act”), and to persons outside the United States in accordance with Regulation S under the Securities Act. We used the net
proceeds from this offering to repay and retire all $320.0 million of our outstanding senior unsecured notes due 2014 (“2014 Notes”).
The 2021 Notes are not redeemable prior to June 1, 2016. At any time on or after June 1, 2016, the 2021 Notes are redeemable at our option, in whole or in part, on not less than thirty nor more than sixty days’ notice, at
the following redemption prices (expressed as percentages of principal amount), plus accrued and unpaid interest (if any) to the date of redemption:
The 2021 Notes mature on June 1, 2021. Semi-annual interest payments are payable on June 1 and December 1.
The 2021 Notes are senior unsecured obligations which rank equally in right of payment with our existing and future senior unsecured debt, including our 2019 Notes, and senior in right of payment to all future subordinated indebtedness.
The 2021 Notes were issued pursuant to an Indenture, dated as of the Closing Date, between us and Union Bank, N.A., as trustee.
We are not required to make mandatory sinking fund payments with respect to the 2021 Notes.
Upon the occurrence of a change of control, each holder of the 2021 Notes will have the right to require us to purchase all or any part (equal to $1,000 or an integral multiple thereof, except that no 2021 Note will be purchased in part if the remaining portion thereof would not be at least $2,000) of such holder’s 2021 Notes at a purchase price equal to 101% of the principal amount of such 2021 Notes, plus accrued and unpaid interest on such 2021 Notes, if any. If we or certain of our subsidiaries engage in asset sales, we must generally either invest the net cash proceeds from such sales in our business within a period of time, prepay debt under any outstanding credit facility, or make an offer to purchase a principal amount of the 2021 Notes equal to the excess net cash proceeds, with the purchase price equal to 100% of their principal amount, plus accrued and unpaid interest, if any.
The covenants in the Indenture restrict us and certain of our subsidiaries from incurring additional debt, but permits debt under the Senior Credit Facility and vendor financing as long as our leverage ratio, as defined, does not exceed 5.5 to one. If our leverage ratio does not exceed 5.5 to one, we are able to enter into sale and leaseback transactions; pay dividends or distributions on capital stock or repurchase capital stock; issue stock of subsidiaries; make certain investments; create liens on assets to secure debt; enter into transactions with affiliates; merge or consolidate with another company; and transfer and sell assets. These covenants are subject to a number of limitations and exceptions, as further described in the Indenture.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
On August 15, 2011, we closed an exchange offer pursuant to which it offered new 2021 Notes identical to the original notes except that the new 2021 Notes were registered under the Securities Act.
We paid closing costs totaling $3.6 million in connection with the offering, which were recorded as deferred loan costs and are being amortized over the term of the 2021 Notes. During the year ended December 31, 2011, we recorded a $9.1 million Loss on Extinguishment of Debt on our Consolidated Income Statement. Included in the loss was $2.9 million in unamortized deferred loan costs, $1.5 million for the unamortized portion of the original issue discount and $4.7 million in call premium payments to redeem our 2014 Notes
We were in compliance with all 2021 Notes loan covenants at December 31, 2012.
(b)
We pay interest of 8.63% on notes that are due in 2019 (“2019 Notes”). The 2019 Notes are senior unsecured obligations which rank equally in right of payment with the existing and future senior unsecured debt, including our 2021 Notes described previously, and senior in right of payment to all future subordinated indebtedness. The 2019 Notes are carried on our Consolidated Balance Sheets net of the unamortized portion of the discount, which is being amortized to Interest Expense over the term of the 2019 Notes using the effective interest method and an effective interest rate of 9.09%.
The 2019 Notes are redeemable at our option, in whole or in part, on not less than thirty days nor more than sixty days notice, at the following redemption prices (expressed as percentages of principle amount), plus accrued and unpaid interest (if any) to the date of redemption:
The 2019 Notes mature on November 15, 2019. Semi-annual interest payments are payable on May 15 and November 15 of each year.
The 2019 Notes were issued pursuant to an Indenture, dated as of November 3, 2009, between us and Union Bank, N.A., as trustee.
We are not required to make mandatory sinking fund payments with respect to the 2019 Notes.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Upon the occurrence of a change of control, each holder of the 2019 Notes will have the right to require us to purchase all or any part (equal to $1,000 or an integral multiple thereof, except that no 2019 Note will be purchased in part if the remaining portion thereof would not be at least $2,000) of such holder’s 2019 Notes at a purchase price equal to 101% of the principal amount of such 2019 Notes, plus accrued and unpaid interest on such 2019 Notes, if any. If we or certain of our subsidiaries engage in asset sales, we must generally either invest the net cash proceeds from such sales in our business within a period of time, prepay debt under any outstanding credit facility, or make an offer to purchase a principal amount of the 2019 Notes equal to the excess net cash proceeds, with the purchase price equal to 100% of their principal amount, plus accrued and unpaid interest, if any.
The covenants in the Indenture restrict us and certain of our subsidiaries from incurring debt, but permits debt under the Senior Credit Facility and vendor financing as long as our leverage ratio, as defined, does not exceed 5.5 to one. If our leverage ratio does not exceed 5.5 to one, we are able to enter into sale and leaseback transactions; pay dividends or distributions on capital stock or repurchase capital stock; issue stock of subsidiaries; make certain investments; create liens on assets to secure debt; enter into transactions with affiliates; merge or consolidate with another company; and transfer and sell assets. These covenants are subject to a number of limitations and exceptions, as further described in the Indenture.
We paid closing costs totaling $9.4 million in connection with the offering, which were recorded as deferred loan costs and are being amortized over the term of the 2019 Notes.
We were in compliance with all 2019 Notes loan covenants at December 31, 2012.
(c)
The Senior Credit Facility includes an $80.0 million term loan, including Supplement No. 3 discussed below, and a $75.0 million revolving credit facility with a $25.0 million sublimit for letters of credit. Our term loan is fully drawn.
On July 31, 2012, GCI Holdings, Inc. (“Holdings”), our wholly owned subsidiary, entered into an Add-On Term Loan Supplement No. 3 (“Supplement No. 3”) to our Senior Credit Facility. The Supplement No. 3 provided for an additional $30.0 million term loan with an initial interest rate of LIBOR plus 2.5%, payable in accordance with the terms of our Senior Credit Facility. Holdings used the term loan proceeds to pay down revolving loans under our Senior Credit Facility, thus increasing availability under the revolving portion of our Senior Credit Facility.
Under the revolving portion of the Senior Credit Facility, we have borrowed $10.0 million and have $349,000 of letters of credit outstanding, which leaves $64.7 million available for borrowing as of December 31, 2012. The Senior Credit Facility will mature on January 29, 2015.
The interest rate on our Senior Credit Facility is LIBOR plus the following Applicable Margin set forth opposite each applicable Total Leverage Ratio below:
Borrowings under the Senior Credit Facility are subject to certain financial covenants and restrictions on indebtedness. Our Senior Credit Facility Total Leverage Ratio (as defined) may not exceed 5.25 to one; the Senior Leverage Ratio (as defined) may not exceed 3.00 to one; and our Interest Coverage Ratio (as defined) must not be less than 2.50 to one at any time.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The obligations under the Senior Credit Facility are secured by a security interest on substantially all of the assets of GCI Holdings, Inc. and the subsidiary guarantors, and on the stock of GCI Holdings, Inc.
(d)
UUI and Unicom, Inc. (“Unicom”), our wholly owned subsidiaries, have entered into various loans with the RUS and CoBank. The long-term debt is due in monthly installments of principal based on a fixed rate amortization schedule. The interest rates on the various loans to which this debt relates range from 2.4% to 4.5%. Through UUI and Unicom, we have $6.2 million available for borrowing for specific capital expenditures under existing borrowing arrangements. Substantially all of the assets of UUI and Unicom are collateral for the amounts due to RUS and CoBank.
Maturities of long-term debt as of December 31, 2012 are as follows (amounts in thousands):
(7) Income Taxes
Total income tax expense of $12.1 million, $7.4 million and $9.2 million for the years ended December 31, 2012, 2011 and 2010, respectively, was allocated to income in each year.
Income tax expense consists of the following (amounts in thousands):
Total income tax expense differed from the “expected” income tax expense determined by applying the statutory federal income tax rate of 35% as follows (amounts in thousands):
GCI, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at December 31, 2012 and 2011 are summarized below (amounts in thousands):
GCI, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
At December 31, 2012, we have tax net operating loss carryforwards of $293.3 million that will begin expiring in 2020 if not utilized, and alternative minimum tax credit carryforwards of $1.9 million available to offset regular income
taxes payable in future years. Our utilization of remaining acquired net operating loss carryforwards is subject to annual limitations pursuant to Internal Revenue Code section 382 which could reduce or defer the utilization of
these losses.
Our tax net operating loss carryforwards are summarized below by year of expiration (amounts in thousands):
Tax benefits associated with recorded deferred tax assets are considered to be more likely than not realizable through taxable income earned in carryback years, future reversals of existing taxable temporary differences, and future
taxable income exclusive of reversing temporary differences and carryforwards. The amount of deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carryforward
period are reduced.
We file federal income tax returns in the U.S. and in various state jurisdictions. We are no longer subject to U.S. or state tax examinations by tax authorities for years 2007 and earlier except that certain U.S. federal income tax
returns for years after 1997 are not closed by relevant statutes of limitations due to unused net operating losses reported on those income tax returns.
We recognize accrued interest on unrecognized tax benefits in interest expense and penalties in selling, general and administrative expenses. We did not have any unrecognized tax benefits as of December 31, 2012, 2011 and
2010, and accordingly, we did not recognize any interest expense. Additionally, we recorded no penalties during the years ended December 31, 2012, 2011 and 2010.
We did not record any excess tax benefit generated from stock options exercised during the years ended December 31, 2012, 2011 and 2010, since we are in a net operating loss carryforward position and the income tax deduction
will not yet reduce income taxes payable. The cumulative excess tax benefits generated for stock options exercised that have not been recognized is $7.9 million at December 31, 2012.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(8) Financial Instruments
Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties. At December 31, 2012 and 2011, the fair values of cash and cash equivalents, net receivables, inventories, accounts payable, accrued payroll and payroll related obligations, accrued interest, accrued liabilities, and subscriber deposits approximate their carrying value due to the short-term nature of these financial instruments. The carrying amounts and approximate fair values of our financial instruments at December 31, 2012 and 2011 follow (amounts in thousands):
The following methods and assumptions were used to estimate fair values:
Current and long-term debt and capital lease obligations: The fair values of our 2021 Notes, 2019 Notes, RUS debt, CoBank mortgage note payable, and capital leases are based upon quoted market prices for the same or similar issues or on the current rates offered to us for the same remaining maturities. The fair value of our Senior Credit Facility is estimated to approximate the carrying value because this instrument is subject to variable interest rates.
Other Liabilities: Lease escalation liabilities are valued at the discounted amount of future cash flows using quoted market prices on current rates offered to us. Deferred compensation liabilities are carried at fair value, which is the amount payable as of the balance sheet date. Asset retirement obligations are recorded at their fair value and, over time, the liability is accreted to its present value each period.
Fair Value Measurements
Assets measured at fair value on a recurring basis as of December 31, 2012 and 2011 are as follows (amounts in thousands):
GCI, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
The valuation of our mutual funds is determined using quoted market prices in active markets utilizing market observable inputs.
(9) Stockholders’ Equity
Common Stock
We were incorporated in 1997 and issued 100 shares of our no par Class A common stock to GCI in our initial capitalization. We received all ownership interests in subsidiaries previously held by GCI and proceeds from GCI’s
August 1, 1997 common stock offering. We recorded $206.6 million associated with our initial capitalization. All of our issued and outstanding Class A common stock is owned by GCI.
Shared-Based Compensation
GCI’s Amended and Restated 1986 Stock Option Plan ("Stock Option Plan"), provides for the grant of options and restricted stock awards (collectively "award") for a maximum of 15.7 million shares of GCI Class A common stock,
subject to adjustment upon the occurrence of stock dividends, stock splits, mergers, consolidations or certain other changes in corporate structure or capitalization. If an award expires or terminates, the shares subject to the
award will be available for further grants of awards under the Stock Option Plan. The Compensation Committee of GCI’s Board of Directors administers the Stock Option Plan. Substantially all restricted stock awards granted vest
over periods of up to three years. Substantially all options vest in equal installments over a period of five years and expire ten years from the date of grant. The requisite service period of our awards is generally the same as the
vesting period. Options granted pursuant to the Stock Option Plan are only exercisable if at the time of exercise the option holder is our employee, non-employee director, or a consultant or advisor working on our behalf. New
shares of GCI Class A common stock are issued when stock option agreements are exercised or restricted stock awards are granted. We have 3.7 million shares available for grant under the Stock Option Plan at December 31,
2012.
The fair value of restricted stock awards is determined based on the number of shares granted and the quoted price of GCI’s common stock. We use a Black-Scholes-Merton option pricing model to estimate the fair value of
stock options issued. The Black-Scholes-Merton option pricing model incorporates various and highly subjective assumptions, including expected term and expected volatility. We have reviewed our historical pattern of option
exercises and have determined that meaningful differences in option exercise activity existed among employee job categories. Therefore, we have categorized these awards into two groups of employees for valuation purposes.
We estimated the expected term of options granted by evaluating the vesting period of stock options, employee’s past exercise and post-vesting employment departure behavior, and expected volatility of the price of the
underlying shares.
We estimated the expected volatility of GCI’s common stock at the grant date using the historical volatility of GCI’s common stock over the most recent period equal to the expected stock option term and evaluated the extent to
which available information indicated that future volatility may differ from historical volatility.
The risk-free interest rate assumption was determined using the Federal Reserve nominal rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued. GCI and GCI,
Inc. have never paid any cash dividends on GCI’s common stock and we do not anticipate paying any cash dividends in the foreseeable future. Therefore, we assumed an expected dividend yield of zero.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
No options were granted during the years ended December 31, 2012 and 2011. The following table shows our assumptions used to compute the share-based compensation expense for stock options granted during the
year ended December 31, 2010:
We estimate pre-vesting option forfeitures at the time of grant and periodically revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We record share-based compensation expense only
for those awards expected to vest using an estimated forfeiture rate based on our historical pre-vesting forfeiture data. We review our forfeiture estimates annually and adjust our share-based compensation expense in the
period our estimate changes.
A summary of option activity under the Stock Option Plan as of December 31, 2012 and changes during the year then ended is presented below:
The weighted average grant date fair value of options granted during the year ended December 31, 2010 was $2.84 per share. There were no options granted during the years ended December 31, 2012 and 2011. The total fair
value of options vesting during the years ended December 31, 2012, 2011 and 2010, was $560,000, $379,000 and $377,000, respectively. The total intrinsic values, determined as of the date of exercise, of options exercised in the
years ended December 31, 2012, 2011 and 2010, were $1.3 million, $287,000 and $511,000, respectively. We received $2.1 million, $947,000 and $659,000 in cash from stock option exercises in the years ended December 31, 2012,
2011 and 2010, respectively.
A summary of nonvested restricted stock award activity under the Stock Option Plan for the year ended December 31, 2012, follows (share amounts in thousands):
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following is a summary of our share-based compensation expense for the years ended December 31, 2012, 2011 and 2010 (amounts in thousands):
Share-based compensation expense is classified as Selling, General and Administrative Expense in our Consolidated Income Statements. Unrecognized share-based compensation expense was $6.4 million relating to 1.1 million
restricted stock awards and $111,000 relating to 43,000 unvested stock options as of December 31, 2012. We expect to recognize share-based compensation expense over a weighted average period of 1.4 years for stock options
and 2.2 years for restricted stock awards.
On August 6, 2009, GCI filed a Tender Offer Statement on Schedule TO (“Exchange Offer”) with the SEC. The Exchange Offer was an offer by GCI to eligible officers, employees and stakeholders, other than officers of GCI who
also serve on GCI’s Board of Directors (“Participants”) to exchange, on a grant-by-grant basis, their outstanding eligible stock options that were granted under GCI’s Stock Option Plan, whether vested or unvested, for shares of
restricted stock of GCI Class A common stock that we granted under the Stock Option Plan (“Restricted Stock”). We issued 1,908,890 shares of Restricted Stock to Participants in accordance with the terms of the Exchange Offer.
In accordance with the terms of the Restricted Stock agreement, one-half of the Restricted Stock received in exchange for eligible options vested on December 20, 2011, and the remainder vested on February 28, 2012.
Employee Stock Purchase Plan
In 1986, GCI adopted an Employee Stock Purchase Plan (“GCI 401(k) Plan”) qualified under Section 401 of the Internal Revenue Code of 1986. The GCI 401(k) Plan provides for acquisition of GCI’s Class A common stock at market
value as well as various mutual funds. The GCI 401(k) Plan permits each employee who has completed one year of service to elect to participate. Eligible employees could elect to reduce their compensation by up to 50 percent of
such compensation (subject to certain limitations) up to a maximum of $17,000, $16,500 and $16,500 during the years ended December 31, 2012, 2011 and 2010, respectively. Contributions may be made on either a pretax or Roth
basis.
Eligible employees were allowed to make catch-up contributions of no more than $5,500 during the year ended December 31, 2012 and will be able to make such contributions limited to $5,500 during the year ending December 31,
2013. We do not match employee catch-up contributions.
We may match up to 100% of employee salary reductions in any amount, decided by GCI’s Board of Directors each year, but not more than 10 percent of any one employee’s compensation will be matched in any year. Matching
contributions vest over the initial six years of employment. For the year ended December 31, 2012, the combination of employee and matching contributions (pre-tax contributions and Roth basis) could not exceed the lesser of
100 percent of an employee’s compensation or $34,000 excluding catch-up contributions. For the years ended December 31, 2011 and 2010, the combination of employee and matching contributions (pre-tax contributions and
Roth basis) could not exceed the lesser of 100 percent of an employee’s compensation or $33,000 excluding catch-up contributions.
Employee contributions receive up to 100% matching and employees self-direct their matching investment. Our matching contributions allocated to participant accounts totaled $7.5 million, $7.1 million and $6.9 million for the
years ended December 31, 2012, 2011 and 2010, respectively. We used cash to fund all of our employer-matching contributions during the years ended December 31, 2012, 2011 and 2010.
GCI, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
(10) Industry Segments Data
Our reportable segments are business units that offer different products and are each managed separately.
A description of our reportable segments follows:
Consumer - We offer a full range of voice, video, data and wireless services to residential customers.
Network Access - We offer a full range of voice, data and wireless services to common carrier customers.
Commercial - We offer a full range of voice, video, data and wireless services to local, national and global businesses, governmental entities and public and private educational institutions.
Managed Broadband - We offer data services to rural school districts, hospitals and health clinics through our SchoolAccess® and ConnectMD® initiatives and managed video conferencing.
Regulated Operations - We offer voice and data services to residential, business, and governmental customers in areas of rural Alaska.
Corporate related expenses including engineering, information technology, accounting, legal and regulatory, human resources, and other general and administrative expenses for the years ended December 31, 2012, 2011
and 2010, are allocated to our segments using segment margin for the years ended December 31, 2011, 2010 and 2009, respectively. Bad debt expense for the years ended December 31, 2012, 2011 and 2010, is allocated to our
segments using a combination of specific identification and allocations based upon segment revenue for the years ended December 31, 2012, 2011 and 2010, respectively. Corporate related expenses and bad debt expense are
specifically identified for our Regulated Operations segment and therefore, are not included in the allocations.
We evaluate performance and allocate resources based on earnings before depreciation and amortization expense, net interest expense, income taxes, share-based compensation expense, accretion expense, loss attributable to non-controlling interests, and non-cash contribution adjustment (“Adjusted EBITDA”). Management believes that this measure is useful to investors and other users of our financial information in evaluating operating profitability as an analytical indicator of income generated to service debt and fund capital expenditures. In addition, multiples of current or projected earnings before depreciation and amortization, net interest expense, and income taxes (“EBITDA”) are used to estimate current or prospective enterprise value. The accounting policies of the reportable segments are the same as those described in Note 1, “Business and Summary of Significant Accounting Policies” of this Form 10-K. Intersegment sales are recorded at cost plus an agreed upon intercompany profit.
We earn all revenues through sales of services and products within the United States. All of our long-lived assets are located within the United States of America, except approximately 82% of our undersea fiber optic cable systems which transit international waters and all of our satellite transponders.
Summarized financial information for our reportable segments for the years ended December 31, 2012, 2011 and 2010 follows (amounts in thousands):
GCI, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
GCI, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
A reconciliation of reportable segment revenues to consolidated revenues follows (amounts in thousands):
A reconciliation of reportable segment Adjusted EBITDA to consolidated income before income taxes follows (amounts in thousands):
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Assets at December 31, 2012, 2011 and 2010, and capital expenditures for the years ended December 31, 2012, 2011 and 2010 are not allocated to reportable segments as our Chief Operating Decision Maker does not review a balance sheet or capital expenditures by segment to make decisions about resource allocations or to evaluate segment performance.
We did not have any major customers for the years ended December 31, 2012, 2011 and 2010.
(11) Related Party Transactions
We entered into a long-term capital lease agreement in 1991 with the wife of GCI’s President and CEO for property occupied by us. The leased asset was capitalized in 1991 at the owner’s cost of $900,000 and the related obligation was recorded. The lease agreement was amended in April 2008 and our existing capital lease asset and liability increased $1.3 million to record the extension of this capital lease. The amended lease terminates on September 30, 2026.
In January 2001 we entered into an aircraft operating lease agreement with a company owned by GCI’s President and CEO. The lease was amended several times, most recently on May 9, 2011. The amended lease agreement added the lease of a second aircraft. The lease term of the original aircraft could be terminated at any time upon 90 days written notice. This notice was provided and as of January 1, 2013, the original aircraft lease, and its monthly rate of $45,000, ended. The lease term of the second aircraft may be terminated at any time upon 12 months’ written notice. The monthly lease rate of the second aircraft is $132,000. In 2001, we paid a deposit of $1.5 million in connection with the lease. The deposit will be repaid to us no later than six months after the agreement terminates.
(12) Non-controlling Interests
We have entered into several arrangements under the NMTC program with US Bancorp to help fund a $59.3 million project to extend terrestrial broadband service for the first time to rural Northwestern Alaska communities via
a high capacity hybrid fiber optic and microwave network. When completed, the project, called TERRA-Northwest (“TERRA-NW”), will connect to the TERRA-Southwest (“TERRA-SW”) network and provide a high capacity
backbone connection from the served communities to the Internet. The NMTC program was provided for in the Community Renewal Tax Relief Act of 2000 (the “Act”) to induce capital investment in qualified lower income
communities. The Act permits taxpayers to claim credits against their federal income taxes for up to 39% of qualified investments in the equity of community development entities (“CDEs”). CDEs are privately managed
investment institutions that are certified to make qualified low-income community investments.
On August 30, 2011, we entered into the first arrangement (“NMTC #1”). In connection with the NMTC #1 transaction we loaned $58.3 million to TIF, a special purpose entity created to effect the financing arrangement, at 1%
interest due August 30, 2041. Simultaneously, US Bancorp invested $22.4 million in TIF. TIF then contributed US Bancorp’s contribution and the loan proceeds to certain CDEs. The CDEs, in turn, loaned the $76.8 million in
funds less payment of placement fees, at interest rates varying from 1% to 3.96%, to Unicom, as partial financing for TERRA-NW.
On October 3, 2012, we entered into the second arrangement (“NMTC #2”). In connection with the NMTC #2 transaction we loaned $37.7 million to TIF 2 and TIF 2-USB, special purpose entities created to effect the financing
arrangement, at 1% interest due October 2, 2042. Simultaneously, US Bancorp invested $17.5 million in TIF 2 and TIF 2-USB. TIF 2 and TIF 2-USB then contributed US Bancorp’s contributions and the loan proceeds to certain
CDEs. The CDEs, in turn, loaned the $55.2 million in funds less payment of placement fees, at interest rates varying from 0.7099% to 0.7693%, to Unicom, as partial financing for TERRA-NW.
On December 11, 2012, we entered into the third arrangement (“NMTC #3”). In connection with the NMTC #3 transaction we loaned $8.2 million to TIF 3, a special purpose entity created to effect the financing arrangement, at
1% interest due December 10, 2042. Simultaneously, US Bancorp invested $3.8 million in TIF 3. TIF 3 then contributed US Bancorp’s contributions and the loan proceeds to a CDE. The CDE, in turn, loaned the $12.0 million in
funds less payment of placement fees, at an interest rate of 1.35%, to Unicom, as partial financing for TERRA-NW.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
US Bancorp is the sole investor in TIF, TIF 2, TIF 2-USB and TIF 3, and as such, is entitled to substantially all of the benefits derived from the NMTCs. All of the loan proceeds to Unicom, net of syndication and arrangement
fees, are restricted for use on TERRA-NW. Restricted cash of $30.9 million and $15.9 million was held by Unicom at December 31, 2012 and 2011, respectively, and is included in our Consolidated Balance Sheets. We began
construction on TERRA-NW in 2012 and expect to complete all current phases of the project in 2014. We began offering service on Phase 1 of this new facility on January 3, 2013.
These transactions include put/call provisions whereby we may be obligated or entitled to repurchase US Bancorp’s interests in TIF, TIF 2, TIF 2-USB and/or TIF 3. We believe that US Bancorp will exercise the put options in
August 2018, October 2019 and December 2019, at the end of the compliance periods for NMTC #1, NMTC #2 and NMTC #3, respectively. The NMTCs are subject to 100% recapture for a period of seven years as provided in
the Internal Revenue Code. We are required to be in compliance with various regulations and contractual provisions that apply to the NMTC arrangements. Non-compliance with applicable requirements could result in
projected tax benefits not being realized by US Bancorp. We have agreed to indemnify US Bancorp for any loss or recapture of NMTCs until such time as our obligation to deliver tax benefits is relieved. There have been no
credit recaptures as of December 31, 2012. The value attributed to the put/calls is nominal.
We have determined that TIF, TIF 2, TIF 2-USB and TIF 3 are VIEs. The consolidated financial statements of TIF, TIF 2, TIF 2-USB and TIF 3 include the CDEs discussed above. The ongoing activities of the VIEs - collecting
and remitting interest and fees and NMTC compliance - were all considered in the initial design and are not expected to significantly affect economic performance throughout the life of the VIEs. Management considered the
contractual arrangements that obligate us to deliver tax benefits and provide various other guarantees to US Bancorp; US Bancorp’s lack of a material interest in the underlying economics of the project; and the fact that we are
obligated to absorb losses of the VIEs. We concluded that we are the primary beneficiary of each and consolidated the VIEs in accordance with the accounting standard for consolidation.
US Bancorp’s contributions, net of syndication fees and other direct costs incurred in structuring the NMTC arrangements, are included in Non-controlling Interests on the Consolidated Balance Sheets. Incremental costs to
maintain the structure during the compliance period are recognized as incurred to selling, general and administrative expense.
The following table summarizes the impact of the VIEs consolidated as of December 31, 2012 and 2011 (amounts in thousands):
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(13) Commitments and Contingencies
Operating Leases as Lessee
We lease business offices, have entered into site lease agreements and use satellite transponder and fiber capacity and certain equipment pursuant to operating lease arrangements. Many of our leases are for multiple years and contain renewal options. Rental costs under such arrangements amounted to $37.4 million, $36.3 million and $31.0 million for the years ended December 31, 2012, 2011 and 2010, respectively.
Capital Leases as Lessee
We entered into a long-term capital lease agreement in 1991 with the wife of GCI’s President and CEO for property occupied by us as further described in Note 11, Related Party Transactions.
We have a capital lease agreement for transponder capacity on Intelsat, Ltd.’s (“Intelsat”) Galaxy 18 spacecraft that successfully launched in 2008. The Intelsat Galaxy 18 C-band and Ku-Band transponders are being leased over an expected term of 14 years. At lease inception the present value of the lease payments, excluding telemetry, tracking and command services and back-up protection, was $98.6 million.
A summary of future minimum lease payments follows (amounts in thousands):
The leases generally provide that we pay the taxes, insurance and maintenance expenses related to the leased assets. Several of our leases include renewal options, escalation clauses and immaterial amounts of contingent rent expense. We expect that in the normal course of business leases that expire will be renewed or replaced by leases on other properties.
Operating Leases as Lessor and IRU Revenue
We enter into lease or service arrangements for IRU capacity on our fiber optic cable systems with third parties and for many of these leases or service arrangements, we received up-front cash payments. We have $47.8 million
and $45.8 million in deferred revenue at December 31, 2012 and 2011 respectively, representing cash received from customers for which we will recognize revenue in the future. The arrangements under these operating leases
expire on various dates through 2032. The revenue will be recognized over the terms of the agreements.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
A summary of minimum future lease or service arrangement cash receipts including IRUs and the provision of certain other service are as follows (amounts in thousands):
The cost of assets that are leased to customers is $259.8 million and $258.6 million as of December 31, 2012 and 2011, respectively. The carrying value of assets leased to customers is $143.6 million and $153.1 million as of December 31, 2012 and 2011, respectively.
Guaranteed Service Levels
Certain customers have guaranteed levels of service with varying terms. In the event we are unable to provide the minimum service levels we may incur penalties or issue credits to customers.
Self-Insurance
Through December 31, 2012, we were self-insured for losses and liabilities related primarily to health and welfare claims up to $500,000 per incident and $2.0 million per year per beneficiary above which third party insurance applied. These limits will remain the same for 2013. A reserve of $2.7 million and $1.6 million was recorded at December 31, 2012 and 2011, respectively, to cover estimated reported losses, estimated unreported losses based on past experience modified for current trends, and estimated expenses for settling claims. We are self-insured for all losses and liabilities related to workers’ compensation claims in Alaska and have a workers compensation excess insurance policy to make claim for any losses in excess of $500,000 per incident. A reserve of $2.4 million and $1.9 million was recorded at December 31, 2012 and 2011, respectively, to cover estimated reported losses and estimated expenses for open and active claims. Included in this reserve for the years ended December 31, 2012 and 2011, was $1.0 million and $1.1 million, respectively, for the GCI-owned aircraft accident further discussed below. Actual losses will vary from the recorded reserves. While we use what we believe are pertinent information and factors in determining the amount of reserves, future additions to the reserves may be necessary due to changes in the information and factors used.
We are self-insured for damage or loss to certain of our transmission facilities, including our buried, undersea, and above-ground transmission lines. If we become subject to substantial uninsured liabilities due to damage or loss to such facilities, our financial position, results of operations or liquidity may be adversely affected.
Litigation, Disputes, and Regulatory Matters
We are involved in various lawsuits, billing disputes, legal proceedings, and regulatory matters that have arisen from time to time in the normal course of business. The range of possible losses from asserted and unasserted
claims recorded and possibly recorded in the future do not have a material adverse effect on our financial position, results of operations or liquidity. In addition, in August 2010, a GCI-owned aircraft was involved in an
accident resulting in five fatalities and injuries to the remaining four passengers on board. We had aircraft and liability insurance coverage in effect at the time of the accident. During 2012, final payments on all resolved claims
were made with the exception of any potential claims for environmental remediation. All paid claims related to the accident have been resolved within insurance policy limits and were recorded net of these recoveries in our
Consolidated Income Statements. We cannot predict the likelihood or nature of any potential claims for environmental remediation.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Universal Service
As an ETC, we receive support from the USF to provide wireline local access and wireless services in high cost areas. On November 29, 2011, the FCC published the High Cost Order which divided support to Alaska between Urban and Remote areas. CETCs serving Urban areas that generally include Anchorage, Fairbanks, and Juneau will follow national reforms, had support per provider per service area capped as of January 1, 2012, and a five-step phase-down commenced on July 1, 2012. In addition to broader reforms, the FCC tailored revisions specifically for CETCs serving Remote Alaska, intended to address the unique challenges for serving these areas. Support to these locations is capped and is being distributed on a per-line basis until the later of July 1, 2014, or the last full month prior to the implementation of a successor funding mechanism. A further rulemaking to consider successor funding mechanisms is underway. We cannot predict at this time the outcome of this proceeding or its effect on Remote high cost support available to us, but our revenue for providing local services in these areas would be materially adversely affected by a substantial reduction of USF support.
Wireless Acquisition
On June 4, 2012, we entered into an Asset Purchase and Contribution Agreement (“Wireless Agreement”) by and among Alaska Communications Systems Group, Inc. (“ACS”), GCI, ACS Wireless, Inc., a wholly owned subsidiary of ACS (“ACS Member”), GCI Wireless Holdings, LLC, a wholly owned subsidiary of GCI, and The Alaska Wireless Network, LLC (“AWN”), a wholly owned subsidiary of GCI, pursuant to which the parties have agreed to contribute the respective wireless network assets of GCI, ACS and their affiliates to AWN. We entered into this agreement to provide a robust, statewide network with the spectrum mix, scale, advanced technology and cost structure necessary to compete with Verizon Wireless (“Verizon”) and AT&T Mobility, LLC (“AT&T Mobility”) in Alaska. After the transaction closes AWN will provide wholesale services to GCI and ACS. GCI and ACS will use the AWN network in order to continue to sell services to their respective retail customers. GCI and ACS will continue to compete against each other and other wireless providers in the retail market.
Under the terms of the Wireless Agreement, we agreed to purchase certain wireless network assets from ACS and its affiliates for $100.0 million and we will contribute the purchased assets, our wireless network assets and certain rights to use capacity to AWN. ACS also agreed to contribute its remaining wireless network assets and certain rights to use capacity to AWN. Upon the contribution of assets to AWN, ACS Member will own one-third of AWN and we will own two-thirds of AWN. ACS Member will be entitled to receive preferential cash distributions totaling $190.0 million over the first four years of AWN’s operations and we will be entitled to all remaining cash distributions during that period. We anticipate that the $190.0 million preferential distributions to ACS will constitute approximately $80 million in excess of the distributions otherwise attributable to their ownership percentage during such period. Following the initial four year period, we and ACS Member will receive distributions proportional to our ownership interests. We are evaluating the accounting treatment for this transaction.
The closing of the transactions is subject to the satisfaction of customary closing conditions, including the receipt of required governmental and third party consents and approvals and the expiration of any applicable waiting periods under competition laws. The waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 has expired without any objections. The transactions are expected to close in the second quarter of 2013.
Cable Service Rate Reregulation
Federal law permits regulation of basic cable programming services rates. However, Alaska law provides that cable television service is exempt from regulation by the RCA unless 25% of a system’s subscribers request such
regulation by filing a petition with the RCA. At December 31, 2012, only the Juneau system is subject to RCA regulation of its basic service rates. No petition requesting regulation has been filed for any other system. The
Juneau system serves 7% of our total basic service subscribers at December 31, 2012.
GCI, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
TERRA-Northwest
As a requirement of NMTC #1, NMTC #2 and NMTC #3, we have guaranteed completion of TERRA-NW by December 31, 2014. We plan to fund an additional $20.7 million for TERRA-NW. We began construction in 2012
and expect to complete all current phases of the project in 2014. We began offering service on Phase 1 of this new facility on January 3, 2013.
Denali Media Holdings
On November 9, 2012, we entered into asset purchase agreements, pursuant to which Denali Media Holdings, a wholly owned subsidiary of GCI, through its wholly owned subsidiaries, Denali Media Anchorage, Corp. and
Denali Media Southeast, Corp., agreed to purchase three Alaska broadcast stations: CBS affiliate KTVA-TV of Anchorage and NBC affiliates KATH-TV in Juneau and KSCT-TV of Sitka, for a total of $7.6 million (“Media
Agreements”). The Media Agreements are subject to the satisfaction of customary closing conditions, including the receipt of required governmental approvals from the FCC. The transactions are expected to close in
the second half of 2013.
(14) Selected Quarterly Financial Data (Unaudited)
The following is a summary of unaudited quarterly results of operations for the years ended December 31, 2012 and 2011 (amounts in thousands):
(15) Subsequent Event
On February 15, 2013, we borrowed $10.0 million under the revolving portion of our Senior Credit Facility. After consideration of this transaction, we have $54.7 million available for borrowing under the revolving portion of
our Senior Credit Facility.
Item 15(b). Exhibits
Listed below are the exhibits that are filed as a part of this Report (according to the number assigned to them in Item 601 of Regulation S-K):
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
GCI, INC.
By:
/s/ Gregory F. Chapados
Gregory F. Chapados, President
(Chief Executive Officer)
Date:
March 8, 2013
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Signature
Title
Date
/s/ Gregory F. Chapados
President and Director
March 8, 2013
Gregory F. Chapados
(Principal Executive Officer)
/s/ John M. Lowber
Treasurer and Director
March 8, 2013
John M. Lowber
(Principal Financial Officer)
/s/ Lynda L. Tarbath
Vice President, Chief Accounting
March 8, 2013
Lynda L. Tarbath
Officer
(PPrincipal Accounting Officer)