Item 1. Business
About Alaska Communications
We provide leading integrated communications services in and out of Alaska. Our wireline and wireless communications networks extend throughout Alaska and connect to the contiguous states via our two diverse undersea fiber optic cable systems: (i) the AKORN system that we launched in April 2009 and (ii) the Northstar system that was acquired as part of the acquisition of Crest Communications Corporation (“Crest”) in 2008.
Our wireline business comprises one of the most expansive networks in Alaska and forms the foundation of our enterprise business. Our wireless business includes a statewide third generation (“3G”) wireless network. Both segments rely on our highly skilled workforce of approximately 840 employees.
Alaska Communications was incorporated in 1998 under the laws of the State of Delaware. We began doing business as ACS in May, 1999, following our acquisition of the Anchorage Telephone Utility and CenturyTel’s Alaska assets. The Company was rebranded as “Alaska Communications” in September of 2010.
Our principal executive offices are located at 600 Telephone Avenue, Anchorage, Alaska 99503. Our telephone number is (907) 297-3000.
Business Segments
We have two reportable business segments, wireline and wireless. See “Note 18 - Business Segments”, in the Notes to Consolidated Financial Statements for an illustrative view of selected financial information for 2010, 2009 and 2008.
Wireline
Our wireline segment comprises four lines of business: Enterprise, Retail, Wholesale and Access. We provide communications services including voice, data, broadband, multi-protocol label switching (“MPLS”), Metro Ethernet, network access, long distance, data hosting, video conferencing, and other services to consumers, carriers, businesses, enterprise and government customers throughout Alaska and to and from Alaska.
Enterprise
Our enterprise line of business integrates our data, data hosting, and information technology services delivered over our wireline networks to business customers, multi-national corporations, municipal, state and federal governments, and other telecommunications carriers. It relies heavily on our ability to provide redundant, scalable and managed high bandwidth data connections throughout Alaska and to the contiguous states and beyond. We seek to provide these customers comprehensive, value-added services that make communications more secure, reliable and efficient.
In 2010, we completed our purchase of a 49% equity interest in TekMate and closed several enterprise contracts delivering services beyond connectivity: these contracts provide for video conferencing, hosting and managed services, and are, in many cases, delivered with our partner TekMate. We anticipate that our focus will increasingly be applied to a larger addressable market and with the ACS solution set of Connect / Host / Managesm.
In addition to the traditional corporate and government opportunities, our enterprise customers and future growth focus include rural education and rural healthcare, fleet management, user friendly connectivity solutions, outsourcing, and managed services both inside Alaska and outside of it.
Retail
Our retail services include traditional voice, broadband data, internet access, long distance and other communications products and services. Our retail line of business provides communications and information services to residential customers, businesses and various governmental entities.
Wholesale
Our wholesale line of business serves competitive local exchange carriers by offering, for resale, our local exchange network, including unbundled network elements.
Access
Our access line of business provides voice and data termination services through our local telephone facilities. Our network access customers include long distance and other competing carriers that use our local exchange facilities to provide voice telephone service to their customers.
Network and Technology
We serve approximately 172,000 access lines in Alaska. We continue to upgrade our network in order to provide more customers with broadband capabilities. Our fiber network, which is extensive within Alaska’s urban areas and connects the primary areas of Anchorage, Fairbanks and Juneau with each other and the contiguous states, offers us the opportunity to provide our customers with improved network reliability and speed for voice and data applications. We provide voice, data, and Internet service to all of the major population centers in Alaska. Our high-speed data network relies on advanced packet-based MPLS technology. We own and operate the most expansive IP networks in Alaska using MPLS and Metro Ethernet technology. Our MPLS network provides the long-haul framework for our “Metro Ethernet” service, which we market to businesses and government customers. Metro Ethernet offers our customers scalable, high-speed data and customized information technology products and services, as well as Internet connectivity.
We also own and operate extensive high-speed fiber optic cable systems throughout Alaska and undersea fiber optic cables that connect Alaska with the contiguous states.
Our network in Oregon and Washington includes terrestrial transport components linking Nedonna Beach, Oregon to a Network Operations Control Center (“NOCC”) in Hillsboro, Oregon and collocation facilities in Portland, Oregon and Seattle, Washington. In addition, AKORN, our state-of-the-art undersea fiber optic cable system connects our Alaskan network from Homer, Alaska to our facilities in Florence, Oregon along a diverse path within Alaska, the Pacific Northwest and undersea in the Pacific Ocean. Northstar, our other undersea fiber optic systems, comprises approximately 1,900 miles with cable landing facilities in Anchorage, Nikiski, Homer, Whittier, Juneau, and Valdez, Alaska, and Florence and Nedonna Beach, Oregon. Together, these fiber optic cables provide extensive bandwidth as well as collapsible ring protection designed to serve our most demanding customers’ critical communications requirements. Through our landing stations in Oregon, we also provide an at-the-ready landing point for other large fiber optic cables, and their operators, connecting the U.S. to networks in Asia and other parts of the world. We currently manage landing facilities for approximately one third of all transpacific cables in the United States.
Competition
We face strong competition in our wireline business segment. Competitors include General Communications, Inc. (“GCI”), AT&T, Matanuska Telephone Association, Inc. (“MTA”), and, increasingly, various wireless and broadband service providers. Factors contributing to the industry’s increasingly competitive market include regulatory changes, product substitution, technological advances, excess network capacity and the entrance of new competitors. In this environment, competition is based on price and pricing plans, the types of services
offered, the combination of services into bundled offerings, customer service, the quality and reliability of services provided, and the development of new products and services. For more information associated with the risks of our competitive environment, see “Item 1A
Item 1A. Risk Factors
We face a variety of risks that may affect our business, financial condition and results of operations, some of which are beyond our control. The risks described below are not the only ones we face and should be considered in addition to the other cautionary statements and risks described elsewhere and the other information contained in this report and in our other filings with the SEC, including our subsequent reports on Forms 10-Q and 8-K. Additional risks and uncertainties not known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs, our business, financial condition and results of operations could be seriously harmed.
Risks Relating to Our Industry
The telecommunications industry in Alaska is extremely competitive and will become even more competitive if and when Verizon enters the market.
The telecommunications industry in Alaska is extremely competitive and will become even more competitive if and when Verizon enters the market. We face increasing competition for a small number of customers from national wireless carriers that have entered or will enter our market. New market entrants will make it more difficult for us to attract and retain customers. We may also lose roaming revenues from carriers that enter the Alaskan market.
Wireless Competition
We face strong competition from wireless competitors including AT&T and GCI. Our principal wireless competitor, AT&T, is one of the largest wireless service providers in the U.S. AT&T also has more Alaskan customers than we do and we believe that they serve more than 50% of the wireless customers in Alaska. In addition, Verizon Wireless has acquired the 700 MHz C-Block wireless spectrum license covering Alaska. Verizon currently holds no other spectrum in Alaska, and we expect it to use the acquired spectrum to deploy 4G services in Alaska, although we cannot predict when Verizon would choose to deploy the service in Alaska. We cannot predict whether Verizon will build its own facilities in Alaska or provide service through a local partner. If Verizon partners with a local provider that currently competes with us, both Verizon and such local competitor would gain strength in our market.
As large national carriers, both AT&T and Verizon have vastly greater access to financial, technical and other resources than we do. They have greater access to popular devices and greater market power to obtain these devices on more favorable terms than we do. AT&T and Verizon, thus, may be able to offer lower prices, additional products, services, features or other incentives that we cannot match. Larger competitors, such as AT&T and Verizon may also be in a position to respond more quickly to new technologies and be able to undertake more extensive marketing campaigns. Moreover, AT&T and Verizon operate their own nationwide network, whereas we rely on roaming agreements with other carriers to provide coverage outside Alaska, and conversely, provide revenue to us for our coverage in Alaska. Our reliance on these agreements could adversely affect our ability to maintain competitive pricing or roaming revenues, which would have a material adverse effect on our financial results.
Wireline Competition
Our principal wireline competitor, GCI, is the dominant cable television provider in Alaska. In consumer markets, GCI attempts to use its dominant cable television position by bundling its cable services with competitive telephony services, which are often based on leases of our facilities. We do not offer television service, and thus, are unable to offer competing bundles. In addition, GCI has aggressively deployed cable telephony in order to move its telephone customers off of our network and onto its own cable system. Significant, continued migration of customers would result in a significant reduction of revenue for us. In addition, GCI holds a dominant position in the current long-haul voice and data markets, where it owns and operates two of the four existing undersea fiber optic cables connecting Alaska to the contiguous states and has a number of significant contracts with large carrier customers. GCI competes very aggressively on price in this market to defend its market share. In addition, AT&T has acquired a substantial amount of interstate and intrastate fiber optic capacity from GCI, which may allow it to offer additional competing service from its national platform.
These strong competitive pressures in both our wireless and wireline business segments could have a material adverse effect on our business, operating results, margins and financial condition.
Device Access
Exclusive Arrangements between wireless device manufacturers and large wireless carriers hamper our ability to procure and sell many popular wireless handsets and other devices.
Our wireless business competes against national and well-funded wireless service providers, most notably, AT&T and in the future, potentially, Verizon. As a smaller carrier, we do not have access to many wireless products and services that AT&T and Verizon can offer. We are precluded from obtaining new wireless devices subject to exclusive agreements with large wireless carriers, such as the iPhone®, which only AT&T and Verizon can offer. Other than AT&T and potentially, Verizon, no other national wireless provider has a presence in our market. Even so, exclusive arrangements for new devices, into which other national carriers enter, make them unavailable to us. Because devices subject to exclusivity agreements may be those most sought after by customers, our inability to sell those devices may harm our ability to stay competitive. Because wireless subscribers are permitted to retain their wireless phone numbers when changing to another wireless carrier within the same geographic area, customers may change carriers simply to obtain a device that we do not offer. Our limited ability to procure certain devices could increase wireless customer churn and may also limit our flexibility to price our services for quality of customer experience, which could have a material adverse effect on our revenue, results of operations and cash flows.
If we do not adapt to rapid technological advancements and changes in telecommunications standards, our ability to compete would be strained, and as a result, we would lose customers.
Our success will likely depend on our ability to adapt to rapid technological changes in the telecommunications industry. Our failure to adopt a new technology or our choice of one technology over another may have an adverse effect on our ability to compete or meet the demands of our customers. Technological changes could, among other things, reduce the barriers to entry facing our competitors providing local service in our service areas. The pace of technology change and our ability to deploy new technologies may be constrained by insufficient capital and/or the need to generate sufficient cash to make interest payments on our debt and to maintain our dividend policy.
New products and services may arise out of technological developments and our inability to keep pace with these developments may reduce the attractiveness of our services. Some of our competitors may have greater resources to respond to changing technology than we do. If we fail to adapt successfully to technological
changes or fail to obtain access to new technologies, we could lose customers and be unable to attract new customers and/or sell new services to our existing customers. We may be unable to successfully deliver new products and services, and we may not generate anticipated revenues from such products or services.
Risks Relating to Our Debt
Substantial Debt
Our substantial debt could adversely affect our financial health, financing options and liquidity position.
We have a substantial amount of debt. As of December 31, 2010, and for the year then ended, we had total debt of $553.3 million and a loss before income tax expense of $0.8 million. Our debt could have important consequences for you as a holder of our common stock. For example, our substantial debt and the related loan covenants could:
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require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, future business opportunities, our dividend and other general corporate purposes;
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limit our flexibility to plan, adjust or react to changing economic, market or industry conditions, reduce our ability to withstand competitive pressures and increase our vulnerability to general adverse economic and industry conditions;
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place us at a competitive disadvantage to many of our competitors who are less leveraged than we are;
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limit our ability to borrow additional amounts for working capital, capital expenditures, future business opportunities, including strategic acquisitions and other general corporate requirements or hinder us from obtaining such financing on terms favorable to us or at all; or
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limit our ability to refinance our debt.
The terms of our senior credit facility and the terms of our other debt allows us and our subsidiaries to incur additional debt upon the satisfaction of certain conditions. If new debt is added, the related risks described above would intensify.
Our substantial debt exposes us to adverse changes in interest rates. In the past we have entered into floating-to-fixed interest rate swaps to hedge our exposure to interest rate changes. With the refinancing of our senior debt on October 21, 2010, we terminated the related swaps and entered into replacement swaps that will fix the interest rates on $385.0 million of notional term loan value at 6.47% for the period June 30, 2012 through September 30, 2015. Until that time, while we have partially limited our exposure to interest rate risk by acquiring an interest rate cap that limits the London Interbank Offered Rate (“LIBOR”) to 3.0%, we will be directly exposed to increases in our interest expense any time LIBOR exceeds 1.5% up to a cap of 3.0%. We are also subject to credit risk related to our counterparties on the swaps and the interest rate cap and to interest rate fluctuations on interest generated by our debt in excess of the notional term loans referenced above. For more specific information related to our exposure to changes in interest rates and our use of floating-to-fixed interest rate swaps, please see “Item 7A - Quantitative and Qualitative Disclosures About Market Risk.”
Debt-Related Financial Covenants
Financial covenants in our debt instruments limit our operating flexibility.
Our senior credit facility requires us to maintain certain financial ratios and adhere to other covenants that, among other things, restrict our ability to take specific actions, even if we believe such actions are in our best interest. These include restrictions on our ability to:
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pay dividends or distributions on, redeem or repurchase our capital stock;
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issue certain preferred or redeemable capital stock;
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incur additional debt;
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create liens;
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make certain types of investments, loans, advances or other forms of payments;
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issue, sell or allow distributions on capital stock of specified subsidiaries;
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prepay or defease specified debt;
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enter into transactions with affiliates; or
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merge, consolidate or sell our assets.
Our ability to meet the financial ratios is dependent, among other factors, on our achieving targeted results of operations. We may not be able to achieve these targets for a variety of reasons, some of which are beyond our control, including the potential negative impact on our operations that could occur if, and when, Verizon enters the Alaska market. For example, based on our current total leverage, if competition from Verizon and the related loss of roaming revenue (or any other factor or combination of factors) caused the Company’s Adjusted EBITDA, as defined in our senior credit facility, to drop below approximately $107.6 million for any four consecutive quarters, the Company would be required to suspend its dividend. If Adjusted EBITDA dropped below $102.5 million for any four consecutive quarters then the company could be in default (for comparison, Adjusted EBITDA was $126.3 million in 2010). Upon the occurrence of an event of default under our senior credit facility, the lenders could elect to declare all amounts outstanding under our senior credit facility to be immediately due and payable. Such a default or acceleration may allow our other creditors to accelerate our other debt. If the lenders accelerate the payment of the debt under our senior credit facility, our assets may not be sufficient to repay our debts.
Debt Service Requirements
We require a significant amount of cash to service our debt, pay dividends, fund our growth projects and meet other liquidity needs.
Our ability to make payments on and to refinance our debt, including amounts borrowed under our senior credit facility and our 5.75% Convertible Notes due 2013, to pay dividends, and to fund planned capital expenditures, including any strategic acquisitions we may make, if any, will depend on our ability to generate cash in the future. We cannot assure you that our business will generate sufficient cash flow from operations such that our currently anticipated growth in revenues and cash flow will be realized on schedule or that future borrowings will be available to us in an amount sufficient to enable the repayment of our debt, pay dividends or to fund our other liquidity needs.
We may need to refinance all or a portion of our debt, including the convertible notes, on or before maturity. Our 2010 senior credit facility requires $100.0 million of our currently outstanding convertible notes to be repaid or refinanced by December 19, 2012, to prevent a default event. We may not be able to refinance any of our debt on commercially reasonable terms or at all. If we are unable to refinance our debt or obtain new financing under these circumstances, we would have to consider other options, including:
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sales of certain assets to meet our debt service requirements;
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reduce cash available for dividends;
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sales of equity; and
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negotiations with our lenders to restructure the applicable debt.
If we are forced to pursue any of the above options our business and the value of our common stock could be adversely affected.
Convertible Debt Related Risks
The call options we purchased and the warrants we sold contemporaneously with the sale of our convertible notes may affect the trading price of our common stock and the value of the convertible notes.
The counterparties to the call options we purchased and warrants we sold may engage in hedging activities and modify their hedge positions from time to time prior to the conversion or maturity of our senior convertible notes, particularly around the time of any conversion of the notes. These hedging activities may include purchasing and selling shares of our common stock, or other of our securities, or other instruments, including over-the-counter derivative instruments. The effect, if any, of these activities on the trading price of our common stock or the convertible notes, will depend in part on market conditions at the time and cannot be reasonably predicted at this time. Any of these activities could adversely affect the trading price of our common stock and the value of the convertible notes.
Risks related to our Business
AKORN and Northstar Fiber Profitability
We may not successfully operate our AKORN and Northstar fiber facilities that connect Alaska to the contiguous states profitably.
Realization of the anticipated benefits of our redundant interstate investments will depend on our ability to attract significant enterprise customers requiring robust data service capabilities. We will continue to be required to devote significant management attention and resources to sustaining and promoting operations and maintaining support. We will face challenges in our abilities to do the following:
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develop attractive products and services that operate seamlessly with our existing technology and infrastructure;
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maintain and upgrade timely the complex underlying hardware and software technology that drives optimal use of these facilities;
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attract a sufficient volume of traffic on these fiber facilities to make them profitable;
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offer products and services that use these fiber facilities that are attractive to our target customers;
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preserve key customer, supplier and other important relationships and resolve potential conflicts that may arise; and
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generate sufficient revenues to maintain increased indebtedness raised to complete these projects.
If we do not maintain or improve our current relationships with existing customers and develop new large volume and enterprise customers, we may not be able to realize our targets for sales and revenue growth. If we are unable to achieve our projected revenue growth and margins anticipated from the investment, we may be unable to profitably operate these facilities.
Long-Haul Fiber Competition
Increased supply of interstate and international long-haul fiber in Alaska could adversely impact prices for bandwidth, which could in turn, adversely affect our projected and actual sales, margins and profitability of our fiber facility.
Significant increases in fiber transport capacity in the United States have at times exerted downward pressure on prices, margins and profitability. The market for long-haul fiber in Alaska is characterized by high capital investment and relatively high fixed costs, coupled with a limited number of large customers. Some of our existing and potential competitors have greater name recognition and more established relationships with our target customers. Further, these competitors may have more experience with the repair and maintenance of the underlying data transport technology, and its associated costs, than we do. Our primary wireline competitor, GCI, has adopted a very aggressive pricing policy in the long-haul interstate voice and data markets. GCI has also sold a very large amount of capacity to AT&T, which allows them to serve their own needs and sell to others, effectively establishing a national competitor in this market. We cannot predict with any certainty what the prevailing market prices will be for interstate voice and data transport or when prices for these services will stabilize, if at all.
Access Lines
We provide services to many customers over access lines, and if we continue to lose access lines, our revenues, earnings and cash flow from operations may decrease.
Our business generates revenue by delivering voice and data services over access lines. We have experienced net access line loss consistently over the past few years. During the year ended December 31, 2010, the number of access lines we serve declined by 7.1%. We expect to experience net access line loss in our markets for an unforeseen period of time. Our inability to retain access lines would adversely affect our revenues, earnings and cash flow from operations.
Access Charges and USF Support
Revenues from network access charges may be reduced or lost.
We received approximately 17.6% of our operating revenues for the year ended December 31, 2010 from local exchange network access charges. The amount of revenue that we receive from these access charges is calculated in accordance with requirements set by the FCC and the RCA. Any change in these requirements may reduce our revenues and earnings. Access charges have consistently decreased in past years. We do not receive access revenue related to our competitors’ retail customers that are served by UNEs or by the competitors’ own facilities. To the extent that competitors move customers on to UNEs or off our network entirely, our access revenues will decrease. We do not receive access revenue from VoIP calls and growth of this service will reduce our access revenues.
The FCC has actively reviewed new mechanisms for inter-carrier compensation that, in some cases, could eliminate access charges entirely. Elimination of access charges would likely have a material adverse effect on our revenue and earnings. In any event, we believe that new mechanisms for inter-carrier compensation would more likely than not reduce this source of revenue. Similarly, the RCA has adopted regulations modifying intrastate access charges that may reduce our revenue.
In addition, we have periodically been involved in disputes about interstate access revenues. We cannot assure you that claims alleging excess charges will not be made in the future nor whether we would prevail against such claims.
We may not continue to receive as much USF support as we have in the past.
We receive USF (and equivalent state universal service support) revenues to support our wireline operations in high cost areas. The FCC has proposed new rules requiring competitive carriers to justify support based on some measure of their own costs or on a model and allowing certain ILEC ETCs that lose lines to increase their local switching support from the USF. The FCC also has proposed reforms that could affect the amount of funding for ILECs, including using “reverse auctions” to determine one or more recipients of high cost support in any geographic area based on the lowest bidder for that support and phasing out support for voice services and targeting support to broadband networks. Notably, on February 8, 2011, as part of a request for public comment, the FCC indicated support for the elimination of the “identical support” rule that permits competitive carriers, such as ACSW and our wireless competitors, to apply for funding based on the support received by the incumbent carrier. Should those changes be implemented, the extent of any transition period or any special treatment for carriers located in Alaska is uncertain. In addition, members of Congress have indicated that they may seek enactment of legislation addressing universal service reform, including legislation to limit growth of explicit universal service support funds. These and other proposed rule changes could reduce our support in the future. For more information on this and our regulatory environment, please see “Item 1 - Business-Regulation.”
Roaming Charges
We derive a significant portion of our wireless revenue from roaming charges. This revenue may fluctuate or decline in the future as a result of general economic, contractual and competitive factors.
Approximately 7.8% of our revenue for the year ended December 31, 2010 was derived from roaming charges incurred by other wireless providers whose customers traveled within our coverage areas. The revenue we recognize from these roaming charges may in the future be volatile or decline as a result of a number of factors, many of which are outside our control. These factors include the strength of the Alaskan economy and its primary industries, including tourism, general economic factors affecting commerce between Alaska and other States and countries, unresolved political matters which may affect public and private spending in Alaska and others. For example, our service areas include a number of summer tourist destinations in Alaska. As a result, in these areas, our roaming revenue generally increases during summer months and declines during other periods and depends heavily on the number of tourists who visit Alaskan tourist destinations. In addition, we cannot assure you our roaming agreements with other providers will continue to generate similar roaming revenues. Our agreements with other carriers have varying terms of varying length, including some which are terminable on short notice. In the event these roaming agreements expire or are terminated, we may be unable to renegotiate or replace these agreements on similar or acceptable terms. Failure to obtain acceptable roaming agreements could lead to a significant decline in our revenue and operating income. Lastly, changes in the network footprints of our roaming partners, or those of our competitors who are able to provide roaming coverage in our service areas, could have a material adverse effect on us. For example, if Verizon enters the Alaska market, we estimate we could potentially lose up to 90% of our roaming revenue and we may also lose roaming revenue from other partners if they moved their roaming relationship to Verizon or if we retained the relationship, but the presence of Verizon, coupled with our other competitors, pushed down market rates for roaming charges.
Economic Conditions
The successful operation and growth of our businesses depends heavily on economic conditions in Alaska.
The vast majority of our customers and operations are located in Alaska. Due to our geographical concentration, the successful operation and growth of our businesses depends on economic conditions in Alaska. The Alaskan economy, in turn, depends upon many factors, including:
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the strength of the natural resources industries, particularly oil production and prices;
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the strength of the Alaskan tourism industry;
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the level of government and military spending; and
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the continued growth of services industries.
The customer base for telecommunications services in Alaska is small and geographically concentrated. According to the Alaska Department of Labor and Workforce Development estimates, the population of Alaska is approximately 710,231 as of April 31, 2010, approximately 60% of whom live in Anchorage, Fairbanks and Juneau. Alaska’s economy is heavily dependent on investment by oil companies and state tax revenues correlate with the price of oil. During 2010, the price of crude oil continued to exhibit significant volatility. We do not know what the long-term effect on the Alaskan economy will be or if it will even be stable.
Pension and Deferred Compensation Plans
We may incur substantial and unexpected liabilities arising out of our pension and deferred compensation plans.
Our post-retirement benefits, pension, and deferred compensation plans could result in substantial liabilities on our balance sheet. These plans and activities have and will generate substantial cash requirements for us and these requirements may increase beyond our expectations in future years based on changing market conditions. The difference between plan obligations and assets, or the funded status of the plans, is a significant factor in determining the net periodic benefit costs of our pension plans and the ongoing funding requirements of those plans. Changes in interest rates, mortality rates, health care costs, early retirement rates, investment returns and the market value of plan assets can affect the funded status of our defined benefit pension, other post-retirement and post-employment benefit plans and cause volatility in the net periodic benefit cost and future funding requirements of the plans. In the future, we may be required to make additional contributions to our defined benefit plan. Plan liabilities may impair our liquidity, have an unfavorable impact on our ability to obtain financing and place us at a competitive disadvantage compared to some of our competitors who do not have such liabilities and cash requirements.
In addition, on behalf of substantially all of our employees, we participate in the Alaska Electrical Pension Fund (the “AEPF”). The AEPF is a multi-employer pension plan to which we make fixed, per employee contributions through our collective bargaining agreement with the IBEW, which covers our IBEW represented workforce, and a special agreement, which covers most of our non-represented workforce. Because our contribution requirements are fixed, we cannot easily adjust our annual plan contributions to address our own financial circumstances. Further, because we do not control the AEPF, we are not aware at all times whether the plan is fully funded. In general, if a funding shortfall in the AEPF exists, we incur a contingent withdrawal liability. Our contingent withdrawal liability is an amount based on our pro-rata share among AEPF participants of the value of the funding shortfall. This contingent liability becomes due and payable by us if we terminate our participation in the AEPF. Moreover, if another participant in the AEPF goes bankrupt, we would become liable for a pro-rata share of the bankrupt participant’s vested, but unpaid, liability for accrued benefits for that participant’s employees. This could result in a substantial unexpected contribution requirement and making such a contribution could have a material adverse effect on our cash position and other financial results. These sources of potential liability are difficult to predict.
Regulations
New governmental regulations may impose obligations on us to upgrade our existing technology or adopt new technology that may require additional capital and we may not be able to comply in a timely manner with these new regulations.
Our markets are heavily regulated. We cannot predict the extent the government will impose new unfunded mandates on us. Such mandates have included those related to emergency location, providing access to hearing-impaired customers, law enforcement assistance and local number portability. Each of these government mandates has imposed new requirements for capital that we could not have predicted with any precision. Along with these obligations, the FCC has imposed deadlines for compliance with these mandates. We may not be able to provide services that comply with these mandates in time to meet the imposed deadlines. Further, we cannot predict whether other mandates from the FCC or other regulatory authorities, will occur in the future or the demands they may place on our capital expenditures. For more information on our regulatory environment and the risks it presents to us, see “Item 1 - Business - Regulation”.
Labor
Labor costs and the terms of our principal collective bargaining agreement may hurt our ability to remain competitive, which could cause our financial performance to suffer.
Labor costs are a significant component of our expenses and approximately 74% of our workforce is represented by the IBEW. As a result of our collective bargaining agreement with the IBEW, we may experience pressure to increase wages and benefits for our employees. We believe our labor costs are higher than our competitors who employ a non-unionized workforce. In addition, we may make strategic and operational decisions that require the consent of the IBEW. The IBEW may not provide consent when we need it, or it may require additional wages, benefits or other consideration be paid in return for its consent.
Our primary in-state competitor, GCI, does not use union labor and pays lower compensation than we do. We cannot assure you that our labor costs will ever become competitive.
In addition, the IBEW has brought and may continue to bring grievances to binding arbitration. The IBEW may also bring court actions and may seek to compel us to engage in the bargaining processes where we believe we have no such obligation. If successful, there is a risk these judicial or arbitral avenues could create additional costs that we did not anticipate.
Key Members of Senior Management
We depend on key members of our senior management team.
Our success depends largely on the skills, experience and performance of key members of our senior management team as well as our ability to attract and retain other highly qualified management and technical personnel. There is intense competition for qualified personnel in our industry and we may not be able to attract and retain the personnel necessary for the development of our business. Our remote location also presents a challenge to us in attracting new talent. If we lose one or more of our key employees, our ability to successfully implement our business plan could be materially adversely affected. We do not maintain any “key person” insurance on any of our personnel.
Vendors
We rely on a limited number of key suppliers and vendors for timely supply of equipment and services for our network infrastructure and customer support services. If these suppliers or vendors experience problems or favor our competitors, we could fail to obtain the equipment and services we require to operate our business successfully.
We depend on a limited number of suppliers and vendors for equipment and services for our network and certain customer services. If suppliers of our equipment or providers of services on which we rely experience financial difficulties, service or billing interruptions, patent litigation or other problems, subscriber growth and our operating results could suffer.
Suppliers that use proprietary technology, including CDMA technology, as an integral component of our network, effectively lock us into one or few suppliers for key network components. Other suppliers require us to maintain exclusive relationships under a contract. As a result, we have become reliant upon a limited number of network equipment manufacturers and one wireless billing service provider. In the event it becomes necessary to seek alternative suppliers and vendors, we may be unable to obtain satisfactory replacement suppliers or vendors on economically attractive terms on a timely basis, or at all, which could increase costs and may cause disruption in service.
Network / E-911 Failure
A failure of our network could cause significant delays or interruptions of service, which could cause us to lose customers.
To be successful, we will need to continue to provide our customers reliable service over our network. Our network and infrastructure are constantly at risk of physical damage to access lines or other facilities as a result of human, natural or other factors. These factors may include pandemics, acts of terrorism, sabotage, natural disasters, power surges or outages, software defects, contractor or vendor failures, labor disputes and other disruptions that may be beyond our control. Should we experience a prolonged system failure or a significant service interruption, our customers may choose a different provider and our reputation may be damaged. Further, we may not have adequate insurance coverage, which would result in unexpected expense. Notably,
similar to other undersea fiber optic cable operators, we do not carry insurance that would cover the cost of repair of our undersea cables and, thus, we would bear the full cost of any necessary repairs.
A failure of enhanced emergency calling services associated with our network may harm our business.
We provide E-911 service to our customers where such service is available. We also contract from time to time with municipalities to upgrade their public safety answering points such that those facilitates become capable of receiving our transmission of a 911 caller’s location information and telephone number. If the emergency call center is unable to process such information, the caller is provided only basic 911 services. In these instances, the emergency caller may be required to verbally advise the operator of such caller’s location at the time of the call. Any inability of the answering point to automatically recognize the caller’s location or telephone number, whether or not it occurs as a result of our network operations, may cause us to incur liability or cause our reputation or financial results to suffer.
Wireless Devices
Wireless devices may pose health and safety risks and driving while using a wireless phone may be prohibited; as a result, demand for our services may decrease.
Media reports have suggested that, and studies have been undertaken to determine whether, certain radio frequency emissions from wireless handsets and cell sites may be linked to various health concerns, including cancer. Further, radio frequency emissions may interfere with various electronic medical devices, including hearing aids and pacemakers. If consumers’ health concerns over radio frequency emission increase, they may be discouraged from using wireless handsets. In addition, studies have indicated that using wireless devices while driving may impair a driver’s attention. Regulators may impose or increase restrictions on the location and operation of cell sites or increase regulation on the use of handsets, and wireless providers may be exposed to litigation. Our fleet management service allows for the remote starting of vehicles. In certain situations this could result in injuries or damages for which we may be exposed to litigation. New government regulations in any of these matters may adversely affect our results of operations.
Future Acquisitions
Future acquisitions could result in operating and financial difficulties.
Our future growth may depend, in part, on acquisitions. To the extent that we grow through acquisitions, we will face the operational and financial risks that commonly accompany that strategy. We would also face operational risks, such as failing to assimilate the operations and personnel of the acquired businesses, disrupting their ongoing businesses, increasing complexity of our business, impairing management resources and their relationships with employees and customers as a result of changes in their ownership and management. Further, the evaluation and negotiation of potential acquisitions, as well as the integration of an acquired business, may divert management time and other resources. Some acquisitions may not be successful and their performance may result in the impairment of their carrying value. Certain financial and operational risks related to acquisitions that may have a material impact on our business are:
•
Use of cash resources and incurrence of debt and contingent liabilities in funding acquisitions may limit other potential uses of our cash, including stock repurchases, dividend payments and retirement of outstanding indebtedness;
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Amortization expenses related to acquired intangible assets and other adverse accounting consequences;
•
Costs incurred in identifying and performing due diligence on potential acquisition targets that may or may not be successful;
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Difficulties and expenses in assimilating the operations, products, technology, privacy protection systems, information systems or personnel of the acquired company;
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Impairment of relationships with employees, suppliers and affiliates of our business and the acquired business;
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The assumption of known and unknown debt and liabilities of the acquired company;
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Failure to generate adequate returns on our acquisitions and investments;
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Entrance into markets in which we have no direct prior experience; and
•
Impairment of goodwill or other intangible assets arising from our acquisitions.
Risks related to the On-going IRS Audit
We are subject to a significant ongoing IRS audit, which could, in the event we prove unable to effectively enforce the indemnification obligations of third parties, require us to pay significant amounts.
As discussed in the section entitled “Legal Proceedings” in Item 3 of this Report, the Internal Revenue Service (the “Service”) issued a Notice of Proposed Adjustment (“NOPA”) on April 19, 2010 with respect to the 2006, 2007 and 2008 taxable years of Crest. In that notice, the Service asserts that advances made to entities which Crest acquired out of bankruptcy in 2002 should be characterized as debt for tax purposes. Crest had characterized the advances as equity for tax purposes. The Service asserts that debt characterization resulted in cancellation of indebtedness income. On November 2, 2010, the Service issued a revised Notice of Proposed Adjustment in which it continues to assert that the advances referenced above are debt for tax purposes and seeks to impose penalties in respect of the asserted income tax deficiencies. In addition, the revised notice asserts that the method employed by the same entities acquired by Crest to determine cost of goods sold related to the sales of indefeasible rights of use was unreasonable and that the entities inappropriately depreciated basis in “dark fiber”. Should the appeals process fail to overturn the proposed adjustments; should we be unable to preserve the corporate structure of the Crest subsidiaries; and should we prove unable to effectively enforce the indemnification provisions in the Stock Purchase Agreement (“SPA”), this could have a material effect on our consolidated financial position, results of operations and cash flows.
Risks related to our Common Stock
Dividends
You may not receive the level of dividends provided for in our dividend policy or any dividends at all.
We are not obligated to pay dividends. Our Board of Directors may decide not to pay dividends at any time and for any reason. We might not generate sufficient cash from operations in the future to pay dividends on our common stock in the intended amounts or at all. If our cash flows from operations for future periods were to fall below our minimum expectations, we would need either to reduce or eliminate dividends or, to the extent permitted under the terms of our senior credit facility or any future agreement governing our debt, fund a portion of our dividends with borrowings or from other sources. Future dividends, if any, will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions, business opportunities, any competitive or technological developments, our increased need to make capital expenditures, provisions of applicable law and other factors that our Board of Directors may deem relevant. For example, if Verizon enters our markets, the results of its presence could, over time, significantly reduce our cash available for dividends, both through reduction of our customer and roaming revenues and through the need for us to devote additional cash toward capital expenditures to attempt to remain competitive and/or pay down debt to maintain debt covenant compliance. Should we reduce or eliminate dividends, the market price of our common stock may decline.
Volatility
Continued volatility in the price of our common stock would negatively affect us and our stockholders.
The trading price of our common stock was volatile during 2010 in response to a number of factors, many of which are beyond our control, including actual or anticipated variations in quarterly financial results, actual or anticipated variations in our dividend policy, changes in financial expectations by securities analysts and announcements by our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments. In addition, our financial results or dividend payments may be below the expectations of securities analysts and investors. Broad market and industry factors have also negatively affected the price of our common stock regardless of our operating performance and we do not know how long these adverse market conditions will continue. Future volatility in our stock price could materially adversely affect the trading market and prices for our common stock as well as our ability to issue additional securities or to secure additional financing.
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
Our principal properties do not lend themselves to simple description by character and location. The components of our gross investment in property, plant and equipment consisted of the following as of December 31, 2010 and 2009:
Our property, plant and equipment are used in each of our wireline and wireless business segments and we allocate assets to our segments.
Land, buildings and support assets consist of land, land improvements, cellular towers, central office and certain administrative office buildings as well as general purpose computers, office equipment, vehicles and other general support equipment. Central office switching and transmission and wireless switching and transmission consist primarily of switches, routers and transmission electronics for our regulated and wireless entities, respectively. Outside plant and cable and wire facilities include primarily conduit and cable. We own substantially all of our telecommunications equipment required for our business. However, we lease certain facilities and equipment under various capital and operating lease arrangements when the leasing arrangements are more favorable to us than purchasing the assets.
We own and lease office facilities and related equipment for executive headquarters, administrative personnel, central office buildings and operations in locations throughout Alaska and Oregon. Our principal executive and administrative offices are located in Anchorage, Alaska. We believe we have appropriate easements, rights-of-way and other arrangements for the accommodation of our pole lines, underground conduits, aerial, underground and undersea cables and wires and wireless towers and antennas. However, these properties do not lend themselves to simple description by character and location.
In addition to land and structures, our property consists of equipment necessary for the provision of communication services. This includes central office equipment, customer premises equipment and connections, radio and wireless antennas, towers, pole lines, video head-end, remote terminals, aerial, underground and undersea cable and wire facilities, vehicles, furniture and fixtures, computers and other equipment. We also own certain other communications equipment held as inventory for sale or lease. Substantially all of our communications equipment and other network equipment is located in buildings that we own or on land within our local service or wireless coverage area.
We have insurance to cover losses incurred in the ordinary course of business, including excess general liability, property coverage including business interruption, director and officers and excess employment practices liability, excess auto, crime, fiduciary and non-owned aircraft insurance in amounts typical of similar operators in our industry and with reputable insurance providers. Central office equipment, buildings, furniture and fixtures and certain operating and other equipment are insured under a blanket property insurance program. This program provides substantial limits of coverage against “all risks” of loss including fire, windstorm, flood, earthquake and other perils not specifically excluded by the terms of the policies. As is typical in the communications industry, we are self-insured for damage or loss to certain of our transmission facilities, including our buried, undersea and above ground transmission lines. We self-insure with respect to employee health insurance and workers’ compensation, primary general liability, primary auto liability and primary employment practices liability subject to stop-loss insurance with insurance carriers that caps our liability at specified limits. We believe our insurance coverage is adequate; however, if we become subject to substantial uninsured liabilities due to damage or loss to such facilities, our financial position, results of operations or liquidity may be adversely affected.
Substantially all of our assets (including those of our subsidiaries) have been pledged as collateral for our senior credit facility.
Item 3.
Item 3. Legal Proceedings
We are involved in various claims, legal actions and regulatory proceedings arising in the ordinary course of business, including various legal proceedings involving regulatory matters described under “Item 1 - Business-Regulation”. We have recorded litigation reserves of $1.0 million as of December 31, 2010 against certain current claims and legal actions. We believe that the disposition of these matters will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
On April 19, 2010, the Service issued a Notice of Proposed Adjustment with respect to the 2006, 2007 and 2008 taxable years of Crest, which we acquired on October 30, 2008. Crest had acquired certain entities out of bankruptcy in 2002. The original majority stockholder of these entities, an Australian insurance company, AMP, had made certain advances to the entities. These entities entered into bankruptcy in 2001 and the bankruptcy court approved a plan which effectively subordinated these advances to all other creditors. Upon acquiring the entities in 2002, Crest characterized the advances as equity for tax purposes. The Service asserted that characterization of the AMP advances as equity was incorrect and that Crest had additional income due to the cancellation of debt.
On November 2, 2010, the Service issued revised Notices of Proposed Adjustments (“Revised NOPAs”) in which it continues to assert that the advances referenced above are debt for tax purposes and seeks to impose penalties in respect of the asserted income tax deficiencies. In addition, the Revised NOPAs assert that the method employed by the same entities acquired by Crest to determine cost of goods sold related to the sales of indefeasible rights of use (“IRUs”) was unreasonable as well as the entities inappropriately depreciated tax basis in unlit fiber pairs. The cancellation of indebtedness income at the amounts set out in the Revised NOPAs, including issues surrounding IRU sales and the depreciation of unlit fiber pairs, could result in a charge to income tax expense of approximately $89.8 million, $50.4 million of which would be a result of additional taxes payable and $39.4 million of which would be a result of the reduction in recognized deferred tax assets.
On December 17, 2010, we filed a response to the Revised NOPAs in which we objected to the proposed adjustments set forth. On January 6, 2011, the Service requested additional factual information relating to the IRUs. We responded to these requests on January 27, 2011.
We believe there are errors within the adjustments asserted by the Service. If the Service accepts the corrections we believe are appropriate, but still prevails on the underlying debt versus equity issue, the result is expected to be a receivable from the IRS for the overpayment of Alternative Minimum Tax of $2.8 million, a charge to income tax expense of approximately $29.7 million, and a net reduction in recognized deferred tax assets. We are unable to say it is more likely than not it will prevail on the underlying debt versus equity issue, but we believe it is more likely than not that we will prevail on the other issues contained in the NOPAs. Therefore, in the second quarter of 2010, in accordance with the guidance in Accounting Standards Codification (“ASC”) Topic 740, Income Taxes (“ASC 740”), we recorded $29.7 million in additional income tax expense, and $2.8 million receivable pending resolution with the IRS.
The additional income tax expense of $29.7 million is made up of two components: the first representing $11.0 million for the tax effect of losing net operating losses (“NOLs”) while the remaining $18.7 million represents a deferred tax liability for the difference in outside basis in certain Crest subsidiaries. Through enforcing indemnification rights, preserving the corporate structure of the Crest subsidiaries and other proactive steps, it should be possible to mitigate most or all of the cash impact of the $18.7 million deferred tax liability for as long as the Company remains a going concern. ASC 740 requires recognition of a deferred tax liability for outside basis differences. An outside basis difference represents the amount by which the book basis of an investment in a domestic subsidiary for financial reporting purposes exceeds the tax basis in such subsidiary. For certain Crest subsidiaries, the cancellation of debt created a difference in outside basis that we cannot recover in a tax-free manner and as such, a deferred liability was established.
The SPA underlying our acquisition of Crest provides for indemnification for the Company by the former stockholders (“Selling Stockholders”) of Crest. This indemnity was entered into with the intent to mitigate the impact our potential tax exposure to items such as those raised by the NOPAs. We and the selling stockholders intend to contest all issues raised by the NOPAs through various avenues of appeal. However, should the appeals process fail to overturn the NOPAs, should we be unable to preserve the corporate structure of the Crest subsidiaries and should we prove unable to effectively enforce the indemnification provisions in the SPA, this could have a material effect on our consolidated financial position, results of operations and cash flows.
For an additional discussion of certain risks associated with legal proceedings, see “Risk Factors” in Item 1A of this Report.
Item 4.
Item 4. (Removed and Reserved)
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
Our common stock is traded on the NASDAQ Global Select Market under the symbol ‘ALSK’. The following table presents, for the periods indicated, the high and low sales prices of our common stock as reported by NASDAQ.
As of February 15, 2011, there were 44.7 million shares of our common stock issued and outstanding and approximately 531 record holders of our common stock. Because brokers and other institutions hold many of our shares of existing common stock on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.
Dividends
On October 28, 2004, we announced the adoption of a dividend policy by our Board of Directors and declared our first quarterly dividend. The following table summarizes all of the dividends paid from that date forward:
Based on approximately 44.7 million shares outstanding on February 15, 2011 and an assumed dividend of $0.86 per share per annum, dividends payable during 2011 would be approximately $38.5 million.
Our ability to make dividend payments in the future will depend on future competitive market and economic conditions and on financial, business, regulatory and other factors, many of which are beyond our control. Accordingly, our Board of Directors may modify or revoke this policy at any time. Thus, you may not receive any dividends.
Factors that may affect our dividend policy are:
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we are a holding company and rely on dividends, interest and other payments, advances and transfer of funds from our subsidiaries to meet our debt service and pay dividends;
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we may not have enough cash to pay dividends due to changes in our operating earnings, working capital requirements and anticipated cash needs;
•
nothing requires us to declare or pay dividends;
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while the dividend policy adopted by our Board of Directors reflects an intention to distribute a substantial portion of our cash generated by our business in excess of operating needs, interest and principal payments on debt and capital expenditures to pay dividends, our board could modify or revoke this policy at any time;
•
even if our dividend policy is not modified or revoked, the actual amount of dividends distributed under the policy and the decision to make any distribution will remain, at all times, entirely at the discretion of our Board of Directors;
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the amount of dividends that we may distribute will be limited by restricted payment and leverage covenants in our senior credit facility and potentially, the terms of any future debt that we may incur;
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the amount of dividends that we may distribute is subject to restrictions under Delaware law; and
•
our stockholders have no contractual or other legal right to dividends.
See “Item 1A - Risk Factors-Risks related to our Common Stock”. You may not receive the level of dividends provided for in our dividend policy or any dividends at all.
Securities Authorized for Issuance under Equity Compensation Plans
The information set forth in this Report under “Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters-Securities Authorized for Issuance under Equity Compensation Plans” is incorporated herein by reference.
Item 6.
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements and the Notes thereto in Part IV, Item 15 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and related notes and the other financial information included elsewhere in this Form 10-K.
Important Changes to Presentation
In the quarter ended March 31, 2010, we identified a cumulative adjustment which reduced wireline revenue by $5.8 million and wireline income tax expense of $2.4 million over a five year period beginning January 1, 2005. The adjustment was determined to be an immaterial error in the calculation of a regulatory liability payable to the Universal Service Administration Company (“USAC”) for high cost loop support, and the related income tax expense. We concluded that these errors were not material to any of its prior period financial statements under the guidance of SEC Staff Accounting Bulletin (“SAB”) No. 99 Materiality. Although the errors were and continue to be immaterial to prior periods, because of the significance of the out of period correction in the first quarter of 2010, we applied the guidance of SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements, and revised its prior period financial statements. In addition to an increase of $3.1 million in the Company’s accumulated deficit on December 31, 2008, the schedules that follow recast the immaterial error to reflect the balances as if they had been recorded in the proper periods.
The following schedule presents a reconciliation of the effects of the adjustments made to our previously reported balance sheet line items for December 31, 2009:
The following schedule presents a reconciliation of the effects of the adjustments made to our previously reported annual consolidated statements of operations for the twelve months ended December 31, 2009 and 2008, respectively:
The following schedule presents a reconciliation of the effects of the adjustments made to our previously reported consolidated statements of cash flows for the twelve months ended December 31, 2009 and 2008, respectively:
Additionally, on July 1, 2009, our incumbent local exchange carrier operations discontinued accounting for regulated enterprises as prescribed by ASC Topic 980 Regulated Operations (“ASC 980”) and reassessed certain other related practices. As a result, we were required to:
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recognize an “extraordinary item” as a result of the extinguishment of all our jurisdictional assets and liabilities net of the liability representing our asset retirement obligation in accordance with ASC Topic 410 - Asset Retirement and Environmental Obligations (“ASC 410”);
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eliminate all intercompany transactions;
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reclassify bad debt expense as a component of Selling, General and Administrative (“SG&A”); and
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make certain other reclassifications in the Consolidated Statement of Operations to separate operating expenses into cost of services and sales and SG&A.
The discussion that follows in this “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations”, unless otherwise specifically indicated, takes these foregoing changes into account.
Overview
The sections that follow provide information about important aspects of our operations and investments and include discussions of our results of operations, financial condition and sources and uses of cash. In addition, we have highlighted key trends and uncertainties to the extent practicable. The content and organization of the financial and non-financial data presented in these sections are consistent with information we use in evaluating our own performance and allocating our resources. We also monitor the state of the economy in general. In doing so, we compare Alaskan economic activity with broader economic conditions. In general, we believe that the Alaskan telecommunications market, as well as general economic activity in Alaska, is affected by certain economic factors, which include:
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activity in the oil and gas markets;
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tourism levels;
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military activity;
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the cost of long-haul telecommunications bandwidth;
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local customer preferences;
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average usage of Internet technology:
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unemployment levels; and
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housing activity.
We have observed variances in the factors affecting the Alaskan economy as compared to the U.S. as a whole. Some factors, particularly the price of oil and gas, may have the opposite effect on the Alaskan economy than the U.S. economy as a whole. In forecasting the local economic conditions that affect us, we take particular note of these factors.
We have also responded to the difficult market conditions experienced throughout the fiscal years ended December 31, 2009 and 2010 in the U.S. as a whole. During that time, our management developed and executed a cost reduction plan designed to aggressively reduce costs while seeking to reallocate resources to growth areas of our business.
Strategy
Our results of operations, financial position and sources and uses of cash in the current and future periods reflect our focus on the following strategic imperatives:
Emphasis on Top-Line Growth
We emphasize revenue growth as well as growth in net cash provided by operating activities. We devote more resources to higher growth markets such as wireline broadband connections, including our long-haul fiber optic cables connecting our network to the contiguous states, as well as expanded strategic services to business markets and wireless broadband, rather than to the traditional wireline voice market.
Investment with Discipline
We focus on gaining market share in those markets that contain high revenue producing customers. In our wireline business, we focus on deploying and selling broadband connections to enterprise customers in each market covered by our network. We have targeted investment in deploying high-speed fiber conductivity in and between Alaska’s urban centers. We invested heavily in interstate capacity through our acquisition of Crest and construction of AKORN. We have increasingly targeted carrier voice and customers with demand for sophisticated data solutions. Revenues from these customers grew 7.1% compared with last year, primarily driven by sales of advanced IP services and increases in revenues from agreements with carriers to terminate their Alaskan long distance traffic. We have directed resources towards offering wireless plans that encourage customer adoption of data services, large monthly minute postpaid plans and unlimited postpaid plans. By directing resources carefully, we seek to distinguish ourselves from our competitors in a cost effective way.
Grow our Connect / Host / Managesm Offerings
We seek to drive increased enterprise sales both inside and outside of the state with our extensive Alaskan network, the development of our data hosting and server collocations products and our 49% investment in TekMate. Ultimately, this strategy is aimed to develop both geographic and line of business expansion.
Continuous Enhancement of Products and Services
We intend to continue to introduce new services that draw upon our core competencies and that we believe will be attractive to our target customers. In considering new services, we look for market opportunities that we believe present significant growth opportunities, such as our investments in our AKORN and Northstar cable systems and our first-to-market deployment of 3G services. We also plan to selectively pursue acquisitions that will enable us to broaden our service offerings.
Process Improvement to Achieve Operational Excellence
While focusing resources on revenue growth and market share gains, we continually challenge our management team and employees at all levels to lower expenses and enhance the customer experience. We have made certain investments in web based sales and service capabilities in 2010 and we expect to maintain our focus on (a) building necessary infrastructure and (b) front-line employee driven process improvement aimed at excellence in customer experience.
Pay for Performance
We embrace a culture of urgency and accountability. We establish goals for all of our employees that are tied to the imperatives described above. We seek to provide our non-represented employees cash incentives and equity compensation that are tied to these goals. We design executive compensation programs carefully to align executives’ and stockholders’ long-term interests.
Careful Cash Flow Management
We aim to create value for our shareholders by carefully investing cash flows generated by the business in specific opportunities and transactions that support these imperatives. In addition, we use our cash flows to maintain and grow our dividend payout to shareholders. In light of continued uncertainty in the U.S. credit markets, our Board of Directors has continued to maintain our current $0.86 per share annual dividend policy. Under this policy, we returned $38.4 million in cash dividends to our stockholders during 2010.
Revenue Sources by Segment
Wireline
Revenue from our wireline business services is generated from enterprise, retail and wholesale customer segments as well as from the provision of network access services to interexchange and wireless carriers.
Enterprise
We generate enterprise revenue from:
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multi-site business customers and state and federal governments by providing connectivity, hosting and collocation services; and advanced network services; and
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other carriers by providing capacity and transport services; and local and long distance private line and data services.
Retail
We generate revenue from retail residential and business customers primarily from:
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basic local telephone service including features to customers within our service areas;
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ISP services including DSL and dial up;
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long distance services; and
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CPE sales to business customers.
The number of local telephone customers we serve continues to steadily decline. We expect this trend to continue.
The table below sets forth subscriber numbers as of December 31, 2010, 2009 and 2008:
Wholesale Business
We generate revenue from wholesale customers primarily from:
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providing competitive local service to CLECs on either a wholesale or UNE basis as prescribed under the Telecommunications Act;
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carrier billing and collection services; and
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providing carriers with access to space and power at our central office locations.
The number of telephone lines we serve on a wholesale basis has continued to decline. The rate of wholesale line loss has generally outpaced the rate of retail line loss and has accelerated since 2005. This accelerated decline is primarily a result of a specific CLEC customer migrating its customers onto its own cable telephony plant. The table below sets forth subscriber numbers as of December 31, 2010, 2009 and 2008:
Network Access Business
Our LECs provide access service to numerous interexchange carriers and may also bill and collect long distance charges from interexchange carrier customers on behalf of the interexchange carriers. The amount of access charge revenue associated with a particular interexchange carrier varies depending on long distance calling patterns and the relative market share of each long distance carrier. The major sources of network access revenue are:
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interstate access charges;
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intrastate access charges;
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federal USF support; and
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wireless carrier access charges.
Wireless
Our business provides wireless voice, data and other value-added services across our owned and operated network in Alaska and across the contiguous states, Hawaii and Canada with our roaming partners. We generate wireless revenue primarily from:
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sale of pre-paid and post-paid wireless voice plans to our Alaskan subscribers;
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sale of value-added feature services, including data, to our Alaskan subscribers;
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equipment sales;
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providing the contiguous states and Canadian carriers with roaming access to our network for their subscribers; and
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CETC subsidies.
While our wireless business had been a principal driver of revenue growth since 2005, with an increase in competition, higher penetration rates and limited access to data centric devices, we continue to experience subscriber losses in 2010.
The table below sets forth subscriber numbers as of December 31, 2010, 2009 and 2008:
Results of Operations
The following table summarizes our operations for the years ended December 31, 2010, 2009 and 2008. Net income for the year ended December 31, 2010 was affected by $29.7 million additional income tax expense for the effects of the on-going Crest IRS audit, and $13.3 million in extinguishment of debt expenses arising from the extinguishment of our 2005 credit facility and related interest rate swaps. Net income for the year ended December 31, 2009 was affected by a $37.3 million extraordinary gain related to the write-off of jurisdictional assets and liabilities required by the discontinuance of regulatory accounting while net income for the year ended December 31, 2008 was affected by an impairment charge on goodwill and intangible assets of $29.6 million.
Year ended December 31, 2010 Compared to the Year ended December 31, 2009
Operating Revenues
Wireline
Enterprise: Enterprise revenue increased $3.2 million or 7.1% in 2010, primarily due to an increase of $6.6 million in data sales which was offset, in part, by a $1.8 million decline in revenue from an expired capacity swap and a $1.6 million decline in carrier voice revenue. We expect enterprise revenues to continue to increase as we gain share in the provisioning of IP data services to carrier, federal and commercial customers and we roll out our Connect/Host/Managesm solution set.
Retail: Declines in retail switched access lines in service during 2010 were concentrated in the residential market which we believe continues to be impacted by wireless substitution. Retail revenue decreased $2.8 million, or 3.3%, year over year primarily due to a $2.1 million decline in local exchange revenue associated with residential line losses, a $1.0 million decline in long distance sales and a $1.0 million net decrease in revenue for the release of company liabilities for commercial developer deposits. These losses were offset, in part, by a $1.3 million increase in revenue from our existing ISP subscriber base.
Wholesale: Wholesale revenues decreased by $2.0 million, or 17.8%, over the prior year due to continued decline in line counts. We believe this decline is primarily attributable to the ongoing migration of lines by our key competitor to its propriety cable telephony plant and the decision of another competitor, and wholesale customer, to exit the market. We expect wholesale revenue will continue to decline.
Access: Access revenue declined $2.4 million, or 3.9%, primarily due to higher out of period settlements in 2009.
Wireless
Wireless revenue decreased slightly to $140.6 million in 2010 as compared to $141.0 in 2009. Voice revenue decreased $9.3 million consistent with the 12.3% decline in subscribers from 137,365 to 120,413, due in part to limited access to certain data centric handsets. Additionally, equipment and accessory revenue declined $1.1 million. Offsetting these decreases were increases of $7.3 million in roaming revenue from non-ACS customers, $2.6 million in data revenue due to the rapid adoption of smart phones and the growing popularity of data rich features.
Operating Expense
Wireline
Wireline operations include local telephone, Internet, interexchange and cable systems operating costs.
Cost of Services and Sales: Wireline cost of services and sales decreased $6.9 million to $75.6 million in 2010 primarily due to a $6.2 million decrease in labor expense resulting from an overall reduction in our workforce and lower cash and stock compensation incentive payments. Additionally, we experienced decreases of $1.4 million in maintenance contracts, $0.7 million in paystation expenses, $0.5 million in land and building related charges and $0.2 million in ISP access and leased circuits. These decreases were partially offset by increases of $1.3 million in advanced network services expense and $0.8 million in long distance COGS.
Selling, General and Administrative Costs: Wireline SG&A expenses decreased $1.8 million to $65.5 million in 2010. These decreases include a $2.1 million reduction in bad debt expense in the current year driven by a $1.2 million out of period true up to our allowance for uncollectible accounts in 2009, and improved collection processes in 2010 and a $1.1 million decrease in labor costs resulting from the overall reduction in our general work force. Additionally, the prior year was affected by a $1.0 million charge related to the repudiation of a contract commitment from a bankrupt vendor. Offsetting these decreases were increases of $1.6 million in advertising expense and $0.6 million in legal and IT consulting in 2010 and the non-recurrence of a $0.4 million favorable property tax settlement in 2009.
Wireless:
Cost of Services and Sales: Wireless costs of services and sales increased $1.6 million to $55.3 million in 2010 driven primarily by increases of $2.2 million in handset, accessory and data content expenses partially offset by a $0.9 million decrease in network costs.
Selling, General and Administrative: Wireless SG&A expenses decreased $1.2 million in 2010 driven by a shift in advertising expense from our wireless segment to our wireline segment with more brand versus product advertising.
Depreciation and Amortization:
Depreciation and amortization expense decreased 11.4% in 2010 to $72.1 million as compared to $81.4 million in 2009. The decrease from the same period in the prior year was primarily due to a number of pooled asset classes reaching their maximum depreciable lives and a reduction in depreciable value in the assets purchased from Crest Communications resulting from the reallocation of purchase price from fixed assets to deferred tax assets under purchase accounting. These declines were partially offset by the acceleration of depreciation on certain wireless assets and other additions to our asset base.
Loss on Disposal of Assets
The loss on disposal of certain property was $2.8 million in 2010 and $4.3 million in 2009. Impairment charges for certain IT projects were the primary driver of expense in both years.
Other Income and Expense:
Other income and expense for 2010 is a net expense which increased to $48.0 million as compared to a net expense of $38.3 million in 2009. The net increase of $9.7 million in expense over the prior year is primarily due to the early termination of out-of-the-money interest rate swaps and the extinguishment of our 2005 senior credit facility which resulted in a $13.3 million loss on extinguishment of debt. Offsetting this increase was a net decrease in interest expense following the expiration of certain out-of-the-money swaps.
Income Taxes
Income taxes are currently being calculated using our estimated effective tax rate for the year ended December 31, 2010 of 33.5% exclusive of the $29.7 million additional income tax expense recorded in the second quarter for the effects of the on-going Crest IRS audit. “ PART I, Item 3, Legal Proceedings” for more information on the IRS issue. At December 31, 2010 we had federal NOL carry forwards of $150.4 million and state NOLs of $147.0 million. Income tax expense will not involve a significant cash outflow until these NOLs are exhausted.
Extraordinary Item
In 2009, the discontinuance of regulatory accounting required us to write off all previously held jurisdictional assets and liabilities. As our jurisdictional liability represented the regulatory equivalent of an asset retirement obligation (“ARO”), we also assessed our regulatory assets to determine the ARO required under ASC 410. The impact of extinguishing our jurisdictional liability, net of the portion of the liability representing the ARO for regulated assets required by ASC 410, was recorded as an extraordinary gain of $37.3 million, net of taxes.
Net Income (loss)
Our net loss was $30.7 million in 2010 compared to net income of $33.8 million in 2009. The year over year change from net income to net loss primarily reflects the $29.7 million additional income tax expense recorded for the effects of the Crest IRS audit in 2010 compared to the $37.3 million extraordinary gain recognized in 2009 relating to the extinguishment of our jurisdictional liability.
Year ended December 31, 2009 Compared to the Year ended December 31, 2008
Operating Revenues
Wireline
Enterprise: Enterprise revenue increased $11.2 million, or 32.7%, in 2009, primarily reflecting our commercial launch of AKORN in April 2009 and our acquisition of Crest in October 2008, which together positioned ACS to capture a greater share of the carrier customer voice and commercial data market in the contiguous states. We experienced an increase of $14.1 million in data sales which was offset, in part, by a $2.1 million decline in wholesale carrier voice revenue and a $1.1 million decline in revenue from an expired capacity exchange agreement with another carrier. We expect enterprise revenues to increase as we gain share in the provision of IP data services to carrier, federal and commercial customers.
Retail: Retail revenue decreased by $3.8 million, or 4.2%, to $85.5 million in 2009. Declines in retail switched access lines in service in 2009 were concentrated in the residential market which we believe is impacted by
wireless substitution. Retail revenue decreased primarily due to $2.4 million declines in local exchange revenue associated with residential line losses, a $1.5 million decline in CPE sales to businesses and a $1.4 million decline in long distance sales. These losses were offset, in part, by a $0.9 million increase in revenue from our existing ISP subscriber base and a $1.2 million release of company liabilities for deposits made by commercial developers.
Wholesale: Wholesale revenues decreased by $2.9 million, or 20.1%, in 2009. We believe this decrease is primarily attributable to the on-going migration of lines by our key competitor to its proprietary cable telephony plant. We expect that wholesale revenue will continue to decline.
Access: Access revenue declined $7.1 million, or 10.1%, primarily reflecting lower levels of eligible cost recovery, lines in service, traffic sensitive activity levels and reserve adjustments. We expect access revenues to continue to decline over time.
Wireless
Wireless revenue declined 0.8% to $141.0 million in 2009 as compared to $142.1 in 2008. Voice revenue declined $7.0 million consistent with the 7.3% decline in subscribers from 148,139 to 137,365, largely due to limited access to data centric handsets. Equipment and accessory revenue declined $3.0 million and roaming revenue from non-ACS customers decreased $1.2 million. Offsetting these decreases were increases of $6.4 million in CETC revenue, and $3.7 million in data revenue due to the adoption of smart phones and the growing popularity of data rich features.
Operating Expense
Wireline
Wireline operations include local telephone, Internet, interexchange and cable systems operating costs.
Cost of Services and Sales: Wireline cost of services and sales increased $9.3 million to $82.5 million in 2009 primarily reflecting a $2.2 million increase in labor, $2.0 million increase in service contracts and $1.4 million increase in land and building charges, which were all primarily related to our new cable operations. Additionally, we experienced an increase of $1.8 million in ISP access and leased circuits, $0.7 million in DSL COGS, and $0.6 million in legal expenses and a favorable property tax settlement of $0.4 million.
Selling, General and Administrative Costs: Wireline SG&A expenses decreased $8.0 million to $67.4 million due to $8.0 million in labor expenses, inclusive of a $5.0 decrease in stock compensation expense, and a $1.7 million decline in advertising expenses. Offsetting these decreases was an increase in bad debt expense of $0.7 million primarily driven by an out of period true up to our allowance for uncollectible accounts and a $1.0 million charge related to the repudiation of a contract commitment from a bankrupt vendor.
Wireless
Cost of Services and Sales: Wireless costs of services and sales decreased $5.2 million to $53.7 million primarily driven by reductions of $3.3 million in handset, accessory and data content expense and $1.4 million in costs associated with backhaul for our wireless footprint.
Selling, General and Administrative: Wireless SG&A expenses in 2009 were $24.3 million as compared to $24.5 million in 2008, with a $2.0 million increase in advertising expense offsetting a $1.6 million decrease in labor expenses.
Depreciation and Amortization:
Depreciation and amortization expense increased 9.9% in 2009 to $81.4 million as compared to $74.0 million in 2008. The increase reflects the change in maximum reserve levels on our regulated subsidiary assets resulting in an increase in expense as depreciation recommenced for residual values in asset classes that had previously been fully depreciated under regulatory accounting. Also contributing to the increase in depreciation expense was the increase in our depreciable asset base due to the addition of AKORN in the second quarter of 2009 and the Crest assets during the fourth quarter of 2008.
Loss on Disposal of Assets:
The loss on disposal of certain property was $3.6 million higher than the prior year primarily due to impairment charges for certain IT projects.
Loss on Impairment of Goodwill and Intangible Assets:
As a result of our impairment test in the fourth quarter of 2008, we determined that $29.6 million of goodwill and intangibles were impaired on our wireline segment. The goodwill impairment charge was primarily driven by adverse equity market conditions, the industry transition from wireline to wireless products and services, decreases in current market multiples and the decline in our stock price throughout 2008. This charge reduced goodwill, but does not impact our overall business operations or cash flows. The tax benefit derived from recording the impairment charge was recorded as a deferred income tax asset.
Other Income and Expense
Other income and expense for 2009 is a net expense which increased to $38.3 million as compared to a net expense of $32.6 million in 2008. The $5.7 million net increase compared to 2008 is due to reductions of capitalized interest on fixed assets in the course of construction following the commercial launch of AKORN in April 2009, higher interest expense on the $125.0 million 5.75% Convertible Notes issued April 8, 2008, and a decline in interest income due to a reduced amount of excess investible cash. Affecting interest expense on the $125.0 million, 5.75% Convertible Notes was the adoption of Financial Accounting Standards Board (“FASB”) FASB Staff Position (“FSP”) 14-1, Accounting for Convertible Debt that may be Settled in Cash Upon Conversion (ASC Topic 470-20, Debt with Conversion and Other Options) on January 1, 2009. The adoption of FASB FSP 14-1 required us to separate the portion of the debt that is related to the conversion feature from the portion related to the debt feature. The portion of the debt related to the conversion feature is considered equity and the principal amount of the debt is discounted by the equity portion. The discount is amortized over the life of the debt as additional interest expense resulting in non-cash interest expense of $4.4 million and $2.9 million in 2009 and 2008, respectively.
Income Taxes
Income taxes are currently being calculated using our estimated effective tax rate for the year ended December 31, 2009 of 37.6%. At December 31, 2009 we had federal tax NOL carry forwards of approximately $174.2 million and state NOL carry forwards of $150.8 million. Income tax expense will not involve a significant cash outflow until these NOLs are exhausted.
Extraordinary Item
The discontinuance of regulatory accounting required us to write off all previously held jurisdictional assets and liabilities. As our jurisdictional liability represented the regulatory equivalent of an asset retirement obligation, we also assessed our regulatory assets to determine the ARO required under ASC 410. The impact of extinguishing our jurisdictional liability, net of the portion of the liability representing the ARO for regulated assets required by ASC 410, was recorded as an extraordinary gain of $37.3 million, net of taxes.
Net Income (loss)
Net income was $33.8 million in 2009 compared to a net loss of $11.7 million in 2008. The year over year change from net loss to net income primarily reflects the $37.3 million extraordinary gain recognized in 2009 relating to the extinguishment of our jurisdictional liability, compared to a goodwill impairment charge of $29.6 million assessed against our wireline segment in 2008.
Liquidity and Capital Resources
A summary of significant sources and use of funds for the years ended December 31, 2010 and 2009 is as follows:
Sources
Sources in General
We have satisfied our cash requirements for the year ended December 31, 2010 for operations, capital expenditures and debt service primarily through internally generated funds and other financing activities, including use of funds drawn from our revolving credit facility. For the year ended December 31, 2010, our net cash flows provided by operating activities were $86.4 million inclusive of $11.1 million in cash charges for the early extinguishment of interest rate swaps arising from the extinguishment of our 2005 senior credit facility. At December 31, 2010, we had $15.3 million in cash and cash equivalents and $4.9 million in restricted cash.
On October 21, 2010, we entered into a new $470.0 million senior credit facility which consists of a drawn term loan of $440.0 million and an undrawn revolving loan of $30.0 million (the “revolver”). The 2010 senior credit facility generated net proceeds of approximately $2.4 million after repaying in full, and retiring, our 2005 senior credit facility and deducting fees and expenses associated with the debt issuance of $7.3 million. The $440.0 million term loan generally bears interest at LIBOR plus 4.0% per annum or 5.5%, whichever is greater, has a term of six years and is be repayable in quarterly installments equal to 0.25% of the original principal amount of the term loan, with the remainder to be paid on the term maturity date. The revolver has a term of five years and to the extent it is drawn, also generally bears interest at LIBOR plus 4.0% per annum or 5.5%, whichever is greater, and, to the extent undrawn, has commitment fees equal to 0.625% per annum. The term loan matures on October 21, 2016 and the revolver matures on October 21, 2015.
In connection with the 2010 senior credit facility, we entered into forward floating-to-fixed interest rate swaps and a buy back of the 1.5% LIBOR floor as a component of our cash flow hedging strategy. The notional amounts of the swaps are $192.5 million, $115.5 million and $77.0 million, respectively, with interest rates of 6.463%, 6.470% and 6.475%, respectively, inclusive of a 4.0% LIBOR spread. The swaps begin on June 30, 2012 and continue through September 30, 2015. In order to protect against extreme movements in LIBOR prior to the start of the swaps, we also acquired an interest rate cap at a cost of $0.1 million for the period between January 1, 2011 and June 30, 2012, capping LIBOR at 3.0% on a notional principle amount of $385.0 million.
The net proceeds of the 2010 senior credit facility were used to repay in full, and retire, the 2005 senior credit facility. As a result, we incurred a charge of approximately $2.2 million by of writing off unamortized debt issuance costs in association with the early extinguishments of debt during the fourth quarter of 2010.
As of December 31, 2010, total long-term obligations outstanding, including current portion, were $553.3 million consisting of a $435.7 million draw from our new senior credit facility, net of a $4.3 debt discount, $112.4 million of convertible notes, net of a $12.6 million debt discount, and $5.2 million in capital lease obligations. As of December 31, 2010, we had full access to our $30.0 million revolving credit facility. We intend to access the capital markets to raise new debt to pay down our $125.0 million convertible notes before December 19, 2012, as our 2010 senior secured credit facility requires us to repay or refinance $100.0 million of these notes before this date.
Senior Credit Facility
Our senior credit facility contains a number of restrictive covenants and events of default, including covenants limiting capital expenditures, incurrence of debt and payment of dividends. The senior credit facility also requires that we achieve certain financial ratios quarterly including a total leverage ratio, senior secured leverage ratio and a fixed charge coverage ratio and we are currently operating comfortably within these restrictions. These measures are defined more specifically below:
Total Leverage Ratio: Our “total leverage ratio” may not exceed 5.25 to 1. “Total leverage ratio” means, generally, as at the last day of any fiscal quarter, the ratio of our (a) total debt to (b) Adjusted EBITDA (more specifically defined below) for the period of four of our consecutive fiscal quarters ended on such date, all determined on a consolidated basis in accordance with Generally Accepted Accounting Principles. Further, the credit agreement calls for a suspension of dividends if, for the most recently ended period of four consecutive fiscal quarters, the total leverage ratio is equal to or greater than 5.00:1.00.
Senior Secured Leverage Ratio: Our “senior secured leverage ratio” may not exceed 4.40 to 1. “Senior Secured Leverage Ratio” means, as of the last day of any fiscal quarter, the ratio of our (a) senior secured debt to (b) Adjusted EBITDA (more specifically defined below).
Fixed Charges Coverage Ratio: Our “fixed charges coverage ratio” may not be less than 2.75 to 1. The ratio of (a) “Adjusted EBITDA” to (b) “Fixed Charges” is defined specifically in our senior credit facility, and more generally, below:
“Adjusted EBITDA” means, consolidated net income, plus the sum of:
•
consolidated interest expense;
•
provision for income taxes based on income;
•
depreciation and amortization expense,
•
unrealized losses on financial derivatives
•
non-cash, stock-based compensation expense,
•
extraordinary, non-recurring or unusual losses;
•
the cumulative effect of a change in accounting principles; and
•
all other non-cash charges that represent an accrual for which no cash is expected to be paid in the next twelve months;
minus (to the extent included in determining consolidated net income) the sum of:
•
unrealized gains on financial derivatives;
•
extraordinary, non-recurring or unusual gains;
•
gains on sales of assets other than in the ordinary course of business; and
•
all other non-cash income.
“Fixed charges” means (a) cash interest expense plus (b) income tax.
Uses
Our networks require the timely maintenance of plant and infrastructure. Our historical capital expenditures have been, and continue to be, significant. Cash outflows for capital expenditures for the year ended December 31, 2010 were $40.9 million inclusive of $2.5 million in net settlements of capital expenditure payables. New capital acquisition for 2010 totaled $38.3 million inclusive of $1.6 million in capitalized interest.
Future capital requirements may change due to impacts of regulatory decisions that affect our ability to recover our investments, changes in technology, the effects of competition, changes in our business strategy and our decision to pursue specific acquisition and investment opportunities. We intend to fund future capital expenditures with cash on hand and net cash generated from operations.
On August 31, 2010, for $2.1 million, we completed the purchase of a 49% equity interest in TekMate, LLC, Alaska’s largest privately owned information technology services company. Our strategy is to combine our business broadband and other communications offerings with our newly launched data hosting services and the information technology products of TekMate.
Cash interest expense, net of cash interest income, for 2010 was $28.9 million. Through a series of interest rate swap transactions, interest on 87.5% of our new term loan is effectively fixed at an annual rate of 6.5% for the period June 30, 2012 through September 30, 2015. Our $125.0 million convertible debt has a fixed coupon of 5.75%.
From time to time we may seek to retire, repurchase or exchange our convertible notes in open market purchases, privately negotiated transactions dependent on market conditions, liquidity and contractual obligations and other factors. The timing and amount of such purchases, if any, depend upon cash needs and market conditions, among other things. While under the terms of our term loan we may also be required to make certain prepayments based on annual gains in our restricted payment baskets, we were not required and did not make term loan prepayments during 2010.
Since October 28, 2004, we have paid quarterly dividends on our common stock. During 2010 we paid $38.4 million to common shareholders. Based on current shares outstanding at February 15, 2011 of approximately 44.7 million shares and our current annual dividend policy of $0.86 per share, maintenance of our current dividend policy would result in $38.5 million in cash being paid to common stockholders over the next four quarters. Dividends on our common stock are not cumulative.
We believe that we will have sufficient cash on hand; cash provided by operations and available borrowing capacity under our revolving credit facility to service our debt, pay our quarterly dividends and fund our operations, capital expenditures and other obligations over the next twelve months. Our ability to meet such obligations will be dependent upon our future financial performance, which is, in turn, subject to future economic conditions and to financial, business, regulatory and other factors, many of which are beyond our control.
Other Material Obligations and Commitments
Current accounting standards require us to disclose our material obligations and commitments to make future payments under contracts, such as debt and lease agreements, and other contingent commitments, such as debt guarantees.
Contractual Obligations
Our contractual obligations as of December 31, 2010, are in the following table. Generally, long-term liabilities are included in the table based on the year of required payment or an estimate of the year of payment. Such estimates of payment are based on a review of past trends for these items as well as a forecast of future activities. Certain items were excluded from the following table where the year of payment is unknown and could not be reasonably estimated.
Many of our other non-current liabilities have been excluded from the following table due to the uncertainty of the timing of payments combined with the absence of historical trending to be used as a predictor of such payments.
Off-Balance Sheet Arrangements
We have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity or market or credit risk support and we do not engage in leasing, hedging, research and development services or other relationships that expose us to any material liabilities that are not reflected on our balance sheet or included in “Contractual Obligations” above.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
We have identified certain policies and estimates as critical to our business operations and the understanding of our past or present results of operations. We consider these policies and estimates critical because they had a material impact, or they have the potential to have a material impact, on our financial statements and they require significant judgments, assumptions or estimates.
Regulatory and Intercompany Accounting
Our consolidated financial statements include all majority-owned subsidiaries. Prior to July 1, 2009, our local telephone company subsidiaries charged other subsidiaries based on regulated rates for telecommunications services. Intercompany revenue between regulated local telephone companies and all other subsidiaries were not eliminated upon consolidation, in accordance with the accounting principles prescribed by ASC 980. Other intercompany balances were eliminated upon consolidation.
As of July 1, 2009, we discontinued using the accounting principles prescribed by ASC 980. Historically, consistent with the application of ASC 980 and industry practice, intercompany revenues between our regulated local telephone companies and all other subsidiaries were not eliminated upon consolidation. With the discontinuance of regulatory accounting we now eliminate intercompany revenue between our regulated local telephone and all other subsidiaries. Further, we revised our statement of operations to distinguish our cost of services and sales from our SG&A expenses. Under ASC 980, we accounted for bad debt expense as a reduction of revenue. We now account for bad debt expense as SG&A expense.
Revenue Recognition Policies
We recognize revenue for recurring services when earned, which is usually on a month-to-month basis. We also recognize non-recurring revenues, including activation fees and usage sensitive charges, when earned. Where we have determined that certain bundled products, including coupled wireline and wireless services, constitute arrangements with multiple deliverables, we allocate and measure using units of accounting and our judgment within the arrangement based on relative fair values.
We recognize access revenue when we earn it. We participate in access revenue pools with other telephone companies. Such pools are funded by toll revenue and/or access charges regulated by the FCC within the interstate jurisdiction. Much of the interstate access revenue is initially recorded based on estimates. These estimates are derived from interim financial statements, available separations studies and the most recent information available about achieved rates of return. These estimates are subject to adjustment in future accounting periods as additional operational information becomes available for us and the other telephone companies. To the extent that disputes arise over revenue settlements, we defer revenue collected until settlement methodologies are resolved and finalized. Although we have withdrawn from interstate access pools, we have a remaining liability for certain periods prior to July 1, 2009.
Income Taxes
We use the asset-liability method of accounting for income taxes and account for income tax uncertainties using the “more-likely-than-not” threshold. Under the asset-liability method, deferred taxes reflect the temporary differences between the financial and tax bases of assets and liabilities using the enacted tax rates in effect in the years in which the differences are expected to reverse. In the future, our deferred tax assets may be reduced by a valuation allowance if management determines it is more likely than not that the value of our deferred tax assets will not be fully realized.
Derivative Financial Instruments
We recognize all asset or liability derivatives at fair value. The accounting for changes in fair value is contingent on the intended use of the derivative and its designation as a hedge. Derivatives that are not hedges are adjusted to fair value through earnings. If a derivative is a hedge, depending on the nature of the hedge, changes in fair value either offset the change in fair value of the hedged assets, liabilities or firm commitments through earnings, or are recognized in other comprehensive income until the hedged transaction is recognized in earnings. The change in a derivative’s fair value related to the ineffective portion of a hedge, if any, is
immediately recognized in earnings. We do not enter into any derivative contracts for speculative purposes. On the date a derivative contract is entered into, we designate the derivative as either a fair value or cash flow hedge. We formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. If we determine that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, we would discontinue hedge accounting prospectively.
Recently Issued Accounting Pronouncements
In October 2009, the FASB issued Accounting Standard Update (“ASU”) No. 2009-13, Revenue Recognition - Multiple-Deliverable Revenue Arrangements a Consensus of the FASB Emerging Issues Task Force. This statement provides principles for allocation of consideration among the multiple-elements of the arrangement, allowing more flexibility in identifying and accounting for separate deliverables. ASU 2009-13 introduces an estimated selling price method for valuing the elements of a bundled arrangement if vendor-specific objective evidence or third party evidence of selling price is not available, and significantly expands related disclosure requirements. This standard is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We do not expect the adoption of this pronouncement to have a material effect on our financial statements.
In October 2009, the FASB issued ASU No. 2009-14, Software - Certain Revenues Arrangements That Include Software Elements. The update was issued to clarify the accounting for revenue arrangements that contain tangible products and software and how to segregate the revenue elements if the software is “more than incidental” to the product as a whole. This update is effective for fiscal years beginning on or after June 15, 2010. We do not expect the adoption of this pronouncement to have a material effect on our financial statements.
Item 7A.
Item 7A. Quantitative and qualitative disclosures about market risk
As of December 31, 2010, we had our 2010 senior credit facility and 5.75% convertible notes outstanding. These on-balance sheet financial instruments, to the extent they provide for variable rates of interest, expose us to interest rate risk, with the primary interest rate risk exposure resulting from changes in LIBOR or the prime rate, which are used to determine the interest rates that are applicable to borrowings under our senior credit facility.
The following table provides information about our sensitivity to market risk associated with fluctuations in interest rates as of December 31, 2010. To the extent that our financial instruments expose us to interest rate risk, they are presented within each market risk category in the table below. The table presents principal cash flows and related expected interest rates by year of maturity for our 2010 senior credit facility, 5.75% convertible notes due in 2013 and capital leases and other long-term obligations outstanding at December 31, 2010. Weighted average variable rates for the 2010 senior credit facility are based on implied forward rates in the LIBOR yield curve as of December 31, 2010. Fair values as of December 31, 2010 included herein have been determined based on (i) quoted market prices for the 2010 senior credit facility and (ii) quoted market prices for the 5.75% convertible notes. Our consolidated financial statements contain descriptions of the 2010 senior credit facility, 5.75% convertible notes and capital leases and other long-term obligations and should be read in conjunction with the following table.
Liquidity Risk
We currently hold a $0.6 million portfolio of auction rate securities. These investments are not currently liquid and in the event we need to access these funds, we will not be able to do so without a loss of principal, unless a future auction on these investments is successful. During 2008, we concluded that these investments were other-than-temporarily impaired and an impairment charge was taken to the income statement of $0.2 million. Quarterly reviews in 2010 and 2009 resulted in no further impairment. We may need to access these funds for operational purposes during the time that these investments are expected to remain illiquid.
Our substantial debt, specifically its term and maturity, could have a material adverse effect on our available liquidity. See the matters described in “Item 1A - Risk Factors - Risks Related to Our Debt.”
Item 8.
Item 8. Financial Statements and Supplementary Data
Consolidated financial statements of Alaska Communications Systems Group, Inc. and Subsidiaries are submitted as a separate section of this Form 10-K. See “Index to Consolidated Financial Statements”, which appears on page hereof.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures.
As of the end of the period covered by this Annual Report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended. Based on the evaluation, our Chief Executive Officer and our Chief Financial Officer believe that, as of the end of the period covered by this Annual Report on Form 10-K, our disclosure controls and procedures were effective at ensuring that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosure.
Management’s Report on Internal Control over Financial Reporting.
Our management, including our Chief Executive Officer and our Chief Financial Officer, does not expect that our disclosure controls and internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Additionally, controls may be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls.
The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Changes in internal control over financial reporting.
There was no change in our internal control over financial reporting that occurred in the fourth quarter of 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
Not applicable.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information required by this item is incorporated into this 10-K by reference to our Proxy Statement for our 2011 Annual Meeting of Stockholders.
Item 11.
Item 11. Executive Compensation Summary Compensation Table
Information on compensation of our directors and executive officers is incorporated into this 10-K by reference to our Proxy Statement for our 2011 Annual Meeting of Stockholders.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information with respect to security ownership of certain beneficial owners and management is incorporated into this 10-K by reference to our Proxy Statement for our 2011 Annual Meeting of Stockholders.
Securities Authorized for Issuance under Equity Compensation Plans
As of December 31, 2010, the number of securities remaining available for future issuance under equity compensation plans includes 3,051,048 shares under the Alaska Communications Systems Group, Inc. 1999 Stock Incentive Plan, 176,438 shares under the Alaska Communications Systems Group, Inc. 1999 Non-Employee Director Stock Compensation Plan and 121,783 shares under the Alaska Communications Systems Group, Inc. 1999 Employee Stock Purchase Plan. All shares reserved under the non-qualified stock option agreement between Liane Pelletier and Alaska Communications Systems Group, Inc. have been awarded through stock options.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information with respect to such contractual relationships is incorporated into this 10-K by reference to our Proxy Statement for our 2011 Annual Meeting of Stockholders.
Item 14.
Item 14. Principal Accountant Fees and Services
Information on our audit committee’s pre-approval policy for audit services and information on our principal accountant fees and services is incorporated into this 10-K by reference to our Proxy Statement for our 2011 Annual Meeting of Stockholders.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) 1. Financial Statements
Our consolidated financial statements are submitted as a separate section of this Form 10-K. See “Index to Consolidated Financial Statements” which appears on page.
2. Financial Statement Schedule
Our financial statement schedules for the Company and its subsidiaries are submitted as a separate section of this Form 10-K. See “Index to Consolidated Financial Statements” that appears on page hereof.
(b) Exhibits. The exhibits to this report are listed below. Other than exhibits that are filed herewith, all exhibits listed below are exhibits of the Registrant and are incorporated herein by reference as exhibits thereto.
*
Management contract or compensatory plan or arrangement required to be filed as an exhibit to this form.
**
Confidential treatment of certain portions of this exhibit has been requested pursuant to a request for confidential treatment filed with the Securities and Exchange Commission. Omitted portions have been filed separately with the Commission.
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets - December 31, 2010 and 2009
Consolidated Statements of Operations - Years Ended December 31, 2010, 2009 and 2008
Consolidated Statements of Stockholders’ Equity (Deficit) and Comprehensive Income (Loss) Years Ended December 31, 2010, 2009 and 2008
Consolidated Statements of Cash Flows - Years Ended December 31, 2010, 2009 and 2008
Notes to Consolidated Financial Statements - Years Ended December 31, 2010, 2009 and 2008
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Alaska Communications Systems Group, Inc.:
We have audited the accompanying consolidated balance sheets of Alaska Communications Systems Group, Inc. and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity (deficit) and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Alaska Communications Systems Group, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Alaska Communications System’s Group, Inc.’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2011 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Anchorage, Alaska
February 28, 2011
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Alaska Communications Systems Group, Inc.:
We have audited Alaska Communications Systems Group, Inc.’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Alaska Communications Systems Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A.(B)). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Alaska Communications Systems Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Alaska Communications Systems Group, Inc. and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity (deficit) and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2010, and our report dated February 28, 2010 expressed an unqualified opinion on those consolidated financial statements.
Anchorage, Alaska
February 28, 2011
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Consolidated Balance Sheets
December 31, 2010 and 2009
(In Thousands, Except Per Share Amounts)
See Notes to Consolidated Financial Statements
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Consolidated Statements of Operations
Years ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
See Notes to Consolidated Financial Statements
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Consolidated Statements of Stockholders’ Equity (Deficit)
and Comprehensive Income (Loss)
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
See Notes to Consolidated Financial Statements
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Consolidated Statements of Cash Flows
Years Ended December 31, 2010, 2009 and 2008
(In Thousands)
See Notes to Consolidated Financial Statements
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements
Years Ended December 31, 2010, 2009 and 2008
1. DESCRIPTION OF COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Alaska Communications Systems Group, Inc. and Subsidiaries (the “Company” or “ACS Group”), a Delaware corporation, provides wireline, wireless and other telecommunications and network services to consumer, business, and enterprise customers in the State of Alaska and beyond using its statewide and interstate telecommunications network. The Company was formed in October of 1998 for the purpose of acquiring and operating telecommunications properties.
The accompanying consolidated financial statements for the Company are as of December 31, 2010 and 2009 and for the years ended December 31, 2010, 2009 and 2008. They represent the consolidated financial position, results of operations and cash flows of ACS Group and the following wholly owned subsidiaries:
•
Alaska Communications Systems Holdings, Inc. (“ACS Holdings”)
•
ACS of Alaska, Inc. (“ACSAK”)
•
ACS of the Northland, Inc. (“ACSN”)
•
ACS of Fairbanks, Inc. (“ACSF”)
•
ACS of Anchorage, Inc. (“ACSA”)
•
ACS Wireless, Inc. (“ACSW”)
•
ACS Long Distance, Inc. (“ACSLD”)
•
ACS Internet, Inc. (“ACSI”)
•
ACS Messaging, Inc. (“ACSM”)
•
ACS Cable Systems, Inc. (“ACSC”)
•
Crest Communications Corporation (“Crest”)
•
WCI Cable, Inc.
•
WCIC Hillsboro, LLC.
•
Alaska Northstar Communications, LLC.
•
WCI Lightpoint, LLC.
•
Worldnet Communications, Inc.
•
Alaska Fiber Star, LLC.
In addition to the wholly owned subsidiaries, the Company has a 49% interest in TekMate, LLC (“TekMate”) which is represented in the Company’s consolidated financial statements as an equity method investment.
A summary of significant accounting policies followed by the Company is set forth below:
Basis of Presentation
The consolidated financial statements include all subsidiaries of the Company. All significant intercompany accounts have been eliminated. In the opinion of management, the financial statements contain all normal, recurring adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows for all periods presented.
Significant Changes in Accounting Practice, Reclassifications and Adjustments
As previously reported in the Company’s quarterly filing for the three months ended March 31, 2010, the Company identified a cumulative adjustment which reduced wireline revenue by $5,764 and wireline income tax expense of $2,369 over a five year period beginning January 1, 2005. The adjustment was determined to be an immaterial error in the calculation of a regulatory liability payable to the Universal Service Administration Company (“USAC”) for high cost loop support, and the related income tax expense. The Company concluded that these errors were not material to any of its prior period financial statements under the guidance of SEC Staff Accounting Bulletin (“SAB”) No. 99 Materiality. Although the errors were and continue to be immaterial to prior periods, because of the significance of the out-of-period correction in the first quarter of 2010, the Company applied the guidance of SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements, and revised its prior period financial statements.
In addition to an increase of $3,119 in the Company’s accumulated deficit on December 31, 2008, the schedules that follow recast the immaterial error to reflect the balances as if they had been recorded in the proper periods.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The following schedule presents a reconciliation of the effects of the adjustments made to the Company’s previously reported balance sheet line items for December 31, 2009:
The following schedule presents a reconciliation of the effects of the adjustments made to the Company’s previously reported annual consolidated statements of operations for the twelve months ended December 31, 2009 and 2008, respectively:
The following schedule presents a reconciliation of the effects of the adjustments made to the Company’s previously reported consolidated statements of cash flows for the twelve months ended December 31, 2009 and 2008, respectively:
Additionally, certain reclassifications have been made to the 2009 and 2008 financial statements to conform to the current reporting format and include the Company’s discontinuance of regulatory accounting under Accounting Standards Codification (“ASC”) Topic 980 Regulated Operations (“ASC 980”). As a result of the approval of a petition submitted to the Federal Communications Commission (“FCC”) to be re-characterized from a “rate-of-return” carrier to a “price-cap” carrier and other factors, the Company ceased application of
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
regulatory accounting effective July 1, 2009. See Note 2 - “Discontinuance of Regulatory Accounting” for a complete discussion of these changes.
Use of Estimates
The preparation of financial statements in conformity with U.S. 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. Among the significant estimates affecting the financial statements are those related to the realizable value of accounts receivable, long-lived assets, goodwill and intangible assets, legal contingencies, stock-based compensation and income taxes. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, which management believes is reasonable under the circumstances. Assumptions are adjusted as facts and circumstances dictate. Illiquid credit markets, volatile equity and energy markets, and declines in consumer spending have combined to increase the uncertainty in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results may differ significantly from those estimates. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the financial statements of future periods.
Cash and Cash Equivalents
For purposes of the “Consolidated Balance Sheets” and “Consolidated Statements of Cash Flows”, the Company generally considers all highly liquid investments with a maturity at acquisition of three months or less to be cash equivalents.
Restricted Cash
In the twelve months ended December 31, 2010, the Company released $931 from restricted cash primarily representing funds released from escrow related to claims against the Crest Communications Corporation former stockholders (“Selling Stockholders”). These funds were applied toward the settlement of a capital project funded by the Crest selling shareholders and for costs incurred in connection with the current IRS audit. See Note 5 - Crest Communication Acquisition for more information on the audit. As of December 31, 2010, $3,646 remains in escrow for the indemnification of the Company pending resolution of the audit.
The remaining balance of $1,266 is held in certificates of deposit as required under the terms of certain contracts to which the Company is a party. When the restrictions are lifted, the Company will transfer these funds back into its operating accounts.
Bad Debt Reserves
The Company establishes estimated bad debt reserves against uncollectible receivables incurred during the period. These estimates are derived through a monthly analysis of account aging profiles and a review of historical recovery experience. Receivables are charged off against the allowance when management believes the uncollectability of the receivable is confirmed. Subsequent recoveries, if any, are credited to the allowance. The Company records bad debt expense as a component of Selling general and administrative expense on the “Consolidated Statements of Operations”. The Allowance for doubtful accounts at December 31, 2010, 2009 and 2008 was $6,616, $6,066 and $5,912, respectively. The Provision for uncollectable accounts for the year ended December 31, 2010, 2009 and 2008 was $2,863, $6,258 and $4,753, respectively.
Materials and Supplies
Materials and supplies are carried in inventory at the lower of weighted average cost or market. Cash flows related to the sale of inventory, primarily wireless devices and accessories, are included in operating activities in the Company’s “Consolidated Statements of Cash Flows”.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Property, Plant and Equipment
Telephone property, plant and equipment is stated at historical cost of construction including certain capitalized overhead and interest charges. Renewals and betterments of telephone plant are capitalized while repairs, as well as renewals of minor items, are charged to cost of sales and services as incurred. The Company uses a group composite depreciation method in accordance with industry practice. Under this method, telephone plant retired in the ordinary course of business, less salvage, is charged to accumulated depreciation with no gain or loss recognized. The composite annualized rate of depreciation for all classes of telephone property, plant, and equipment was 5.2%, 5.5% and 4.8% for 2010, 2009, and 2008, respectively. Non-telephone plant is stated at historical cost including certain capitalized overhead and interest charges, and when sold or retired a gain or loss is recognized. Depreciation of property is provided on the straight-line method over estimated service lives ranging from 2 to 50 years.
The Company is the lessee of equipment and buildings under capital leases expiring in various years through 2025. The assets and liabilities under capital leases are initially recorded at the lower of the present value of the minimum lease payments or the fair value of the assets at the inception of the lease. The assets are amortized over the lower of their related lease terms or the estimated productive lives. Amortization of assets under capital leases is included in depreciation and amortization expense.
The Company is also the lessee of various land, building and personal property under operating lease agreements for which expense is recognized on a monthly basis. Increases in rental rates are recorded as incurred which approximates the straight-line method.
Capitalized Interest
The Company capitalizes interest charges associated with construction in progress based on a weighted average interest cost calculated on the Company’s outstanding debt. Interest expense for the years ended December 31, 2010, 2009 and 2008 was $34,754, $38,411 and $34,072, net of capitalized interest of $1,639, $3,607 and $4,984, respectively.
Asset retirement obligations
The Company records liabilities for obligations related to the retirement and removal of long-lived assets. The Company records, as liabilities, the fair value of asset retirement obligations on a discounted basis when they are incurred, which is typically at the time the asset is installed or acquired. Amounts recorded for the related assets are increased by the amount of these obligations. Over time, the liabilities increase due to the change in their present value, and the initial capitalized costs are depreciated over the useful life of the related assets. The liabilities are eventually extinguished when the asset is taken out of service.
Non-current Investments
The Company’s non-current investment balance is made up of auction rate securities (“ARS”). Beginning February 13, 2008, the Company experienced failed auctions for ARS issues and at that time, ceased to purchase auction rate securities. The Company believes that the current lack of liquidity relating to ARS investments will have no impact on the ability to fund ongoing operations and growth initiatives.
Equity Method of Accounting
The Company accounts for investments greater than 20% in affiliates, which are not under Company control, by the equity method of accounting. Under this method, our equity investments are carried at acquisition cost, increased by the Company’s proportionate share of the investee’s net income, and decreased by the proportionate share of the investee’s net losses and by dividends received.
Goodwill and Intangible Assets
Goodwill and indefinite-lived intangible assets are not amortized but are assessed for impairment on at least an annual basis. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their residual values and reviewed for impairment in accordance with the provisions of ASC Topic 350-20-35, Intangibles -Goodwill and Other, Subsequent measurement (“ASC 350”).
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Debt Issuance Costs
Underwriting and certain other costs associated with the issuance of the Company’s senior credit facility and senior unsecured notes are being amortized using the straight line method which approximates the effective interest method over the term of the related instruments. In the fourth quarter of 2010, the Company capitalized $7,276 in debt issuance costs incurred in obtaining its 2010 Senior Secured Credit Facility and, during 2008, the Company capitalized $4,368 of debt issuance costs of incurred in the course of its convertible debt offering. Amortization of debt issuance costs in the “Consolidated Statements of Cash Flows” for 2010, 2009 and 2008, was $4,651 (inclusive of a write off of $2,182 in debt issuance costs on the 2005 Senior Secured Credit Facility), $2,594 and $2,410, respectively.
Debt Discounts
The Company’s 2010 Senior Secured Credit Facility was issued at a 1.0% discount and the Company’s 5.75% Convertible Notes have an equity portion that is attributable to their conversion feature. These debt discounts are accreted to interest expense using the effective interest method. Accretion of debt discounts, in the “Consolidated Statements of Cash Flows” for 2010, 2009 and 2008, were $5,023, $4,374 and $2,880, respectively.
Preferred Stock
The Company has 5,000, no par, shares authorized, none of which were issued or outstanding at December 31, 2010 and 2009.
Revenue Recognition
Substantially all recurring non-usage sensitive service revenues are billed one month in advance and are deferred until earned. Non-recurring and usage sensitive revenues are billed in arrears and are recognized when earned. Certain of the Company’s bundled products and services, primarily in wireless, have been determined to be revenue arrangements with multiple deliverables. Total consideration received in these arrangements is allocated and measured using units of accounting within the arrangement based on relative fair values. Wireless offerings include wireless phones and service contracts sold together in the Company’s stores. The handset and accessories associated with these direct channel sales is recognized at the time the related wireless phone is sold and is classified as equipment sales. Monthly service revenue is recognized as services are rendered.
Prior to the Company’s conversion to price caps effective July 1, 2009, the Company participated in interstate access revenue pools with other telephone companies. These pools were funded by toll revenue and access charges regulated by the FCC within the interstate jurisdiction. Much of the interstate access revenue was initially recorded based on estimates which were derived from interim financial information, available separations studies and the most recent information available about achieved rates of return. These estimates are subject to adjustment in future accounting periods as additional operational information becomes available for the Company and the other telephone companies. To the extent that disputes arise over revenue settlements, the Company’s policy is to defer the recognition of revenue until settlement methodologies are resolved and finalized. At December 31, 2010 the Company’s deferred revenue was $7,234 as compared to $3,255 at December 31, 2009. This increase primarily reflects a $5,896 reserve recorded in 2010 pending the settlement of a prior period amended filing for high cost loop support with National Exchange Carrier’s Association (“NECA”), offset partially by cost study true-ups from settlement of interstate access pools.
Concentrations of Risk
Cash is maintained with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand. The Company has not experienced any losses on such deposits.
The Company performs credit evaluations of its suppliers and customers. The Company’s customers do not, individually, represent a material concentration of risk. During 2010, 2009 and 2008, no customer accounted for 10% or more of consolidated revenues.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Company also depends on a limited number of suppliers and vendors for equipment and services for its network, and in the case of the Company’s wireless segment, billing processes. The Company’s subscriber growth and operating results could be adversely affected if these suppliers experience financial or credit difficulties, service interruptions, patent litigation, or other problems.
At December 31, 2010, approximately 74% of the Company’s employees are represented by the International Brotherhood of Electrical Workers, Local 1547 (“IBEW”). The Master Collective Bargaining Agreement between the Company and the IBEW expires on December 31, 2012. This agreement governed the terms and conditions of employment for all IBEW represented employees working for the Company in the state of Alaska. The Company considers employee relations to be good however any deterioration in that relationship could have a negative impact on the Company’s operations.
The Company provides voice, data and wireless telecommunication services to its customers throughout Alaska. Accordingly, the Company’s financial performance is directly influenced by the competitive environment in Alaska, including the risk of additional entrants such as, potentially, Verizon, and by economic factors specifically in Alaska. The most significant factor is the level of Alaskan oil production since the state is almost entirely dependent on this resource for its general operating revenue. Other factors influencing the Alaskan economy include the level of tourism, government spending, and the movement of United States military personnel. Any deterioration in these markets would likely have a negative impact on the Company’s performance.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense totaled $7,570, $7,360 and $7,074 in 2010, 2009 and 2008, respectively and is included in Selling, general and administrative expense in the Company’s “Consolidated Statements of Operations”.
Income Taxes
The Company utilizes the asset-liability method of accounting for income taxes. Under the asset-liability method, deferred taxes reflect the temporary differences between the financial and tax basis of assets and liabilities using the enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent that management believes it is more likely than not that such deferred tax assets will not be realized. The Company evaluates tax positions taken or expected to be taken in the course of preparing its financial statements to determine whether the tax positions are “more likely than not” of being sustained by the applicable tax authority. The Company records interest and penalties for underpayment of income taxes as income tax expense.
Taxes Collected from Customers and Remitted to Government Authorities
The Company excludes taxes collected from customers and payable to government authorities from revenue. Taxes payable to government authorities are presented as a liability on the “Consolidated Balance Sheets”.
Regulatory Accounting and Regulation
The local telephone exchange activities of the Company are subject to rate regulation by the FCC for interstate telecommunication service and the Regulatory Commission of Alaska (“RCA”) for intrastate and local exchange telecommunication service. The Company, as required by the FCC, accounts for such activity separately. Long distance services of the Company are subject to regulation as a non-dominant interexchange carrier by the FCC for interstate telecommunication services and the RCA for intrastate telecommunication services. Wireless, Internet and other non-common carrier services are not subject to rate regulation.
Non-Operating Expense
The Company periodically evaluates the fair value of its investments and other non-operating assets against their carrying value whenever market conditions indicate a change in that fair value. Any changes relating to declines in the fair value of non-operating assets are charged to non-operating expense under the caption “Other” in the “Consolidated Statements of Operations”.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Derivative Financial Instruments
The Company recognizes all asset or liability derivatives at fair value. The accounting for changes in fair value is contingent on the intended use of the derivative and its designation as a hedge. Derivatives that are not hedges are adjusted to fair value through earnings. If a derivative is a hedge, depending on the nature of the hedge, changes in fair value either offset the change in fair value of the hedged assets, liabilities or firm commitments through earnings, or are recognized in other comprehensive income until the hedged transaction is recognized in earnings. The change in a derivative’s fair value related to the ineffective portion of a hedge, if any, is immediately recognized in earnings. The Company does not enter into any derivative contracts for speculative purposes. On the date a derivative contract is entered into, the Company designates the derivative as either a fair value or cash flow hedge. The Company formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. If the Company determines that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company would discontinue hedge accounting prospectively.
Dividend Policy
The Company’s Board of Directors has established a dividend policy of $0.86 per share of the Company’s common stock on an annualized basis, subject to the continued performance and liquidity needs of the Company. In 2010, 2009 and 2008, the Company’s Board of Directors declared quarterly cash dividends of $0.215 per share. Dividends on the Company’s common stock are not cumulative.
Share-Based Payments
Stock options. The fair value for each stock option granted was estimated at the date of grant using a Black-Scholes option pricing model. Expected volatilities are based on historical volatilities of the Company’s common stock; the expected life represents the weighted average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and the Company’s historical exercise patterns; the dividend yield is based on dividend yield of the option strike price at grant date; and the risk free interest rate on the grant date, for which the Company uses the lowest then effective Federal Funds interest rate stated by the Board of Governors of the Federal Reserve System.
Restricted stock. The Company determines the fair value of restricted stock based on the number of shares granted and the quoted market price of the Company’s common stock on the date of grant, discounted for estimated dividend payments that do not accrue to the employee during the vesting period.
Performance share units (“PSUs”). The Company re-measures the fair value of each PSU at each reporting period and records adjusted expense attributable to such period based on changes to the expected performance period or fair value of the Company’s common stock or if the PSUs otherwise vest, expire, or are determined by the Compensation Committee to be unlikely to vest prior to expiration. Compensation expense is recorded over the expected performance period, which is estimated by the Compensation Committee of the Company’s Board of Directors.
Stock-settled stock appreciation rights (“SSARs”). The Company computes the fair value of each SSAR at the date of grant using the same Black-Scholes pricing methodology that its uses to compute the fair value of a stock option on the Company’s common stock.
Restricted stock unit equivalents (“RSUEs”). The Company’s outstanding RSUEs were settled in shares of the Company’s common stock on a one-for-one basis on July 31, 2009. Prior to settlement, compensation expense was recorded upon award and was adjusted at the close of each reporting period based upon the fair value of the Company’s common stock.
Tax treatment. Stock-based compensation is treated as a temporary difference for income tax purposes and increases deferred tax assets until the compensation is realized for income tax purposes. To the extent that realized tax benefits exceed the book based compensation, the excess tax benefit is credited to additional paid in capital.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Accounting for Pensions The Company recognizes the over-funded or under-funded status of its defined benefit post-retirement plan as an asset or liability on its balance sheet, and it recognizes changes in that funded status in the year in which the changes occur. The ACS Retirement Plan, which is the Company’s sole single-employer defined benefit plan, is frozen. The ACS Retirement Plan’s accumulated benefit obligation is the actuarial present value, as of the Company’s December 31, 2010 measurement date, of all benefits attributed by the pension benefit formula.
The amount of benefit to be paid depends on a number of future events incorporated into the pension benefit formula, including estimates of the average life of employees or survivors and average years of service rendered. It is measured based on assumptions concerning future interest rates and future employee compensation levels. The accumulated benefit obligation for the Company’s pension plans was $14,976 and $14,129 at December 31, 2010 and December 31, 2009, respectively.
Unrecognized prior service credits and costs and net actuarial gains and losses are recognized as a component of other comprehensive income, net of tax, the actuarial gains and losses and the prior service costs and credits that arise during the period. The estimated net loss and prior service cost for pension benefits that will be amortized from comprehensive income into net periodic benefit cost in 2011 is $733.
Earnings per Share
The Company computes earnings per share based on the weighted number of shares of common stock and dilutive potential common share equivalents outstanding.
2. DISCONTINUANCE OF REGULATORY ACCOUNTING
Prior to July 1, 2009, the Company’s incumbent local exchange carrier (“ILEC”) operations followed the accounting for regulated enterprises prescribed by ASC 980. This accounting recognizes the economic effects of rate-making actions of regulatory bodies in the financial statements of the Company’s ILEC operations.
On April 17, 2009 the FCC granted the Company’s petition for waiver of certain rules to facilitate the conversion of the Company’s ILECs to “price-cap” regulation, under which ILECs may fix interstate rates at any level less than or equal to certain specified amounts. To establish pricing in accordance with these rules, the Company’s ILECs have withdrawn from certain tariffs and revenue pools administered by the NECA and jointly filed with the FCC a new tariff effective as of July 1, 2009. These ILECs also continue to receive interstate common line support from the universal service fund at the disaggregated per line levels each received in 2008.
The Company expects average traffic sensitive rates to decrease over time until they are less than or equal to the cap applicable to such rates. The Company’s local and intrastate rates continue to be subject to a form of “rate-of-return” regulation enforced by the RCA.
Finally, the Company experienced continuous and substantial change in the mix of customer and revenue base away from services generated by regulated rates. The Company does not expect this trend to reverse in favor of regulated revenues. Therefore, as of July 1, 2009, management determined that it was no longer appropriate to continue to apply regulatory accounting under ASC 980.
Effect of Discontinuance
Discontinuance of regulatory accounting required the Company to extinguish all of its previously established jurisdictional assets and liabilities. The Company’s jurisdictional assets accounted for the disparity between State and Federal depreciation rates. Extinguishing these assets did not affect the Company’s Consolidated Statements of Operations as the blended rates used to calculate the assets were determined to approximate the estimated useful lives of the assets. The Company’s jurisdictional liability represented the regulatory equivalent of an asset retirement obligation (“ARO”), therefore management assessed its regulated assets to determine the ARO required under ASC Topic 410 - Asset Retirement and Environmental Obligations (“ASC 410”) and retained an ARO liability of $1,285. The impact of extinguishing the Company’s jurisdictional liability net of the ARO determined in accordance with ASC 410, of $63,417 or $37,346 net of tax, was recorded as an extraordinary gain in the Company’s “Consolidated Statement of Operations” on July 1, 2009. In evaluating the Company’s discontinuance of regulatory accounting, fixed asset lives and salvage values were reviewed. Upon
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
2. DISCONTINUANCE OF REGULATORY ACCOUNTING (Continued)
completion of this review, it was determined that asset lives were still appropriate, however, changes in the industry and current technology indicated the historical salvage values were no longer appropriate and the original cost of these pools should be fully depreciated. The corresponding change resulted in an increase in depreciation expense for asset pools that had previously been fully depreciated. Additionally, management reviewed long-lived assets for evidence of impairment concluding no impairment existed.
As a result of the discontinuance of regulatory accounting, the Company has made certain reclassifications and adjustments to previously reported 2009 and 2008 financial statements to conform to current presentation. The effect of these reclassifications and adjustments, are as follows:
The reclassifications had no affect on the Company’s previously reported operating cash flow, income before taxes, or net income.
3. COMPREHENSIVE INCOME (LOSS)
Components of comprehensive income (loss) are as follows:
4. EQUITY METHOD INVESTMENT
On August 31, 2010, the Company completed the purchase of a 49% interest in TekMate, LLC, for a purchase price of $2,060. The price paid to acquire the Company’s share of the net assets of TekMate differs from the underlying book value of such net assets. This premium of $1,641 is accounted for as equity method goodwill and is included within the Equity method investment on the balance sheet. The purchase agreement included a preferred distribution to the sellers of $698 which is payable from future earnings. When the subsequent earnings of TekMate exceed $698, the Company will begin to realize its share of TekMate’s earnings in Revenue on the statement of operations. As of December 31, 2010, earnings have not exceeded the preferred distribution and no revenue has been recognized by the Company. The investment represents the Company’s maximum exposure to loss as a result of the Company’s ownership interest.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
4. EQUITY METHOD INVESTMENT (Continued)
The investment in TekMate is accounted for under the equity method, and consisted of the following at December 31, 2010:
5. CREST COMMUNICATIONS ACQUISITION
Effective October 30, 2008, the Company closed its purchase of 100% of the outstanding stock of Crest Communications Corporation. The results of Crest’s operations have been included in the Company’s consolidated financial statements and further in the wireline segment in the business segment footnote, since that date. Crest’s operations include the operation of an undersea fiber system of approximately 1,900 miles with cable landing facilities in Whittier, Juneau, and Valdez, Alaska and Nedonna Beach, Oregon. The system also includes terrestrial transport components linking Nedonna Beach, Oregon to the Network Operations Control Center in Hillsboro, Oregon and collocation facilities in Portland, Oregon and Seattle, Washington.
On the date of purchase, a valuation of the business enterprise and acquired assets and liabilities was performed resulting in a determination that the fair value of the business enterprise was greater than the total acquisition price. The major asset acquired was the Northstar fiber network connecting Alaska with the Lower 48, which was valued based on replacement cost. Accordingly, the total cost of the acquisition has been allocated to the assets acquired and the liabilities assumed based on a pro-rata reduction of their estimated fair value at the date of acquisition.
On October 30, 2009, during the finalization of purchase accounting, the aggregate purchase price was adjusted from $64,960 to $65,400, net of $1,072 in cash acquired and inclusive of $4,169 cash consideration that was placed in an escrow account to be used for the settlement of any potential claims of misrepresentations, breach of warranties or covenants or for other indemnifications. At December 31, 2010 $3,646 remained in the escrow account to be used for the settlement of expenses related to the current IRS audit discussed below. All other escrow issues have been resolved.
The final adjustments to the preliminary allocation, primarily reflects the reallocation of property, plant and equipment to deferred tax assets as the result of the final evaluation of the expected utilization of Crest’s net operating loss carry forwards. The following table summarizes the fair value of the assets acquired and liabilities assumed on both a preliminary and final basis.
On April 19, 2010, the Internal Revenue Service (the “Service”) issued a Notice of Proposed Adjustment (“NOPA”) with respect to the 2006, 2007 and 2008 taxable years of Crest, which was acquired by the Company on October 30, 2008. Crest had acquired certain entities out of bankruptcy in 2002. The original majority stockholder of these entities, an Australian insurance company, AMP, had made certain advances to the entities. These entities entered into bankruptcy in 2001 and the bankruptcy court approved a plan which
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
5. CREST COMMUNICATIONS ACQUISITION (Continued)
effectively subordinated these advances to all other creditors. Upon acquiring the entities in 2002, Crest characterized the advances as equity for tax purposes. The Service is asserting that characterization of the AMP advances as equity was incorrect and that Crest had additional taxable income due to the cancellation of debt.
On November 2, 2010, the Internal Revenue Service reissued their original NOPA and issued four additional NOPAs which restate their original position on debt versus equity and assess the Company for accuracy related penalties and for adjustments to the tax treatment of optical cables, fibers and related conduit. The cancellation of indebtedness income at the amounts set out in the combined NOPAs could result in a charge to income tax expense of approximately $89,843, $50,353 of which would be a result of additional taxes payable and $39,490 of which would be a result of the reduction in recognized deferred tax assets.
The Company believes there are errors within the adjustments asserted by the Service. If the Service accepts the corrections the Company believes are appropriate, but prevails on the underlying debt versus equity issue, the result is expected to be a receivable from the IRS for the overpayment of alternative minimum tax of $2,781, a charge to income tax expense of approximately $29,678, and a net reduction in recognized deferred tax assets. The Company believes it is more likely than not that it will prevail on the factual errors included in the NOPAs; however, it is unable to conclude it is more likely than not it will prevail on the underlying debt versus equity issue. Therefore, in accordance with the guidance in ASC Topic 740 -Income Taxes (“ASC 740”), the Company recorded $29,678 in additional income tax expense and a $2,781 receivable in the second quarter of 2010, pending resolution with the Service.
The additional income tax expense is made up of two components: the first representing $11,018 for the tax effect of losing NOLs while the remaining $18,660 represents a deferred tax liability for the difference in outside basis in certain Crest subsidiaries. ASC 740 requires recognition of a deferred tax liability for outside basis differences. An outside basis difference represents the amount by which the book basis of an investment in a domestic subsidiary for financial reporting purposes exceeds the tax basis in such subsidiary. For certain Crest subsidiaries, the cancellation of debt created a difference in outside basis that the Company cannot recover in a tax-free manner and as such, a deferred tax liability was established. Through enforcing indemnification rights, preserving the corporate structure of the Crest subsidiaries and other proactive steps, it is possible to mitigate most or all of the cash impact of the $18,660 deferred tax liability for as long as the Company remains a going concern.
The Stock Purchase Agreement (“SPA”) underlying the Company’s acquisition of Crest provides for indemnification for the Company by the former stockholders (“Selling Stockholders”) of Crest. This indemnity was entered into with the intent to mitigate the impact on the Company of potential tax exposure items such as those raised by the NOPAs. The Company and the selling stockholders intend to contest all issues raised by the NOPAs through various avenues of appeal. However, should the appeals process fail to overturn the NOPAs, should the Company be unable to preserve the corporate structure of the Crest subsidiaries and should the Company prove unable to effectively enforce the indemnification provisions in the SPA, this could have a material adverse effect on the Company’s consolidated financial position, results of operations and cash flows.
6. FAIR VALUE MEASUREMENTS
The Company has developed valuation techniques based upon observable and unobservable inputs to calculate the fair value of long-term monetary assets and liabilities. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy:
•
Level 1 - Quoted prices for identical instruments in active markets;
•
Level 2 - Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable; and
•
Level 3 - Significant inputs to the valuation model are unobservable.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
6. FAIR VALUE MEASUREMENTS (Continued)
The fair values of cash and cash equivalents, net accounts receivable, and payable, other short-term monetary assets and liabilities and capital leases approximate carrying values due to their nature. The fair value of the Company’s 2010 senior credit facility, convertible notes and other long-term obligations of $563,004 at December 31, 2010, were estimated based on dealer quoted prices. The carrying values of these liabilities were $553,309 at December 31, 2010.
Fair Value Measurements on a Recurring Basis
Financial assets and liabilities are classified in the fair value hierarchy in their entirety based on the lowest level of input that is significant to the fair value measurements. The Company’s assessment of the significance of a particular input to the fair value measurements requires judgment and may affect the valuation of the assets and liabilities being measured and their level within the fair value hierarchy.
The following table presents the balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 and 2009 at each hierarchical level:
The following table presents the reconciliation disclosures about fair value measurements at December 31, 2010, 2009 and 2008 using significant unobservable inputs (“Level 3”).
Non-current investments consist of auction rate securities that have maturity dates greater than one year from December 31, 2010. The investments in ARS are included in Level 3 as no active market or significant other observable inputs exist. The Company assigned a value to its ARS portfolio by reviewing the value assigned to similar securities by brokerages, relative yields and assessing credit risk. An assessment was performed in which management determined that the securities were other-than-temporarily impaired, and in 2008, a charge of $245 was recognized in the statement of operations. The fair value of ARS held by the Company at December 31, 2010 decreased by $650 from the value at December 31, 2008 due to the redemption by issuers, at face value of $500 and $150, in the years ended December 31, 2010 and 2009, respectively. The Company
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
6. FAIR VALUE MEASUREMENTS (Continued)
continued to experience redemptions thus no further impairment was recorded in 2010 or 2009. The securities are interest bearing with an average yield of 0.78% and 0.48% in 2010 and 2009, respectively.
Derivative contracts, included in other long-term assets and other long term liabilities, comprised of out-of-the-money interest rate swaps that are valued using models based on readily observable market parameters for all substantial terms of the derivative contracts and thus, are classified within Level 2.
Fair Value Measurements on a Nonrecurring Basis
Beginning January 1, 2009, the Company adopted the fair value measurement requirements related to non-financial assets and non-financial liabilities that are not required or permitted to be measured at fair value on a recurring basis. Those include assets measured at fair value in goodwill impairment testing, indefinite-lived intangible assets measured at fair value for impairment assessment, non-financial long-lived assets measured at fair value for impairment assessment and those initially measured at fair value in a business combination. The adoption of these requirements had no material impact on the consolidated financial statements. During the fourth quarter of 2009, using level three inputs, the Company performed an impairment assessment of certain long lived assets; primarily IT system software with a carrying value of $10,899. The Company determined the fair value of these assets, held in the wireline segment, to be $7,173 as of December 31, 2009. Accordingly the Company recorded an impairment charge of $3,726. During the fourth quarter of 2010, the Company recorded an additional impairment charge of $2,285 when it was determined that certain assets were abandoned.
7. ACCOUNTS RECEIVABLE
Accounts receivable - trade consists of the following at December 31, 2010 and 2009:
8. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at December 31, 2010 and 2009:
*
No depreciation charges are recorded for land.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
8. PROPERTY PLANT AND EQUIPMENT (Continued)
The following is a summary of property held under capital leases included in the above property, plant and equipment at December 31, 2010 and 2009:
Amortization of assets under capital leases included in depreciation expense for the year ended December 31, 2010, 2009, and 2008 was $1,211, $1,087 and $938, respectively. Future minimum payments, including interest, under these leases for the next five years and thereafter are as follows:
The Company leases various land, buildings, right-of-ways and personal property under operating lease agreements. Rental expense under operating leases for the year ended December 31, 2010, 2009 and 2008 was $9,629, $8,247 and $7,559, respectively.
Future minimum payments under these leases for the next five years and thereafter are as follows:
9. ASSET RETIREMENT OBLIGATIONS
The Company accounts for asset retirement obligations in accordance with ASC 410 which requires the Company to recognize asset retirement obligations that are conditional on future events. Uncertainty about the timing or settlement of the obligation is factored into the measurement of the liability.
Historically, the Company followed ASC 980 for asset retirement obligations associated with its ILEC plant. However, the Company’s discontinuance of regulatory accounting, effective July 1, 2009, required the Company to extinguish all of its previously established jurisdictional assets and liabilities. One of the Company’s jurisdictional liabilities, required to be eliminated in 2009, represented the regulatory equivalent of an ARO, therefore management assessed its regulatory assets to determine the ARO required under ASC 410 and retained a liability of $1,285 rather than fully eliminating the balance.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
9. ASSET RETIREMENT OBLIGATIONS (Continued)
The Company’s current retirement obligation of $5,838 represents the estimated obligation related to the removal of certain cell sites at the end of their operating lease term, adjusted for accretion and depreciation over the life of the lease, as well as the removal and disposal of certain equipment and batteries in both leased and owned properties.
The following table outlines the changes in the accumulated retirement obligation liability:
10. GOODWILL AND OTHER INTANGIBLE ASSETS
The Company performs its annual impairment test as of the beginning of the fourth quarter or more frequently if events or changes in circumstance indicate possible impairment. The Company determines the fair value of each reporting unit for purposes of this test primarily by using a discounted cash flow valuation technique corroborated by comparative market multiples to determine the fair value of its businesses for comparison to their corresponding book values. Significant estimates used in the valuation include estimates of future cash flows, both future short-term and long-term growth rates and estimated cost of capital for purposes of arriving at a discount factor. If the book value exceeds the estimated fair value for a reporting unit, a potential impairment is indicated and ASC 350 prescribes the approach for determining the impairment amount, if any.
The testing conducted by the Company of its goodwill balance in the fourth quarter of 2010 and 2009 indicated no impairment existed. In 2008, the Company determined that goodwill attributable to its wireline operating segment was impaired resulting in an aggregate goodwill impairment charge of $29,553 that was recognized in the fourth quarter of 2008. The goodwill impairment recognized in 2008 was primarily driven by adverse equity market conditions, the industry and company’s transition from wireline to wireless products and services, decreases in current market multiples and the decline in the Company’s stock price. This impairment charge reduced goodwill but did not impact the Company’s overall business operations or cash flows. The tax benefit derived from recording the impairment charge was recorded as a deferred income tax benefit and included in the deferred tax assets as part of the net operating loss carry forwards.
Additionally, the Company annually reassesses previously recognized indefinite lived intangible assets. Cellular and PCS licenses have terms of ten years, but are renewable indefinitely through a routine process involving a nominal fee. These fees are expensed as incurred. The Company has determined that no legal, regulatory, contractual, competitive, economic or other factors currently exist that limit the useful life of its Cellular and PCS licenses. Therefore, the Company is not amortizing its Cellular and PCS licenses based on the determination that these assets have indefinite lives. The Company evaluates its determination of indefinite useful lives for its Cellular and PCS licenses each reporting period. Indefinite lived intangible assets are tested for impairment at least annually by comparing the fair value of the assets to their carrying amount. In 2008, the Company determined that the gross carrying value of $88 for domain and trade names associated with the Company’s wireline segment was impaired and recorded an impairment charge of $88. At December 31, 2010 and 2009, the Company’s indefinite lived intangible asset balance consisted of $24,118 in wireless licenses.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
10. GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)
11. ACCOUNTS PAYABLE, ACCRUED AND OTHER CURRENT LIABILITIES
Accounts payable, accrued and other current liabilities consist of the following at December 31, 2010 and 2009:
12. LONG-TERM OBLIGATIONS
Long-term obligations consist of the following at December 31, 2010 and 2009:
The aggregate maturities of long-term obligations for each of the next five years and thereafter, at December 31, 2010, are as follows:
2010 Senior Secured Credit Facility
In the fourth quarter of 2010, the Company completed a transaction whereby it entered into a new $470,000 senior secured credit facility (the “2010 Senior Credit Facility”) and used $440,000 of term loan borrowings
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
12. LONG-TERM OBLIGATIONS (Continued)
under that facility, together with available cash on hand, to repay in full and redeem the $425,889 of outstanding principal under the Company’s 2005 senior credit facility, together with interest accrued thereon, to unwind three interest rate swap agreements associated with the 2005 senior credit facility at a cost of $11,145 and pay underwriters’ discounts and transaction fees and expenses associated with the refinancing transaction. Accordingly, the Company recorded a $13,339 loss on the extinguishment of debt and capitalized deferred financing costs of $7,276 related to the 2010 senior secured credit facility. The new term loan outstanding under the 2010 senior secured credit facility generally bears interest at LIBOR plus 4.0% per annum or 5.5%, whichever is greater, with quarterly principal payments equal to 0.25% of the original principal balance due beginning with first quarter of 2011. The $440,000 term portion of the facility was recorded net of a 1.0% discount, or $4,400, of the debt issuance.
Additionally, as part of the 2010 senior credit facility, the Company has a $30,000 revolving credit agreement, which was undrawn as of December 31, 2010. To the extent drawn, the revolving credit agreement generally bears interest at a rate of annual LIBOR plus 4.0% per annum or 5.5%, whichever is greater. To the extent the $30,000 revolving credit facility is not drawn, the Company will pay an annual commitment fee of 0.625% of the average daily undrawn principal amount over its term.
The Term Facility matures on October 21, 2016 and the Revolving Facility matures on October 21, 2015 unless accelerated pursuant to an event of default or as described below. The Revolver Facility shall be available on a revolving basis during the period commencing on October 21, 2010 and ending five (5) years after the closing date, unless otherwise agreed by the required Lenders and as described below.
The maturity date on the Credit Facilities may be accelerated to December 19, 2012 in the event that (a) the Company’s 5.75% convertible notes due in 2013 are not refinanced, purchased or defeased such that no more than $25,000 of principal amount of such Convertible Notes are outstanding prior that date and (b) the Borrower’s Senior Secured Leverage Ratio as of December 19, 2012 is greater than or equal to 2.75 to 1.00. The Credit Facilities also provide for events of default customary for credit facilities of this type, including non-payment, defaults on other debt, misrepresentation, breach of covenants, representations and warranties, and insolvency and bankruptcy. After the occurrence of an event of default and for so long as it continues, the Administrative Agent or the Requisite Lenders, as defined in the Credit Agreement, may increase the interest rate then in effect on all outstanding obligations by 2.0%. Upon an event of default relating to insolvency, bankruptcy or receivership, the amounts outstanding under the Credit Facilities will become immediately due and payable and the lender commitments will be automatically terminated. Upon the occurrence and continuation of any other event of default, the Administrative Agent and/or the Requisite Lenders may accelerate payment of all obligations and terminate the Lenders’ commitments under the Credit Facilities.
In connection with the 2010 Senior Credit Facility, the Company entered into forward floating-to-fixed interest rate swaps and a buy back of the 1.5% LIBOR floor, as a component of its cash flow hedging strategy. The notional amounts of the swaps are $192,500, $115,500 and $77,000 with interest rates of 6.463%, 6.470% and 6.475%, respectively, inclusive of a 4.0% LIBOR spread. The swaps begin on June 30, 2012 and continue through September 30, 2015. In order to protect against extreme movements in LIBOR prior to the start of the swaps, the Company has acquired an interest rate cap at a cost of $119 for the period between December 31, 2010 and June 30, 2012, capping LIBOR at 3.0% on a notional principal amount of $385,000.
At September 30, 2010, due to the expected extinguishment of debt coincident with the new debt transaction, three interest rate swaps with a total notional balance of $207,900 ceased to be highly effective, and as such, the Company discontinued prospective hedge accounting and concluded it was appropriate to reclassify amounts previously recorded in Accumulated other comprehensive income related to the affected derivatives. The amount reclassified in the third quarter of 2010 from Other comprehensive income to the Interest expense line of the Consolidated Statements of Operations, as a result of the hedges becoming ineffective, was $11,258. The Company ultimately settled these swaps for $11,145 with cash on hand during the fourth quarter of 2010.
The 2010 senior secured credit facility contains a number of restrictive covenants and events of default, including covenants limiting capital expenditures, incurrence of debt and payment of dividends. The 2010 senior credit facility also requires that the Company achieve certain financial ratios quarterly.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
12. LONG-TERM OBLIGATIONS (Continued)
5.75% Convertible Notes due 2013
On April 8, 2008 the Company closed the sale of $125,000 aggregate principal 5.75% Convertible Notes due March 1, 2013. The notes were sold in a private placement pursuant to Rule 144A under the Securities Act of 1933. The Company received net proceeds from the offering of $110,053 after underwriter fees, the convertible note hedge, proceeds from the warrant and other associated costs.
The notes are unsecured obligations of the Company, subordinate to its obligations under its 2010 senior credit facility, pay interest semi-annually in arrears on March 1 and September 1 of each year and will be convertible upon satisfaction of certain conditions. Upon conversion, holders will receive an amount in cash, shares of the Company’s common stock or a combination of both. The notes are guaranteed by substantially all of the Company’s existing subsidiaries. Holders of the notes will have the right to require the Company to repurchase all or some of their notes at 100% of their principal, plus any accrued interest, upon the occurrence of certain events.
Concurrent with the issuance of the notes, the Company entered into convertible note hedge transactions with an affiliate of one of the initial purchasers and certain other financial institutions for the purpose of reducing the potential dilution to common stockholders. If the Company is required to issue shares of its common stock upon conversion of the notes, the Company has the option of receiving up to 9,266 shares of its common stock when the price is between $12.90 and $16.42 per share upon conversion. The Company entered into warrant transactions with the same counterparties whereby the financial institutions have the option of receiving up to the same number of shares of the Company’s common stock when the price exceeds $16.42 per share upon conversion. The convertible note hedge had a cost of $20,431 and has been accounted for as an equity transaction in accordance with ASC Topic 815-40, Derivatives and Hedging - Contracts in Entity’s Own Equity (“ASC 815-40”). Tax benefits of $1,056 were recorded for the year ended December 31, 2008, as an offset to the hedge. All future tax benefits from the deduction related to the purchase of the call option, as part of the convertible note hedge transaction, will be recorded to additional paid in capital over the term of the hedge transaction. The Company received proceeds of $9,852 related to the sale of the warrants, which has been classified as equity because they meet all of the equity classification criteria within ASC 815-40.
The call options purchased and warrants sold contemporaneously with the sale of the convertible notes are equity contracts that meet the paragraph 15(74) scope exception of ASC Topic 815-10, Derivatives and Hedging, and hence do not need to be marked-to-market through earnings. In addition, since the call option and warrant transactions are accounted for as equity transactions, the payment associated with the purchase of the call options and the proceeds received from the issuance of the warrants were recorded in Additional paid in capital in stockholders’ equity as separate equity transactions.
Each $1,000 principal of the notes are convertible into 77.5014 shares of the Company’s common stock, which is the equivalent of $12.90 per share, subject to adjustment upon the occurrence of specified events set forth under the terms of the note. Upon conversion, subject to certain covenants under its existing credit facility, the Company intends to pay the holders the cash value of the applicable number of shares of its common stock, up to the principal amount of the note. Amounts in excess of the principal balance may be paid in cash or in stock at the Company’s option. Holders may convert their notes, at their option, at any time prior to the close of business on the business day immediately preceding the maturity date for the notes under the following circumstances:
•
during any fiscal quarter after the fiscal quarter ended June 30, 2008 (and only during any such fiscal quarter), if the last reported sale price of the Company’s common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is equal to or more than 130.0% of the conversion price of the notes on the applicable trading day;
•
during the five scheduled trading day period after any five consecutive trading-day period (the “measurement period”) in which the trading price per $1,000 principal amount of the notes for each day of the measurement period was less than the 98.0% of the product of the last reported sale price of the Company’s common stock and the conversion rate of the notes on each such day; or
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
12. LONG-TERM OBLIGATIONS (Continued)
•
upon the occurrence of specified corporate transactions described in the indenture governing the notes.
In addition, holders may also convert their notes at their option at any time beginning on November 1, 2012 and ending at the close of business on the second scheduled trading day immediately preceding the maturity date for the notes, without regard to the foregoing circumstances.
Holders who convert their notes in connection with a change of control may be entitled to a make-whole premium in the form of an increase in the conversion rate. In addition, upon a change in control, liquidation, dissolution or de-listing, the holders of the notes may require the Company to repurchase for cash all or any portion of their notes for 100% of the principal amount plus accrued and unpaid interest. As of December 31, 2010, none of the conditions allowing holders of the notes to convert, or requiring the Company to repurchase the notes, had been met. The Company may not redeem the notes prior to maturity.
While it is the Company’s intent to settle the principal portion of this debt in cash, under the provisions of, ASC Topic 260-10, Earnings per Share (“ASC 260-10”), the Company must use the “if converted” method in calculating the diluted earnings per share effect of the assumed conversion of the Company’s contingently convertible debt. Under the “if converted” method, the after tax effect of interest expense related to the convertible securities is added back to net income and the convertible debt is assumed to have been converted into common stock at the earlier of the debt issuance date or the beginning of the period. The Company’s convertible debt was anti-dilutive for the twelve month periods ended December 31, 2010, 2009 and 2008.
Also in accordance with ASC 260-10, the warrants sold in connection with the hedge transaction will have no impact on earnings per share until the Company’s share price exceeds $16.42. Prior to exercise, the Company will include the effect of additional shares that may be issued using the “treasury stock” method. The call options purchased as part of the hedging transaction were anti-dilutive as of December 31, 2010 and, therefore, had no effect on earnings per share.
In May 2008, FASB required that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be accounted for by bifurcating the liability and equity components of the instruments in a manner that reflects the entity’s non-convertible debt borrowing rate when interest cost is recognized in subsequent periods. This requirement was effective as of the beginning of an entity’s first fiscal year beginning after December 15, 2008 and adoption was required to be applied retrospectively to all periods presented. Early adoption was prohibited. The Company retrospectively applied this to the $125,000, 5.75% Convertible Notes issued on April 8, 2008, bifurcating the notes into the liability portion and the equity portion attributable to the conversion feature of the notes. In doing so, the Company used the discounted cash flow approach to value the debt portion of the notes. The cash flow stream from the coupon interest payments and the final principal payment were discounted at 11% to arrive at the valuations. The Company used 11% as the appropriate discount rate after examining the interest rates for similar instruments issued in the same time frame for similar companies without the conversion feature.
The following table includes selected data regarding the convertible notes as of December 31, 2010 and 2009:
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
12. LONG-TERM OBLIGATIONS (Continued)
The following table details the interest components of the convertible notes contained in the Company’s “Consolidated Statements of Operations” for the years ended December 31, 2010 and 2009, respectively:
Capital Leases and Other Long-term Obligations
The Company is a lessee under various capital leases and other financing agreements totaling $5,194 and $5,969 with a weighted average interest rate of 9.87% and 10.19% at December 31, 2010 and 2009, respectively.
13. OTHER LONG-TERM LIABILITIES
Other long-term liabilities consist of the following at December 31, 2010 and 2009:
14. INCOME TAXES
The following table includes a reconciliation of federal statutory tax at 35% to the recorded tax benefit, for each year ended December 31, 2010, 2009 and 2008, respectively:
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
14. INCOME TAX (Continued)
The income tax provision for the years ended December 31, 2010 and 2009 comprised of the following charges:
The Company accounts for income taxes under the asset-liability method. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are recorded at a combined federal and state effective rate of 41.20% and 40.75% as of December 31, 2010 and 2009, respectively, are as follows:
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
14. INCOME TAX (Continued)
In the year ended December 31, 2010, the Company generated a taxable loss which was offset by a tax benefit related to NOLs. Additionally, as discussed below, during the second quarter of 2010 the Company recorded a $29,678 deferred tax expense arising from the Internal Revenue service audit of Crest’s income tax returns for 2006 through 2008. In the year ended December 31, 2009, the Company generated a taxable loss. Offsetting the loss in 2009, the Company recorded a tax benefit related to NOL’s generated in 2009.
The Company files consolidated income tax returns with all if its subsidiaries for U.S. Federal purposes and with the States of Alaska and Oregon. The Company is no longer subject to examination for years prior to 2007. With the exception of the Crest audit, the Company is not currently being audited, nor has it been notified of any pending audits. Except as described below, the Company is not aware of any controversial or unsupported positions taken on its tax returns that have not either been resolved in prior audits, by amending prior returns or by adjusting NOL carry forwards to rectify its filings. The Company has a $162 and $126 current income tax receivable at December 31, 2010 and 2009, respectively. The Company has a long term income tax receivable of $2,781 and $0 at December 31, 2010 and 2009, respectively.
The Company accounts for income tax uncertainties using a threshold of “more-likely-than-not” in accordance with the provisions of ASC 740. The Company has reviewed all of its tax filings and positions taken on its returns and has not identified any material current or future effect on its consolidated results of operations, cash flows or financial position, other than the Crest audit issue described below.
In 2008, the Company acquired Crest Communications Corporation. In June 2009, the Internal Revenue Service commenced an audit of Crest’s tax returns for the years ended December 31, 2006, December 31, 2007 and October 30, 2008. In April and November of 2010, the Internal Revenue Service issued Notices of Proposed Adjustment with respect to the 2006, 2007 and 2008 taxable years of Crest. The NOPAs assess the Company for additional taxable income on cancellation of debt and related attribute reduction, for accuracy related penalties and for adjustments to the tax treatment of optical cables, fibers and related conduit. The Company has responded to the Service and believes it is more likely than not that it will prevail on the factual errors included in the NOPAs; however it is unable to conclude it is more likely than not it will prevail on the underlying debt versus equity issue. Therefore, in accordance with the guidance in ASC 740 in the second quarter of 2010, the Company recorded $29,678 in additional income tax expense and $2,781 receivable pending resolution of the matter. The Company did not recognize any interest or penalties on the deferred tax liability. See Note 5 - Crest Acquisition for more information. The eventual outcome of the audit is unknown, however the Crest purchase agreement provides for an indemnification of the Company by the previous owners which could mitigate the impact of adjustments, if any, resulting from the audits.
In connection with the provisions of ASC Topic 718, Compensation - Stock Compensation, the Company elected to calculate the pool of excess tax benefits under the modified retrospective method, but only to prior interim periods in the year of initial adoption. Future tax benefits increased $821 and decreased $548 in 2010 and 2009, respectively.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
14. INCOME TAX (Continued)
The Company has available at December 31, 2010, unused acquired and operating loss carry forwards of $150,400 for federal tax purposes and $146,973 for state tax purposes that may be applied against future taxable income as shown below:
Acquired unused operating loss carry forwards associated with the Company’s acquisition of Internet Alaska in June 2000 and Crest in October of 2008 are limited by Section 382 of the Internal Revenue Code. Internet Alaska is limited to $216 and Crest is limited to $2,227 per year. To the extent that these limits are not used they can be carried forward to subsequent years thereby effectively increasing that year’s limitation.
Section 382 of the Internal Revenue Code imposes an annual limit on the ability of loss corporations that undergo an “ownership change”. This limitation restricts the amount of operating losses that can be used to reduce its future taxable income. On December 7, 2005, the Company underwent an ownership change thereby subjecting it to the Section 382 loss limitation rules. The corrected overall annual limitation at date of ownership change was $14,874 per year annually increased by unrealized built-in gains of $10,794. The increase in limitation is in effect through the year 2010. The taxable loss generated in 2005 after the change in ownership from December 7, 2005 through the end of the year was $1,489 and has no limitations.
15. EARNINGS PER SHARE
Earnings per share are based on weighted average number of shares of common stock and dilutive potential common shares equivalents outstanding. Basic earnings per share includes no dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of an entity. The Company includes dilutive stock options based on the “treasury stock” method. Due to the Company’s reported net losses before extraordinary items for the years ended December 31, 2010, 2009 and 2008 respectively, 3,563, 3,342 and 2,763 potential common share equivalents outstanding, which consisted of options, restricted stock and stock-settled stock appreciation rights granted to employees and deferred shares granted to directors, were anti-dilutive. Also excluded from the calculation were shares related to the Company’s convertible debt which were anti-dilutive for the twelve month periods ended December 31, 2010, 2009 and 2008.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
15. EARNINGS PER SHARE (Continued)
The following table sets forth the computation of basic and diluted earnings per share for the years ended December 31, 2010, 2009 and 2008:
16. STOCK INCENTIVE PLANS
Under the Company’s stock incentive plans, ACS Group, through the Compensation and Personnel Committee of its Board of Directors, may grant stock options, restricted stock, stock appreciation rights and other awards to officers, employees and non-employee directors. Since inception, ACS Group reserved 14,710 shares of authorized common stock for issuance under its stock incentive plans. In general, instruments issued under the plans vest ratably over three, four or five years and the plans terminate in 2012. After the plans terminate, all shares granted under the plan, prior to termination, continue to vest under the terms of the grant when awarded.
Alaska Communications Systems Group, Inc. 1999 Stock Incentive Plan
In July 2009, ACS shareholders approved the Alaska Communications Systems Group, Inc. 1999 Stock Incentive Plan, as amended (“1999 SIP”), which permits the granting of stock options, restricted stock, stock appreciation rights and other awards to officers and employees. The Company reserved 12,160 shares under this plan. At December 31, 2010, 13,284 equity instruments were granted, 4,042 were forfeited, and 5,957 were exercised. A total of 133 shares that were surrendered for payroll taxes or exercise price may be reissued under the plan and 3,051 shares are available for grant under the plan.
The Company began granting restricted stock in 2005 in lieu of stock options as the primary equity based incentive for executive and non-union represented employees. The time based restricted stock awards have vesting terms that range from three to five years with equal annual vesting amounts. The performance based restricted stock awards cliff vest in five years and have accelerated vesting terms of one third per year if certain profitability and capital expenditure criteria are met. A long-term incentive program (“LTIP”) also exists for executive management. LTIP awards are awarded annually and cliff vest in five years with accelerated vesting in three years if cumulative three year profitability criteria are met.
The Company granted performance share units (“PSUs”) in June 2008 to certain executives under the 1999 SIP. PSUs were awarded on the condition that the participant remains employed or in the service of the Company from the date of the Agreement through the time of vesting. Compensation expense associated with outstanding performance share units were recorded over the estimated performance period which would likely result in the vesting of the awards. The amount of expense recorded each period was dependent upon an estimate of the number of shares that would ultimately be issued. As the payout of these awards was subject to the approval of the compensation committee, the awards were re-measured at each reporting period end until such time as they vested or cancelled. In March 2009, the Compensation and Personnel Committee determined that 50% of the units vested based upon completion of certain goals. In June 2009, the Committee determined approximately 80% of the remaining units had vested based upon individual achievement of the remaining goals and the balance of unvested units were cancelled.
The Company granted SSARs under the 1999 SIP to Liane Pelletier, the Company’s Chief Executive Officer and two other named executive officers in 2008 and 2009. The SSARs have a term of five years and include
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
16. STOCK INCENTIVE PLANS (Continued)
ratable vesting through April 2011.
2003 Options for Officer Inducement Grant
During 2003, the Company’s Board of Directors awarded 1,000 options as an inducement grant in hiring the Company’s Chief Executive Officer. As of December 31, 2010, 800 options have been exercised/converted and 200 are currently outstanding.
2008 Restricted Stock Unit Equivalents for Officer Inducement Grant
In September 2008, the Company entered into an amended and restated employment agreement with Liane Pelletier, the Company’s Chief Executive Officer. Under the agreement, the Company granted the executive 100 fully vested restricted stock unit equivalents (“RSUEs”). These RSUEs were settled in shares of the Company’s common stock, reserved under the 1999 SIP, on a one-for-one basis on July 31, 2009. The Company also paid cash equal to dividends declared on shares of the Company’s common stock from September 1, 2008 through July 31, 2009. The Company accounted for these RSUEs as a liability, re-measured at each reporting period, until July 31, 2009.
Alaska Communications Systems Group, Inc. 1999 Employee Stock Purchase Plan
The 1999 Employee Stock Purchase Plan, as amended, was approved by ACS shareholders in July 2009 and will expire in December 2012. The Company reserved 1,050 shares under this plan. At December 31, 2010, 122 shares are available for issuance and sale. All ACS Group employees and all of the employees of designated subsidiaries generally will be eligible to participate in the purchase plan, other than employees whose customary employment is 20 hours or less per week, is not more than five months in a calendar year or who are ineligible to participate due to restrictions under the Internal Revenue Code.
A participant in the purchase plan may authorize regular salary deductions up to of a maximum of 15% and a minimum of 1% of base compensation. The number shares which may be purchased by any employee during any calendar year may not exceed the lessor of 10 shares per offering period or a fair market value of $25. The amounts so deducted and contributed are applied to the purchase of shares of common stock at 85% of the lesser of the fair market value of such shares on the offering date or the purchase date for such offering period. There are two six month purchase periods in each calendar year; the offering dates are January 1 and July 1 and the purchase dates are June 30 and December 31. The first offering period under the plan commenced on January 1, 2000. Shares are purchased on the open market or issued from authorized but un-issued shares on behalf of participating employees on the purchase date and each such participant has the rights of a stockholder with respect to such shares. During the year ended December 31, 2010, approximately 18% of eligible employees elected to participate in the plan.
ACS Group, Inc. 1999 Non-Employee Director Stock Compensation Plan
The non-employee director stock compensation plan, as amended was approved by ACS shareholders in July 2009. The Company reserved 500 shares under this plan. At December 31, 2010, 324 shares were awarded and 176 shares are available for grant under the plan. In 2007, the Company’s policy required directors to receive not less than 50% of their annual retainer in the form of ACS Group’s stock. Directors were permitted to elect up to 100% of their annual retainer in the form of ACS Group’s stock. Beginning January 1, 2008, the Company’s policy was revised to require that Directors receive a portion of their annual retainer in the form of ACS Group’s stock. Once a year, the Directors elect the method by which they receive their stock (issued or deferred). During the year ended December 31, 2010, 39 shares under the plan were awarded to directors, of which 22 were deferred until termination of service.
Stock Compensation Expense
Total compensation cost for share-based payments was $3,989, $4,273 and $9,477 for the twelve months ended December 31, 2010, 2009 and 2008, respectively.
The Company purchases, from shares reserved under the 1999 SIP, sufficient vested shares to cover employee payroll tax withholding requirements upon the vesting of restricted stock. From time to time the Company also purchases sufficient vested shares to cover employee payroll tax withholding requirements at the aggregate
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
16. STOCK INCENTIVE PLANS (Continued)
exercise price upon exercise of options. Shares repurchased by the Company for this purpose are reallocated to the share reserve with a value deemed to be the fair market value of the shares on the date of surrender and are set aside for future grants under the plan. The Company expects to repurchase approximately 222 shares in 2011. This amount is based upon an estimation of the number of shares of restricted stock awards expected to vest and options expected to be exercised during 2011.
Valuation Assumptions
Assumptions used for valuation of equity instruments awarded during the twelve months ended December 31, 2010, 2009 and 2008:
Equity Instruments Outstanding
Stock Options and Stock Settled Stock Appreciation Rights
Stock options were not granted for the twelve months ended December 31, 2010, 2009 and 2008. There were no SSARs granted for the twelve months ended December 31, 2010. There were 775 SSARs granted for each of the twelve months ended December 31, 2009 and 2008.
Proceeds from the exercise of stock options for the year ended December 31, 2010 were $159. Information on outstanding options under the plan for the year ended December 31, 2010 is summarized as follows:
Restricted Stock Units and Performance Share Units
There were 801, 845 and 846 restricted stock grants for the twelve months ended December 31, 2010, 2009 and 2008, respectively. No RSUEs were converted and no PSUs were granted in the twelve months ended December 31, 2010. However, in the years ended December 31, 2009 100 RSUEs were converted to common stock and in 2008 263 PSUs were granted.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
16. STOCK INCENTIVE PLANS (Continued)
Restricted stock grants outstanding, all of which are un-vested at December 31, 2010, are as follows:
Selected Information on Equity Instruments
Select information on equity instruments under the plan for the years ended December 31, 2010, 2009 and 2008 follows:
Unamortized stock-based payment and the weighted average expense period at December 31, 2010, are as follows:
17. RETIREMENT PLANS
Pension benefits for substantially all of the Company’s Alaska-based employees are provided through the Alaska Electrical Pension Fund (“AEPF”). The Company pays a contractual hourly amount based on employee classification or base compensation. As a multi-employer defined benefit plan, the accumulated benefits and plan assets are not determined for, or allocated separately to, the individual employer. During 2009, the Company received a notice of Zone Freezing Election from the Joint Board of Trustees of the AEPF. The election was a onetime event allowable under the Worker, Retiree and Employer Recovery Act of 2008 which freezes the plan’s zone status for the 2008 plan year at January 1, 2008 values. The notice certified that the plan was in the Green or Safe Zone for the upcoming plan year. During 2010, the Company received notice that the plan remained in the green zone for the upcoming plan year. The Company can not accurately project any change in the plan status in future years given the uncertainty of economic conditions or the effect of actuarial valuations versus actual performance in the market. As a multi-employer defined benefit plan, the accumulated benefits and plan assets are not determined for or allocated separately to an individual employer. The Company’s portion of the plan’s pension cost for 2010, 2009 and 2008 was $9,643, $10,799 and $11,548, respectively.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
17. RETIREMENT PLANS (Continued)
The Company also provides a 401(k) retirement savings plan covering substantially all of its employees. The plan allows for discretionary contributions as determined by the Board of Directors, subject to Internal Revenue Code limitations. There was a $101, $81 and $18 matching contribution for 2010, 2009 and 2008 respectively.
The Company also has a separate defined benefit plan that covers certain employees previously employed by Century Telephone Enterprise, Inc. (“CenturyTel Plan”). This plan was transferred to the Company in connection with the acquisition of CenturyTel’s Alaska properties. Existing plan assets and liabilities of the CenturyTel Plan were transferred to the ACS Retirement Plan on September 3, 1999. Accrued benefits under the ACS Retirement Plan were determined in accordance with the provisions of the CenturyTel Plan. Upon completion of the transfer to the Company, covered employees ceased to accrue benefits under the plan. On November 1, 2000, the ACS Retirement Plan was amended to conform early retirement reduction factors and various other terms to those provided by the AEPF. As a result of this amendment, prior service cost of $1,992 was recorded and is being amortized over the expected service life of the plan participants at the date of the amendment. The Company uses the traditional unit credit method for the determination of pension cost for financial reporting and funding purposes and complies with the funding requirements under the Employee Retirement Income Security Act of 1974 (“ERISA”). With the down turn in the economy over the past few years, the plan is not adequately funded under ERISA at December 31, 2010. Management is currently assessing the timing and amount of a contribution the Company will make during 2011 to maintain required funding levels. Management is also estimating what additional contributions the Company may be required to make in subsequent years in the event the value of the plan’s assets remains volatile or continue to decline. The Company did not contribute to the fund in 2010 for the 2009 tax year nor did it contribute to the fund in 2008 for the 2007 tax year. The Company did make a $35 contribution in 2009 for the 2008 tax year. The Company uses a December 31 measurement date for the plan.
The following is a calculation of the funded status of the ACS Retirement Plan using beginning and ending balances for 2010 and 2009 for the projected benefit obligation and the plan assets:
The plan’s projected benefit obligation equals its accumulated benefit obligation. The 2010 and 2009 liability balance of $3,885 and $3,342 respectively, is recorded on the balance sheet in other long-term liabilities.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
17. RETIREMENT PLANS (Continued)
The following table represents the net periodic pension expense for the ACS Retirement Plan for 2010, 2009 and 2008:
In 2011, the Company expects amortization of net gains and losses of $733.
The assumptions used to account for the plan as of December 31, 2010 and 2009 are as follows:
The discount rates were calculated using a proprietary yield curve based on the top 30% of the universe of bonds included in the bond pool. The expected long-term rate of return on assets rate is the best estimate of future expected return for the asset pool, given the expected returns and allocation targets for the various classes of assets.
Based on risk and return history for capital markets along with asset allocation risk and return projections, the following asset allocation guidelines were developed for the plan:
The plan’s asset allocations at December 31, 2010 and 2009 by asset category are as follows:
*
May include mutual funds comprised of both stocks and bonds.
The following table reflects major categories of plan assets as of December 31, 2010, inputs and valuation techniques used to measure the fair value of plan assets regarding the ACS Retirement Plan:
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
17. RETIREMENT PLANS (Continued)
*
May include mutual funds comprised of both stocks and bonds.
The fundamental investment objective of the plan is to generate a consistent total investment return sufficient to pay plan benefits to retired employees while minimizing the long-term cost to the Company. The long-term (10 year and beyond) plan asset growth objective is to achieve a rate of return that exceeds the actuarial interest assumption after fees and expenses.
Because of the Company’s long-term investment objectives, the Plan administrator is directed to resist being reactive to short-term capital market developments and to maintain an asset mix that is continuously rebalanced to adhere to the plan investment mix guidelines. The Plan’s investment goal is to protect the assets’ long-term purchasing power. The Plan’s assets are managed in a manner that emphasizes a higher exposure to equity markets versus other asset classes. It is expected that such a strategy will provide a higher probability of meeting the plan’s actuarial rate of return assumption over time.
The benefits expected to be paid in each of the next five years and in the aggregate for the five fiscal years thereafter are as follows:
The Company also has a separate executive post-retirement health benefit plan. The Alaska Communications Systems Executive Retiree Health Benefit Plan (“The ACS Health Plan”) was adopted by the Company in November 2001 and amended in October 2002. The ACS Health Plan covers a select group of former management employees and provides a graded subsidy for medical, dental and vision coverage. The Compensation and Personnel Committee of the Board of Directors decided to terminate The ACS Health Plan in January 2004. Two people qualified under the plan are eligible for future benefits and the plan is closed to future participants.
The Company uses the projected unit credit method for the determination of post-retirement health cost for financial reporting and funding purposes and complies with the funding requirements under ERISA. No contribution was made to The ACS Health Plan for 2010, 2009 or 2008, and no contribution is expected in 2011. The Company uses a December 31 measurement date for the plan.
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
17. RETIREMENT PLANS (Continued)
The fundamental investment objective of the plan is to realize an annual total investment return consistent with the conservative risk tolerance plan dictated by the Company. The investment profile of the plan emphasizes liquidity and income, some capital stock investment and some fluctuation of investment return. It is anticipated that the investment manager will achieve this objective by investing the account’s assets in mutual funds. The portfolio may hold common stock, fixed income securities, money market instruments and U.S. Treasury obligations. On December 31, 2010, the plan was overfunded by $75 with plan assets of $213. The net periodic post-retirement cost for 2010 was $0.
18. BUSINESS SEGMENTS
The Company’s segments and their principal activities consist of the following:
•
Wireline - Wireline provides communication services including voice, broadband and data, next generation IP network services, network access, long distance and other services to consumers, carriers, business and government customers.
•
Wireless - Wireless products and services include voice and data products and other value added services and equipment sales.
The Company also incurs interest expense, interest income and other operating and non-operating income and expense at the corporate level, which are not allocated to the business segments nor are they evaluated by management in analyzing the performance of the business segments. These non-operating income and expense items are provided in the accompanying table under the caption “All Other” in order to assist the users of these financial statements in reconciling the operating results and total assets of the business segments to the consolidated financial statements. Common use assets are held at ACS Holdings and are allocated to the business segments based on operating revenue. The accounting policies of the segments are the same as those described in the summary of significant accounting policies.
The following table illustrates selected financial data for each segment as of and for the year ended December 31, 2010:
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
18. BUSINESS SEGMENTS (Continued)
The following table illustrates selected financial data for each segment as of and for the year ended December 31, 2009:
With the discontinuance of regulatory accounting as of July 1, 2009, the Company recorded the elimination of its regulatory assets and liabilities resulting in an extraordinary gain in 2009. Additionally, the Company retrospectively reclassified certain items in the financial statements to conform to the current presentation. See Note 2 - “Discontinuance of Regulatory Accounting” for a detailed description of these changes. The reclassifications had no affect on the Company’s previously reported operating cash flow, income before taxes or net income.
The following table illustrates selected financial data for each segment as of and for the year ended December 31, 2008:
19. COMMITMENTS AND CONTINGENCIES
The Company enters into purchase commitments with vendors in the ordinary course of business. The Company also has long-term purchase contracts with vendors to support the ongoing needs of its business. These purchase commitments and contracts have varying terms and in certain cases may require the Company to buy goods and services in the future at predetermined volumes and at fixed prices.
As a result of the NOPAs and Revised NOPAs issued in connection with the IRS audit of Crest, the Company recorded $29,678 in additional income tax expense and a $2,781 receivable based on its assessment of the more likely than not outcome of the matter. Additionally, the Company is involved in various claims, legal actions
ALASKA COMMUNICATIONS SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements, Continued
Years Ended December 31, 2010, 2009 and 2008
(In Thousands, Except Per Share Amounts)
19. COMMITMENTS AND CONTINGENCIES (Continued)
and regulatory proceedings arising in the ordinary course of business and has recorded litigation reserves of $1,020 as of December 31, 2010 against certain current claims and legal actions. The Company believes that the disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows. However, with respect to the Crest Audit, should the appeals process fail to overturn the NOPA, should the Company be unable to preserve the corporate structure of the Crest subsidiaries, and should the Company prove unable to effectively enforce the indemnification provisions in the purchase agreement pursuant to which it acquired Crest, the matter could have a material effect on the Company’s consolidated financial position, results of operations and cash flows. It is the Company’s policy to expense cost associated with loss contingencies as they are incurred.
The Company pledges substantially all property, assets and revenue as collateral on its outstanding debt instruments.
20. SELECTED QUARTERLY FINANCIAL INFORMATION (Unaudited)