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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C.
20549
 FORM 10-Q (Mark One) x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period
fromto. Commission file number 333-82363 ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.  Delaware
(State or Other Jurisdiction
of Incorporation or Organization)
    
    91-1921377
(I.R.S. Employer
Identification No.)
 600 Telephone Avenue, Anchorage, Alaska 99503
(Address of Principal Executive Offices) (Zip Code) (907) 297-3000
(Registrants Telephone Number, Including Area Code) Not Applicable
(Former name, former address and former three months, if changed since last report) Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yesx      Noo Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yeso     Nox APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the last practicable date.




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TABLE OF CONTENTS PageNumberPART I.
    
    Financial InformationItem 1.
    
    Financial Statements:Consolidated Balance Sheets (unaudited) As of June 30, 2004 and December 31, 2003
    
    
    3Consolidated Statements of Operations (unaudited) For the Three and Six Months Ended June 30, 2004 and 2003
    
    
    4Consolidated Statements of Cash Flows (unaudited) For the Six Months Ended June 30, 2004 and 2003
    
    
    5Notes to Consolidated Financial Statements (unaudited)
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    24Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    39Item 4.
    
    Controls and Procedures
    
    
    39PART II.
    
    Other InformationItem 1.
    
    Legal Proceedings
    
    
    40Item 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    41Item 3.
    
    Defaults upon Senior Securities
    
    
    41Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    41Item 5.
    
    Other Information
    
    
    41Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    41Signatures
    
    
    
    
    42EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 2




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC. 
 Consolidated Balance Sheets
 (Unaudited, In Thousands)
 June 30,
    
    December 31,2004
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    81,585
    
    
    $
    97,798Restricted cash
    
    
    4,885
    
    
    
    3,635Accounts receivable-trade, net of allowance of $4,001 and $4,432
    
    
    37,033
    
    
    
    41,718Accounts
receivable - affiliate
    
    
    17,433
    
    
    
    148Materials and supplies
    
    
    8,962
    
    
    
    10,099Prepayments and other current assets
    
    
    7,039
    
    
    
    5,850Total current assets
    
    
    156,937
    
    
    
    159,248Property, plant and equipment
    
    
    1,051,458
    
    
    
    1,041,904Less: accumulated depreciation
    
    
    628,112
    
    
    
    603,760Property, plant and equipment, net
    
    
    423,346
    
    
    
    438,144Goodwill
    
    
    38,403
    
    
    
    38,403Intangible assets, net
    
    
    21,963
    
    
    
    22,055Debt issuance costs, net of amortization of $6,631 and $5,417
    
    
    17,153
    
    
    
    18,587Deferred charges and other assets
    
    
    9,494
    
    
    
    8,750Total assets
    
    $
    667,296
    
    
    $
    685,187Liabilities and Stockholders EquityCurrent liabilities:Current portion of long-term obligations
    
    $
    2,290
    
    
    $
    2,267Accounts payable-affiliates
    
    
    3,370
    
    
    
    3,817Accounts payable, accrued and other current liabilities
    
    
    40,142
    
    
    
    46,991Income taxes payable
    
    
    
    
    
    
    1,095Advance billings and customer deposits
    
    
    8,557
    
    
    
    8,766Total current liabilities
    
    
    54,359
    
    
    
    62,936Long-term obligations, net of current portion
    
    
    531,493
    
    
    
    532,737Other deferred credits and long-term liabilities
    
    
    75,766
    
    
    
    71,065Commitments and contingencies
    
    
    
    
    
    
    Stockholders equity:Common stock, $.01 par value; 1,000 shares authorized,
1 share issued and outstanding
    
    
    
    
    
    
    Paid in capital in excess of par value
    
    
    287,242
    
    
    
    287,242Accumulated deficit
    
    
    (277,021
    )
    
    
    (264,250
    )Accumulated other comprehensive loss
    
    
    (4,543
    )
    
    
    (4,543
    )Total stockholders equity
    
    
    5,678
    
    
    
    18,449Total liabilities and stockholders equity
    
    $
    667,296
    
    
    $
    685,187
 See Notes to Consolidated Financial Statements 3




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC. 
 Consolidated Statements of Operations
 (Unaudited, In Thousands)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Operating revenue:Local telephone
    
    $
    52,948
    
    
    $
    55,210
    
    
    $
    108,730
    
    
    $
    109,211Wireless
    
    
    13,461
    
    
    
    11,947
    
    
    
    25,062
    
    
    
    22,277Directory
    
    
    
    
    
    
    3,353
    
    
    
    
    
    
    
    11,631Internet
    
    
    5,105
    
    
    
    9,037
    
    
    
    9,718
    
    
    
    16,193Interexchange
    
    
    3,790
    
    
    
    4,449
    
    
    
    7,199
    
    
    
    8,476Total operating revenue
    
    
    75,304
    
    
    
    83,996
    
    
    
    150,709
    
    
    
    167,788Operating expense:Local telephone (exclusive of depreciation and amortization)
    
    
    29,112
    
    
    
    26,852
    
    
    
    61,636
    
    
    
    54,107Wireless (exclusive of depreciation and amortization)
    
    
    8,331
    
    
    
    7,341
    
    
    
    16,259
    
    
    
    14,251Directory (exclusive of depreciation and amortization)
    
    
    
    
    
    
    1,800
    
    
    
    
    
    
    
    5,249Internet (exclusive of depreciation and amortization)
    
    
    6,407
    
    
    
    13,485
    
    
    
    13,913
    
    
    
    24,099Interexchange (exclusive of depreciation and amortization)
    
    
    4,858
    
    
    
    6,212
    
    
    
    9,874
    
    
    
    11,830Depreciation and amortization
    
    
    18,810
    
    
    
    22,091
    
    
    
    37,916
    
    
    
    44,691Loss (gain) on disposal of assets
    
    
    (2
    )
    
    
    (97,285
    )
    
    
    225
    
    
    
    (96,539
    )Total operating expense (gain)
    
    
    67,516
    
    
    
    (19,504
    )
    
    
    139,823
    
    
    
    57,688Operating income
    
    
    7,788
    
    
    
    103,500
    
    
    
    10,886
    
    
    
    110,100Other income (expense):Interest expense
    
    
    (11,346
    )
    
    
    (14,920
    )
    
    
    (22,794
    )
    
    
    (27,607
    )Interest income and other
    
    
    232
    
    
    
    4,787
    
    
    
    462
    
    
    
    4,979Total other expense
    
    
    (11,114
    )
    
    
    (10,133
    )
    
    
    (22,332
    )
    
    
    (22,628
    )Income (Loss) before income taxes and discontinued operations
    
    
    (3,326
    )
    
    
    93,367
    
    
    
    (11,446
    )
    
    
    87,472Income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income (Loss) from continuing operations
    
    
    (3,326
    )
    
    
    93,367
    
    
    
    (11,446
    )
    
    
    87,472Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (52
    )Net income (loss)
    
    $
    (3,326
    )
    
    $
    93,367
    
    
    $
    (11,446
    )
    
    $
    87,420
 See Notes to Consolidated Financial Statements 4




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC. 
 Consolidated Statements of Cash Flows
 (Unaudited, In Thousands)
 Six Months EndedJune 30,2004
    
    2003Cash Flows from Operating Activities:Net income (loss)
    
    $
    (11,446
    )
    
    $
    87,420Adjustments to reconcile net income (loss) to net cash provided by operating activities:Loss on discontinued operations
    
    
    
    
    
    
    52Depreciation and amortization
    
    
    37,916
    
    
    
    44,691Loss (gain) on disposal of assets
    
    
    225
    
    
    
    (96,539
    )Amortization of debt issuance costs and original issue discount
    
    
    1,693
    
    
    
    5,317Other deferred credits
    
    
    2,562
    
    
    
    1,671Changes in components of working capital:Accounts receivable and other current assets
    
    
    (12,891
    )
    
    
    1,725Accounts payable and other current liabilities
    
    
    (8,600
    )
    
    
    (9,085
    )Other
    
    
    (744
    )
    
    
    (122
    )Net cash used in discontinued operations
    
    
    
    
    
    
    (41
    )Net cash provided by operating activities
    
    
    8,715
    
    
    
    35,089Cash Flows from Investing Activities:Construction and capital expenditures
    
    
    (20,873
    )
    
    
    (15,303
    )Net proceeds from sale of business
    
    
    
    
    
    
    138,091Release of funds from escrow
    
    
    
    
    
    
    3,539Placement of funds in restricted account
    
    
    (1,250
    )
    
    
    (200
    )Net cash provided (used) by investing activities
    
    
    (22,123
    )
    
    
    126,127Cash Flows from Financing Activities:Payments on long-term debt
    
    
    (1,480
    )
    
    
    (113,079
    )Dividends
    
    
    (1,325
    )
    
    
    (2,142
    )Net cash used by financing activities
    
    
    (2,805
    )
    
    
    (115,221
    )Increase (decrease) in cash and cash equivalents
    
    
    (16,213
    )
    
    
    45,995Cash and cash equivalents at beginning of the period
    
    
    97,798
    
    
    
    18,565Cash and cash equivalents at the end of the period
    
    $
    81,585
    
    
    $
    64,560Supplemental Cash Flow Data:Interest paid, net of amounts capitalized of $87 and $92
    
    $
    21,286
    
    
    $
    23,770Income taxes paid
    
    $
    1,120
    
    
    $
    Supplemental Noncash Transactions:Property acquired under capital leases and mortgages
    
    $
    
    
    
    $
    2,340Interest rate swap marked to market
    
    $
    
    
    
    $
    (3,640
    )
 See Notes to Consolidated Financial Statements 5




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC. 
 Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts)
 1. DESCRIPTION OF COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Alaska Communications Systems Holdings, Inc. and Subsidiaries (the
Company or ACS Holdings), a Delaware corporation, is engaged principally in
providing local telephone, wireless, Internet, interexchange network and other
services to its retail consumer, business customers and wholesale customers in
the State of Alaska through its telecommunications subsidiaries. The Company is
a wholly owned subsidiary of Alaska Communications Systems Group, Inc. (the
Parent or ACS Group). The financial statements for the Company represent the consolidated
financial position, results of operations and cash flows principally of the
following entities:  
    
    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) On May 8, 2003, the Company completed the sale of a majority interest
(87.42%) in the then newly formed ACS Media LLC (the Directories Business).
Subsequently, on August 27, 2003, the Company sold substantially all of its
remaining interest in the Directories Business. As a result of these
transactions, the Company now owns less than 0.1% of the Directories Business. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted pursuant to rules and regulations of the Securities and Exchange
Commission. However, the Company believes the disclosures which are made are
adequate to make the information presented not misleading. The consolidated
financial statements and footnotes included in this Form 10-Q should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2003. Certain reclassifications have been made to the 2003
financial statements to make them conform to the current presentation. In the opinion of management, the financial statements contain all
adjustments (consisting of normal recurring adjustments) necessary to present
fairly the consolidated financial position, results of operations and cash
flows for all periods presented. The results of operations for the six months
ended June 30, 2004 and 2003 are not necessarily indicative of the results of
operations which might be expected for the entire year or any other interim
periods. Revenue Recognition Access revenue is recognized when earned. The Company participates in
access revenue pools with other telephone companies. Such pools are funded by
toll revenue and/or access charges regulated by the Regulatory Commission of
Alaska (RCA) within the intrastate jurisdiction and the Federal
Communications Commission (FCC) within the interstate jurisdiction. Much of
the interstate access revenue is initially recorded based on estimates. These
estimates are derived from interim financial 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. To the extent that
disputes arise over revenue settlements, the Companys
policy is to defer revenue collected until settlement methodologies are
resolved and finalized. At June 30, 2004 and 2003, the Company had liabilities
of $17,922 and $15,423, respectively, related to its estimate of refundable
access revenue. 6




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1.
    
    DESCRIPTION OF COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued) Regulatory Accounting and Regulation The local telephone exchange operations of the Company account for costs
in accordance with the accounting principles for regulated enterprises
prescribed by Statement of Financial Accounting Standards (SFAS) No. 71,
Accounting for the Effects of Certain Types of Regulation.This accounting
recognizes the economic effects of rate regulation by recording cost and a
return on investment as such amounts are recovered through rates authorized by
regulatory authorities. Accordingly, under SFAS No. 71, plant and equipment is
depreciated over lives approved by regulators and certain costs and obligations
are deferred based upon approvals received from regulators to permit recovery
of such amounts in future years. The Company implemented, effective January 1, 2003, higher depreciation
rates for its regulated telephone plant for the interstate jurisdiction, which
management believes approximate the economically useful lives of the underlying
plant. As a result, the Company has recorded a regulatory asset under SFAS No.
71 of $26,950 and $17,231 as of June 30, 2004 and December 31, 2003,
respectively, related to depreciation of the regulated telephone plant
allocable to its intrastate and local jurisdictions. The Company has also
deferred as a regulatory asset $894 of costs incurred in connection with
regulatory rate making proceedings, which is being amortized over three years
starting in 2003. The balance of this regulatory asset was $447 at June 30,
2004. If the Company were not following SFAS No. 71, these costs would have
been charged to expense as incurred. The Company also has a regulatory
liability of $52,685 at June 30, 2004 related to accumulated removal costs. If
the Company were not following SFAS No. 71, it would have followed SFAS No. 143
for asset retirement obligations. Non-regulated revenues and costs incurred by
the local telephone exchange operations and non-regulated operations of the
Company are not accounted for under SFAS No. 71 principles. Stock Incentive Plans The Companys employees participate in various plans of ACS Group. The
Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, in accounting for its stock incentive plans.
Accordingly, no compensation cost has been recognized for options with exercise
prices equal to or greater than fair value on the date of grant. No
compensation costs were charged to operations for the six months ended June 30,
2004 or 2003. If compensation costs had been determined consistent with SFAS
No. 123, Accounting for Stock-Based Compensation,the Companys net income
(loss) and net income (loss) per share on a pro forma basis for the three and
six months ended June 30, 2004 and 2003 would have been as follows: For the three months ended
    
    For the six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net Income ( Loss):As reported
    
    $
    (3,326
    )
    
    $
    93,367
    
    
    $
    (11,446
    )
    
    $
    87,420Deduct: Total Stock
based employee
compensation
expense determined
under fair value
based method for
all awards, net of
tax effect
    
    
    (345
    )
    
    
    507
    
    
    
    (312
    )
    
    
    79Pro forma
    
    $
    (3,671
    )
    
    $
    93,874
    
    
    $
    (11,758
    )
    
    $
    87,499
 7




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The fair value for these options was estimated at the date of grant using
a Black-Scholes option pricing model with the following weighted average
assumptions for grants: 2004
    
    2003Risk free rate
    
    
    3.92
    %
    
    
    2.56
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected volatility factor
    
    
    55.1
    %
    
    
    65.7
    %Expected option life (years)
    
    
    6.8
    
    
    
    6.1
 2. NEW ACCOUNTING STANDARDS On August 15, 2001, the Financial Accounting Standards Board (FASB)
issued SFAS No. 143,Accounting for Asset Retirement Obligations. This
statement is effective for financial statements issued for fiscal years
beginning after June 15, 2002. SFAS No. 143 addresses financial accounting and
reporting obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This standard generally
applies to legal obligations associated with the retirement of long-lived
assets that result from the acquisition, construction, development and/or the
normal operation of a long-lived asset. Under the new accounting method, asset
retirement obligations are recognized in the period in which they are incurred
if a reasonable estimate of fair value can be made. When the liability is
initially recorded, the cost is capitalized and increases the carrying value of
the related long-lived asset. The liability is then accreted to its present
value each period and the capitalized cost is depreciated over the estimated
useful life of the related asset. At the settlement date, the obligation is
settled for its recorded amount or a gain or loss is recognized upon
settlement. In accordance with federal and state regulations, depreciation expense for
the Companys local exchange carriers regulated operations have historically
included an additional provision for cost of removal. Under SFAS No. 143, the
additional cost of removal provision would no longer be included in
depreciation expense, because it does not meet the recognition and measurement
principles of an asset retirement obligation. On December 20, 2002, the FCC
notified local exchange carriers that they should not adopt the provisions of
SFAS No. 143 unless specifically required by the FCC in the future. As a result
of the FCC ruling, the Company will continue to record depreciation expense for
cost of removal for its local exchange carrier subsidiaries that follow SFAS
No. 71 accounting. Prior to SFAS No. 143, asset removal costs that qualified
and did not qualify for asset retirement obligations were recorded in
accumulated depreciation. In accordance with SFAS No. 143 and SFAS No. 71, the
accumulated asset retirement removal costs were reclassified as regulatory
liabilities in 2003. Accumulated retirement removal costs in other deferred
credits and long-term liabilities not qualifying for asset retirement
obligations were $52,685 and $50,546 at June 30, 2004 and December 21, 2003,
respectively. The Company applied the provisions of SFAS No. 143 to its nonregulated
subsidiaries effective January 1, 2003. The Companys wireless segment has
entered into cell site operating leases, which are subject to the provisions of
this statement. Cell site lease agreements may contain clauses requiring
restoration of the leased site at the end of the lease term, creating an asset
retirement obligation. Landlords may choose not to exercise these rights as
cell sites may be considered useful improvements. The Companys initial
adoption of this statement by its nonregulated subsidiaries did not have a
material impact on its results of operations, financial position or cash flows. In December 2003, the FASB reissued SFAS No. 132, Employers Disclosure
about Pensions and Other Postretirement Benefits.This revised statement
requires expanded disclosures with respect to pension plan assets, benefit
obligations, cash flows, benefit costs and other relevant information. However
this revised statement does not change the measurement and recognition
provisions of previous FASB statements related to pensions and other
postretirement benefits. The Company was required to adopt this revised
statement for 2003. The Companys adoption of this revised statement did not
have a material impact on its financial position, results of operations, or
cash flows. The expanded disclosures required by this statement are included in
Note 5, Retirement Plans. 8




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2. NEW ACCOUNTING STANDARDS (Continued) In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities(revised December 2003). FIN 46
addresses when a company should include in its financial statements the assets,
liabilities and activities of a variable interest entity. FIN 46 defines
variable interest entities as those entities with a business purpose that
either do not have any equity investors with voting rights or have equity
investors that do not provide sufficient financial resources for the entity to
support its activities. FIN 46 also requires disclosures about variable
interest entities that a company is not required to consolidate, but in which
it has a significant variable interest. FIN 46 consolidation requirements are
effective for all variable interest entities created after January 31, 2003,
and to pre-existing entities in the first fiscal year or interim period ending
after December 15, 2003. Certain disclosure requirements are effective for
financial statements issued after January 31, 2003. The adoption of FIN 46 had
no effect on the Companys financial position, results of operations or cash
flows. 3. DISCONTINUED OPERATIONS On March 30, 2002, the Company approved a plan to sell its wireless cable
television service segment. As a result of this decision, the operating revenue
and expense of this segment has been classified as discontinued operations
under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. The Company completed its disposal of the wireless cable television
segment as of March 31, 2003. The following discloses the results of the discontinued operations for the
six months ended June 30, 2003: Six Months EndedJune 30,2003Operating revenue
    
    $
    110Operating expense
    
    
    162Loss from discontinued operations
    
    $
    (52
    )
 4. STOCK INCENTIVE PLANS The Companys employees participate in various plans of ACS Group, which
through its Compensation Committee of the Board of Directors, may grant stock
options, stock appreciation rights and other awards to officers, employees and
non-employee directors. At June 30, 2004, ACS Group has reserved a total of
6,060 shares of authorized common stock for issuance under the plans. In
general, options under the plans vest ratably over three, four or five years
and the plans terminate in approximately 10 years. Alaska Communications Systems Group, Inc. 1999 Stock Incentive Plan ACS Group has reserved 4,910 shares under this plan, which was adopted by
the Company in November 1999. At June 30, 2004, 6,710 options have been
granted, 2,747 have been forfeited, 718 have been exercised, and 947 shares are
available for grant under the plan. ACS Group, Inc. 1999 Non-Employee Director Stock Compensation Plan The non-employee director stock compensation plan was adopted by ACS Group
in November 1999. ACS Group has reserved 150 shares under this plan. At June
30, 2004, 126 shares have been awarded and 24 shares are available for grant
under the plan. For 2004, directors are required to receive not less than 50%
of their annual retainer in the form of ACS Groups stock and may have elected
to receive up to 100%
of their annual retainer in the form of ACS Groups stock. In 2003, directors
did not have the option of 9




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receiving stock and received their entire annual
retainer and meeting fees in cash, therefore no shares were awarded from this
plan during 2003. On March 31, 2004, seven shares under the plan were awarded
to directors, of which five were elected to be deferred until termination of
service by the directors. On June 30, 2004, eight shares under the plan were
awarded to directors, of which six were elected to be deferred until
termination of service by the directors. Alaska Communications Systems Group, Inc. 1999 Employee Stock Purchase Plan This plan was also adopted by ACS Group in November 1999. ACS Group has
reserved 1,000 shares under this plan. At June 30, 2004, 462 shares are
available for issuance and sale. On June 30, 2004, 41 shares were issued under
the plan. The plan will terminate on December 31, 2009. 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 or is for not more than five months in
a calendar year, or who are ineligible to participate due to restrictions under
the Internal Revenue Code. 5. RETIREMENT PLANS Pension benefits for substantially all of the Companys employees are
provided through the Alaska Electrical Pension Plan (AEPP). The Company pays
a contractual hourly amount based on employee classification or base
compensation. As a multi-employer defined contribution plan, the accumulated
benefits and plan assets are not determined for or allocated separately to the
individual employer. The Company also provides a 401(k) retirement savings plan
covering substantially all of its employees. The Company 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 1, 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 AEPP. As a result of this amendment, prior service
cost of $1,992 was recorded and will be 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). The Company uses a December 31 measurement date for the plan. The following table represents the net periodic pension expense for the
ACS Retirement Plan for the three and six months ended June 30, 2004 and 2003: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Interest cost
    
    $
    190
    
    
    $
    183
    
    
    $
    374
    
    
    $
    366Expected return on plan assets
    
    
    (187
    )
    
    
    (166
    )
    
    
    (377
    )
    
    
    (332
    )Amortization of loss
    
    
    113
    
    
    
    142
    
    
    
    251
    
    
    
    284Amortization of prior service cost
    
    
    51
    
    
    
    51
    
    
    
    101
    
    
    
    102Net periodic pension expense
    
    $
    167
    
    
    $
    210
    
    
    $
    349
    
    
    $
    420
 The Company 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 management or highly
compensated employees. The group of eligible employees is selected by a 10




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##### Table of Contents



committee appointed by the Compensation Committee of ACS Groups Board of
Directors. Each eligible employee must complete 10 years of service and be
employed by the Company in the capacity of an executive officer for a minimum
of 36 consecutive months immediately preceding retirement. The ACS Health Plan
provides a graded subsidy for medical, dental, and vision coverage. The
amendment revised the premium subsidy, added a premium subsidy cap and suspends
retirees benefits from the ACS Health Plan during any period the retiree has
access to employer health benefits. The Compensation Committee of the Board of
Directors decided to terminate the ACS Health Plan in January 2004. The three
people already qualified under the plan will receive future benefits, but 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. The Company uses a December 31 measurement date for
the plan. The following represents the net periodic postretirement benefit expense
for the ACS Health Plan for the three and six months ended June 30, 2004 and
2003: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Service cost
    
    $
    2
    
    
    $
    3
    
    
    $
    3
    
    
    $
    6Interest cost
    
    
    4
    
    
    
    5
    
    
    
    8
    
    
    
    9Expected return on plan assets
    
    
    (3
    )
    
    
    (3
    )
    
    
    (6
    )
    
    
    (5
    )Amortization of prior service cost
    
    
    2
    
    
    
    2
    
    
    
    4
    
    
    
    4Net periodic postretirement
benefit expense
    
    $
    5
    
    
    $
    7
    
    
    $
    9
    
    
    $
    14
 6. BUSINESS SEGMENTS The Company has four reportable segments: local telephone, wireless,
Internet and interexchange. Local telephone provides landline
telecommunications services and consists of local telephone service, network
access and deregulated and other revenue; wireless provides wireless
telecommunications service; Internet provides Internet service and advanced IP
based private networks; and interexchange provides switched and dedicated long
distance services. Each reportable segment is a strategic business offering
different services than those offered by the other segments. The Company
evaluates the performance of its segments based on operating income (loss). Previously, the Company reported its Directories Business as a separate
segment. The Company sold an 87.42% interest in its Directories Business during
the second quarter of 2003 and is no longer directly engaged in day-to-day
management of that business. Therefore, the Directories Business no longer
constitutes a reportable segment. Accordingly, the historical operating results
for the Directories Business for the three and six months ended June 30, 2003
are included in All Other in the accompanying tables. The Company also had a
wireless cable television service segment that did not meet the criteria for a
reportable segment that was previously included in All Other and is now
reported as discontinued operations. The Company also incurs interest expense, interest income, equity in
earnings of investments 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 the chief operating decision maker in
analyzing the performance of the business segments. These non operating income
and expense items are provided in the accompanying table under the caption 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 the
Company 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. 11




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##### Table of Contents



6. BUSINESS SEGMENTS (continued) The following table illustrates selected financial data for each segment
as of and for the six months ended June 30, 2004: LocalTelephone
    
    Wireless
    
    Internet
    
    Interexchange
    
    All Other
    
    Eliminations
    
    TotalOperating revenue
    
    $
    108,710
    
    
    $
    25,083
    
    
    $
    9,718
    
    
    $
    8,177
    
    
    $
    11,644
    
    
    $
    (12,623
    )
    
    $
    150,709Depreciation and amortization
    
    
    25,275
    
    
    
    3,623
    
    
    
    1,786
    
    
    
    248
    
    
    
    6,984
    
    
    
    
    
    
    
    37,916Operating income (loss)
    
    
    12,995
    
    
    
    3,316
    
    
    
    (6,411
    )
    
    
    (2,072
    )
    
    
    3,058
    
    
    
    
    
    
    
    10,886Interest expense
    
    
    (160
    )
    
    
    (12
    )
    
    
    
    
    
    
    (94
    )
    
    
    (22,528
    )
    
    
    
    
    
    
    (22,794
    )Interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    565
    
    
    
    
    
    
    
    565Income tax provision (benefit)
    
    
    5,190
    
    
    
    1,360
    
    
    
    
    
    
    
    
    
    
    
    (6,550
    )
    
    
    
    
    
    
    Net income (loss)
    
    
    7,645
    
    
    
    1,944
    
    
    
    (6,411
    )
    
    
    (2,166
    )
    
    
    (12,458
    )
    
    
    
    
    
    
    (11,446
    )Total assets
    
    
    518,466
    
    
    
    105,978
    
    
    
    5,699
    
    
    
    22,730
    
    
    
    14,423
    
    
    
    
    
    
    
    667,296Capital expenditures
    
    
    10,735
    
    
    
    7,018
    
    
    
    1,055
    
    
    
    49
    
    
    
    2,016
    
    
    
    
    
    
    
    20,873
 Operating revenue disclosed above includes intersegment operating revenue
of $12,966 for local telephone, $886 for wireless, $1,104 for interexchange and
$11,630 for all other. In accordance with SFAS No. 71, intercompany revenue
between local telephone and all other segments is not eliminated above. The following table illustrates selected financial data for each segment
as of and for the six months ended June 30, 2003: LocalTelephone
    
    Wireless
    
    Internet
    
    Interexchange
    
    All Other
    
    Eliminations
    
    TotalOperating revenue
    
    $
    109,211
    
    
    $
    22,318
    
    
    $
    16,193
    
    
    $
    13,668
    
    
    $
    24,239
    
    
    $
    (17,841
    )
    
    $
    167,788Depreciation and amortization
    
    
    28,738
    
    
    
    2,929
    
    
    
    4,832
    
    
    
    1,117
    
    
    
    7,075
    
    
    
    
    
    
    
    44,691Operating income (loss)
    
    
    15,665
    
    
    
    1,096
    
    
    
    (15,758
    )
    
    
    157
    
    
    
    108,949
    
    
    
    (9
    )
    
    
    110,100Interest expense
    
    
    (279
    )
    
    
    (2
    )
    
    
    (67
    )
    
    
    (148
    )
    
    
    (27,111
    )
    
    
    
    
    
    
    (27,607
    )Interest income
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    596
    
    
    
    
    
    
    
    597Income tax provision (benefit)
    
    
    5,881
    
    
    
    724
    
    
    
    
    
    
    
    
    
    
    
    (6,605
    )
    
    
    
    
    
    
    Income (loss) from
continuing operations
    
    
    9,506
    
    
    
    370
    
    
    
    (15,825
    )
    
    
    9
    
    
    
    93,421
    
    
    
    (9
    )
    
    
    87,472Total assets
    
    
    476,412
    
    
    
    76,298
    
    
    
    (42,789
    )
    
    
    (1,341
    )
    
    
    166,156
    
    
    
    
    
    
    
    674,736Capital expenditures
    
    
    8,728
    
    
    
    542
    
    
    
    3,250
    
    
    
    10
    
    
    
    5,113
    
    
    
    
    
    
    
    17,643
 Operating revenue disclosed above includes intersegment operating revenue
of $14,472 for local telephone, $883 for wireless, $1,130 for interexchange and
$12,608 for all other. In accordance with SFAS No. 71, intercompany revenue
between local telephone and all other segments is not eliminated above. The following table illustrates selected financial data for each segment
as of and for the three months ended June 30, 2004: LocalTelephone
    
    Wireless
    
    Internet
    
    Interexchange
    
    All Other
    
    Eliminations
    
    TotalOperating revenue
    
    $
    52,938
    
    
    $
    13,470
    
    
    $
    5,105
    
    
    $
    4,319
    
    
    $
    5,845
    
    
    $
    (6,373
    )
    
    $
    75,304Depreciation and amortization
    
    
    12,426
    
    
    
    1,978
    
    
    
    784
    
    
    
    91
    
    
    
    3,531
    
    
    
    
    
    
    
    18,810Operating income (loss)
    
    
    6,682
    
    
    
    2,173
    
    
    
    (2,249
    )
    
    
    (694
    )
    
    
    1,876
    
    
    
    
    
    
    
    7,788Interest expense
    
    
    (79
    )
    
    
    
    
    
    
    
    
    
    
    (47
    )
    
    
    (11,220
    )
    
    
    
    
    
    
    (11,346
    )Interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    278
    
    
    
    
    
    
    
    278Income tax provision (benefit)
    
    
    2,691
    
    
    
    894
    
    
    
    
    
    
    
    
    
    
    
    (3,585
    )
    
    
    
    
    
    
    Net income (loss)
    
    
    3,912
    
    
    
    1,279
    
    
    
    (2,249
    )
    
    
    (741
    )
    
    
    (5,527
    )
    
    
    
    
    
    
    (3,326
    )Total assets
    
    
    514,964
    
    
    
    108,257
    
    
    
    6,302
    
    
    
    23,295
    
    
    
    14,478
    
    
    
    
    
    
    
    667,296Capital expenditures
    
    
    5,235
    
    
    
    3,609
    
    
    
    453
    
    
    
    38
    
    
    
    1,018
    
    
    
    
    
    
    
    10,353
 Operating revenue disclosed above includes intersegment operating revenue
of $6,642 for local telephone, $452 for wireless, $582 for interexchange and
$5,841 for all other. In accordance with SFAS No. 71, intercompany revenue
between local telephone and all other segments is not eliminated above. The following table illustrates selected financial data for each segment
as of and for the three months ended June 30, 2003: 12




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##### Table of Contents



6. BUSINESS SEGMENTS (continued LocalTelephone
    
    Wireless
    
    Internet
    
    Interexchange
    
    All Other
    
    Eliminations
    
    TotalOperating revenue
    
    $
    55,210
    
    
    $
    11,965
    
    
    $
    9,037
    
    
    $
    7,568
    
    
    $
    9,640
    
    
    $
    (9,424
    )
    
    $
    83,996Depreciation and amortization
    
    
    14,046
    
    
    
    1,484
    
    
    
    2,422
    
    
    
    562
    
    
    
    3,577
    
    
    
    
    
    
    
    22,091Operating income (loss)
    
    
    8,747
    
    
    
    1,413
    
    
    
    (8,827
    )
    
    
    500
    
    
    
    101,667
    
    
    
    
    
    
    
    103,500Interest expense
    
    
    (143
    )
    
    
    (1
    )
    
    
    (33
    )
    
    
    (74
    )
    
    
    (14,669
    )
    
    
    
    
    
    
    (14,920
    )Interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    351
    
    
    
    
    
    
    
    351Income tax provision (benefit)
    
    
    3,374
    
    
    
    720
    
    
    
    
    
    
    
    
    
    
    
    (4,094
    )
    
    
    
    
    
    
    Income (loss) from
continuing operations
    
    
    5,230
    
    
    
    692
    
    
    
    (8,860
    )
    
    
    426
    
    
    
    95,879
    
    
    
    
    
    
    
    93,367Total assets
    
    
    476,514
    
    
    
    76,598
    
    
    
    (42,425
    )
    
    
    (1,059
    )
    
    
    165,108
    
    
    
    
    
    
    
    674,736Capital expenditures
    
    
    4,734
    
    
    
    421
    
    
    
    2,018
    
    
    
    2
    
    
    
    1,922
    
    
    
    
    
    
    
    9,097
 Operating revenue disclosed above includes intersegment operating revenue
of $8,497 for local telephone, $469 for wireless, $689 for interexchange and
$6,287 for all other. In accordance with SFAS No. 71, intercompany revenue
between local telephone and all other segments is not eliminated above. 7. RELATED PARTY TRANSACTIONS Fox Paine & Company, LLC whose affiliates hold a majority of the Companys
outstanding shares, receives an annual management fee in the amount of one
percent of the Companys earnings before interest expense, income taxes and
depreciation and amortization, calculated without regard to the fee. The
management fee expense for the three and six months ended June 30, 2004 was
$220 and $522, respectively, and for the three and six months ended June 30,
2003 it was $304 and $571, respectively. At June 30, 2004, the payable due to
Fox Paine was $525. On April 17, 2001, the Company issued an interest bearing note receivable
to an officer totaling $328. The note bore interest at the Mid-Term Applicable
Federal Rate and was due on April 15, 2005. The note was secured by a pledge of
100 shares of ACS Groups stock held in the officers name. In accordance with
an addendum to the officers employment agreement dated May 3, 2001, the loan
was to be forgiven ratably over a three year period ending April 16, 2004. Upon
the closing of the sale of the Companys Directories Business on May 8, 2003
for which the officer received a fee of $840, he waived certain rights under
his employment agreement, including the forgiveness terms of this indebtedness
that would have occurred during 2003 and 2004. On May 8, 2003, the officer paid
off the note balance of $238, including accrued interest. During 2003, the Company spun off its Directory Business to ACS Media LLC
and subsequently sold 99.9% of its interest in ACS Media LLC to the public
through a Canadian income fund. As part of that transaction, the Company
entered into several long-term contracts with ACS Media LLC, including a 50-
year publishing agreement, a 50-year license agreement, a 45-year
non-compete agreement, and a 10-year billing and collection agreement. At June
30, 2004 and December 31, 2003, the Company had recorded in accounts payable 
affiliates $2,845 and $2,867, respectively, due to ACS Media LLC under these
contracts, primarily under the billing and collection agreement. The Company
has a right to minority representation of one manager of the permitted nine
managers of ACS Media LLC so long as its contracts with ACS Media LLC are in
effect. Currently, Wray T. Thorn, a director of the Company and employee of Fox
Paine & Company, LLC, the Companys majority shareholder, is a manager of ACS
Media LLC. On September 14, 2003, the Company entered into an agreement with a
retiring officer to reacquire 267 shares of the Companys stock owned by the
officer in 2004 at a purchase price per share equal to the highest average
closing price of a share of the Companys stock during any 5-consecutive day
trading period in January 2004. The officer delivered the shares to the Company
in 2004, and the Company will make the repurchase payments totaling $1,262 to
the officer in four equal quarterly installments commencing on March 31, 2004.
The Company has made two quarterly installment payments and $631 remains
outstanding as of June 30, 2004. 13




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##### Table of Contents



The Company understands that on September 19, 2003, Fox Paine entered into
a consulting agreement with a now retired officer of the Company. The
consulting term began on January 1, 2004 and will continue for one year, after
which either party may terminate the arrangement. During the consulting term,
the retired officer will advise Fox Paine on and evaluate potential
opportunities in the telecommunications industry, and Fox Paine will pay the
retired officer a monthly fee of $20 for these services. 8. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS ACS Holdings and its subsidiaries were guarantors of ACS Groups 13%
senior discount debentures, which were redeemed in full by ACS Group on June
14, 2004. Additionally, ACS Group and ACS Holdings subsidiaries are guarantors
under ACS Holdings 9 3/8 % senior subordinated notes and 9 7/8% senior
unsecured notes. All ACS Group and ACS Holdings subsidiaries (the Combined
Subsidiaries) are 100% owned. The guarantees are full and unconditional. In
addition, all guarantees are joint and several. Accordingly, the interim
condensed consolidating financial statements are presented below. See ACS
Groups 10-Q (Commission File Number 000-28167) for ACS Group only financial
statements. Condensed Consolidating Balance Sheet
June 30, 2004 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedAssetsCurrent assets:Cash and cash equivalents
    
    $
    99
    
    
    $
    81,486
    
    
    $
    
    
    
    $
    81,585Restricted cash
    
    
    
    
    
    
    4,885
    
    
    
    
    
    
    
    4,885Accounts receivable-trade, net
    
    
    13,365
    
    
    
    23,668
    
    
    
    
    
    
    
    37,033Accounts receivable-affiliates
    
    
    41,089
    
    
    
    (23,656
    )
    
    
    
    
    
    
    17,433Materials and supplies
    
    
    8,962
    
    
    
    
    
    
    
    
    
    
    
    8,962Prepayments and other current assets
    
    
    3,216
    
    
    
    3,823
    
    
    
    
    
    
    
    7,039Total current assets
    
    
    66,731
    
    
    
    90,206
    
    
    
    
    
    
    
    156,937Investments
    
    
    
    
    
    
    400,402
    
    
    
    (400,402
    )
    
    
    Property, plant and equipment
    
    
    951,886
    
    
    
    99,572
    
    
    
    
    
    
    
    1,051,458Less: accumulated depreciation
    
    
    576,305
    
    
    
    51,807
    
    
    
    
    
    
    
    628,112Property, plant and equipment, net
    
    
    375,581
    
    
    
    47,765
    
    
    
    
    
    
    
    423,346Goodwill
    
    
    
    
    
    
    
    
    
    
    38,403
    
    
    
    38,403Intangible assets
    
    
    21,963
    
    
    
    
    
    
    
    
    
    
    
    21,963Debt issuance costs, net
    
    
    
    
    
    
    17,153
    
    
    
    
    
    
    
    17,153Deferred charges and other assets
    
    
    2,205
    
    
    
    7,289
    
    
    
    
    
    
    
    9,494Total assets
    
    $
    466,480
    
    
    $
    562,815
    
    
    $
    (361,999
    )
    
    $
    667,296Liabilities and Stockholders EquityCurrent liabilities:Current portion of long-term obligations
    
    $
    528
    
    
    $
    1,762
    
    
    $
    
    
    
    $
    2,290Accounts payable-affiliates
    
    
    2,775
    
    
    
    595
    
    
    
    
    
    
    
    3,370Accounts payable, accrued and other current liabilities
    
    
    14,450
    
    
    
    25,692
    
    
    
    
    
    
    
    40,142Advance billings and customer deposits
    
    
    8,554
    
    
    
    3
    
    
    
    
    
    
    
    8,557Total current liabilities
    
    
    26,307
    
    
    
    28,052
    
    
    
    
    
    
    
    54,359Long-term obligations, net of current portion
    
    
    4,298
    
    
    
    527,195
    
    
    
    
    
    
    
    531,493Deferred income taxes
    
    
    4,004
    
    
    
    (4,004
    )
    
    
    
    
    
    
    Other deferred credits and long-term liabilities
    
    
    69,873
    
    
    
    5,894
    
    
    
    (1
    )
    
    
    75,766Stockholders equity:Common stock
    
    
    2
    
    
    
    
    
    
    
    (2
    )
    
    
    Treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Paid in capital in excess of par value
    
    
    491,240
    
    
    
    287,242
    
    
    
    (491,240
    )
    
    
    287,242Retained earnings (accumulated deficit)
    
    
    (129,244
    )
    
    
    (277,021
    )
    
    
    129,244
    
    
    
    (277,021
    )Accumulated other comprehensive loss
    
    
    
    
    
    
    (4,543
    )
    
    
    
    
    
    
    (4,543
    )Total stockholders equity
    
    
    361,998
    
    
    
    5,678
    
    
    
    (361,998
    )
    
    
    5,678Total liabilities and stockholders equity
    
    $
    466,480
    
    
    $
    562,815
    
    
    $
    (361,999
    )
    
    $
    667,296
 14




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##### Table of Contents



8. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Balance Sheet
December 31, 2003 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedAssetsCurrent assets:Cash and cash equivalents
    
    $
    139
    
    
    $
    97,659
    
    
    $
    
    
    
    $
    97,798Restricted cash
    
    
    
    
    
    
    3,635
    
    
    
    
    
    
    
    3,635Accounts receivable-trade, net
    
    
    13,803
    
    
    
    27,915
    
    
    
    
    
    
    
    41,718Accounts receivable-affiliates
    
    
    33,777
    
    
    
    (33,629
    )
    
    
    
    
    
    
    148Materials and supplies
    
    
    10,027
    
    
    
    72
    
    
    
    
    
    
    
    10,099Prepayments and other current assets
    
    
    2,877
    
    
    
    2,973
    
    
    
    
    
    
    
    5,850Total current assets
    
    
    60,623
    
    
    
    98,625
    
    
    
    
    
    
    
    159,248Investments
    
    
    
    
    
    
    399,384
    
    
    
    (399,384
    )
    
    
    Property, plant and equipment
    
    
    931,840
    
    
    
    110,064
    
    
    
    
    
    
    
    1,041,904Less: accumulated depreciation and amortization
    
    
    553,816
    
    
    
    49,944
    
    
    
    
    
    
    
    603,760Property, plant and equipment, net
    
    
    378,024
    
    
    
    60,120
    
    
    
    
    
    
    
    438,144Goodwill
    
    
    
    
    
    
    
    
    
    
    38,403
    
    
    
    38,403Intangible assets, net
    
    
    22,055
    
    
    
    
    
    
    
    
    
    
    
    22,055Debt issuance costs, net
    
    
    
    
    
    
    18,587
    
    
    
    
    
    
    
    18,587Deferred charges and other assets
    
    
    2,501
    
    
    
    6,249
    
    
    
    
    
    
    
    8,750Total assets
    
    $
    463,203
    
    
    $
    582,965
    
    
    $
    (360,981
    )
    
    $
    685,187Liabilities and Stockholders EquityCurrent liabilities:Current portion of long-term obligations
    
    $
    500
    
    
    $
    1,767
    
    
    $
    
    
    
    $
    2,267Accounts payable-affiliates
    
    
    2,867
    
    
    
    950
    
    
    
    
    
    
    
    3,817Accounts payable, accrued and other current liabilities
    
    
    15,038
    
    
    
    31,953
    
    
    
    
    
    
    
    46,991Income taxes payable
    
    
    
    
    
    
    1,095
    
    
    
    
    
    
    
    1,095Advance billings and customer deposits
    
    
    8,766
    
    
    
    
    
    
    
    
    
    
    
    8,766Total current liabilities
    
    
    27,171
    
    
    
    35,765
    
    
    
    
    
    
    
    62,936Long-term obligations, net of current portion
    
    
    4,661
    
    
    
    528,076
    
    
    
    
    
    
    
    532,737Deferred income taxes
    
    
    5,220
    
    
    
    (5,220
    )
    
    
    
    
    
    
    Other deferred credits and long-term liabilities
    
    
    65,170
    
    
    
    5,895
    
    
    
    
    
    
    
    71,065Stockholders equity:Common stock
    
    
    25
    
    
    
    
    
    
    
    (25
    )
    
    
    Paid in capital in excess of par value
    
    
    501,374
    
    
    
    287,242
    
    
    
    (501,374
    )
    
    
    287,242Retained earnings (accumulated deficit)
    
    
    (140,418
    )
    
    
    (264,250
    )
    
    
    140,418
    
    
    
    (264,250
    )Accumulated other comprehensive loss
    
    
    
    
    
    
    (4,543
    )
    
    
    
    
    
    
    (4,543
    )Total stockholders equity
    
    
    360,981
    
    
    
    18,449
    
    
    
    (360,981
    )
    
    
    18,449Total liabilities and stockholders equity
    
    $
    463,203
    
    
    $
    582,965
    
    
    $
    (360,981
    )
    
    $
    685,187
 15




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##### Table of Contents



8. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Operations
Three Months Ended June 30, 2004 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedOperating revenue:Local telephone
    
    $
    52,938
    
    
    $
    10
    
    
    $
    
    
    
    $
    52,948Wireless
    
    
    13,470
    
    
    
    
    
    
    
    (9
    )
    
    
    13,461Internet
    
    
    5,105
    
    
    
    
    
    
    
    
    
    
    
    5,105Interexchange
    
    
    4,319
    
    
    
    
    
    
    
    (529
    )
    
    
    3,790Other
    
    
    
    
    
    
    5,835
    
    
    
    (5,835
    )
    
    
    Total operating revenue
    
    
    75,832
    
    
    
    5,845
    
    
    
    (6,373
    )
    
    
    75,304Operating expense:Local telephone
    
    
    33,793
    
    
    
    438
    
    
    
    (5,119
    )
    
    
    29,112Wireless
    
    
    9,317
    
    
    
    
    
    
    
    (986
    )
    
    
    8,331Internet
    
    
    6,611
    
    
    
    
    
    
    
    (204
    )
    
    
    6,407Interexchange
    
    
    4,922
    
    
    
    
    
    
    
    (64
    )
    
    
    4,858Depreciation and amortization
    
    
    15,279
    
    
    
    3,531
    
    
    
    
    
    
    
    18,810Gain on disposal of assets
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Total operating expense
    
    
    69,920
    
    
    
    3,969
    
    
    
    (6,373
    )
    
    
    67,516Operating income
    
    
    5,912
    
    
    
    1,876
    
    
    
    
    
    
    
    7,788Other income (expense):Interest expense
    
    
    (126
    )
    
    
    (11,220
    )
    
    
    
    
    
    
    (11,346
    )Interest income and other
    
    
    5
    
    
    
    2,431
    
    
    
    (2,204
    )
    
    
    232Total other income (expense)
    
    
    (121
    )
    
    
    (8,789
    )
    
    
    (2,204
    )
    
    
    (11,114
    )Income (loss) before income taxes
    
    
    5,791
    
    
    
    (6,913
    )
    
    
    (2,204
    )
    
    
    (3,326
    )Income tax expense (benefit)
    
    
    3,587
    
    
    
    (3,587
    )
    
    
    
    
    
    
    Net income (loss)
    
    $
    2,204
    
    
    $
    (3,326
    )
    
    $
    (2,204
    )
    
    $
    (3,326
    )
 16




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##### Table of Contents



8. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Operations
Three Months Ended June, 2003 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedOperating revenue:Local telephone
    
    $
    55,210
    
    
    $
    
    
    
    $
    
    
    
    $
    55,210Wireless
    
    
    11,965
    
    
    
    
    
    
    
    (18
    )
    
    
    11,947Directory
    
    
    3,353
    
    
    
    
    
    
    
    
    
    
    
    3,353Internet
    
    
    9,037
    
    
    
    
    
    
    
    
    
    
    
    9,037Interexchange
    
    
    5,408
    
    
    
    
    
    
    
    (959
    )
    
    
    4,449Other
    
    
    
    
    
    
    6,287
    
    
    
    (6,287
    )
    
    
    Total operating revenue
    
    
    84,973
    
    
    
    6,287
    
    
    
    (7,264
    )
    
    
    83,996Operating expense:Local telephone
    
    
    31,965
    
    
    
    142
    
    
    
    (5,255
    )
    
    
    26,852Wireless
    
    
    8,311
    
    
    
    
    
    
    
    (970
    )
    
    
    7,341Directory
    
    
    1,832
    
    
    
    
    
    
    
    (32
    )
    
    
    1,800Internet
    
    
    14,198
    
    
    
    
    
    
    
    (713
    )
    
    
    13,485Interexchange
    
    
    6,506
    
    
    
    
    
    
    
    (294
    )
    
    
    6,212Depreciation and amortization
    
    
    18,514
    
    
    
    3,577
    
    
    
    
    
    
    
    22,091Gain on disposal of assets
    
    
    (97,285
    )
    
    
    
    
    
    
    
    
    
    
    (97,285
    )Total operating expense
    
    
    (15,959
    )
    
    
    3,719
    
    
    
    (7,264
    )
    
    
    (19,504
    )Operating income
    
    
    100,932
    
    
    
    2,568
    
    
    
    
    
    
    
    103,500Other income (expense):Interest expense
    
    
    (251
    )
    
    
    (14,669
    )
    
    
    
    
    
    
    (14,920
    )Interest income and other
    
    
    4,407
    
    
    
    58,833
    
    
    
    (58,453
    )
    
    
    4,787Total other income (expense)
    
    
    4,156
    
    
    
    44,164
    
    
    
    (58,453
    )
    
    
    (10,133
    )Income (loss) before income taxes
    
    
    105,088
    
    
    
    46,732
    
    
    
    (58,453
    )
    
    
    93,367Income tax expense (benefit)
    
    
    46,635
    
    
    
    (46,635
    )
    
    
    
    
    
    
    Net income (loss)
    
    $
    151,723
    
    
    $
    93,367
    
    
    $
    (58,453
    )
    
    $
    93,367
 17




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##### Table of Contents



8. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Operations
Six Months Ended June 30, 2004 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedOperating revenue:Local telephone
    
    $
    108,710
    
    
    $
    20
    
    
    $
    
    
    
    $
    108,730Wireless
    
    
    25,083
    
    
    
    
    
    
    
    (21
    )
    
    
    25,062Internet
    
    
    9,718
    
    
    
    
    
    
    
    
    
    
    
    9,718Interexchange
    
    
    8,177
    
    
    
    
    
    
    
    (978
    )
    
    
    7,199Other
    
    
    
    
    
    
    11,624
    
    
    
    (11,624
    )
    
    
    Total operating revenue
    
    
    151,688
    
    
    
    11,644
    
    
    
    (12,623
    )
    
    
    150,709Operating expense:Local telephone
    
    
    70,227
    
    
    
    1,572
    
    
    
    (10,163
    )
    
    
    61,636Wireless
    
    
    18,142
    
    
    
    
    
    
    
    (1,883
    )
    
    
    16,259Internet
    
    
    14,363
    
    
    
    
    
    
    
    (450
    )
    
    
    13,913Interexchange
    
    
    10,001
    
    
    
    
    
    
    
    (127
    )
    
    
    9,874Depreciation and amortization
    
    
    30,932
    
    
    
    6,984
    
    
    
    
    
    
    
    37,916Loss on disposal of assets
    
    
    195
    
    
    
    30
    
    
    
    
    
    
    
    225Total operating expense
    
    
    143,860
    
    
    
    8,586
    
    
    
    (12,623
    )
    
    
    139,823Operating income
    
    
    7,828
    
    
    
    3,058
    
    
    
    
    
    
    
    10,886Other income (expense):Interest expense
    
    
    (266
    )
    
    
    (22,528
    )
    
    
    
    
    
    
    (22,794
    )Interest income and other
    
    
    9
    
    
    
    1,470
    
    
    
    (1,017
    )
    
    
    462Total other expense
    
    
    (257
    )
    
    
    (21,058
    )
    
    
    (1,017
    )
    
    
    (22,332
    )Income (loss) before income taxes
    
    
    7,571
    
    
    
    (18,000
    )
    
    
    (1,017
    )
    
    
    (11,446
    )Income tax expense (benefit)
    
    
    6,554
    
    
    
    (6,554
    )
    
    
    
    
    
    
    Net income (loss)
    
    $
    1,017
    
    
    $
    (11,446
    )
    
    $
    (1,017
    )
    
    $
    (11,446
    )
 18




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##### Table of Contents



8. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Operations
Six Months Ended June, 2003 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedOperating revenue:Local telephone
    
    $
    109,211
    
    
    $
    
    
    
    $
    
    
    
    $
    109,211Wireless
    
    
    22,318
    
    
    
    
    
    
    
    (41
    )
    
    
    22,277Directory
    
    
    11,631
    
    
    
    
    
    
    
    
    
    
    
    11,631Internet
    
    
    16,193
    
    
    
    
    
    
    
    
    
    
    
    16,193Interexchange
    
    
    10,227
    
    
    
    
    
    
    
    (1,751
    )
    
    
    8,476Other
    
    
    110
    
    
    
    12,608
    
    
    
    (12,718
    )
    
    
    Total operating revenue
    
    
    169,690
    
    
    
    12,608
    
    
    
    (14,510
    )
    
    
    167,788Operating expense:Local telephone
    
    
    64,205
    
    
    
    434
    
    
    
    (10,532
    )
    
    
    54,107Wireless
    
    
    15,994
    
    
    
    
    
    
    
    (1,743
    )
    
    
    14,251Directory
    
    
    5,359
    
    
    
    
    
    
    
    (110
    )
    
    
    5,249Internet
    
    
    25,541
    
    
    
    
    
    
    
    (1,442
    )
    
    
    24,099Interexchange
    
    
    12,394
    
    
    
    
    
    
    
    (564
    )
    
    
    11,830Other
    
    
    160
    
    
    
    
    
    
    
    (160
    )
    
    
    Depreciation and amortization
    
    
    37,628
    
    
    
    7,073
    
    
    
    (10
    )
    
    
    44,691Gain on disposal of assets
    
    
    (96,538
    )
    
    
    
    
    
    
    (1
    )
    
    
    (96,539
    )Total operating expense
    
    
    64,743
    
    
    
    7,507
    
    
    
    (14,562
    )
    
    
    57,688Operating income
    
    
    104,947
    
    
    
    5,101
    
    
    
    52
    
    
    
    110,100Other income (expense):Interest expense
    
    
    (496
    )
    
    
    (27,111
    )
    
    
    
    
    
    
    (27,607
    )Interest income and other
    
    
    4,408
    
    
    
    58,332
    
    
    
    (57,761
    )
    
    
    4,979Total other income (expense)
    
    
    3,912
    
    
    
    31,221
    
    
    
    (57,761
    )
    
    
    (22,628
    )Income (loss) before income taxes
and discontinued operations
    
    
    108,859
    
    
    
    36,322
    
    
    
    (57,709
    )
    
    
    87,472Income tax expense (benefit)
    
    
    46,635
    
    
    
    (46,635
    )
    
    
    
    
    
    
    Income (loss) from continuing operations
    
    
    62,224
    
    
    
    82,957
    
    
    
    (57,709
    )
    
    
    87,472Loss from discontinued operations, net
    
    
    
    
    
    
    
    
    
    
    (52
    )
    
    
    (52
    )Net income (loss)
    
    $
    62,224
    
    
    $
    82,957
    
    
    $
    (57,761
    )
    
    $
    87,420
 19




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##### Table of Contents



8. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 2004 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedNet cash provided (used) by operating activities
    
    $
    19,152
    
    
    $
    (10,437
    )
    
    $
    
    
    
    $
    8,715Cash Flows from Investing Activities:Construction and capital expenditures
    
    
    (18,857
    )
    
    
    (2,016
    )
    
    
    
    
    
    
    (20,873
    )Placement of funds in restricted
    
    
    
    
    
    
    (1,250
    )
    
    
    
    
    
    
    (1,250
    )Net cash used by investing activities
    
    
    (18,857
    )
    
    
    (3,266
    )
    
    
    
    
    
    
    (22,123
    )Cash Flows from Financing Activities:Payments on long-term debt
    
    
    (335
    )
    
    
    (1,145
    )
    
    
    
    
    
    
    (1,480
    )Dividends
    
    
    
    
    
    
    (1,325
    )
    
    
    
    
    
    
    (1,325
    )Net cash used by financing activities
    
    
    (335
    )
    
    
    (2,470
    )
    
    
    
    
    
    
    (2,805
    )Decrease in cash and cash equivalents
    
    
    (40
    )
    
    
    (16,173
    )
    
    
    
    
    
    
    (16,213
    )Cash and cash equivalents, beginning of the period
    
    
    139
    
    
    
    97,659
    
    
    
    
    
    
    
    97,798Cash and cash equivalents, end of the period
    
    $
    99
    
    
    $
    81,486
    
    
    $
    
    
    
    $
    81,585Supplemental Cash Flow Data:Interest paid, net of capitalized interest of $87
    
    $
    296
    
    
    $
    20,991
    
    
    $
    
    
    
    $
    21,287Income taxes paid
    
    $
    1,120
    
    
    $
    
    
    
    $
    
    
    
    $
    1,120
 20




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##### Table of Contents



8. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 2003 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedNet cash provided (used) by operating activities
    
    $
    (124,533
    )
    
    $
    159,622
    
    
    $
    
    
    
    $
    35,089Cash Flows from Investing Activities:Construction and capital expenditures
    
    
    (10,245
    )
    
    
    (5,058
    )
    
    
    
    
    
    
    (15,303
    )Net proceeds from sale of business
    
    
    138,091
    
    
    
    
    
    
    
    
    
    
    
    138,091Release of funds from escrow
    
    
    
    
    
    
    3,539
    
    
    
    
    
    
    
    3,539Placement of funds in restricted account
    
    
    
    
    
    
    (200
    )
    
    
    
    
    
    
    (200
    )Net cash provided (used) by investing activities
    
    
    127,846
    
    
    
    (1,719
    )
    
    
    
    
    
    
    126,127Cash Flows from Financing Activities:Payments on long-term debt
    
    
    (3,026
    )
    
    
    (110,053
    )
    
    
    
    
    
    
    (113,079
    )Dividends
    
    
    
    
    
    
    (2,142
    )
    
    
    
    
    
    
    (2,142
    )Net cash use by financing activities
    
    
    (3,026
    )
    
    
    (112,195
    )
    
    
    
    
    
    
    (115,221
    )Increase in cash and cash equivalents
    
    
    287
    
    
    
    45,708
    
    
    
    
    
    
    
    45,995Cash and cash equivalents, beginning of the period
    
    
    (73
    )
    
    
    18,638
    
    
    
    
    
    
    
    18,565Cash and cash equivalents, end of the period
    
    $
    214
    
    
    $
    64,346
    
    
    $
    
    
    
    $
    64,560Supplemental Cash Flow Data:Interest paid, net of capitalized interest of $92
    
    $
    531
    
    
    $
    23,239
    
    
    $
    
    
    
    $
    23,770Income taxes paid
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Supplemental Noncash Transactions:Property acquired under capital leases and mortgages
    
    $
    2,340
    
    
    $
    
    
    
    $
    
    
    
    $
    2,340Interest rate swap marked to market
    
    $
    
    
    
    $
    (3,640
    )
    
    $
    
    
    
    $
    (3,640
    )
 21




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##### Table of Contents



9. COMMITMENTS AND CONTINGENCIES The Company is involved in various claims, legal actions and regulatory
proceedings arising in the ordinary course of business and has recorded
litigation reserves of $3,442 at June 30, 2004 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. A class action lawsuit was filed against the Company on March 14, 2001.
The litigation alleges various contract and statutory claims concerning the
Companys decision to terminate its Infinite Minutes long distance plan.
Although the Company believes this suit is without merit and intends to
vigorously defend its position, it is impossible to predict the outcome. The Company has disputes with Dobson Communications over reciprocal
payments and tower ownership. The Company cannot predict the outcome of these
disputes. On July 15, 2002 the Company fulfilled a commitment to Neptune
Communications, L.L.C. (Neptune) to provide a loan for the aggregate
principal amount of $15,000 in return for certain consideration. The Company
has an agreement that enables it to purchase additional fiber optic capacity in
future years from Neptune, the expenditures for which are expected to be
significant and may exceed $25,000 over the next four years. ACS expects to
spend approximately $4,500 in the third quarter related to capacity additions
under this agreement. While the Company has an agreement with Neptune, certain
material terms of the agreement remain subject to continued renegotiation. The
significant provisions of this agreement are: (i) purchase commitments by the
Company for capacity in 2005 and 2007, the final price and quantity of which
are subject to future events, (ii) Neptunes restoration of the Companys
traffic carried on another cable system, (iii) and specific interconnection
arrangements between the Company and Neptune, should the Company exercise its
option to purchase certain network assets from Neptune. The Company is
currently negotiating open elements of its agreement with Neptune and
renegotiating other terms and conditions of the agreement. It is impossible to
determine the ultimate outcome of these negotiations at this time. The loan was
written down to zero, its estimated fair value, during the quarter ended
September 30, 2003. 10. OTHER EVENTS ACS Group filed with the Securities and Exchange Commission on June 1,
2004 Amendment No. 1 to its registration statements for a proposed initial
public offering of its Income Deposit Securities (IDSs), a separate proposed
offering of its senior subordinated notes and the proposed reclassification of
its existing common stock into cash and shares of new class B common stock. An
IDS is a unit containing one share of new class A common stock of ACS Group and
a fixed principal amount of senior subordinated notes of ACS Group. The senior
subordinated notes to be sold in the separate offering will be identical to
those senior subordinated notes included in the IDSs. A majority of the shares
of class B common stock issued in the reclassification would be subject to a
mandatory exchange for IDSs within approximately 12 days following the offering
with the remaining shares of class B common stock issued in the
reclassification subject to a mandatory exchange for IDSs on the second
anniversary of the offering provided certain conditions are met. The completion
of the proposed offerings and reclassification is subject to a number of
conditions, including the approval of the reclassification by the holders of a
majority of the ACS Groups outstanding existing common stock. ACS Group plans
to use the net proceeds of the proposed offerings, together with available
cash, to refinance certain outstanding indebtedness and to finance the cash
portion of the proposed reclassification of ACS Groups outstanding existing
common stock, including shares held by its majority shareholders, affiliates of
Fox Paine & Company, LLC. 22




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##### Table of Contents



10. OTHER EVENTS (continued) On July 27, 2004, the Company adopted a plan to terminate early an
aircraft operating lease it had entered into in November 1999 and ceased use of
the leased aircraft. Under the terms of the lease, the Company has a right to
sell the aircraft, or alternatively to permit the lessor to sell the aircraft.
In either event, the Company is liable to the lessor for any deficiency of
proceeds of such sale against a termination value schedule as set forth in the
lease agreement. The Company believes, based on broker assessments and an
initial offer it has received, that the market value for the aircraft is below
the current termination value set forth in the lease agreement. The Company
also expects to incur other exit costs associated with the lease termination.
As a result of the planned lease termination, the Company expects to record a
loss during the third quarter of 2004 currently estimated to be in the range of
$2,500 to $3,000 under SFAS No. 146, Accounting for Costs Associated with Exit
or Disposal Activities. 23




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##### Table of Contents



Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 FORWARD LOOKING STATEMENTS AND ANALYSTS REPORTS This Form 10-Q and future filings by the Company on Forms 10-K, 10-Q and
8-K and future oral and written statements by the Company and its management
may include, certain forward-looking statements as defined under the Private
Securities Litigation Reform Act of 1995, including (without limitation)
statements with respect to anticipated future operating and financial
performance, financial position and liquidity, growth opportunities and growth
rates, pricing plans, acquisition and divestitive opportunities, business
prospects, strategic alternatives, business strategies, regulatory and
competitive outlook, investment and expenditure plans, financing needs and
availability, and other similar forecasts and statements of expectation. Words
such as aims, anticipates, believes, could, estimates, expects,
hopes, intends, may, plans, projects, seeks, should, and will,
and variations of these words and similar expressions, are intended to identify
these forward-looking statements. These forward looking statements are subject
to certain risks and uncertainties that could cause actual results to differ
materially from the Companys historical experience and its present
expectations or projections.Forward-looking statements by the Company and its
management are based on estimates, projections, beliefs and assumptions of
management and are not guarantees of future performance. The Company disclaims
any obligation to update or revise any forward-looking statement based on the
occurrence of future events, the receipt of new information, or otherwise. Actual future performance, outcomes and results may differ materially from
those expressed in forward-looking statements made by the Company and its
management as a result of a number of important factors. Examples of these
factors include (without limitation) rapid technological developments and
changes in the telecommunications industries; ongoing deregulation (and the
resulting likelihood of significantly increased price and product/service
competition) in the telecommunications industry as a result of the
Telecommunications Act of 1996 (the 1996 Act) and other similar federal and
state legislation and the federal and state rules and regulations enacted
pursuant to that legislation; regulatory limitations on the Companys ability
to change its pricing for communications services; the possible future
unavailability of SFAS No. 71, Accounting for the Effects of Certain Types of
Regulation,to the Companys wireline subsidiaries; and possible changes in the
demand for the Companys products and services. In addition to these factors,
actual future performance, outcomes and results may differ materially because
of other, more general, factors including (without limitation) changes in
general industry and market conditions and growth rates; changes in interest
rates or other general national, regional or local economic conditions;
governmental and public policy changes; changes in accounting policies or
practices adopted voluntarily or as required by accounting principles generally
accepted in the United States of America; and the continued availability of
financing in the amounts, at the terms and on the conditions necessary to
support the Companys future business. Investors should also be aware that while the Company does, at various
times, communicate with securities analysts, it is against the Companys policy
to disclose to them any material non-public information or other confidential
information.Accordingly, investors should not assume that the Company agrees
with any statement or report issued by an analyst irrespective of the content
of the statement or report. To the extent that reports issued by securities
analysts contain any projections, forecasts or opinions, such reports are not
the responsibility of the Company. 24




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##### Table of Contents



INTRODUCTION The Company generates revenue primarily through:  
    
    the provision of local telephone services, including:  
    
    basic local service to retail customers within the Companys service areas,
    
    wholesale service to competitive local exchange carriers (CLECs),
    
    network access services to interexchange
carriers for origination and termination of interstate and
intrastate long distance phone calls,
    
    enhanced services,
    
    ancillary services, such as billing and collection, and
    
    universal service payments;  
    
    the provision of wireless services;
    
    the provision of Internet services; and
    
    the provision of interexchange network long-distance and data services. In addition, the Company provides video entertainment services through its
partnership with the satellite operator, Dish Network. Local
Telephone -The Company is the largest local exchange carrier
(LEC) in Alaska and the 13th largest in the United States. Basic local
service is generally provided at a flat monthly rate and allows the user to
place unlimited calls within a defined local calling area. Access revenues are
generated in part by billing interexchange carriers for access to the LECs
local network and its customers and in part by billing the local customers
themselves. Universal service revenues are a subsidy paid to rural LECs to
support the high cost of providing service in rural markets. Changes in revenue are largely attributable to changes in the number of
access lines, local service rates and minutes of use. Other factors can also
impact revenue, including:  
    
    intrastate and interstate revenue settlement methodologies,
    
    authorized rates of return for regulated services,
    
    whether an access line is used by a business or consumer subscriber,
    
    intrastate and interstate calling patterns,
    
    customers selection of various local rate plan options,
    
    selection of enhanced calling services, such as voice mail, and
    
    other subscriber usage characteristics. LECs have three basic tiers of customers:  
    
    consumer and business customers located in their
local service areas that pay for local phone service and a
portion of network access,
    
    interexchange carriers that pay for access to long
distance calling customers located within its local service
areas and
    
    CLECs that pay for wholesale access to the Companys
network in order to provide competitive local service on either
a wholesale or unbundled network element (UNE) basis as
prescribed under the 1996 Act. 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
upon long distance calling patterns and the relative market share of each long
distance carrier. The Companys local service rates for end users are authorized by the RCA.
Authorized rates are set by the FCC and the RCA for interstate and intrastate
access charges, respectively, and may change from time to time. 25




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##### Table of Contents



Wireless- The Company is one of the largest statewide providers of
wireless services in Alaska, currently serving approximately 91,000
subscribers. Its wireless network covers over 480,000 residents, including all
major population centers and highway corridors. The Company currently operates
a TDMA digital network in substantially all of its service areas, and has begun
to upgrade this network to a new generation of digital network known as CDMA
1xRTT which provides customers with improved voice call quality, mobile data
speeds of 64kbps and provides a platform for the launch of enhanced services.
The Company began offering CDMA 1xRTT services in several of its service areas
in May 2004. In June 2004 the Company began offering wireless broadband
service based on EV-DO which enables computer connectivity with speeds that
burst up to 2mbps to its wireless markets in Anchorage, Fairbanks, and Juneau. Internet- The Company is the second largest provider of Internet access
services in Alaska with approximately 45,000 customers. The Company offers
dial-up and dedicated digital subscriber line (DSL) Internet access to its
customers. The Company is a single source provider of advanced IP based private
networks in Alaska. Interexchange-The Company provides switched and dedicated long distance
services to approximately 43,000 customers in Alaska. The traffic from these
customers is carried over the Companys owned or leased facilities. Satellite Television The Company provides video entertainment services
on a resale basis through the Companys partnership with the satellite
provider, DISH Network. The Company entered into this agreement in August 2003. Critical Accounting Policies and Accounting Estimates Management is responsible for the financial statements presented elsewhere
in this 10-Q and has evaluated the accounting policies used in their
preparation.Management believes these policies to be reasonable and
appropriate. The Companys significant accounting policies are described in
Note 1 in the Notes to the Consolidated Financial Statements included in the
Companys Annual Report on Form 10-K for the year ended December 31, 2003. The
following discussion identifies those accounting policies that management
believes are critical in the preparation of the Companys financial statements,
the judgments and uncertainties affecting the application of those policies,
and the possibility that materially different amounts would be reported under
different conditions or using different assumptions. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of commitments and contingencies at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Among the significant estimates affecting
the financial statements are those related to the realizable value of accounts
receivable, long-lived assets (in particular, those assets accounted for under
SFAS No. 71, Accounting for the Effects of Certain Types of Regulation)income
taxes, network access revenue reserves and litigation reserves. Actual results
may differ from those estimates. The Company uses an allowance method to estimate the net realizable value
of accounts receivable. As of June 30, 2004 and 2003, the allowance for
doubtful accounts receivable was $4.0 and $4.4 million, respectively. Actual
collection results could vary significantly from managements estimate. Access revenue is recognized when earned. The Company participates in
access revenue pools with other telephone companies. Such pools are funded by
toll revenue and/or access charges regulated by the RCA within the intrastate
jurisdiction and 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. To the extent that
disputes arise over revenue settlements, the Companys policy is to defer
revenue collected until settlement methodologies are resolved and finalized. 26




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##### Table of Contents



At June 30, 2004 the Company had recorded liabilities of $17.9 million
related to its estimate of refundable access revenue. Actual results could vary
from this estimate. The Company utilizes the liability method of accounting for income taxes.
Under the 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.Deferred tax assets are reduced by a valuation allowance to the extent
that it is more likely than not that such deferred tax assets will not be
realized. The cumulative valuation allowance against deferred tax assets was
$98.8 million as of June 30, 2004. The local telephone exchange operations of the Company account for costs
in accordance with the accounting principles for regulated enterprises
prescribed by SFAS No. 71.This accounting recognizes the economic effects of
rate regulation by recording cost and a return on investment as such amounts
are recovered through rates authorized by regulatory authorities. Accordingly,
under SFAS No. 71, plant and equipment is depreciated over lives approved by
regulators and certain costs and obligations are deferred based upon approvals
received from regulators to permit recovery of such amounts in future years. The Company implemented, effective January 1, 2003, higher depreciation
rates for its regulated telephone plant for the interstate jurisdiction which
management believes approximate the economically useful lives of the underlying
plant. As a result, the Company has recorded a regulatory asset under SFAS No.
71 of $27.0 million as of June 30, 2004 related to depreciation of the
regulated telephone plant allocable to its intrastate and local jurisdictions.
The Company has also deferred as a regulatory asset $0.9 million of costs
incurred in connection with regulatory rate making proceedings, which is being
amortized over three years starting in 2003. The balance of this regulatory
asset was $0.4 million at June 30, 2004. If the Company were not following SFAS
No. 71, it would have recorded additional cumulative depreciation expense of
$27.0 million for the intrastate and local jurisdictions and the deferred costs
incurred in connection with regulatory rate making proceedings would have been
charged to expense as incurred. The Company also has a regulatory liability of
$52.7 million at June 30, 2004 related to accumulated removal costs. If the
Company were not following SFAS No. 71, it would have followed SFAS No. 143 for
asset retirement obligations. Non-regulated revenues and costs incurred by the
local telephone exchange operations and non-regulated operations of the Company
are not accounted for under SFAS No. 71 principles. Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets. In accordance with the guidelines of this accounting
principle, goodwill and indefinite-lived intangible assets are no longer
amortized but will be assessed for impairment on at least an annual basis. SFAS
No. 142 requires that goodwill be tested for impairment at the reporting unit
level upon adoption and at least annually thereafter, utilizing a two-step
methodology. The initial step requires the Company to determine the fair value
of each reporting unit and compare it to the carrying value, including
goodwill, of such unit. If the fair value exceeds the carrying value, no
impairment loss would be recognized. However, if the carrying value of the
reporting unit exceeds its fair value, the goodwill of the unit may be
impaired. The amount, if any, of the impairment is then measured in the second
step. The Company determined the fair value of each reporting unit for purposes
of this test primarily by using a discounted cash flow valuation technique.
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. At June 30, 2004 the
Company had recorded goodwill of $38.4 million applicable to its local
telephone and wireless segments. The Company is involved in various claims, legal actions and regulatory
proceedings arising in the ordinary course of business, and has recorded
litigation reserves of $3.4 million against certain claims and legal actions as
of June 30, 2004. 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 beyond the amounts already
recorded. Estimates involved in developing these litigation reserves could
change as these claims, legal actions and regulatory proceedings are resolved. 27




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##### Table of Contents



RESULTS OF OPERATIONS Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003 All amounts are discussed at the consolidated level after the elimination
of intercompany revenue and expense. Operating Revenue Operating revenue decreased $8.7 million, or 10.3%, for the three months
ended June 30, 2004 compared to the three months ended June 30, 2003. Wireless
revenue increased compared to the corresponding period of 2003, while local
telephone, internet and interexchange revenue decreased compared to the
corresponding period of 2003. On May 8, 2003, the Company completed the sale of
a majority interest (87.42%) in its Directories Business. The Company did not
have any revenues from operations from the Directories Business after that
date, but had recorded $3.4 million of revenues from this business for the
three months ended June 30, 2003. Local Telephone Local telephone revenue, which consists of local network service, network
access and deregulated and other revenue, decreased $2.3 million, or 4.1%, for
the three months ended June 30, 2004 compared to the same period in 2003. The
following table summarizes the Companys consolidated local telephone revenue
by category: Three Months EndedJune 30,2004
    
    2003(in thousands)Local telephone revenue:Local network service
    
    $
    22,995
    
    
    $
    25,219Network access
    
    
    24,539
    
    
    
    25,140Deregulated and other
    
    
    5,414
    
    
    
    4,851Total local telephone revenue
    
    $
    52,948
    
    
    $
    55,210
 The following table summarizes the Companys local telephone access lines: As of June 30,2004
    
    2003Local telephone access lines:Retail
    
    
    212,737
    
    
    
    227,604Wholesale
    
    
    21,310
    
    
    
    18,868Unbundled
network elements - platform (UNE - P)
    
    
    4,814
    
    
    
    4,892Unbundled
network elements - loop (UNE - L)
    
    
    68,662
    
    
    
    66,864Total local telephone access lines
    
    
    307,523
    
    
    
    318,228
 Local network service revenue decreased $2.2 million or 8.8% from the
prior year, while access lines in service decreased 3.4% to 307,523, inclusive
of a reduction of 2,538 internal lines that ceased to be counted following a
change in line count methodology. Exclusive of the change in line count
methodology, lines in service decreased by 2.6% from the prior year. The
decrease reflects the net effect of retail market share losses offset by
increases in wholesale revenue. Also contributing to the decrease in local
network service are decreases in feature, directory assistance and cellular
access revenue. The Company experienced a loss of direct retail customers during the year
as customers cancelled second lines they were not using or switched to
competing service providers. This reduction in direct retail 28




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##### Table of Contents



customers was
partially offset by an increase in wholesale lines. Generally, if a retail
local network service customer of the Company switches to a competitor, the
Company continues to provide the line to the competitor on a wholesale basis at
reduced revenue per line. Management believes that the continuing loss of
retail market share it has experienced in certain of its markets is partially
attributable to below cost interconnection rates mandated by the RCA for UNEs.
During the first quarter of 2000, the Company reopened interconnection
proceedings for its Anchorage market and during the second quarter of 2001
filed for an interim and refundable UNE rate increase of approximately $10 per
month per loop. On October 25, 2001, the RCA granted ACSA an interim UNE rate
increase of $1.07, bringing the UNE rate up from $13.85 to $14.92. The interim
rate increase was implemented in November 2001 and generated approximately $0.8
million in additional annual revenue during 2003. The RCA held a formal hearing
on final Anchorage UNE rates during November 2003 and issued an order on June
25, 2004 granting ACSA an increase in UNE loop rates from $14.92 to $19.15.
This increase is expected to result in additional revenue of approximately
$3.1 million annually at current demand levels. Both parties have asked the RCA
to reconsider portions of its decision. On April 18, 2004, ACSF and ACSAK settled a dispute with GCI concerning
their claim to a rural exemption. As part of that agreement the parties also
agreed to new interconnection agreements between: (1) ACSF and GCI; and (2)
ACSAK and GCI. Among other elements of the agreement, the parties have agreed
to an increase in UNE rates for local loops in ACSF and ACSAK commencing on
January 1, 2005. In compliance with Alaska Public Utilities Commission (APUC) orders
related to the approval of the acquisition of the four LECs in 1999, ACS filed
local service rate cases for all of its LEC businesses with the RCA on July 2,
2001. The RCAs decisions on revenue requirements have a direct impact on the
retail rates and intrastate access rates that the Company is allowed to charge.
A RCA finding of over earnings generally leads to rate reductions while a RCA
finding of under earnings generally results in rate increases. In October 2001, ACSA filed for increased interim local service rates in
Anchorage in order to expedite a partial recovery of its total revenue
deficiency. On November 15, 2001, the RCA approved an interim and refundable
rate increase for ACSA of 24% for certain services.This interim rate increase
was implemented in November 2001 and generated approximately $3.8 million in
annual revenue for 2003. The RCA concluded the revenue requirement phase of the
hearing for ACSA by finding ACSA to be under earning. On June 24, 2004, ACSA
filed the cost-of-service and rate-design studies required in the original 1999
APUC orders. The RCA has scheduled rate hearings during December 2004 to hear
evidence on any unresolved issues. On March 25, 2003, the RCA issued an order approving new revenue
requirements for ACSF, ACSAK, and ACSN. The RCA found over earnings by ACSF and
ACSN and under earnings by ACSAK. In compliance with RCA orders, ACSF, ACSAK,
ACSN filed cost of service and rate design studies, and supporting testimony,
consistent with the RCA revenue requirements orders. A stipulated rate
settlement for ACSF, ACSAK and ACSN was approved by the RCA on
April 8, 2004.
This settlement is expected to reduce revenue, though the quantitative
impact on revenue is not determinable at this time. Network access revenue decreased $0.6 million or 2.4% for the three months
ended June 30, 2004 compared to the same period in 2003. Network access revenue
is based on a regulated return on rate base and recovery of allowable expense
associated with the origination and termination of toll calls for the Companys
retail and resale customers.Management expects that network access revenue
will decline as a component of local telephone revenue for the foreseeable
future. Deregulated and other revenue, which increased $0.6 million or 11.6% for
the three months ended June 30, 2004, consists principally of billing and
collection (B&C) services, space and power rents, deregulated equipment
sales, paystation revenue, regulated directory listing revenue, and other
miscellaneous telephone revenue. The increase in deregulated and other revenue
is due principally to an increase in B&C services and messaging revenue. 29




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##### Table of Contents



Wireless Wireless revenue increased $1.5 million, or 12.7% for the three months
ended June 30, 2004 compared to the three months ended June 30, 2003. This
increase is due primarily to the following:  
    
    Growth in average subscribers of 8.5% for the three months
ended June 30, 2004 over the prior year period.
    
    An increase in monthly average revenue per unit, or ARPU, of
3.9% from $48.24 for the three months ended June 30, 2003 to $50.11
for the three months ended June 30, 2004 primarily as a result of
increased minutes of use over calling plan allotments. Subscriber
average minutes of use increased from 244 minutes for the three
months ended June 30, 2003 to 256 minutes for the three months ended
June 30, 2004.
    
    Higher gross customer adds in the three months ended June 30,
2004 resulting in $1 million of handset revenue compared to $0.5
million for the same time period in 2003. Internet Internet revenue decreased $3.9 million, or 43.5%, for the three months
ended June 30, 2004 compared to the same time period in 2003. This decrease is
primarily due to the loss of $4.8 million in revenue associated with the
Companys contract with the State of Alaska which was terminated in October
2003 offset by $0.9 million of revenue increases primarily as a result of
growth in DSL subscribers of 41.5% from 14,817 at June 30, 2003 to 20,963 at
June 30, 2004. On September 15, 2003, the Company received notification from the State of
Alaska that it intended to terminate a five year Telecommunications Services
Partnering Agreement (TPA) with the Company. Subsequently, the Company and
the State negotiated and agreed to a definitive Settlement Agreement and Mutual
Release effective October 14, 2003, outlining the terms of disentanglement
between the parties. The Company completed its remaining obligations under the
Settlement Agreement during the first quarter of 2004. Interexchange Interexchange revenue decreased $0.7 million, or 14.8%, for the three
months ended June 30, 2004, compared to the same time period in 2003. This is
primarily due to the loss of revenue associated with the State of Alaska
discussed under Internet above. Both intrastate and interstate revenue
declined from the previous year. Long distance subscribers decreased from
44,289 in 2003 to 42,653 in 2004, and the quarterly minutes of use decreased
from 36.7 million in 2003 to 33.1 million in 2004. The decline in subscribers
and minutes of use was primarily due to the loss of the State of Alaska
contract. Operating Expense Operating expense increased $87.0 million, or 446.2%, for the three months
ended June 30, 2004. The increase is primarily attributable to the $97.3
million gain on disposal of assets recognized in the three months ended June
30, 2003 mitigated by the following cost reductions:  
    
    Cost avoidance following the termination of the State of
Alaska contract.
    
    Reduction in depreciation and amortization of $3.3 million
following an order by the RCA to reduce depreciation rates, which
the Company adopted in the fourth quarter of 2003.
    
    Cost avoidance following the sale of a majority interest
(87.42%) in the Directories Business, which had recorded $1.8
million of expense for the six months ended June 30, 2003. Depreciation and amortization associated with the operation of each of the
Companys segments has been included in total depreciation and amortization. Local Telephone 30




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##### Table of Contents



The components of local telephone expense are plant specific operations,
plant non-specific operations, customer operations, corporate operations and
property and other operating tax expense.Local telephone expense increased
$2.3 million or 8.4% for the three months ended June 30, 2004, compared to the
same time period in 2003.The increase in local telephone expense was primarily
attributable to a higher proportion of shared costs being allocated to the
local telephone segment following the termination of the State of Alaska
contract. Wireless Wireless expense increased $1.0 million, or 13.5%, for the three months
ended June 30, 2004 compared to the three months ended June 30, 2003. This
increase is due substantially to an increase in minutes of use from 60.4
million minutes in the three months ended June 30, 2003 to 68.7 million minutes
in the three months ended June 30, 2004. Additionally, the cost of goods sold
for cell phones increased $0.57 million for the three months ended June 30,
2004 compared to the same period in 2003 as the Company gained 3,092
subscribers for the three months ended June 30, 2004 compared to 669
subscribers for the three months ended June 30, 2003. The Company also incurred
costs associated with the planned launch in selected regions of its CDMA 1x RTT
and EV-DO networks in May 2004 and June 2004, respectively. Internet Internet expense decreased by $7.1 million, or 52.5%, for the three months
ended June 30, 2004 compared to the three months ended June 30, 2003. The
decrease in Internet expense was due principally to the elimination of the
direct operating costs and a lower proportion of shared costs being allocated
to this segment following the termination of the Companys contract with the
State of Alaska. As discussed above, this contract with the State of Alaska was
terminated effective October 2003. Interexchange Interexchange expenses decreased by $1.4 million, or 21.8% for the three
months ended June 30, 2004 compared to the three months ended June 30, 2003.
The majority of this decrease was the result of the decline in long distance
minutes of use as discussed under interexchange service revenue above and is
primarily attributable to the loss of the contract with the State of Alaska. Depreciation and Amortization Depreciation and amortization expense decreased $3.3 million, or 14.9%,
for the three months ended June 30, 2004 compared to the three months ended
June 30, 2003. The decrease in depreciation is due principally to depreciation
rate decreases ordered by the RCA for ACSA which the Company adopted for the
intrastate and local jurisdictions during the fourth quarter of 2003,
retroactive to January 1, 2003. Gain/Loss on Disposal of Assets For the three months ended June 30, 2003, the Company recognized a gain on
disposition of the majority interest of its directory business of $97.6 million
on a pre-tax basis. Interest Expense Interest expense decreased $3.6 million to $11.3 million for the three
months ended June 30, 2004 compared to $14.9 million for the three months ended
June 30, 2003. The Companys interest expense declined due to lower term loan
balances, market interest rate effects on the Companys variable interest rate
debt, and the early extinguishment of its interest rate swap contract during
the fourth quarter of 2003. This was partially additional interest expense in
2004 resulting from the $182 million aggregate principal amount of 9 7/8%
senior unsecured notes due 2011 issued by the Company in August 2003. Interest Income and Other 31




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Interest income and other declined by $4.6 million to $0.2 million for the
three months ended June 30, 2004 compared to $4.8 million in the prior year
comparable period. The decline was principally due to a gain on foreign
exchange of $4.1 million recorded during the three months ended June 30, 2003
realized in connection with the sale of a majority interest (87.42%) in the
Directories Business to a Canadian income fund on May 8, 2003. Also
contributing to the decline was lower equity in the earnings of the retained
interest in the Directories Business during the three months ended June 30,
2004 as a result of selling an additional 12.48% of that business on August 27,
2003. Income Taxes The Company has fully reserved the income tax benefit resulting from the
consolidated losses it has incurred since May 14, 1999, the date of the
acquisition of substantially all of its operations. Net loss The change in net loss is primarily a result of the factors discussed
above. Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003 All amounts are discussed at the consolidated level after the elimination
of intercompany revenue and expense. Operating Revenue Operating revenue decreased $17.1 million, or 10.2%, for the six months
ended June 30, 2004 compared to the six months ended June 30, 2003. Wireless
revenue increased compared to the corresponding period of 2003, while local
telephone, internet and interexchange revenue decreased compared to the
corresponding period of 2003. On May 8, 2003, the Company completed the sale of
a majority interest (87.42%) in its Directories Business. The Company did not
have any revenues from operations from the Directories Business after that
date, but had recorded $11.6 million of revenues from this business for the six
months ended June 30, 2003. Local Telephone Local telephone revenue, which consists of local network service, network
access and deregulated and other revenue, decreased $0.5 million, or 0.4%, for
the six months ended June 30, 2004 compared to the same period in 2003. The
following table summarizes the Companys consolidated local telephone revenue
by category: Six Months EndedJune 30,2004
    
    2003(in thousands)Local telephone revenue:Local network service
    
    $
    45,748
    
    
    $
    49,348Network access
    
    
    52,234
    
    
    
    50,201Deregulated and other
    
    
    10,748
    
    
    
    9,662Total local telephone revenue
    
    $
    108,730
    
    
    $
    109,211
 The following table summarizes the Companys local telephone access lines: 32




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As of June 30,2004
    
    2003Local telephone access lines:Retail
    
    
    212,737
    
    
    
    227,604Wholesale
    
    
    21,310
    
    
    
    18,868Unbundled
network elements - platform (UNE - P)
    
    
    4,814
    
    
    
    4,892Unbundled
network elements - loop (UNE - L)
    
    
    68,662
    
    
    
    66,864Total local telephone access lines
    
    
    307,523
    
    
    
    318,228
 Local network service revenue decreased $3.6 million or 7.3% from the
prior year, while access lines in service decreased 3.4% to 307,523, inclusive
of a reduction of 2,538 internal lines that ceased to be counted following a
change in line count methodology. Exclusive of the change in line count
methodology, lines in service decreased by 2.6% from the prior year. The
decrease reflects the net effect of retail market share losses offset by
increases in wholesale revenue. Also contributing to the decrease in local
network service are decreases in feature, directory assistance and cellular
access revenue. The Company experienced a loss of direct retail customers during the year
as customers cancelled second lines they were not using or switched to
competing service providers. This reduction in direct retail customers was
partially offset by an increase in wholesale lines. Generally, if a retail
local network service customer of the Company switches to a competitor, the
Company continues to provide the line to the competitor on a wholesale basis at
reduced revenue per line. Management believes that the continuing loss of
retail market share it has experienced in certain of its markets is partially
attributable to below cost interconnection rates mandated by the RCA for UNEs. Network access revenue increased $2.0 million to $52.2 million for the six
months ended June 30, 2004 compared to the same period in 2003. The increase in
network access revenue is due to ongoing true-ups to prior years interstate
access and universal service fund studies. Network access revenue is based on a
regulated return on rate base and recovery of allowable expense associated with
the origination and termination of toll calls for the Companys retail and
resale customers.Management expects that network access revenue will decline
as a component of local telephone revenue for the foreseeable future. Deregulated and other revenue, which increased $1.1 million to $10.7
million for the six months ended June 30, 2004, consists principally of billing
and collection (B&C) services, space and power rents, deregulated equipment
sales, paystation revenue, regulated directory listing revenue, and other
miscellaneous telephone revenue. The increase in deregulated and other revenue
is due principally to an increase in B&C services and messaging revenue. Wireless Wireless revenue increased $2.8 million, or 12.5%, to $25.1 million for
the six months ended June 30, 2004 compared to $22.3 million for the six months
ended June 30, 2003. This increase is due primarily to the following:  
    
    Growth in average subscribers of 7.9% for the six months
ended June 30, 2004 over the prior year period.
    
    An increase in monthly average revenue per unit, or ARPU, of
4.3% from $44.97 for the six months ended June 30, 2003 to $46.91
for the six months ended June 30, 2004 primarily as a result of
increased minutes of use over calling plan allotments. Subscriber
average minutes of use increased from 217 minutes for the six months
ended June 30, 2003 to 239 minutes for the six months ended June 30,
2004.
    
    Higher gross customer adds in the six months ended June 30,
2004 resulting in $1.6 million of handset revenue, compared to $0.9
million for the six months ended June 30, 2003. 33




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Internet Internet revenue decreased $6.5 million, or 40.0%, to $9.7 million for the
six months ended June 30, 2004 compared to $16.2 million for the six months
ended June 30, 2003. This decrease is primarily due to the loss of $8.4 million
in revenue associated with the Companys contract with the State of Alaska,
which was terminated in October 2003, offset by $1.8 million of revenue
increases as a result of growth in DSL subscribers of 41.0% from 14,817 at June
30, 2003 to 20,963 at June 30, 2004. Interexchange Interexchange revenue decreased from $8.5 million for the six months ended
June 30, 2003 to $7.2 million for the six months ended June 30, 2004 primarily
due to the termination of services to the State of Alaska. Both intrastate and
interstate revenue declined from the previous year. Long distance subscribers
decreased from 44,289 at June 30, 2003 to 42,653 at June 30, 2004. Total
minutes of use decreased from 74.6 million in 2003 to 65.3 million for the six
months ended June 30, 2004. Operating Expense Operating expense increased $82.1 million, or 142.4%, from $57.7 million
for the six months ended June 30, 2003 to $139.8 million for the six months
ended June 30, 2004. The increase is primarily attributable to the $96.5
million gain on disposal of assets recognized in the six months ended June 30,
2003 mitigated by the following cost reductions:  
    
    Cost avoidance following the termination of the State of
Alaska contract.
    
    Reduction in depreciation and amortization of $6.8 million
following an order by the RCA to reduce depreciation rates which the
Company adopted in the fourth quarter of 2003.
    
    Cost avoidance following the sale of a majority interest
(87.42%) in the Directories Business, which had recorded $5.3
million of expense for the six months ended June 30, 2003. Depreciation and amortization associated with the operation of each of the
Companys segments has been included in total depreciation and amortization. Local Telephone The components of local telephone expense are plant specific operations,
plant non-specific operations, customer operations, corporate operations and
property and other operating tax expense.Local telephone expense increased to
$61.6 million for the six months ended June 30, 2004 from $54.1 million for the
six months ended June 30, 2003.The increase in local telephone expense was
primarily attributable to employee severance and recruiting costs, consulting
fees, and a higher proportion of shared costs being allocated to the local
telephone segment following the termination of the State of Alaska contract. Wireless Wireless expense increased $2.0 million, or 14.1%, for the six months
ended June 30, 2004 compared to the six months ended June 30, 2003. This
increase is due substantially to an increase in minutes of use from 107.6
million minutes in the six months ended June 30, 2003 to 127.8 million minutes
in the six months ended June 30, 2004. Additionally, the cost of goods sold
for cell phones increased $0.84 million for the three months ended June 30,
2004 compared to the same period in 2003. The Company also incurred costs
associated with the planned launch in selected regions of its CDMA 1x RTT and
EV-DO networks in May 2004 and June 2004, respectively. Internet Internet
expense decreased by $10.2 million, or 42.3%, from $24.1 million
in 2003 to $13.9 million in 2004. The decrease in Internet expense was due
principally to the elimination of the operating
costs associated with the Companys contract with the State of Alaska. As
discussed above, this contract 34




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with the State of Alaska was terminated
effective October 2003. The decrease was offset by an increase in DSL cost of
goods sold of $1.1 million due to the increase of DSL subscribers of 41%. Interexchange Interexchange expenses decreased by $2.0 million, or 16.5% to $9.9 million
for the six months ended June 30, 2004 compared to the six months ended June
30, 2003. The majority of this decrease was the result of the decline in long
distance minutes of use, as discussed under interexchange service revenue
above, and is primarily attributable to the loss of the contract with the State
of Alaska. Depreciation and Amortization Depreciation and amortization expense decreased $6.8 million, or 15.2%, to
$37.9 million for the six months ended June 30, 2004 compared to the six months
ended June 30, 2003. The decrease in depreciation is due principally to
depreciation rate decreases ordered by the RCA for ACSA which the Company
adopted for the intrastate and local jurisdictions during the fourth quarter of
2003, retroactive to January 1, 2003. Gain/Loss on Disposal of Assets For the six months ended June 30, 2003, the Company recognized a gain on
disposition of the majority interest of its directory business of $97.6 million
on a pre-tax basis. The Company also recorded a non-cash loss on the disposal
of certain fixed assets of $1.1 million during 2003, the majority of which were
wireless assets. Interest Expense Interest expense decreased $4.8 million to $22.8 million for the six
months ended June 30, 2004 compared to $27.6 million for the six months ended
June 30, 2003. The Companys interest expense declined due to lower term loan
balances, market interest rate effects on the Companys variable interest rate
debt, and the early extinguishment of its interest rate swap contract during
the fourth quarter of 2003. This was partially offset by additional interest
expense in 2004 resulting from the $182 million aggregate principal amount of 9
7/8% senior unsecured notes due 2011 issued by the Company in August 2003. Interest Income and Other Interest income and other declined by $4.5 million to $0.5 million for the
six months ended June 30, 2004 compared to $5.0 million in the prior year
comparable period. The decline was principally due to a gain on foreign
exchange of $4.1 million recorded during the six months ended June 30, 2003
realized in connection with the sale of a majority interest (87.42%) in the
Directories Business to a Canadian income fund on May 8, 2003. Also
contributing to the decline was lower equity in the earnings of the retained
interest in the Directories Business during the six months ended June 30, 2004
as a result of selling an additional 12.48% of that business on August 27,
2003. Income Taxes The Company has fully reserved the income tax benefit resulting from the
consolidated losses it has incurred since May 14, 1999, the date of the
acquisition of substantially all of its operations. Discontinued Operations On March 30, 2002, the Companys management approved a plan to offer for
sale its wireless cable television service segment. As a result of this
decision, the operating revenue and expense of this segment has been classified
as discontinued operations under SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets,for the six months ended June 30, 2003. The
Company has fully reserved in the form of a valuation allowance the income tax
benefit of this discontinuance. The Company completed its disposal of its
wireless cable television segment as of March 31, 2003. 35




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Net loss The change in net loss is primarily a result of the factors discussed
above. LIQUIDITY AND CAPITAL RESOURCES The Company has satisfied its cash requirements for operations, capital
expenditures and debt service primarily through internally generated funds, the
sale of stock and debt financing. For the six months ended June 30, 2004 the
Companys cash flows from operating activities were $8.7 million. At June 30,
2004, the Company had approximately $102.6 million in net working capital, with
approximately $81.6 million represented by cash and cash equivalents. As of
June 30, 2004 the Company had $50.0 million of remaining capacity under its
revolving credit facility, representing 100% of available capacity. The Company has outstanding a $199.0 million bank credit agreement
(Senior Credit Facility), $150.0 million in 9 3/8 % senior subordinated notes
due 2009 and $182.0 million in 9 7/8% senior unsecured notes due 2011,
representing substantially all of the Companys long-term debt of $533.8
million as of June 30, 2004.On May 14, 2004, the Company called its $17.3
million 13% senior discount debentures due 2011. The redemption was completed
on June 14, 2004 at 106.5% of the outstanding principal and as a result a call
premium of $1.1 million was paid. Interest on the Companys senior
subordinated notes and senior unsecured notes is payable semiannually.Interest
on borrowings under the Senior Credit Facility is payable monthly, bi-monthly,
quarterly or semi-annually at the Companys option. The Senior Credit Facility
requires $500 thousand quarterly principal payments that commenced on March 31,
2004, with the balance due in 2010. The Senior Credit Facility, the senior
subordinated notes and the senior unsecured notes contain a number of
restrictive covenants and events of default, including covenants limiting
capital expenditures, incurrence of debt, and the payment of dividends, and the
Senior Credit Facility requires the Company to achieve certain financial
ratios. The Company is in compliance with all of its debt covenants as of the
date of this filing. On July 15, 2002 the Company fulfilled a commitment to Neptune to provide
a loan for the aggregate principal amount of $15.0 million in return for
certain consideration. The Company has an agreement that enables it to purchase
additional fiber optic capacity in future years from Neptune, the expenditures
for which are expected to be significant and may exceed $25 million over the
next four years. ACS expects to spend approximately $4.5 million in the third
quarter related to capacity additions under this agreement. While the Company
has an agreement with Neptune, certain material terms of the agreement remain
subject to continued renegotiation. The significant provisions of this
agreement are: (i) purchase commitments by the Company for capacity in 2005 and
2007, the final price and quantity of which are subject to future events, (ii)
Neptunes restoration of the Companys traffic carried on another cable system,
(iii) interconnection arrangements between the Company and Neptune, should the
Company exercise its option to purchase certain network assets from Neptune.
The Company is currently negotiating open elements of its agreement with
Neptune and renegotiating other terms and conditions of the agreement. It is
impossible to determine the ultimate outcome of these negotiations at this
time. The loan was written down to zero, its estimated fair value, during the
quarter ended September 30, 2003. The local telephone network requires the timely maintenance of plant and
infrastructure. The Companys historical capital expenditures have been
significant. The construction and geographic expansion of the Companys
wireless network has required significant capital. The implementation of the
Companys interexchange network and data services strategy is also capital
intensive. Capital expenditures for 2003 were $50.7 million, of which $11.5
million was expended on CDMA 1x RTT build out and $3.5 million was expended on
the TPA. The Company anticipates capital spending of between $50 million and
$55 million for 2004 and has spent $20.9 million in the first six months of
2004. The Company intends to fund its future capital expenditures with cash on
hand, through internally generated cash flows, and if necessary, through
borrowings under the revolving credit facility. 36




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The Companys capital requirements may change due to, among other things:
impacts of regulatory decisions that affect the Companys ability to recover
its investments, changes in technology, the effects of competition, changes in
the Companys business strategy, and the Companys decision to pursue specific
acquisition opportunities. The Company believes that it will have sufficient working capital provided
by operations and available borrowing capacity under the existing revolving
credit facility to service its debt and fund its operations, capital
expenditures and other obligations over the next 12 months.The Companys
ability to service its debt and fund its operations, capital expenditures and
other obligations will be dependent upon its 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 the Companys
control. ACS Group filed with the Securities and Exchange Commission on June 1,
2004 Amendment No. 1 to its registration statements for a proposed initial
public offering of its Income Deposit Securities (IDS), a separate proposed
offering of its senior subordinated notes and the proposed reclassification of
its existing common stock into cash and shares of new class B common stock. An
IDS is a unit containing one share of new class A common stock of ACS Group and
a fixed principal amount of senior subordinated notes of ACS Group. The senior
subordinated notes to be sold in the separate offering will be identical to
those senior subordinated notes included in the IDSs. A majority of the shares
of class B common stock issued in the reclassification would be subject to a
mandatory exchange for IDSs within approximately 12 days following the offering
with the remaining shares of class B common stock issued in the
reclassification subject to a mandatory exchange for IDSs on the second
anniversary of the offering provided certain conditions are met. The completion
of the proposed offerings and reclassification is subject to a number of
conditions, including the approval of the reclassification by the holders of a
majority of ACS Groups outstanding existing common stock. ACS Group plans to
use the net proceeds of the proposed offerings, together with available cash,
to refinance certain outstanding indebtedness and to finance the cash portion
of the proposed reclassification of ACS Groups outstanding existing common
stock, including shares held by its majority shareholders, affiliates of Fox
Paine & Company, LLC. Outlook The Company expects that, overall, the demand for telecommunications
services in Alaska will grow, particularly as a result of:  
    
    increasing demand for wireless voice and data
services following the launch of its CDMA 1xRTT network,
    
    growth in demand for DSL and Internet access services
due to higher business and consumer bandwidth needs, and
    
    increasing demand for private network services by
government and business on a statewide basis on either a circuit
switched or IP basis. The Company believes that it will be able to capitalize on this demand
through its diverse service offerings on its owned circuit switched and IP
facilities, new sales and marketing initiatives directed toward basic voice,
enhanced and data services, and offering customers an integrated bundle of
telecommunications services including local telephone, wireless, Internet, long
distance, messaging and video entertainment. There are currently a number of regulatory proceedings underway at the
state and federal levels that could have a significant impact on the Companys
operations.The Company cannot predict with certainty the impact of current or
future regulatory developments on any of its businesses. The telecommunications industry is extremely competitive, and the Company
expects competition to intensify in the future. As an incumbent local exchange
carrier (ILEC), the Company faces competition mainly from resellers, local
providers who lease its UNEs and, to a lesser degree, from providers of local
telephone services over separate facilities. Moreover, while wireless telephone
services have historically complemented traditional LEC services, the Company
anticipates that existing and emerging wireless technologies may increasingly
compete with LEC services. Similarly, local and 37




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##### Table of Contents



interexchange service competition may come from cable television providers and
voice over IP providers. In wireless services, the Company currently competes
with at least one other wireless provider in each of its wireless service
areas. In the highly competitive business for Internet access services, the
Company currently competes with a number of established online service
companies, interexchange carriers and cable companies. In the interexchange
market, the Company believes it currently has less than 5% of total revenue in
Alaska and faces competition from the two major interexchange providers. The telecommunications industry is subject to continuous technological
change. The Company expects that new technological developments in the future
will generally serve to enhance its ability to provide service to its
customers.However, these developments may also increase competition or require
the Company to make significant capital investments to maintain its leadership
position in Alaska. Impact of Inflation The effect of inflation on the Companys financial results has not been
significant in the periods presented. 38




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has issued senior subordinated notes, senior unsecured notes,
senior discount debentures and has entered into a bank credit facility. These
on-balance sheet financial instruments, to the extent they provide for variable
rates of interest, expose the Company 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 the Companys bank credit facility. 
 ITEM 4. CONTROLS AND PROCEDURES Evaluation of disclosure controls and procedures The Company carried out an evaluation of the effectiveness of the design
and operation of the Companys disclosure controls and procedures (as defined
in the Securities Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) and
15d-15(e)) as of the end of the period covered by this report under the
supervision and with the participation of the Companys management, including
the Companys Chief Executive Officer and its Chief Financial Officer. Based
upon that evaluation, the Companys Chief Executive Officer and its Chief
Financial Officer concluded that the Companys disclosure controls and
procedures are effective. Disclosure controls and procedures are controls and other procedures that
are designed to ensure that information required to be disclosed in Company
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Securities
and Exchange Commissions rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in Company reports filed under the
Exchange Act is accumulated and communicated to management to allow timely
decisions regarding required disclosure. Changes in internal controls There were no significant changes in the Companys internal controls or,
to its knowledge, in other factors that could significantly affect its
disclosure controls and procedures subsequent to the date the Company carried
out this evaluation. 39




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##### Table of Contents



PART II OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS. The Company is involved in the following and various other claims, legal
actions and regulatory proceedings arising in the ordinary course of business.
The Company cannot predict with certainty when or how these matters will be
resolved. In the opinion of management, the ultimate disposition of these
matters is unlikely to have a material adverse effect on the Companys
consolidated financial position, results of operations or cash flows.  
    
    A class action lawsuit was filed against the Company on May 11,
2001.The litigation alleges various contract and statutory claims
concerning the Companys decision to modify its Infinite Minutes long
distance plan.A trial is scheduled for September 2004. A class of
approximately 24,000 has been certified. The Company believes this suit
to be without merit and intends to maintain a vigorous defense, but
cannot predict the outcome of the litigation.
    
    The Company has ongoing disputes with Dobson Communications
concerning certain reciprocal compensation requirements and the
ownership of a tower.
    
    ACSA has filed rate design and cost of service studies, as well as
testimony, concerning retail rates for Anchorage. An ACSA retail rate
hearing is scheduled for the fourth quarter of 2004.
    
    On June 25, 2004, the RCA issued an order in the arbitration of
Anchorage UNE rates and an interconnection agreement between ACSA and
GCI. This order increased loop rates and certain nonrecurring charges,
ordered ACSA to provide switching and related facilities, and resolved
a number of outstanding contract issues. The RCA has been asked to
reconsider portions of its decision.
    
    In May 2003, ACSW applied for ETC status for Matanuska Telephone
Association and ACSF service areas. On July 30, 2004 the RCA granted
this ACSW petition subject to ACSW meeting certain conditions set forth
in the order. 40




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##### Table of Contents



ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES. None. 
 ITEM 3.DEFAULTS UPON SENIOR SECURITIES. None. 
 ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 
 ITEM 5.OTHER INFORMATION. None. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.  (a)
    
    Exhibits: 31.1
    
    Certification of Liane Pelletier, Chief Executive Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act if 2002.31.2
    
    Certification of David Wilson, Chief Financial Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act if 2002.32.1
    
    Certification of Liane Pelletier, Chief Executive Officer,
pursuant to 18 U.S.C. Section 1350, as adopted to Section 906 of the
Sarbanes-Oxley Act if 2002.32.2
    
    Certification of David Wilson, Chief Financial Officer,
pursuant to 18 U.S.C. Section 1350, as adopted to Section 906 of The
Sarbanes-Oxley Act of 2002.
  (b)
    
    Reports on Form 8-K: None. 41




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report on Form 10-Q to be signed on its behalf
by the undersigned, thereunto duly authorized. Date: August 6, 2004
    
    ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
 /s/ Liane PelletierLiane PelletierChief Executive Officer,
Chairman of the Board and
President /s/ David WilsonDavid WilsonSenior Vice President and
Chief Financial Officer
(Principal Accounting Officer) 42