General Communication Inc. Annual Report 1998

FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (X) ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 or ( ) TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File No. 0-15279 GENERAL COMMUNICATION, INC. (Exact name of registrant as specified in its charter) ALASKA 92-0072737 (State or other jurisdiction of (I.R.S. Employerincorporation or organization) Identification No.)2550 Denali Street Suite 1000 Anchorage, Alaska 99503(Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (907) 265-5600 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Class A common stock Class B common stock (Title of class) (Title of class)Indicate by check mark whether the registrant (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months, and (2) has been subject to such filing requirementsfor the past 90 days. Yes X No .Indicate by check mark if disclosure of delinquent filers pursuant to Item 405of Regulation S-K is not contained herein, and will not be contained, to thebest of registrant's knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. [X]The aggregate market value of the voting stock held by non-affiliates of theregistrant, computed by reference to the average bid and asked prices of suchstock as of the close of trading on February 26, 1999 was approximately$159,669,544. The number of shares outstanding of the registrant's common stock as of February 26, 1999, was: Class A common stock - 45,949,783 shares; and Class B common stock - 4,056,252 shares. DOCUMENTS INCORPORATED BY REFERENCECertain portions of the registrant's definitive Proxy Statement to be filedpursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended,in connection with the Annual Meeting of Stockholders of the registrant to beheld on June 10, 1999 are incorporated by reference into Part III of thisreport. 1 GENERAL COMMUNICATION, INC. 1998 ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS Page ---- Glossary................................................................................................................3Cautionary statement regarding forward looking statements..............................................................10Part I.................................................................................................................11 Item 1. Business...................................................................................................11 General..........................................................................................................11 Financial information about the Company's industry segments......................................................11 Historical development of the Company's business during the past fiscal year.....................................12 Narrative description of the business done and intended to be done by the Company................................14 Alaska voice, video and data markets.............................................................................15 Long Distance Telecommunication services.......................................................................15 Cable services.................................................................................................21 Local access services..........................................................................................26 Internet services..............................................................................................28 Environmental regulations........................................................................................30 Patents, trademarks, licenses, certificates of public convenience and necessity, and military franchises.........31 Regulation, franchise authorizations and tariffs.................................................................32 Financial information about the Company's foreign and domestic operations and export sales.......................42 Seasonality......................................................................................................42 Customer sponsored research......................................................................................43 Backlog of orders and inventory..................................................................................43 Geographic concentration and Alaska economy......................................................................43 Employees........................................................................................................45 Other............................................................................................................45 Item 2. Properties.................................................................................................45 Item 3. Legal Proceedings..........................................................................................46 Item 4. Submission of matters to a vote of security holders........................................................46Part II................................................................................................................47 Item 5. Market for the registrant's common equity and related stockholder matters..................................47 Market Information for Common Stock..............................................................................47 Holders..........................................................................................................47 Dividends........................................................................................................47 Item 6. Selected Financial Data....................................................................................48 Item 7. Management's discussion and analysis of financial condition and results of operations......................49 Item 7A. Quantitative and qualitative disclosures about market risk................................................65 Item 8. Consolidated financial statements and supplementary data...................................................66 Item 9. Changes in and disagreements with accountants on accounting and financial disclosure.......................66Part III...............................................................................................................66Part IV................................................................................................................99 Item 14. Exhibits, consolidated financial statement schedules, and reports on Form 8-K.............................99 2 GLOSSARYACCESS CHARGES -- Expenses incurred by an IXC and paid to LECs for accessing thelocal networks of the LECs in order to originate and terminate long-distancecalls and provide the customer connection for private line services.ALASKA UNITED -- Alaska United Fiber System Partnership -- a Alaska partnershipwholly owned by the Company. Alaska United was organized to construct andoperate a new fiber optic cable connecting various locations in Alaska and thelower 49 states and foreign countries through Seattle, Washington.APUC -- ALASKA PUBLIC UTILITY COMMISSION -- A state regulatory body empowered toestablish and enforce rules and regulations governing public utility companiesand others, such as the Company, within the state of Alaska (sometimes referredto as Public Service Commissions, or PSCs, or Public Utility Commissions, orPUCs).ATM -- Asynchronous Transfer Mode -- An international ISDN high-speed,high-volume, packet-switching transmission protocol standard. ATM uses short,uniform, 53-byte cells to divide data into efficient, manageable packets forvery fast switching through a high-performance communications network. The53-byte cells contain 5-byte destination address headers and 48 data bytes. ATMis the first packet-switched technology designed from the ground up to supportintegrated voice, video, and data communication applications. It is well-suitedto high-speed WAN transmission bursts. ATM currently accommodates transmissionspeeds from 64 kilobytes per second to 622 megabits per second. ATM may supportgigabit speeds in the future.BASIC SERVICE -- The basic service tier includes, at a minimum, all signals ofdomestic television broadcast stations provided to any subscriber, any public,educational, and governmental programming required by the franchise to becarried on the basic tier, and any additional video programming service added tothe basic tier by the cable operator.BOC -- BELL SYSTEM OPERATING COMPANY -- A LEC owned by any of the remaining fiveRegional Bell Operating Companies, which are holding companies establishedfollowing the AT&T Divestiture Decree to serve as parent companies for the BOCs.BACKBONE -- A centralized high-speed network that interconnects smaller,independent networks.BANDWIDTH -- The number of bits of information which can move through acommunications medium in a given amount of time.BRI -- Basic Rate Interface -- An ISDN offering that allows two 64 kilobytes persecond "B" channels and one 16 kilobytes per second "D" channel to be carriedover one typical single pair of copper wires. The type of service that would beused to connect a small branch or home office to a remote network. Through theuse of Bonding (bandwidth on Demand) the two 64 kilobytes per second channelscan be combined to create more bandwidth as it becomes necessary. For dataservices such as Internet access, these channels can be bonded together toprovide 2B+D transmission at a rate of 128 kilobytes per second. New technologyincreases the bandwidth of ISDN BRI connections to 230 kilobytes per second.BROADBAND -- A high-capacity communications circuit/path, usually implying aspeed greater than 1.544 megabits per second.CAP -- Competitive Access Provider -- A company that provides its customers withan alternative to the LEC for local transport of private line and special accesstelecommunications services.CENTRAL OFFICES -- The switching centers or central switching facilities of theLECs. 3CLEC -- Competitive Local Exchange Carrier. -- A company that provides itscustomers with an alternative to the ILEC for local transport oftelecommunications services, as allowed under the 1996 Telecom Act.CO-CARRIER STATUS -- A regulatory scheme under which the incumbent LEC isrequired to integrate new, competing providers of local exchange service, intothe systems of traffic exchange, inter-carrier compensation, and otherinter-carrier relationships that already exist among LECs in most jurisdictions.COLLOCATION -- The ability of a CAP to connect its network to the LEC's centraloffices. Physical collocation occurs when a CAP places its network connectionequipment inside the LEC's central offices. Virtual collocation is analternative to physical collocation pursuant to which the LEC permits a CAP toconnect its network to the LEC's central offices on comparable terms, eventhough the CAP's network connection equipment is not physically located insidethe central offices.THE COMPANY -- GCI and its direct and indirect subsidiaries.COMPRESSION / DECOMPRESSION -- A method of encoding/decoding signals that allowstransmission (or storage) of more information than the media would otherwise beable to support. Both compression and decompression require processing capacity,but with many products, the time is not noticeable.CPS -- a Cable Programming Service -- (also known as CPST, Cable ProgrammingService Tier). CPS includes any video programming provided over a cable system,regardless of service tier, including installation or rental of equipment usedfor the receipt of such video programming, other than (1) video programmingcarried on the basic service tier, (2) video programming offered on apay-per-channel or pay-per-programming basis, or (3) a combination of multiplechannels of pay-per-channel or pay-per-programming basis so long as the combinedservice consists of commonly-identified video programming and is not bundledwith any regulated tier of service.DAMA -- Demand Assigned Multiple Access -- The Company's digital satellite earthstation technology that allow calls to be made between remote villages usingonly one satellite hop thereby reducing satellite delay and capacityrequirements while improving quality.DARK FIBER -- An inactive fiber-optic strand without electronics or optronics.Dark fiber is not connected to transmitters, receivers and regenerators.DBS -- Direct Broadcast Satellite -- Subscription television service obtainedfrom satellite transmissions using frequency bands that are internationallyallocated to the broadcast satellite services. Direct-to-home service such asDBS has its origins in the large direct-to-home satellite antennas which werefirst introduced in the 1970's for the reception of video programmingtransmitted via satellite. Because these first-generation direct-to-homesatellites operated in the C-band frequencies at low power, direct-to-homesatellite antennas, or dishes, as they are also known, generally needed to beseven to ten feet in diameter in order to receive the signals being transmitted.More recently, licensees have been using the Ku and extended Ku-bands to providedirect-to-home services enabling subscribers to use a receiving home satellitedish less than one meter in diameter.DS-3 -- A data communications circuit that is equivalent to 28 multiplexed T-1channels capable of transmitting data at 44.736 megabits per second (sometimescalled a T-3).DEDICATED -- Telecommunications lines dedicated or reserved for use byparticular customers.DIGITAL -- A method of storing, processing and transmitting information throughthe use of distinct electronic or optical pulses that represent the binarydigits 0 and 1. Digital transmission and switching technologies employ asequence of these pulses to represent information as opposed to the continuouslyvariable analog signal. The precise digital numbers minimize distortion (such asgraininess or snow in the case of video transmission, or static or otherbackground distortion in the case of audio transmission). 4DLC -- Digital Loop Carrier -- A digital transmission system designed forsubscriber loop plant. Multiplexes a plurality of circuits onto very few wiresor onto a single fiber pair.EQUAL ACCESS -- Connection provided by a LEC permitting a customer to beautomatically connected to the IXC of the customer's choice when the customerdials "1". Also refers to a generic concept under which the BOCs must provideaccess services to AT&T's competitors that are equivalent to those provided toAT&T.FCC -- Federal Communications Commission -- A federal regulatory body empoweredto establish and enforce rules and regulations governing public utilitycompanies and others, such as the Company.FDDI -- Fiber Distributed Data Interface -- Based on fiber optics, FDDI is a 100megabit per second LAN technology used to connect computers, printers, andworkstations at very high speeds. FDDI is also used as backbone technology tointerconnect other LANs.FRAME RELAY -- A wideband (64 kilobits per second to 1.544 megabits per second)packet-based data interface standard that transmits bursts of data over WANs.Frame-relay packets vary in length from 7 to 1024 bytes. Data oriented, it isgenerally not used for voice or video.GCC -- GCI Communication Corp., an Alaska corporation and a wholly ownedsubsidiary of HoldingsGCI -- General Communication, Inc., an Alaska corporation and the Registrant.GCI, Inc. -- a wholly owned subsidiary of GCI, an Alaska corporation and issuerof $180 million of publicly traded bonds.HOLDINGS -- a wholly owned subsidiary of GCI, Inc., an Alaska corporation andparty to the Company's Senior Holdings Loan.HSD -- Home Satellite Dish - see DBS.INBOUND "800" or "888" Service -- A service that assesses long-distancetelephone charges to the called party.ILEC -- Incumbent Local Exchange Carrier -- with respect to an area, the LECthat -- (A) on the date of enactment of the Telecommunications Act of 1996,provided telephone exchange service in such area; and (B)(i) on such date ofenactment, was deemed to be a member of the exchange carrier associationpursuant to section 69.601(b) of the FCC's regulations (47 C.F.R. 69.601(b)); or(ii) is a person or entity that, on or after such date of enactment, became asuccessor or assign of a member described in clause (i).INTEREXCHANGE -- Communication between two different LATAs.ISDN -- Integrated Services Digital Network -- A set of standards fortransmission of simultaneous voice, data and video information over fewerchannels than would otherwise be needed, through the use of out-of-bandsignalling. The most common ISDN system provides one data and two voice circuitsover a traditional copper wire pair, but can represent as many as 30 channels.Broadband ISDN extends the ISDN capabilities to services in the Gigabit range.(See BRI and PRI)ISP -- Internet Service Provider -- a company providing retail and/or wholesaleInternet services.INTERNET -- A global collection of interconnected computer networks which useTCP/IP, a common communications protocol.IXC -- Interexchange Carrier -- A long-distance carrier providing servicesbetween local exchanges. 5LAN -- Local Area Network -- The interconnection of computers for the purpose ofsharing files, programs and various devices such as printers and high-speedmodems. LANs may include dedicated computers or file servers that provide acentralized source of shared files and programs.LATA -- Local Access And Transport Area -- The approximately 200 geographicareas defined pursuant to the AT&T Divestiture Decree. The BOCs are generallyprohibited from providing long-distance service between the LATA in which theyprovide local exchange services, and any other LATA.LEC -- Local Exchange Carrier -- A company providing local telephone services.Each BOC is a LEC.LINE COSTS -- Primarily includes the sum of access charges and transportcharges.LMDS -- Local Multipoint Distribution System -- LMDS uses microwave signals(millimeterwave signals) in the 28 gHz spectrum to transmit voice, video, anddata signals within small cells 3-10 miles in diameter. LMDS allows licenseholders to control up to 1.3 gHz of wireless spectrum in the 28 gHz Ka-band. The1.3 gHz can be used to carry digital data at speeds in excess of one gigabit persecond. LMDS uses a specific band in the microwave spectrum, known as millimeterwaves or the 28 gHz "Ka-band." More tangibly, if LMDS were used on apoint-to-point basis the beam would be about as wide as a pencil lead (about amillimeter) and would have a frequency of approximately 28 billion cycles persecond. The extremely high frequency used and the need for point to multipointtransmissions limits the distance that a receiver can be from a transmitter.This means that LMDS will be a "cellular" technology, based on multiple,contiguous, or overlapping cells. LMDS is expected to provide customers withmultichannel video programming, telephony, video communications, and two-waydata services. Incumbent LECs and cable companies may not obtain the in-region1150 MHz license for three years. Within 10 years, licenses will be required toprovide 'substantial service' in their service regions.LOCAL EXCHANGE -- A geographic area generally determined by a PUC, in whichcalls generally are transmitted without toll charges to the calling or calledparty.LOCAL NUMBER PORTABILITY -- The ability of an end user to change Local ExchangeCarriers while retaining the same telephone number.LOWER 48 STATES or LOWER 48 -- refers to the 48 contiguous states south of orbelow Alaska.LOWER 49 STATES OR LOWER 49 -- refers to the 48 contiguous states south of orbelow Alaska and Hawaii.MAN -- Metropolitan Area Network -- LANs interconnected within roughly a 50 mileradius. MANs typically use fiber optic cable to connect various wire LANs.Transmission speeds may vary from 2 to 100 Megabits per second.MDU -- Multiple Dwelling Unit -- MDUs include multiple-family buildings, such asapartment and condominium complexes.MMDS -- Multichannel Multipoint Distribution Service - also known as wirelesscable. The Multipoint Distribution Service (MDS) was established by the FCC in1972. Originally the Commission thought MDS would be used primarily to transmitbusiness data. However, the service became increasingly popular in transmittingentertainment programming. Unlike conventional broadcast stations whosetransmissions are received universally, MDS programming is designed to reachonly a subscriber based audience. In 1983 the Commission reassigned eightchannels from the Instructional Television Fixed Service (ITFS) to MDS. Theseeight channels make up the MMDS. Frequently, MDS and MMDS channels are used incombination with ITFS channels to provide video entertainment programming tosubscribers. 6NARROWBAND -- A voice grade low-capacity communications circuit/path. It usuallyimplies a speed of 56 kilobits per second or less.NETWORK SWITCHING CENTER -- A location where installed switching equipmentroutes long-distance calls and records information with respect to calls such asthe length of the call and the telephone numbers of the calling and calledparties.NETWORK SYSTEMS INTEGRATION -- Involves the creation of turnkeytelecommunications networks and systems including: (i) route and site selection;(ii) rights of way and legal authorizations and/or acquisition; (iii) design andengineering of the system, including technology and vendor assessment andselection, determining fiber optic circuit capacity, and establishingreliability/flexibility standards; and (iv) project and construction management,including contract negotiations, purchasing and logistics, installation as wellas testing.NPT -- a New Product Tier -- a cable programming service tier offered tosubscribers at prices set by the cable operator.OCC -- Other Common Carrier -- A long-distance carrier other than the Company.PCS -- Personal Communication Services -- PCS encompasses a range of advancedwireless mobile technologies and services. It promises to permit communicationsto anyone, anyplace and anytime while on the move. The CellularTelecommunications Industry Association (CTIA) defines PCS as a "wide range ofwireless mobile technologies, chiefly cellular, paging, cordless, voice,personal communications networks, mobile data, wireless PBX, specialized mobileradio, and satellite-based systems." The FCC defines PCS as a "family of mobileor portable radio communications services that encompasses mobile and ancillaryfixed communications services to individuals and businesses and can beintegrated with a variety of competing networks."PBX -- Private Branch Exchange -- A customer premise communication switch usedto connect customer telephones (and related equipment) to LEC central officelines (trunks), and to switch internal calls within the customer's telephonesystem. Modern PBXs offer numerous software-controlled features such as callforwarding and call pickup. A PBX uses technology similar to that used by acentral office switch (on a smaller scale). (The acronym PBX originally stoodfor "Plug Board Exchange.")POP -- Point of Presence -- The physical access location interface between a LECand a IXC network. The point to which the telephone company terminates asubscriber's circuit for long-distance service or leased line communications.PRI -- Primary Rate Interface -- An ISDN circuit transmitting at T1 (DS-1) speed(equivalent to 24 voice-grade channels). One of the channels ("D") is used forsignaling, leaving 23 ("B") channels for data and voice communication.PRIVATE LINE -- Uses dedicated circuits to connect customer's equipment at bothends of the line. Does not provide any switching capability (unless supported bycustomer premise equipment). Usually includes two local loops and an IXCcircuit.PRIVATE NETWORK -- A communications network with restricted (controlled) access,usually made up of private lines (with some PBX switching).PUBLIC SWITCHED NETWORK -- That portion of a LEC's network available to allusers generally on a shared basis (i.e., not dedicated to a particular user).Traffic along the public switched network is generally switched at the LEC'scentral offices. 7RBOC -- Regional Bell Operating Company -- Any of the remaining five regionalBell holding companies which the AT&T Divestiture Decree established to serve asparent companies for the BOCs.RECIPROCAL COMPENSATION -- The same compensation of a new CLEC for terminationof a local call by the BOC on its network, as the new competitor pays the BOCfor termination of local calls on the BOC network.SCHOOLACCESS(TM) -- the Company's Internet and related services offering toschools in Alaska. The federal mandate through the 1996 Telecom Act to provideuniversal service resulted in schools across Alaska qualifying for varyinglevels of discounts to support the provision of Internet services. The UniversalService Administrative Company through its Schools and Libraries Divisionadministers this federal program.SDN -- Software Defined Network -- A switched long-distance service for verylarge users with multiple locations. Instead of putting together their ownnetwork, large users can get special usage rates for calls carried on regularswitched long-distance lines.SECURITIES REFORM ACT -- Private Securities Litigation Reform Act of 1996.SENIOR HOLDINGS LOAN -- Holding's $200,000,000 and $50,000,000 creditfacilities. See note 6(b) to the accompanying Notes to Consolidated FinancialStatements included in Part II of this Report.SETTLEMENT RATES -- The rates paid to foreign carriers by United Statesinternational carriers to terminate outbound (from the United States) switchedtraffic and by foreign carriers to United States international carriers toterminate inbound (to the United States) switched traffic.SMATV -- Satellite Master Antenna Television -- (also known as "private cablesystems") are multichannel video programming distribution systems that serveresidential, multiple-dwelling units ("MDUs"), and various other buildings andcomplexes. A SMATV system typically offers the same type of programming as acable system, and the operation of a SMATV system largely resembles that of acable system -- a satellite dish receives the programming signals, equipmentprocesses the signals, and wires distribute the programming to individualdwelling units. The primary difference between the two is that a SMATV systemtypically is an unfranchised, stand-alone system that serves a single buildingor complex, or a small number of buildings or complexes in relatively closeproximity to each other.SONET -- Synchronous Optical Network -- A 1984 standard for optical fibertransmission on the public network. 52 megabits per second to 13.22 Gigabits persecond, effective for ISDN services including ATM.TCP/IP -- Transmission Control Protocol/Internet Protocol -- A suite of networkprotocols that allows computers with different architectures and operatingsystem software to communicate with other computers on the Internet.T-1 -- A data communications circuit capable of transmitting data at 1.5megabits per second.TARIFF -- The schedule of rates and regulations set by communications commoncarriers and filed with the appropriate federal and state regulatory agencies;the published official list of charges, terms and conditions governing provisionof a specific communications service or facility, which functions in lieu of acontract between the subscriber or user and the supplier or carrier.TOKEN RING -- A local area network technology used to interconnect personalcomputers, file servers, printers, and other devices. Token Ring LANs typicallyoperate at either 4 megabits per second or 16 megabits per second.TRANSPORT CHARGES -- Expenses paid to facilities-based carriers for transmissionbetween or within LATAs. 8TRS SERVICES -- Telecommunications Relay Services -- Enables telephoneconversations between people with and without hearing or speech disabilities.TRS relies on communications assistants ("CA") to relay the content of callsbetween users of text telephones ("TTYs") and users of traditional handsets(voice users). For example, a TTY user may telephone a voice user by calling aTRS provider where a CA will place the call to the voice user and relay theconversation by transcribing spoken content for the TTY user and reading textaloud for the voice user.WAN -- Wide Area Network -- Remote computer communications system. WANs allowfile sharing among geographically distributed workgroups (typically at highercost and slower speed than LANs or MANs). WANs typically use common carriers'circuits and networks. WANs may serve as a customized communication backbonethat interconnects all of an organization's local networks with communicationstrunks that are designed to be appropriate for anticipated communication ratesand volumes between nodes.WORLD WIDE WEB or WEB -- A collection of computer systems supporting acommunications protocol that permits multi-media presentation of informationover the Internet.1984 CABLE ACT -- The Cable Communications Policy Act of 1984.1992 CABLE ACT -- The Cable Television Consumer Protection and Competition Actof 1992.1996 TELECOM ACT -- The Telecommunications Act of 1996 - The 1996 Telecom Actwas signed into law February 8, 1996. Under its provisions, BOCs can immediatelybegin manufacturing, research and development; GTE Corp. can begin providinginterexchange services through its telephone companies nationwide; laws in 27states that foreclose competition are knocked down; co-carrier status for CLECsis ratified; and the concept of physical collocation of competitors' facilitiesin LECs central offices, which an appeals court rejected, is resurrected.The legislation breaks down the old barriers that prevented three groups ofcompanies, the LECs, including the BOCs, the long-distance carriers, and thecable TV operators, from competing head-to-head with each other. The Actrequires LECs to let new competitors into their business. It also requires theLECs to open up their networks to ensure that new market entrants have a fairchance of competing. The bulk of the legislation is devoted to establishing theterms under which the LECs, and more specifically the BOCs, must open up theirnetworks.The 1996 Telecom Act substantially changed the competitive and regulatoryenvironment for telecommunications providers by significantly amending theCommunications Act including certain of the rate regulation provisionspreviously imposed by the Cable Television Consumer Protection and CompetitionAct of 1992 (the "1992 Cable Act"). The 1996 Telecom Act provides that rateregulation of the cable programming service tier will be phased out altogetherin 1999. Further, the regulatory environment will continue to change pending,among other things, the outcome of legal challenges and FCC rulemaking andenforcement activity in respect of the 1992 Cable Act and the completion of asignificant number of FCC rulemakings under the 1996 Telecom Act. 9 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTSExcept for the historical statements and discussions contained herein, certainstatements in this annual report on Form 10-K constitute forward-lookingstatements within the meaning of the Securities Reform Act. Any Form 10-K,Annual Report to Shareholders, Form 10-Q or Form 8-K of the Company may includeforward looking statements. In addition, other written or oral statements whichconstitute forward looking statements have been made and may in the future bemade by or on behalf of the Company, including statements concerning futureoperating performance, the Company's share of new and existing markets, theCompany's short- and long-term revenue and earnings growth rates, and generalindustry growth rates and the Company's performance relative thereto. Theseforward looking statements rely on a number of assumptions concerning futureevents, including the outcome of litigation, the adoption and implementation ofbalanced and effective rules and regulations by the FCC and the state publicregulatory agencies, and the Company's ability to achieve a significant marketpenetration in new markets. These forward looking statements are subject to anumber of uncertainties and other factors, many of which are outside theCompany's control, that could cause actual results to differ materially fromsuch statements.These statements may be preceded by, followed by, or include the words"believes," "expects, " "anticipates," or similar expressions. For thosestatements, the Company claims protection of the safe-harbor for forward-lookingstatements contained in the Securities Reform Act. The reader is cautioned thatimportant factors, such as the following risks, uncertainties, and otherfactors, in addition to those contained elsewhere in this document, could affectfuture results of the Company, its long-distance services, local accessservices, Internet services, cable services, and wireless services and couldcause those results to differ materially from those expressed in theforward-looking statements: - Material adverse changes in the economic conditions in the markets served by the Company; - The efficacy of the rules and regulations to be adopted by the FCC and state public regulatory agencies to implement the provisions of the 1996 Telecom Act; the outcome of litigation relative thereto; and the impact of regulatory changes relating to access reform; - The Company's responses to competitive products, services and pricing, including pricing pressures, technological developments, alternative routing developments, and the ability to offer combined service packages that include local, cable and Internet services; the extent and pace at which different competitive environments develop for each segment of the Company's business; the extent and duration for which competitors from each segment of the telecommunications industry are able to offer combined or full service packages prior to the Company being able to do so; the degree to which the Company experiences material competitive impacts to its traditional service offerings prior to achieving adequate local service entry; and competitor responses to the Company's products and services and overall market acceptance of such products and services; - The outcome of negotiations with ILECs and state regulatory arbitrations and approvals with respect to interconnection agreements; and the ability to purchase unbundled network elements or wholesale services from ILECs at a price sufficient to permit the profitable offering of local exchange service at competitive rates; - Success and market acceptance for new initiatives, many of which are untested; the level and timing of the growth and profitability of new initiatives, particularly local access services, Internet (consumer and business) services and wireless services; start-up costs associated with entering new markets, including advertising and promotional efforts; successful deployment of new systems and applications to support new initiatives; and local conditions and obstacles; - Uncertainties inherent in new business strategies, new product launches and development plans, including local access services, Internet services, wireless services, digital video services, cable modem services, and transmission services; 10 - Rapid technological changes; - Development and financing of telecommunication, local access, wireless, Internet and cable networks and services; - Future financial performance, including the availability, terms and deployment of capital; the impact of regulatory and competitive developments on capital outlays, and the ability to achieve cost savings and realize productivity improvements; - Availability of qualified personnel; - Changes in, or failure, or inability, to comply with, government regulations, including, without limitation, regulations of the Federal Communications Commission, the Alaska Public Utilities Commission, and adverse outcomes from regulatory proceedings; - The cost of the Company's year 2000 compliance efforts; - Uncertainties in federal military spending levels and military base closures in markets in which the Company operates. - Other risks detailed from time to time in the Company's periodic reports filed with the Securities and Exchange Commission.These forward-looking statements (and such risks, uncertainties and otherfactors) are made only as of the date of this report and the Company expresslydisclaims any obligation or undertaking to disseminate any updates or revisionsto any forward-looking statement contained in this document to reflect anychange in the Company's expectations with regard to those statements or anyother change in events, conditions or circumstances on which any such statementis based. Readers are cautioned not to put undue reliance on such forwardlooking statements. PART IItem 1. BUSINESS.GeneralGCI was incorporated in 1979 under the laws of the State of Alaska and has itsprincipal executive offices at 2550 Denali Street, Suite 1000, Anchorage, AK99503 (telephone number 907-265-5600). Internet users can access informationabout the Company and its services at http://www.gci.com/ andhttp://www.alaskaunited.com/. Internet services are hosted by the Company athttp://www.gci.net/.GCI is primarily a holding company and together with its direct and indirectsubsidiaries, is a diversified telecommunications provider with a leadingposition in facilities-based long-distance service in the State of Alaska and isAlaska's leading cable television and Internet services provider.The Company seeks to become the first significant provider in Alaska of anintegrated package of long-distance, local and wireless telecommunicationsservices, cable television services and Internet services that would be wellpositioned to take advantage of growth opportunities in the communications, dataand entertainment markets.Financial information about the Company's industry segmentsThe Company has four reportable segments: long-distance services, cableservices, local access services and Internet services.A full range of common-carrier long-distance and other telecommunicationservices are offered to business, government, other telecommunications companiesand consumer customers, through its networks of fiber optic cables, digitalmicrowave, and fixed and transportable satellite earth stations. Individuallyinsignificant business units including Network Solutions, cellular resale andproduct sales are included in the "other" industry segment. None of thesebusiness units have ever met the quantitative thresholds for determiningreportable segments. 11The Company provides cable television services to residential, commercial andgovernment users in the State of Alaska. The Company's cable systems serve 26communities and areas in Alaska, including the state's three largest urbanareas, Anchorage, Fairbanks and Juneau. Anchorage cable plant upgrades in 1998enabled the Company to offer digital cable television services and retail cablemodem service (through its Internet segment) in Anchorage, complementing itsexisting service offerings. The Company plans to expand its product offerings asplant upgrades in other communities in Alaska are completed.The Company introduced facilities based competitive local exchange services inAnchorage, Alaska in 1997. The Company has announced plans to provide similarcompetitive local exchange services in Alaska's other major population centers,as access is allowed by the APUC.The Company began offering wholesale and retail Internet services in 1998.Deployment of the new undersea fiber optic cable described below will allow theCompany to offer enhanced services with high-bandwidth requirements.For financial information with respect to industry segments of the Company, seenote 9 of the Notes to Consolidated Financial Statements included in Part II ofthis Report.Historical development of the Company's business during the past fiscal yearAlaska United Project. The Company undertook a major construction project(referred to as Alaska United) with the goal of significantly increasing itscommunications bandwidth to and from locations in Alaska and the lower 49 statesand through interconnection agreements with other carriers, to foreignlocations. After a preliminary route survey was completed and initial costcomponents determined, a detailed sea floor survey was commissioned andcompleted in 1996. The results of this survey pinpointed the exact route thatthe Alaska United fiber would take. The Company entered into a contract withTyco Submarine Systems, Ltd. ("TSS"), one of the world's leading submarine cablevendor which has installed more than 150,000 miles of undersea cable. TSS wasengaged to design, engineer, manufacture and install the undersea cable. Thecable was laid during the period from August to December 1998. Testing occurredafter that and services commenced in late January 1999 for the Anchorage toFairbanks segment and early February 1999 for the complete system. Withconstruction of Alaska United complete, the Company began to transition trafficfrom leased satellite, terrestrial and microwave facilities to Alaska Unitedfacilities in early February 1999.The Alaska United project provides a high capacity fiber optic link betweenpoints in Alaska and the lower 48 states through Seattle, Washington. AlaskaUnited lands at cable terminal stations in Whittier, Valdez and Juneau, Alaska.From Whittier, the fiber follows the Alaska railroad, highway, and over-landrights-of-ways to Anchorage. Between Whittier and Valdez, the Companyconstructed a second undersea fiber optic cable. The cable connects in Valdezwith a fiber constructed by Kanas Telecom, Inc. ("Kanas"). The Company exchangedDark Fiber with Kanas to obtain facilities from Valdez to Fairbanks. In Juneauand Seattle, Alaska United connects through terminal stations to the Company'sexisting network. The cable terminal stations house the power feed equipmentnecessary to power the undersea fiber optic cable system and the SONET equipmentwhich transports data across the terrestrial network and the undersea fibernetwork.The Alaska United system is 2,331 miles long (1,995 miles undersea and 336 overland) and has a total design capacity of 10 billion bits per second (22 timeswhat was currently available). It can route traffic in different directions inthe event of equipment failures, and once paired with the Company's existingcapacity on the North Pacific Cable, users can achieve route diversity toachieve multiple fiber paths for back-up purposes. It will deliver a minimum of32,256 simultaneous clear channel voice or data circuits at transmission speedsof 2.5 billion bits per second. As demand increases, capacity can be quadrupledto support a minimum of 129,024 simultaneous clear channel voice or datacircuits at speeds of 10 billion bits per second. The only other fiber opticcable connecting Alaska with the contiguous United States had reached itscapacity limit of 6,048 simultaneous voice or data circuits at transmissionspeeds of 420 million bits per second. 12Financing for the Alaska United undersea fiber project included $75 millionthrough a separate bank credit agreement dated January 27, 1998 and $50 millionfrom funds raised through the 1997 issuance of senior notes. See note 6 to theaccompanying Notes to Consolidated Financial Statements included in Part II ofthis Report.Local Access Services. The Company began offering local exchange services inAnchorage in September 1997 and provided service to approximately 28,300 and3,300 lines at December 31, 1998 and 1997, respectively.The Company's local access services face significant competition from themunicipally owned utility Anchorage Telephone Utility ("ATU") and AT&T Alascom,Inc. In October 1998 the Municipality of Anchorage approved AlaskaCommunications Systems, Inc.'s ("ACS") offer to acquire the operations of ATU.ACS is an entity formed by Fox Paine & Company, LLC ("Fox Paine") and amanagement team led by former executives of Pacific Telecom, Inc. ("PTI"). Thesale of ATU was approved by the citizens of the Municipality in April 1998.Consummation of the transaction is subject to regulatory approval and otherconditions.Century Telephone Enterprises, Inc. ("CenturyTel") reported in August 1998 thatit entered into a definitive agreement to sell the stock of its Alaskaoperations to ALEC Acquisition Corporation ("ALEC"). ALEC is led by formerexecutives of PTI and Fox Paine. It is anticipated that the transaction willclose in the second quarter 1999, subject to regulatory approvals and customaryclosing conditions. CenturyTel acquired the Alaska properties as part of the PTIacquisition completed in December 1997.Due to uncertainties surrounding regulatory approvals and possible newrequirements that may be imposed by regulatory authorities, the Company is notable to determine if the sale of ATU or the CenturyTel properties will have amaterial effect on the Company's financial position, results of operations orliquidity.PTI, through subsidiary companies, provides local telephone services inFairbanks and Juneau, Alaska. Although the PTI subsidiaries are classified asRural Telephone Companies under the 1996 Telecom Act, PTI is currently owned byCentury Telephone Company of Louisiana, one of the largest independent telephonecompanies in the Nation. PTI subsidiaries' legal status entitles them to anexemption of certain material interconnection terms of the 1996 Telecom Act,until such "rural exemption" is lifted by the State of Alaska. The Companyrequested that continuation of the "rural exemption" of the PTI subsidiariesrelating to the Fairbanks and Juneau markets be examined. In January 1998, theAPUC denied the Company's request to terminate the rural exemption. The basis ofthe APUC's decision was primarily that various rulemaking proceedings (includingUniversal Service and access charge reform) must be completed before theexemption would be revoked. Those rulemaking proceedings have been largelycompleted. Further, in March 1999 the Company received a favorable decision onits appeal of the APUC decision, and the issues have been remanded to the APUCfor proceedings leading to a decision on or before July 2, 1999. Otherlegislative and judicial efforts are also underway to achieve a change in theAPUC ruling. The Company may, however, provide local service on its ownfacilities to a limited number of consumers in Juneau and Fairbanks.The Company believes local access services competition is in the best interestsof consumers and intends to vigorously pursue before the APUC in the remandedproceedings that the "rural exemption" not be continued for the Fairbanks andJuneau markets. The Company cannot, however, predict the effect that ongoing orfuture regulatory developments might have on competitive local access servicesmarkets in Alaska or on the Company specifically. See Part I, Item 1. Business,Regulation, Franchise Authority and Tariffs.Cable Services Expansion. The Company completed an $11.5 million upgrade to itsAnchorage cable infrastructure in 1998 that significantly increased the capacityand reliability of the system, made it possible to support two-way applicationssuch as cable modems (as further described below) and digital cable televisionprogramming, and provides the capacity for additional program offerings.Digital cable television services were offered in Anchorage in 1998, offeringenhanced picture and audio quality, over 100 channels of programs, 40 channelsof digital music, and many channels of premium and pay-per-view products. 13Internet Services. The Company's statewide SchoolAccess(TM) services (Internetaccess and related products and services for Alaska schools) commenced January1998.GCI began a limited rollout of its dial-up Internet service in April 1998, whichallowed the Company to test its new state-of-the-art Internet platform. TheCompany began its broad based offering in October 1998 and initiated a majorpromotion in February 1999. Services were initially offered to residents ofAnchorage, Fairbanks, Kodiak, Juneau, Kenai, Soldotna, Palmer and Wasilla,Alaska. Other Alaska communities were added over the next several months andcontinue to be added. GCI.net service supports 56 kilobit per second dial-upconnections with support for both V.90 and Kflex technologies. The Companybelieves its service has one of the best first-try connect rates and the fastestspeeds available of any provider in Alaska. The Company plans to introduceadditional service upgrades and promotional offerings in the future.The Company began a limited introduction of cable modem services in 1998,providing high-speed, dedicated access to the Internet.Satellite Transponders. The Company entered into a purchase and lease-purchaseoption agreement in August 1995 for the acquisition of satellite transponders tomeet its long-term satellite capacity requirements. The launch of the satellitein August 1998 failed. The Company did not assume launch risk and the launch hasbeen rescheduled for the fourth quarter of 1999. The Company will continue tolease transponder capacity until the delivery of the transponders on thereplacement satellite.Rural Equal Access. In 1996 the Company constructed 56 new earth stations inWestern and Northern Alaska. As construction of those DAMA stations werecompleted, the Company requested Equal Access from the LECs serving thosecommunities. Under Federal Communications Commission rules, substantially allLECs have three years to comply with an equal access request. The three yeartime period is expiring for many of those locations and LECs startedimplementing the equal access conversion process in late 1998 and will continueto convert locations though March 1999. As a result, approximately 34 ruralDAMA-served communities will be converted during this period to equal accessenabling the Company's customers to access its network without dialing extradigits.PCS and LMDS licenses. The Company began developing plans for PCS wirelesscommunications service deployment in 1995 and subsequently conducted a technicaltrial of its candidate technology. The Company has invested approximately $2.2million in its PCS license at December 31, 1998. PCS licensees are required tooffer service to at least one-third of their market population within five yearsor risk losing their licenses. Service must be extended to two-thirds of thepopulation within 10 years. The Company invested approximately $275,000 in itsLMDS license in 1998. LMDS licensees are required to provide 'substantialservice' in their service regions within 10 years. The Company is currentlyevaluating its wireless strategy and expects to complete such evaluation withinthe next six months. The Company expects that its wireless strategy will allowretention of the PCS and LMDS licenses pursuant to their terms.Narrative description of the business done and intended to be done by theCompanyGeneralThe Company operates a broadband communications network that permits thedelivery of a seamless integrated bundle of communications, entertainment andinformation services. The Company offers a wide array of consumer communicationsand entertainment services--including local telephone, long-distance andwireless communications, cable television, consulting services, network anddesktop computing outsourced services, and dial-up and cable modem Internetaccess services at a wide range of speeds--all under the GCI brand name.The Company's management believes that the size and growth potential of thevoice, video and data market, the increasing deregulation of telecommunicationservices, and the increased convergence of telephony, wireless, and cableservices offer the Company considerable opportunities to integrate itstelecommunication, Internet and cable services and expand into communicationsmarkets both within and, longer-term, outside of Alaska. The 14Company's management expects the rate of growth in industry-widetelecommunication revenues to continue to increase as the historical dominanceof monopoly providers is challenged as a result of deregulation. Considerablederegulation has already taken place in the United States as a result of the1996 Telecom Act with the barriers to competition between long-distance, localexchange and cable providers being lowered. The Company's management believesthat its acquisition of cable television systems and its development of localexchange service, Internet services, and wireless services leave it wellpositioned to take advantage of deregulated markets.The Company is one of Alaska's leading providers of telecommunication, Internetand cable television services and maintains a strong competitive position. Thereis active competition in the sale of substantially all products and servicesoffered by the Company.For calendar year 1998, the Company estimates that the aggregatetelecommunications, cable television, and Internet markets in Alaska generatedrevenues of approximately $931 million. Of this amount, approximately $475million was attributable to interstate and intrastate long-distance service,$327 million was attributable to local exchange services, $72 million wasattributed to cable television, $38 million was attributable to wirelesscommunications services, and $19 million was attributable to Internet services.Alaska Voice, Video and Data MarketsThe Alaskan voice, video and data markets are unique within the United States.Alaska is physically distant from the rest of the United States and ischaracterized by large geographical size and relatively small, dense populationclusters (with the exception of population centers such as Anchorage, Fairbanksand Juneau). It lacks a well-developed terrestrial transportationinfrastructure, and the majority of Alaska's communities are accessible only byair or water. As a result, Alaska's telecommunication networks are differentfrom those found in the lower 49 states.Alaska today relies extensively on satellite-based long-distance transmissionfor intrastate calling between remote communities where investment in aterrestrial network would be uneconomic or impractical. Also, given theremoteness of Alaska's communities and lack, in many cases, of major civicinstitutions such as hospitals, libraries and universities, Alaskans aredependent on telecommunications to access the resources and information of largemetropolitan areas in the rest of the U.S. and elsewhere. In addition tosatellite-based communications, the telecommunications infrastructure in Alaskaincludes traditional copper wire, digital microwave links between Anchorage andFairbanks and Juneau and fiber optic cable. For interstate and internationalcommunication, Alaska is currently connected to the lower 49 states by twoundersea fiber optic cables with a current capacity of 57 DS3s (can be upgradedto 201 DS3s) and is backed-up by additional satellite capacity.Fiber optics is the preferred method of carrying Internet, voice, video and datacommunications, eliminating the delay commonly found in satellite connections.Widespread use of high capacity fiber optic facilities will allow expansion ofbusiness, government and educational infrastructure in Alaska.Long-Distance ServicesIndustry. With the Communications Act of 1934, telecommunications wasestablished as a regulated industry. The main objective of this act was tocreate an affordable and universal telephone service for the American people. Asa result, AT&T was granted exclusive rights to serve the telecommunicationsindustry. The next several decades brought significant improvements intechnology. New advances created opportunities for providers of lower-costservices to enter the market, and in order to facilitate the entry of these newcompetitors, regulatory policies were changed. The government stepped into themarket on January 1, 1984, and broke-up AT&T's near monopoly. The government'sobjective was to provide for greater competition in the telecommunicationsindustry, as well as make room for the creation of more diversified products.The Federal Communications Commission set price caps in 1989 to regulate theprices that AT&T could charge for their services. Yet, by 1991 the market hadbecome so much more competitive with regards to both long-distance and localcalls, that the FCC decided to deregulate most of AT&T's services. 15The United States Congress passed the 1996 Telecom Act that permitted the localphone companies, the long-distance companies, and the cable service firms topenetrate each other's market. This has provided the telecommunications industrywith new capabilities resulting in an industry that is more competitive thanever before. To reduce the burden and facilitate competitive advantages,companies are merging and acquiring other telecommunication and cable televisionfirms.The long-distance telephone services market according to the Standard and Poor'stelecommunication survey is worth over $68 billion. AT&T is the main contributorto this sum, contributing over 50% of the total revenues. The rest of the shareof the revenues is contributed by MCI WorldCom, Sprint Corp. ("Sprint"), andover 400 smaller firms. Under new regulations, BOCs and ILECs are able to enterthe long-distance market, providing additional competitive pressures on theindustry. To retain customers, as in the case of the long-distance carriers, andto win customers for the new competitors, rates may continue to be reduced.Advancements within the next few years are expected to combine services directedtoward voice communication with other activities such as data sharing, on-screencollaboration, faxing, and game playing, among many other things.The Company believes that the telecommunications industry in 1999 will besignificantly impacted by federal and state regulators. Consummation of mergersbetween long-distance companies, local access services companies, and cabletelevision companies is expected continue to blur the distinction betweenproduct lines and competitors. Synergies developed through mergers andacquisitions and obtaining end-to-end connectivity with customers is expected todrive profitability and success in penetrating new markets. Industry analystsbelieve that successful competitors will be the companies that can minimizeregulatory battles and begin to offer a full suite of integrated services totheir customers, using a network that is largely under their control.Growth in data is expected to be a key component of continuing industry revenuegrowth. ISPs have become major customers and many long-distance companies haveacquired ISPs and web-hosting companies.General. The Company supplies a full range of common-carrier long-distance andother telecommunication products and services. The Company operates astate-of-the-art, competitive telecommunications network employing the latestdigital transmission technology based upon fiber optic and digital microwavefacilities within and between Anchorage, Fairbanks and Juneau, including aself-constructed and financed digital fiber optic cable and additional ownedcapacity on another undersea fiber optic cable, both linking Alaska to thenetworks of other carriers in the lower 49 states, and the use of satellitetransmission to remote areas of Alaska (and for certain inter-state traffic aswell). Virtually all switched services are computer controlled, digitallyswitched, and interconnected by a packet switched signaling network.The Company provides interstate and intrastate long-distance services throughoutAlaska using its own facilities or facilities leased from other carriers. TheCompany also provides (or joins in providing with other carriers)telecommunication services to and from Alaska, Hawaii, the lower 48 states, andmany foreign nations and territories.The Company offers cellular services by reselling other cellular providers'services. The Company expects to offer wireless services over its ownfacilities, and has purchased in FCC auctions PCS and LMDS wireless broadbandlicenses covering markets in Alaska. The Company is required by the FCC toprovide adequate broadband PCS service to at least one-third of the populationin its licensed areas within five years of being licensed and two-thirds of thepopulation in its licensed areas within ten years of being licensed. The Companyis required by the FCC to provide `substantial service' in its service regionwithin 10 years to retain its LMDS license. The licenses are granted for tenyear terms from the original date of issuance and may be renewed by the Companyby meeting the FCC's renewal criteria and upon compliance with the FCC's renewalprocedures. 16Products. The Company's long-distance services industry segment is engaged inthe transmission of interstate and intrastate switched MTS and private line andprivate network communication service between the major communities in Alaska,and the remaining United States and foreign countries. The Company's messagetoll services include intrastate, interstate and international direct dial,toll-free 800, 888 and 877 services, 900 services, GCI calling card, debit card,operator and enhanced conference calling, frame relay, SDN, ISDN technologybased services, as well as termination of northbound toll service for MCIWorldCom, Sprint and several large resellers who do not have facilities of theirown in Alaska. The Company also provides origination of southbound calling cardand toll-free 800, 888 and 877 toll services for MCI WorldCom and Sprint.Regulated telephone relay services for the deaf, hard-of-hearing and speechimpaired are provided through the Company's operator service center. The Companyoffers its message services to commercial, residential, and governmentsubscribers. Subscribers may generally cancel service at any time. Toll relatedservices account for approximately 65.0%, 70.0%, and 86.0% of the Company's1998, 1997, and 1996 revenues, respectively. Private line and private networkservices utilize voice and data transmission circuits, dedicated to particularsubscribers, which link a device in one location to another in a differentlocation.The Company has positioned itself as a price and customer service leader in theAlaska telecommunication market. Rates charged for the Company's long-distanceservices are designed to be equal to or below those for comparable servicesprovided by its competitors.In addition to providing communication services, the Company also designs,sells, services and operates, on behalf of certain customers, dedicatedcommunication and computer networking equipment and provides field/depot, thirdparty, technical support, telecommunications consulting and outsourcing servicesthrough its Network Solutions business. The Company also supplies integratedvoice and data communication systems incorporating interstate and intrastatedigital private lines, point-to-point and multipoint private network and smallearth station services. The Company's Network Solutions sales and servicesrevenue totaled $13.3, $10.2 and $10.8 million in the years ended December 31,1998, 1997 and 1996, respectively, or approximately 5.4%, 4.5% and 6.6% of totalrevenues, respectively. Presently, there are five companies in Alaska thatactively sell and maintain data and voice communication systems.The Company's ability to integrate telecommunications networks and datacommunication equipment has allowed it to maintain its market position on thebasis of "value added" support services rather than price competition. Theseservices are blended with other transport products into unique customersolutions, including managed services and outsourcing.Facilities. Currently, the Company's telecommunication facilities comprise majorearth stations at Eagle River, Fairbanks, Juneau, Prudhoe Bay, Valdez, Kodiak,Sitka, Ketchikan, Unalaska and Cordova, all in Alaska and at Issaquah,Washington, serving the communities in their vicinity. The Eagle River andFairbanks earth stations are linked by digital microwave facilities todistribution centers in Anchorage and Fairbanks, respectively. The Issaquahearth station is connected with the Seattle distribution center by means ofdiversely routed fiber optic cable transmission systems, each having thecapability to restore the other in the event of failure. The Juneau earthstation and distribution centers are colocated. The Ketchikan, Prudhoe Bay,Valdez, Kodiak, Sitka, Unalaska and Cordova installations consist only of anearth station. The Company constructed microwave facilities serving the KenaiPeninsula communities and owns a 49 percent interest in an earth station locatedon Adak Island in Alaska. The Company maintains an operator service center inWasilla, Alaska. Each of the distribution centers contains electronic switchesto route calls to and from local exchange companies and, in Seattle, to obtainaccess to MCI WorldCom, Sprint and other facilities to distribute the Company'ssouthbound traffic to the remaining 49 states and international destinations.The Company, using its DAMA facilities, expanded its network to 56 additionallocations within the State of Alaska in 1996. The digital DAMA system allowscalls to be made between remote villages using only one satellite hop therebyreducing satellite delay and capacity requirements while improving quality. TheCompany obtained the necessary APUC and FCC approvals waiving currentprohibitions against construction of competitive facilities in rural Alaska,allowing for deployment of DAMA technology in 56 sites in rural Alaska 17on a demonstration basis. Construction and partial deployment occurred in 1996,with deployment completed in 1997. All sites were operational at December 31,1998.As described previously, the Company completed construction and placed intoservice in February 1999 a fiber optic cable connecting Anchorage, Whittier,Valdez, Fairbanks and Juneau, Alaska and Seattle Washington. The Company alsoowns a portion of an additional undersea fiber optic cable. The fiber opticcables allow the Company to carry its Anchorage, Eagle River, Wasilla, Palmer,Kenai Peninsula, Valdez, Whittier, Glenallen, Fairbanks, and Juneau area trafficto and from the contiguous lower 48 states over terrestrial circuits,eliminating the one-quarter second delay associated with satellite circuits. TheCompany's preferred routing for this traffic is via undersea fiber optic cable,which makes available satellite capacity to carry the Company's rural interstateand intrastate traffic.The Company employs satellite transmission for rural intrastate traffic andcertain other major routes and uses advanced digital transmission technologythroughout its system. Pursuant to a purchase and lease-purchase optionagreement entered into in August 1995 the Company leases C-band transponders onHughes Communications Galaxy, Inc. (now PanAmSat Corporation ("PanAmSat"))Galaxy IX satellite and has agreed to acquire satellite transponders on PanAmSatGalaxy XR satellite to meet its long-term satellite capacity requirements. TheGalaxy XR satellite is expected to be placed in service during the fourthquarter of 1999.The Company employs advanced transmission technologies to carry as many voicecircuits as possible through a satellite transponder without sacrificing voicequality. Other technologies such as terrestrial microwave systems, metalliccable, and fiber optics tend to be favored more for point-to-point applicationswhere the volume of traffic is substantial. With a sparse population spread overa wide geographic area, neither terrestrial microwave or fiber optictransmission technology will be economically feasible in rural Alaska in theforeseeable future.Customers. The Company had approximately 82,000, 89,000 and 93,900 active Alaskasubscribers to its message telephone service at December 31, 1998, 1997 and1996, respectively. Approximately 12,100, 11,500 and 11,000 of these werebusiness and government users at December 31, 1998, 1997 and 1996, respectively,and the remainder were residential customers. Reductions in residential customercounts are primarily attributed to new competitive pressures in Anchorage andother markets served by the Company. MTS revenues averaged approximately $11.1million per month during 1998.Equal access conversions have been completed in all communities served withCompany owned facilities. The Company estimates that it carries over 40% ofbusiness MTS traffic and approximately 35% of residential MTS traffic as astatewide average for both originating interstate and intrastate traffic.A summary of switched MTS traffic minutes follows: Interstate Minutes --------------------------------------- Combined Interstate Inter- and Inter- Intra- South- North- Calling national national state TotalFor Quarter ended bound bound Card Minutes Minutes Minutes Minutes- ---------------------------------------------------------------------------------------------------------------------- (amounts in thousands) March 31, 1996 76,369 49,158 6,094 1,890 133,511 28,910 162,421 June 30, 1996 81,753 51,465 6,049 1,964 141,231 30,671 171,902 September 30, 1996 86,094 52,856 6,453 1,896 147,299 31,253 178,552 December 31, 1996 82,255 55,675 7,863 1,774 147,567 30,374 177,941 ----------------------------------------------------------------------------------------- Total 1996 326,471 209,154 26,459 7,524 569,608 121,208 690,816 ========================================================================================= 18 Interstate Minutes --------------------------------------- Combined Interstate Inter- and Inter- Intra- South- North- Calling national national state TotalFor Quarter ended bound bound Card Minutes Minutes Minutes Minutes- ---------------------------------------------------------------------------------------------------------------------- (amounts in thousands) March 31, 1997 83,284 56,588 8,110 1,741 149,723 32,020 181,743 June 30, 1997 85,933 58,420 7,189 1,795 153,337 34,405 187,742 September 30, 1997 93,510 60,390 5,530 1,842 161,272 34,755 196,027 December 31, 1997 87,657 61,992 5,157 1,703 156,509 31,962 188,471 ----------------------------------------------------------------------------------------- Total 1997 350,384 237,390 25,986 7,081 620,841 133,142 753,983 ========================================================================================= March 31, 1998 86,899 64,116 4,810 1,889 157,714 33,082 190,796 June 30, 1998 93,817 67,296 4,353 1,910 167,376 34,890 202,266 September 30, 1998 103,423 61,690 4,227 1,940 171,280 35,748 207,028 December 31, 1998 90,792 61,514 4,197 1,706 158,209 33,598 191,807 ----------------------------------------------------------------------------------------- Total 1998 374,931 254,616 17,587 7,445 654,579 137,318 791,897 =========================================================================================All minutes data were taken from the Company's billing statistics reports.In 1993, the Company entered into a significant business relationship with MCI(now MCI WorldCom) which includes the following agreements: - the Company agreed to terminate all Alaska-bound MCI long-distance traffic and MCI agreed to terminate all of the Company's long-distance traffic terminating in the lower 49 states excluding Washington, Oregon and Hawaii; - MCI licensed certain service marks to the Company for use in Alaska; - MCI, in connection with providing to the Company credit enhancement to permit the Company to purchase a portion of an undersea cable linking Seward, Alaska, with Pacific City, Oregon, leased from the Company all of the capacity owned by the Company on the undersea fiber optic cable and the Company leased such capacity back from MCI; - MCI purchased certain service marks of the Company; and - the parties agreed to share some communications network resources and various marketing, engineering and operating resources. The Company also handles MCI's 800, 888 and 877 traffic originating in Alaska and terminating in the lower 49 states and handles traffic for MCI's calling card customers when they are in Alaska. Concurrently with these agreements, MCI purchased approximately 31% (19.1% as of December 31, 1998) of GCI's Common Stock and presently controls nominations to two seats on the Board. In conjunction with the Cable Acquisition Transactions, MCI purchased an additional two million shares at a premium to the then current market price for $13 million or $6.50 per share.Revenues attributed to MCI WorldCom in 1998, and MCI in 1997 and 1996 totaled$35.9 million, $34.3 million and $29.2 million, or 14.5%, 15.3% and 17.7% oftotal revenues, respectively. The contract was amended in March 1996 extendingits term three years to March 31, 2001. The amendment also reduced the rate indollars to be charged by the Company for certain MCI WorldCom traffic for theperiod April 1, 1996 through July 1, 1999 and thereafter.In 1993 the Company entered into a long-term agreement with Sprint, pursuant towhich the Company agreed to terminate all Alaska-bound Sprint long-distancetraffic and Sprint agreed to handle substantially all of the Company'sinternational traffic. Services provided pursuant to the contract with Sprintresulted in revenues in 191998, 1997 and 1996 of approximately $25.4 million, $24.4 million and $18.8million, or approximately 10.3%, 10.9% and 11.4% of total revenues,respectively.With the contracts and amendment described above, the Company is assured thatMCI WorldCom and Sprint, the Company's two largest customers, will continue tomake use of the Company's service during the extended term. Both MCI WorldComand Sprint are major customers of the Company in its long-distance servicesindustry segment. Loss of one or both of these customers would have asignificant detrimental effect on the Company's revenues and contribution. Thereare no other individual customers, the loss of which would have a materialimpact on the Company's revenues or gross profit.Other common carriers traffic routed to the Company for termination in Alaska islargely dependent on traffic routed to MCI WorldCom and Sprint by theircustomers. Pricing pressures, new program offerings and market consolidationcontinue to evolve in the markets served by MCI WorldCom and Sprint. If, as aresult, their traffic is reduced, or if their competitors' costs to terminate ororiginate traffic in Alaska are reduced, the Company's traffic will also likelybe reduced, and the Company's pricing may be reduced to respond to competitivepressures. The Company is unable to predict the effect on the Company of suchchanges, however given the materiality of other common carriers revenues to theCompany, a significant reduction in traffic or pricing could have a materialadverse effect on the Company's financial position, results of operations andliquidity.The Company provided private line and private network communication products andservices, including SchoolAccess(TM) private line facilities, to approximately1,269 commercial and government accounts in 1998. Approximately 7.9%, 7.1% and8.5% of total revenues were generated by these products and services during theyears ended December 31, 1998, 1997 and 1996, respectively.Although the Company has several agreements to facilitate the origination andtermination of international toll traffic, it has neither foreign operations norexport sales (see Part I, Item 1. Business, Foreign and Domestic Operations andExport Sales).Competition. The long-distance industry is intensely competitive, rapidlyevolving and subject to constant technological change. Competition is based uponprice and pricing plans, the types of services offered, customer service,billing services, perceived quality, reliability and availability. Certain ofthe Company's competitors are substantially larger and have greater financial,technical and marketing resources than the Company. Although the Companybelieves it has the human and technical resources to pursue its strategy andcompete effectively in this competitive environment, its success will dependupon its ability to profitably provide high quality, high value services atprices generally competitive with, or lower than, those charged by itscompetitors.In the long-distance market, the Company competes against AT&T Alascom, ATU, theMatanuska Telephone Cooperative, certain smaller rural LEC affiliates, and mayin the future compete against new market entrants. AT&T Alascom, the Company'sprincipal competitor in long-distance services, has substantially greaterresources than the Company. This competitor's interstate rates are integratedwith those of AT&T Corp. and are regulated in part by the FCC. While the Companyinitially competed based upon offering substantial discounts, those discountshave been eroded in recent years due to lowering of prices by AT&T Alascom andentry of other competitors into the long-distance markets served by the Company.Under the terms of AT&T's acquisition of Alascom, AT&T Alascom rates andservices must mirror those offered by AT&T, so changes in AT&T prices indirectlyaffect the rates and services of the Company. AT&T's and AT&T Alascom'sinterstate prices are regulated under a price cap plan whereby their rate ofreturn is no longer regulated or restricted. Price increases by AT&T and AT&TAlascom generally improve the Company's ability to raise its prices while pricedecreases pressure the Company to follow. The Company believes it has, so far,successfully adjusted its pricing and marketing strategies to respond to AT&Tand other competitors' pricing practices. However, if competitors significantlylower their rates, the Company may be forced to reduce its rates, which couldhave a material adverse effect on the Company. 20As allowed under the 1996 Telecom Act, ATU and other LECs entered the interstateand international long-distance market, and pursuant to APUC authorization,entered the intrastate long-distance market in 1997. ATU and other LECs resellother carriers' services in the provision of their interstate and intrastatelong-distance servicesA carrier has publicly announced that it has begun construction of fiber opticfacilities connecting points in Alaska to the lower 48 states, with serviceexpected to commence in 1999. An additional fiber system would provide directcompetition to the Company's provision of service on its owned fiber opticfacilities. The Company believes it can successfully compete with products andservices offered by the competing carrier.In the wireless communications services market, the Company's PCS businessexpects to compete against the cellular subsidiaries of AT&T and ATU in theAnchorage market and the cellular subsidiaries of PTI and others outside ofAnchorage.Cable ServicesIndustry. The programmed video services industry includes traditional broadcasttelevision, cable television, wireless cable, and DBS systems. Cable televisionproviders have added non-broadcast programming, utilized improved technology toincrease channel capacity and expanded service markets to include more denselypopulated areas and those communities in which off-air reception is notproblematic. Broadcast television stations including network affiliates andindependent stations generally serve the urban centers. One or more localtelevision stations may serve smaller communities. Rural communities may notreceive local broadcasting or have cable systems but may receive directbroadcast programming via a satellite dish.In Alaska, cable television was introduced in the 1970s to provide televisionsignals to communities with few or no available off-air television signals andto communities with poor reception or other reception difficulties caused byterrain interference. Since that time, as on the national level, the cabletelevision providers in Alaska have added non-broadcast programming.Advancements in technology, facility upgrades and network expansion to enablemigration to digital programming are expected to have a significant impact oncable services in the future. The industry is expected to be challenged bychanging federal, state and local regulations, intense competition, anduncertain technologies and standards.Acquisitions and mergers are shaping the cable industry in a technologicalconvergence similar to what is happening in the telecommunications industry.AT&T has received stockholder and regulatory approvals and closed its $48billion takeover of cable television provider Tele-Communications Inc. inFebruary 1999, gaining the last mile connection to homeowners with fiber andcoaxial cable over which it is expected to sell online access and Internet phoneservice. AT&T is also negotiating with other cable companies for access to theirlines.Convergence of TV and the Internet isn't expected to become a widespreadphenomenon until at least 2000. Analysts expect that as many as 5 million cablesubscribers may sign up in 1999 for high-speed cable modems that will give themaccess to the Internet. The Company is currently offering such high-speed cablemodem access in the Anchorage area.Basic cable pricing is expected to be impacted by two forces; possiblereimposition of rate regulations and additional competition from wireless cableproviders. After averaging 3.4% growth for the last five years, industryanalysts project that cable subscriber growth in 1999 may slow to 1.8%, or 66.6million homes. Industry analysts predict that cable providers may see a 12% hikein ad revenues, to $6.9 billion.Direct-broadcast satellite operators increased their subscriptions byapproximately 39% in 1998, to 8.9 million, according to industry analysts. Theindustry is expected to add 2.6 million subscribers in 1999. With digitaltransmissions and compression, cable operators are better able to offer avariety and quality of channels to rival DBS, with pay-per-view choices that canapproximate video-on-demand. 21Digital video is projected to grow significantly over the next three to fouryears as cable network upgrade efforts are completed and the cost of digitalset-top technology decreases. Margins related to digital programming areexpected to climb due to the ability to reuse programming at low or noincremental cost.Analysts believe data services will be an additional opportunity for cableproviders in the next three to five years and that cable will be the most widelyavailable, most cost efficient way to access the Internet at very high speedsand with high video quality. The incremental opportunity for cable from data mayrival that of digital video according to industry analysts. Additionalopportunities are expected in voice-over cable applications that will allowcable providers to offer local telephone service to cable subscribers.The market for programmed video services in Alaska includes traditionalbroadcast television, cable television, wireless cable, and DBS systems.Broadcast television stations including network affiliates and independentstations serve the urban centers in Alaska. Seven, four and two broadcaststations serve Anchorage, Fairbanks and Juneau, respectively. In addition,several smaller communities such as Bethel are served by one local televisionstation. Other rural communities without cable systems receive a single statesponsored channel of television by a satellite dish and a low power transmitter.In Alaska, cable television was introduced in the 1970s to provide televisionsignals to communities with few or no available off-air television signals andto communities with poor reception or other reception difficulties caused byterrain interference. Since that time, as on the national level, the cabletelevision providers in Alaska have added non-broadcast programming, utilizedimproved technology to increase channel capacity and expanded service markets toinclude more densely populated areas and those communities in which off-airreception is not problematic.General. As a result of acquisitions completed effective October 31, 1996, theCompany has become Alaska's leading cable television service provider toresidential, commercial and government users in the State of Alaska. TheCompany's cable television systems serve 26 communities and areas in Alaska,including the state's three largest urban areas, Anchorage, Fairbanks, andJuneau. The state-wide Company cable systems consist of approximately 1,806miles of installed cable plant having 300 to 550 MHz of channel capacity.The Company completed a $12.5 million upgrade in 1998 that significantlyincreased the capacity and reliability of the Anchorage and Juneau cablesystems. The Company laid more than 200 miles of fiber optic cable in Anchorageand increased the carrying capacity of 900 miles of cable television line from450 MHz to 550 MHz.The result of such upgrades is an increase in channel capacity and systemreliability, facilitating the delivery of additional video programming and newservices such as enhanced video, high-speed Internet access and telephony, andthe capability to support two-way applications such as cable modems and digitalcable. The Company completed field testing and deployed its digital convertercable service in Anchorage in 1998. Digital compression has enabled the Companyto increase the channel capacity of its Anchorage cable communications systemsto more than 100 channels, provide digital audio channels, as well as improvepicture and sound quality.Products. The programming services offered to subscribers of the Company's cabletelevision systems differ by system (all information as of December 31, 1998).Anchorage, Bethel, Kenai and Soldotna systems. Each system offers a basicservice. In addition, Anchorage and Bethel offer a CPS. A NPT is only offered inthe Anchorage cable system. The Anchorage system, which is located in the urbancenter for Alaska, is fully addressable, with all optional services scrambled,aside from the broadcast basic. Kenai, Soldotna, and Bethel had fewer channels,less service options and less an urban orientation, and use traps for programcontrol. As a result, these smaller systems do not have access to pay-per-viewservices. 22The composition and rates of the levels of service vary between the systems. TheAnchorage cable system offers a basic service that includes 21 channels. TheAnchorage cable system offers a CPS that includes 29 channels at an additionalcost. Subscribers, for an additional cost, receive the six channel NPT servicewhich includes TNT, CNN, Discovery, MSNBC, Outdoor Life and the Sci-/Fi Channel.The Bethel cable system offers a basic service and a CPS of 13 channels for anadditional cost per month. Basic service for the Kenai/Soldotna cable systemconsisted of 32 channels. Pay TV services are available either individually oras part of a value package. Commercial subscribers such as hospitals, hotels andmotels were charged negotiated monthly service fees. Apartment and othermulti-unit dwelling complexes received basic services at a negotiated bulk rate.Fairbanks, Juneau, Ketchikan and Sitka systems. The programming servicescurrently offered to subscribers are structured so that each cable system offersa basic service and a CPS. Each of the cable systems has different basic servicepackages at different rates. Fairbanks, the second largest city in Alaska, has afully addressable system and offers a 12 channel basic and 33 channel CPS tier.Three channels of pay-per-view are available to basic and CPS subscribers.Fairbanks, North Pole, Fort Wainwright, and Eielson Air Force Base are allserved by the Fairbanks headend and have the same lineup. Fort Greely, a remotemilitary post, is a stand-alone system, which is fully addressable. Fort Greelyhas 8 basic channels, a 21 channel CPS tier, and 1 pay-per-view channelavailable to all subscribers. The Juneau cable system offers a 13 channel basicservice package and a Tier 1 that includes basic service plus an additional 4channels. The system also offers a CPS Tier 2 that consists of basic serviceplus Tier 1 service and additional 40 channels. The Ketchikan system offers a 9channel basic service and a CPS Tier 1 that consists of basic service plus 33additional channels. The system also offers a NPT Tier 2 that consists of basicservice, the CPS Tier 1 and an additional 5 channels. The Sitka system offers an8 channel basic service. Expanded basic service includes basic service plus 40additional channels.The Juneau system was upgraded in 1998. The Ketchikan and Sitka systems areexpected to be upgraded in 2000. The Juneau upgrade consisted of extending thebandwidth to 550Mhz, activating the reverse and introducing advanced analog settop boxes. The new set tops allowed Juneau subscribers access to impulse pay perview including highly secured 24 hour adult products, 30 channels of CD qualitymusic and a new on screen navigator.Kodiak, Valdez, Cordova, Petersburg, Wrangell, Kotzebue and Nome systems. Thesesystems offer up to 30 channels of the most popular basic cable channels, aswell as the major broadcast networks, packaged into three levels of service. InNome, Kotzebue and Cordova, basic service consists of three channels, one ofwhich is a PBS channel. PBS service is also included with the 10 channels ofbasic service in Kodiak, 7 in Valdez and 5 each in Wrangell and Petersburg. Inaddition, Wrangell and Petersburg have matching line-ups with 30 channel CPStiers, 10 channel NPT tiers and 5 channels of premium service. Nome offers a 23channel CPS Tier 1, 9 channel CPS Tier 2 and 5 channels of premium service.Kotzebue closely matches Nome with the exception of one less channel in both CPSTier 1 and premium offering. In addition to basic service, Cordova offers a 22channel CPS Tier 1, 10 Channel CPS Tier 2 with 4 premium channels available.In 1998, system upgrades were completed in Kodiak and Valdez. In Kodiak, 6channels were added to basic service. The CPS tier added 8 new channelsincluding Disney which was formally a premium service. The NPT tier was reducedto 11 channels with 2 new networks. Premium services were repackaged for bettervalue. The total available channels are now 47. Nome and Kotzebue systems arebeing upgraded with completion expected in March 1999. The upgrade will allowthe launch of additional programming and the shift of Disney from premium totier service. The Cordova system is expected to be upgraded in 2000.Seward system. The Seward cable system was upgraded in 1997. Total channels wereincreased to 49, packaged in two levels of service. Basic service was expandedfrom 3 to 8 channels. CPS had 30 channels (including basic service) and wasexpanded to 44. All of the channels, with the exception of local originationprogramming and a single translator channel licensed to the City of Seward, werereceived via satellite. In addition there were five channels of premium payservices. The system is fully addressable. The system provides 12 channels to300 outlets in a State of Alaska correction facility through a separate receiveand headend site. 23Homer system. The Homer cable system was upgraded in 1997. Total channels wereincreased to 50 packaged into two levels of service. Basic service was expandedfrom 8 channels to 12. CPS had 36 channels (including basic service channels)and was expanded to 45 channels. All of the channels, with the exception of fourlocal translator channels and local origination programming, are received viasatellite. In addition, five channels of premium pay services are offered. Thesystem is fully addressable.Facilities. The Company's cable television businesses are located in Anchorage,Eagle River, Chugiak, Peters Creek, Kenai, Soldotna, Bethel, Fort Richardson,Elmendorf Air Force Base, Fairbanks, Fort Wainwright, North Pole, Fort Greely,Eielson Air Force Base, Juneau, Sitka, Ketchikan, Petersburg, Wrangell, Cordova,Homer, Sitka, Valdez, Kodiak, Kotzebue, and Nome, Alaska. Company facilitiesinclude cable plant and head-end distribution equipment. Certain of the head-enddistribution centers are colocated with customer service and administrativeoffices.Customers. As of December 31, 1998 the Company cable systems passedapproximately 171,000 homes or approximately 77% of all households in Alaska,and served approximately 112,000 subscribers. 1998 revenues derived from cabletelevision services totaled $57.6 million, or 23.4% of total revenues in 1998.As of December 31, 1997 the Company cable systems passed approximately 167,500homes or approximately 78% of all households in Alaska, and served approximately108,000 subscribers. 1997 revenues derived from cable television servicestotaled $55.2 million, or 24.7% of total revenues.Competition. A number of cable operators other than the Company provide cableservice in Alaska. All of these companies are relatively small, with the largesthaving fewer than 6,500 subscribers. Cable television systems face competitionfrom alternative methods of receiving and distributing television signals andfrom other sources of news, information and entertainment such as off-airtelevision broadcast programming, newspapers, movie theaters, live sportingevents, interactive computer services, Internet services and home videoproducts, including videotape cassette and video disks. The extent to which acable television system is competitive depends, in part, upon the cable system'sability to provide quality programming and other services at competitive prices.The Company's Fairbanks, Alaska system faces significant competition fromalternative cable television providers. Upgrades to the Company's Fairbanksfacilities, expanded product offerings and increased marketing efforts areexpected to increase market penetration from 45.6% at December 31, 1998. TheCompany's average market penetration rate for all systems was 61.4% at December31, 1998.The 1996 Telecom Act authorizes LECs and others to provide a wide variety ofvideo services competitive with services provided by cable systems and toprovide cable services directly to subscribers. Certain LECs in Alaska may seekto provide video services within their telephone service areas through a varietyof distribution methods. Cable systems could be placed at a competitivedisadvantage if the delivery of video services by LECs becomes widespread sinceLECs may not be required, under certain circumstances, to obtain localfranchises to deliver such video services or to comply with the variety ofobligations imposed upon cable systems under such franchises. Issues ofcross-subsidization by LECs of video and telephony services also pose strategicdisadvantages for cable operators seeking to compete with LECs who provide videoservices.The Cable Systems face limited additional competition from private SMATV systemsthat serve condominiums, apartment and office complexes and private residentialdevelopments. The operators of these SMATV systems often enter into exclusiveagreements with building owners or homeowners' associations. Due to thewidespread availability of reasonably priced earth stations, SMATV systems nowcan offer both improved reception of local television stations and many of thesame satellite-delivered program services offered by franchised cable systems.The ability of the Cable Systems to compete for subscribers in residential andcommercial developments served by SMATV operators is uncertain. The 1996 TelecomAct gives cable operators greater flexibility with respect to pricing of cabletelevision services provided to subscribers in multi-dwelling unit residentialand commercial developments. It also broadens the definition of SMATV systemsnot subject to regulation as a franchised cable television service. 24The availability of reasonably-priced HSD earth stations enables individualhouseholds to receive many of the satellite-delivered program services formerlyavailable only to cable subscribers. Furthermore, the 1992 Cable Act containsprovisions, which the FCC has implemented with regulations, to enhance theability of cable competitors to purchase and make available to HSD ownerscertain satellite-delivered cable programs at competitive costs.In recent years, the FCC and the Congress have adopted policies providing a morefavorable operating environment for new and existing technologies that provide,or have the potential to provide, substantial competition to cable systems.These technologies include, among others, DBS services that transmit signals bysatellite to receiving facilities located on the premises of subscribers.Programming is currently available to the owners of DBS facilities throughconventional, medium and high-powered satellites.DBS systems are expected to use video compression technology to increase thechannel capacity of their systems to provide movies, broadcast stations andother program services competitive with those of cable systems. The extent towhich DBS systems are competitive with the service provided by cable systemsdepends, among other things, on the availability of reception equipment atreasonable prices and on the ability of DBS operators to provide competitiveprogramming. DBS services do not currently provide local programming and DBSsignals are subject to degradation from atmospheric conditions such as rain andsnow. The receipt of DBS signals in Alaska currently has the disadvantage ofrequiring subscribers to install larger satellite dishes (generally three to sixfeet in diameter) because of the weaker satellite signals currently available innorthern latitudes. In addition, existing satellites have a relatively lowaltitude above the horizon when viewed from Alaska, making their signals subjectto interference from mountains, buildings and other structures. This couldchange in the future as more transponder space becomes available in the westernarc through consolidation of DBS operators.Cable television systems also compete with wireless program distributionservices such as MMDS providers which use low-power microwave frequencies totransmit video programming over-the-air to subscribers. There are MMDS operatorswho are authorized to provide or are providing broadcast and satelliteprogramming to subscribers in areas served by several of the Company's cablesystems, including Anchorage, Fairbanks and Juneau. Additionally, the FCC hasallocated frequencies in the 28 gHz band for a new multichannel wireless videoservice similar to MMDS. MMDS operations have the disadvantage of requiringline-of-sight access, making their signals subject to interference frommountains, buildings and other structures, and are subject to interference fromrain, snow and wind. In 1997 ATU purchased a minority interest in a MMDSprovider that currently provides service in some portions of Anchorage andFairbanks. At this time, the MMDS service has not been integrated with ATU'stelecommunications services. The Company is unable to predict whether wirelessvideo services will have a material impact on its operations.Other new technologies may become competitive with non-entertainment servicesthat cable television systems can offer. The FCC has authorized televisionbroadcast stations to transmit textual and graphic information useful both toconsumers and businesses. The FCC also permits commercial and non-commercial FMstations to use their subcarrier frequencies to provide non-broadcast servicesincluding data transmissions. The FCC established an over-the-air interactivevideo and data service that will permit two-way interaction with commercial andeducational programming along with informational and data services. LECs andother common carriers also provide facilities for the transmission anddistribution to homes and businesses of interactive computer-based services,including the Internet, as well as data and other non-video services. The FCChas conducted spectrum auctions for licenses to provide PCS. PCS will enablelicense holders, including cable operators, to provide voice and data services.The Company acquired a license to provide PCS services in Alaska.Advances in communications technology as well as changes in the marketplace areconstantly occurring. The Company cannot predict the effect that ongoing orfuture developments might have on the telecommunications and cable televisionindustries or on the Company specifically. 25Cable television systems generally operate pursuant to franchises granted on anon-exclusive basis. The 1992 Cable Act gives local franchising authoritiesjurisdiction over basic cable service rates and equipment in the absence of"effective competition," prohibits franchising authorities from unreasonablydenying requests for additional franchises and permits franchising authoritiesto operate cable systems. Well-financed businesses from outside the cableindustry (such as the public utilities that own certain of the poles on whichcable is attached) may become competitors for franchises or providers ofcompeting services.Local Access ServicesIndustry. 1998 was distinguished by a continuing lack of significant progress inopening the local access market up to competition on an industry-wide basis.While the most lucrative business customers have benefited from increased choiceand lower prices, residential customers in most areas will have to wait aslong-distance companies and CLECs drive to lower access costs through regulatoryrelief, development of their own local access solutions such as telephony overcable, LMDS wireless access, or the use of third party suppliers.Use of the Internet and expansion in the use of LANs and WANs have generated anincreased demand for access lines. In the home, the growing use of computers,faxes, and the Internet led to increases in access lines and usage. Theemergence of new services, including digital cellular, personal communicationsservices, interactive TV, and video dial tone, has created opportunities forsignificant growth in local loop services. These opportunities are also layingthe foundation for a restructuring of the newly competitive local loop servicesmarket. Not only are competitors entering the core business of the localtelephone companies, but they are beginning to pursue the fast-growing marketsthat previously were closed to them, such as consumer video.General. The Company's local access services division entered the local servicesmarket in Anchorage in 1997, providing services to residential, commercial, andgovernment users. The Company can access approximately 93% of Anchorage arealocal loops from its collocated remote digital facilities and DLC installations.The Company has experienced significant difficulty in successfully convertingcustomers from the ILEC, due to, among other factors, a lack of access to theILEC's operational support systems that would allow the Company to access itscustomer's information held by the ILEC, lack of adequate state-levelregulations supporting local competition, and disputes with the ILEC overinterpretation of interconnection and arbitration agreements. In spite of strongdemand, in the third and fourth quarters of 1998 the Company delayed activemarketing to residential local service customers in Anchorage. The Company willcontinue to pursue resolution of these existing operational and interconnectionissues while continuing to develop alternative methods of local entry.Products. The Company began offering local exchange services initially inAnchorage during late September 1997. The Company's DLC system allows it tooffer full featured, switched-based local service products to both residentialand commercial customers. In areas where the Company does not have access toloop facilities, it offers resale of the ILEC's local service.The Company offers a number of specially priced package offerings and offers theonly local customer service representatives in Alaska who are available 24 hoursa day. Features offered include enhanced call waiting, caller ID, caller ID oncall waiting, free caller ID box, anonymous call rejection, call forwarding,call forward busy, call forward no answer, enhanced call waiting, fixed callforwarding, follow me call, intercom service forwarding, multi-distinctive ring,per line blocking, selective call forwarding, selective call acceptance,selective call rejection, selective distinctive alert, speed calling, three waycalling, voice mail, inside wire repair plan, non-listed number, andnon-published number.Facilities. During 1997 the Company installed a host 5ESS switching system.Additionally the Company collocated six remote facilities beside or within theILEC's local switching offices to access unbundled loop network elements andinstalled a DLC system beside a smaller, seventh ILEC wire center. These remoteand DLC facilities are interconnected to the host switch via Company-owneddiversely routed fiber optic links. During 1998, the Company expanded itscapacity at each of the remote facilities to allow access to approximately79,000 Anchorage loops. Additionally, the Company provided its ownfacilities-based services to over 80 of 26Anchorage's larger business customers through further expansion and deploymentof SONET fiber transmission facilities, leased and HDSL T-1 facilities, and DLCfacilities.Customers. The Company had approximately 28,300 and 3,300 active lines inservice from Anchorage subscribers to its local access services at December 31,1998 and 1997, respectively. 1998 and 1997 revenues derived from local accessservices totaled $9.9 million and $610,000, respectively, representingapproximately 4.0% and 0.3% of the Company's total revenues in 1998 and 1997,respectively. Approximately 1,000 additional lines were sold and awaitingconnection at December 31, 1998.Competition. In the local exchange services market, the Company believes thatthe 1996 Telecom Act, judicial decisions, and state legislative and regulatorydevelopments will increase the likelihood that barriers to local exchangecompetition will be substantially reduced or removed. These initiatives includerequirements that LECs negotiate with entities such as the Company to provideinterconnection to the existing local telephone network, to allow the purchase,at cost-based rates, of access to unbundled network elements, to establishdialing parity, to obtain access to rights-of-way and to resell services offeredby the ILECs.LECs in Alaska outside of Anchorage have a "rural exemption" from some of theirobligations until and unless the exemption is examined and not continued by theAPUC. Certain pricing provisions of the FCC's Interconnection Decisionimplementing the interconnection portions of the 1996 Telecom Act have beenchallenged and were stayed by the U.S. Court of Appeals for the Eighth Circuit,on a jurisdictional basis. The United States Supreme Court, in February 1999,upheld the jurisdictional basis of the FCC's decisions, and has remanded theproceeding back to the Eighth Circuit for further proceedings. In addition the1996 Telecom Act expressly prohibits any legal barriers to competition inintrastate or interstate communications service under state and local laws. The1996 Telecom Act further empowers the FCC, after notice and an opportunity forcomment, to preempt the enforcement of any statute, regulation or legalrequirement that prohibits, or has the effect of prohibiting, the ability of anyentity to provide any intrastate or interstate telecommunications service. SeePart I, Item 1. Business, Regulation, franchise authorizations and tariffs formore information.In the local exchange market, the Company will compete against various ILECsincluding ATU in Anchorage and PTI in Juneau. PTI acquired the local exchangeportion of the Fairbanks Municipal Utilities System in 1997 and now provideslocal exchange services in Fairbanks. The ACS acquisition of ATU is expected toclose in 1999. ACS management includes former executives of PTI. See - Part I,Item 1. Business, Historical development of the Company's business during thepast fiscal year Local Access Services for more information.In early 1997 the Company received approval from the APUC to provide localexchange services throughout ATU's existing service area. The APUC also approvedan interconnection agreement negotiated and arbitrated between the Company andATU pursuant to the terms of the 1996 Telecom Act. The Company now offers localexchange services to substantially all consumers in the ATU service area,primarily through its own facilities and unbundled local loops leased from ATU.The Company intends to enter new markets, particularly Juneau and Fairbanks,with its local access services. Full competitive entry into new markets issubject to approval by the APUC. See -Regulation, Franchise Authorizations andTariffs, Telecommunications Operations for more information.The 1996 Telecom Act also provides ILECs with new competitive opportunities. TheCompany believes that it has certain advantages over these companies inproviding its telecommunications services, including the Company's brandawareness by Alaskan customers, its facilities based telecommunications network,and management's prior experience in, and knowledge of, the Alaskan market. The1996 Telecom Act provides that rates charged by ILECs for interconnection to theincumbent carrier's network are to be nondiscriminatory and based upon the costof providing such interconnection, and may include a "reasonable profit," whichterms are subject to interpretation by regulatory authorities. If ILECs chargealternative providers (such as the Company) unreasonably high fees forinterconnection to the LECs' networks, or significantly lower their retail ratesfor 27local exchange services, the alternative provider's local service business couldbe placed at a significant competitive disadvantage.Internet ServicesIndustry. The Internet continues to expand at a significant rate, with thenumber of sites almost doubling each year. In February 1998 there were more than29 million sites on the Internet worldwide, with a projected 90 millionconnected by the turn of the century. The signs are that the Internet willbecome as commonplace as the TV in a few years. Analysts predict that the amountof Internet traffic will likely continue to rise as fast as capacity allows forthe foreseeable future. Voice over the Internet may have a major impact onbusiness and the entire telecommunications industry in the future.The use of Intranets has significantly increased, with an estimated 60 to 70percent of US corporations using an Intranet. Current growth rates suggest that138 million people worldwide will be connected from their desks to an in-houseIntranet by 2001.An Intranet allows information to be decentralized in an organization. It usesInternet-compatible standards, available on virtually any computer. An Intranetis also - by mainframe computer standards - fast and inexpensive to set up. Thisadds to its appeal, particularly for larger companies with complex legacy datasystems.Industry analysts believe that one of the key tools for business advantage overthe next two years will be the Extranet. This is an Intranet (internal, secure,full of sensitive data) connected to trusted customers and suppliers.Implementing an Extranet creates the concept of the virtual enterprise, in whichall the organizations in a supply chain integrate their systems and operations.This concept is not new, but has been achieved in the past using EDI on privatenetworks. Extranets promise to remove many of the obstacles which have preventedfirms from sharing their data (stock levels, production schedules, demandforecasts) with customers and suppliers. However, there are issues of standards,lack of consumer confidence and security.Music sits perfectly in the digital stream so it comes as no surprise thatleading record companies and music retailers are selling direct over theInternet. According to industry analysts, CD sales to date are small - $47million in 1997 - but are predicted to grow fast. Technology may turn productsinto a service, delivered over the Internet.Concerns about Internet-based commerce remain. One serious preoccupation is thatan overloaded Internet might crash. However, capacity on the Internet continuesto increase. Technology enables fiber to carry more data, and more cables andsatellite channels are being introduced. In 1995, the world's entire telecomtraffic amounted to a data rate of a terabit a second. Currently, a singleoptical fiber strand can carry three times that data.While more viewers are tuning out television networks, they're logging onto theInternet. In 1999, 43.9 million American households are expected by industryanalysts to be able to go online, roughly 43% of the country raisingonline-shopping revenues by a projected 69%, to $11.9 billion, while advertisingrevenues will increase by a projected 62%, to $3.3 billion.Major court decisions and legislative action are expected to shape the worldwideInternet in 1999, including - the impact of the U.S. vs. Microsoft antitrust trial, - possible recognition that traditional encryption regulation is obsolete, - minimum-regulation approaches to information privacy as a new consumer movement tries to use international privacy law to rein in the behavior of large corporations in the U.S. economy, - the potential for continuing increases in inexperienced investors investing through online brokers and increased instances of investor losses that lead to arbitration claims against the brokers, - the impact of more Internet patents preventing others from doing certain things, such as designing and maintaining certain types of Web sites, - the legality of hyperlinking without permission, 28 - pending re-introduction of database legislation in Congress that would create a new form of intellectual property in databases, - decisions regarding whether cryptographic source code is First Amendment speech, and hence exportable, or that no program is covered by the First Amendment, - renewed calls by the FBI and others for domestic controls of obscenity-related cryptography, and - the development of rating and filtering systems outside the United States.General. The Company's Internet services division entered the Internet servicesmarket in 1998, providing retail services to residential, commercial, andgovernment users and providing wholesale carrier services to other ISPs. Cablenetwork upgrades in the Anchorage area have allowed the Company to offerhigh-speed cable modem Internet access, the first of its kind in Alaska.Products. The Company currently offers two types of Internet access forresidential use: dial up Internet access and high-speed cable modem Internetaccess. The Company's initial residential high-speed cable modem Internetservice offers 256 kilobits per second access speed as compared with up to 56kilobits per second access through standard copper wire modem access. Free24-hour customer service and technical support via telephone or online areprovided. The service also offers free data transfer up to five gigabytes permonth and can be left connected 24-hours-a-day, 365-days-a-year, allowing forreal-time information and e-mail access.The Company believes cable modem services will be the next generation ofInternet access. This service is expected to appeal to families, professionalswho work-at-home, educators, those involved in electronic commerce and peoplewho enjoy interactive computer games. Cable modem access overcomes thelimitations of slower dial-up service and the higher cost of dedicated Internetservices and provides always-available, high-speed access to the Internet. Cablemodems use Company owned coaxial cable that provides cable television service,instead of the traditional copper wire from the ILEC. Coaxial cable has a muchgreater carrying capacity than telephone wire and can be used to simultaneouslydeliver both cable television and Internet access services.The Company currently offers several Internet service packages for commercialuse: Dial up access, frame relay and high-speed cable modem Internet access. TheCompany's business high-speed cable modem Internet service offers access speedsranging from 128 kilobits per second to 512 kilobits per second, free monthlydata transfers of up to 25 gigabytes and free 24-hour customer service andtechnical support. Business services also include dedicated Internet access, apersonalized web page and e-mail addressing.Significant new marketing campaigns were introduced in February and March 1999featuring bundled residential and commercial Internet products. Additionalbandwidth was made available to the Company's Internet segment resulting fromcompletion of the Alaska United Project as previously described. The newInternet offerings are coupled with the Company's long-distance and localservices offerings and provide free basic Internet services if certainlong-distance or local services plans are selected. Value-added Internetfeatures are available for additional charges.The Company provides Internet access for Alaska schools using a platformincluding many of the latest advancements in technology. Services are deliveredthrough a locally available circuit, existing Company lines, or satellite earthstations.Facilities. The Internet is an interconnected global public computer network oftens of thousands of packet-switched networks using the Internet protocol. TheInternet is effectively a network of networks routing data throughout the world.Access to the Internet is provided by the Company using a platform includingmany of the latest advancements in technology. The physical platform isconcentrated in Anchorage and is extended into many remote areas of the state.The Company's Internet platform includes: - A frame relay trunk connecting the Anchorage POP to an Internet access point in Seattle. - Routers on each end of the frame relay trunk to control the flow of data over the trunk. 29 - The Anchorage POP consists of a main router, a bank of servers that perform proxy and cache functions, database servers providing authentication and user demographic data, and access servers for dial in users.SchoolAccess(TM) Internet service delivery to over 152 schools in rural Alaskais accomplished by three variations on primary delivery systems: - In communities where the Company has terrestrial interconnects or existing service over regional earth stations, the Company has configured intermediate distribution POPs. Schools that are within these service boundaries are connected locally to one of those POPs. - In communities where the Company has extended telecommunications services via its DAMA earth station program, SchoolAccess(TM) is provided via a satellite trunk circuit to an intermediate distribution POP at the Eagle River Earth Station. - In communities or remote locations where the Company has not extended telecommunications services, SchoolAccess(TM) is provided via a dedicated (usually on premise) DAMA VSAT satellite station. The DAMA connects to an intermediate distribution POP located in Anchorage.In all cases, Internet access is delivered to a router located at the servicepoint. The Company's Internet management platform constantly monitors thisdemarcation router; continual communication is maintained with all of therouters in the network. The availability and quality of service, as well asstatistical information on traffic loading, are continuously monitored forquality assurance. The management platform has the capability to remotely accessthe routers, permitting changes in router configuration without the need tophysically be at the service point.GCI.net offers a unique combination of innovative network design and aggressiveperformance management. The new Internet platform has received a certificationof Cisco Powered Network status, placing it in the top one percent of allservice providers worldwide and the only ISP in Alaska with such designation.The Company operates and maintains what it believes is the largest, mostreliable, and highest performance Internet network in the State of Alaska.Customers. The Company had approximately 7,200 active residential subscribers toits Internet service at February 9, 1999. 1998 revenues derived from Internetservices totaled $4.6 million, representing approximately 1.9% of the Company'stotal revenues.Competition. The Internet industry is intensely competitive, rapidly evolvingand subject to constant technological change. Competition is based upon priceand pricing plans, the types of services offered, customer service, billingservices, perceived quality, reliability and availability. Although the Companybelieves it has the human and technical resources to pursue its strategy andcompete effectively in this competitive environment, its success will dependupon its ability to profitably provide high quality, high value bundled servicesat prices generally competitive with, or lower than, those charged by itscompetitors.As of December 31, 1998, the Company competed with more than 25 Alaska basedInternet providers, and competed with other domestic, non-Alaska based providersthat provide national service coverage. Several of the providers havesubstantially greater financial, technical and marketing resources than theCompany. The Company has, so far, successfully adjusted its pricing andmarketing strategies to respond to competitors' pricing practices.Environmental RegulationsThe Company and its subsidiaries may undertake activities which, under certaincircumstances may affect the environment. Accordingly, they are subject tofederal, state, and local regulations designed to preserve or protect theenvironment. The FCC, the Bureau of Land Management, the U.S. Forest Service,and the National Park Service are required by the National Environmental PolicyAct of 1969 to consider the environmental impact 30prior to the commencement of facility construction. Management believes thatcompliance with such regulations has no material effect on the Company'sconsolidated operations. The principal effect of Company facilities on theenvironment would be in the form of construction of facilities and networks atvarious locations in Alaska and between Alaska and Seattle Washington. Companyfacilities have been constructed in accordance with federal, state and localbuilding codes and zoning regulations whenever and wherever applicable. Somefacilities may be on lands that may be subject to state and federal wetlandregulation.Uncertainty as to the applicability of environmental regulations is caused inmajor part by the federal government's decision to consider a change in thedefinition of wetlands. Most of the Company's facilities are on lands leased bythe Company, and, with respect to all of these facilities, the Company isunaware of any violations of lease terms or federal, state or local regulationspertaining to preservation or protection of the environment.The Company's Alaska United project consists, in part, of deploying land-basedand undersea fiber optic cable facilities between Anchorage, Whittier, Valdez,and Juneau, Alaska and Seattle, Washington. The engineered route passes overwetlands and other environmentally sensitive areas. The Company believes itsconstruction methods used for buried cable have a very minimal impact on theenvironment. The agencies, among others, that are involved in permitting andoversight of the Company's cable deployment efforts are the US Army Corps ofEngineers, The National Marine Fisheries Service, US Fish & Wildlife, US CoastGuard, National Oceanic and Atmospheric Administration, Alaska Department ofNatural Resources, and the Alaska Office of the Governor - GovernmentalCoordination. The Company is unaware of any violations of federal, state orlocal regulations or permits pertaining to preservation or protection of theenvironment.In the course of operating the cable television systems, the Company has usedvarious materials defined as hazardous by applicable governmental regulations.These materials have been used for insect repellent, locate paint and poletreatment, and as heating fuel, transformer oil, cable cleaner, batteries, andin various other ways in the operation of those systems. Management of theCompany does not believe that these materials, when used in accordance withmanufacturer instructions, pose an unreasonable hazard to those who use them orto the environment.Patents, Trademarks, Licenses, Certificates of Public Convenience and Necessity,and Military FranchisesNeither the Company nor its affiliates hold patents, franchises or concessionsfor telecommunications services or local access services. The Company holdsregistered service marks for the terms SchoolAccess(TM), Free Fridays forBusiness(TM) and Unlimited Weekends(TM). The Communications Act of 1934 givesthe FCC the authority to license and regulate the use of the electromagneticspectrum for radio communication. The Company through its long-distance servicesindustry segment holds licenses for its satellite and microwave transmissionfacilities for provision of its long-distance services. The Company acquired alicense for use of a 30-megahertz block of spectrum for providing PCS servicesin Alaska. The PCS license has an initial duration of 10 years. The Companyexpects to renew the PCS license for an additional 10-year term under FCC rules.The Company acquired a LMDS license in 1998 for use of a 150-megahertz block ofspectrum in the 28 gigahertz Ka-band for providing wireless services. The LMDSlicense has an initial duration of 10 years. Within 10 years, licensees will berequired to provide 'substantial service' in their service regions. TheCompany's operations may require additional licenses in the future.Applications for transfer of control of 15 certificates of public convenienceand necessity held by the acquired cable companies to the Company were approvedin an APUC order dated September 23, 1996, with transfers to be effective onOctober 31, 1996. Such transfer of control allowed the Company to take controland operate the cable systems of the acquired cable companies located in Alaska.The approval of the transfer of the 15 certificates of public convenience andnecessity to the Company by the FCC is not required under federal law, with onearea of limited exception. The Cable Companies operate in part through the useof several radio-band frequencies licensed through the FCC. These licenses weretransferred to the Company prior to October 31, 1996. 31The Company obtained consent of the military commanders at the military basesserviced by the acquired cable systems to the assignment of the respectivefranchises for those bases.Regulation, Franchise Authorizations and TariffsThe following summary of regulatory developments and legislation does notpurport to describe all present and proposed federal, state, and localregulation and legislation affecting the Company's businesses. Other existingfederal and state regulations are currently the subject of judicial proceedings,legislative hearings and administrative proposals which could change, in varyingdegrees, the manner in which these industries operate. Neither the outcome ofthese proceedings nor their impact upon the industries in which the Companyoperates or the Company itself can be predicted at this time.Telecommunications Operations. The following is a summary of federal laws,regulations and tariffs, and a description of certain state and local lawspertaining to the telecommunications operations of the Company (long-distance,local access and wireless).General. The Company is subject to regulation by the FCC and by the APUC as anon-dominant provider of long-distance services. Among other regulatoryrequirements, the Company is required to file tariffs with the FCC forinterstate and international service, and with the APUC for intrastate servicebut such tariffs routinely become effective without intervention by the FCC,APUC or other third parties since the Company is a non-dominant carrier. TheCompany received approval from the APUC in February 1997 to permit the Companyto provide local access services throughout ATU's existing service area.Military franchise requirements also affect the Company in its provision oftelecommunications and cable television services to military bases.Because the Company is authorized to offer local access services in Anchorage,it is regulated as a CLEC by the APUC. In addition, the Company will be subjectto other regulatory requirements, including certain requirements imposed by the1996 Telecom Act on all LECs, which requirements include permitting resale ofLEC services, number portability, dialing parity, and reciprocal compensation.As a PCS and LMDS licensee, the Company is subject to regulation by the FCC, andmust comply with certain buildout and other conditions of the license, as wellas with the FCC's regulations governing the PCS and LMDS services. On a morelimited basis, the Company may be subject to certain regulatory oversight by theAPUC (e.g., in the areas of consumer protection), although states are notpermitted to regulate the rates of PCS, LMDS and other commercial wirelessservice providers. PCS and LMDS licensees may also be subject to regulatoryrequirements of local jurisdictions pertaining to, among other things, thesiting of tower facilities.1996 Telecom Act and Related Rulings. A key industry development was passage ofthe 1996 Telecom Act that was signed into law February 8, 1996. The Act isintended by Congress to open up the marketplace to competition and has had adramatic impact on the telecommunications industry. The legislation breaks downthe old barriers that prevented three groups of companies, the LECs, includingthe RBOCs, the long-distance carriers, and the cable TV operators, fromcompeting head-to-head with each other. The Act requires LECs to let newcompetitors into their business. It also requires the LECs to open up theirnetworks to ensure that new market entrants have a fair chance of competing. Thebulk of the legislation is devoted to establishing the terms under which theLECs must open up their networks.Enactment of the bill affected local exchange service markets almost immediatelyby requiring states to authorize local exchange service competition.Competitors, including resellers are able to market new bundled service packagesto attract customers. Over the long term, the requirement that LECs unbundleaccess to their networks may lead to increased price competition. Local exchangeservice competition may not take hold immediately because interconnectionarrangements are not in place in most areas.In August 1996, the FCC adopted rules and regulations, including pricing rules(the "Pricing Rules") to implement the local competition provisions of the 1996Telecom Act, including with respect to the terms and 32conditions of interconnection with LEC networks and the standards governing thepurchase of unbundled network elements and wholesale services from LECs. Theseimplementing rules rely on state public utilities commissions to develop thespecific rates and procedures applicable to particular states within theframework prescribed by the FCC.On July 18, 1997, the United States Court of Appeals for the Eighth Circuitissued a decision holding that the FCC lacks authority to establish pricingrules to implement the sections of the local competition provisions of the 1996Telecom Act applicable to interconnection with LEC networks and the purchase ofunbundled network elements and wholesale services from LECs. Accordingly, theCourt vacated the rules that the FCC had adopted in August 1996, and which hadbeen stayed by the Court since September 1996. However, since the stay wasissued, most states have used the Pricing Rules as guidelines in establishingpermanent rates, or interim rates that will apply pending the determination ofpermanent rates in subsequent state proceedings. Nevertheless, there can be noassurance that the prices and other conditions established in each state willprovide for effective local service entry and competition or provide the Companywith new market opportunities.On October 14, 1997, the Eighth Circuit Court of Appeals vacated an FCC Rulethat had prohibited ILECs from separating network elements that are combined inthe LEC's network, except at the request of the competitor purchasing theelements. This decision increased the difficulty and costs of providingcompetitive local access services through the use of unbundled network elementspurchased from the ILECs.On January 25, 1999, the United States Supreme Court issued a decision reversingin material part the decisions of the Eighth Circuit, and specifically upholdingthe authority of the FCC to establish pricing rules and preventing theseparation of network elements that are already combined. The Supreme Courtremanded the cases to the Eighth circuit for further proceedings consistent withits decision.In 1997, the FCC issued important decisions on the structure and level of accesscharges and universal service. These decisions will impact the industry inseveral ways, including the following: - An additional subsidy was created to support telecommunications services for schools, libraries and rural health care providers. All carriers providing telecommunications services are required to fund this program, which is capped at $2.7 billion per year. However, LECs can pass their portion of these costs on to long-distance carriers. - Per-minute interstate access rates charged by LECs will decline over time to become cost-based. - Certain monthly flat-rate charges paid by some local telephone customers increased beginning in 1998. - Certain per-minute access charges paid by long-distance companies were converted to flat monthly charges based on pre-subscribed lines. - A basis has been established for replacing implicit access subsidies with an explicit interstate universal service fund beginning in 1999.A number of LECs, long-distance companies and others have appealed some or allof the FCC's orders. The effective date of the orders has not been delayed, butthe appeals are expected to take a year or more to conclude. The impact of theseFCC decisions on the Company is difficult to determine, but is not expected tobe material.Some BOCs have also challenged the 1996 Telecom Act restrictions on their entryinto long-distance markets as unconstitutional. A federal district court inWichita Falls, Texas, ruled the restrictions unlawful because they constituted alegislative act that imposed punishment without a judicial proceeding. TheUnited States government and others filed appeals of this decision. The federaldistrict court delayed implementing its decision pending resolution of theappeals. The Company is unable to predict the outcome of such rulemakings orlitigation or the substantive effect (financial or otherwise) of the 1996Telecom Act and the rulemakings on the Company. 33On January 26, 1998, the United States Supreme Court agreed to review theaforementioned decisions of the Eighth Circuit Court of Appeals. Under thenormal procedures of the Court, arguments were heard and a decision is expectedin 1999.In February 1999 the U.S. Supreme Court lifted a court order that barred the FCCfrom imposing local phone competition rules on the five Bell companies as acondition for allowing them to offer long-distance service. The decision waswidely expected. The justices, without comment, voided a second Eighth CircuitCourt of Appeals opinion. The lower court had barred the FCC from imposing thosesame pricing rules as requirements for approval of long-distance applications.The BOCs continue to challenge the substance of the FCC rules, arguing that therules do not allow them to fully recover the money they spent building theirnetworks. The Eighth Circuit Court of Appeals may rule on this issue in 1999.On March 4, 1999, an Alaska Superior Court Judge determined that the APUC erredin reaching its decision to deny the Company's request to provide full localtelephone service in Fairbanks and Juneau, Alaska. This service would beprovided in competition against PTI, the existing monopoly provider. The Courtremanded the case back to the APUC for proceedings leading to a decision on orbefore July 2, 1999. Among other things, the Court has instructed the APUC tocorrectly assign the burden of proof to PTI rather than the Company, and todecide on the Company's specific requests to provide service in Fairbanks andJuneau based on criteria established in the 1996 Telecom Act. The Court statedthat "this must be accomplished cognizant of the intent of theTelecommunications Act to promote competition in the local market." The Companybelieves this decision is important to bring about the benefits of competitionto other communities in Alaska.Reciprocal Compensation. In response to requests by carriers that the FCCclarify how local telephone companies should compensate one another fordelivering traffic to Internet service providers, the FCC concluded on February25, 1999 that long-distance carriers are bound by their existing interconnectionagreements, as interpreted by state commissions, and thus are subject toreciprocal compensation obligations to the extent provided by such agreements oras determined by state commissions. The FCC declared that Internet traffic isjurisdictionally mixed and appears to be largely interstate in nature. But thedecision preserves the rule that exempts the Internet and other informationservices from interstate access charges. This means that those consumers whocontinue to access the Internet by dialing a seven-digit number will not incurlong-distance charges when they do so. In a notice of proposed rulemaking, theFCC also asked for comment on proposals governing future carrier-to-carriercompensation for handling this traffic.Specifically, the FCC had been asked by parties to determine whether localtelephone companies are entitled to receive reciprocal compensation fordelivering calls to their customers that are information service providers,particularly ISPs. Generally, new entrants to the local telephone businesscontend that calls to ISPs are local traffic and, therefore, subject toreciprocal compensation. Incumbent local telephone companies, on the other hand,generally contend that calls to ISPs are beyond the scope of reciprocalcompensation agreements.The FCC, in its decision, noted that it traditionally has determined thejurisdictional nature of communications by the end points of the communication.Accordingly, the FCC concluded that the calls at issue in that proceeding do notterminate at the ISPs' local servers, but continue to their ultimatedestinations, specifically at websites that are often located in other states orcountries. As a result, the FCC found that, although some Internet traffic isintrastate, a substantial portion of Internet traffic is interstate andtherefore subject to federal jurisdiction.This jurisdictional decision does not, however, determine whether calls to ISPsare subject to reciprocal compensation in any particular instance. The FCC notedthat parties may have agreed that ISP-bound traffic should be subject toreciprocal compensation, or a state commission, in the exercise of its statutoryauthority to arbitrate interconnection disputes, may have imposed reciprocalcompensation obligations for this traffic. In either case, the FCC noted thatcarriers are bound by their existing interconnection contracts, as interpretedby state commissions. 34The FCC also stated that adopting a federal rule to govern reciprocalcompensation in the future would serve the public interest. As a general matter,the FCC tentatively concluded that commercial negotiations are the ideal meansof establishing the terms of interconnection contracts, and reciprocalcompensation agreements in particular. The FCC, therefore, asked for comment ontwo alternative proposals for implementing such a regime in the future.The FCC tentatively concluded that inter-carrier compensation for thisinterstate traffic should be governed prospectively by interconnectionagreements negotiated and arbitrated under sections 251 and 252 of the Act.Resolution of failures to reach agreement on inter-carrier compensation forinterstate ISP-bound traffic then would occur through arbitrations conducted bystate commissions, which are appealable to federal district courts. The FCC alsoasked for comment on an alternative proposal, under which inter-carriercompensation would be governed by a set of federal rules, and disputes would beresolved by federal, state, or third-party arbitrators.Cable Services. The following is a summary of federal laws and regulationsmaterially affecting the growth and operation of the cable services industry anda description of certain state and local laws.General. The Company is subject to federal and state regulation as a cabletelevision operator pursuant to the 1984 Cable Act and 1992 Cable Act, bothamended by the 1996 Telecom Act. The 1992 Cable Act significantly expanded thescope of cable television regulation on an industry-wide basis by imposing rateregulation, carriage requirements for local broadcast stations, customer serviceobligations and other requirements. The 1992 Cable Act and the FCC's rulesimplementing that Act generally have increased the administrative andoperational expenses and in certain instances required rate reductions for cabletelevision systems and have resulted in additional regulatory oversight by theFCC and state or local authorities.Principal responsibility for implementing the policies of the 1934, 1984 and1992 Cable Acts and the 1996 Telecom Act is allocated between the FCC and stateor local franchising authorities. The FCC and state regulatory agencies arerequired to conduct numerous rulemaking and regulatory proceedings to implementthe 1996 Telecom Act, and such proceedings may materially affect the cableindustry.Rate Regulation. The 1992 Cable Act authorized rate regulation for cablecommunications services and equipment in communities that are not subject to"effective competition," as defined by federal law. Most cable communicationssystems are now subject to rate regulation for basic cable service and equipmentby local officials under the oversight of the FCC, which has prescribed detailedcriteria for such rate regulation. The 1992 Cable Act also requires the FCC toresolve complaints about rates for CPSTs (other than programming offered on aper channel or per program basis, which programming is not subject to rateregulation) and to reduce any such rates found to be unreasonable. The 1996Telecom Act eliminates the right of individuals to file CPST rate complaintswith the FCC and requires the FCC to issue a final order within 90 days afterreceipt of CPST rate complaints filed by any franchising authority. The 1992Cable Act limits the ability of cable television systems to raise rates forbasic and certain cable programming services (collectively, the "RegulatedServices").FCC regulations govern rates that may be charged to subscribers for RegulatedServices. The FCC uses a benchmark methodology as the principal method ofregulating rates for Regulated Services. Cable operators are also permitted tojustify rates using a cost-of-service methodology, which contains a rebuttablepresumption of an industry-wide 11.25% after tax rate of return on an operator'sallowable rate base. Franchising authorities are empowered to regulate the ratescharged for monthly basic service, for additional outlets and for theinstallation, lease and sale of equipment used by subscribers to receive thebasic cable service tier, such as converter boxes and remote control units. TheFCC's rules require franchising authorities to regulate these rates on the basisof actual cost plus a reasonable profit, as defined by the FCC. Cable operatorsrequired to reduce rates may also be required to refund overcharges withinterest. The FCC has also adopted comprehensive and restrictive regulationsallowing operators to modify their regulated rates on a quarterly or annualbasis using various methodologies that account for changes in the number ofregulated channels, inflation and increases in certain external costs, such asfranchise and other governmental fees, copyright and retransmission consentfees, taxes, 35programming fees and franchise-related obligations. The Company cannot predictwhether the FCC will modify these "going forward" regulations in the future.The 1996 Telecom Act provides for rate deregulation of CPSTs by March 1999,although legislation has been proposed to extend the regulatory period.Deregulation may occur sooner for systems in markets where comparable videoprogramming services, other than DBS, are offered by local telephone companies,or their affiliates, or by third parties using the local telephone company'sfacilities, or where "effective competition" is established under the 1992 CableAct. The 1996 Telecom Act also modifies the uniform rate provision of the 1992Cable Act by prohibiting regulation of nonpredatory bulk discount rates offeredto subscribers in commercial and residential developments and permits regulatedequipment rates to be computed by aggregating costs of broad categories ofequipment at the franchise, system, regional or company level.Anti-Buy Through Provisions. The 1992 Cable Act requires cable systems to permitsubscribers to purchase video programming offered by the operator on a perchannel or a per program basis without the necessity of subscribing to any tierof service, other than the basic cable service tier, unless the system's lack ofaddressable converter boxes or other technological limitations does not permitit to do so. The statutory exemption for cable systems that do not have thetechnological capability to offer programming in the manner required by thestatute is available until a system obtains such capability, but not later thanDecember 2002. The FCC may waive such time periods, if deemed necessary. Many ofthe Company's systems do not have the technological capability to offerprogramming in the manner required by the statute and thus currently are exemptfrom complying with the requirement.Must Carry/Retransmission Consent. The 1992 Cable Act contains broadcast signalcarriage requirements that allow local commercial television broadcast stationsto elect once every three years to require a cable system to carry the station,subject to certain exceptions, or to negotiate for "retransmission consent" tocarry the station. A cable system generally is required to devote up toone-third of its activated channel capacity for the carriage of local commercialtelevision stations whether pursuant to the mandatory carriage or retransmissionconsent requirements of the 1992 Cable Act. Local non-commercial televisionstations are also given mandatory carriage rights; however, such stations arenot given the option to negotiate retransmission consent for the carriage oftheir signals by cable systems. Additionally, cable systems are required toobtain retransmission consent for all distant commercial television stations(except for commercial satellite-delivered independent "superstations" such asWGN), commercial radio stations and certain low-power television stationscarried by such systems. In March 1997, the US Supreme Court upheld theconstitutional validity of the 1992 Cable Act's mandatory signal carriagerequirements. The FCC will conduct a rulemaking in the future to consider therequirements, if any, for mandatory carriage of digital television signals.Designated Channels. The Communications Act permits franchising authorities torequire cable operators to set aside certain channels for public, educationaland governmental access programming. The 1984 Cable Act also requires a cablesystem with 36 or more channels to designate a portion of its channel capacityfor commercial leased access by third parties to provide programming that maycompete with services offered by the cable operator. The FCC has adopted rulesregulating: (i) the maximum reasonable rate a cable operator may charge forcommercial use of the designated channel capacity; (ii) the terms and conditionsfor commercial use of such channels; and (iii) the procedures for the expeditedresolution of disputes concerning rates or commercial use of the designatedchannel capacity.Franchise Procedures. The 1984 Cable Act affirms the right of franchisingauthorities (state or local, depending on the practice in individual states) toaward one or more franchises within their jurisdictions and prohibitsnon-grandfathered cable systems from operating without a franchise in suchjurisdictions. The 1992 Cable Act encourages competition with existing cablesystems by (i) allowing municipalities to operate their own cable systemswithout franchises; (ii) preventing franchising authorities from grantingexclusive franchises or from unreasonably refusing to award additionalfranchises covering an existing cable system's service area; and (iii)prohibiting (with limited exceptions) the common ownership of cable systems andcolocated MMDS or SMATV systems. The FCC has relaxed its restrictions onownership of SMATV systems to permit a cable operator to 36acquire SMATV systems in the operator's existing franchise area so long as theprogramming services provided through the SMATV system are offered according tothe terms and conditions of the cable operator's local franchise agreement. The1996 Telecom Act provides that the cable/SMATV and cable/MMDS cross-ownershiprules do not apply in any franchise area where the operator faces "effectivecompetition" as defined by federal law.The Cable Acts also provide that in granting or renewing franchises, localauthorities may establish requirements for cable-related facilities andequipment, but not for video programming or information services other than inbroad categories. The Cable Acts limit the payment of franchise fees to 5% ofrevenues derived from cable operations and permit the cable operator to obtainmodification of franchise requirements by the franchise authority or judicialaction if warranted by changed circumstances. A federal appellate court heldthat a cable operator's gross revenue includes all revenue received fromsubscribers, without deduction, and overturned an FCC order which had held thata cable operator's gross revenue does not include money collected fromsubscribers that is allocated to pay local franchise fees. The Company cannotpredict the ultimate resolution of these matters. The 1996 Telecom Act generallyprohibits franchising authorities from (i) imposing requirements in the cablefranchising process that require, prohibit or restrict the provision oftelecommunications services by an operator, (ii) imposing franchise fees onrevenues derived by the operator from providing telecommunications services overits cable system, or (iii) restricting an operator's use of any type ofsubscriber equipment or transmission technology.The 1984 Cable Act contains renewal procedures designed to protect incumbentfranchisees against arbitrary denials of renewal. The 1992 Cable Act madeseveral changes to the renewal process which could make it easier for afranchising authority to deny renewal. Moreover, even if the franchise isrenewed, the franchising authority may seek to impose new and more onerousrequirements such as significant upgrades in facilities and services orincreased franchise fees as a condition of renewal. Similarly, if a franchisingauthority's consent is required for the purchase or sale of a cable system orfranchise, such authority may attempt to impose more burdensome or onerousfranchise requirements in connection with a request for such consent.Historically, franchises have been renewed for cable operators that haveprovided satisfactory services and have complied with the terms of theirfranchises. The Company believes that it has generally met the terms of itsfranchises and has provided quality levels of service. The Company anticipatesthat its future franchise renewal prospects generally will be favorable.Various courts have considered whether franchising authorities have the legalright to limit the number of franchises awarded within a community and to imposecertain substantive franchise requirements (e. g. access channels, universalservice and other technical requirements). These decisions have beeninconsistent and, until the US Supreme Court rules definitively on the scope ofcable operators' First Amendment protections, the legality of the franchisingprocess generally and of various specific franchise requirements is likely to bein a state of flux.Ownership Limitations. Pursuant to the 1992 Cable Act, the FCC adopted rulesprescribing national subscriber limits and limits on the number of channels thatcan be occupied on a cable system by a video programmer in which the operatorhas an attributable interest. The effectiveness of these FCC horizontalownership limits has been stayed because a federal district court found thestatutory limitation to be unconstitutional. An appeal of that decision has beenconsolidated with appeals challenging the FCC's regulatory ownershiprestrictions and is pending. The 1996 Telecom Act eliminates the statutoryprohibition on the common ownership, operation or control of a cable system anda television broadcast station in the same service area and directs the FCC toreview its broadcast-cable ownership restrictions. Pursuant to the mandate ofthe 1996 Telecom Act, the FCC eliminated its regulatory restriction oncross-ownership of cable systems and national broadcasting networks. 37LEC Ownership of Cable Systems. The 1996 Telecom Act made far-reaching changesin the regulation of LECs that provide cable services. The 1996 Telecom Acteliminated federal legal barriers to competition in the local telephone andcable communications businesses, preempted legal barriers to competition thatpreviously existed in state and local laws and regulations, and set basicstandards for relationships between telecommunications providers. The 1996Telecom Act eliminated the statutory telephone company/cable televisioncross-ownership prohibition, thereby allowing LECs to offer video services intheir telephone service areas. LECs may provide service as traditional cableoperators with local franchises or they may opt to provide their programmingover unfranchised "open video systems," subject to certain conditions,including, but not limited to, setting aside a portion of their channel capacityfor use by unaffiliated program distributors on a non-discriminatory basis. The1996 Telecom Act generally limits acquisitions and prohibits certain jointventures between LECs and cable operators in the same market.Pole Attachment. The Communications Act requires the FCC to regulate the rates,terms and conditions imposed by public utilities for cable systems' use ofutility pole and conduit space unless state authorities can demonstrate thatthey adequately regulate pole attachment rates. In the absence of stateregulation, the FCC administers pole attachment rates on a formula basis. Insome cases, utility companies have increased pole attachment fees for cablesystems that have installed fiber optic cables and that are using such cablesfor the distribution of non-video services. The FCC has concluded that, in theabsence of state regulation, it has jurisdiction to determine whether utilitycompanies have justified their demand for additional rental fees and that theCommunications Act does not permit disparate rates based on the type of serviceprovided over the equipment attached to the utility's pole. The FCC's existingpole attachment rate formula, which may be modified by a pending rulemaking,governs charges for utilities for attachments by cable operators providing onlycable services. The 1996 Telecom Act and the FCC's implementing regulationsmodify the current pole attachment provisions of the Communications Act byimmediately permitting certain providers of telecommunications services to relyupon the protections of the current law and by requiring that utilities providecable systems and telecommunications carriers with nondiscriminatory access toany pole, conduit or right-of-way controlled by the utility. The FCC adopted newregulations to govern the charges for pole attachments used by companiesproviding telecommunications services, including cable operators. These new poleattachment rate regulations will become effective in February 2001. Anyresulting increase in attachment rates will be phased in equal annual incrementsover a period of five years, beginning in February 2001. The ultimate impact ofany revised FCC rate formula or of any new pole attachment rate regulations onthe Company cannot be determined at this time.Other Statutory Provisions. The 1992 Cable Act, the 1996 Telecom Act and FCCregulations preclude any satellite video programmer affiliated with a cablecompany, or with a common carrier providing video programming directly to itssubscribers, from favoring an affiliated company over competitors and requiressuch programmers to sell their programming to other multichannel videodistributors. These provisions limit the ability of program suppliers affiliatedwith cable companies or with common carriers providing satellite-delivered videoprogramming directly to their subscribers to offer exclusive programmingarrangements to their affiliates. In December 1997, the FCC initiated arulemaking to address a number of possible changes to its program access rules.Among the issues on which the FCC has sought comment is whether the FCC hasjurisdiction to extend its program access rules to terrestrially-deliveredprogramming, and if it does have such jurisdiction, whether it should expand therules in this fashion. This rulemaking is pending at the FCC.The 1992 Cable Act requires cable operators to block fully both the video andaudio portion of sexually explicit or indecent programming on channels that areprimarily dedicated to sexually oriented programming or alternatively to carrysuch programming only at "safe harbor" time periods currently defined by the FCCas the hours between 10 p. m. to 6 a. m. The Communications Act also includesprovisions, among others, concerning horizontal and vertical ownership of cablesystems, customer service, subscriber privacy, marketing practices, equalemployment opportunity, obscene or indecent programming, regulation of technicalstandards and equipment compatibility.Other FCC Regulations. The FCC revised its cable inside wiring rules to providea more specific procedure for the disposition of internal cable wiring thatbelongs to an incumbent cable operator that is forced to terminate its 38cable services in a MDU building by the building owner. The FCC is alsoconsidering additional rules relating to MDU inside wiring that, if adopted, maydisadvantage incumbent cable operators. The FCC has various rulemakingproceedings pending that will implement the 1996 Telecom Act; it also hasadopted regulations implementing various provisions of the 1992 Cable Act andthe 1996 Telecom Act that are the subject of petitions requestingreconsideration of various aspects of its rulemaking proceedings. Other FCCregulations covering such areas as equal employment opportunity, syndicatedprogram exclusivity, network program non-duplication, closed captioning of videoprogramming, registration of cable systems, maintenance of various records andpublic inspection files, microwave frequency usage, origination cablecasting andsponsorship identification, antenna structure notification, marking andlighting, carriage of local sports broadcast programming, application of rulesgoverning political broadcasts, limitations on advertising contained innon-broadcast children's programming, consumer protection and customer service,indecent programming, programmer access to cable systems, programmingagreements, technical standards, consumer electronics equipment compatibilityand DBS implementation. The FCC has the authority to enforce its regulationsthrough the imposition of substantial fines, the issuance of cease and desistorders and/or the imposition of other administrative sanctions, such as therevocation of FCC licenses needed to operate certain transmission facilitiesoften used in connection with cable operations.Other bills and administrative proposals pertaining to cable communications havepreviously been introduced in Congress or considered by other governmentalbodies over the past several years. It is probable that further attempts will bemade by Congress and other governmental bodies relating to the regulation ofcommunications services.Copyright. Cable communications systems are subject to federal copyrightlicensing covering carriage of television and radio broadcast signals. Inexchange for filing certain reports and contributing a percentage of theirrevenues to a federal copyright royalty pool, cable operators can obtain blanketpermission to retransmit copyrighted material on broadcast signals. The natureand amount of future payments for broadcast signal carriage cannot be predictedat this time. In a report to Congress, the Copyright Office recommended thatCongress make major revisions of both the cable television and satellitecompulsory licenses to make them as simple as possible to administer, to providecopyright owners with full compensation for the use of their works, and to treatevery multichannel video delivery system the same, except to the extent thattechnological differences or differences in the regulatory burdens placed uponthe delivery system justify different copyright treatment. The possiblesimplification, modification or elimination of the compulsory copyright licenseis the subject of continuing legislative review. The elimination or substantialmodification of the cable compulsory license could adversely affect theCompany's ability to obtain suitable programming and could substantiallyincrease the cost of programming that remains available for distribution to theCompany's subscribers. The Company cannot predict the outcome of thislegislative activity.Cable operators distribute programming and advertising that use music controlledby the two principal major music performing rights organizations, theAssociation of Songwriters, Composers, Artists and Producers ("ASCAP") andBroadcast Music, Inc. ("BMI"). In October 1989, the special rate court of the USDistrict Court for the Southern District of New York imposed interim rates onthe cable industry's use of ASCAP-controlled music. The same federal districtcourt established a special rate court for BMI. BMI and cable industryrepresentatives concluded negotiations for a standard licensing agreementcovering the performance of BMI music contained in advertising and otherinformation inserted by operators into cable programming and on certain localaccess and origination channels carried on cable systems. ASCAP and cableindustry representatives have met to discuss the development of a standardlicensing agreement covering ASCAP-controlled music in local origination andaccess channels and pay-per- view programming. Although the Company cannotpredict the ultimate outcome of these industry negotiations or the amount, ifany, of license fees it may be required to pay for past and future use ofASCAP-controlled music, it does not believe such license fees will besignificant to the Company's financial position, results of operations orliquidity.State and Local Regulation. Because a cable communications system uses localstreets and rights-of-way, cable systems are subject to state and localregulation. Cable communications systems generally are operated pursuant 39to non-exclusive franchises, permits or licenses granted by a municipality orother state or local government entity. Franchises generally are granted forfixed terms and in many cases are terminable if the franchisee fails to complywith material provisions. The terms and conditions of franchises vary materiallyfrom jurisdiction to jurisdiction. Each franchise generally contains provisionsgoverning cable service rates, franchise fees, franchise term, systemconstruction and maintenance obligations, system channel capacity, design andtechnical performance, customer service standards, franchise renewal, sale ortransfer of the franchise, territory of the franchisee, indemnification of thefranchising authority, use and occupancy of public streets and types of cableservices provided. The 1992 Cable Act immunizes franchising authorities frommonetary damage awards arising from regulation of cable communications systemsor decisions made on franchise grants, renewals, transfers and amendments.Internet Operations. The following is a summary of federal laws, regulations andtariffs, and a description of certain state and local laws pertaining to theInternet operations of the Company.With significant growth in Internet activity and commerce over the past severalyears the FCC and other regulatory bodies have been challenged to develop newmodels that allow them to achieve the public policy goals of competition anduniversal service. Many aspects of regulation and coordination of Internetactivities and traffic are evolving and are facing unclear regulatory futures.Changes in regulations in the future will have a significant impact on ISPs,Internet commerce and Internet services.The Internet has been able to grow and develop outside the existing regulatorystructure because the FCC has made conscious decisions to limit the applicationof its rules. The federal government's efforts have been directed away fromburdening the Internet with regulation. ISPs and other companies in the Internetindustry have not been required to gain regulatory approval for their actions.The 1996 Telecom Act adopts such a position. The 1996 Act states that it is thepolicy of the United States "to preserve the vibrant and competitive free marketthat presently exists for the Internet and other interactive computer services,unfettered by Federal or State regulation."Regulatory policy approaches toward the Internet have focused on several areas:avoiding unnecessary regulation, questioning the applicability of traditionalrules, Internet governance (such as the allocation of domain names),intellectual property, network reliability, privacy, spectrum policy, standards,security, and international regulation.Government may influence the evolution of the Internet in many ways, includingdirectly regulating, participating in technical standards development, providingfunding, restricting anti-competitive behavior by dominant firms, facilitatingindustry cooperation otherwise prohibited by antitrust laws, promoting newtechnologies, encouraging cooperation between private parties, representing theUnited States in international intergovernmental bodies, and large-scalepurchasing of services.There are many ways Internet growth could be negatively impacted which mayrequire future regulation and oversight. Moving toward proprietary standards orclosed networks would reduce the degree to which new services could leverage theexisting infrastructure. The absence of competition in the ISP market, or thetelecommunications infrastructure market, could reduce incentives forinnovation. Excessive or misguided government intervention could distort theoperation of the marketplace, and lead companies to expend valuable resourcesworking through the regulatory process. Insufficient government involvement mayalso, however, have negative consequences. Some issues may require a degree ofcentral coordination, even if only to establish the initial terms of adistributed, locally-controlled system. The end result, in the absence ofcollective action, may be an outcome that no one favors. In addition, thefailure of the federal government to identify Internet-related areas that shouldnot be subject to regulation leaves open opportunities for state, local, orinternational bodies to regulate excessively and/or inconsistently.There is no one entity or organization that governs the Internet. Eachfacilities-based network provider that is interconnected with the globalInternet controls operational aspects of their own network. Certain functions, 40such as domain name routing and the definition of the TCP/IP protocol, arecoordinated by an array of quasi-governmental, intergovernmental, andnon-governmental bodies. The United States government, in many cases, has handedover responsibilities to these bodies through contractual or other arrangements.In other cases, entities have emerged to address areas of need such as theInternet Society ("ISOC"), a non-profit professional society founded in 1992.ISOC organizes working groups and conferences, and coordinates some of theefforts of other Internet administrative bodies. Internet standards andprotocols are developed primarily by the Internet Engineering Task Force("IETF"), an open international body mostly comprised of volunteers. The work ofthe IETF is coordinated by the Internet Engineering Steering Group, and theInternet Architecture Board, which are affiliated with ISOC. The InternetAssigned Numbers Authority handles Internet addressing matters under a contractbetween the Department of Defense and the Information Sciences Institute at theUniversity of Southern California.The legal authority of any of these bodies is unclear. Most of the underlyingarchitecture of the Internet was developed under the auspices, directly orindirectly, of the United States government. The government has not, however,defined whether it retains authority over Internet management functions, orwhether these responsibilities have been delegated to the private sector. Thedegree to which any existing body can lay claim to representing "the Internetcommunity" is also unclear. Membership in the existing Internet governanceentities is drawn primarily from the research and technical communities.The 1996 Telecom Act provides little direct guidance as to whether the FCC hasauthority to regulate Internet-based services. Section 223 concerns access byminors to obscene, harassing, and indecent material over the Internet and otherinteractive computer networks, and sections 254, 706, and 714 address mechanismsto promote the availability of advanced telecommunications services, possiblyincluding Internet access. Section 230 states a policy goal "to preserve thevibrant and competitive free market that presently exists for the Internet andother interactive computer services, unfettered by Federal or State regulation."None of these sections, however, specifically addresses the FCC's jurisdiction.Nothing in the 1996 Telecom Act expressly limits the FCC's authority to regulateservices and facilities connected with the Internet, to the extent that they arecovered by more general language in any section of the Act. Moreover, it is notclear what such a limitation would mean even if it were adopted. TheCommunications Act directs the FCC to regulate "interstate and foreign commercein communication by wire and radio," and the FCC and state public utilitycommissions indisputably regulate the rates and conditions under which ISPspurchase services and facilities from telephone companies. Given the absence ofclear statutory guidance, the FCC must determine whether or not it has theauthority or the obligation to exercise regulatory jurisdiction over specificInternet-based activities. The FCC may also decide whether to forebear fromregulating certain Internet-based services. Forbearance allows the FCC todecline to adopt rules that would otherwise be required by statute. Undersection 401 of the 1996 Telecom Act, the FCC must forbear if regulation wouldnot be necessary to prevent anticompetitive practices and to protect consumers,and forbearance would be consistent with the public interest. Finally, the FCCcould consider whether to preempt state regulation of Internet services thatwould be inconsistent with achievement of federal goals.The FCC has not attempted to regulate the companies that provide the softwareand hardware for Internet telephony, or the access providers that transmit theirdata, as common carriers or telecommunications service providers. In March 1996,America's Carriers Telecommunication Association ("ACTA"), a trade associationprimarily comprised of small and medium-size interexchange carriers, filed apetition with the FCC asking the FCC to regulate Internet telephony. ACTA arguesthat providers of software that enables real-time voice communications over theInternet should be treated as common carriers and subject to the regulatoryrequirements of Title II. The FCC has sought comment on ACTA's request. Othercountries are considering similar issues.The FCC has not considered whether any of the rules that relate to radio andtelevision broadcasters should also apply to analogous Internet-based services.The vast majority of Internet traffic today travels over wire facilities, 41rather than the radio spectrum. As a policy matter, however, a continuous, live,generally-available music broadcast over the Internet may appear similar to atraditional radio broadcast, and the same arguments may be made about streamingvideo applications. The FCC will need to consider the underlying policyprinciples that, in the language of the Act and in FCC decisions, have formedthe basis for regulation of the television and radio broadcast industries.The FCC does not regulate the prices charged by ISPs or Internet backboneproviders. However, the vast majority of users connect to the Internet overfacilities of existing telecommunications carriers. Those telecommunicationscarriers are subject to varying levels of regulation at both the federal and thestate level. Thus, regulatory decisions exercise a significant influence overthe economics of the Internet market. Economics is expected to drive thedevelopment of both the Internet and of other communications technologies.Internet access is understood to be an enhanced service under FCC rules,therefore ISPs are treated as end users, rather than carriers, for purposes ofthe FCC's interstate access charge rules. This distinction, created when the FCCestablished the access charge system in 1983, is often referred to as the "ESPexemption." Thus, when ISPs purchase lines from LECs, the ISPs buy those linesunder the same tariffs that any business customer would use -- typically voicegrade measured business lines or 23 channel ISDN primary rate interface (PRI).Although these services generally involve a per-minute usage charge in additionto a monthly fee, the usage charge is assessed only for outbound calls. ISPs,however, exclusively use these lines to receive calls from their customers, andthus effectively pay flat monthly rates. By contrast, IXCs that interconnectwith LECs are considered carriers, and thus are required to pay interstateaccess charges for the services they purchase. Most of the access charges thatcarriers pay are usage-sensitive in both directions. Thus, IXCs are assessedper-minute charges for both originating and terminating calls. The FCC concludedin the Local Competition Order that the rate levels of access charges appear tosignificantly exceed the incremental cost of providing these services. The FCCin December 1996 launched a comprehensive proceeding to reform access charges ina manner consistent with economic efficiency and the development of localcompetition.The revenue effects of Internet usage today depend to a significant extent onthe structure of state tariffs. Internet usage generates less revenue for LECsin states where flat local service rates have been set low, with compensatingrevenues in the form of per-minute intrastate toll charges. Because ISPs onlyreceive local calls, they do not incur these usage charges. By contrast, instates where flat charges make up a higher percentage of LEC revenues, ISPs willhave a less significant revenue effect. ISP usage is also affected by therelative pricing of services such as ISDN Primary Rate Interface (PRI), framerelay, and fractional T-1 connections, which are alternatives to analog businesslines. The prices for these services, and the price difference on aper-voice-channel basis between the options available to ISPs, varies widelyacross different states. In many cases, tariffs for these and other dataservices are based on assumptions that do not reflect the realities of theInternet access market today. The scope of local calling areas also affects thearchitecture of Internet access services. In states with larger unmeasured localcalling areas, ISPs need fewer POPs in order to serve the same customers througha local call.The Company is presently unable to determine what the impact of potentialInternet regulatory actions and decisions will be on the Company's liquidity,results of operations and cash flows.Financial information about the Company's foreign and domestic operations andexport salesAlthough the Company has several agreements to facilitate the origination andtermination of international toll traffic, it has neither foreign operations norexport sales. The Company conducts operations throughout the western contiguousUnited States, Alaska and Hawaii and believes that any subdivision of itsoperations into distinct geographic areas would not be meaningful. Revenuesassociated with international toll traffic were $7.0 million, $7.6 million and$8.3 million for the years ended December 31, 1998, 1997 and 1996, respectively.SeasonalityLong-distance revenues have historically been highest in the summer months as aresult of temporary population increases attributable to tourism and increasedseasonal economic activity such as construction, commercial 42fishing, and oil and gas activities. Cable television revenues, on the otherhand, are higher in the winter months because consumers tend to watch moretelevision, and spend more time at home, during these months. Local service andInternet operations are not expected to exhibit significant seasonality. TheCompany's ability to implement construction projects is also reduced during thewinter months because of cold temperatures, snow and short daylight hours.Customer-sponsored researchThe Company has not expended material amounts during the last three fiscal yearson customer-sponsored research activities.Backlog of Orders and InventoryAs of December 31, 1998 and 1997, the Company's long-distance services segmenthad a backlog of equipment sales orders of approximately $202,000 and $104,000,respectively. The increase in backlog as of December 31, 1998 can be attributedprimarily to sales growth in 1998 as compared to 1997. The Company expects thatall of the orders in backlog at the end of 1998 will be delivered during 1999.Geographic Concentration and Alaska EconomyThe Company offers voice and data telecommunication and video services tocustomers primarily throughout Alaska. As a result of this geographicconcentration, the Company's growth and operations depend upon economicconditions in Alaska. The economy of Alaska is dependent upon the naturalresource industries, and in particular oil production, as well as tourism,government, and United States military spending. Any deterioration in thesemarkets could have an adverse impact on the Company. Almost $4 of every $10produced in Alaska comes from the oil industry. 73 percent ($1.5 billion) ofcore Alaska state treasury receipts came from the oil industry in 1998 throughproduction taxes, ad valorem taxes, corporate income taxes, royalties and leasepayments.The volume of oil transported by the TransAlaska Oil Pipeline System over thepast 20 years has been as high as 2.0 million barrels per day in 1988.Production has begun to decline in recent years and is presently down 40% fromthe 1988 levels. The two largest producers of oil in Alaska (the primary usersof the TransAlaska Oil Pipeline System) continue to explore, develop and producenew oil fields and to enhance recovery from existing fields to offset thedecline in production from the Prudhoe Bay field. Both companies have investedlarge sums of money in developing and implementing oil recovery techniques atthe Prudhoe Bay field and other nearby fields.Market prices for North Slope oil declined to below $10 per barrel in 1998, wellbelow the average price used by the State of Alaska to budget its oil relatedrevenues. Oil companies and service providers have announced cost cuttingmeasures to offset a portion of the declining revenues. Oil company and relatedoil field service company layoffs reportedly will result in a reduction of oilindustry jobs by at least 39 percent in 1999.BP Alaska Exploration ("BP") announced that it would cut costs in Alaska by 30percent, including layoffs of approximately 600 employees and other cost-cuttingmeasures such as decreased production and delayed exploration efforts. Projectsthat are underway are reportedly not affected by the cutbacks, however BP didnotify state officials that it would delay its exploration of the Genesee testsite east of Prudhoe.Atlantic Richfield Company ("ARCO") announced that it would cut 80 Alaska jobs,which reportedly amounts to five percent of its workforce in the state. ARCO hasalso indicated that the cost cuts will not affect the development of the Alpinefield west of Prudhoe Bay.BP Amoco announced in April 1999 its intention to purchase ARCO for $26.8billion. BP Amoco and ARCO together reportedly hold approximately 75 percent ofthe ownership of the Alaska North Slope oil fields and in the company thatoperates the Trans-Alaska Pipeline System. Alaska law stipulates that no singlecompany can hold drilling leases to more than 500,000 onshore state-owned acres. 43The BP Amoco-ARCO combination would control about 860,000 acres, however thecompanies have reportedly said they will give up 360,000 acres to comply withAlaska laws. Realignment of operations following the acquisition reportedly willresult in the layoff of 400 personnel in Alaska. The Company is not able topredict the effect of the acquisition of ARCO by BP Amoco on Alaska's economy oron the Company.The effects of low oil prices will impact the state of Alaska's economy, and isexpected to particularly hurt state and local government and oil servicecompanies. As much as half of the drilling fleet that worked on the slope in1998 could be idle during 1999. Oil field service and drilling contractors cutoperating costs to adjust for decreasing production and exploration. TheCompany, as an outsourcing services provider to the oil industry, reduced itsoutsourcing work force by 8 employees in February 1999.The state of Alaska December 1998 forecast for future oil production and staterevenues indicates that analysts do not expect oil prices to recover forapproximately two years. As a result, the Alaska Department of Revenue forecastanticipates that production will fall from 1.28 million barrels a day in FiscalYear 1998 to 1.18 million in Fiscal Year 1999.Since actual revenues to the state of Alaska are expected to fall significantlyshort of budgeted revenues, (an estimated $1.04 billion deficit for the comingbudget year), the Governor of the state of Alaska has announced his intention toimplement cost-cutting and revenue enhancing measures. The state of Alaskamaintains surplus accounts that are intended to fund budgetary shortfalls andwould be expected to fund a portion of the revenue shortfall.Although the depressed oil prices are expected to have a substantial effect onAlaska's economy, analysts believe that tourism, air cargo, and service sectorsare strong enough to offset a portion of the downturn. These industries havehelped offset the prevailing pattern of oil industry downsizing that hasoccurred during much of the last several years. Three other factors that supportAlaska's economy are the healthy national economy, low interest rates, and lowinflation. Construction is expected to remain strong over the next few years;$315 million of federal money is expected to be distributed to the state ofAlaska for highways and other federally supported projects.Effective March 1997, the State of Alaska passed new legislation relaxing stateoil royalties with respect to marginal oil fields that the oil companies claimwould not be economic to develop otherwise. No assurance can be given that oilcompanies doing business in Alaska will be successful in discovering new fieldsor further developing existing fields which are economic to develop and produceoil with access to the pipeline or other means of transport to market, even withthe reduced level of royalties.Should oil companies not be successful in these discoveries or developments, orthe price of oil remain at its current depressed levels, the long term trend ofcontinued decline in oil production from the Prudhoe Bay field area isinevitable with a corresponding adverse impact on the economy of the state, ingeneral, and on demand for telecommunications and cable television services,and, therefore, on the Company, in particular. The Company is not able topredict the effect of declining production and prices on the State of Alaska'seconomy or on the Company.The Company has, since its entry into the telecommunication marketplaceaggressively marketed its services to seek a larger share of the availablemarket. However, with a small population of approximately 600,000 people,one-half of whom are located in the Anchorage area and the rest of whom arespread out over the vast reaches of Alaska, the customer base in Alaska islimited. No assurance can be given that the driving forces in the Alaskaeconomy, and in particular, oil production, will continue at levels to providean environment for expanded economic activity. 44EmployeesThe Company and its direct and indirect subsidiaries employ approximately 972persons as of February 19, 1999. The Company and its subsidiaries are notparties to any union contracts with their employees. The Company believes thatits future success will depend upon its continued ability to attract and retainhighly skilled and qualified employees. The Company believes that its relationswith its employees are satisfactory.OtherNo material portion of the businesses of the Company is subject to renegotiationof profits or termination of contracts at the election of the federalgovernment.Item 2. PROPERTIESGeneral. The Company's property, plant and equipment in service totaled $282.8million at December 31, 1998, of which $148.0 relates to long-distance services,$95.6 relates to cable services, $27.9 relates to local access services, and$11.3 relates to Internet services. These properties consist primarily ofswitching equipment, satellite earth stations, fiber-optic networks, microwaveradio and cable and wire facilities, cable head-end equipment, coaxialdistribution networks, routers, servers, transportation equipment, computerequipment and general office equipment. Substantially all of the Company'sproperties secure its Senior Holdings Loan and Fiber Facility. See note 6 to theNotes to Consolidated Financial Statements included in Part II of this Reportfor further discussion.The Company's construction in progress totaled $119.6 million at December 31,1998, of which $114.9 relates to Alaska United fiber-optic facilities connectingAnchorage, Juneau, Fairbanks, Valdez and Whittier, Alaska to Seattle Washington,and $4.7 relates to telecommunications and Internet construction projects thatwere not complete at December 31, 1998.Long-Distance Services. The Company operates a state-of-the-art, competitivetelecommunications network employing the latest digital transmission technologybased upon fiber optic and digital microwave facilities within and betweenAnchorage, Fairbanks and Juneau. The Company's network includes digital fiberoptic cables linking Alaska to the contiguous 48 states and providing access toother carriers' networks for communications around the world. The Company usessatellite transmission to remote areas of Alaska and for certain interstatetraffic.The Company's long-distance services segment owns properties and facilitiesincluding satellite earth stations, and distribution, transportation and officeequipment. Additionally, the Company acquired in December 1992, access tocapacity on an undersea fiber optic cable from Seward, Alaska to Pacific City,Oregon. The undersea fiber optic cable capacity is owned subject to anoutstanding mortgage. The Company completed construction of an additional fiberoptic cable facility linking Alaska to Seattle, Washington in February, 1999,which is owned subject to an outstanding mortgage.The Company entered into a purchase and lease-purchase option agreement inAugust 1995 for the acquisition of satellite transponders on the PanAmSat GalaxyXR satellite to meet its long-term satellite capacity requirements. The balancepayable upon expected delivery of the transponders during the fourth quarter of1999 in addition to the $9.1 million deposit previously paid totalsapproximately $43.5 million. The Company's remaining commitment will likely befunded from its Senior Holdings Loan. The purchase and lease-purchase optionagreement provides for the interim lease of transponder capacity on the PanAmSatGalaxy IX satellite through the delivery of the purchased transponders.The Company leases its long-distance services industry segment's executive,corporate and administrative facilities in Anchorage, Fairbanks and Juneau,Alaska. The Company's operating, executive, corporate and administrativeproperties are in good condition. The Company considers its properties suitableand adequate for its present needs and are being fully utilized. 45Cable Services. The Cable Systems serve 26 communities and areas in Alaskaincluding Anchorage, Fairbanks and Juneau, the state's three largest urbanareas. As of December 31, 1998 the Cable Systems consisted of approximately1,806 miles of installed cable plant having between 300 to 550 MHz of channelcapacity. The Company leases its cable services industry segment's operatingfacilities in substantially all locations. Such properties are in goodcondition. The Company considers its properties suitable and adequate for itspresent and anticipated future needs.Local Access Services. The Company operates a state-of-the-art, competitivelocal access telecommunications network employing the latest digitaltransmission technology based upon fiber optic facilities within Anchorage. TheCompany leases its local access services industry segment's operating facilitiesin Anchorage. Such properties are in good condition. The Company considers itsproperties suitable and adequate for its present and anticipated future needs.Internet Services. The Company operates a state-of-the-art, competitive Internetnetwork employing the latest available technology. The Company leases itsInternet services industry segment's operating facilities, located primarily inAnchorage. Such properties are in good condition. The Company considers itsproperties suitable and adequate for its present and anticipated future needs.Item 3. LEGAL PROCEEDINGSExcept as set forth in this item, neither the Company, its property nor any ofits subsidiaries or their property is a party to or subject to any materialpending legal proceedings. The Company and its subsidiaries are parties tovarious claims and pending litigation as part of the normal course of business.The Company is also involved in several administrative proceedings and filingswith the FCC, Department of Labor and state regulatory authorities. In theopinion of management, except as noted below, the nature and disposition ofthese matters are considered routine and arising in the ordinary course ofbusiness which management believes, even if resolved unfavorably to the Company,would not have a materially adverse affect on the Company's business or itsfinancial position, results of operations or liquidity.Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) Date of meeting - June 4, 1998 Nature of meeting - 1998 annual meeting of shareholders (b) Election of Directors: Names of directors elected at the meeting: Donne F. Fisher Votes: 54,009,905 For; 1,367,485 Withheld William P. Glasgow Votes: 54,990,085 For; 387,305 Withheld James M. Schneider Votes: 55,105,849 For; 271,541 Withheld Names of directors whose term of office continued after the meeting: Carter F. Page Ronald A. Duncan Robert M. Walp Jeffrey C. Garvey John W. Gerdelman Donald T. Lynch Larry E. Romrell 46 (c) Not applicable. (d) Not applicable. PART IIItem 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERSMarket Information for Common Stock. Shares of GCI's Class A common stock aretraded on the Nasdaq National Market tier of The Nasdaq Stock Market under thesymbol GNCMA. Shares of GCI's Class B common stock are traded on theOver-the-Counter market. The following table sets forth the high and low salesprice for the above-mentioned common stock for the periods indicated. Theprices, rounded up to the nearest eighth, represent prices between dealers, donot include retail markups, markdowns, or commissions, and do not necessarilyrepresent actual transactions. Class A Class B ----------------------------------- ----------------------------------- High Low High Low ---- --- ---- --- 1997: First Quarter 8 1/8 6 8 1/8 6 Second Quarter 8 5/8 6 1/4 8 5/8 6 1/4 Third Quarter 9 1/4 6 1/2 9 1/4 6 1/2 Fourth Quarter 8 1/8 6 3/8 8 1/8 6 3/81998: First Quarter 8 3/8 6 1/8 8 3/8 6 1/8 Second Quarter 8 5 1/2 8 5 1/2 Third Quarter 6 1/8 2 5/8 6 1/8 2 5/8 Fourth Quarter 5 2 1/2 5 2 1/2Holders. As of December 31, 1998 there were 1,873 holders of record of GCI'sClass A common stock and 626 holders of record of GCI's Class B common stock(amounts do not include the number of shareholders whose shares are held ofrecord by brokers, but do include the brokerage house as one shareholder).Dividends. GCI and GCI, Inc. have never paid cash dividends on their commonstock and have no present intention of doing so. Payment of cash dividends inthe future, if any, will be determined by GCI's Board of Directors in light ofthe Company's earnings, financial condition and other relevant considerations.The Company's existing bank loan agreements contain provisions that prohibitpayment of dividends, other than stock dividends (see note 6 to the ConsolidatedFinancial Statements included in Part II of this Report). 47Item 6. SELECTED FINANCIAL DATAThe following table presents selected historical information relating tofinancial condition and results of operations over the past five years. Years ended December 31, ------------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (Amounts in thousands except per share amounts) Revenues (1) $ 246,795 223,809 164,894 129,279 116,981 Net earnings (loss) before income taxes and extraordinary item (2) $ (10,920) (2,235) 12,690 12,601 11,681 Loss on early extinguishment of debt, net of income tax benefit of $180 $ 0 521 0 0 0 Net earnings (loss) $ (6,797) (2,183) 7,462 7,502 7,134 Basic net earnings (loss) per common share $ (0.14) (0.05) 0.28 0.32 0.30 Diluted net earnings (loss) per common share $ (0.14) (0.05) 0.27 0.31 0.30 Total assets (3) $ 646,116 545,302 447,335 84,765 74,249 Long-term debt, including current portion (3) $ 351,657 250,084 223,242 9,980 12,554 Obligations under capital leases, including current portion $ 2,186 1,188 746 1,047 1,297 Total stockholders' equity (3, 4) $ 200,007 204,439 149,554 43,016 35,093 Dividends declared per Common share (5) $ 0.00 0.00 0.00 0.00 0.00 1 The 1997 revenue increase is primarily attributed to the Company's reporting 12 months of cable television service revenues as compared to two months reported in 1996. 2 The Company's net losses in 1998 and 1997 are primarily attributed to additional depreciation, amortization and interest expense resulting from the cable company acquisitions in October 1996 and startup losses from the Company's entry into local access services and Internet services markets. 3 Increases in the Company's total assets, long-term debt and stockholders' equity in 1996 as compared to 1995 result in part from the cable company acquisitions and MCI (now MCI WorldCom) stock issuance described in notes 2 and 8 to the Notes to Consolidated Financial Statements included in Part II of this Report. Increases in assets and long-term debt in 1998 as compared to 1997 result primarily from the Company's construction of a fiber-optic system connecting points in Alaska with Seattle Washington as further described in note 11 to the accompanying Notes to Consolidated Financial Statements included in Part II of this Report. 4 The 1997 increase in stockholders' equity is primarily attributed to the Company's equity offering in August 1997, described in note 8 to the accompanying Notes to Consolidated Financial Statements included in Part II of this Report. 5 The Company has never paid a cash dividend on its common stock and does not anticipate paying any dividends in the foreseeable future. The Company intends to retain its earnings, if any, for the development of its business. Payment of cash dividends in the future, if any, will be determined by the board of directors of the Company in light of the Company's earnings, financial condition, credit agreements and other relevant considerations. The Company's existing bank loan agreements contain provisions that prohibit payment of dividends, other than stock dividends, as further described in note 6 to the Notes to Consolidated Financial Statements included in Part II of this Report. 48Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONSThe following discussion and analysis should be read in conjunction with theCompany's Consolidated Financial Statements and the notes thereto and otherfinancial data appearing elsewhere in this Report on Form 10-K. See -CautionaryStatement Regarding Forward-Looking Statements. OverviewThe Company has experienced significant growth in recent years through bothstrategic acquisitions and growth in its existing businesses. The Company hashistorically met its cash needs for operations through its cash flows fromoperating activities. Cash requirements for acquisitions and capitalexpenditures have been provided through the Company's financing activities, aswell as its existing cash and cash equivalents.Long-distance services. The Company has historically reported revenuesprincipally from the provision of interstate and intrastate long-distanceservices to residential, commercial and governmental customers and to othercommon carriers (principally MCI, now MCI WorldCom, and Sprint). These servicesaccounted for approximately 91.9% of the Company's long-distance servicesrevenues during 1998. Factors that have the greatest impact on year-to-yearchanges in telecommunications services revenues include the rate per minutecharged to customers and usage volumes, usually expressed as minutes of use.These factors in turn depend in part upon economic conditions in Alaska. Theeconomy of Alaska is dependent upon the natural resource industries, inparticular oil production, as well as tourism, government and United Statesmilitary spending.The Company's telecommunication cost of sales and services has consistedprincipally of the direct costs of providing services, including local accesscharges paid to LECs for the origination and termination of long-distance callsin Alaska, fees paid to other long-distance carriers to carry calls thatterminate in areas not served by the Company's network (principally the lower 49states, most of which calls are carried over MCI's network, and internationallocations, which calls are carried principally over Sprint's network), and thecost of equipment sold to the Company's customers. During 1998, local accesscharges accounted for 42.6% of telecommunications cost of sales and services,fees paid to other long-distance carriers represented 33.2%, satellitetransponder lease and undersea fiber maintenance costs represented 10.0%,telecommunications equipment accounted for 4.8%, and network solutions andoutsourcing costs represented 7.0% of telecommunications cost of sales andservices.The Company's long-distance selling, general, and administrative expenses haveconsisted of operating and engineering, customer service, sales andcommunications, management information systems, general and administrative,legal and regulatory expenses. Most of these expenses consist of salaries, wagesand benefits of personnel and certain other indirect costs (such as rent,travel, utilities, insurance and property taxes). A significant portion oflong-distance selling, general, and administrative expenses, 30.9% during 1998,represents the cost of the Company's advertising, promotion and market analysisprograms.Long-distance telecommunication services face significant competition from AT&TAlascom, Inc., long-distance resellers, and from local telephone companies thathave entered the long-distance market. The number of active long-distancecustomers billed by the Company has decreased approximately 7.9% during 1998.Gains in the number of commercial and small business customers billed were morethan offset by a reduction in the number of residential customers billed.Increased usage volumes and traffic carried for other common carriers havegenerally offset usage reductions attributed to the decrease in the number ofactive residential customers billed. The Company believes its approach todeveloping, pricing, and providing long-distance services and bundling differentbusiness segment services will continue to allow it to be competitive inproviding those services.Other common carrier traffic routed to the Company for termination in Alaska islargely dependent on traffic routed to MCI WorldCom and Sprint by theircustomers. Pricing pressures, new program offerings and 49market consolidation continue to evolve in the markets served by MCI WorldComand Sprint. If, as a result, their traffic is reduced, or if their competitors'costs to terminate or originate traffic in Alaska are reduced, the Company'straffic will also likely be reduced, and the Company's pricing may be reduced torespond to competitive pressures. The Company is unable to predict the effect onthe Company of such changes, however given the materiality of other commoncarrier revenues to the Company, a significant reduction in traffic or pricingcould have a material adverse effect on the Company's financial position,results of operations and liquidity.Services included in the Other segment as described in note 9 to theaccompanying consolidated financial statements are included in the Long-DistanceServices segment for purposes of this Management's Discussion and Analysis.See Part I, Item 1. Business, Long-distance Services, Competition for additionalinformation regarding long-distance services competition.Cable services. Following the cable system acquisitions effective October 31,1996, the Company now reports a significant level of revenues from the provisionof cable services. During 1998, cable revenues represented 23.4% of consolidatedrevenues. The cable systems serve 26 communities and areas in Alaska, includingthe state's three largest population centers, Anchorage, Fairbanks and Juneau.The Company generates cable services revenues from three primary sources: (1)programming services, including monthly basic or premium subscriptions andpay-per-view movies or other one-time events, such as sporting events; (2)equipment rentals or installation; and (3) advertising sales. During 1998programming services generated 85.7% of total cable services revenues, equipmentrental and installation fees accounted for 7.9% of such revenues, advertisingsales accounted for 5.0% of such revenues, and other services accounted for theremaining 1.4% of total cable services revenues. The primary factors thatcontribute to year-to-year changes in cable services revenues are averagemonthly subscription and pay-per-view rates, the mix among basic, premium andpay-per-view services, and the average number of subscribers during a givenreporting period.The cable systems' cost of sales and selling, general and administrativeexpenses have consisted principally of programming and copyright expenses,labor, maintenance and repairs, marketing and advertising, rental expense, andproperty taxes. During 1998 programming and copyright expenses representedapproximately 40.1% of total cable cost of sales and selling, general andadministrative expenses. Marketing and advertising costs representedapproximately 9.5% of such total expenses.Cable services face competition from alternative methods of receiving anddistributing television signals and from other sources of news, information andentertainment. The Company believes its cable television services will continueto be competitive based on providing, at reasonable prices, a greater variety ofprogramming and other communication services than are available off-air orthrough other alternative delivery sources and upon superior technicalperformance and customer service. See Part I, Item 1. Business, Cable Services,Competition for additional information regarding cable services competition.Local access services. The Company began offering local exchange services inAnchorage during late September 1997. The Company generates local accessservices revenues from four primary sources: (1) business and residential basicdial tone revenues; (2) business private line and special access revenues; (3)reciprocal access revenues from the incumbent LEC; and (4) business andresidential feature and other charges, including voice mail, caller ID,distinctive ring, inside wiring and subscriber line charges. Local exchangeservices revenues totaled $9.9 million representing 4.0% of total revenues in1998. The primary factors that contribute to year-to-year changes in localaccess services revenues are the average number of business and residentialsubscribers during a given reporting period and the average monthly ratescharged for non-traffic sensitive services. 50Operating and engineering expenses represented approximately 8.8% of total localaccess services cost of sales and selling, general and administrative expensesduring 1998. Marketing and advertising costs represented approximately 4.7% ofsuch total expenses, customer service and general and administrative costsrepresented approximately 53.4% of such total expenses, and local access cost ofsales represented approximately 33.1% of such total expenses. The Companyexpects that it will generate operating losses from local exchange servicesduring 1999.The Company's local access services face significant competition from ATU andAT&T Alascom, Inc. The Company believes its approach to developing, pricing, andproviding local access services will continue to allow it to be competitive inproviding those services. See Part I, Item 1. Business, Local Access Services,Competition and Part I, Item 1. Business, Historical development of theCompany's business during the past fiscal year, Local Access Services foradditional information regarding local access services competition.Internet services. The Company began offering Internet services in severalmarkets in Alaska during 1998. The Company generates Internet services revenuesfrom three primary sources: (1) access product services, including commercialDIAS, ISP DIAS, and retail dial-up service revenues; (2) SchoolAccess(TM) DIASand server revenues; and (3) network management services. Internet servicesrevenues totaled $4.6 million representing 1.9% of total revenues in 1998. Theprimary factors that contribute to year-to-year changes in Internet servicesrevenues are average monthly subscription rates, the number of customersselecting added features, and the average number of subscribers during a givenreporting period.Operating and general and administrative expenses represented approximately17.4% of total Internet services cost of sales and selling, general andadministrative expenses during 1998.Significant new marketing campaigns were introduced in February and March 1999featuring bundled residential and commercial Internet products. Additionalbandwidth was made available to the Company's Internet segment resulting fromcompletion of the Alaska United Project. The new Internet offerings are coupledwith the Company's long-distance and local services offerings and provide freebasic Internet services if certain long-distance or local services plans areselected. Value-added Internet features are available for additional charges.The Company competes with a number of Internet service providers in its markets.The Company believes its approach to developing, pricing, and providing Internetservices will continue to allow it to be competitive in providing thoseservices. See Part I., Item 1. Business, Internet Services, Competition forinformation regarding Internet services competition.Other services, other expenses and net loss. Telecommunications servicesrevenues reported in the "Other" segment have been attributable to corporatenetwork management contracts, telecommunications equipment sales and service,other miscellaneous revenues (including revenues from prepaid and debit callingcards, the installation and leasing of customers' very small aperture terminal("Vsat") equipment, and fees charged to MCI WorldCom and Sprint for certainbilling services), and costs associated with PCS wireless communicationsservices. The Company began developing plans for PCS service deployment in 1995and subsequently conducted a technical trial of its candidate technology. TheCompany has invested approximately $2.1 million in its PCS license at December31, 1998. PCS licensees are required to offer service to at least one-third oftheir market population within five years or risk losing their licenses. Servicemust be extended to two-thirds of the population within 10 years. The Company iscurrently reevaluating its wireless strategy and expects to complete suchreevaluation within the next six months. The Company expects that its wirelessstrategy will allow retention of the PCS license pursuant to its terms.Depreciation and amortization and interest expense on a consolidated basis isexpected to be higher in 1999 as compared to 1998 resulting primarily fromadditional depreciation on 1998 and 1999 capital expenditures and additionaloutstanding long-term debt. As a result, the Company anticipates recording netlosses in 1999. 51 Results of OperationsThe following table sets forth selected Statement of Operations data as apercentage of total revenues for the periods indicated (underlying data roundedto the nearest thousands): Year Ended December 31, Percentage Change ----------------------- ----------------- 1998 1997 vs. vs. 1998 1997 1996 1997 1996 ---- ---- ---- ---- ---- Statement of Operations Data: Revenues: Long-distance services 70.7% 75.0% 94.3% 4.1% 8.0% Cable services 23.4% 24.6% 5.7% 4.5% 482.2% Local services 4.0% 0.3% --- 1,524.3% NA Internet services 1.9% 0.1% --- 2,422.5% NA ---------------------------------------------------------------- Total revenues 100.0% 100.0% 100.0% 10.3% 35.7% Cost of sales and services 47.0% 49.6% 56.2% 4.5% 19.9% Selling, general and administrative expenses 36.1% 32.9% 28.1% 21.2% 58.5% Depreciation and amortization 13.0% 10.6% 5.7% 34.8% 152.6% ---------------------------------------------------------------- Operating income 3.9% 6.9% 10.0% (37.9%) (6.1%) Net earnings (loss) before income taxes (4.4%) (1.0%) 7.7% (388.6%) (117.6%) Net earnings (loss) (2.8%) (1.0%) 4.5% (211.4%) (129.3%)Other Operating Data: Cable operating income (1) 12.4% 18.9% 23.2% (31.7%) 374.6% Local operating loss (2) (112.2%) (581.8%) NA (213.3%) 307.9% Internet operating (loss) income (3) 0.1% (13.4%) NA 106.1% NA- -----------------------------------------------(1) Computed as a percentage of total cable services revenues. (2) Computed as a percentage of total local services revenues. (3) Computed as a percentage of total Internet services revenues.Year Ended December 31, 1998 Compared to Year Ended December 31, 1997.Revenues. Total revenues increased 10.3% from $223.8 million in 1997 to $246.8million in 1998. Long-distance transmission revenues from commercial,residential, governmental, and other common carrier customers increased 2.6%from $156.6 million in 1997 to $160.6 million in 1998. This increase reflected a5.3% increase in interstate minutes of use to 654.0 million minutes and a 4.6%increase in intrastate minutes of use to 137.3 million minutes. Long-distancerevenue growth in 1998 was largely due to a 4.4% increase in revenues from othercommon carriers (principally MCI WorldCom and Sprint), from $58.7 million in1997 to $61.3 million in 1998. Private line and private network transmissionservices revenues increased 22.0%, from $15.9 million in 1997 to $19.4 millionin 1998.The above increases in long-distance transmission revenues were offset in partby a 5.1% reduction in the Company's average rate per minute on long-distancetraffic from $0.177 per minute in 1997 to $0.168 per minute in 1998. Thedecrease in rates resulted from the Company's promotion of and customers'enrollment in new calling plans offering discounted rates and length of servicerebates, such new plans being prompted in part by the Company's primarylong-distance competitor, AT&T Alascom, reducing its rates and entry of LECsinto long-distance markets served by the Company. Operator services revenuesdecreased 14.3% from $7.0 million in 1997 to $6.0 million in 1998. Trafficcarried by the Company's operator service center 52decreased in part from increased usage of prepaid calling cards and cellulartelephones by tourists visiting the state of Alaska.Systems sales and services revenues (included in long-distance segment revenues)increased 30.7% from $10.2 million in 1997 to $13.3 million in 1998, primarilydue to an increase in the number of large equipment sales transactions in 1998as compared to 1997 and increased revenues derived from outsourcing services.Cable revenues increased 4.5% from $55.2 million in 1997 to $57.6 million in1998. Programming services revenues increased 3.1% to $49.4 million in 1998resulting from an increase of 3,900 basic subscribers served by the Company andan increase of $0.47 in revenue per average basic subscriber, per month. Newfacility construction efforts in 1998 resulted in additional homes passed whichcontributed to additional subscribers and revenues. Other factors includedfacility upgrades which allowed the introduction of digital cable services inAnchorage, increased promotional and advertising efforts and increases in basicand premium service rates in certain areas. Advertising sales revenues increased31.9% to $2.9 million in 1998 due to increased promotion of the Company'sadvertising and ad insertion capabilities. Equipment rental and installationrevenues increased 6.2% to $4.5 million in 1998 due to increased equipmentrentals and installation services provided by the Company. Offsetting theseincreases were reductions in pay-per-view and premium service revenues.Local access services revenues increased from $610,000 in 1997 to $9.9 millionin 1998. 1998 revenues reflect a full 12 months of local services operations andgrowth as compared to start-up operations in 1997. At December 31, 1998approximately 28,000 lines were in service and approximately 1,000 additionallines were awaiting connection.Internet services revenues increased from $182,000 in 1997 to $4.6 million in1998. 1998 revenues reflect a full 12 months of Internet services operations andgrowth as compared to start-up operations in 1997. The Company had approximately7,200 active residential subscribers to its Internet service at February 9,1999.Cost of sales and services. Cost of sales and services totaled $111.1 million in1997 and $116.1 million in 1998. As a percentage of total revenues, cost ofsales and services decreased from 49.6% in 1997 to 47.0% in 1998. The decreasein cost of sales and services as a percentage of revenues is primarilyattributed to changes in the Company's product mix due to the addition of newproduct lines for a full year of operations (local access services andInternet), and reduced long-distance cost of sales as a percentage oflong-distance revenues. The margin improvement was partially offset by increasedcable services cost of sales as a percentage of cable services revenues.The decrease in long-distance cost of sales and services as a percentage ofrevenues is primarily attributed to: 1) a refund received in the first quarterof 1998 totaling approximately $1.1 million from a LEC in respect of itsearnings that exceeded regulatory requirements, 2) reductions in access chargespaid by the Company to other carriers for distribution of its traffic, and 3)avoidance of access charges resulting from the Company's distribution andtermination of its traffic on its own network instead of paying other carriersto distribute and terminate its traffic. The Company expects margins to widen asincreasing amounts of traffic are carried on its own facilities.Cable cost of sales and services as a percentage of revenues is less as apercentage of revenues than are long-distance, local access and Internetservices cost of sales and services. Cable services rate increases did not keeppace with increases in programming and copyright costs in 1998. Programmingcosts increased on most of the Company's offerings and the Company incurredadditional costs on new programming introduced in 1998.Local access services cost of sales and services totaled 61.7% and 43.8% as apercentage of 1998 and 1997 local access services revenues, respectively.Internet services cost of sales and services totaled 74.1% and 132.4% as apercentage of 1998 and 1997 Internet services revenues, respectively. TheCompany's local 53access and Internet services operations commenced in 1997. Fluctuations in costof sales and services as a percentage of revenues are expected to occur asstart-up products develop into mature product lines.Selling, general and administrative expenses. Selling, general andadministrative expenses increased 22.0% from $73.6 million in 1997 to $89.8million in 1998, and, as a percentage of revenues, increased from 32.9% in 1997to 36.4% in 1998. This increase resulted from: - Local access services operating, engineering, sales, customer service and administrative cost increases, from $3.4 million in 1997 as compared to $12.3 million in 1998. The Company initiated local access services in September 1997. The increase was necessary to provide the operations, engineering, customer service and support infrastructure necessary to accommodate expected growth in the Company's local access services customer base. - Increased long-distance general and administrative expenses of $3.2 million in 1998 due to increased personnel and other costs in customer service, engineering, operations, accounting, human resources, legal and regulatory, and management information services. Increased customer service expenses were associated with support of increased sales volumes and expenditures necessary to integrate customer service operations across product lines. - Increased long-distance sales, advertising, telemarketing, carrier relations, business development and rural services costs totaling $15.3 million in 1997 compared to $17.6 million in 1998. Increased selling costs were associated with the introduction of various marketing plans and other proprietary rate plans and cross promotion of products and services. - Cable services operating, engineering, sales, customer service and administrative cost increases, from $18.8 million in 1997 as compared to $19.8 million in 1998. The increase was primarily incurred to promote and market the Company's cable services. - Internet services operating, engineering, sales, customer service and administrative cost increases, from $27,000 in 1997 as compared to $715,000 in 1998. The Company initiated its Internet services in 1998. The increase was necessary to provide the operations, engineering, customer service and support infrastructure necessary to accommodate expected growth in the Company's Internet services customer base.Depreciation and amortization. Depreciation and amortization expense increased34.5% from $23.8 million in 1997 to $32.0 million in 1998. The increase isattributable to the Company's $64.6 million of facilities placed into serviceduring 1997 for which a full year of depreciation was recorded during the yearending December 31, 1998 and the $58.4 million of facilities placed into servicein 1998 for which a partial year of depreciation was recorded during 1998 onequipment and facilities placed into service in 1998.Interest expense, net. Interest expense, net of interest income, increased 12.5%from $17.6 million in 1997 to $19.8 million in 1998. This increase resultedprimarily from increases in the Company's average outstanding indebtednessresulting primarily from construction of new long-distance and Internetfacilities, expansion and upgrades of cable television facilities, andinvestment in local access services equipment and facilities. Such increaseswere offset in part by increases in the amount of interest capitalized during1998.Income tax benefit. Income tax benefit increased from $0.6 million in 1997 to$4.1 million in 1998 due to the Company incurring a larger net loss beforeincome taxes and extraordinary item in 1998 as compared to 1997. The Company'seffective income tax rate increased from 25.6% in 1997 to 37.8% in 1998 due tothe net loss and the proportional amount of items that are nondeductible forincome tax purposes.In conjunction with the 1996 Cable Companies acquisition, the Company incurred anet deferred income tax liability of $24.4 million and acquired net operatinglosses totaling $57.6 million. The Company determined that approximately $20million of the acquired net operating losses would not be utilized for incometax purposes, and elected with its December 31, 1996 income tax returns toforego utilization of such acquired losses under Internal Revenue Code section1.1502-32(b)(4). Deferred tax assets were not recorded associated with theforegone losses and, accordingly, no valuation allowance was provided. AtDecember 5431, 1998, the Company has (1) tax net operating loss carryforwards ofapproximately $51.0 million that will begin expiring in 2008 if not utilized,and (2) alternative minimum tax credit carryforwards of approximately $2.0million available to offset regular income taxes payable in future years. TheCompany's utilization of remaining net operating loss carryforwards is subjectto certain limitations pursuant to Internal Revenue Code section 382.Tax benefits associated with recorded deferred tax assets are considered to bemore likely than not realizable through taxable income earned in carrybackyears, future reversals of existing taxable temporary differences, and futuretaxable income exclusive of reversing temporary differences and carryforwards.The amount of deferred tax asset considered realizable, however, could bereduced in the near term if estimates of future taxable income during thecarryforward period are reduced. The Company estimates that its effective incometax rate for financial statement purposes will be approximately 38% in 1999. TheCompany expects that its operations will generate net income before income taxesduring the carryforward periods to allow utilization of loss carryforwards forwhich no allowance has been established.Year Ended December 31, 1997 Compared to Year Ended December 31, 1996.Revenues. Total revenues increased 35.7% from $164.9 million in 1996 to $223.8million in 1997. The Company reported two months' of cable services revenues in1996 following its acquisition of the Cable Systems effective October 31, 1996.Cable revenues increased $45.7 million to $55.2 million resulting from 12months' of activity being recorded in 1997. Long-distance transmission revenuesfrom commercial, residential, governmental, and other common carrier customersincreased 9.8% from $142.6 million in 1996 to $156.6 million in 1997. Thisincrease reflected a 9.0% increase in interstate minutes of use to 620.8 millionminutes and a 9.8% increase in intrastate minutes of use to 133.1 millionminutes. Long-distance revenue growth in 1997 was largely due to a 22.3%increase in revenues from other common carriers (principally MCI and Sprint),from $48.0 million in 1996 to $58.7 million in 1997 and a 12.7% increase inprivate line and private network transmission services revenues, from $14.1million in 1996 to $15.9 million in 1997.The above increases in revenues were affected in part by a 1.1% reduction in theCompany's average rate per minute on long-distance traffic from $0.179 perminute in 1996 to $0.177 per minute in 1997. The decrease in rates resulted fromthe Company's promotion of and customers' enrollment in new calling plansoffering discounted rates and length of service rebates, such new plans beingprompted in part by the Company's primary long-distance competitor, AT&TAlascom, reducing its rates and entry of LECs into long-distance markets servedby the Company. Systems sales and services revenues decreased 6.4% from $10.9million in 1996 to $10.2 million in 1997, primarily due to a reduced number oflarge equipment sales transactions in 1997 as compared to 1996. Otherlong-distance revenues decreased $0.7 million to $1.1 million due primarily toreduced revenues from short term Vsat leases.Cost of sales and services. Cost of sales and services totaled $92.7 million in1996 and $111.1 million in 1997. As a percentage of total revenues, cost ofsales and services decreased from 56.2% in 1996 to 49.6% in 1997. The decreasein cost of sales and services as a percentage of revenues is primarilyattributed to changes in the Company's product mix. The Company reported 12months of cable operations in 1997 as compared to two months in 1996. Cable costof sales and services as a percentage of sales are less than long-distance andlocal services cost of sales and services as a percentage of sales. The increasein cable revenues as a percentage of total revenues (5.8% in 1996 to 24.7% in1997) resulted in an overall decrease in the Company's cost of sales andservices as a percentage of sales.Additionally, cost of sales and services as a percentage of revenues wereaffected in part by reductions in the rate per minute billed to the Company forthe local access and interstate termination services it obtains from thirdparties. Decreases in 1997 cost of sales and services as compared to 1996 wereoffset in part by refunds in the first two quarters of 1996 aggregatingapproximately $960,000 from a LEC and the National Exchange Carriers Associationin respect of earnings by them that exceeded regulatory requirements. 55Local access services cost of sales and services totaled 43.8% as a percentageof 1997 local access services revenues. Internet services cost of sales andservices totaled 132.4% as a percentage of 1997 Internet services revenues. TheCompany's local access and Internet services operations commenced in 1997.Fluctuations in cost of sales and services as a percentage of revenues areexpected to occur as start-up products develop into mature product lines.Selling, general and administrative expenses. Selling, general andadministrative expenses increased 58.6% from $46.4 million in 1996 to $73.6million in 1997, and, as a percentage of revenues, increased from 28.1% in 1996to 32.9% in 1997. This increase resulted from: - The Company's reporting 12 months' of cable television selling, general and administrative expenses in 1997 ($18.8 million) as compared to two months' in 1996 ($3.0 million). - Operating, engineering, sales, customer service and administrative costs totaling $4.1 million as compared to $870,000 in 1996 associated with the Company's local services segment which initiated service in September 1997. - Increased telecommunication general and administrative expenses of $5.1 million in 1997 due to increased personnel and other costs in customer service, engineering, operations, accounting, human resources, legal and regulatory, and management information services. Cost increases were associated with the development, introduction, or planned introduction, and support of new products and services including cable television services, rural message and data telephone services, PCS services, and Internet services. Increased customer service expenses were associated with support of increased sales volumes and expenditures necessary to integrate customer service operations across product lines. - Bad debt expense totaling $3.0 million for 1997 compared to $1.7 million in 1996 (directly associated with increased revenues). - Increased long-distance segment sales, advertising, telemarketing, carrier relations, business development and rural services costs totaling $13.0 million in 1996 compared to $15.3 million in 1997. Increased selling costs were associated with the introduction of various marketing plans and other proprietary rate plans and cross promotion of products and services.Depreciation and amortization. Depreciation and amortization expense increased153.2% from $9.4 million in 1996 to $23.8 million in 1997. Of this increase,$13.3 million resulted from the Company's acquisition of the cable systemseffective October 31, 1996, with the balance of the increase attributable to theCompany's $38.6 million investment in facilities during 1996 for which a fullyear of depreciation was recorded during the year ending December 31, 1997 andthe 1997 investment of $73.7 million in facilities for which a partial year ofdepreciation was recorded during 1997.Interest expense, net. Interest expense, net of interest income, increased375.7% from $3.7 million in 1996 to $17.6 million in 1997. This increaseresulted primarily from increases in the Company's average outstandingindebtedness resulting primarily from its acquisition of the Cable Systems,construction of new facilities in rural Alaska, expansion and upgrades of cabletelevision facilities, and investment in local services equipment andfacilities. Such increases were offset in part by increases in the amount ofinterest capitalized during 1997.Loss on extinguishment of debt. The Company recorded a net loss onextinguishment of debt of $521,000 in 1997 resulting from refinancing itspreviously outstanding Senior Credit Facility effective August 1, 1997. The lossresulted from the write-off of unamortized deferred debt issuance costs. Theloss is reported in the accompanying Consolidated Financial Statements net of anincome tax benefit of $180,000.Income tax expense. Income tax expense decreased from $5.2 million in 1996 to abenefit of $0.6 million in 1997 due to the Company incurring a net loss beforeincome taxes and extraordinary item in 1997 as compared to net earnings in 1996.The Company's effective income tax rate decreased from 41.2% in 1996 56to 25.6% in 1997 due to the net loss and the proportional amount of items thatare nondeductible for income tax purposes.SEASONALITY; FLUCTUATIONS IN QUARTERLY RESULTS OF OPERATIONSThe following chart provides selected unaudited statement of operations datafrom the Company's quarterly results of operations during 1998 and 1997: (Amounts in thousands, except per share amounts) ------------------------------------------------------------- First Second Third Fourth Total Quarter Quarter Quarter Quarter Year ------------------------------------------------------------- 1998 ---- Revenues Long-distance services $ 42,034 45,838 44,478 42,306 174,656 Cable services $ 14,201 14,041 14,484 14,914 57,640 Local access services $ 1,014 2,048 2,744 4,102 9,908 Internet services $ 903 1,014 1,060 1,614 4,591 ------------------------------------------------------------- Total revenues $ 58,152 62,941 62,766 62,936 246,795 Operating income $ 2,437 1,447 1,730 3,230 8,844 Net income (loss) $ (1,616) (2,066) (2,076) (1,039) (6,797) Basic EPS $ (0.03) (0.04) (0.04) (0.02) (0.14) Diluted EPS $ (0.03) (0.04) (0.04) (0.02) (0.14) 1997 ---- Revenues Telecommunications services $ 39,201 42,097 44,378 42,176 167,852 Cable services $ 13,656 14,055 13,294 14,160 55,165 Local access services $ --- --- 255 355 610 Internet services $ 24 34 29 95 182 ------------------------------------------------------------- Total revenues $ 52,881 56,186 57,956 56,786 223,809 Operating income $ 3,292 2,786 3,786 5,518 15,382 Loss on debt extinguishment $ --- --- 433 88 521 Net income (loss) $ (525) (832) (928) 102 (2,183) Basic extraordinary item per share $ --- --- (0.01) --- (0.01) Diluted extraordinary item per share $ --- --- (0.01) --- (0.01) Basic net loss per share $ (0.01) (0.02) (0.02) --- (0.05) Diluted net loss per share $ (0.01) (0.02) (0.02) --- (0.05)Total revenues for the quarter ended December 31, 1998 ("fourth quarter") were$62.9 million, representing a 0.2% increase from total revenues in the thirdquarter of 1998 ("third quarter") of $62.8 million. Increased new business linerevenues (local access services and Internet services) were offset by decreasedlong-distance services revenues. The decrease in long-distance services revenuesresulted in part from a 7.4% decrease in minutes of traffic carried during thefourth quarter (approximately 15.3 million minutes) as compared to the thirdquarter and a decrease in the average rate per minute billed during the fourthquarter (approximately $0.004) as compared to the third quarter (a 2.2%decrease). Entry of two LECs into the Anchorage area long-distance marketcontributed to the reductions in revenue and minutes of use. Partiallyoffsetting this decrease was an increase in cable services revenues to $14.9million in the fourth quarter from $14.5 million in the third quarter. Asfurther described below, cable revenues are generally higher during the wintermonths as compared to the summer months.Cost of sales and services for the third and fourth quarters were consistent atapproximately $29.7 million. As a percentage of revenues, fourth quarter cost ofsales and services was 47.2% as compared to 47.3 % for the third quarter. 57Selling, general and administrative expenses for the third and fourth quarterswere consistent at approximately $23.0 million. As a percentage of sales, fourthquarter selling, general and administrative expenses were 36.5% as compared to36.7 % for the third quarter.The Company reported a net loss of $1.1 million for the fourth quarter ascompared to a net loss of $2.1 million during the third quarter. The reduced netloss was primarily attributable to reduced depreciation expense during thefourth quarter as compared to the third quarter. The Company forecasts annualcapital expenditures and computes depreciation expense during the year based onsuch forecasts. The actual amount of capital additions placed into service in1998 was less than the estimates used to compute depreciation expense duringprior quarters of 1998, resulting in reduced depreciation expense in the fourthquarter.Long-distance revenues have historically been highest in the summer months as aresult of temporary population increases attributable to tourism and increasedseasonal economic activity such as construction, commercial fishing, and oil andgas activities. Cable television revenues, on the other hand, are higher in thewinter months because consumers spend more time at home and tend to watch moretelevision during these months. Local service operations are not expected toexhibit significant seasonality. The Company's ability to implement constructionprojects is also reduced during the winter months because of cold temperatures,snow and short daylight hours. LIQUIDITY AND CAPITAL RESOURCESThe Company's 1998 cash flows from operating activities totaled $21.8 million,net of changes in the components of working capital. Additional sources of cashduring 1998 included long-term borrowings of $103.2 million, release to theCompany of $39.4 million of cash restricted to fund capital expenditures,repayments of notes receivable totaling $1.8 million, proceeds from GCI'sissuance of a stock warrant totaling $708,000, and class A common stock issuanceproceeds totaling $190,000. The Company's expenditures for property andequipment, including construction in progress, totaled $149.0 million and $64.6million in 1998 and 1997, respectively. Uses of cash during 1998 includedrepayment of $2.0 million of long-term borrowings and capital lease obligations,purchases of other assets totaling $3.1 million, payment of deferred debt andstock issuance costs totaling $1.7 million, an increase in notes receivable of$1.7 million, and purchase of GCI's common stock to fund deferred compensationagreements totaling $568,000.Net receivables increased $8.7 million from December 31, 1997 to December 31,1998 resulting from increased revenues in 1998 as compared to 1997, and fromreceivables associated with the Company's provision of its SchoolAccess(TM)services which totaled $4.5 million at December 31, 1998. The Company isprocessing reimbursement requests for each of the schools utilizing itsSchoolAccess(TM) services for funding from the new federal School and LibrariesCorporation. The Company expects payment of outstanding balances during thesecond and third quarters of 1999.Working capital totaled $8.3 million at December 31, 1998, a $13.3 millionincrease from the working capital deficit of $5.0 million as of December 31,1997. The increase in working capital is primarily attributed to increased cashbalances from 1998 operating activities including increases in trade accountsreceivable, and cash obtained through the Company's credit agreements, stockoption and stock warrant transactions.The Holdings $200,000,000 ($150,000,000 as amended) and $50,000,000 creditfacilities mature June 30, 2005. The Holdings Loan facilities were amended in1999 (see below) and bear interest, as amended, at either Libor plus 1.00% to2.50%, depending on the leverage ratio of Holdings and certain of itssubsidiaries, or at the greater of the prime rate or the federal funds effectiverate (as defined) plus 0.05%, in each case plus an additional 0.00% to 1.375%,depending on the leverage ratio of Holdings and certain of its subsidiaries.$106.7 million and $64.7 million were drawn on the credit facilities as ofDecember 31, 1998 and 1997, 58respectively. Amounts drawn on the credit agreements during 1998 were used tofund property and equipment expansions and upgrades and provided working capitalnecessary for new product lines (local access services and Internet services).On April 13, 1999, the Company obtained amendments from its lenders that areparties to its Holdings credit facilities (see note 6 to the Accompanying Notesto Consolidated Financial Statements). These amendments contain, among otherthings, provisions for payment of a one-time amendment fee of 0.25% of theaggregate commitment, an increase in the commitment fee by 0.125% per annum onthe unused portion of the commitment, and an increase in the interest rate by0.25%. The amended facilities reduce the aggregate commitment by $50 million to$200 million, and limit capital expenditures to $35 million in 1999, $35 millionin 2000 with no limits thereafter (excluding amounts to be paid for purchasedsatellite transponder facilities). The amended facilities require that Holdingsreceive $20 million in proceeds from a GCI preferred stock issuance by May 31,1999 (see below).The amended Holding's credit facilities and GCI, Inc.'s public notes (see note 6to the accompanying Notes to Consolidated Financial Statements) containrestrictions on the operations and activities of the Company, includingrequirements that the Company comply with certain financial covenants andfinancial ratios. Under the amended Holding's credit facility, Holdings may notpermit the ratio of senior debt to annualized operating cash flow of Holdingsand certain of its subsidiaries to exceed 3.5 to 1.0 through March 31, 1999 (3.0to 1.0 from April 1, 1999 through December 31, 1999), total debt to annualizedoperating cash flow to exceed 7.0 to 1.0 from closing of the amendments to June30, 1999 (6.25 to 1.00 from July 1, 1999 through March 31, 2000), and annualizedoperating cash flow to interest expense to exceed 1.5 to 1.0 from closing of theamendments to September 30, 1999 (1.75 to 1.0 from October 1, 1999 through March31, 2000). Each of the foregoing ratios decreases in specified increments duringthe life of the credit facility. The credit facility requires Holdings tomaintain a ratio of annualized operating cash flow to debt service of Holdingsand certain of its subsidiaries of at least 1.25 to 1.0, and annualizedoperating cash flow to fixed charges of at least 1.0 to 1.0 (which adjusts to1.05 to 1.0 in April, 2003 and thereafter). The public notes impose arequirement that the leverage ratio of GCI, Inc. and certain of its subsidiarieswill not exceed 7.5 to 1.0 prior to December 31, 1999 and 6.0 to 1.0 thereafter,subject to the ability of GCI, Inc. and certain of its subsidiaries to incurspecified permitted indebtedness without regard to such ratios.On January 27, 1998 Alaska United closed a $75 million project finance facility("Fiber Facility") to construct a fiber optic cable system connecting Anchorage,Fairbanks, Valdez, Whittier, Juneau and Seattle (see note 11 to the accompanyingNotes to Consolidated Financial Statements). The Fiber Facility provides up to$75 million in construction financing and bears interest at either Libor plus3.0%, or at the lender's prime rate plus 1.75%. The interest rate will declineto Libor plus 2.5%-2.75%, or, at the Company's option, the lender's prime rateplus 1.25%-1.5% after the project completion date and when the loan balance is$40,000,000-60,000,000 or less. Alaska United is required to pay a commitmentfee equal to 0.375% per annum on the unused portion of the commitment. $61.2million was borrowed under the facility at December 31, 1998. The Fiber Facilityis a 10-year term loan that is interest only for the first 5 years. The facilitycan be extended an additional two years at any time between the second and fifthanniversary of closing the facility if the Company can demonstrate projectedrevenues from certain capacity commitments will be sufficient to pay alloperating costs, interest, and principal installments based on the extendedmaturity.The Fiber Facility contains, among others, covenants requiring certainintercompany loans and advances in order to maintain specific levels of cashflow necessary to pay operating costs, interest and principal installments.Additional covenants pertain to the timely completion of certain projectconstruction milestones. The Fiber Facility also contains a guarantee thatrequires, among other terms and conditions, Alaska United complete the projectby the completion date and pay any non-budgeted costs of the project. All ofAlaska United's assets, as well as a pledge of the partnership interests' owningAlaska United, collateralize the Fiber Facility. Construction of the fiberfacility was completed and the facility was placed into service on February 4,1999. The project was completed on-budget. 59The Company will use approximately half the capacity of the Alaska Unitedproject to carry its own traffic, in addition to its existing owned and leasedfacilities. One of the Company's large commercial customers signed agreements inFebruary and March 1999 for the immediate lease of three DS3 circuits on AlaskaUnited facilities within Alaska, and between Alaska and the lower 48 states. Thelease agreements provide for three year terms, with renewal options foradditional terms. The Company continues to pursue opportunities to leasecapacity on its system.The Company's expenditures for property and equipment, including construction inprogress, totaled $149.0 million and $65.5 million during 1998 and 1997,respectively. The Company anticipates that its capital expenditures in 1999 maytotal as much as $68.5 million, including approximately $43.5 million forsatellite transponders. Planned capital expenditures over the next five yearsinclude those necessary for continued expansion of the Company's long-distance,local exchange and Internet facilities, the development and construction of aPCS network, and continued upgrades to its cable television plant. Sources offunds for these planned capital expenditures are expected to include internallygenerated cash flows and borrowings under the Company's credit facilitiesdescribed above.The Company's ability to invest in discretionary capital and other projects willdepend upon its future cash flows and access to borrowings under its creditfacilities. Management anticipates that cash flow generated by the Company andborrowings under its credit facilities will be sufficient to fund capitalexpenditures and its working capital requirements. Should cash flows beinsufficient to support additional borrowings, such investment in capitalexpenditures will likely be reduced.The Company entered into a purchase and lease-purchase option agreement inAugust 1995 for the acquisition of satellite transponders to meet its long-termsatellite capacity requirements. The launch of the satellite in August 1998failed. The Company did not assume launch risk and the launch has beenrescheduled for the fourth quarter of 1999. The Company will continue to leasetransponder capacity until the delivery of the transponders on the replacementsatellite. The balance payable upon expected delivery of the transponders duringthe fourth quarter of 1999 in addition to the $9.1 million deposit previouslypaid totals approximately $43.5 million.On April 2, 1999 the Company received commitments for the issuance of 20,000shares of convertible redeemable accreting preferred stock ("Preferred Stock").Proceeds totaling $20 million (before payment of costs and expenses) will beused for general corporate purposes and to provide additional liquidity. TheCompany's amended Senior Holdings Loan facilities limit use of such proceeds(see note 6 to the accompanying Notes to Consolidated Financial Statements). ThePreferred Stock contains a $1,000 per share liquidation preference, plus accruedbut unpaid dividends and fees. Dividends will be payable semi-annually at therate of 8.5% of the liquidation preference. Prior to the five-year anniversaryfollowing closing, dividends are payable, at the Company's option, in cash or inadditional fully-paid shares of Preferred Stock. Dividends are payable only incash following the five-year anniversary of closing. Mandatory redemption isrequired 12 years from the date of closing. The Company and Holders of thePreferred Stock will have the right after the four-year anniversary of closing(or occurrence of a triggering event, as defined) to convert the stated value,in whole or in part, into registered shares of GCI class A common stock. Theconversion price will be the lesser of $6.00 or 120% of the average closingprice of GCI's class A common stock for the 10 trading days prior to closing.At any time subsequent to the third anniversary following closing, and assumingthe stock is trading at two times the conversion price, the Company may requireimmediate conversion at a price equal to two times the conversion price. ThePreferred Stock, subject to lender approval, will be exchangeable in whole or inpart, at the Company's option, into subordinated debt with terms and conditionscomparable to those governing the Preferred Stock. The Preferred Stock will besenior to all other classes of the Company's equity securities, and will havevoting rights equal to that number of shares of common stock into which it canbe 60converted. The holders of the Preferred Stock will, as a class, be entitled toelect one GCI director. Closing is expected to take place prior to April 30,1999.The long-distance services, local access services, cable services, Internetservices and wireless services industries are experiencing increasingcompetition and rapid technological changes. The Company's future results ofoperations will be affected by its ability to react to changes in thecompetitive environment and by its ability to implement new technologies. TheCompany is unable to determine how competition, technological changes and itsnet operating losses will affect its ability to obtain financing.The Company believes that it will be able to meet its current and long-termliquidity and capital requirements, including fixed charges, through its cashflows from operating activities, existing cash, cash equivalents, short-terminvestments, credit facilities, and other external financing and equity sources. NEW ACCOUNTING PRONOUNCEMENTSIn June 1998, the Accounting Standards Board issued SFAS No. 133, "Accountingfor Derivative Instruments and Hedging Activities," effective for yearsbeginning after June 15, 1999. SFAS No. 133 establishes accounting and reportingstandards requiring that every derivative instrument, including certainderivative instruments imbedded in other contracts, be recorded in the balancesheet as either an asset or liability measured at its fair value. SFAS No. 133requires that changes in the derivative's fair value be recognized currently inearnings unless specific hedge criteria are met. Special accounting forqualifying hedges allow a derivative's gains or losses to offset related resultson the hedged item in the income statement and requires that a company mustformally document, designate and assess the effectiveness of transactions thatreceive hedge accounting. Management of the Company expects that adoption ofSFAS No. 133 will not have a material impact on the Company's year-end 2000financial statements.In April 1998, the American Institute of Certified Public Accountants (AICPA)issued Statement of Position ("SOP") 98-5, "Reporting on the costs of Start-UpActivities". SOP 98-5 provides guidance on the financial reporting of start-upcosts and organization costs and requires costs of start-up activities andorganization costs to be expensed as incurred. SOP 98-5 is effective forfinancial statements for fiscal years beginning after December 15, 1998.Management of the Company expects that the adoption of SOP 98-5 will result in aone-time expense of approximately $365,000 (net of income tax effect) in thefirst quarter of 1999 associated with the write-off of unamortized start-upcosts. Alaska EconomyThe Company offers telecommunication and video services to customers primarilythroughout Alaska. As a result of this geographic concentration, the Company'sgrowth and operations depend upon economic conditions in Alaska. The economy ofAlaska is dependent upon the natural resource industries, and in particular oilproduction, as well as tourism, government, and United States military spending.Any deterioration in these markets could have an adverse impact on the Company.Oil revenues over the past several years have contributed in excess of 75% ofthe revenues from all segments of the Alaska economy and are expected to accountfor 73% in 1999.The volume of oil transported by the TransAlaska Oil Pipeline System over thepast 20 years has been as high as 2.0 million barrels per day in 1988. Over thepast several years, it has begun to decline. Market prices for North Slope oildeclined to below $10 per barrel in 1998, well below the average price perbarrel used by the State of Alaska to budget its oil related revenues. Oilcompanies and service providers have announced cost cutting measures to offset aportion of the declining revenues. Oil company and related oil field servicecompany layoffs reportedly will result in a reduction of oil industry jobs by atleast 39 percent in 1999. 61The effects of low oil prices will impact the state of Alaska's economy, and isexpected to particularly hurt state and local government and oil servicecompanies. As much as half of the drilling fleet that worked on the slope in1998 could be idle during 1999. Oil field service and drilling contractors cutoperating costs to adjust for decreasing production and exploration. TheCompany, as an outsourcing services provider to the oil industry, reduced itsoutsourcing work force by 8 employees in February 1999.Since oil revenues to the state of Alaska are expected to fall significantlyshort of budgeted revenues, (estimated at $1.04 billion for the coming budgetyear), the Governor of the state of Alaska has announced his intention toimplement cost-cutting and revenue enhancing measures. The State of Alaskamaintains surplus accounts that are intended to fund budgetary shortfalls andwould be expected to fund a portion of the revenue shortfall.BP Amoco announced in April 1999 its intention to purchase ARCO for $26.8billion. BP Amoco and ARCO together reportedly hold approximately 75 percent ofthe ownership of the Alaska North Slope oil fields and in the company thatoperates the Trans-Alaska Pipeline System. Alaska law stipulates that no singlecompany can hold drilling leases to more than 500,000 onshore state-owned acres.The BP Amoco-ARCO combination would control about 860,000 acres, however thecompanies have reportedly said they will give up 360,000 acres to comply withAlaska laws. Realignment of operations following the acquisition reportedly willresult in the layoff of 400 positions in Alaska.No assurance can be given that oil companies doing business in Alaska will besuccessful in discovering new fields or further developing existing fields whichare economic to develop and produce oil with access to the pipeline or othermeans of transport to market, even with the reduced level of royalties. TheCompany is not able to predict the effect of declines in the price of NorthSlope oil or the acquisition of ARCO by BP Amoco on Alaska's economy or on theCompany. See Part I, Item 1. Business, Geographic Concentration and AlaskaEconomy. SeasonalityLong-distance revenues have historically been highest in the summer months as aresult of temporary population increases attributable to tourism and increasedseasonal economic activity such as construction, commercial fishing, and oil andgas activities. Cable television revenues, on the other hand, are higher in thewinter months because consumers tend to watch more television, and spend moretime at home, during these months. The Company's local access services revenuesare not expected to exhibit significant seasonality. The Company's Internetaccess services are expected to reflect seasonality trends similar to the cabletelevision segment. The Company's ability to implement construction projects isreduced during the winter months because of cold temperatures, snow and shortdaylight hours. Year 2000 CostsMany financial information and operational systems in use today may not be ableto interpret dates after December 31, 1999 because such systems allow only twodigits to indicate the year in a date. As a result, such systems are unable todistinguish January 1, 2000 from January 1, 1900, which could have adverseconsequences on the operations of an entity and the integrity of informationprocessing. This could result in a system failure or miscalculations causingdisruptions of operations, including, among other things, a shut down in acompany's operations, a temporary inability to process transactions, sendinvoices or engage in similar normal business activities. This potential problemis referred to as the "Year 2000" or "Y2K" issue.State of readiness. The Company has undertaken various initiatives to evaluatethe Year 2000 readiness of the products and services sold by the Company("Products"), the information technology systems used in the Company'soperations ("IT Systems"), its non-IT systems, such as power to its facilities,HVAC systems, building security, voice mail and other systems, as well as thereadiness of its customers and suppliers. The 62Company has identified eight Year 2000 target areas that cover the entire scopeof the Company's business and has internally established teams committed tocompleting an 8-step Compliance Validation Process ("CVP") for each target area.Each team is expected to fully complete this process on or before September 1,1999. The table below identifies the Company's target areas as well as the8-step CVP with its expected timeline. Team activity is currently focusedtowards the process of completing Phase 2. ----------------------------------------------- --------------------------------------------------------------------- Year 2000 Target Areas Compliance Validation Process ----------------------------------------------- --------------------------------------------------------------------- 1. Business Computer Systems PHASE 1 2. Technical Infrastructure 1. Team Formation Completed 1st quarter 1997 3. End-User Computing 2. Inventory Assessment Completed 4th quarter 1998 4. Switching and Head-end Equipment 3. Compliance Assessment Completed 4th quarter 1998 5. Logistics 4. Risk Assessment Completed 4th quarter 1998 6. Facilities 7. Customers ------------------------------- ------------------------------------- 8. Suppliers/Key Service Providers PHASE 2 5. Resolution/Remediation Expected completion 2nd quarter 1999 6. Validation Expected completion 3rd quarter 1999 7. Contingency Plan Expected completion 3rd quarter 1999 8. Sign-Off Acceptance Expected completion 4th quarter 1999 ----------------------------------------------- ------------------------------- -------------------------------------In 1997, the Company established a corporate-wide Year 2000 task force toaddress Y2K issues. This effort is comprehensive and encompasses software,hardware, electronic data interchange, networks, PC's, facilities, embeddedchips, century certification, supplier and customer readiness, contingencyplanning, and domestic and international operations. The Company is currently onschedule and is more than 50% complete as of December 31, 1998. The Company hastested, replaced or upgraded most of its critical business applications andsystems and has begun the century testing phase for these critical technologysystems. The target date to repair or replace the remaining critical businessinformation systems is June 30, 1999. The Company is assessing its telephone andcable systems and equipment and the target date to complete equipment andfacilities efforts is also June 30, 1999. The Company has prioritized itsthird-party relationships as critical, severe or sustainable, has completed theassessment phase for third parties (except for assessment of its key customerswhich is scheduled to be complete in March 1999), has requested a Y2K contractwarranty in many new key contracts and is developing contingency plans forcritical third parties, including key customers, suppliers and other serviceproviders.With respect to the Company's relationships with third parties, the Companyrelies both domestically and internationally upon various vendors, governmentalagencies, utility companies, telecommunications service companies, deliveryservice companies and other service providers. Although these service providersare outside the Company's control, the Company has mailed letters to those withwhom it believes its relationships are material and has verbally communicatedwith some of its strategic customers to determine the extent to which interfaceswith such entities are vulnerable to Year 2000 issues and whether products andservices purchased from or by such entities are Year 2000 ready.Over 400 companies have been contacted directly by mail, by telephone, throughon-site visits or through inquiry of their Y2K Internet web sites to determinetheir state of readiness. Responses vary from confirmation that the supply ofproducts or services provided to the Company will continue without interruptionor delay through the year 2000, to providing their plans for making theirproducts or service delivery systems Y2K compliant. The Company is currentlyevaluating the sufficiency of the responses received from these third parties.The Company intends to complete follow-up activities, including but not limitedto site surveys, phone surveys and mailings, with significant vendors andservice providers as part of the Phase 2 validation. 63Costs to address year 2000 issues. Costs related to the Y2K issue are expensedas incurred and are funded through the Company's operating cash flows and itscredit agreements. Through December 31, 1998, the Company has expensedincremental remediation costs totaling $1.1 million, with remaining incrementalremediation costs estimated at approximately $2.9 million. Management mustbalance the requirements for funding discretionary capital expenditures withrequired year 2000 efforts given its limited resources. The Company has notdeferred any critical information technology projects because of its Year 2000program efforts, which are being addressed primarily through a dedicated teamwithin the Company's information technology group.Time and cost estimates are based on currently available information and couldbe affected by the ability to correct all relevant computer codes and equipment,and the Y2K readiness of the Company's business partners, among other factors.At this time, the Company does not possess information necessary to estimate thepotential financial impact of Year 2000 compliance issues relating to itsvendors, customers and other third parties.Risk of year 2000 issues. If necessary modifications and conversions by theCompany are not made on a timely basis, or if key third parties are not Y2Kready, Y2K problems could have a material adverse effect on the Company'sfinancial condition, results of operations and liquidity. However, the Companyis focusing on identifying and addressing all aspects of its operations that maybe affected by the Year 2000 issue and is addressing the most criticalapplications first.Although the Company considers them unlikely, the Company believes that thefollowing several situations, not in any particular order, make up the Company'smost reasonably likely worst case Year 2000 scenarios: - Disruption of electrical power supplies resulting from extended regional power failure(s). The Company's major switching and information systems are protected by emergency standby electrical generators in the event of short-term power outages. If electrical supplies from regional electric utilities are disrupted for longer periods of time, the Company may be required to power-down its electronic switching, head-end and computer equipment. The Company is closely monitoring electrical utilities that provide service to the Company for their Year 2000 readiness. Based on their progress reports and completion of assessments, the Company believes that there will be no significant impact on its operations in the major communities served by the Company. Many of the electrical companies serving smaller rural communities employ equipment that is manual or controlled by non date-effecting equipment, however they may experience outages if they do not receive fuel from their suppliers. - Disruption of a Significant Customer's Ability to Accept Products or Pay Invoices. The Company's significant customers are large, well-informed customers, mostly in the telecommunications and oil and gas industries, who are disclosing information to their vendors that indicates they are well along the path toward Year 2000 compliance. These customers have demonstrated their awareness of the Year 2000 issue by issuing requirements of their suppliers and indicating the stages of identification and remediation which they consider adequate for progressive calendar quarters leading up to the century mark. The Company's significant customers, moreover, are substantial companies that the Company believes would be able to make adjustments in their processes as required to cause timely payment of invoices. - Disruption of Supplies and Materials. In early 1998 the Company began an ongoing process of surveying its vendors with regard to their Year 2000 readiness and is now in the process of assessing and cataloging their responses to the survey. The Company is hopeful of receiving adequate responses from remaining critical vendors and many non-critical vendors within the first two quarters of 1999. The Company expects to work with vendors that show a need for assistance or that provide inadequate responses, and in many cases expects that survey results will be refined significantly by such work. Where ultimate survey results show that the need arises, the Company will arrange for back-up vendors before the changeover date. Supplies and materials necessary for invoicing and other 64 functions will be acquired in bulk prior to December 31, 1999 to provide an adequate inventory to bridge up to three months of vendor supply chain disruptions. - Disruption of the Company's administrative and billing IT systems. The Company is proceeding with a scheduled upgrade of its current financial software systems to state-of-the-art systems and such process has required Year 2000 compliance in the various invitations for proposals. Year 2000 testing is occurring as upgrades proceed and, in addition, will occur after all upgrades are completed at the end of the first quarter of 1999. The Company's billing and information systems continue to be assessed and remediated. System processes have been prioritized so that critical date-sensitive systems and functionality are remediated first. Non-critical systems and functionality are remediated following critical systems. The Company's efforts are proceeding on-target and on-budget. Accordingly, the Company believes that, after assessment and remediation, if any disruptions do occur, such will be dealt with promptly and will be no more severe with respect to correction or impact than would be an unexpected billing or information system error. - Disruption of the Company's Non-IT Systems. The Company continues to conduct a comprehensive assessment of all non-IT systems, including among other things its switching and head-end systems and operations, with respect to both embedded processors and obvious computer control. For some systems, upgrades are already scheduled and it is expected that the Phase 1 assessments will highlight by the end of the second quarter of 1999 any further remediation needs. Considering the nature of the equipment and systems involved, the Company expects that the timing of assessment to be such that it will be able to complete any remediation efforts on a reasonably short schedule, and in any case before arrival of the Year 2000. The Company also believes that, after such assessment and remediation, if any disruptions do occur, such will be dealt with promptly and will be no more severe with respect to correction or impact than would be an unexpected breakdown of well-maintained equipment. - De-Listing of Company as a Vendor to Certain Customers. Several of the Company's principal customers have required updated reports in the form of answers to extensive multiple-choice surveys on the Company's Year 2000 compliance efforts. According to these customers, failure to reply to the readiness survey would have led to de-listing as a service supplier at the present time, resulting in possible current inability to bid on procurements requiring service delivery in the future. The Company has responded to these reports on a timely basis. The Company has not been de-listed as a supplier to any customers. Several significant customers have scheduled monitoring meetings during 1999.Contingency plans. The Company is in the process of developing specificcontingency plans for potential Year 2000 disruptions. The aforementioned 8-stepCompliance Validation Process includes contingency planning by each team andsuch plans, as developed, will be carefully reviewed by the Company. The Companyis developing contingency plans for its most critical areas, but details of suchplans will depend on the Company's final assessment of the problem as well asthe evaluation and success of its remediation efforts. Future disclosures willinclude contingency plans as they become available. REGULATORY DEVELOPMENTSSee Part I, Item 1 Business., Regulation, Franchise Authorizations and Tariffsfor regulatory developments affecting the Company. InflationThe Company does not believe that inflation has a significant effect on itsoperations.Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKThe Company's Senior Holdings Loan described in note 6 to the financialstatements as well as in Management's Discussion and Analysis carries interestrate risk. Amounts borrowed under this Agreement bear interest at either Liborplus 0.75% to 2.25%, depending on the leverage ratio of Holdings and certain of 65its subsidiaries, or at the greater of the prime rate or the federal fundseffective rate (as defined) plus 0.05%, in each case plus an additional 0.0% to1.125%, depending on the leverage ratio of Holdings and certain of itssubsidiaries. Should the lenders' base rate or the leverage ratios change, theCompany's interest expense will increase or decrease accordingly. As of December31, 1998, the Company had borrowed $106.7 million subject to interest rate risk.On this amount, a 1% increase in the interest rate would cost the Company$1,067,000 in additional gross interest cost on an annual basis.The Company's Fiber Facility described in note 6 to the financial statements aswell as in Management's Discussion and Analysis carries interest rate risk.Amounts borrowed under this Agreement bear interest at either Libor plus 3.0%,or at the Company's choice, the lender's prime rate plus 1.75%. The interestrate will decline to Libor plus 2.5%-2.75%, or at the Company's choice, thelender's prime rate plus 1.25%-1.5% after the project completion date and whenthe loan balance is $60,000,000 or less. Should the lenders' base rate or theleverage ratios change, the Company's interest expense will increase or decreaseaccordingly. As of December 31, 1998, the Company had borrowed $61.2 millionsubject to interest rate risk. On this amount, a 1% increase in the interestrate would cost the Company $612,000 in additional gross interest cost on anannual basis.Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAThe consolidated financial statements of the Company are filed under this Item,beginning on Page 67. The financial statement schedules required underRegulation S-X are filed pursuant to Item 14 of this Report.Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURENone. PART IIIIncorporated herein by reference from the Company's Proxy Statement for its 1999Annual Shareholders' meeting. 66 INDEPENDENT AUDITORS' REPORT ----------------------------The Board of Directors and StockholdersGeneral Communication, Inc.:We have audited the accompanying consolidated balance sheets of GeneralCommunication, Inc. and Subsidiaries as of December 31, 1998 and 1997, and therelated consolidated statements of operations, stockholders' equity and cashflows for each of the years in the three-year period ended December 31, 1998.These consolidated financial statements are the responsibility of the Company'smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.We conducted our audits in accordance with generally accepted auditingstandards. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, 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 presentfairly, in all material respects, the financial position of GeneralCommunication, Inc. and Subsidiaries as of December 31, 1998 and 1997, and theresults of their operations and their cash flows for each of the years in thethree-year period ended December 31, 1998 in conformity with generally acceptedaccounting principles. /s/ KPMG LLPAnchorage, AlaskaMarch 26, 1999, except for notes 6 and 12, which are dated as of April 13, 1999 67 GENERAL COMMUNICATION, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, ASSETS 1998 1997- --------------------------------------------------------------------------------- ----------- ----------- (Amounts in thousands) Current assets: Cash and cash equivalents $ 12,008 3,048 ----------- ----------- Receivables: Trade 38,890 29,599 Income taxes (note 7) 4,262 4,752 Other 412 649 ----------- ----------- 43,564 35,000 Less allowance for doubtful receivables 887 1,070 ----------- ----------- Net receivables 42,677 33,930 ----------- ----------- Prepaid and other current assets 2,132 2,520 Deferred income taxes, net (note 7) 1,947 1,675 Inventories 1,878 2,164 Notes receivable (note 4) 650 897 ----------- ----------- Total current assets 61,292 44,234 ----------- -----------Restricted cash (note 11) --- 39,406 ----------- -----------Property and equipment in service, at cost (notes 6, 9, 10, and 11): Land and buildings 1,109 981 Telephony distribution systems 144,896 116,016 Cable television distribution systems 89,736 69,445 Support equipment 42,056 32,596 Transportation equipment 2,183 2,643 Property and equipment under capital leases 2,819 2,718 ----------- ----------- 282,799 224,399 Less accumulated depreciation 82,972 58,406 ----------- ----------- Net property and equipment in service 199,827 165,993 Construction in progress 119,645 18,513 ----------- ----------- Net property and equipment 319,472 184,506 ----------- -----------Cable franchise agreements, net of amortization of $11,184 and $6,022 at December 31, 1998 and 1997, respectively (note 2) 195,308 200,470Other intangible assets, net of amortization (notes 2 and 5) 45,874 46,064Deferred loan and Senior Notes costs, net of amortization 9,877 9,379Transponder deposit (note 11) 9,100 9,100Undersea fiber optic cable deposit (note 11) --- 9,094Notes receivable (note 4) 1,432 1,331Other assets, at cost, net of amortization 3,761 1,718 ----------- ----------- Total other assets 265,352 277,156 ----------- ----------- Total assets $ 646,116 545,302 =========== ===========See accompanying notes to consolidated financial statements. (Continued) 68 GENERAL COMMUNICATION, INC. AND SUBSIDIARIES Consolidated Balance Sheets (Continued) December 31, LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997- --------------------------------------------------------------------------------- ----------- ----------- (Amounts in Thousands) Current liabilities: Current maturities of long-term debt (note 6) $ 1,799 1,634 Current maturities of obligations under capital leases (notes 10 and 11) 511 198 Accounts payable 27,550 24,965 Accrued interest 8,072 7,649 Accrued payroll and payroll related obligations 6,555 5,680 Accrued liabilities 3,197 5,111 Subscriber deposits and deferred revenues 5,300 3,898 Accrued income taxes (note 7) --- 111 ----------- ----------- Total current liabilities 52,984 49,246Long-term debt, excluding current maturities (note 6) 349,858 248,450Obligations under capital leases, excluding current maturities (note 11) 1,189 400Obligations under capital leases due to related party, excluding current maturities (notes 10 and 11) 486 590Deferred income taxes, net of deferred income tax benefit (note 7) 38,275 38,904Other liabilities 3,317 3,273 ----------- ----------- Total liabilities 446,109 340,863 ----------- -----------Stockholders' equity (notes 2, 3, 6, 7 and 8): Common stock (no par): Class A. Authorized 100,000,000 shares; issued and outstanding 45,895,415 and 45,279,045 shares at December 31, 1998 and 1997, respectively 172,708 170,322 Class B. Authorized 10,000,000 shares; issued and outstanding 4,060,620 and 4,062,892 shares at December 31, 1998 and 1997, respectively; convertible on a share-per-share basis into Class A common stock 3,432 3,432 Less cost of 347,958 and 202,768 Class A common shares held in treasury at December 31, 1998 and 1997, respectively (1,607) (1,039) Paid-in capital 5,609 4,425 Notes receivable issued upon stock option exercise (note 4) (637) --- Retained earnings 20,502 27,299 ----------- ----------- Total stockholders' equity 200,007 204,439 ----------- ----------- Commitments and contingencies (notes 10, 11 and 12) Total liabilities and stockholders' equity $ 646,116 545,302 =========== ===========See accompanying notes to consolidated financial statements. 69 GENERAL COMMUNICATION, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended December 31, 1998, 1997 and 1996 1998 1997 1996 ------------- ------------ ------------- (Amounts in thousands except per share amounts) Revenues (notes 9 and 10) $ 246,795 223,809 164,894Cost of sales and services 116,073 111,077 92,664Selling, general and administrative expenses 89,833 73,583 46,412Depreciation and amortization expense (note 9) 32,045 23,767 9,409 ------------- ------------ ------------- Operating income (note 9) 8,844 15,382 16,409Interest expense, net (notes 3 and 6) 19,764 17,617 3,719 ------------- ------------ ------------- Net earnings (loss) before income taxes and extraordinary item (10,920) (2,235) 12,690Income tax expense (benefit) (notes 3 and 7) (4,123) (573) 5,228 ------------- ------------ ------------- Net earnings (loss) before extraordinary loss on early extinguishment of debt (6,797) (1,662) 7,462 Loss on early extinguishment of debt, net of income tax benefit of $180 (note 6) --- 521 --- ------------- ------------ ------------- Net earnings (loss) $ (6,797) (2,183) 7,462 ============= ============ =============Basic earnings (loss) per common share: Net earnings (loss) before extraordinary loss $ (0.14) (0.04) 0.28 Extraordinary loss 0.00 (0.01) 0.00 ------------- ------------ ------------- Net earnings (loss) $ (0.14) (0.05) 0.28 ============= ============ =============Diluted earnings (loss) per common share: Net earnings (loss) before extraordinary loss $ (0.14) (0.04) 0.27 Extraordinary loss 0.00 (0.01) 0.00 ------------- ------------ ------------- Net earnings (loss) $ (0.14) (0.05) 0.27 ============= ============ =============See accompanying notes to consolidated financial statements. 70 GENERAL COMMUNICATION, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Years ended December 31, 1998, 1997 and 1996 Class A Notes Shares of Class A Class B Shares Receiv- Common Stock Common Common Held in Paid-in able Retained(Amounts in thousands) Class A Class B Stock Stock Treasury Capital Issued Earnings ------------------------------------------------------------------------------- Balances at December 31, 1995 19,680 4,176 $13,912 3,432 (389) 4,041 --- 22,020Net earnings --- --- --- --- --- --- --- 7,462Class B shares converted to Class A shares 102 (102) --- --- --- --- --- ---Tax effect of excess stock compensation expense for tax purposes over amounts recognized for financial reporting purposes (note 7) --- --- --- --- --- 187 --- ---Shares issued to MCI (notes 2 and 8) 2,000 --- 13,000 --- --- --- --- ---Shares issued pursuant to acquisitions, net of costs totaling $432 (note 2) 14,723 --- 86,278 --- --- --- --- ---Shares purchased and held in Treasury --- --- --- --- (621) --- --- ---Shares issued under stock option plan 82 --- 231 --- --- --- --- ---Shares issued and issuable under officer stock option agreements --- --- --- --- --- 1 --- --- -------------------------------------------------------------------------------Balances at December 31, 1996 36,587 4,074 113,421 3,432 (1,010) 4,229 --- 29,482Net loss --- --- --- --- --- --- --- (2,183)Class B shares converted to Class A shares 11 (11) --- --- --- --- --- ---Tax effect of excess stock compensation expense for tax purposes over amounts recognized for financial reporting purposes (note 7) --- --- --- --- --- 65 --- ---Shares issued upon public offering, net of issuance costs of $4,024 (note 8) 7,000 --- 46,726 --- --- --- --- ---Shares issued upon conversion of convertible note net of fees of $16 (notes 2 and 8) 1,538 --- 9,983 --- --- --- --- ---Shares acquired pursuant to officer deferred compensation agreement --- --- --- --- (29) --- --- ---Shares issued under stock option plan 57 --- 192 --- --- 63 --- ---Shares issued and issuable under officer stock option agreements 86 --- --- --- --- 68 --- --- -------------------------------------------------------------------------------Balances at December 31, 1997 45,279 4,063 170,322 3,432 (1,039) 4,425 --- 27,299Net loss --- --- --- --- --- --- --- (6,797)Class B shares converted to Class A shares 2 (2) --- --- --- --- --- ---Tax effect of excess stock compensation expense for tax purposes over amounts recognized for financial reporting purposes (note 7) --- --- --- --- --- 157 --- ---Shares purchased and held in Treasury --- --- --- --- (568) --- --- ---Shares issued under stock option plan (note 8) 315 --- 827 --- --- 319 --- ---Notes issued upon stock option exercise (note 4) --- --- --- --- --- --- (637) ---Shares issued to Employee Stock Purchase Plan 299 --- 1,574 --- --- --- --- ---Warrants issued (note 8) --- --- --- --- --- 708 --- ---Stock offering issuance costs --- --- (15) --- --- --- --- --- -------------------------------------------------------------------------------Balances at December 31, 1998 45,895 4,061 $172,708 3,432 (1,607) 5,609 (637) 20,502 ===============================================================================See accompanying notes to consolidated financial statements. 71 GENERAL COMMUNICATION, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 1998, 1997 and 1996 1998 1997 1996 ------------- ----------- ------------ (Amounts in thousands) Cash flows from operating activities: Net earnings (loss) $ (6,797) (2,183) 7,462 Adjustments to reconcile net earnings (loss) to net cash provided by operating activities: Depreciation and amortization 32,045 23,767 9,409 Deferred income tax (benefit) expense (744) 4,410 2,252 Employee Stock Purchase Plan expense funded with stock 1,574 --- --- Deferred compensation and compensatory stock options 376 477 507 Disposals of property and equipment 62 71 30 Loss on early extinguishment of debt --- 701 --- Bad debt expense (recovery), net of write-offs (183) 473 (34) Other noncash income and expense items 92 (125) (42) Change in operating assets and liabilities (note 3) (4,643) 3,202 2,724 ------------- ------------- ------------ Net cash provided by operating activities 21,782 30,793 22,308 ------------- ------------- ------------Cash flows from investing activities: Acquisitions of businesses, net of cash acquired (notes 2 and 3) --- (547) (72,818) Purchases of property and equipment, including construction period interest (148,973) (64,644) (38,642) Restricted cash investment 39,406 (39,406) --- Purchases of other assets and intangible assets (3,140) (1,292) (10,959) Payment of undersea fiber optic cable deposit --- (9,094) --- Notes receivable issued (1,715) (698) (515) Payments received on notes receivable 1,769 32 288 ------------- ------------- ------------ Net cash used in investing activities (112,653) (115,649) (122,646) ------------- ------------- ------------Cash flows from financing activities: Long-term borrowings - senior notes --- 180,000 --- Long-term borrowings - bank debt 103,224 88,305 208,000 Repayments of long-term borrowings and capital lease obligations (2,017) (231,021) (5,039) Retirement of bank debt assumed --- --- (105,200) Proceeds from equity offering --- 50,750 --- Proceeds from common stock issuance 190 192 13,231 Payment of debt and stock issuance costs (1,706) (13,642) (701) Proceeds from warrant issuance 708 --- --- Purchase of treasury stock (568) (29) (621) ------------- ------------- ------------ Net cash provided by financing activities 99,831 74,555 109,670 ------------- ------------- ------------ Net increase (decrease) in cash and cash equivalents 8,960 (10,301) 9,332 Cash and cash equivalents at beginning of year 3,048 13,349 4,017 ------------- ------------- ------------ Cash and cash equivalents at end of year $ 12,008 3,048 13,349 ============= ============= ============ See accompanying notes to consolidated financial statements. 72 GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements(l) Organization and Summary of Significant Accounting Principles (a) Organization and Business General Communication, Inc. ("GCI"), an Alaska corporation, was incorporated in 1979. GCI and its direct and indirect subsidiaries (collectively, the "Company") offer long-distance telephone service between Anchorage, Fairbanks, Juneau, and other communities in Alaska and the remaining United States and foreign countries. Cable television services are offered throughout Alaska and facilities-based competitive local access services are offered in Anchorage, Alaska. The Company provides services to certain common carriers terminating traffic in Alaska, interstate and intrastate private line services, Internet services, managed services to certain commercial customers and sells and services dedicated communications systems and related equipment. Private network point-to-point data and voice transmission services between Alaska, Hawaii and the western contiguous United States are offered and the Company owns and leases capacity on two undersea fiber optic cables used in the transmission of interstate private line, switched message long-distance and Internet services between Alaska and the remaining United States and foreign countries. (b) Principles of Consolidation The consolidated financial statements include the accounts of GCI, its wholly-owned subsidiary GCI, Inc, GCI, Inc.'s wholly-owned subsidiary GCI Holdings, Inc., GCI Holding Inc.'s wholly-owned subsidiaries GCI Communication Corp., GCI Communication Services, Inc. and GCI Cable, Inc., GCI Communication Services' wholly-owned subsidiary GCI Leasing Co., Inc., GCI Transport Company, Inc., GCI Transport Co., Inc.'s wholly-owned subsidiaries GCI Fiber Co., Inc. and Fiber Hold Company, Inc. and GCI Fiber Co., Inc.'s and Fiber Hold Company, Inc.'s wholly owned partnership Alaska United Fiber System Partnership. All significant intercompany balances and transactions have been eliminated in consolidation. (c) Earnings (Loss) Per Common Share The Company follows the provisions of SFAS No. 128, "Earnings per Share." Basic earnings (loss) per share is calculated by dividing income (loss) available to common shareholders by the weighted average common shares outstanding. Diluted EPS includes the effect of all potentially dilutive securities, such as options and convertible preferred stock. Shares used to calculate earnings (loss) per share consist of the following (amounts in thousands): 1998 1997 1996 ----------- ---------- ---------- Weighted average common shares outstanding 49,186 44,924 26,498 Common equivalent shares outstanding --- --- 802 ----------- ---------- ---------- 49,186 44,924 27,300 =========== ========== ========== Common equivalent shares outstanding of 521,000 and 816,000 are anti-dilutive at December 31, 1998 and 1997, respectively, and are not included in the diluted net earnings (loss) per share calculation. Weighted average shares associated with outstanding stock options totaling 2,071,000, 1,073,000 and 35,000 at December 31, 1998, 1997 and 1996, respectively, have been excluded from the diluted earnings (loss) per share calculations because the options' exercise price was greater than the average market price of the common shares. (d) Cash and Cash Equivalents Cash equivalents consist of short-term, highly liquid investments that are readily convertible into cash. 73 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements (e) Inventories Inventory of merchandise for resale and parts is stated at the lower of cost or market. Cost is determined using the first-in, first-out method for parts and either the first-in, first-out method or the specific identification method for equipment held for resale. (f) Property and Equipment Telecommunications Property and Equipment Telecommunications 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. Construction in progress represents telecommunications distribution systems and support equipment not placed in service on December 31, 1998; management intends to place this equipment in service during 1999. Telecommunications equipment depreciation is computed on a straight-line basis based upon the shorter of the estimated useful lives of the assets or the lease term, if applicable, ranging from 5 to 24 years for buildings, telecommunications distribution equipment (including switches and earth stations), support equipment, transportation equipment and property and equipment under capital lease. Maintenance and repairs are charged to expense as incurred. Expenditures for major renewals and betterments are capitalized. Gains or losses are recognized at the time of ordinary retirements, sales or other dispositions of property. Cable Television Property and Equipment Cable television property and equipment is stated at cost. Cable television equipment depreciation is computed on a straight-line basis over the estimated useful lives of the assets ranging from 5 to 10 years for cable distribution facilities, head-end systems, converters, support equipment and transportation equipment. Maintenance and repairs are charged to expense as incurred. Expenditures for major renewals and betterments are capitalized. Gains or losses are recognized at the time of ordinary retirements, sales or other dispositions of property. (g) Intangible Assets Intangible assets are valued at unamortized cost. Management reviews the valuation and amortization of intangible assets on a periodic basis, taking into consideration any events or circumstances which might indicate diminished value. The assessment of the recoverability is based on whether the asset can be recovered through undiscounted future cash flows. Cable franchise agreements represent certain perpetual operating rights to provide cable services and are being amortized on a straight-line basis over 40 years. Goodwill represents the excess of cost over fair value of net assets acquired and is being amortized on a straight-line basis over periods of 20 to 40 years. The cost of the Company's PCS license and related financing costs have been capitalized as an intangible asset. Once the associated assets are placed into service, the recorded cost of the license and related financing costs will begin being amortized over a 40-year period using the straight-line method. 74 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements (h) Deferred Loan and Senior Notes Costs Debt and Senior Notes issuance costs are deferred and amortized using the straight-line method, which approximates the interest method, over the term of the related debt and notes. Amortization of issuance costs for the Alaska United Fiber Facility (see note 6) are charged to Construction in Progress during the construction period of the undersea fiber optic cable (see note 11). (i) Other Assets Other assets are recorded at cost and are amortized on a straight-line basis over periods of 2-10 years. (j) Revenue from Services and Products Revenues generated from long-distance services are recognized when the services are provided. Revenues from the sale of equipment are recognized at the time the equipment is delivered or installed. Service revenues are derived primarily from maintenance contracts on equipment and are recognized on a prorated basis over the term of the contract. Cable television, local service, Internet service and private line telecommunication revenues are generally billed in advance and are recognized as the associated service is provided. Other revenues are recognized when the service is provided. (k) Research and Development and Advertising Expense The Company expenses advertising and research and development costs as incurred. Advertising expenses were approximately $5,028,000, $2,897,000 and $2,411,000 for the years ended 1998, 1997 and 1996, respectively. (l) Interest Expense Interest costs incurred during the construction period of significant capital projects are capitalized. Interest costs capitalized by the Company totaled $7,764,000, $1,886,000, and $1,034,000 during the years ended December 31, 1998, 1997 and 1996. (m) Income Taxes 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 bases. 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. Deferred tax assets are recognized to the extent that the benefits are more likely to be realized than not. (n) Stock Option Plan The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted SFAS 123, "Accounting for Stock-Based Compensation," ("SFAS 123") which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS 123. 75 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements (o) Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (p) Concentrations of Credit Risk Financial instruments that potentially subject the Company 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 issued by highly rated financial institutions. At December 31, 1998, substantially all of the Company's cash and cash equivalents were invested in short-term liquid money instruments. The Company's customers are located primarily throughout Alaska. As a result of this geographic concentration, the Company's growth and operations depend upon economic conditions in Alaska. The economy of Alaska is dependent upon the natural resources industries, and in particular oil production, as well as tourism, government, and United States military spending. Though limited to one geographical area, the concentration of credit risk with respect to the Company's receivables is minimized due to the large number of customers, individually small balances, short payment terms and deposit requirements by certain product lines. (q) Fair Value of Financial Instruments SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of the fair value of financial instruments for which it is practicable to estimate that value. SFAS No. 107 specifically excludes certain items from its disclosure requirements. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation. The carrying amounts at December 31, 1998 and 1997 for the Company's financial assets and liabilities approximate their fair values. (r) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of The Company adopted the provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," on January 1, 1996. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Adoption of this Statement did not have a material impact on the Company's financial position, results of operations, or liquidity. (s) New Accounting Pronouncements In June 1998, the Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," effective for years beginning after June 15, 1999. SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument, including certain derivative instruments imbedded in other contracts, be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge criteria are met. Special accounting for qualifying hedges allow a derivative's gains or losses to offset related results on the hedged item in the income statement and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. Management of the Company expects that 76 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements adoption of SFAS No. 133 will not have a material impact on the Company's year-end 2000 financial statements. In April 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position ("SOP") 98-5, "Reporting on the costs of Start-Up Activities". SOP 98-5 provides guidance on the financial reporting of start-up costs and organization costs and requires costs of start-up activities and organization costs to be expensed as incurred. SOP 98-5 is effective for financial statements for fiscal years beginning after December 15, 1998. Management of the Company expects that the adoption of SOP 98-5 will result in a one-time expense of approximately $365,000 (net of income tax effect) in the first quarter of 1999 associated with the write-off of unamortized start-up costs. (t) Year 2000 Costs The Company charges incremental Y2K assessment and remediation costs to expense as incurred. (u) Reclassifications Reclassifications have been made to the 1996 and 1997 financial statements to make them comparable with the 1998 presentation.(2) Acquisitions Cable Television Systems Effective October 31, 1996, following shareholder and regulatory approvals, the Company completed the acquisition of seven Alaska cable television companies ("Cable Systems"). Under the terms of the transactions, accounted for using the purchase method, the final purchase price was $280.1 million, which was the aggregate value for all the Cable Systems and included certain transaction and financing costs. The purchase price included issuance of 14.7 million shares of GCI's Class A common stock and cash, debt assumption and issuance of subordinated notes. Financing for the transactions was obtained through borrowings under a new $205 million bank credit facility and from additional capital provided from the sale of two million shares of GCI's Class A common stock to MCI (now MCI WorldCom) for $6.50 per share. Acquisition costs totaling $304.4 million were allocated to tangible and identifiable intangible assets and liabilities based upon fair market values. Approximately $206.5 million was allocated to the franchise agreements and approximately $42.4 was allocated to goodwill. Various tax attributes of the Cable Systems gave rise to a deferred tax liability (see note 7) of $24.4 million recorded by the Company as a result of the acquisition. During January 1997, holders of the GCI subordinated notes exercised a conversion option which allowed them to exchange their notes for GCI Class A common shares at a predetermined conversion price of $6.50 per share. As a result, the note holders received a total of 1,538,457 shares of GCI Class A common stock. The final closing required approval of the Alaska Public Utilities Commission ("APUC"), which was granted on September 23, 1996. The APUC approval included several conditions placed on the transfer, such as continuing the existing conditions requiring provision of public access channels and requiring the cable operations to file annual income and operating statements. Astrolabe Group, Inc. Effective December 2, 1997, the Company purchased all of the outstanding shares of Astrolabe Group, Inc. The $1,324,000 purchase was accounted for using the purchase method. The purchase price consisted of a 77 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements payment of $600,000 and the issuance of options to purchase 100,000 shares of GCI's Class A common stock for $.01 per share. (3) Consolidated Statements of Cash Flows Supplemental Disclosures Changes in operating assets and liabilities consist of (amounts in thousands): Year ended December 31, 1998 1997 1996 ------------ ------------ ------------- (Increase) in accounts receivable $ (9,054) (1,540) (4,738) (Increase) decrease in income tax receivable 490 (3,726) (1,026) (Increase) decrease in prepaid and other current assets 388 (274) (467) (Increase) decrease in inventories 286 (575) 412 Increase in accounts payable 2,585 1,050 5,517 Increase (decrease) in accrued liabilities (1,914) 938 914 Increase in accrued payroll and payroll related obligations 875 1,850 1,723 Increase (decrease) in accrued income taxes (111) 111 (547) Increase in accrued interest 423 4,941 2,188 Increase (decrease) in subscriber deposits and deferred revenues 1,402 449 (4) (Decrease) in components of other liabilities (13) (22) (1,248) ------------ ------------ ------------- $ (4,643) 3,202 2,724 ============ ============ ============= Acquisitions of businesses, net of cash acquired consists of (amounts in thousands): Year ended December 31, 1997 1996 ---------------------------- Fair value of assets acquired, net of liabilities assumed $ 1,259 304,441 Bank debt and net working capital deficit assumed --- (110,538) Common stock issued to sellers --- (86,710) Convertible, subordinated debt issued to sellers --- (10,000) Net deferred income tax liability --- (24,375) Deferred credit (712) --- ------------ ------------ Net cash used to acquire businesses $ 547 72,818 ============ ============ No acquisitions occurred in 1998. The holders of $10 million of convertible subordinated notes exercised their conversion rights in January 1997 resulting in the exchange of such notes for 1,538,457 shares of the Company's Class A common stock. Net income tax refunds received totaled $4,243,000 and $1,546,000 during the years ended 1998 and 1997, respectively, and income taxes paid totaled $4,361,000 during the year ended 1996. Interest paid totaled approximately $29,630,000, $17,709,000 and $4,572,000 during the years ended 1998, 1997 and 1996, respectively. 78 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements The Company recorded $157,000, $65,000 and $187,000 during the years ended 1998, 1997 and 1996, respectively, in paid-in capital in recognition of the income tax effect of excess stock compensation expense for tax purposes over amounts recognized for financial reporting purposes. During the year ended December 31, 1998 the Company funded the employer matching portion of Employee Stock Purchase Plan contributions by issuing GCI Class A Common Stock valued at $1,574,000. (4) Notes Receivable Notes receivable consist of the following (amounts in thousands): December 31, --------------------------- 1998 1997 --------------------------- Note receivable from officer bearing interest at the rate paid by the Company on its senior indebtedness, unsecured, due on November 1, 2002 $ 600 --- Note receivable from officer bearing interest at the rate paid by the Company on its senior indebtedness, secured by GCI Class A common stock, due on the 90th day after termination of employment or July 30, 1998, whichever is earlier --- 500 Note receivable from officer bearing interest at the rate paid by the Company on its senior indebtedness, partially secured by GCI Class A and Class B common stock, due on December 31, 2001 350 --- Note receivable from officer bearing interest at 10%, secured by Company stock; due in full on August 26, 2004 224 224 Notes receivable from officers and others bearing interest up to 10% or at the rate paid by the Company on its senior indebtedness, unsecured and secured by Company common stock, shares of other common stock, property and equipment; due through August 26, 2004 1,289 1,155 Interest receivable 256 349 --------------------------- Total notes receivable 2,719 2,228 Less notes receivable issued upon stock option exercise, classified as a component of stockholders' equity 637 --- Less current portion, including current interest receivable 650 897 --------------------------- Long-term portion, including long-term interest receivable $ 1,432 1,331 =========================== 79 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements(5) Other Intangible Assets Other intangible assets consist of the following (amounts in thousands): December 31, ----------------------------- 1998 1997 ----------------------------- Goodwill $ 45,954 45,922 PCS license and related costs 2,196 2,051 Other intangibles 1,181 260 ----------------------------- 49,331 48,233 Less accumulated amortization 3,457 2,169 ----------------------------- Other intangible assets, net of amortization $ 45,874 46,064 =============================(6) Long-term Debt Long-term debt consists of the following (amounts in thousands): December 31, ---------------------------- 1998 1997 ---------------------------- Senior notes (a) $ 180,000 180,000 Senior Holdings Loan (b) 106,700 64,700 Fiber Facility (c) 61,224 --- Undersea Fiber and Equipment Loan Agreement (d) 3,733 5,384 ---------------------------- 351,657 250,084 Less current maturities 1,799 1,634 ---------------------------- Long-term debt, excluding current maturities $ 349,858 248,450 ============================ (a) On August 1, 1997 GCI, Inc. issued $180,000,000 of 9.75% senior notes due 2007 ("Senior Notes"). The Senior Notes were issued at face value. Net proceeds to GCI, Inc. after deducting underwriting discounts and commissions totaled $174,600,000. Issuance costs of $5,576,000 are being amortized to amortization expense over the term of the Senior Notes. The Senior Notes are not redeemable prior to August 1, 2002. After August 1, 2002 the Senior Notes are redeemable at the option of GCI, Inc. under certain conditions and at stated redemption prices. The Senior Notes include limitations on additional indebtedness and prohibit payment of dividends, payments for the purchase, redemption, acquisition or retirement of GCI, Inc.'s stock, payments for early retirement of debt subordinate to the note, liens on property, and asset sales. GCI, Inc. was in compliance with all covenants during the year ending December 31, 1998. The Senior Notes are unsecured obligations of the Company. Net proceeds from the stock (see note 8) and Senior Note offerings and initial draws on the new Senior Holdings Loan (see note 6(b)) facilities were used to repay borrowings outstanding under the Company's then existing credit facilities and to provide initial funding for construction of the Alaska United undersea fiber optic cable (see notes 6 (c) and 11). (b) The Company, through Holdings, entered into $200,000,000 ($150,000,000 as amended) and $50,000,000 credit facilities ("Senior Holdings Loan") effective August 1, 1997 that mature on June 30, 2005. The Senior Holdings Loan facilities, as amended effective April 13, 1999, bear interest at either 80 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements Libor plus 1.00% to 2.50%, depending on the leverage ratio of Holdings and certain of its subsidiaries, or at the greater of the prime rate or the federal funds effective rate (as defined) plus 0.05%, in each case plus an additional 0.00% to 1.375%, depending on the leverage ratio of Holdings and certain of its subsidiaries. Borrowings under the Senior Holdings Loan facilities totaled $106,700,000 and $64,700,000 at December 31, 1998 and 1997, respectively. The Company is required to pay a commitment fee equal to 0.50% per annum on the unused portion of the commitment. Commitment fee expense on the Senior Holdings Loan totaled $512,000 and $240,000 during the years ended December 31, 1998 and 1997, respectively. While Holdings may elect at any time to reduce amounts due and available under the Senior Holdings Loan facilities, a mandatory prepayment is required each quarter if the outstanding borrowings at the following dates of payment exceed the allowable borrowings using the following percentages: Percentage of Reduction of Outstanding Date Range of Quarterly Payments Facilities -------------------------------------------------------- ------------------- September 30, 2000 through December 31, 2001 3.750% March 31, 2002 through December 31, 2003 5.000% March 31, 2004 through December 31, 2004 5.625% March 31, 2005 7.500% July 31, 2005 7.500% and all remaining outstanding balances The facilities contain, among others, covenants requiring maintenance of specific levels of operating cash flow to indebtedness and to interest expense, and limitations on acquisitions and additional indebtedness. The facilities prohibit any direct or indirect distribution, dividend, redemption or other payment to any person on account of any general or limited partnership interest in, or shares of capital stock or other securities of Holdings or any of its subsidiaries. The amended facilities require that Holdings receive $20 million in proceeds from a GCI preferred stock issuance by May 31, 1999 (see note 12). Holdings was in compliance with all Senior Holdings Loan facilities covenants during the year ended December 31, 1998. The Senior Holdings Loan facilities are collateralized by essentially all of Holdings' assets as well as a pledge of Holdings' stock by GCI, Inc. $3.4 million of the Senior Holdings Loan facilities have been used to provide a letter of credit to secure payment of certain access charges associated with the Company's provision of telecommunications services within the State of Alaska. In connection with the funding of the Senior Holdings Loan facilities, Holdings paid bank fees and other expenses of approximately $2,972,000, which is being amortized to amortization expense over the life of the agreement. In connection with the April 13, 1999 amendment, the Company agreed to pay all fees and expenses of its lenders, including an amendment fee of 0.25% of the aggregate commitment. (c) On January 27, 1998, the Company, through Alaska United, closed a $75,000,000 project finance facility ("Fiber Facility") to construct a fiber optic cable system connecting Anchorage, Fairbanks, 81 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements Valdez, Whittier, Juneau and Seattle as further described in note 11. Borrowings under the Fiber Facility totaled $61,224,000 at December 31, 1998. The Fiber Facility provides up to $75 million in construction financing and bears interest at either Libor plus 3.0%, or at the Company's choice, the lender's prime rate plus 1.75%. The interest rate will decline to Libor plus 2.5%-2.75%, or at the Company's choice, the lender's prime rate plus 1.25%-1.5% when the loan balance is $60,000,000 or less. Borrowings under the Fiber Facility totaled $61,224,000 at December 31, 1998. Alaska United is required to pay a commitment fee equal to 0.375% per annum on the unused portion of the commitment. The Fiber Facility is a 10-year term loan that is interest only for the first 5 years. The facility can be extended to a 12 year term loan at any time between the second and fifth anniversary of closing the facility if the Company can demonstrate projected revenues from certain capacity commitments will be sufficient to pay all operating costs, and interest and principal installments based on the extended maturity. The Fiber Facility contains, among others, covenants requiring certain intercompany loans and advances in order to maintain specific levels of cash flow necessary to pay operating costs and interest and principal installments. Additional covenants pertain to the timely completion of certain project construction milestones. The Fiber Facility also contains a guarantee that requires, among other terms and conditions, Alaska United complete the project by the completion date (April 1, 1999) and pay any non-budgeted costs of the project. Alaska United was in compliance with all covenants during the period commencing January 27, 1998 (date of the Fiber Facility) through December 31, 1998. All of Alaska United's assets, as well as a pledge of the partnership interests' owning Alaska United, collateralize the Fiber Facility. In connection with the funding of the Fiber Facility, Alaska United paid bank fees and other expenses of $2,019,000 which are being amortized to Construction in Progress during the construction period of the undersea fiber optic cable. When the fiber optic cable is place in service the issuance costs will be amortized to amortization expense over the life of the agreement. (d) On December 31, 1992, Leasing Company entered into a $12,000,000 loan agreement ("Undersea Fiber and Equipment Loan Agreement"), of which approximately $9,000,000 of the proceeds were used to acquire capacity on the undersea fiber optic cable linking Seward, Alaska and Pacific City, Oregon. Concurrently, Leasing Company leased the capacity under a ten year all events, take or pay, contract with MCI (now MCI WorldCom), who subleased the capacity back to the Company. The lease and sublease agreements provide for equivalent terms of 10 years and identical monthly payments of $200,000. The proceeds of the lease agreement with MCI were pledged as primary security for the financing. The loan agreement provides for monthly payments of $170,000 including principal and interest through the earlier of January 1, 2003, or until repaid. The loan agreement provides for interest at the prime rate less one-quarter percent. Additional collateral includes substantially all of the assets of Leasing Company including the fiber capacity and a security interest in all of its outstanding stock. MCI as a second position security interest in the assets of Leasing Company. (e) GCI Cable entered into a credit facility totaling $205,000,000 effective October 31, 1996, associated with the acquisition of the Cable Companies as described in note 2. In August 1997, the Senior GCI Cable Loan was repaid using proceeds from the Senior Notes (see note 6(a)) and the Senior Holdings Loan (see note 6(b)). In connection with the funding of the loan agreement, GCI Cable, Inc. paid bank fees and other expenses of approximately $764,000 in 1996. The unamortized portion of these bank fees and other 82 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements expenses (net of income tax benefit of $180,000) was recognized as an extraordinary loss on the early extinguishment of debt in 1997. (f) The Company entered into a $62,500,000 interim telephony credit facility with its senior lender during April 1996. In August 1997, the Credit Agreement was repaid using proceeds from the Senior Notes (see note 6(a)) and the Senior GCI Holdings Loan (see note 6(b)). (g) GCI issued convertible subordinated notes totaling $10,000,000 in connection with the cable acquisitions described in note 2. During January 1997, the holders of the GCI subordinated notes exercised a conversion option which allowed them to exchange their notes for GCI Class A common shares at a predetermined conversion price of $6.50 per share. As a result, the former note holders received 1,538,457 shares of GCI Class A common stock. (h) As consideration for MCI's (now MCI WorldCom) role in enabling Leasing Company to finance and acquire the undersea fiber optic cable capacity described at note 6(d) above, Leasing Company agreed to pay MCI $2,040,000 in sixty monthly payments of $34,000. For financial statement reporting purposes, the obligation was recorded at its remaining present value, using a discount rate of 10% per annum. The agreement was secured by a second position security interest in the assets of Leasing Company. The obligation was fully paid at December 31, 1997. As of December 31, 1998 maturities of long-term debt were as follows (amounts in thousands): Year ending December 31, 1999 $ 1,799 2000 1,934 2001 --- 2002 --- 2003 12,950 2004 and thereafter 334,974 -------------- $ 351,657 ==============(7) Income Taxes Total income tax expense (benefit) was allocated as follows: Years ended December 31, --------------------------------- 1998 1997 1996 --------------------------------- (Amounts in thousands) Earnings (loss) from continuing operations $ (4,123) (573) 5,228 Extraordinary item --- (180) --- --------------------------------- (4,123) (753) 5,228 Stockholders' equity, for stock option compensation expense for tax purposes in excess of amounts recognized for financial reporting purposes (157) (65) (187) --------------------------------- $ (4,280) (818) 5,041 ================================= 83 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements Income tax expense (benefit) consists of the following: Years ended December 31, --------------------------------- 1998 1997 1996 --------------------------------- (Amounts in thousands) Current tax expense (benefit): Federal taxes $ (2,858) (4,333) 2,292 State taxes (521) (830) 684 --------------------------------- (3,379) (5,163) 2,976 --------------------------------- Deferred tax expense (benefit): Federal taxes (629) 3,800 1,734 State taxes (115) 610 518 --------------------------------- (744) 4,410 2,252 --------------------------------- $ (4,123) (753) 5,228 ================================= Total income tax expense (benefit) differed from the "expected" income tax expense (benefit) determined by applying the statutory federal income tax rate of 34% as follows: Years ended December 31, --------------------------------------- 1998 1997 1996 --------------------------------------- (Amounts in thousands) "Expected" statutory tax expense (benefit) $ (3,713) (997) 4,314 State income taxes, net of federal benefit (594) (181) 793 Income tax effect of goodwill amortization, nondeductible expenditures and other items, net 441 107 55 Change in valuation allowance --- --- (225) Other (257) 318 291 --------------------------------------- $ (4,123) (753) 5,228 ======================================= 84 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997 are presented below. December 31, -------------------------- 1998 1997 -------------------------- (Amounts in thousands) Net current deferred tax assets: Accounts receivable, principally due to allowance for doubtful accounts $ 354 430 Compensated absences, accrued for financial reporting purposes 804 566 Workers compensation and self insurance health reserves, principally due to accrual for financial reporting purposes 244 266 Other 545 413 -------------------------- Total gross current deferred tax assets 1,947 1,675 Less valuation allowance --- --- -------------------------- Net current deferred tax assets $ 1,947 1,675 ========================== Net long-term deferred tax assets: Net operating loss carryforwards $ 20,871 15,378 Alternative minimum tax credits 2,081 751 Deferred compensation expense for financial reporting purposes in excess of amounts recognized for tax purposes 1,027 966 Employee stock option compensation expense for financial reporting purposes in excess of amounts recognized for tax purposes 327 198 Sweepstakes award in excess of amounts recognized for tax purposes 201 206 Other 99 75 -------------------------- Total long-term deferred tax assets 24,606 17,574 -------------------------- Net long-term deferred tax liabilities: Plant and equipment, principally due to differences in depreciation 56,244 51,643 Amortizable assets 4,784 3,898 Costs recognized for tax purposes in excess of amounts recognized for book purposes 1,319 --- Other 534 937 -------------------------- Total gross long-term deferred tax liabilities 62,881 56,478 -------------------------- Net combined long-term deferred tax liabilities $ 38,275 38,904 ========================== In conjunction with the 1996 Cable Companies acquisition, the Company incurred a net deferred income tax liability of $24.4 million and acquired net operating losses totaling $57.6 million. The Company determined that approximately $20 million of the acquired net operating losses would not be utilized for income tax 85 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements purposes, and elected with its December 31, 1996 income tax returns to forego utilization of such acquired losses under Internal Revenue Code section 1.1502-32(b)(4). Deferred tax assets were not recorded associated with the foregone losses and, accordingly, no valuation allowance was provided. At December 31, 1998, the Company has (1) tax net operating loss carryforwards of approximately $51.0 million that will begin expiring in 2008 if not utilized, and (2) alternative minimum tax credit carryforwards of approximately $2.0 million available to offset regular income taxes payable in future years. The Company's 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. 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 in the near term if estimates of future taxable income during the carryforward period are reduced.(8) Stockholders' Equity Common Stock GCI's Class A common stock and Class B common stock are identical in all respects, except that each share of Class A common stock has one vote per share and each share of Class B common stock has ten votes per share. In addition, each share of Class B common stock outstanding is convertible, at the option of the holder, into one share of Class A common stock. After the transaction described in note 2, MCI (now MCI WorldCom) owns a total of 8,251,509 shares of GCI's Class A and 1,275,791 shares of GCI's Class B common stock which represent approximately 18 and 31 percent of the issued and outstanding shares of the respective class at December 31, 1998 and 1997, respectively. After the transaction described in note 2, the owners of the cable television properties acquired in 1996 owned a total of 14,723,077 shares of GCI's Class A common stock representing approximately 40 percent of the issued and outstanding Class A common shares at December 31, 1996. The holders of the GCI subordinated notes exercised a conversion option in January 1997. As a result the noteholders received 1,538,457 shares of GCI's Class A common stock. GCI issued 7,000,000 shares of its Class A common stock on August 1, 1997 for $7.25 per share, before deducting underwriting discounts and commissions. Net proceeds to GCI totaled $47,959,000. Other costs associated with the stock issuance totaled $1,233,000. Stock Option Plan In December 1986, GCI adopted a Stock Option Plan (the "Option Plan") in order to provide a special incentive to the Company's officers, non-employee directors, and employees by offering them an opportunity to acquire an equity interest in GCI. The Option Plan, as amended in 1998, provides for the grant of options for a maximum of 5,700,000 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 option expires or terminates, the shares subject to the option will be available for further grants of options under the Option Plan. The Option Committee of GCI's Board of Directors administers the Option Plan. The Option Plan provides that all options granted under the Option Plan must expire not later than ten years after the date of grant. If at the time an option is granted the exercise price is less than the market value of the 86 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements underlying common stock, the "in the money" amount at the time of grant is expensed ratably over the vesting period of the option. Options granted pursuant to the Option Plan are only exercisable if at the time of exercise the option holder is an employee or non-employee director of GCI. Information for the years 1996, 1997 and 1998 with respect to the Option Plan follows: Weighted Average Exercise Range of Shares Price Exercise Prices --------------- ------------- ------------------ Outstanding at December 31, 1995 2,288,199 $3.19 $0.75-$4.00 Granted 321,000 $5.79 $3.75-$6.50 Exercised (82,291) $2.80 $0.75-$4.00 Forfeited (79,785) $3.11 $0.75-$4.50 --------------- Outstanding at December 31, 1996 2,447,123 $3.54 $0.75-$6.50 Granted 1,051,000 $6.36 $0.01-$7.63 Exercised (57,285) $3.37 $0.75-$4.00 Forfeited (65,938) $4.82 $0.75-$6.50 --------------- Outstanding at December 31, 1997 3,374,900 $4.39 $0.01-$7.63 Granted 1,150,459 $6.38 $3.25-$7.25 Exercised (264,600) $2.98 $1.00-$4.00 Forfeited (181,000) $6.49 $4.00-$7.00 --------------- Outstanding at December 31, 1998 4,079,759 $4.95 $0.01-$7.63 =============== Available for grant at December 31, 1998 657,817 =============== Stock Options Not Pursuant to a Plan In June 1989, an officer was granted options to acquire 100,000 Class A common shares at $.75 per share. The options vested in equal annual increments over a five-year period, expiring in February 1999. Options to acquire 50,000 shares were exercised during 1998. The Company entered into an incentive agreement in June 1989 with an officer providing for the acquisition of 85,190 remaining shares of Class A common stock of the Company for $.001 per share exercisable through June 1997. The shares under the incentive agreement vested in equal annual increments over a three-year period and were exercised in June 1997. Stock Warrants Not Pursuant to a Plan The Company entered into a warrant agreement in December 1998 with Prime II Management, L.P. ("PMLP"). In lieu of cash payments for services under the amended Management Agreement, PMLP agreed to accept a stock warrant which provides for the purchase of 425,000 shares of GCI class A common stock, with immediate vesting at the option date and an exercise price of $3.25 per share. The warrant expires December 2003. 87 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements The Company entered into a warrant agreement in exchange for services in December 1998 with certain of its legal counsel which provides for the purchase of 16,667 shares of GCI class A common stock, vesting in December 1999, with an exercise price of $3.00 per share, and expiring December 2003. SFAS 123 Disclosures The Company's stock options and warrants expire at various dates through December 2008. At December 31, 1998, 1997 and 1996, the weighted-average remaining contractual lives of options outstanding were 6.71, 6.82 and 6.73 years, respectively. At December 31, 1998, 1997 and 1996, the number of exercisable shares under option was 1,827,130, 1,664,015 and 1,275,903, respectively, and the weighted-average exercise price of those options was $3.49, $3.15 and $2.85, respectively. The per share weighted-average fair value of stock options granted during 1998 was $4.08 for compensatory and non-compensatory options; for 1997, $6.71 per share for compensatory options and $6.50 per share for non-compensatory options; and for 1996, $6.94 per share for compensatory options and $4.40 per share for non-compensatory options. The amounts were determined as of the options' grant dates using a qualified Black-Scholes option-pricing model with the following weighted-average assumptions: 1998 - risk-free interest rate of 4.75%, volatility of 0.6951 and an expected life of 5.7 years; 1997 - risk-free interest rate of 5.46%, volatility of 1.8558 and an expected life of 5.5 years; and 1996 - risk-free interest rate of 5.48%, volatility of 1.8558 and an expected life of 5.7 years. Summary information about the Company's stock options and warrants outstanding at December 31, 1998: Options and Warrants Outstanding Options and Warrants Exercisable ----------------------------------------------------------------------- ------------------------------------- Weighted Number Average outstanding Remaining Weighted Number Weighted Range of Exercise as of Contractual Average Exercisable as Average Exercise Prices 12/31/98 Life Exercise Price of 12/31/98 Price ----------------------------------------------------------------------- ------------------------------------- $0.01 - $1.75 406,000 4.15 $1.17 336,000 $1.41 $3.00 - $3.00 778,667 3.52 $3.00 762,000 $3.00 $3.25 - $3.75 79,459 9.71 $3.28 3,330 $3.75 $4.00 - $4.00 792,300 5.84 $4.00 445,300 $4.00 $4.50 - $4.50 20,000 7.09 $4.50 20,000 $4.50 $6.00 - $6.00 459,500 8.78 $6.00 91,000 $6.00 $6.50 - $6.50 430,500 8.73 $6.50 38,500 $6.50 $6.63 - $6.94 115,000 9.08 $6.84 0 $0.00 $7.00 - $7.00 671,000 8.31 $7.00 88,000 $7.00 $7.25 - $7.63 390,000 8.77 $7.39 43,000 $7.54 ------------------------------------------------- ------------------------------------- $0.01 - $7.63 4,142,426 6.71 $4.89 1,827,130 $3.49 ================================================= ===================================== 88 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements Had compensation cost for the Company's 1996, 1997 and 1998 grants for stock-based compensation plans been determined consistent with SFAS 123, the Company's net income (loss) and net income (loss) per common share would approximate the pro forma amounts below (in thousands except per share data): As Reported Pro Forma ----------------------------------- 1996: Net earnings $ 7,462 7,212 Basic net earnings per common share $ 0.28 0.27 Diluted net earnings per common share $ 0.27 0.26 1997: Net loss $(2,183) (3,387) Basic net loss per common share $ (0.05) (0.08) Diluted net loss per common share $ (0.05) (0.08) 1998: Net loss $(6,797) (8,697) Basic net loss per common share $ (0.14) (0.18) Diluted net loss per common share $ (0.14) (0.18) Pro forma net income (loss) reflects options granted in 1998, 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS 123 is not reflected in the pro forma net income amounts presented above since compensation cost is reflected over the options' vesting period of generally 5 years and compensation cost for options granted prior to January 1, 1995 is not considered. Class A Common Shares Held in Treasury The Company acquired 105,111 shares of its Class A common stock in 1989 for approximately $328,000 to fund a deferred bonus agreement with an officer of the Company. The agreement provides that the balance is payable after the later of termination of employment or six months after the effective date of the agreement. In September 1995, July 1996 and March 1997, the Company acquired a total of 97,657 additional shares of Class A common stock for approximately $711,000 to fund additional deferred compensation agreements for two of its officers. In April and May, 1998, the Company acquired a total of 145,000 additional shares of Class A common stock for approximately $568,000 to fund additional deferred compensation agreements for three of its officers. Employee Stock Purchase Plan In December 1986, GCI adopted an Employee Stock Purchase Plan (the "Plan") qualified under Section 401 of the Internal Revenue Code of 1986 (the "Code"). The Plan provides for acquisition of GCI's Class A and Class B common stock at market value. The Plan permits each employee of GCI and affiliated companies who has completed one year of service to elect to participate in the Plan. Eligible employees may elect to reduce their compensation in any even dollar amount up to 10 percent of such compensation up to a maximum of $10,000 in 1998; they may contribute up to 10 percent of their compensation with after-tax dollars, or they may elect a combination of salary reductions and after-tax contributions. The Company may match employee salary reductions and after tax contributions in any amount, elected 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. The combination of salary reductions, after tax contributions and matching contributions cannot exceed 25 percent of any employee's compensation (determined after salary reduction) for any year. Matching contributions vest over six years. Employee contributions may be invested in GCI common stock, MCI WorldCom common stock, Tele-Communications, Inc. ("TCI") common stock or various 89 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements mutual funds. AT&T's recent acquisition of TCI will result in the conversion of TCI shares of common stock into AT&T shares of common stock. Alternative investment choices may be offered by the Plan commencing as early as the third or fourth quarter of 1999. Employee contributions invested in GCI common stock receive up to 100% matching, as determined by GCI's board of directors each year, in GCI common stock. Employee contributions invested in other than GCI common stock receive up to 50% matching, as determined by the GCI's board of directors each year, in GCI common stock. The Company's matching contributions allocated to participant accounts totaled approximately $2,278,000, $1,800,000 and $1,013,000 for the years ended December 31, 1998, 1997, and 1996, respectively. The Plan may, at its discretion, purchase shares of GCI common stock from GCI at market value or may purchase GCI's common stock on the open market. In 1998 the Company funded employer matching contributions through the issuance of new shares of GCI common stock rather than market purchases and expects to continue to do so in 1999.(9) Industry Segments Data The Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information", in 1998 which changes the way the Company reports information about its operating segments. The information for 1997 and 1996 has been restated from the prior year's presentation in order to conform to the 1998 presentation. The Company's reportable segments are business units that offer different products. The reportable segments are each managed separately because they manage and offer distinct products with different production and delivery processes. The Company has four reportable segments as follows: Long-distance services. A full range of common-carrier long-distance services are offered to business, government, other telecommunications companies and consumer customers, through its networks of fiber optic cables, digital microwave, and fixed and transportable satellite earth stations. Cable services. The Company provides cable television services to residential, commercial and government users in the State of Alaska. The Company's cable systems serve 26 communities and areas in Alaska, including the state's three largest urban areas, Anchorage, Fairbanks and Juneau. Anchorage cable plant upgrades in 1998 enabled the Company to offer digital cable television services and retail cable modem service (through its Internet Services segment) in Anchorage, complementing its existing service offerings. The Company plans to expand its product offerings as plant upgrades are completed in other communities in Alaska. Local access services. The Company introduced facilities based competitive local exchange services in Anchorage in 1997. The Company has announced plans to ultimately provide similar competitive local exchange services in Alaska's other major population centers, as access is allowed by the APUC. Internet services. The Company began offering wholesale and retail Internet services in 1998. Deployment of the new undersea fiber optic cable (see note 11) will allow the Company to offer enhanced services with high-bandwidth requirements. Other services. Services provided by the Company that are included in the other segment are managed services, product sales and cellular telephone services. Included in the other segment are the results of insignificant business units described above which do meet the quantitative thresholds for determining reportable segments. None of these business units have ever met the quantitative thresholds for determining reportable segments. Also included in the other segment are corporate related expenses, including marketing, 90 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements customer service, management information systems, accounting, legal and regulatory, human resources and other general and administrative expenses. The Company evaluates performance and allocates resources based on (1) profit or loss from operations before depreciation, amortization, interest and income taxes, and (2) operating income or loss. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies included in note 1. Intersegment sales are recorded at cost plus an agreed upon intercompany profit. All revenues are earned through sales of services and products within the United States of America ("USA"). All of the Company's long-lived assets are located within the USA. Summarized financial information concerning the Company's reportable segments follows (amounts in thousands): Long- Local Distance Cable Access Internet Services Services Services Services Other Total -------------------------------------------------------------------------- 1998 ---- Revenues: Intersegment $ 2,716 1,330 1,284 --- --- 5,330 External 157,350 57,640 9,908 4,591 17,306 246,795 -------------------------------------------------------------------------- Total revenues 160,066 58,970 11,192 4,591 17,306 252,125 -------------------------------------------------------------------------- Cost of sales and services: Intersegment 1,284 --- 1,254 2,727 --- 5,265 External 79,323 13,407 6,113 3,402 13,828 116,073 -------------------------------------------------------------------------- Total cost of sales and services 80,607 13,407 7,367 6,129 13,828 121,338 -------------------------------------------------------------------------- Contribution: Intersegment 1,432 1,330 30 (2,727) --- 65 External 78,027 44,233 3,795 1,189 3,478 130,722 -------------------------------------------------------------------------- Total contribution 79,459 45,563 3,825 (1,538) 3,478 130,787 Selling, general and administrative expenses 21,019 15,630 8,477 782 43,926 89,833 -------------------------------------------------------------------------- 58,440 29,933 (4,652) (2,320) (40,448) 40,954 Depreciation and amortization 6,976 17,281 2,597 501 4,690 32,045 -------------------------------------------------------------------------- Operating income (loss) $ 51,464 12,652 (7,249) (2,821) (45,138) 8,909 ========================================================================== Total assets $231,727 316,976 31,062 16,535 49,816 646,116 ========================================================================== Capital expenditures $110,177 20,727 8,104 3,836 6,129 148,973 ========================================================================== 91 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements Long- Local Distance Cable Access Internet Services Services Services Services Other Total -------------------------------------------------------------------------- 1997 Revenues: Intersegment $ --- 516 --- --- 172 688 External 154,681 55,165 610 182 13,171 223,809 -------------------------------------------------------------------------- Total revenues 154,681 55,681 610 182 13,343 224,497 -------------------------------------------------------------------------- Cost of sales and services: Intersegment --- --- 472 --- --- 472 External 86,346 12,610 739 241 11,141 111,077 -------------------------------------------------------------------------- Total cost of sales and services 86,346 12,610 1,211 241 11,141 111,549 -------------------------------------------------------------------------- Contribution: Intersegment --- 516 (472) --- 172 216 External 68,335 42,555 (129) (59) 2,030 112,732 -------------------------------------------------------------------------- Total contribution 68,335 43,071 (601) (59) 2,202 112,948 Selling, general and administrative expenses 18,724 18,812 2,802 26 33,219 73,583 -------------------------------------------------------------------------- 49,611 24,259 (3,403) (85) (31,017) 39,365 Depreciation and amortization 6,676 13,320 525 3 3,243 23,767 -------------------------------------------------------------------------- Operating income (loss) $ 42,935 10,939 (3,928) (88) (34,260) 15,598 ========================================================================== Total assets $161,968 311,643 20,357 8,510 42,824 545,302 ========================================================================== Capital expenditures $ 23,107 18,199 9,379 7,496 6,463 64,644 ========================================================================== 1996 Revenues: Intersegment $ --- 40 --- --- --- 40 External 141,374 9,475 --- --- 14,045 164,894 -------------------------------------------------------------------------- Total revenues 141,374 9,515 --- --- 14,045 164,934 -------------------------------------------------------------------------- Cost of sales and services: Intersegment 40 --- --- --- --- 40 External 80,193 2,067 --- --- 10,404 92,664 -------------------------------------------------------------------------- Total cost of sales and services 80,233 2,067 --- --- 10,404 92,704 -------------------------------------------------------------------------- Contribution: Intersegment (40) 40 --- --- --- --- External 61,181 7,408 --- --- 3,641 72,230 -------------------------------------------------------------------------- Total contribution 61,141 7,448 --- --- 3,641 72,230 92 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements Long- Local Distance Cable Access Internet Services Services Services Services Other Total -------------------------------------------------------------------------- Selling, general and administrative expenses 15,442 2,992 842 --- 27,136 46,412 -------------------------------------------------------------------------- 45,699 4,456 (842) --- (23,495) 25,818 Depreciation and amortization 5,025 2,220 --- --- 2,164 9,409 -------------------------------------------------------------------------- Operating income (loss) $ 40,674 2,236 (842) --- (25,659) 16,409 ========================================================================== Total assets $102,739 306,743 3,475 154 34,224 447,335 ========================================================================== Capital expenditures $ 27,765 909 3,475 154 6,339 38,642 ========================================================================== ----------------------- Long-distance services, local access service and Internet services are billed utilizing a unified accounts receivable system and are not reported separately by business segment. All such accounts receivable are included above in the long-distance services segment for all periods presented. A reconciliation of total segment revenues to consolidated revenues follows: Years ended December 31, 1998 1997 1996 ----------------------------------------------- Total segment revenues $ 252,125 224,497 164,934 Less intersegment revenues eliminated in consolidation (5,330) (688) (40) ----------------------------------------------- Consolidated revenues $ 246,795 223,809 164,894 =============================================== A reconciliation of total segment operating income to consolidated net income (loss) before income taxes and extraordinary item follows: Years ended December 31, 1998 1997 1996 ----------------------------------------------- Total segment operating income $ 8,909 15,598 16,409 Less intersegment contribution eliminated in consolidation (65) (216) --- ----------------------------------------------- Consolidated operating income 8,844 15,382 16,409 Interest expense, net (19,764) (17,617) (3,719) ----------------------------------------------- Consolidated net income (loss) before income taxes and extraordinary item $ (10,920) (2,235) 12,690 =============================================== The Company provides message telephone service to MCI WorldCom (see note 10) and Sprint, major customers. The Company earned revenues, included in the long-distance segment, pursuant to a contract with Sprint totaling approximately $25,398,000, $24,357,000 and $18,781,000 for the years ended December 31, 1998, 1997 and 1996 respectively. As a percentage of total revenues, Sprint revenues totaled 10.3%, 10.9% and 11.4% for the years ended December 31, 1998, 1997 and 1996 respectively. (10) Related Party Transactions Pursuant to the terms of a contract with MCI WorldCom, a major shareholder of GCI (see note 8), the Company earned revenues of approximately $35,892,000, $34,315,000 and $29,208,000 for the years ended December 31, 1998, 1997 and 1996, respectively. As a percentage of total revenues, MCI WorldCom revenues totaled 14.5%, 15.3% and 17.7% for the years ended December 31, 1998, 1997 and 1996 respectively. Amounts receivable, net of accounts payable, from MCI WorldCom totaled $4,836,000 and 93 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements $3,933,000 at December 31, 1998 and 1997, respectively. The Company paid MCI WorldCom for distribution of its traffic in the lower 49 states amounts totaling approximately $12,639,000, $14,319,000 and $12,224,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Company entered into a long-term capital lease agreement in 1991 with the wife of the Company's president for property occupied by the Company. The lease is guaranteed by the Company. The lease term is 15 years with monthly payments increasing in $800 increments at each two year anniversary of the lease. Monthly lease costs will increase to $17,600 effective October 1999. If the owner sells the premises prior to the end of the tenth year of the lease, the owner will rebate to the Company one-half of the net sales price received in excess of $900,000. If the property is not sold prior to the tenth year of the lease, the owner will pay the Company the greater of one-half of the appreciated value of the property over $900,000, or $500,000. The leased asset was capitalized in 1991 at the owner's cost of $900,000 and the related obligation was recorded in the accompanying financial statements. GCI Cable, Inc. ("GCI Cable") is a party to a Management Agreement with Prime II Management, L.P. ("PMLP"). Certain of the Prime sellers are affiliated with PMLP. The Management Agreement began on November 1, 1996 and expires on October 31, 2005, however, it can be terminated earlier upon loss of a license to operate the systems, sale of the systems, breach of contract, or upon exercise of an option to terminate the Management Agreement by PMLP or GCI Cable any time after October 31, 2000. The agreement was amended December 15, 1998. Under the terms of the amended Management Agreement, PMLP performs certain services for GCI Cable and will be compensated as follows: November 01, 1996 through October 31, 1997 $1,000,000 November 01, 1997 through December 31, 1997 $ 125,000 January 01, 1998 through January 31, 1999 Warrant to purchase 425,000 shares of GCI stock February 01, 1999 through October 31, 1999 $ 200,000 November 01, 1999 through October 31, 2000 $ 400,000 (plus reimbursement for certain expenses) In connection with the agreement, GCI Cable received services valued at approximately $752,000, $1,040,000 and $197,000 including reimbursable expenses for the periods ended December 31, 1998, 1997 and 1996, respectively. (11) Commitments and Contingencies Leases The Company as Lessee. The Company leases business offices, has entered into site lease agreements and uses certain equipment and satellite transponder capacity pursuant to operating lease arrangements. Rental costs under such arrangements amounted to approximately $11,609,000, $11,574,000 and $7,364,000 for the years ended December 31, 1998, 1997 and 1996, respectively. 94 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements A summary of future minimum lease payments for all leases as of December 31, 1998 follows: Year ending December 31: Operating Capital --------------------------- (Amounts in thousands) 1999 $ 13,388 771 2000 5,549 767 2001 3,937 1,127 2002 2,377 466 2003 2,204 381 2004 and thereafter 3,093 643 --------------------------- Total minimum lease payments $ 30,548 4,155 ============= Less amount representing interest (1,969) Less current maturities of obligations under capital leases (511) ------------- Subtotal - long-term obligations under capital leases 1,675 Less long-term obligations under capital leases due to related party, excluding current maturities (486) ------------- Long-term obligations under capital leases, excluding related party, excluding current maturities $ 1,189 ============= The leases generally provide that the Company pay the taxes, insurance and maintenance expenses related to the leased assets. It is expected that in the normal course of business, except for satellite transponder capacity, leases that expire will be renewed or replaced by leases on other properties. The Company as Lessor. Subsequent to December 31, 1998, the Company signed agreements with a large commercial customer for the immediate lease of three DS3 circuits on Alaska United facilities within Alaska, and between Alaska and the lower 48 states. The lease agreements provide for three year terms, with renewal options for additional terms. Deferred Compensation Plan During 1995, the Company adopted a non-qualified, unfunded deferred compensation plan to provide a means by which certain employees may elect to defer receipt of designated percentages or amounts of their compensation and to provide a means for certain other deferrals of compensation. The Company may, at its discretion, contribute matching deferrals equal to the rate of matching selected by the Company. Participants immediately vest in all elective deferrals and all income and gain attributable thereto. Matching contributions and all income and gain attributable thereto vest over a six-year period. Participants may elect to be paid in either a single lump sum payment or annual installments over a period not to exceed 10 years. Vested balances are payable upon termination of employment, unforeseen emergencies, death and total disability. Participants are general creditors of the Company with respect to deferred compensation plan benefits. Compensation deferred pursuant to the plan totaled approximately $117,000, $58,000 and $167,000 as of December 31, 1998, 1997 and 1996, respectively. Satellite Transponders The Company entered into a purchase and lease-purchase option agreement in August 1995 for the acquisition of satellite transponders to meet its long-term satellite capacity requirements. The launch of the satellite in August 1998 failed. The Company did not assume launch risk and the launch has been rescheduled for the 95 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements fourth quarter of 1999. The Company will continue to lease transponder capacity until delivery of the transponders on the replacement satellite. The balance payable upon expected delivery of the transponders during the fourth quarter of 1999 in addition to the $9.1 million deposit previously paid totals approximately $43.5 million. Self-Insurance The Company is self-insured for losses and liabilities related primarily to health and welfare claims up to predetermined amounts above which third party insurance applies. A reserve of $545,000 was recorded at December 31, 1998 to cover estimated reported losses, estimated unreported losses based on past experience modified for current trends, and estimated expenses for investigating and settling claims. Actual losses will vary from the recorded reserve. While management uses what it believes is 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. Litigation The Company is involved in various disputes, lawsuits, legal proceedings and regulatory matters that have arisen in the normal course of business. While the ultimate results of these items cannot be predicted with certainty, management does not expect at this time the resolution of them to have a material adverse effect on the Company's financial position, results of operations or liquidity. Cable Service Rate Reregulation Beginning in April 1993, the Federal Communications Commission ("FCC") adopted regulations implementing the Cable Television Consumer Protection and Competition Act of 1992 ("The Cable Act of 1992"). Included are rules governing rates charged by cable operators for the basic service tier, the installation, lease and maintenance of equipment (such as converter boxes and remote control units) used by subscribers to receive this tier and for cable programming services other than programming offered on a per-channel or per-program basis (the "regulated services"). Generally, the regulations require affected cable systems to charge rates for regulated services that have been reduced to prescribed benchmark levels, or alternatively, to support rates using costs-of-service methodology. Until March 31, 1999, the regulated services rates charged by the Company may be reviewed by the State of Alaska, operating through the APUC for basic service, or by the FCC for cable programming service. Refund liability for basic service rates is limited to a one-year period. Refund liability for cable programming service rates may be calculated from the date a complaint is filed with the FCC until the rate reduction is implemented. Beginning March 31, 1999, the rates for cable programming services (service tiers above basic service) will no longer be regulated. Only regulation of basic rates, initially through the APUC, will remain. In order for the State of Alaska to exercise rate regulation authority over the Company's basic service rates, 25% of a systems' subscribers must request such regulation by filing a petition with the APUC. At December 31, 1998, the State of Alaska has rate regulation authority over the Juneau system's basic service rates. (The Juneau system serves 8.3% of the Company's total basic service subscribers at December 31, 1998.) Juneau's current rates have been approved by the APUC and there are no other pending filings with the APUC, therefore, there is no refund liability for basic service at this time. Undersea Fiber Optic Cable Contract Commitment The Company signed a contract in July 1997 for construction of the undersea portion of a fiber optic cable system connecting the cities of Anchorage, Juneau, and Seattle via a subsea route. The total system is expected to cost approximately $125 million. Subsea and terrestrial connections extended the fiber optic cable to Fairbanks via Whittier and Valdez. Construction efforts began in September 1998 and were completed in early February 1999. Commercial services commenced in February 1999. Pursuant to the 96 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements contract, the Company paid $77.2 million and $9.1 million during the years ended December 31, 1998 and 1997, respectively, and will pay the remaining balance in installments through April 1999. Approximately $39.4 million of proceeds from the public offerings (see note 8), net of the $9.1 million paid in 1997, were contributed to Alaska United. The use of such proceeds was restricted to funding the construction and deployment of the fiber optic cable system and was reported as Restricted Cash at December 31, 1997 in the accompanying Consolidated Financial Statements. The restricted cash was released to Alaska United in 1998 to fund construction and deployment efforts. In January 1998, the Company secured up to $75 million in bank financing to fund the remaining cost of construction and deployment, of which $61.2 million was outstanding at December 31, 1998 (see note 6 (c)). Year 2000 In 1997, the Company initiated a plan to identify, assess and remediate Year 2000 issues within each of its significant computer programs and certain equipment which contain micro-processors. The plan is addressing the issue of computer programs and embedded computer chips being unable to distinguish between the year 1900 and the year 2000, if a program or chip uses only two digits rather than four to define the applicable year. The Company has divided the plan into two major phases. The first phase, including team formation, inventory assessment, compliance assessment and risk assessment, were completed during 1998. The second phase, including resolution/remediation, validation, contingency planning and sign-off acceptance, was in progress at December 31, 1998. Systems which have been determined not to be Year 2000 compliant are being either replaced or reprogrammed, and thereafter tested for Year 2000 compliance. The plan anticipates that by mid-1999 the conversion, implementation and testing phases will be completed. The current budget for the total cost of remediation (including replacement software and hardware) and testing, as set forth in the plan, is approximately $4.0 million. The Company is in the process of identifying and contacting critical suppliers and customers whose computerized systems interface with the Company's systems, regarding their plans and progress in addressing their Year 2000 issues. The Company has received varying information from such third parties on the state of compliance or expected compliance. Contingency plans are being developed in the event that any critical supplier or customer is not compliant. The failure to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-party suppliers and customers, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company's operations, liquidity or financial condition.(12) Subsequent Event On April 2, 1999 the Company received commitments for the issuance of 20,000 shares of convertible redeemable accreting preferred stock ("Preferred Stock"). Proceeds totaling $20 million (before payment of costs and expenses) will be used for general corporate purposes and to provide additional liquidity. The Company's amended Senior Holdings Loan facilities limit use of such proceeds (see note 6). The Preferred Stock contains a $1,000 per share liquidation preference, plus accrued but unpaid dividends and fees. Dividends will be payable semi-annually at the rate of 8.5% of the liquidation preference. Prior to the five-year anniversary following closing, dividends are payable, at the Company's option, in cash or in additional fully-paid shares of Preferred Stock. Dividends are payable only in cash following the five-year anniversary of closing. Mandatory redemption is required 12 years from the date of closing. 97 (Continued) GENERAL COMMUNICATION, INC. Notes to Consolidated Financial Statements The Company and Holders of the Preferred Stock will have the right after the four-year anniversary of closing (or occurrence of a triggering event, as defined) to convert the stated value, in whole or in part, into registered shares of GCI class A common stock. The conversion price will be the lesser of $6.00 or 120% of the average closing price of GCI's class A common stock for the 10 trading days prior to closing. At any time subsequent to the third anniversary following closing, and assuming the stock is trading at two times the conversion price, the Company may require immediate conversion at a price equal to two times the conversion price. The Preferred Stock, subject to lender approval, will be exchangeable in whole or in part, at the Company's option, into subordinated debt with terms and conditions comparable to those governing the Preferred Stock. The Preferred Stock will be senior to all other classes of the Company's equity securities, and will have voting rights equal to that number of shares of common stock into which it can be converted. The holders of the Preferred Stock will, as a class, be entitled to elect one GCI director. Closing is expected to take place prior to April 30, 1999.(13) Supplementary Financial Data The following is a summary of unaudited quarterly results of operations for the years ended December 31, 1998 and 1997. (Amounts in thousands, except per share amounts) First Second Third Fourth Total Quarter Quarter Quarter Quarter Year ------- ------- ------- ------- ---- 1998 ---- Total revenues $ 58,152 62,941 62,766 62,936 246,795 Net loss $ (1,616) (2,066) (2,076) (1,039) (6,797) Basic net loss per common share $ (0.03) (0.04) (0.04) (0.02) (0.14) Diluted net loss per common share $ (0.03) (0.04) (0.04) (0.02) (0.14) 1997 ---- Total revenues $ 52,881 56,186 57,956 56,786 223,809 Net earnings (loss) $ (525) (832) (928) 102 (2,183) Basic loss per common share: Net loss before extraordinary item $ (0.01) (0.02) (0.01) --- (0.04) Extraordinary loss $ --- --- (0.01) --- (0.01) Net loss $ (0.01) (0.02) (0.02) --- (0.05) Diluted loss per common share: Net loss before extraordinary item $ (0.01) (0.02) (0.01) --- (0.04) Extraordinary loss $ --- --- (0.01) --- (0.01) Net loss $ (0.01) (0.02) (0.02) --- (0.05) 98 PART IVItem 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K Page No. -------- (a)(l) Consolidated Financial Statements Included in Part II of this Report: Independent Auditor's Report..............................................................67 Consolidated Balance Sheets, December 31, 1998 and 1997...................................68 -- 69 Consolidated Statements of Operations, Years ended December 31, 1998, 1997 and 1996...........................................70 Consolidated Statements of Stockholders' Equity, Years ended December 31, 1998, 1997 and 1996...........................................71 Consolidated Statements of Cash Flows, Years ended December 31, 1998, 1997 and 1996...........................................72 Notes to Consolidated Financial Statements................................................73 -- 98(a)(2) Consolidated Financial Statement Schedules Included in Part IV of this Report: Independent Auditors' Report..............................................................106 Schedule VIII - Valuation and Qualifying Accounts, Years ended December 31, 1998, 1997 and 1996...........................................107 Other schedules are omitted as they are not required or are not applicable, or the required information is shown in the applicable financial statements or notes thereto. 99 (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): Exhibit No. Description ------------------------------------------------------------------------------------------------------------ 3.1 Restated Articles of Incorporation of the Company dated August 16, 1993. (23) 3.2 Bylaws of the Company (1) 4.1 1997 Amendment No. 1 to Voting Agreement dated October 31, 1996, among Prime II Management L.P., as agent for the Voting Prime Sellers, MCI Telecommunications Corporation, Ronald A. Duncan, Robert M. Walp and TCI GCI, Inc. (23) 10.1 Employee stock option agreements issued to individuals Spradling, O'Hara, Strid, Behnke, Lewkowski and Snyder (3) 10.2 Lease agreement between GCI Communication Services, Inc. and National Bank of Alaska Leasing Corporation dated January 15, 1992 (4) 10.3 Westin Building Lease (5) 10.4 Duncan and Hughes Deferred Bonus Agreements (6) 10.5 Compensation Agreement between General Communication, Inc. and William C. Behnke dated January 1, 1997 (19) 10.6 Order approving Application for a Certificate of Public Convenience and Necessity to operate as a Telecommunications (Intrastate Interexchange Carrier) Public Utility within Alaska (3) 10.7 1986 Stock Option Plan, as amended (21) 10.8 Loan agreement between National Bank of Alaska and GCI Leasing Co., Inc. dated December 31, 1992 (4) 10.9 Pledge and Security Agreement between National Bank of Alaska and GCI Communication Services, Inc. dated December 31, 1992 (4) 10.10 Lease Agreement between MCI Telecommunications Corporation and GCI Leasing Co., Inc. dated December 31, 1992 (4) 10.11 Sublease Agreement between MCI Telecommunications Corporation and General Communication, Inc. dated December 31, 1992 (4) 10.12 Financial Assistance Agreement between MCI Telecommunications Corporation and GCI Leasing Co., Inc. dated December 31, 1992 (4) 10.13 MCI Carrier Agreement between MCI Telecommunications Corporation and General Communication, Inc. dated January 1, 1993 (8) 10.14 Contract for Alaska Access Services Agreement between MCI Telecommunications Corporation and General Communication, Inc. dated January 1, 1993 (8) 10.15 Promissory Note Agreement between General Communication, Inc. and Ronald A. Duncan, dated August 13, 1993 (9) 10.16 Deferred Compensation Agreement between General Communication, Inc. and Ronald A. Duncan, dated August 13, 1993 (9) 10.17 Pledge Agreement between General Communication, Inc. and Ronald A. Duncan, dated August 13, 1993 (9) 10.18 Revised Qualified Employee Stock Purchase Plan of General Communication, Inc. (10) 10.19 Summary Plan Description pertaining to the Revised Qualified Employee Stock Purchase Plan of General Communication, Inc. (10) 10.20 The GCI Special Non-Qualified Deferred Compensation Plan (11) 100 Exhibit No. Description ------------------------------------------------------------------------------------------------------------ 10.21 Transponder Purchase Agreement for Galaxy X between Hughes Communications Galaxy, Inc. and GCI Communication Corp. (11) 10.22 Equipment Purchase Agreement between GCI Communication Corporation and Scientific-Atlanta, Inc. (11) 10.23 Management Agreement, between Prime II Management, L.P., and GCI Cable, Inc., dated October 31, 1996 (12) 10.24 Third Amended and Restated Credit Agreement, dated as of October 31, 1996, between GCI Communication Corp., and NationsBank of Texas, N.A. (13) 10.25 Licenses: (5) 10.25.1 214 Authorization 10.25.2 International Resale Authorization 10.25.3 Digital Electronic Message Service Authorization 10.25.4 Fairbanks Earth Station License 10.25.5 Fairbanks (Esro) Construction Permit for P-T-P Microwave Service 10.25.6 Fairbanks (Polaris) Construction Permit for P-T-P Microwave Service 10.25.7 Anchorage Earth Station Construction Permit 10.25.8 License for Eagle River P-T-P Microwave Service 10.25.9 License for Juneau Earth Station 10.25.10 Issaquah Earth Station Construction Permit 10.26 ATU Interconnection Agreement between GCI Communication Corp. and Municipality of Anchorage, executed January 15, 1997 (18) 10.27 First Amendment to Third Amended and Restated Credit Agreement entered into among GCI Communication Corp., NationsBank of Texas, N.A., Toronto Dominion (Texas), Inc., Credit Lyonnais New York Branch, and National Bank of Alaska (15) 10.28 Second Amendment to Third Amended and Restated Credit Agreement entered into among GCI Communication Corp., NationsBank of Texas, N.A., Toronto Dominion (Texas), Inc., Credit Lyonnais New York Branch, and National Bank of Alaska (20) 10.29 Asset Purchase Agreement, dated April 15, 1996, among General Communication, Inc., ACNFI, ACNJI and ACNKSI (12) 10.30 Asset Purchase Agreement, dated May 10, 1996, among General Communication, Inc., and Alaska Cablevision, Inc. (12) 10.31 Asset Purchase Agreement, dated May 10, 1996, among General Communication, Inc., and McCaw/Rock Homer Cable System, J.V. (12) 10.32 Asset Purchase Agreement, dated May 10, 1996, between General Communication, Inc., and McCaw/Rock Seward Cable System, J.V. (12) 10.33 Amendment No. 1 to Securities Purchase and Sale Agreement, dated October 31, 1996, among General Communication, Inc., and the Prime Sellers Agent (13) 10.34 First Amendment to Asset Purchase Agreement, dated October 30, 1996, among General Communication, Inc., ACNFI, ACNJI and ACNKSI (13) 10.35 Amendment to Revised Qualified Employee Stock Purchase Plan of General Communication, Inc. (18) 10.36 Order Approving Arbitrated Interconnection Agreement as Resolved and Modified by Order U-96-89(8) dated January 14, 1997 (18) 10.37 Amendment to the MCI Carrier Agreement executed April 20, 1994 (18) 10.38 Amendment No. 1 to MCI Carrier Agreement executed July 26, 1994 (16) 10.39 MCI Carrier Addendum--MCI 800 DAL Service effective February 1, 1994 (16) 10.40 Third Amendment to MCI Carrier Agreement dated as of October 1, 1994 (16) 10.41 Fourth Amendment to MCI Carrier Agreement dated as of September 25, 1995 (16) 101 Exhibit No. Description ------------------------------------------------------------------------------------------------------------ 10.42 Fifth Amendment to the MCI Carrier Agreement executed April 19, 1996 (18) 10.43 Sixth Amendment to MCI Carrier Agreement dated as of March 1, 1996 (16) 10.44 Seventh Amendment to MCI Carrier Agreement dated November 27, 1996 (20) 10.45 First Amendment to Contract for Alaska Access Services between General Communication, Inc. and MCI Telecommunications Corporation dated April 1, 1996 (20) 10.46 Service Mark License Agreement between MCI Communications Corporation and General Communication, Inc. dated April 13, 1994 (19) 10.47 Radio Station Authorization (Personal Communications Service License), Issue Date June 23, 1995 (19) 10.48 Framework Agreement between National Bank of Alaska (NBA) and General Communication, Inc. dated October 31, 1995 (17) 10.49 1997 Call-Off Contract between National Bank of Alaska (NBA) and General Communication, Inc. (GCI) dated November 1, 1996 (20) 10.50 Contract No. 92MR067A Telecommunications Services between BP Exploration (Alaska), Inc. and GCI Network Systems dated April 1, 1992 (20) 10.51 Amendment No. 03 to BP Exploration (Alaska) Inc. Contract No. 92MRO67A effective August 1, 1996 (20) 10.52 Lease Agreement dated September 30, 1991 between RDB Company and General Communication, Inc. (3) 10.53 Certificate of Public Convenience and Necessity No. 436 for Telecommunications Service (Relay Services) (19) 10.54 Order Approving Transfer Upon Closing, Subject to Conditions, and Requiring Filings dated September 23, 1996 (19) 10.55 Order Granting Extension of Time and Clarifying Order dated October 21, 1996 (19) 10.56 Contract for Alaska Access Services among General Communication, Inc. and GCI Communication Corp., and Sprint Communications Company L.P. dated June 1, 1993 (20) 10.57 First Amendment to Contract for Alaska Access Services between General Communication, Inc. and Sprint Communications Company L.P. dated as of August 7, 1996 (20) 10.58 Employment and Deferred Compensation Agreement between General Communication, Inc. and John M. Lowber dated July 1992 (19) 10.59 Deferred Compensation Agreement between GCI Communication Corp. and Dana L. Tindall dated August 15, 1994 (19) 10.60 Transponder Lease Agreement between General Communication Incorporated and Hughes Communications Satellite Services, Inc., executed August 8, 1989 (9) 10.61 Addendum to Galaxy X Transponder Purchase Agreement between GCI Communication Corp. and Hughes Communications Galaxy, Inc. dated August 24, 1995 (19) 10.62 Order Approving Application, Subject to Conditions; Requiring Filing; and Approving Proposed Tariff on an Inception Basis, dated February 4, 1997 (19) 10.63 Resale Solutions Switched Services Agreement between Sprint Communications Company L.P. and GCI Communications, Inc. dated May 31, 1996 (20) 10.64 Commitment Letter from Credit Lyonnais New York Branch, NationsBank of Texas, N.A. and TD Securities (USA) Inc. for Fiber Facility dated as of July 3, 1997 (19) 10.65 Commitment Letter from NationsBank for Credit Facility dated July 2, 1997 (19) 10.66 Supply Contract Between Submarine Systems International Ltd. And GCI Communication Corp. dated as of July 11, 1997. (23) 102 Exhibit No. Description ------------------------------------------------------------------------------------------------------------ 10.67 Supply Contract Between Tyco Submarine Systems Ltd. And Alaska United Fiber System Partnership Contract Variation No. 1 dated as of December 1, 1997. (23) 10.68 $200,000,000 Amended and Restated Credit Agreement between GCI Holdings, Inc. and NationsBank of Texas, N.A., as administrative agent, Credit Lyonnais New York Branch, as documentation agent, and TD Securities (USA), Inc. as syndication agent, dated as of November 14, 1997. (23) 10.69 $50,000,000 Amended and Restated Credit Agreement between GCI Holdings, Inc. and NationsBank of Texas, N.A., as administrative agent, Credit Lyonnais New York Branch, as documentation agent, and TD Securities (USA), Inc. as syndication agent, dated as of November 14, 1997. (23) 10.70 Credit and Security Agreement Dated as of January 27, 1998 among Alaska United Fiber System Partnership as Borrower and The Lenders Referred to Herein and Credit Lyonnais New York Branch as Administrative Agent and Nationsbank of Texas, N.A. as Syndication Agent and TD Securities (USA) , Inc. as Documentation Agent. (24) 10.71 Third Amendment to Contract for Alaska Access Services between General Communication, Inc. and MCI Telecommunications Corporation dated February 27, 1998 * See note 21.1 Subsidiaries of the Registrant (23) 23.1 Consent of KPMG LLP (Accountant for Company) * 27.1 Financial Data Schedule * 99 Additional Exhibits: 99.1 The Articles of Incorporation of GCI Communication Corp. (2) 99.2 The By-laws of GCI Communication Corp. (2) 99.3 The Articles of Incorporation of GCI Communication Services, Inc. (4) 99.4 The By-laws of GCI Communication Services, Inc. (4) 99.5 The Articles of Incorporation of GCI Leasing Co., Inc. (4) 99.6 The By-laws of GCI Leasing Co., Inc. (4) 99.7 The By-laws of GCI Cable, Inc. (14) 99.8 The Articles of Incorporation of GCI Cable, Inc. (14) 99.9 The By-laws of GCI Cable / Fairbanks, Inc. (14) 99.10 The Articles of Incorporation of GCI Cable / Fairbanks, Inc. (14) 99.11 The By-laws of GCI Cable / Juneau, Inc. (14) 99.12 The Articles of Incorporation of GCI Cable / Juneau, Inc. (14) 99.13 The By-laws of GCI Cable Holdings, Inc. (14) 99.14 The Articles of Incorporation of GCI Cable Holdings, Inc. (14) 99.15 The By-laws of GCI Holdings, Inc. (19) 99.16 The Articles of Incorporation of GCI Holdings, Inc. (19) 99.17 The Articles of Incorporation of GCI, Inc. (18) 99.18 The Bylaws of GCI, Inc. (18) 99.19 The By-laws of GCI Transport, Inc. (23) 99.20 The Articles of Incorporation of GCI Transport, Inc. (23) 99.21 The By-laws of Fiber Hold Co., Inc. (23) 99.22 The Articles of Incorporation of Fiber Hold Co., Inc. (23) 99.23 The By-laws of GCI Fiber Co., Inc. (23) 99.24 The Articles of Incorporation of GCI Fiber Co., Inc. (23) 99.25 The By-laws of GCI Satellite Co., Inc. (23) 99.26 The Articles of Incorporation of GCI Satellite Co., Inc. (23) 103 Exhibit No. Description ------------------------------------------------------------------------------------------------------------ 99.27 The Partnership Agreement of Alaska United Fiber System (23) ------------------------- * Filed herewith. Note Certain information has been redacted from Exhibit 10.71 which the Company desires to keep undisclosed and a copy of the unredacted document has been filed separately with the Securities and Exchange Commission. 1 Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1994 2 Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990 3 Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 4 Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 5 Incorporated by reference to the Company's Registration Statement on Form 10 (File No. 0-15279), mailed to the Securities and Exchange Commission on December 30, 1986 6 Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989. 7 Incorporated by reference to the Company's Current Report on Form 8-K dated January 13, 1993. 8 Incorporated by reference to the Company's Current Report on Form 8-K dated June 4, 1993. 9 Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993. 10 Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1994. 11 Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 12 Incorporated by reference to the Company's Form S-4 Registration Statement dated October 4, 1996. 13 Incorporated by reference to the Company's Current Report on Form 8-K dated November 13, 1996. 14 Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1996. 15 Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1997. 16 Incorporated by reference to the Company's Current Report on Form 8-K dated March 14, 1996, filed March 28, 1996. 17 Incorporated by reference to the Company's Amendment to Annual Report dated December 31, 1995 on Form 10-K/A as amended on August 6, 1996. 18 Incorporated herein by reference to the Company's Form S-3 Registration Statement (File No. 333-28001) dated May 29, 1997. 19 Incorporated herein by reference to the Company's Amendment No. 1 to Form S-3/A Registration Statement (File No. 333-28001) dated July 8, 1997. 20 Incorporated herein by reference to the Company's Amendment No. 2 to Form S-3/A Registration Statement (File No. 333-28001) dated July 21, 1997. 104 21 Incorporated herein by reference to the Company's Amendment No. 3 to Form S-3/A Registration Statement (File No. 333-28001) dated July 22, 1997. 22 Incorporated herein by reference to the Company's Form S-8 POS Registration Statement (File No. 33-60222) dated February 20, 1998. 23 Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 24 Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1998.(c) Reports on Form 8-K None. 105 INDEPENDENT AUDITORS' REPORT ----------------------------The Board of Directors and StockholdersGeneral Communication, Inc.:Under date of March 26, 1999, we reported on the consolidated balance sheets ofGeneral Communication, Inc. and Subsidiaries ("Company") as of December 31, 1998and 1997 and the related consolidated statements of operations, stockholders'equity and cash flows for each of the years in the three-year period endedDecember 31, 1998, which are included in the Company's 1998 Annual Report onForm 10-K. In connection with our audits of the aforementioned consolidatedfinancial statements, we also audited the related consolidated financialstatement schedule in the consolidated financial statements, which is listed inthe index in Item 14(a)(2) of the Company's 1998 Annual Report on Form 10-K.This consolidated financial statement schedule is the responsibility of theCompany's management. Our responsibility is to express an opinion on thisconsolidated financial statement schedule based on our audits.In our opinion this consolidated financial statement schedule, when consideredin relation to the basic consolidated financial statements taken as a whole,presents fairly, in all material respects the information set forth therein. /s/ KPMG LLPAnchorage, AlaskaMarch 26, 1999 106 Schedule VIII ------------- GENERAL COMMUNICATION, INC. AND SUBSIDIARIES Valuation and Qualifying Accounts Years ended December 31, 1998, 1997 and 1996 Additions Deductions -------------------- ---------- Balance at Charged Write-offs Balance beginning to profit net of at end Description of year and loss Other recoveries of year- ----------------------------------------------- ---------- --------- ----- ---------- ------- (Amounts in thousands) Year ended December 31, 1998: Allowance for doubtful receivables $1,070 2,795 --- 2,978 887 ===== ====== ===== ====== ======Year ended December 31, 1997: Allowance for doubtful receivables $ 597 3,025 --- 2,552 1,070 ===== ====== ===== ====== =======Year ended December 31, 1996: Allowance for doubtful receivables $ 295 1,736 354 (1) 1,788 597 ===== ===== ===== ====== =====(1) Allowance for doubtful receivables acquired pursuant to the Cable Companyacquisitions described in Note 2 to the Company's consolidated financialstatements. 107SIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized. GENERAL COMMUNICATION, INC. By: /s/ Ronald A. Duncan Ronald A. Duncan, President (Chief Executive Officer)Date: March 24, 1999Pursuant to the requirements of the Securities Exchange Act of 1934, this reporthas been signed below by the following persons on behalf of the registrant andin the capacities and on the date indicated. Signature Title Date- -------------------------------------- ------------------------------------------ ------------------- /s/ Carter F. Page Chairman of Board and Director March 19, 1999- -------------------------------------- -------------------Carter F. Page/s/ Robert M. Walp Vice Chairman of Board and Director March 24, 1999- -------------------------------------- -------------------Robert M. Walp/s/ Ronald A. Duncan President and Director March 24, 1999- -------------------------------------- (Principal Executive Officer) -------------------Ronald A. Duncan /s/ Ronald R. Beaumont Director March 19, 1999- -------------------------------------- -------------------Ronald R. Beaumont/s/ Donne F. Fisher Director March 24, 1999- -------------------------------------- -------------------Donne F. Fisher/s/ William P. Glasgow Director March 24, 1999- -------------------------------------- -------------------William P. Glasgow/s/ Stephen R. Mooney Director March 18, 1999- -------------------------------------- -------------------Stephen R. Mooney/s/ Larry E. Romrell Director March 24, 1999- -------------------------------------- -------------------Larry E. Romrell (Continued) 108SIGNATURES(Continued) Signature Title Date- -------------------------------------- ------------------------------------------ -------------------/s/ James M. Schneider Director March 24, 1999- -------------------------------------- -------------------James M. Schneider/s/ John M. Lowber Senior Vice President, Chief Financial March 24, 1999- -------------------------------------- Officer, Secretary and Treasurer -------------------John M. Lowber (Principal Financial Officer) /s/ Alfred J. Walker Vice President, Chief Accounting March 24, 1999- -------------------------------------- Officer -------------------Alfred J. Walker (Principal Accounting Officer) 109 THIRD AMENDMENT TO CONTRACT FOR ALASKA ACCESS SERVICESThis Third AMENDMENT to the CONTRACT FOR ALASKA ACCESS SERVICES is made as ofthis 27th day of February, 1998, between GENERAL COMMUNICATIONS, INC. and itswholly owned subsidiary GCI COMMUNICATION CORP., an Alaska corporation (together"GCI") with offices located at 2550 Denali Street, Suite, 1000, Anchorage,Alaska 99503-2781, and MCI TELECOMMUNICATIONS CORPORATION ("MCI") with officeslocated at 1801 Pennsylvania Avenue, N.W., Washington, DC 20006.WHEREAS, GCI and MCI entered into a contract for ALASKA ACCESS SERVICES,effective as of January 1, 1993 andWHEREAS, GCI and MCI desire to amend the Contract,NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiencyof which are hereby acknowledged, GCI and MCI agree as follows:1. Paragraph 2. B. (2) of the contract shall be deleted and the following inserted in its place: (2) ******** (except for ********) shall be charged at the following rates per minute in the appropriate periods: Date Rate in Dollars ---- --------------- March 1, 1998 ******** January 1, 1999 ******** January 1, 2000 & thereafter ********There shall be no time of day discount. ******** shall pay the ******** accessand Alascom interchange charges for ********.Any query charges associated with the routing of ******** will be passed on to********.[CERTAIN INFORMATION HAS BEEN REDACTED FROM THIS DOCUMENT WHICH THE COMPANYDESIRES TO KEEP UNDISCLOSED AND A COPY OF THE UNREDACTED DOCUMENT HAS BEEN FILEDDEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.]2. All other terms and conditions of the Contract remain unchanged by thisAmendment and are in full force and effect.3. This Amendment will be effective on March 1, 19984. This Amendment together with the Contract is the complete agreement of theparties and supersedes all other prior contracts and representations concerningits subject matter. Any further amendments must be in writing and signed by bothparties.IN WITNESS WHEREOF, the parties hereto each acting with proper authority haveexecuted this Amendment on the date indicated below.MCI COMMUNICATIONS COMPANYBy: /s/ Printed Name: Donald T. LynchTitle: Senior Vice PresidentGCI COMMUNICATION CORPORATIONBy: /s/Printed Name: Richard WestlundTitle: V.P. Carrier RelationsEXHIBIT 23.1.1The Board of DirectorsGeneral Communication, Inc.:We consent to incorporation by reference in the registration statements (No.33-60728 and No. 33 60222) on Forms S-8 of General Communication, Inc. of ourreport dated March 26, 1999, except for notes 6 and 12, which are dated as ofApril 13, 1999, relating to the consolidated balance sheets of GeneralCommunication, Inc. and subsidiaries as of December 31, 1998 and 1997, and therelated consolidated statements of operations, stockholders' equity and cashflows for each of the years in the three-year period ended December 31, 1998,and the related schedule, which report appears in the December 31, 1998, annualreport on Form 10-K of General Communication, Inc. /s/ KPMG LLPAnchorage, AlaskaApril 13, 1999

5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1998 AND THE CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000808461 GENERAL COMMUNICATION, INC. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 12,008 0 43,564 887 1,878 61,292 402,444 82,972 646,116 52,984 351,533 0 0 179,505 20,502 646,116 0 246,795 0 116,073 119,083 2,795 20,679 (10,920) (4,123) (6,797) 0 0 0 (6,797) (0.14) (0.14)

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General Communication Inc. Annual Report 1998

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General Communication Inc.
Annual Report 1998