##### Table of Contents



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 September 30, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period
from  to . 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. Yes
þ      Noo Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes
o      Noþ 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. None




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TABLE OF CONTENTS  
 PageNumberPART I. Financial InformationItem 1. Financial Statements:Consolidated Balance
Sheets (unaudited)As of September 30, 2004 and
December 31, 2003
    
    
    3Consolidated
Statements of Operations (unaudited)For the Three and Nine Months Ended September 30, 2004 and 2003
    
    
    4Consolidated
Statements of Cash Flows (unaudited)
For the Nine Months Ended September 30, 2004 and 2003
    
    
    5Notes to Consolidated Financial Statements (unaudited)
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    22Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    37Item 4. Controls and Procedures
    
    
    37PART II. Other InformationItem 1. Legal Proceedings
    
    
    38Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    39Item 3. Defaults upon Senior Securities
    
    
    39Item 4. Submission of Matters to a Vote of Security Holders
    
    
    39Item 5. Other Information
    
    
    39Item 6. Exhibits and Reports on Form 8-K
    
    
    39Signatures
    
    
    40EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC. 
 Consolidated Balance Sheets
(Unaudited, In Thousands Except Per Share Amounts)
 September 30,
    
    December 31,2004
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    79,689
    
    
    $
    97,798Restricted cash
    
    
    4,690
    
    
    
    3,635Accounts receivable  trade, net of allowance of $4,005 and $4,432
    
    
    38,233
    
    
    
    41,718Accounts receivable  affiliates
    
    
    17,720
    
    
    
    148Materials and supplies
    
    
    7,051
    
    
    
    10,099Prepayments and other current assets
    
    
    7,287
    
    
    
    5,850Total current assets
    
    
    154,670
    
    
    
    159,248Property, plant and equipment
    
    
    1,058,889
    
    
    
    1,041,904Less: accumulated depreciation
    
    
    640,110
    
    
    
    603,760Property, plant and equipment, net
    
    
    418,779
    
    
    
    438,144Goodwill
    
    
    38,403
    
    
    
    38,403Intangible assets
    
    
    21,917
    
    
    
    22,055Debt issuance cost
    
    
    16,428
    
    
    
    18,587Deferred charges and other assets
    
    
    9,195
    
    
    
    8,750Total assets
    
    $
    659,392
    
    
    $
    685,187Liabilities and Stockholders Equity (Deficit)Current liabilities:Current portion of long-term obligations
    
    $
    2,294
    
    
    $
    2,267Accounts payable  affiliates
    
    
    3,611
    
    
    
    3,817Accounts payable, accrued and other current liabilities
    
    
    48,843
    
    
    
    48,086Advance billings and customer deposits
    
    
    8,678
    
    
    
    8,766Total current liabilities
    
    
    63,426
    
    
    
    62,936Long-term obligations, net of current portion
    
    
    530,970
    
    
    
    532,737Other deferred credits and long-term liabilities
    
    
    75,559
    
    
    
    71,065Commitments and contingencies
    
    
    
    
    
    
    Stockholders equity (deficit):Common stock, $.01 par value; 1,000 authorized,
1 share issued and outstanding
    
    
    
    
    
    
    Paid in capital in excess of par value
    
    
    287,242
    
    
    
    287,242Accumulated deficit
    
    
    (293,262
    )
    
    
    (264,250
    )Accumulated other comprehensive loss
    
    
    (4,543
    )
    
    
    (4,543
    )Total stockholders equity (deficit)
    
    
    (10,563
    )
    
    
    18,449Total liabilities and stockholders equity (deficit)
    
    $
    659,392
    
    
    $
    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 Except Per Share Amounts)
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Operating revenue:Local telephone
    
    $
    51,246
    
    
    $
    53,261
    
    
    $
    159,976
    
    
    $
    162,472Wireless
    
    
    16,204
    
    
    
    12,591
    
    
    
    41,266
    
    
    
    34,868Directory
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,631Internet
    
    
    5,295
    
    
    
    8,223
    
    
    
    15,013
    
    
    
    24,416Interexchange
    
    
    3,878
    
    
    
    4,147
    
    
    
    11,077
    
    
    
    12,623Total operating revenues
    
    
    76,623
    
    
    
    78,222
    
    
    
    227,332
    
    
    
    246,010Operating expense:Local telephone (exclusive of depreciation and amortization)
    
    
    35,170
    
    
    
    30,160
    
    
    
    96,806
    
    
    
    84,267Wireless (exclusive of depreciation and amortization)
    
    
    10,970
    
    
    
    7,545
    
    
    
    27,229
    
    
    
    21,796Directory (exclusive of depreciation and amortization)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,249Internet (exclusive of depreciation and amortization)
    
    
    7,291
    
    
    
    11,730
    
    
    
    21,204
    
    
    
    35,829Interexchange (exclusive of depreciation and amortization)
    
    
    5,637
    
    
    
    6,056
    
    
    
    15,511
    
    
    
    17,886Contract termination and asset impairment charges
    
    
    
    
    
    
    54,539
    
    
    
    
    
    
    
    54,539Depreciation and amortization
    
    
    19,770
    
    
    
    22,044
    
    
    
    57,686
    
    
    
    66,735Loss (gain) on disposal of assets, net
    
    
    2,600
    
    
    
    (15,968
    )
    
    
    2,825
    
    
    
    (112,507
    )Total operating expenses
    
    
    81,438
    
    
    
    116,106
    
    
    
    221,261
    
    
    
    173,794Operating income (loss)
    
    
    (4,815
    )
    
    
    (37,884
    )
    
    
    6,071
    
    
    
    72,216Other income (expense):Interest expense
    
    
    (11,664
    )
    
    
    (21,943
    )
    
    
    (34,371
    )
    
    
    (49,458
    )Interest income and other
    
    
    238
    
    
    
    (15,096
    )
    
    
    614
    
    
    
    (10,209
    )Total other income and expense, net
    
    
    (11,426
    )
    
    
    (37,039
    )
    
    
    (33,757
    )
    
    
    (59,667
    )Income (loss) before income taxes and discontinued operations
    
    
    (16,241
    )
    
    
    (74,923
    )
    
    
    (27,686
    )
    
    
    12,549Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income (loss) from continuing operations
    
    
    (16,241
    )
    
    
    (74,923
    )
    
    
    (27,686
    )
    
    
    12,549Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (52
    )Net income (loss)
    
    $
    (16,241
    )
    
    $
    (74,923
    )
    
    $
    (27,686
    )
    
    $
    12,497
 See Notes to Consolidated Financial Statements 4




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC. 
 Consolidated Statements of Cash Flows
(Unaudited, In Thousands)
 Nine Months EndedSeptember 30,2004

    
    2003Cash Flows from Operating Acitivities:Net income (loss)
    
    $
    (27,686
    )
    
    $
    12,497Adjustments to reconcile net income (loss) to net cash provided by
operating activities:Loss on discontinued operations
    
    
    
    
    
    
    52Depreciation and amortization
    
    
    57,686
    
    
    
    66,735Loss (gain) on disposal of assets and asset impairment charges, net
    
    
    2,825
    
    
    
    (48,748
    )Amortization of debt issuance costs, original issue discount and warrants
    
    
    2,554
    
    
    
    15,866Other deferred credits
    
    
    1,570
    
    
    
    1,743Changes in components of working capital:Accounts receivable and other current assets
    
    
    (12,476
    )
    
    
    8,087Accounts payable and other current liabilities
    
    
    463
    
    
    
    (5,028
    )Other
    
    
    (445
    )
    
    
    (557
    )Net cash used by discontinued operations
    
    
    
    
    
    
    (40
    )Net cash provided by operating activities
    
    
    24,491
    
    
    
    50,607Cash Flows from Investing Activities:Construction and capital expenditures
    
    
    (38,084
    )
    
    
    (29,875
    )Net proceeds from sale of business
    
    
    
    
    
    
    155,268Release of funds from escrow
    
    
    
    
    
    
    3,539Placement of funds in restricted accounts
    
    
    (1,055
    )
    
    
    (645
    )Net cash provided (used) by investing activities
    
    
    (39,139
    )
    
    
    128,287Cash Flows from Financing Activities:Payments on long-term debt
    
    
    (2,136
    )
    
    
    (433,973
    )Proceeds from issuance of long-term debt
    
    
    
    
    
    
    375,970Debt issuance costs
    
    
    
    
    
    
    (14,000
    )Dividends
    
    
    (1,325
    )
    
    
    (4,296
    )Net cash used by financing activities
    
    
    (3,461
    )
    
    
    (76,299
    )Increase (decrease) in cash and cash equivalents
    
    
    (18,109
    )
    
    
    102,595Cash and cash equivalents at the beginning of the period
    
    
    97,798
    
    
    
    18,565Cash and cash equivalents at the end of the period
    
    $
    79,689
    
    
    $
    121,160Supplemental Cash Flow Data:Interest paid, net of amounts capitalized of $140 and $88
    
    $
    35,474
    
    
    $
    32,707Income taxes paid
    
    
    1,120
    
    
    
    Supplemental Noncash Transactions:Property acquired under capital leases and mortgages
    
    $
    
    
    
    $
    2,340Interest rate swap marked to market
    
    $
    
    
    
    $
    (6,361
    )
 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, 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 (Directories Business).
Subsequently, on August 27, 2003, the Company sold substantially all of its
remaining interest in the Directories Business, and now owns less than 0.1%. 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 that 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 three and
nine months ended September 30, 2004 and 2003 are not necessarily indicative of
the results of operations that 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, 6




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ALASKA COMMUNICATIONS
SYSTEMS GROUP, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 1. DESCRIPTION OF COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued) the Companys policy is to defer revenue collected until settlement
methodologies are resolved and finalized. At September 30, 2004 and December
31, 2003, the Company had recorded liabilities of $18,660 and $12,741,
respectively, related to its estimate of refundable access revenue. 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 $31,540 and $17,231 as of September 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 $372 at September
30, 2004. If the Company were not following SFAS No. 71, these deferred costs
would have been charged to expense as incurred. The Company also has a
regulatory liability of $53,470 at September 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 the 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 three and nine months
ended September 30, 2004 or 2003. If compensation costs related to options had
been determined consistent with SFAS No. 123, Accounting for Stock-Based
Compensation,the Companys net income (loss) on a pro forma basis for the
three and nine months ended September 30, 2004 and 2003 would have been as
follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net Income (Loss):As reported
    
    $
    (16,241
    )
    
    $
    (74,923
    )
    
    $
    (27,686
    )
    
    $
    12,497Deduct: Total stock based employee compensation
expense determined under fair value based method
for all awards, net of tax effect
    
    
    (108
    )
    
    
    (24
    )
    
    
    (420
    )
    
    
    (1,877
    )Pro forma
    
    $
    (16,349
    )
    
    $
    (74,947
    )
    
    $
    (28,106
    )
    
    $
    10,620
 7




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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
(Continued) 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
    
    
    3.49
    %
    
    
    2.95
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected volatility factor
    
    
    54.4
    %
    
    
    57.0
    %Expected option life (years)
    
    
    6.68
    
    
    
    6.1
 2. 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
nine months ended September 30, 2003: Nine Months EndedSeptember 30,2003Operating revenue
    
    $
    110Operating expense
    
    
    162Loss from discontinued operations
    
    $
    (52
    )
 3. STOCK INCENTIVE PLANS The Companys employees participate in various plans of ACS Group, which,
through the 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 September 30, 2004, ACS Group has reserved a total
of 10,060 shares of authorized common stock for issuance under the plans. This
includes the 1,000 shares granted to an executive on October 6, 2003. 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 7,160 shares under this plan, which was adopted by
the Company in November 1999. At September 30, 2004, 7,089 options have been
granted, 2,747 have been forfeited, 718 have been exercised, and 2,818 shares
are available for grant under the plan. 8




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 3. STOCK INCENTIVE PLANS (Continued) 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 350 shares under this plan. At
September 30, 2004, 136 shares have been awarded and 214 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 receiving stock
and received their entire annual retainer and meeting fees in cash; therefore,
no shares were awarded under this plan during 2003. On March 31, 2004, 7 shares
under the plan were awarded to directors, of which 5 were elected to be
deferred until termination of service by the directors. On June 30, 2004, 8
shares under the plan were awarded to directors, of which 6 were elected to be
deferred until termination of service by the directors. On September 30, 2004,
10 shares under the plan were awarded to directors, of which 7 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 1,550 shares under this plan. At September 30, 2004, 1,012 shares are
available for issuance and sale. On September 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. 4. 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. 9




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 4. RETIREMENT PLANS (Continued) The following table represents the net periodic pension expense for the
ACS Retirement Plan for the three and nine months ended September 30, 2004 and
2003: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Interest cost
    
    $
    187
    
    
    $
    183
    
    
    $
    561
    
    
    $
    548Expected return on plan assets
    
    
    (189
    )
    
    
    (166
    )
    
    
    (566
    )
    
    
    (498
    )Amortization of loss
    
    
    125
    
    
    
    142
    
    
    
    376
    
    
    
    426Amortization of prior service cost
    
    
    51
    
    
    
    51
    
    
    
    152
    
    
    
    152Net Periodic pension expense
    
    $
    174
    
    
    $
    210
    
    
    $
    523
    
    
    $
    628
 5. 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. During 2003, the Company sold 99.9% interest in the Directories
Business 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 nine months ended September 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 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 held at the Company 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. 10




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 5. BUSINESS SEGMENTS (Continued) The tables below illustrate selected financial data for each segment as of
the specified reporting period. In accordance with SFAS No. 71, intercompany
revenue between local telephone and all other segments is not eliminated in the
following disclosure. Nine months ended September 30, 2004LocalTelephone
    
    Wireless
    
    Internet
    
    Interexchange
    
    All Other
    
    Eliminations
    
    TotalOperating revenue
    
    $
    159,976
    
    
    $
    41,296
    
    
    $
    15,056
    
    
    $
    12,828
    
    
    $
    17,406
    
    
    $
    (19,230
    )
    
    $
    227,332Intersegment revenue included in above
    
    
    19,890
    
    
    
    1,314
    
    
    
    70
    
    
    
    1,949
    
    
    
    17,387
    
    
    
    (19,230
    )
    
    
    21,380Depreciation and amortization
    
    
    38,215
    
    
    
    5,527
    
    
    
    3,031
    
    
    
    339
    
    
    
    10,574
    
    
    
    
    
    
    
    57,686Operating income (loss)
    
    
    11,994
    
    
    
    2,579
    
    
    
    (9,834
    )
    
    
    (3,221
    )
    
    
    4,553
    
    
    
    
    
    
    
    6,071Interest expense
    
    
    (236
    )
    
    
    (12
    )
    
    
    
    
    
    
    (141
    )
    
    
    (33,982
    )
    
    
    
    
    
    
    (34,371
    )Interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    766
    
    
    
    
    
    
    
    766Income tax provision (benefit)
    
    
    4,810
    
    
    
    1,166
    
    
    
    
    
    
    
    
    
    
    
    (5,976
    )
    
    
    
    
    
    
    Income (loss) from continuing operations
    
    
    6,948
    
    
    
    1,401
    
    
    
    (9,834
    )
    
    
    (3,362
    )
    
    
    (22,839
    )
    
    
    
    
    
    
    (27,686
    )Total assets
    
    
    512,258
    
    
    
    107,988
    
    
    
    2,089
    
    
    
    21,624
    
    
    
    15,433
    
    
    
    
    
    
    
    659,392Construction and capital expenditures
    
    
    18,000
    
    
    
    8,704
    
    
    
    7,358
    
    
    
    72
    
    
    
    3,950
    
    
    
    
    
    
    
    38,084
 Nine months ended September 30, 2003LocalTelephone
    
    Wireless
    
    Internet
    
    Interexchange
    
    All Other
    
    Eliminations
    
    TotalOperating revenue
    
    $
    162,472
    
    
    $
    34,929
    
    
    $
    24,416
    
    
    $
    15,380
    
    
    $
    30,913
    
    
    $
    (22,100
    )
    
    $
    246,010Intersegment revenue included in above
    
    
    21,228
    
    
    
    1,351
    
    
    
    
    
    
    
    1,826
    
    
    
    19,775
    
    
    
    (22,100
    )
    
    
    22,080Depreciation and amortization
    
    
    43,115
    
    
    
    4,568
    
    
    
    7,232
    
    
    
    892
    
    
    
    10,928
    
    
    
    
    
    
    
    66,735Operating income (loss)
    
    
    18,748
    
    
    
    3,614
    
    
    
    (57,032
    )
    
    
    (18,253
    )
    
    
    125,148
    
    
    
    (9
    )
    
    
    72,216Interest expense
    
    
    (355
    )
    
    
    (3
    )
    
    
    (93
    )
    
    
    (192
    )
    
    
    (48,815
    )
    
    
    
    
    
    
    (49,458
    )Interest income
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,055
    
    
    
    
    
    
    
    1,085Income tax provision (benefit)
    
    
    6,712
    
    
    
    1,485
    
    
    
    
    
    
    
    
    
    
    
    (8,197
    )
    
    
    
    
    
    
    Income (loss) from continuing operations
    
    
    11,712
    
    
    
    2,126
    
    
    
    (57,125
    )
    
    
    (18,445
    )
    
    
    74,290
    
    
    
    (9
    )
    
    
    12,549Total assets
    
    
    497,546
    
    
    
    81,824
    
    
    
    (85,431
    )
    
    
    (18,066
    )
    
    
    179,738
    
    
    
    
    
    
    
    655,611Construction and capital expenditures
    
    
    14,994
    
    
    
    6,533
    
    
    
    4,226
    
    
    
    52
    
    
    
    6,410
    
    
    
    
    
    
    
    32,215
 Three months ended September 30, 2004LocalTelephone
    
    Wireless
    
    Internet
    
    Interexchange
    
    All Other
    
    Eliminations
    
    TotalOperating revenue
    
    $
    51,246
    
    
    $
    16,213
    
    
    $
    5,338
    
    
    $
    4,651
    
    
    $
    5,782
    
    
    $
    (6,607
    )
    
    $
    76,623Intersegment revenue included in above
    
    
    6,924
    
    
    
    428
    
    
    
    70
    
    
    
    845
    
    
    
    5,757
    
    
    
    (6,607
    )
    
    
    7,417Depreciation and amortization
    
    
    12,940
    
    
    
    1,904
    
    
    
    1,245
    
    
    
    91
    
    
    
    3,590
    
    
    
    
    
    
    
    19,770Operating income (loss)
    
    
    (1,001
    )
    
    
    (737
    )
    
    
    (3,423
    )
    
    
    (1,149
    )
    
    
    1,495
    
    
    
    
    
    
    
    (4,815
    )Interest expense
    
    
    (76
    )
    
    
    
    
    
    
    
    
    
    
    (47
    )
    
    
    (11,541
    )
    
    
    
    
    
    
    (11,664
    )Interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    288
    
    
    
    
    
    
    
    288Income tax provision (benefit)
    
    
    (380
    )
    
    
    (194
    )
    
    
    
    
    
    
    
    
    
    
    574
    
    
    
    
    
    
    
    Income (loss) from continuing operations
    
    
    (697
    )
    
    
    (543
    )
    
    
    (3,423
    )
    
    
    (1,196
    )
    
    
    (10,382
    )
    
    
    
    
    
    
    (16,241
    )Total assets
    
    
    506,343
    
    
    
    111,931
    
    
    
    2,089
    
    
    
    23,596
    
    
    
    15,433
    
    
    
    
    
    
    
    659,392Construction and capital expenditures
    
    
    7,182
    
    
    
    1,687
    
    
    
    6,303
    
    
    
    23
    
    
    
    1,968
    
    
    
    
    
    
    
    17,163
 Three months ended September 30, 2003LocalTelephone
    
    Wireless
    
    Internet
    
    Interexchange
    
    All Other
    
    Eliminations
    
    TotalOperating revenue
    
    $
    53,261
    
    
    $
    12,611
    
    
    $
    8,223
    
    
    $
    5,153
    
    
    $
    6,674
    
    
    $
    (7,700
    )
    
    $
    78,222Intersegment revenue included in above
    
    
    6,991
    
    
    
    469
    
    
    
    
    
    
    
    697
    
    
    
    6,674
    
    
    
    (7,700
    )
    
    
    7,131Depreciation and amortization
    
    
    14,377
    
    
    
    1,639
    
    
    
    2,400
    
    
    
    (225
    )
    
    
    3,853
    
    
    
    
    
    
    
    22,044Operating income (loss)
    
    
    1,550
    
    
    
    1,629
    
    
    
    (41,939
    )
    
    
    (15,323
    )
    
    
    16,199
    
    
    
    
    
    
    
    (37,884
    )Interest expense
    
    
    (76
    )
    
    
    (1
    )
    
    
    (26
    )
    
    
    (44
    )
    
    
    (21,796
    )
    
    
    
    
    
    
    (21,943
    )Interest income
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    367
    
    
    
    
    
    
    
    396Income tax provision (benefit)
    
    
    831
    
    
    
    761
    
    
    
    
    
    
    
    
    
    
    
    (1,592
    )
    
    
    
    
    
    
    Income (loss) from continuing operations
    
    
    1,900
    
    
    
    199
    
    
    
    (42,878
    )
    
    
    (15,013
    )
    
    
    (19,131
    )
    
    
    
    
    
    
    (74,923
    )Total assets
    
    
    497,546
    
    
    
    81,824
    
    
    
    (85,431
    )
    
    
    (18,066
    )
    
    
    179,738
    
    
    
    
    
    
    
    655,611Construction and capital expenditures
    
    
    6,266
    
    
    
    5,991
    
    
    
    976
    
    
    
    42
    
    
    
    1,297
    
    
    
    
    
    
    
    14,572
 11




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 6. 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 nine months ended September 30, 2004
was $242 and $764, respectively, and for the three and nine months ended
September 30, 2003 was $302 and $873, respectively. At September 30, 2004, the
payable due to Fox Paine was $767. 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
September 30, 2004, the Company had recorded in accounts payable  affiliates
$2,844, 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, Leonard A. Steinberg, an
officer of the Company, 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 is making repurchase payments totaling $1,262 to the
officer in four equal quarterly installments that commenced on March 31, 2004.
The Company made three quarterly installment payments and $316 remains
outstanding as of September 30, 2004. 7. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS ACS Holdings and its subsidiaries were guarantors of ACS Groups senior
discount debentures. 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 (Combined
Subsidiaries) are 100% owned. The guarantees are full and unconditional, as
well as 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. 12




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 7. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Balance Sheet
September 30, 2004 Combined
    
    ACS Holdings
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedAssetsCurrent assets:Cash and cash equivalents
    
    $
    95
    
    
    $
    79,594
    
    
    $
    
    
    
    $
    79,689Restricted cash
    
    
    
    
    
    
    4,690
    
    
    
    
    
    
    
    4,690Accounts receivable  trade, net of allowance
    
    
    14,367
    
    
    
    23,866
    
    
    
    
    
    
    
    38,233Accounts receivable  affiliates
    
    
    40,221
    
    
    
    (22,501
    )
    
    
    
    
    
    
    17,720Materials and supplies
    
    
    7,051
    
    
    
    
    
    
    
    
    
    
    
    7,051Prepayments and other current assets
    
    
    4,114
    
    
    
    3,173
    
    
    
    
    
    
    
    7,287Total current assets
    
    
    65,848
    
    
    
    88,822
    
    
    
    
    
    
    
    154,670Investments
    
    
    10
    
    
    
    396,052
    
    
    
    (396,051
    )
    
    
    11Property, plant and equipment
    
    
    957,467
    
    
    
    101,422
    
    
    
    
    
    
    
    1,058,889Less: Accumulated depreciation
    
    
    (584,730
    )
    
    
    (55,380
    )
    
    
    
    
    
    
    (640,110
    )Property, plant and equipment, net
    
    
    372,737
    
    
    
    46,042
    
    
    
    
    
    
    
    418,779Goodwill
    
    
    
    
    
    
    
    
    
    
    38,403
    
    
    
    38,403Intangible assets
    
    
    21,917
    
    
    
    
    
    
    
    
    
    
    
    21,917Debt issuance cost
    
    
    
    
    
    
    16,428
    
    
    
    
    
    
    
    16,428Deferred charges and other assets
    
    
    1,700
    
    
    
    7,484
    
    
    
    
    
    
    
    9,184Total assets
    
    $
    462,212
    
    
    $
    554,828
    
    
    $
    (357,648
    )
    
    $
    659,392Liabilities and Stockholders Equity (Deficit)Current liabilities:Current portion of long-term obligations
    
    $
    538
    
    
    $
    1,756
    
    
    $
    
    
    
    $
    2,294Accounts payable  affiliates
    
    
    2,773
    
    
    
    838
    
    
    
    
    
    
    
    3,611Accounts payable, accrued and other current liabilities
    
    
    11,726
    
    
    
    32,746
    
    
    
    4,371
    
    
    
    48,843Advance billings and customer deposits
    
    
    8,672
    
    
    
    6
    
    
    
    
    
    
    
    8,678Total current liabilities
    
    
    23,709
    
    
    
    35,346
    
    
    
    4,371
    
    
    
    63,426Long-term obligations, net of current portion
    
    
    4,209
    
    
    
    526,761
    
    
    
    
    
    
    
    530,970Deferred income taxes
    
    
    2,612
    
    
    
    (2,612
    )
    
    
    
    
    
    
    Other deferred credits and long-term liabilities
    
    
    74,035
    
    
    
    5,895
    
    
    
    (4,371
    )
    
    
    75,559Stockholders equity (deficit):Common stock
    
    
    2
    
    
    
    
    
    
    
    (2
    )
    
    
    Paid in capital in excess of par value
    
    
    491,240
    
    
    
    287,242
    
    
    
    (491,240
    )
    
    
    287,242Accumulated deficit
    
    
    (133,595
    )
    
    
    (293,261
    )
    
    
    133,594
    
    
    
    (293,262
    )Accumulated other comprehensive loss
    
    
    
    
    
    
    (4,543
    )
    
    
    
    
    
    
    (4,543
    )Total stockholders equity (deficit)
    
    
    357,647
    
    
    
    (10,562
    )
    
    
    (357,648
    )
    
    
    (10,563
    )Total liabilities and stockholders equity (deficit)
    
    $
    462,212
    
    
    $
    554,828
    
    
    $
    (357,648
    )
    
    $
    659,392
 13




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 7. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Balance Sheet
As of 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 of allowance
    
    
    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
    
    
    (553,816
    )
    
    
    (49,944
    )
    
    
    
    
    
    
    (603,760
    )Property, plant and equipment, net
    
    
    378,024
    
    
    
    60,120
    
    
    
    
    
    
    
    438,144Goodwill
    
    
    
    
    
    
    
    
    
    
    38,403
    
    
    
    38,403Intangible assets
    
    
    22,055
    
    
    
    
    
    
    
    
    
    
    
    22,055Debt issuance cost
    
    
    
    
    
    
    18,587
    
    
    
    
    
    
    
    18,587Deferred charges and other assets
    
    
    2,501
    
    
    
    6,249
    
    
    
    
    
    
    
    8,750Total assets
    
    $
    463,203
    
    
    $
    582,965
    
    
    $
    (360,981
    )
    
    $
    685,187Liabilities and Stockholders Equity (Deficit)Current 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
    
    
    
    33,048
    
    
    
    
    
    
    
    48,086Advance 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
    
    
    
    
    
    
    
    71,065Stockholders equity (deficit):Common stock
    
    
    25
    
    
    
    
    
    
    
    (25
    )
    
    
    Paid in capital in excess of par value
    
    
    501,374
    
    
    
    287,242
    
    
    
    (501,374
    )
    
    
    287,242Accumulated deficit
    
    
    (140,418
    )
    
    
    (264,250
    )
    
    
    140,418
    
    
    
    (264,250
    )Accumulated other comprehensive loss
    
    
    
    
    
    
    (4,543
    )
    
    
    
    
    
    
    (4,543
    )Total stockholders equity (deficit)
    
    
    360,981
    
    
    
    18,449
    
    
    
    (360,981
    )
    
    
    18,449Total liabilities and stockholders equity (deficit)
    
    $
    463,203
    
    
    $
    582,965
    
    
    $
    (360,981
    )
    
    $
    685,187
 14




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 7. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Operations
Three Months Ended September 30, 2004 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedOperating revenue:Local telephone
    
    $
    51,247
    
    
    $
    5,781
    
    
    $
    (5,782
    )
    
    $
    51,246Wireless
    
    
    16,213
    
    
    
    
    
    
    
    (9
    )
    
    
    16,204Internet
    
    
    5,338
    
    
    
    
    
    
    
    (43
    )
    
    
    5,295Interexchange
    
    
    4,651
    
    
    
    
    
    
    
    (773
    )
    
    
    3,878Total operating revenue
    
    
    77,449
    
    
    
    5,781
    
    
    
    (6,607
    )
    
    
    76,623Operating expense:Local telephone
    
    
    39,525
    
    
    
    696
    
    
    
    (5,051
    )
    
    
    35,170Wireless
    
    
    12,220
    
    
    
    
    
    
    
    (1,250
    )
    
    
    10,970Internet
    
    
    7,525
    
    
    
    
    
    
    
    (234
    )
    
    
    7,291Interexchange
    
    
    5,709
    
    
    
    
    
    
    
    (72
    )
    
    
    5,637Depreciation and amortization
    
    
    16,180
    
    
    
    3,590
    
    
    
    
    
    
    
    19,770Loss on disposal of assets
    
    
    2,600
    
    
    
    
    
    
    
    
    
    
    
    2,600Total operating expense
    
    
    83,759
    
    
    
    4,286
    
    
    
    (6,607
    )
    
    
    81,438Operating income (loss)
    
    
    (6,310
    )
    
    
    1,495
    
    
    
    
    
    
    
    (4,815
    )Other income (expense):Interest expense
    
    
    (123
    )
    
    
    (11,541
    )
    
    
    
    
    
    
    (11,664
    )Interest income and other
    
    
    3
    
    
    
    (4,115
    )
    
    
    4,350
    
    
    
    238Total other expense
    
    
    (120
    )
    
    
    (15,656
    )
    
    
    4,350
    
    
    
    (11,426
    )Income (loss) before income taxes
    
    
    (6,430
    )
    
    
    (14,161
    )
    
    
    4,350
    
    
    
    (16,241
    )Income tax (expense) benefit
    
    
    2,080
    
    
    
    (2,080
    )
    
    
    
    
    
    
    Net income (loss)
    
    $
    (4,350
    )
    
    $
    (16,241
    )
    
    $
    4,350
    
    
    $
    (16,241
    )
 15




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 7. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Operations
Three Months Ended September 30, 2003 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedOperating revenue:Local telephone
    
    $
    53,261
    
    
    $
    
    
    
    $
    
    
    
    $
    53,261Wireless
    
    
    12,611
    
    
    
    
    
    
    
    (20
    )
    
    
    12,591Internet
    
    
    8,223
    
    
    
    
    
    
    
    
    
    
    
    8,223Interexchange
    
    
    5,153
    
    
    
    
    
    
    
    (1,006
    )
    
    
    4,147Other
    
    
    
    
    
    
    6,674
    
    
    
    (6,674
    )
    
    
    Total operating revenue
    
    
    79,248
    
    
    
    6,674
    
    
    
    (7,700
    )
    
    
    78,222Operating expense:Local telephone
    
    
    35,578
    
    
    
    169
    
    
    
    (5,587
    )
    
    
    30,160Wireless
    
    
    8,617
    
    
    
    
    
    
    
    (1,072
    )
    
    
    7,545Internet
    
    
    11,435
    
    
    
    
    
    
    
    295
    
    
    
    11,730Interexchange
    
    
    7,392
    
    
    
    
    
    
    
    (1,336
    )
    
    
    6,056Contract termination as asset impairment
    
    
    54,539
    
    
    
    
    
    
    
    
    
    
    
    54,539Depreciation and amortization
    
    
    18,191
    
    
    
    3,853
    
    
    
    
    
    
    
    22,044Loss (gain) on disposal of assets
    
    
    (15,974
    )
    
    
    6
    
    
    
    
    
    
    
    (15,968
    )Total operating expense
    
    
    119,778
    
    
    
    4,028
    
    
    
    (7,700
    )
    
    
    116,106Operating income (loss)
    
    
    (40,530
    )
    
    
    2,646
    
    
    
    
    
    
    
    (37,884
    )Other income (expense):Interest expense
    
    
    (147
    )
    
    
    (21,796
    )
    
    
    
    
    
    
    (21,943
    )Interest income and other
    
    
    512
    
    
    
    (64,127
    )
    
    
    48,519
    
    
    
    (15,096
    )Total other income (expense)
    
    
    365
    
    
    
    (85,923
    )
    
    
    48,519
    
    
    
    (37,039
    )Income (loss) before income taxes
    
    
    (40,165
    )
    
    
    (83,277
    )
    
    
    48,519
    
    
    
    (74,923
    )Income tax (expense) benefit
    
    
    (8,354
    )
    
    
    8,354
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    (48,519
    )
    
    $
    (74,923
    )
    
    $
    48,519
    
    
    $
    (74,923
    )
 16




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 7. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Operations
Nine Months Ended September 30, 2004 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedOperating revenue:Local telephone
    
    $
    159,957
    
    
    $
    17,425
    
    
    $
    (17,406
    )
    
    $
    159,976Wireless
    
    
    41,296
    
    
    
    
    
    
    
    (30
    )
    
    
    41,266Internet
    
    
    15,056
    
    
    
    
    
    
    
    (43
    )
    
    
    15,013Interexchange
    
    
    12,828
    
    
    
    
    
    
    
    (1,751
    )
    
    
    11,077Total operating revenue
    
    
    229,137
    
    
    
    17,425
    
    
    
    (19,230
    )
    
    
    227,332Operating expense:Local telephone
    
    
    109,752
    
    
    
    2,268
    
    
    
    (15,214
    )
    
    
    96,806Wireless
    
    
    30,362
    
    
    
    
    
    
    
    (3,133
    )
    
    
    27,229Internet
    
    
    21,888
    
    
    
    
    
    
    
    (684
    )
    
    
    21,204Interexchange
    
    
    15,710
    
    
    
    
    
    
    
    (199
    )
    
    
    15,511Depreciation and amortization
    
    
    47,112
    
    
    
    10,574
    
    
    
    
    
    
    
    57,686Loss on disposal of assets
    
    
    2,795
    
    
    
    30
    
    
    
    
    
    
    
    2,825Total operating expense
    
    
    227,619
    
    
    
    12,872
    
    
    
    (19,230
    )
    
    
    221,261Operating income
    
    
    1,518
    
    
    
    4,553
    
    
    
    
    
    
    
    6,071Other income (expense):Interest expense
    
    
    (389
    )
    
    
    (33,982
    )
    
    
    
    
    
    
    (34,371
    )Interest income and other
    
    
    12
    
    
    
    (2,732
    )
    
    
    3,334
    
    
    
    614Total other expense
    
    
    (377
    )
    
    
    (36,714
    )
    
    
    3,334
    
    
    
    (33,757
    )Income (loss) before income taxes
    
    
    1,141
    
    
    
    (32,161
    )
    
    
    3,334
    
    
    
    (27,686
    )Income tax (expense) benefit
    
    
    (4,475
    )
    
    
    4,475
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    (3,334
    )
    
    $
    (27,686
    )
    
    $
    3,334
    
    
    $
    (27,686
    )
 17




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 7. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Operations
Nine Months Ended September 30, 2003 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedOperating revenue:Local telephone
    
    $
    162,472
    
    
    $
    
    
    
    $
    
    
    
    $
    162,472Wireless
    
    
    34,929
    
    
    
    
    
    
    
    (61
    )
    
    
    34,868Directory
    
    
    11,631
    
    
    
    
    
    
    
    
    
    
    
    11,631Internet
    
    
    24,416
    
    
    
    
    
    
    
    
    
    
    
    24,416Interexchange
    
    
    15,380
    
    
    
    
    
    
    
    (2,757
    )
    
    
    12,623Other
    
    
    
    
    
    
    19,282
    
    
    
    (19,282
    )
    
    
    Total operating revenue
    
    
    248,828
    
    
    
    19,282
    
    
    
    (22,100
    )
    
    
    246,010Operating expense:Local telephone
    
    
    99,783
    
    
    
    603
    
    
    
    (16,119
    )
    
    
    84,267Wireless
    
    
    24,611
    
    
    
    
    
    
    
    (2,815
    )
    
    
    21,796Directory
    
    
    5,359
    
    
    
    
    
    
    
    (110
    )
    
    
    5,249Internet
    
    
    36,976
    
    
    
    
    
    
    
    (1,147
    )
    
    
    35,829Interexchange
    
    
    19,786
    
    
    
    
    
    
    
    (1,900
    )
    
    
    17,886Other
    
    
    9
    
    
    
    
    
    
    
    (9
    )
    
    
    Contract termination as asset impairment
    
    
    54,539
    
    
    
    
    
    
    
    
    
    
    
    54,539Depreciation and amortization
    
    
    55,809
    
    
    
    10,926
    
    
    
    
    
    
    
    66,735Loss (gain) on disposal of assets
    
    
    (112,513
    )
    
    
    6
    
    
    
    
    
    
    
    (112,507
    )Total operating expense
    
    
    184,359
    
    
    
    11,535
    
    
    
    (22,100
    )
    
    
    173,794Operating income
    
    
    64,469
    
    
    
    7,747
    
    
    
    
    
    
    
    72,216Other income (expense):Interest expense
    
    
    (643
    )
    
    
    (48,815
    )
    
    
    
    
    
    
    (49,458
    )Interest income and other
    
    
    4,920
    
    
    
    (5,887
    )
    
    
    (9,242
    )
    
    
    (10,209
    )Total other income (expense)
    
    
    4,277
    
    
    
    (54,702
    )
    
    
    (9,242
    )
    
    
    (59,667
    )Income (loss) before income taxes and
discontinued operations
    
    
    68,746
    
    
    
    (46,955
    )
    
    
    (9,242
    )
    
    
    12,549Income tax (expense) benefit
    
    
    (59,452
    )
    
    
    59,452
    
    
    
    
    
    
    
    Income (loss) from continuing operations
    
    
    9,294
    
    
    
    12,497
    
    
    
    (9,242
    )
    
    
    12,549Loss from discontinued operations
    
    
    (52
    )
    
    
    
    
    
    
    
    
    
    
    (52
    )Net income (loss)
    
    $
    9,242
    
    
    $
    12,497
    
    
    $
    (9,242
    )
    
    $
    12,497
 18




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 7. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2004 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedNet cash provided (used) by operating
activities
    
    $
    34,604
    
    
    $
    (10,113
    )
    
    $
    
    
    
    $
    24,491Cash Flows from Investing Activities:Construction and capital expenditures
    
    
    (34,234
    )
    
    
    (3,850
    )
    
    
    
    
    
    
    (38,084
    )Placement of funds in restricted accounts
    
    
    
    
    
    
    (1,055
    )
    
    
    
    
    
    
    (1,055
    )Net cash used by investing activities
    
    
    (34,234
    )
    
    
    (4,905
    )
    
    
    
    
    
    
    (39,139
    )Cash Flows from Financing Activities:Payments on long-term debt
    
    
    (414
    )
    
    
    (1,722
    )
    
    
    
    
    
    
    (2,136
    )Dividends
    
    
    
    
    
    
    (1,325
    )
    
    
    
    
    
    
    (1,325
    )Net cash used by financing activities
    
    
    (414
    )
    
    
    (3,047
    )
    
    
    
    
    
    
    (3,461
    )Decrease in cash and cash equivalents
    
    
    (44
    )
    
    
    (18,065
    )
    
    
    
    
    
    
    (18,109
    )Cash and cash equivalents, beginning of the period
    
    
    139
    
    
    
    97,659
    
    
    
    
    
    
    
    97,798Cash and cash equivalents, end of the period
    
    $
    95
    
    
    $
    79,594
    
    
    $
    
    
    
    $
    79,689Supplemental Cash Flow Data:Interest paid, net of capitalized interest
    
    $
    409
    
    
    $
    32,621
    
    
    $
    
    
    
    $
    35,474Income taxes paid
    
    $
    1,120
    
    
    $
    
    
    
    $
    
    
    
    $
    1,120
 19




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 7. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2003 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedNet cash provided (used) by operating activities
    
    $
    (128,362
    )
    
    $
    178,969
    
    
    $
    
    
    
    $
    50,607Cash Flows from Investing Activities:Construction and capital expenditures
    
    
    (23,520
    )
    
    
    (6,355
    )
    
    
    
    
    
    
    (29,875
    )Net proceeds from sale of business
    
    
    155,268
    
    
    
    
    
    
    
    
    
    
    
    155,268Other investing activities
    
    
    
    
    
    
    2,894
    
    
    
    
    
    
    
    2,894Net cash provided (used) by investing activities
    
    
    131,748
    
    
    
    (3,461
    )
    
    
    
    
    
    
    128,287Cash Flows from Financing Activities:Payments on long-term debt
    
    
    (3,123
    )
    
    
    (430,850
    )
    
    
    
    
    
    
    (433,973
    )Proceeds from issuance of long-term debt
    
    
    
    
    
    
    375,970
    
    
    
    
    
    
    
    375,970Debt issuance costs
    
    
    
    
    
    
    (14,000
    )
    
    
    
    
    
    
    (14,000
    )Dividends
    
    
    
    
    
    
    (4,296
    )
    
    
    
    
    
    
    (4,296
    )Net cash provided (used) by financing activities
    
    
    (3,123
    )
    
    
    (73,176
    )
    
    
    
    
    
    
    (76,299
    )Increase in cash and cash equivalents
    
    
    263
    
    
    
    102,332
    
    
    
    
    
    
    
    102,595Cash and cash equivalents, beginning of the period
    
    
    (73
    )
    
    
    18,638
    
    
    
    
    
    
    
    18,565Cash and cash equivalents, end of the period
    
    $
    190
    
    
    $
    120,970
    
    
    $
    
    
    
    $
    121,160Supplemental Cash Flow Data:Interest paid, net of capitalized interest
    
    $
    639
    
    
    $
    30,943
    
    
    $
    
    
    
    $
    32,707Supplemental
Noncash Transactions:Property
acquired under capital leases and mortgage
    
    $
    2,340
    
    
    $
    
    
    
    $
    
    
    
    $
    2,340Interest
rate swap marked to market
    
    $
    
    
    
    $
    (6,361
    )
    
    $
    
    
    
    $
    (6,361
    )
 20




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements
(Unaudited, In Thousands Except Per Share Amounts) 8. 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
reserves of $4,623 as of September 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 May 11, 2001. The
litigation alleges various contract and statutory claims concerning the
Companys decision to terminate its Infinite Minutes long distance plan. The
parties have agreed to settle the matter for a combination of: (1) 12 ten
dollar per month coupons, to be applied against the Companys services; (2) 100
free interstate long distance minutes per month for 12 months; and (3) $950 in
cash for plaintiffs legal fees. The settlement has been submitted to the court
for approval. On October 27, 2004, the court granted preliminary approval of
the settlement and final approval is expected in February 2005. AT&T Alascom has requested a refund of interstate access charges paid to
the Company during 2002. The company is currently reviewing and evaluating this
request. The Companys existing access reserves are sufficient to cover any
refund the Company may eventually find appropriate. The Company has disputes with Dobson Communications over tower ownership.
The Company cannot predict the outcome of these disputes. On July 15, 2002, the Company fulfilled a commitment to Crest (formerly
Neptune) Communications, L.L.C. (Crest) 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 Crest, the expenditures for which may be significant and may
exceed $20,000 over the next two years. ACS purchased capacity under this
agreement of $5,602 in the third quarter of 2004. While the Company has an
agreement with Crest, 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 2006, the final
price and quantity of which are subject to future events, (ii) Crests
restoration of the Companys traffic carried on another cable system, and (iii)
specific interconnection arrangements between the Company and Crest, should the
Company exercise its option to purchase certain network assets from Crest. The
Company is currently negotiating open elements of its agreement with Crest 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 three months ended
September 30, 2003. 9. OTHER EVENTS The ACS Group announced on October 28, 2004 the adoption of a dividend policy
by its Board of Directors and declared its first quarterly dividend of $0.185
per share, payable on January 19, 2005 to holders of record on December 31,
2004.While ACS Group intends to continue to pay quarterly dividends, such
payment is subject to ACS Groups future operating and financial performance,
capital expenditures, working capital requirements and other factors.
Accordingly, ACS Groups Board of Directors may modify or revoke this policy at
any time. The Company is the sole subsidiary of ACS Group and comprises
substantially all of its assets and operations. Accordingly, the Company is
obligated to fund dividends declared by ACS Group. Simultaneous with the
announcement of the dividend policy, the Company also announced the withdrawal
of its registration statements for a proposed initial public offering of Income
Deposit Securities (IDSs), a separate proposed offering of senior
subordinated notes and the proposed reclassification of its existing common
stock into cash and shares of new class B common stock which it
had filed with the Securities and Exchange Commission. No securities were sold
under the withdrawn registration statements. 21




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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 Alaska Communications Systems
Holding, Inc. and Subsidiaries (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 divestiture opportunities, business
prospects, strategic alternatives, business strategies, regulatory and
competitive outlook, investment and expenditure plans, financing needs and
availability, dividends, 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 (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. 22




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INTRODUCTION The Company is a wholly owned subsidiary of Alaska Communications Systems
Group, Inc. (ACS Group). The Company generates revenue primarily through:  
    
    the provision of local telephone services, including:  
    
    basic local services to retail customers within the Companys service areas;
    
    wholesale services 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. 23




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Wireless- The Company is the second largest statewide provider of
wireless services in Alaska, currently serving approximately 96,000
subscribers. Its wireless network footprint covers over 480,000 residents,
including all major population centers and highway and ferry corridors in
Alaska. The Company currently operates a TDMA digital network in substantially
all of its service areas, and is rolling out a new generation of digital
network known as CDMA 1xRTT, which provides customers with improved voice call
quality, average mobile data speeds of 70-80kbps 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 high speed
data connectivity with speeds that burst up to 2mbps to its wireless markets in
Anchorage, Fairbanks, and Juneau. The Company estimates that the new CDMA
service currently covers 73% of its total wireless footprint of 480,000
residents. Internet- The Company is the second largest provider of Internet access
services in Alaska with approximately 46,000 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 44,000 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 current agreement with the provider became
effective August 2003 and will either be renegotiated or terminate December
2005. 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 September 30, 2004, the allowance for doubtful
accounts receivable was $4.0 million. 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. At
September 30, 2004, the Company had recorded liabilities of $18.7 million
related to its estimate of refundable access revenue. Actual results could vary
from this estimate. 24




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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
$105.4 million as of September 30, 2004, which represents 100% of all deferred
tax assets. 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 $31.5 million as of September 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 September 30, 2004. If the Company were not following
SFAS No. 71, it would have recorded additional cumulative depreciation expense
of $31.5 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 $53.5 million at September 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 September 30, 2004,
the Company had recorded goodwill of $38.4 million applicable to its local
telephone and wireless segments and intangible assets of $21.9 million related
primarily to its wireless segment. 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 $4.6 million against certain claims and legal actions as
of September 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. 25




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RESULTS OF OPERATIONS All amounts are discussed at the consolidated level after the elimination
of intercompany revenue and expense. Three Months Ended September 30, 2004 Compared to Three Months Ended September
30, 2003 Operating Revenue Operating revenue decreased $1.6 million, or 2.0% for the three months
ended September 30, 2004 compared to the three months ended September 30, 2003.
Wireless revenue increased, while local telephone, Internet and interexchange
revenue decreased, compared to the corresponding period of 2003. Local Telephone Local telephone revenue, which consists of local network service, network
access and deregulated and other revenue, decreased $2.0 million, or 3.8%, for
the three months ended September 30, 2004 compared to the same period in 2003.
The following table summarizes the Companys consolidated local telephone
revenue by category: Three Months EndedSeptember 30,2004
    
    2003(in thousands)Local telephone revenue:Local network service
    
    $
    23,224
    
    
    $
    24,022Network access
    
    
    23,128
    
    
    
    23,750Deregulated and other
    
    
    4,894
    
    
    
    5,489Total local telephone revenue
    
    $
    51,246
    
    
    $
    53,261
 The following table summarizes the Companys local telephone access lines: As of September 30,2004
    
    2003Local telephone access lines:Retail
    
    
    209,414
    
    
    
    221,956Wholesale
    
    
    17,498
    
    
    
    18,803Unbundled network elements  platform (UNE  P)
    
    
    6,250
    
    
    
    4,899Unbundled network elements  loop (UNE  L)
    
    
    68,522
    
    
    
    67,542Total local telephone access lines
    
    
    301,684
    
    
    
    313,200
 Local network service revenue decreased $0.8 million or 3.3% for the three
months ended September 30, 2004, compared to the three months ended September
30, 2003, while access lines in service decreased 3.7% to 301,684, adjusted for
a reduction of 2,788 internal lines that ceased to be counted following a
change in line count methodology. The decrease in revenue reflects the net
effect of network access line losses, loss of retail lines to UNE lines and
regulatory rate changes offset by increases in UNE rates. Also contributing to
the decrease in local network service are decreases in feature and directory
assistance revenue. Consistent with the U.S. telecommunications industry trend, the Company
experienced a loss of network access lines as customers migrated to broadband
Internet services reducing demand for second lines, migrated to cable
telephony, or replaced landline service with wireless service. 26




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Management believes that operating revenues have declined due to overall
line decrease and the net impact of certain regulatory issues:  
    
    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. On October 25, 2001, the RCA granted ACS of Anchorage, Inc.
(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. The loop rate was later adjusted to a final loop rate of
$18.64. This increase is expected to result in additional revenue of
approximately $2.7 million annually at current demand levels.  
    
    On April 18, 2004, ACS of Fairbanks, Inc. (ACSF) and ACS of
Alaska, Inc. (ACSAK) settled a dispute with GCI, Inc. (GCI)
concerning their claim to a rural exemption from certain obligations
under the Telecommunications Act of 1996. 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. The
Company estimates that this rate increase will generate approximately
$0.5 million of additional revenue in 2005 at current demand levels.  
    
    In compliance with Alaska Public Utilities Commission (APUC)
orders related to the approval of the acquisition of the four LECs in
1999, the Company 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 ACS of the
Northland, Inc (ACSN). The RCA found over earnings by ACSF and
ACSN of approximately $4.6 million annually, and under earnings
by ACSAK of approximately $0.7 million annually. 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 and the revenue requirement orders were
implemented in June 2004. Network access revenue decreased $0.6 million, or 2.6%, for the three
months ended September 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 expenses 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 decreased $0.6 million, or 10.8%, for
the three months ended September 30, 2004, compared to the same period in 2003,
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
decrease in deregulated 27




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and other revenue is due principally to a decrease in paystation dial
around revenue. During the three months ended September 30, 2004, the Company
reversed $418,000 of previously recognized paystation revenue following
notification from a clearinghouse that AT&T had previously over-funded the
shared revenue pool. The Company has ceased recognizing paystation dial around
revenue until it can adequately estimate future receipts. Wireless Wireless revenue increased $3.6 million, or 28.7%, for the three months
ended September 30, 2004 compared to the three months ended September 30,2003.
This increase is due primarily to the following:  
    
    growth in average subscribers of 11.8% for the three months
ended September 30, 2004 over the prior year period;
    
    increase in monthly average revenue per unit, or ARPU, of
9.1% to $47.43 for the three months ended September 30, 2004 from
$43.47 for the three months ended September 30, 2003, primarily as a
result of increased plan revenues, roaming and regulatory
surcharges. Subscriber average minutes of use increased to 264
minutes per month for the three months ended September 30, 2004 from
256 minutes per month for the three months ended September 30, 2003;
    
    higher gross customer adds in the three months ended
September 30, 2004 resulting in $1.4 million of handset revenue
compared to $0.7 million for the same time period in 2003. Internet Internet revenue decreased $2.9 million, or 35.6%, for the three months
ended September 30, 2004 compared to the three months ended September 30, 2003.
This decrease is primarily due to the loss of $3.9 million in revenue
associated with the Companys contract with the State of Alaska which was
terminated in October 2003, offset by revenue increases as a result of growth
in DSL subscribers of 38.7% to 22,592 at September 30, 2004 from 16,294 at
September 30, 2003. 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 $0.3 million, or 6.5%, for the three
months ended September 30, 2004, compared to the three months ended September
30, 2003. This is primarily due to the loss of revenue associated with the
State of Alaska TPA discussed under Internet above. Both intrastate and
interstate revenue declined from the previous year. While long distance
subscribers increased to 44,334 at September 30 2004, from 43,499 in 2003 at
September 30, 2003, quarterly minutes of use decreased to 36.6 million for the
three months ended September 30 2004, from 39.0 million for the three months
ended September 30, 2003. The decline in minutes of use was primarily due to
the loss of the State of Alaska TPA. Operating Expense Operating expense decreased $34.7 million, or 29.9%, for the three months
ended September 30, 2004, compared to the three months ended September 30,
2003. The decrease is primarily attributable to the following:  
    

    contract termination and asset impairment charges of $54.5
million arising primarily from the termination of the State of
Alaska TPA in October 2003; 28




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
    
    gain on disposal of assets of $16.0 million, related to the
sale of the majority of the Companys remaining interest in the
directory business unit, during the three months ended September 30,
2003;
    
    reduction in depreciation and amortization of $2.3 million
following an order by the RCA to reduce depreciation rates, which
the Company adopted in the fourth quarter of 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
$5.0 million, or 16.6%, for the three months ended September 30, 2004, compared
to the three months ended September 30, 2003.The net increase in local
telephone expense was primarily attributable to:  
    
    allocation of $2.0 million in one-time early termination
charges of an aircraft operating lease;
    
    write-off of $1.6 million of obsolete inventory;
    
    increase in legal reserves of $0.6 million and $0.7 million
in nonrecurring charges for various open disputes and commitments;
    
    write-down of $0.4 million of reimbursable expenses;
    
    increased cellular access charges related to reciprocal compensation of $0.8 million;
    
    decreases in costs associated with the corresponding decreases in local telephone revenue. Wireless Wireless expense increased $3.4 million, or 45.4%, for the three months
ended September 30, 2004 compared to the three months ended September 30, 2003.
This increase resulted primarily from an increase in minutes of use to 74.0
million minutes in the three months ended September 30, 2004 from 64.0 million
minutes in the three months ended September 30, 2003. Additionally, the cost of
goods sold for cell phones increased $1.1 million for the three months ended
September 30, 2004 compared to the same period in 2003 as the Company added
9,219 gross subscribers for the three months ended September 30, 2004 compared
to 6,010 subscribers for the three months ended September 30, 2003. In
addition, $0.8 million of costs were allocated for early termination of the
Companys aircraft operating lease and the write-down of vendor credits
recorded in the three months ended September 30, 2004. Internet Internet expense decreased by $4.4 million, or 37.8%, for the three months
ended September 30, 2004 compared to the three months ended September 30, 2003.
The decrease in Internet expense was due principally to the elimination of
direct operating costs and a lower proportion of shared costs being allocated
to this segment following the termination of the State of Alaska TPA, (as
discussed above, this contract with the State of Alaska was terminated
effective October 2003), offset in part by $1.2 million in allocated costs for
the early termination of the companys aircraft operating lease and an
inventory write-down recorded in the three months ended September 30, 2004. Interexchange Interexchange expenses decreased by $0.4 million, or 6.9% for the three
months ended September 30, 2004 compared to the three months ended September
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 State of Alaska TPA,
offset by increased legal costs of $695 associated with the defense in the
Infinite Minutes litigation. Depreciation and Amortization Depreciation and amortization expense decreased $2.3 million, or 10.3%,
for the three months ended September 30, 2004 compared to the three months
ended September 30, 2003. The decrease in 29




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depreciation is due principally to depreciation rate decreases ordered by the
RCA for ACSA that the Company adopted for the intrastate and local
jurisdictions during the fourth quarter of 2003, retroactive to January 1,
2003. In addition, on September 30, 2003, the Company recorded a significant
asset reduction on the Internet business unit due to the termination of the
State of Alaska contract. Gain/Loss on Disposal of Assets For the three months ended September 30, 2003, the Company recognized a
gain of $15.9 million on a pre-tax basis, as a result of the disposition of
99.23% of its remaining 12.58% interest of its Directory Business, offset by a
non-cash loss on the disposal of certain fixed assets. In the third quarter of
2004, the Company incurred a net loss of $2.6 million following the disposal of
certain wireless assets driven by the network upgrade from TDMA to CDMA. Interest Expense Interest expense decreased $10.3 million, or 46.8%, for the three months
ended September 30, 2004 compared to the three months ended September 30, 2003,
due to the early extinguishment of debt charges of $9.7 million during the
three months ended September 30, 2003, combined with lower term loan balances
and market interest rate effects on the Companys variable interest rate debt. Interest Income and Other During the three months ended September 30, 2003 the Company wrote off a
$15.9 million note receivable from Crest (formerly Neptune). 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. Nine Months Ended September 30, 2004 Compared to Nine Months Ended
September 30, 2003 Operating Revenue Operating revenue decreased $18.7 million, or 7.6%, for the nine months
ended September 30, 2004 compared to the nine months ended September 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
nine months ended September 30, 2003. On September 4, 2003 the Company sold the
majority of its remaining interest and now owns less than 0.1% of the
Directories Business. Local Telephone Local telephone revenue, which consists of local network service, network
access and deregulated and other revenue, decreased $2.5 million, or 1.5%, for
the nine months ended September 30, 2004 compared to the nine months ended
September 30, 2003. 30




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The following table summarizes the Companys consolidated local telephone
revenue by category: Nine Months EndedSeptember 30,2004
    
    2003(in thousands)Local telephone revenue:Local network service
    
    $
    68,972
    
    
    $
    73,370Network access
    
    
    75,362
    
    
    
    73,951Deregulated and other
    
    
    15,642
    
    
    
    15,151Total local telephone revenue
    
    $
    159,976
    
    
    $
    162,472
 The following table summarizes the Companys local telephone access lines: As of September 30,2004
    
    2003Local telephone access lines:Retail
    
    
    209,414
    
    
    
    221,956Wholesale
    
    
    17,498
    
    
    
    18,803Unbundled network elements  platform (UNE  P)
    
    
    6,250
    
    
    
    4,899Unbundled network elements  loop (UNE  L)
    
    
    68,522
    
    
    
    67,542Total local telephone access lines
    
    
    301,684
    
    
    
    313,200
 Local network service revenue decreased $4.4 million, or 6.0%, for the
nine months ended September 30, 2004, compared to the nine months ended
September 30, 2003, while access lines in service decreased 3.7% to 301,684,
adjusted for a reduction of 2,788 internal lines that ceased to be counted
following a change in line count methodology. The decrease in revenue reflects
the net effect of network access line losses, loss of retail lines to UNE lines
and regulatory rate changes offset by increases in UNE rates. Also contributing
to the decrease in local network service are decreases in feature and directory
assistance revenue. Consistent with the U.S. telecommunications industry trend, the Company
experienced a loss of network access lines as customers migrated to broadband
Internet services reducing demand for second lines, migrated to cable
telephony, or replaced landline service with wireless service. Network access revenue increased $1.4 million, or 1.9%, for the nine
months ended September 30, 2004 compared to the nine months ended September 30,
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 expenses 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 $0.5 million, or 3.2%, for
the nine months ended September 30, 2004, compared to the nine months ended
September 30, 2003, consists principally of 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, including revenue earned from the sold directories
business, and messaging revenue, offset by the decrease in paystation dial
around revenue discussed in the three month operating results above. 31




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Wireless Wireless revenue increased $6.4 million, or 18.4%, for the nine months
ended September 30, 2004 compared to the nine months ended September 30, 2003.
This increase is due primarily to the following:  
    
    growth in average subscribers of 11.8% for the nine months
ended September 30, 2004 over the prior year period;
    
    an increase in monthly average revenue per unit, or ARPU, of
4.9%, to $43.87 for the nine months ended September 30, 2004, from
$41.81 for the nine months ended September 30, 2003, primarily as a
result of increased plan revenue, roaming, and regulatory
surcharges;
    
    higher gross customer adds in the nine months ended September
30, 2004 resulting in $3.0 million of handset revenue compared to
$1.6 million for the nine months ended September 30, 2003. Internet Internet revenue decreased $9.4 million, or 38.5%, for the nine months
ended September 30, 2004 compared to the nine months ended September 30, 2003.
This decrease is primarily due to the loss of $12.3 million in revenue
associated with the State of Alaska TPA, which was terminated in October 2003,
offset by approximately $1.3 million of revenue increases as a result of growth
in DSL subscribers of 38.7% to 22,592 at September 30, 2004, from 16,294 at
September 30, 2003. Interexchange Interexchange revenue decreased $1.5 million, or 12.3%, for the nine
months ended September 30, 2004, compared to the nine months ended September
30, 2003, primarily due to the termination of services to the State of Alaska
TPA. Both intrastate and interstate revenue declined from the previous year.
While long distance subscribers increased to 44,334 at September 30, 2004 from
43,499 at September 30, 2003, total minutes of use decreased to 101.9 million
for the nine months ended September 30, 2004, from 113.5 million for the nine
months ended 2003. Operating Expense Operating expense increased $47.5 million, or 27.3%, for the nine months
ended September 30, 2004, compared to the nine months ended September 30, 2003.
The increase is primarily attributable to the $113.5 million gain on disposal
of assets, net of $54.5 million of contract termination and asset impairment
charges, recognized in the nine months ended September 30, 2003, offset by the
following cost reductions:  
    
    cost avoidance following the termination of the State of
Alaska TPA;
    
    reduction in depreciation and amortization of $9.0 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 in
the Directories Business, which had recorded $5.2 million of expense
for the nine months ended September 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
$12.5 million, or 14.9%, for the nine months ended September 30, 2004, compared
to the nine months ended September 30, 2003.The increase in local telephone
expense was primarily attributable to a shift in the Company focus from the
State of Alaska TPA, as reflected in our Internet and interexchange segments,
to core business services resulting in higher allocation of shared costs. Other
contributing factors include:  
    
    allocation of $2.0 million in one-time early termination
charges of an aircraft operating lease;
    
    write-off of $1.6 million of obsolete inventory; 32




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
    
    increase in legal reserves of $0.6 million and $0.7 million
in nonrecurring charges for various open disputes and commitments;
    
    write down of $0.4 million of reimbursable expenses;
    
    increased cellular access charges related to reciprocal compensation of $0.8 million. Wireless Wireless expense increased $5.4 million, or 24.9%, for the nine months
ended September 30, 2004 compared to the nine months ended September 30, 2003.
This increase resulted primarily from an increase in minutes of use to 201.8
million minutes in the nine months ended September 30, 2004, from 171.6 million
minutes in the nine months ended September 30, 2003. Additionally, the cost of
goods sold for cell phones increased $2.0 million for the nine months ended
September 30, 2004 compared to the nine months ended September 30, 2003,
primarily due to higher hand set sales. Operating expenses were also impacted
by the allocation of $0.8 million in costs for the early termination of the
companys aircraft operating lease and the write down of vendor credits. Internet Internet expense decreased by $14.6 million, or 40.8%, compared to the
nine months ended September 30, 2003. The decrease in Internet expense was due
principally to the elimination of the operating costs associated with the State
of Alaska TPA. As discussed above, this contract with the State of Alaska was
terminated effective October 2003. The decrease was offset by an increase in
DSL cost of goods sold of $1.4 million due to the 38.7% increase in DSL
subscribers and $1.2 million in allocated costs for the early termination of
the Companys aircraft operating lease and inventory write downs. Interexchange Interexchange expenses decreased by $2.4 million, or 13.3%, compared to
the nine months ended September 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 State of Alaska TPA, offset by increased legal costs of $980 associated
with the defense in the Infinite Minutes litigation. Depreciation and Amortization Depreciation and amortization expense decreased $9.0 million, or 13.6%,
for the nine months ended September 30, 2004 compared to the nine months ended
September 30, 2003. The decrease in depreciation is due principally to
depreciation rate decreases ordered by the RCA for ACSA that the Company
adopted for the intrastate and local jurisdictions during the fourth quarter of
2003, retroactive to January 1, 2003. In addition, on September 30, 2003, the
Company recorded a significant asset reduction on the Internet business unit
due to the termination of the State of Alaska contract. Gain/Loss on Disposal of Assets For the nine months ended September 30, 2003, the Company recognized a
gain of $113.5 million on a pre-tax basis, on disposition of its Directories
Business, offset by a non-cash loss on the disposal of certain fixed assets. In
the nine months ended September 30, 2004, the Company incurred a loss of $2.8
million following the disposal of certain wireless assets, driven by the
network upgrade from TDMA to CDMA. Interest Expense Interest expense decreased $15.1 million, or 30.5%, for the nine months
ended September 30, 2004 compared to the nine months ended September 30, 2003,
due to the early extinguishment of debt charges of $9.7 million during the
three months ended September 30, 2003, combined with lower term loan balances
and market interest rate effects on the Companys variable interest rate debt. 33




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Interest Income and Other Interest income and other increased by $10.8 million for the nine months
ended September 30, 2004 compared to the nine months ended September 30, 2003,
primarily due to a $15.9 million non-operating impairment loss on a Crest
(formerly Neptune) note receivable being recorded in the third quarter of
2003, offset in part by a $4.3 million gain on foreign exchange on the sale of
the Directories Business. 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 nine months ended September 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. 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 nine months ended September 30, 2004
the Companys cash flows from operating activities were $24.5 million. At
September 30, 2004, the Company had approximately $91.2 million in net working
capital, with $79.7 million represented by cash and cash equivalents. As of
September 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 $198.5 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 $533.3
million as of September 30, 2004.On May 14, 2004, the ACS Group called $17.3
million of its 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. ACS Holdings provided the
capital resources to fund this transaction. The Board of Directors has
authorized the Company to buy back up to $10 million of debt in the open market
during the three months ended December 31, 2004. From time to time the Company
considers making purchases of its outstanding debt securities on the open
market or in negotiated transactions. The timing and amount of such purchases,
if any, will depend upon cash needs and market conditions, among other things.
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 $500,000 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. 34




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On July 15, 2002 the Company fulfilled a commitment to Crest (formerly
Neptune) Communications, L.L.C. (Crest) 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 Crest, the expenditures for which may be
significant and may exceed $20.million over the next two years. ACS purchased
capacity under this agreement of $5.6 million in the third quarter of 2004.
While the Company has an agreement with Crest, 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 2006, the final price and quantity of which are subject to future
events, (ii) Crests restoration of the Companys traffic carried on another
cable system, (iii) and specific interconnection arrangements between the
Company and Crest, should the Company exercise its option to purchase certain
network assets from Crest. The Company is currently negotiating open elements
of its agreement with Crest 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 three months 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 State of Alaska TPA. The Company anticipates capital spending of between
$50 million and $55 million for 2004, and has spent $38.1 million in the first
nine months of 2004, inclusive of $12.8 million invested in CDMA 1xRTT and
EV-DO infrastructure and interstate network access capacity. 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.At September 30, 2004 the Company had allocated
$55.0 million of its current unrestricted cash balance of $79.7 million to fund
the completion of its CDMA 1xRTT and EV-DO build out and to secure fiber
capacity within Alaska and to the lower 48 states in the United States under
the terms of its agreement with Crest. The Companys capital requirements may change due to: 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, among other things. The ACS Group announced on October 28, 2004 the adoption of a dividend
policy by its Board of Directors and declared its first quarterly dividend of
$0.185 per share, payable on January 19, 2005 to holders of record on December
31, 2004.While ACS Group intends to continue to pay quarterly dividends, such
payment is subject to ACS Groups future operating and financial performance,
capital expenditures, working capital requirements and other factors.
Accordingly, ACS Groups Board of Directors may modify or revoke this policy at
any time. The Company is the sole subsidiary of ACS Group and comprises
substantially all of its assets and operations. Accordingly, the Company is
obligated to fund dividends declared by ACS Group. Simultaneous with the
announcement of the dividend policy, the Company also announced the withdrawal
of its registration statements for a proposed initial public offering of Income
Deposit Securities (IDSs), a separate proposed offering of senior
subordinated notes and the proposed reclassification of its existing common
stock into cash and shares of new class B common stock which it had filed with
the Securities and Exchange Commission. No securities were sold under the
withdrawn registration statements. 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, pay quarterly dividends, and fund its
operations, capital expenditures and other obligations over the next 12 months.
The Companys ability to meet such 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. 35




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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
telecommunication services including local telephone, wireless, Internet, long
distance, messaging and video entertainment. Consistent with the U.S. telecommunications industry, the Company
experienced a loss in network access lines during the year as customers
cancelled second lines, replaced wireline services with wireless, and lines
migrated to cable telephony. The Companys primary UNE customer has announced
plans to migrate most of its Anchorage area customers to its own cable
telephony plant during the next 3-5 years. Consequently, the Company
anticipates that these trends will continue. 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 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 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 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. 36




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has issued senior subordinated notes and senior unsecured
notes 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. 37




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##### Table of Contents



PART II OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS. 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 terminate its Infinite Minutes long distance plan. The
parties have agreed to settle the matter for a combination of: (1) 12 ten
dollar per month coupons, to be applied against the Companys services; (2) 100
free interstate long distance minutes per month for 12 months; and (3) $950 in
cash for plaintiffs legal fees. The settlement has been submitted to the court
for approval. On October 27, 2004, the court granted preliminary approval of
the settlement and final approval is expected in February 2005. The Company is litigating a dispute with Dobson Communications concerning
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 adjusted the loop rate for some computational errors, but
otherwise has denied petitions to reconsider portions of its decision. The
parties submitted a final interconnection agreement reflecting all of the RCAs
decisions on October 27, 2004. 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. On
October 1, 2004, ACSW was certified as a CETC for these areas. The Company is involved in these 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. 38




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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. 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. Exhibits:  31.1
    
    Certification of Liane Pelletier, Chief Executive Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of David Wilson, Chief Financial Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 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 of 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. 39




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. Date: November 10, 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) 40