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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 
 FORM 10-Q (Mark One)x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934For the quarterly period ended March 31, 2004ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period fromto. Commission file number 000-28167 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 or15(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 x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes o No x APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes
o No o APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the last
practicable date.




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TABLE OF CONTENTS PageNumberPART I.
    
    Financial InformationItem 1.
    
    Financial Statements:Consolidated Balance Sheets (unaudited) As of March 31, 2004 and December 31, 2003
    
    
    3Consolidated Statements of Operations (unaudited) For the Three Months Ended March 31, 2004 and 2003
    
    
    4Consolidated Statements of Cash Flows (unaudited) For the Three Months Ended March 31, 2004 and 2003
    
    
    5Notes to Consolidated Financial Statements (unaudited)
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    31Item 4.
    
    Controls and Procedures
    
    
    31PART II.
    
    Other InformationItem 1.
    
    Legal Proceedings
    
    
    32Item 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    33Item 3.
    
    Defaults upon Senior Securities
    
    
    33Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    33Item 5.
    
    Other Information
    
    
    33Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    33Signatures
    
    
    34EXHIBIT 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 Share Amounts)
 March 31,
    
    December 31,2004
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    92,279
    
    
    $
    97,798Restricted cash
    
    
    3,635
    
    
    
    3,635Accounts receivable-trade, net of allowance of $4,283 and $4,432
    
    
    37,592
    
    
    
    41,718Accounts receivable-affiliate
    
    
    448
    
    
    
    148Materials and supplies
    
    
    9,171
    
    
    
    10,099Prepayments and other current assets
    
    
    5,743
    
    
    
    5,850Total current assets
    
    
    148,868
    
    
    
    159,248Property, plant and equipment
    
    
    1,044,547
    
    
    
    1,041,904Less: accumulated depreciation
    
    
    613,953
    
    
    
    603,760Property, plant and equipment, net
    
    
    430,594
    
    
    
    438,144Goodwill
    
    
    38,403
    
    
    
    38,403Intangible assets, net
    
    
    22,009
    
    
    
    22,055Debt issuance costs, net of amortization of $5,914 and $5,196
    
    
    17,870
    
    
    
    18,587Deferred charges and other assets
    
    
    8,544
    
    
    
    8,750Total assets
    
    $
    666,288
    
    
    $
    685,187Liabilities and Stockholders EquityCurrent liabilities:Current portion of long-term obligations
    
    $
    2,294
    
    
    $
    2,267Accounts payable-affiliates
    
    
    3,904
    
    
    
    3,817Accounts payable, accrued and other current liabilities
    
    
    39,463
    
    
    
    46,991Income taxes payable
    
    
    
    
    
    
    1,095Advance billings and customer deposits
    
    
    8,387
    
    
    
    8,766Total current liabilities
    
    
    54,048
    
    
    
    62,936Long-term obligations, net of current portion
    
    
    532,010
    
    
    
    532,737Other deferred credits and long-term liabilities
    
    
    69,964
    
    
    
    71,065Commitments and contingencies
    
    
    
    
    
    
    Stockholders equity:Common stock, $.01 par value; 1,000 shares authorized,
1 share issued and outstanding
    
    
    
    
    
    
    Contributed capital
    
    
    287,242
    
    
    
    287,242Accumulated deficit
    
    
    (272,433
    )
    
    
    (264,250
    )Accumulated other comprehensive loss
    
    
    (4,543
    )
    
    
    (4,543
    )Total stockholders equity
    
    
    10,266
    
    
    
    18,449Total liabilities and stockholders equity
    
    $
    666,288
    
    
    $
    685,187
 See Notes to Consolidated Financial Statements 3




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC. 
 Consolidated Statements of Operations
 (Unaudited, In Thousands)
 Three Months EndedMarch 31,2004
    
    2003Operating revenue:Local telephone
    
    $
    55,782
    
    
    $
    54,001Wireless
    
    
    11,601
    
    
    
    10,330Directory
    
    
    
    
    
    
    8,278Internet
    
    
    4,613
    
    
    
    7,156Interexchange
    
    
    3,409
    
    
    
    4,027Total operating revenue
    
    
    75,405
    
    
    
    83,792Operating expense:Local telephone (exclusive of depreciation and amortization)
    
    
    32,524
    
    
    
    27,255Wireless (exclusive of depreciation and amortization)
    
    
    7,928
    
    
    
    6,910Directory (exclusive of depreciation and amortization)
    
    
    
    
    
    
    3,449Internet (exclusive of depreciation and amortization)
    
    
    7,506
    
    
    
    10,614Interexchange (exclusive of depreciation and amortization)
    
    
    5,016
    
    
    
    5,618Depreciation and amortization
    
    
    19,106
    
    
    
    22,600Loss on disposal of assets
    
    
    227
    
    
    
    746Total operating expense
    
    
    72,307
    
    
    
    77,192Operating income
    
    
    3,098
    
    
    
    6,600Other income (expense):Interest expense
    
    
    (11,448
    )
    
    
    (12,687
    )Interest income and other
    
    
    230
    
    
    
    192Total other expense
    
    
    (11,218
    )
    
    
    (12,495
    )Loss before income taxes and discontinued operations
    
    
    (8,120
    )
    
    
    (5,895
    )Income tax
    
    
    
    
    
    
    Loss from continuing operations
    
    
    (8,120
    )
    
    
    (5,895
    )Loss from discontinued operations
    
    
    
    
    
    
    (52
    )Net loss
    
    $
    (8,120
    )
    
    $
    (5,947
    )
 See Notes to Consolidated Financial Statements 4




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC. 
 Consolidated Statements of Cash Flows
 (Unaudited, In Thousands)
 Three Months EndedMarch 31,2004
    
    2003Cash Flows from Operating Activities:Net loss
    
    $
    (8,120
    )
    
    $
    (5,947
    )Adjustments to reconcile net loss to net cash provided by operating activities:Loss on discontinued operations
    
    
    
    
    
    
    52Depreciation and amortization
    
    
    19,106
    
    
    
    22,600Loss on disposal of assets
    
    
    227
    
    
    
    746Amortization of debt issuance costs and original issue discount
    
    
    845
    
    
    
    1,033Capitalized interest
    
    
    (45
    )
    
    
    Other deferred credits
    
    
    (2,285
    )
    
    
    (41
    )Changes in components of working capital:Accounts receivable and other current assets
    
    
    4,664
    
    
    
    4,631Accounts payable and other current liabilities
    
    
    (8,915
    )
    
    
    (4,423
    )Other
    
    
    206
    
    
    
    17Net cash used in discontinued operations
    
    
    
    
    
    
    (41
    )Net cash provided by operating activities
    
    
    5,683
    
    
    
    18,627Cash Flows from Investing Activities:Construction and capital expenditures, net of capitalized interest
    
    
    (10,311
    )
    
    
    (6,115
    )Release of funds from escrow
    
    
    
    
    
    
    3,339Placement of funds in restricted account
    
    
    
    
    
    
    (200
    )Net cash used by investing activities
    
    
    (10,311
    )
    
    
    (2,976
    )Cash Flows from Financing Activities:Payments on long-term debt
    
    
    (828
    )
    
    
    (316
    )Dividends
    
    
    (63
    )
    
    
    (418
    )Net cash used by financing activities
    
    
    (891
    )
    
    
    (734
    )Increase (decrease) in cash and cash equivalents
    
    
    (5,519
    )
    
    
    14,917Cash and cash equivalents at beginning of the period
    
    
    97,798
    
    
    
    18,565Cash and cash equivalents at the end of the period
    
    $
    92,279
    
    
    $
    33,482Supplemental Cash Flow Data:Interest paid
    
    $
    11,870
    
    
    $
    8,401Income taxes paid
    
    $
    1,120
    
    
    $
    Supplemental Noncash Transactions:Property acquired under capital leases and mortgages
    
    $
    
    
    
    $
    2,340Interest rate swap marked to market
    
    $
    
    
    
    $
    (1,662
    )
 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 and business customers and wholesale customers
in the State of Alaska through its telecommunications subsidiaries. The Company
is a wholly owned subsidiary of Alaska Communications Systems Group, Inc. (the
Parent or ACS Group). The financial statements for the Company represent the consolidated
financial position, results of operations and cash flows principally of the
following entities:  
    
    Alaska Communications Systems Holdings, Inc.
    
    ACS 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 newly formed ACS Media LLC (the Directories Business).
Subsequently, on August 27, 2003, the Company sold substantially all of its
remaining interest in the Directories Business. As a result of this
transaction, the Company now owns less than 0.1% of the Directories Business. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted pursuant to rules and regulations of the Securities and Exchange
Commission. However, the Company believes the disclosures which are made are
adequate to make the information presented not misleading. The consolidated
financial statements and footnotes included in this Form 10-Q should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2003. Certain reclassifications have been made to the 2003
financial statements to make them conform to the current presentation. In the opinion of management, the financial statements contain all
adjustments (consisting of normal recurring adjustments) necessary to present
fairly the consolidated financial position, results of operations and cash
flows for all periods presented. The results of operations for the three months
ended March 31, 2004 and 2003 are not necessarily indicative of the results of
operations which might be expected for the entire year or any other interim
periods. Revenue Recognition Access revenue is recognized when earned. The Company participates in
access revenue pools with other telephone companies. Such pools are funded by
toll revenue and/or access charges regulated by the Regulatory Commission of
Alaska (RCA) within the intrastate jurisdiction and the Federal
Communications Commission (FCC) within the interstate jurisdiction. Much of
the interstate access revenue is initially recorded based on estimates. These
estimates are derived from interim financial statements, available separations
studies and the most recent information available about achieved rates of
return. These estimates are subject to adjustment in future accounting periods
as additional operational information becomes available. To the extent that
disputes arise over revenue settlements, the Companys policy is to defer
revenue collected until settlement methodologies are resolved and finalized. At
March 31, 2004 and 2003, the Company had liabilities of $13,053 and $17,532,
respectively, related to its estimate of refundable access revenue. 6




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  1.
    
    DESCRIPTION OF COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued) Regulatory Accounting and Regulation The local telephone exchange operations of the Company account for costs
in accordance with the accounting principles for regulated enterprises
prescribed by Statement of Financial Accounting Standards (SFAS) No. 71,
Accounting for the Effects of Certain Types of Regulation.This accounting
recognizes the economic effects of rate regulation by recording cost and a
return on investment as such amounts are recovered through rates authorized by
regulatory authorities. Accordingly, under SFAS No. 71, plant and equipment is
depreciated over lives approved by regulators and certain costs and obligations
are deferred based upon approvals received from regulators to permit recovery
of such amounts in future years. The Company implemented, effective January 1, 2003, higher depreciation
rates for its regulated telephone plant for the interstate jurisdiction, which
management believes approximate the economically useful lives of the underlying
plant. As a result, the Company has recorded a regulatory asset under SFAS No.
71 of $21,850 and $2,418 as of March 31, 2004 and 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 $521 at March 31, 2004. If the Company were not following
SFAS No. 71, these costs would have been charged to expense as incurred. The
Company also has a regulatory liability of $51,730 at March 31, 2004 related to
accumulated removal costs. If the Company were not following SFAS No. 71, it
would have followed SFAS No. 143 for asset retirement obligations.
Non-regulated revenues and costs incurred by the local telephone exchange
operations and non-regulated operations of the Company are not accounted for
under SFAS No. 71 principles. Stock Incentive Plans The Companys employees participate in various plans of ACS Group. The
Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, in accounting for its stock incentive plans.
Accordingly, no compensation cost has been recognized for options with exercise
prices equal to or greater than fair value on the date of grant. No
compensation costs were charged to operations for the three months ended March
31, 2004 or 2003. If compensation costs had been determined consistent with
SFAS No. 123, Accounting for Stock-Based Compensation,the Companys net loss
and net loss per share on a pro forma basis for the three months ended March
31, 2004 and 2003 would have been as follows: For the three months endedMarch 31,2004
    
    2003Net loss:As reported
    
    $
    (8,120
    )
    
    $
    (5,947
    )Pro forma
    
    
    (8,087
    )
    
    
    (6,375
    )
 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
    
    
    2.94
    %
    
    
    2.88
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected volatility factor
    
    
    55.2
    %
    
    
    64.2
    %Expected option life (years)
    
    
    6.8
    
    
    
    6.1
 7




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  2.
    
    NEW ACCOUNTING STANDARDS On August 15, 2001, the Financial Accounting Standards Board (FASB)
issued SFAS No. 143,Accounting for Asset Retirement Obligations. This
statement is effective for financial statements issued for fiscal years
beginning after June 15, 2002. SFAS No. 143 addresses financial accounting and
reporting obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This standard generally
applies to legal obligations associated with the retirement of long-lived
assets that result from the acquisition, construction, development and/or the
normal operation of a long-lived asset. Under the new accounting method, asset
retirement obligations are recognized in the period in which they are incurred
if a reasonable estimate of fair value can be made. When the liability is
initially recorded, the cost is capitalized and increases the carrying value of
the related long-lived asset. The liability is then accreted to its present
value each period and the capitalized cost is depreciated over the estimated
useful life of the related asset. At the settlement date, the obligation is
settled for its recorded amount or a gain or loss is recognized upon
settlement. In accordance with federal and state regulations, depreciation expense for
the Companys local exchange carriers regulated operations have historically
included an additional provision for cost of removal. Under SFAS No. 143, the
additional cost of removal provision would no longer be included in
depreciation expense, because it does not meet the recognition and measurement
principles of an asset retirement obligation. On December 20, 2002, the FCC
notified local exchange carriers that they should not adopt the provisions of
SFAS No. 143 unless specifically required by the FCC in the future. As a result
of the FCC ruling, the Company will continue to record depreciation expense for
cost of removal for its local exchange carrier subsidiaries that follow SFAS
No. 71 accounting. Prior to SFAS No. 143, asset removal costs that qualified
and did not qualify for asset retirement obligations were recorded in
Accumulated depreciation. In accordance with SFAS No. 143 and SFAS No. 71, the
accumulated asset retirement removal costs were reclassified as regulatory
liabilities in 2003. Accumulated retirement removal costs in Other deferred
credits and long-term liabilities not qualifying for asset retirement
obligations were $51,730 at March 31, 2004. The Company applied the provisions of SFAS No. 143 to its nonregulated
subsidiaries effective January 1, 2003. The Companys wireless segment has
entered into cell site operating leases, which are subject to the provisions of
this statement. Cell site lease agreements may contain clauses requiring
restoration of the leased site at the end of the lease term, creating an asset
retirement obligation. Landlords may choose not to exercise these rights as
cell sites may be considered useful improvements. The Companys initial
adoption of this statement did not have a material impact on its results of
operations, financial position or cash flows. In December 2003, the FASB reissued SFAS No. 132, Employers Disclosure
about Pensions and Other Postretirement Benefits.This revised statement
requires expanded disclosures with respect to pension plan assets, benefit
obligations, cash flows, benefit costs and other relevant information. However
this revised statement does not change the measurement and recognition
provisions of previous FASB statements related to pensions and other
postretirement benefits. The Company was required to adopt this revised
statement for 2003. The Companys adoption of this revised statement did not
have a material impact on its financial position, results of operations, or
cash flows. The expanded disclosures required by this statement are included in
Note 5, Retirement Plans. 8




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  2.
    
    NEW ACCOUNTING STANDARDS (Continued) In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities(revised December 2003). FIN 46
addresses when a company should include in its financial statements the assets,
liabilities and activities of a variable interest entity. FIN 46 defines
variable interest entities as those entities with a business purpose that
either do not have any equity investors with voting rights or have equity
investors that do not provide sufficient financial resources for the entity to
support its activities. FIN 46 also requires disclosures about variable
interest entities that a company is not required to consolidate, but in which
it has a significant variable interest. FIN 46 consolidation requirements are
effective for all variable interest entities created after January 31, 2003,
and to pre-existing entities in the first fiscal year or interim period ending
after December 15, 2003. Certain disclosure requirements are effective for
financial statements issued after January 31, 2003. The adoption of FIN 46 has
no effect on the Companys financial position, results of operations or cash
flows.  3.
    
    DISCONTINUED OPERATIONS On March 30, 2002, the Company approved a plan to sell its wireless cable
television service segment. As a result of this decision, the operating revenue
and expense of this segment has been classified as discontinued operations
under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. The Company completed its disposal of its wireless cable television
segment as of March 31, 2003. The following discloses the results of the discontinued operations for the
three months ended March 31, 2003: Three Months EndedMarch 31,2003Operating revenue
    
    $
    110Operating expense
    
    
    162Loss from discontinued operations
    
    $
    (52
    )
  4.
    
    STOCK INCENTIVE PLANS The Companys employees participate in various plans of ACS Group, which
through its Compensation Committee of the Board of Directors, may grant stock
options, stock appreciation rights and other awards to officers, employees and
non-employee directors. At March 31, 2004, ACS Group has reserved a total of
6,060 shares of authorized common stock for issuance under the plans. In
general, options under the plans vest ratably over three, four or five years
and the plans terminate in approximately 10 years. Alaska Communications Systems Group, Inc. 1999 Stock Incentive Plan ACS Group has reserved 4,910 shares under this plan, which was adopted by
the Company in November 1999. At March 31, 2004, 6,710 options have been
granted, 2,712 have been forfeited, 441 have been exercised, and 912 shares are
available for grant under the plan. 9




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  4.
    
    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 150 shares under this plan. At March
31, 2004, 117 shares have been awarded and 33 shares are available for grant
under the plan. For 2004, directors are required to receive not less than 25%
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 from this plan during 2003. On March 31, 2004, seven shares
under the plan were awarded to directors, of which five were elected to be
deferred until termination of service by the directors. Alaska Communications Systems Group, Inc. 1999 Employee Stock Purchase Plan This plan was also adopted by ACS Group in November 1999. ACS Group has
reserved 1,000 shares under this plan. At March 31, 2004, 502 shares are
available for issuance and sale. The plan will terminate on December 31, 2009.
All ACS Group employees and all of the employees of designated subsidiaries
generally will be eligible to participate in the purchase plan, other than
employees whose customary employment is 20 hours or less per week or is for not
more than five months in a calendar year, or who are ineligible to participate
due to restrictions under the Internal Revenue Code.  5.
    
    RETIREMENT PLANS Pension benefits for substantially all of the Companys employees are
provided through the Alaska Electrical Pension Plan (AEPP). The Company pays
a contractual hourly amount based on employee classification or base
compensation. As a multi-employer defined contribution plan, the accumulated
benefits and plan assets are not determined for or allocated separately to the
individual employer. The Company also provides a 401(k) retirement savings plan
covering substantially all of its employees. The Company also has a separate defined benefit plan that covers certain
employees previously employed by Century Telephone Enterprise, Inc.
(CenturyTel Plan). This plan was transferred to the Company in connection
with the acquisition of CenturyTels Alaska Properties. Existing plan assets
and liabilities of the CenturyTel Plan were transferred to the ACS Retirement
Plan on September 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. 10




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  5.
    
    RETIREMENT PLANS (Continued) The following table represents the net periodic pension expense for the
ACS Retirement Plan for the three months ended March 31, 2004 and 2003: Three Months EndedMarch 31,2004
    
    2003Interest cost
    
    $
    184
    
    
    $
    183Expected return on plan assets
    
    
    (190
    )
    
    
    (166
    )Amortization of loss
    
    
    138
    
    
    
    142Amortization of prior service cost
    
    
    51
    
    
    
    51Net periodic pension expense
    
    $
    183
    
    
    $
    210
 The Company also has a separate executive post retirement health benefit
plan. The Alaska Communications Systems Executive Retiree Health Benefit Plan
(The ACS Health Plan) was adopted by the Company in November 2001 and amended
in October 2002. The ACS Health Plan covers a select group of management or
highly compensated employees. The group of eligible employees is selected by a
committee appointed by the Compensation Committee of ACS Groups Board of
Directors. Each eligible employee must complete 10 years of service and be
employed by the Company in the capacity of an executive officer for a minimum
of 36 consecutive months immediately preceding retirement. The ACS Health Plan
provides a graded subsidy for medical, dental, and vision coverage. The
amendment revised the premium subsidy, added a premium subsidy cap and suspends
retirees benefits from the ACS Health Plan during any period the retiree has
access to employer health benefits. The Compensation Committee of the Board of
Directors decided to terminate the ACS Health Plan in January 2004. The three
people already qualified under the plan will receive future benefits, but the
plan is closed to future participants. The Company uses the projected unit
credit method for the determination of post retirement health cost for
financial reporting and funding purposes and complies with the funding
requirements under ERISA. The Company uses a December 31 measurement date for
the plan. The following represents the net periodic postretirement benefit expense
for the ACS Health Plan for the three months ended March 31, 2004 and 2003: Three Months EndedMarch 31,2004
    
    2003Service cost
    
    $
    2
    
    
    $
    3Interest cost
    
    
    4
    
    
    
    5Expected return on plan assets
    
    
    (3
    )
    
    
    (3
    )Amortization of prior service cost
    
    
    2
    
    
    
    2Net periodic postretirement benefit expense
    
    $
    5
    
    
    $
    7
  6.
    
    BUSINESS SEGMENTS The Company has four reportable segments: local telephone, wireless,
Internet and interexchange. Local telephone provides landline
telecommunications services and consists of local telephone service, network
access and deregulated and other revenue; wireless provides wireless
telecommunications service; Internet provides Internet service and advanced IP
based private networks; and interexchange provides switched and dedicated long
distance services. Each reportable segment is a strategic business offering
different services than those offered by the other segments. The Company
evaluates the performance of its segments based on operating income (loss). 11




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  6.
    
    BUSINESS SEGMENTS (Continued) Previously, the Company reported its Directories Business as a separate
segment. The Company sold an 87.42% interest in its Directories Business during
the second quarter of 2003 and is no longer directly engaged in day-to-day
management of that business. Therefore, the Directories Business no longer
constitutes a reportable segment. Accordingly, the historical operating results
for the Directories Business for the three months ended March 31, 2003 are
included in All Other in the accompanying tables. The Company also had a
wireless cable television service segment that did not meet the criteria for a
reportable segment, that was previously included in All Other and is now
reported as discontinued operations. The Company also incurs interest expense, interest income, equity in
earnings of investments and other operating and non operating income and
expense at the corporate level which are not allocated to the business
segments, nor are they evaluated by the chief operating decision maker in
analyzing the performance of the business segments. These non operating income
and expense items are provided in the accompanying table under the caption All
Other in order to assist the users of these financial statements in
reconciling the operating results and total assets of the business segments to
the consolidated financial statements. Common use assets are held at the
Company and are allocated to the business segments based on operating revenue.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The following table illustrates selected financial data for each segment
as of and for the three months ended March 31, 2004: LocalTelephone
    
    Wireless
    
    Internet
    
    Interexchange
    
    All Other
    
    Eliminations
    
    TotalOperating revenue
    
    $
    55,772
    
    
    $
    11,613
    
    
    $
    4,613
    
    
    $
    3,858
    
    
    $
    5,799
    
    
    $
    (6,250
    )
    
    $
    75,405Depreciation and amortization
    
    
    12,849
    
    
    
    1,645
    
    
    
    1,002
    
    
    
    157
    
    
    
    3,453
    
    
    
    
    
    
    
    19,106Operating income (loss)
    
    
    6,313
    
    
    
    1,143
    
    
    
    (4,162
    )
    
    
    (1,378
    )
    
    
    1,182
    
    
    
    
    
    
    
    3,098Interest expense
    
    
    (81
    )
    
    
    (12
    )
    
    
    
    
    
    
    (47
    )
    
    
    (11,308
    )
    
    
    
    
    
    
    (11,448
    )Interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    197
    
    
    
    
    
    
    
    197Income tax provision (benefit)
    
    
    2,499
    
    
    
    466
    
    
    
    
    
    
    
    
    
    
    
    (2,965
    )
    
    
    
    
    
    
    Net income (loss)
    
    
    3,733
    
    
    
    665
    
    
    
    (4,162
    )
    
    
    (1,425
    )
    
    
    (6,931
    )
    
    
    
    
    
    
    (8,120
    )Total assets
    
    
    517,813
    
    
    
    102,939
    
    
    
    7,655
    
    
    
    23,264
    
    
    
    14,617
    
    
    
    
    
    
    
    666,288Capital expenditures
    
    
    5,235
    
    
    
    3,609
    
    
    
    453
    
    
    
    38
    
    
    
    976
    
    
    
    
    
    
    
    10,311
 Operating revenue disclosed above includes intersegment operating revenue
of $6,324 for local telephone, $434 for wireless, $522 for interexchange and
$5,789 for all other. In accordance with SFAS No. 71, intercompany revenue
between local telephone and all other segments is not eliminated above. The following table illustrates selected financial data for each segment
as of and for the three months ended March 31, 2003: LocalTelephone
    
    Wireless
    
    Internet
    
    Interexchange
    
    All Other
    
    Eliminations
    
    TotalOperating revenue
    
    $
    54,001
    
    
    $
    10,353
    
    
    $
    7,156
    
    
    $
    6,100
    
    
    $
    14,599
    
    
    $
    (8,417
    )
    
    $
    83,792Depreciation and amortization
    
    
    14,692
    
    
    
    1,445
    
    
    
    2,410
    
    
    
    555
    
    
    
    3,498
    
    
    
    
    
    
    
    22,600Operating income (loss)
    
    
    6,918
    
    
    
    (317
    )
    
    
    (6,931
    )
    
    
    (343
    )
    
    
    7,282
    
    
    
    (9
    )
    
    
    6,600Interest expense
    
    
    136
    
    
    
    1
    
    
    
    34
    
    
    
    74
    
    
    
    12,442
    
    
    
    
    
    
    
    12,687Interest income
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    245
    
    
    
    
    
    
    
    246Income tax provision (benefit)
    
    
    2,507
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    (2,511
    )
    
    
    
    
    
    
    Income (loss) from
continuing operations
    
    
    3,684
    
    
    
    24
    
    
    
    (6,487
    )
    
    
    (649
    )
    
    
    (2,458
    )
    
    
    (9
    )
    
    
    (5,895
    )Total assets
    
    
    519,411
    
    
    
    82,063
    
    
    
    (31,367
    )
    
    
    3,488
    
    
    
    122,591
    
    
    
    
    
    
    
    696,186Capital expenditures
    
    
    3,994
    
    
    
    121
    
    
    
    1,232
    
    
    
    8
    
    
    
    3,100
    
    
    
    
    
    
    
    8,455
 Operating revenue disclosed above includes intersegment operating revenue
of $5,975 for local telephone, $413 for wireless, $440 for interexchange and
$6,670 for all other. In accordance with SFAS No. 71, intercompany revenue
between local telephone and all other segments is not eliminated above. 12




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  7.
    
    RELATED PARTY TRANSACTIONS Fox Paine & Company, LLC whose affiliates hold a majority of ACS Group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 months ended March 31, 2004 and 2003 was
$220 and $304, respectively. At March 31, 2004, the payable due to Fox Paine
was $1,206. 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 March
31, 2004, the Company had recorded in accounts payable  affiliates $2,698 due
to ACS Media LLC under these contracts, primarily under the billing and
collection agreement. The Company has a right to minority representation of one
manager of the permitted nine managers of ACS Media LLC so long as its
contracts with ACS Media LLC are in effect. Currently, Wray T. Thorn, a
director of the Company and employee of Fox Paine & Company, the Companys
majority shareholder, is a manager of ACS Media LLC. On September 14, 2003, the Company entered into an agreement with a
retiring officer to reacquire 267 shares of ACS Group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 ACS Groups stock during any 5-consecutive day
trading period in January 2004. The officer will deliver the shares to the
Company in 2004, and the Company will make the repurchase payments totaling
$1,262 to the officer in four equal quarterly installments commencing on March
31, 2004. The Company understands that on September 19, 2003, Fox Paine entered into
a consulting agreement with a now retired officer of the Company. The
consulting term will begin on January 1, 2004 and continue for one year, after
which either party may terminate the arrangement. During the consulting term,
the retired officer will advise Fox Paine on and evaluate potential
opportunities in the telecommunications industry, and Fox Paine will pay the
officer a monthly fee of $20 for these services. 13




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  8.
    
    CONDENSED CONSOLIDATING FINANCIAL STATEMENTS ACS Holdings and it subsidiaries are guarantors of the ACS Groups senior
discount debentures. Additionally, ACS Group and ACS Holdings subsidiaries are
guarantors under ACS Holdings 9 3/8 % senior subordinated notes. All ACS
Groups and Holdings subsidiaries (the Subsidiaries) are 100% owned. The
guarantees are full and unconditional. In addition, all guarantees are joint
and several. Accordingly, the interim condensed consolidating financial
statements are presented below. Additionally, see ACS Groups 10-Q (Commission
File Number 000-28167) for ACS Group only financial statements. Condensed Consolidating Balance Sheet
March 31, 2004 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedAssetsCurrent assets:Cash and cash equivalents
    
    $
    152
    
    
    $
    92,127
    
    
    $
    
    
    
    $
    92,279Restricted cash
    
    
    
    
    
    
    3,635
    
    
    
    
    
    
    
    3,635Accounts receivable-trade, net
    
    
    12,577
    
    
    
    25,015
    
    
    
    
    
    
    
    37,592Accounts receivable-affiliates
    
    
    32,533
    
    
    
    (32,085
    )
    
    
    
    
    
    
    448Materials and supplies
    
    
    9,172
    
    
    
    (1
    )
    
    
    
    
    
    
    9,171Prepayments and other current assets
    
    
    2,805
    
    
    
    2,938
    
    
    
    
    
    
    
    5,743Total current assets
    
    
    57,239
    
    
    
    91,629
    
    
    
    
    
    
    
    148,868Investments
    
    
    
    
    
    
    398,198
    
    
    
    (398,198
    )
    
    
    Property, plant and equipment
    
    
    945,908
    
    
    
    98,639
    
    
    
    
    
    
    
    1,044,547Less: accumulated depreciation
    
    
    565,612
    
    
    
    48,341
    
    
    
    
    
    
    
    613,953Property, plant and equipment, net
    
    
    380,296
    
    
    
    50,298
    
    
    
    
    
    
    
    430,594Goodwill
    
    
    
    
    
    
    
    
    
    
    38,403
    
    
    
    38,403Intangible assets
    
    
    22,009
    
    
    
    
    
    
    
    
    
    
    
    22,009Debt issuance costs, net
    
    
    
    
    
    
    17,870
    
    
    
    
    
    
    
    17,870Deferred charges and other assets
    
    
    2,413
    
    
    
    6,131
    
    
    
    
    
    
    
    8,544Total assets
    
    $
    461,957
    
    
    $
    564,126
    
    
    $
    (359,795
    )
    
    $
    666,288Liabilities and Stockholders EquityCurrent liabilities:Current
portion of long-term obligations
    
    $
    518
    
    
    $
    1,776
    
    
    $
    
    
    
    $
    2,294Accounts payable-affiliates
    
    
    2,605
    
    
    
    1,299
    
    
    
    
    
    
    
    3,904Accounts payable, accrued and other current liabilities
    
    
    11,754
    
    
    
    25,450
    
    
    
    2,259
    
    
    
    39,463Income taxes payable
    
    
    3,593
    
    
    
    (3,593
    )
    
    
    
    
    
    
    Advance billings and customer deposits
    
    
    8,384
    
    
    
    3
    
    
    
    
    
    
    
    8,387Total current liabilities
    
    
    26,854
    
    
    
    24,935
    
    
    
    2,259
    
    
    
    54,048Long-term obligations, net of current portion
    
    
    4,386
    
    
    
    527,624
    
    
    
    
    
    
    
    532,010Deferred income taxes
    
    
    4,594
    
    
    
    (4,594
    )
    
    
    
    
    
    
    Other deferred credits and long-term liabilities
    
    
    66,329
    
    
    
    5,895
    
    
    
    (2,260
    )
    
    
    69,964Commitments and contingencies
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stockholders equity:Common stock
    
    
    2
    
    
    
    
    
    
    
    (2
    )
    
    
    Contributed capital
    
    
    491,240
    
    
    
    287,242
    
    
    
    (491,240
    )
    
    
    287,242Retained earnings (accumulated deficit)
    
    
    (131,448
    )
    
    
    (272,433
    )
    
    
    131,448
    
    
    
    (272,433
    )Accumulated other comprehensive loss
    
    
    
    
    
    
    (4,543
    )
    
    
    
    
    
    
    (4,543
    )Total stockholders equity
    
    
    359,794
    
    
    
    10,266
    
    
    
    (359,794
    )
    
    
    10,266Total liabilities and stockholders equity
    
    $
    461,957
    
    
    $
    564,126
    
    
    $
    (359,795
    )
    
    $
    666,288
 14




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##### Table of Contents



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




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  8.
    
    CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2004 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedOperating revenue:Local telephone
    
    $
    55,772
    
    
    $
    10
    
    
    $
    
    
    
    $
    55,782Wireless
    
    
    11,613
    
    
    
    
    
    
    
    (12
    )
    
    
    11,601Internet
    
    
    4,613
    
    
    
    
    
    
    
    
    
    
    
    4,613Interexchange
    
    
    3,858
    
    
    
    
    
    
    
    (449
    )
    
    
    3,409Other
    
    
    
    
    
    
    5,789
    
    
    
    (5,789
    )
    
    
    Total operating revenue
    
    
    75,856
    
    
    
    5,799
    
    
    
    (6,250
    )
    
    
    75,405Operating expense:Local telephone
    
    
    36,434
    
    
    
    1,134
    
    
    
    (5,044
    )
    
    
    32,524Wireless
    
    
    8,825
    
    
    
    
    
    
    
    (897
    )
    
    
    7,928Internet
    
    
    7,752
    
    
    
    
    
    
    
    (246
    )
    
    
    7,506Interexchange
    
    
    5,079
    
    
    
    
    
    
    
    (63
    )
    
    
    5,016Depreciation and amortization
    
    
    15,653
    
    
    
    3,453
    
    
    
    
    
    
    
    19,106Loss on disposal of assets
    
    
    197
    
    
    
    30
    
    
    
    
    
    
    
    227Total operating expense
    
    
    73,940
    
    
    
    4,617
    
    
    
    (6,250
    )
    
    
    72,307Operating income
    
    
    1,916
    
    
    
    1,182
    
    
    
    
    
    
    
    3,098Other income (expense):Interest expense
    
    
    (140
    )
    
    
    (11,308
    )
    
    
    
    
    
    
    (11,448
    )Interest income and other
    
    
    4
    
    
    
    (961
    )
    
    
    1,187
    
    
    
    230Total other income (expense)
    
    
    (136
    )
    
    
    (12,269
    )
    
    
    1,187
    
    
    
    (11,218
    )Income (loss) before income taxes
    
    
    1,780
    
    
    
    (11,087
    )
    
    
    1,187
    
    
    
    (8,120
    )Income tax expense (benefit)
    
    
    2,967
    
    
    
    (2,967
    )
    
    
    
    
    
    
    Net income (loss)
    
    $
    (1,187
    )
    
    $
    (8,120
    )
    
    $
    1,187
    
    
    $
    (8,120
    )
 16




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  8.
    
    CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2003 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedOperating revenue:Local telephone
    
    $
    54,001
    
    
    $
    
    
    
    $
    
    
    
    $
    54,001Wireless
    
    
    10,353
    
    
    
    
    
    
    
    (23
    )
    
    
    10,330Directory
    
    
    8,278
    
    
    
    
    
    
    
    
    
    
    
    8,278Internet
    
    
    7,156
    
    
    
    
    
    
    
    
    
    
    
    7,156Interexchange
    
    
    6,100
    
    
    
    
    
    
    
    (2,073
    )
    
    
    4,027Other
    
    
    
    
    
    
    6,321
    
    
    
    (6,321
    )
    
    
    Total operating revenue
    
    
    85,888
    
    
    
    6,321
    
    
    
    (8,417
    )
    
    
    83,792Operating expense:Local telephone
    
    
    32,387
    
    
    
    292
    
    
    
    (5,424
    )
    
    
    27,255Wireless
    
    
    8,483
    
    
    
    
    
    
    
    (1,573
    )
    
    
    6,910Directory
    
    
    3,527
    
    
    
    
    
    
    
    (78
    )
    
    
    3,449Internet
    
    
    11,677
    
    
    
    
    
    
    
    (1,063
    )
    
    
    10,614Interexchange
    
    
    5,888
    
    
    
    
    
    
    
    (270
    )
    
    
    5,618Other
    
    
    9
    
    
    
    
    
    
    
    (9
    )
    
    
    Depreciation and amortization
    
    
    19,104
    
    
    
    3,496
    
    
    
    
    
    
    
    22,600Loss on disposal of assets
    
    
    746
    
    
    
    
    
    
    
    
    
    
    
    746Total operating expense
    
    
    81,821
    
    
    
    3,788
    
    
    
    (8,417
    )
    
    
    77,192Operating income
    
    
    4,067
    
    
    
    2,533
    
    
    
    
    
    
    
    6,600Other income (expense):Interest expense
    
    
    (245
    )
    
    
    (12,442
    )
    
    
    
    
    
    
    (12,687
    )Interest income and other
    
    
    1
    
    
    
    (501
    )
    
    
    692
    
    
    
    192Total other expense
    
    
    (244
    )
    
    
    (12,943
    )
    
    
    692
    
    
    
    (12,495
    )Income (loss) before income taxes and
discontinued operations
    
    
    3,823
    
    
    
    (10,410
    )
    
    
    692
    
    
    
    (5,895
    )Income tax expense (benefit)
    
    
    4,463
    
    
    
    (4,463
    )
    
    
    
    
    
    
    Income (loss) from continuing operations
    
    
    (640
    )
    
    
    (5,947
    )
    
    
    692
    
    
    
    (5,895
    )Loss from discontinued operations, net
    
    
    (52
    )
    
    
    
    
    
    
    
    
    
    
    (52
    )Net income (loss)
    
    $
    (692
    )
    
    $
    (5,947
    )
    
    $
    692
    
    
    $
    (5,947
    )
 17




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ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  8.
    
    CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2004 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedNet cash provided (used) by operating activities
    
    $
    9,605
    
    
    $
    (3,922
    )
    
    $
    
    
    
    $
    5,683Cash Flows from Investing Activities:Construction and capital expenditures
    
    
    (9,335
    )
    
    
    (976
    )
    
    
    
    
    
    
    (10,311
    )Net cash used by investing activities
    
    
    (9,335
    )
    
    
    (976
    )
    
    
    
    
    
    
    (10,311
    )Cash Flows from Financing Activities:Payments on long-term debt
    
    
    (257
    )
    
    
    (571
    )
    
    
    
    
    
    
    (828
    )Dividends
    
    
    
    
    
    
    (63
    )
    
    
    
    
    
    
    (63
    )Net cash provided (used) by financing activities
    
    
    (257
    )
    
    
    (634
    )
    
    
    
    
    
    
    (891
    )Increase (decrease) in cash and cash equivalents
    
    
    13
    
    
    
    (5,532
    )
    
    
    
    
    
    
    (5,519
    )Cash and cash equivalents, beginning of the period
    
    
    139
    
    
    
    97,659
    
    
    
    
    
    
    
    97,798Cash and cash equivalents, end of the period
    
    $
    152
    
    
    $
    92,127
    
    
    $
    
    
    
    $
    92,279Supplemental Cash Flow Data:Interest paid
    
    $
    180
    
    
    $
    11,690
    
    
    $
    
    
    
    $
    11,870Income taxes paid
    
    $
    1,120
    
    
    $
    
    
    
    $
    
    
    
    $
    1,120
 18




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  8.
    
    CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (Continued) Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2003 Combined
    
    ACS Holdings
    
    
    
    
    
    ACS HoldingsSubsidiaries
    
    Parent Only
    
    Eliminations
    
    ConsolidatedNet cash provided (used) by operating activities
    
    $
    5,783
    
    
    $
    12,844
    
    
    $
    
    
    
    $
    18,627Cash Flows from Investing Activities:Construction and capital expenditures
    
    
    (5,355
    )
    
    
    (760
    )
    
    
    
    
    
    
    (6,115
    )Release of funds from escrow
    
    
    
    
    
    
    3,339
    
    
    
    
    
    
    
    3,339Placement of funds in restricted account
    
    
    
    
    
    
    (200
    )
    
    
    
    
    
    
    (200
    )Net cash provided (used) by investing activities
    
    
    (5,355
    )
    
    
    2,379
    
    
    
    
    
    
    
    (2,976
    )Cash Flows from Financing Activities:Payments on long-term debt
    
    
    (236
    )
    
    
    (80
    )
    
    
    
    
    
    
    (316
    )Dividends
    
    
    
    
    
    
    (418
    )
    
    
    
    
    
    
    (418
    )Net cash provided (used) by financing activities
    
    
    (236
    )
    
    
    (498
    )
    
    
    
    
    
    
    (734
    )Increase in cash and cash equivalents
    
    
    192
    
    
    
    14,725
    
    
    
    
    
    
    
    14,917Cash and cash equivalents, beginning of the period
    
    
    (73
    )
    
    
    18,638
    
    
    
    
    
    
    
    18,565Cash and cash equivalents, end of the period
    
    $
    119
    
    
    $
    33,363
    
    
    $
    
    
    
    $
    33,482Supplemental Cash Flow Data:Interest paid
    
    $
    259
    
    
    $
    8,142
    
    
    $
    
    
    
    $
    8,401Income taxes paid
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Supplemental Noncash Transactions:Property acquired under capital leases and mortgages
    
    $
    
    
    
    $
    2,340
    
    
    $
    
    
    
    $
    2,340Interest rate swap marked to market
    
    $
    
    
    
    $
    (1,662
    )
    
    $
    
    
    
    $
    (1,662
    )
 19




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##### Table of Contents



ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC.
Notes to Consolidated Financial Statements, Continued
(Unaudited, In Thousands Except Per Share Amounts)  9.
    
    COMMITMENTS AND CONTINGENCIES The Company is involved in various claims, legal actions and regulatory
proceedings arising in the ordinary course of business and has recorded
litigation reserves of $3,442 at March 31, 2004 against certain current claims
and legal actions. The Company believes that the disposition of these matters
will not have a material adverse effect on the Companys consolidated financial
position, results of operations or cash flows. A class action lawsuit was filed against the Company on March 14, 2001.
The litigation alleges various contract and statutory claims concerning the
Companys decision to terminate its Infinite Minutes long distance plan.
Although the Company believes this suit is without merit and intends to
vigorously defend its position, it is impossible to predict the outcome. The Company has disputes with Dobson Communications over reciprocal
payments and tower ownership. The Company cannot predict the outcome of these
disputes. On July 15, 2002 the Company fulfilled a commitment to Neptune
Communications, L.L.C. (Neptune) to provide a loan for the aggregate
principal amount of $15,000 in return for certain consideration. The Company
has an agreement that enables it to purchase additional fiber optic capacity in
future years from Neptune, the expenditures for which are expected to be
significant and may exceed $25,000 over the next four years. While the Company
has an agreement with Neptune, certain material terms of the agreement remain
subject to continued renegotiation. The significant provisions of this
agreement are: (i) purchase commitments by the Company for capacity in 2005 and
2007, the final price and quantity of which are subject to future events, (ii)
Neptunes restoration of the Companys traffic carried on another cable system,
(iii) and specific interconnection arrangements between the Company and
Neptune, should the Company exercise its option to purchase certain network
assets from Neptune. The Company is currently negotiating open elements of its
agreement with Neptune and renegotiating other terms and conditions of the
agreement. It is impossible to determine the ultimate outcome of these
negotiations at this time.  10.
    
    SUBSEQUENT EVENTS ACS Group filed preliminary registration statements with the Securities
and Exchange Commission on April 9, 2004 for a proposed initial public offering
of its Income Deposit Securities, a separate proposed offering of its senior
subordinated notes and the proposed reclassification of its existing common
stock into cash and shares of new class B common stock. An IDS is a unit
containing one share of new class A common stock of ACS Group and a fixed
principal amount of senior subordinated notes of ACS Group. The senior
subordinated notes to be sold in the separate offering will be identical to
those senior subordinated notes included in the IDSs. A majority of the shares
of class B common stock issued in the reclassification would be subject to a
mandatory exchange for IDSs within approximately 12 days following the offering
with the remaining shares of class B common stock issued in the
reclassification subject to a mandatory exchange for IDSs on the second
anniversary of the offering provided certain conditions are met. The completion
of the proposed offerings and reclassification is subject to a number of
conditions, including the approval of the reclassification by the holders of a
majority of ACS Groups outstanding existing common stock. ACS Group plans to
use the net proceeds of the proposed offerings, together with available cash,
to refinance certain outstanding indebtedness and to finance the cash portion
of the proposed reclassification of ACS Groups outstanding existing common
stock, including shares held by its majority shareholders, affiliates of Fox
Paine & Company, LLC. 20




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##### Table of Contents



Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS AND ANALYSTS REPORTS This Form 10-Q and future filings by the Company on Forms 10-K, 10-Q and
8-K and future oral and written statements by the Company and its management
may include, certain forward-looking statements as defined under the Private
Securities Litigation Reform Act of 1995, including (without limitation)
statements with respect to anticipated future operating and financial
performance, financial position and liquidity, growth opportunities and growth
rates, pricing plans, acquisition and divestitive opportunities, business
prospects, strategic alternatives, business strategies, regulatory and
competitive outlook, investment and expenditure plans, financing needs and
availability, and other similar forecasts and statements of expectation. Words
such as aims, anticipates, believes, could, estimates, expects,
hopes, intends, may, plans, projects, seeks, should, and will,
and variations of these words and similar expressions, are intended to identify
these forward-looking statements. These forward looking statements are subject
to certain risks and uncertainties that could cause actual results to differ
materially from the Companys historical experience and its present
expectations or projections.Forward-looking statements by the Company and its
management are based on estimates, projections, beliefs and assumptions of
management and are not guarantees of future performance. The Company disclaims
any obligation to update or revise any forward-looking statement based on the
occurrence of future events, the receipt of new information, or otherwise. Actual future performance, outcomes and results may differ materially from
those expressed in forward-looking statements made by the Company and its
management as a result of a number of important factors. Examples of these
factors include (without limitation)rapid technological developments and
changes in the telecommunications industries; ongoing deregulation (and the
resulting likelihood of significantly increased price and product/service
competition) in the telecommunications industry as a result of the
Telecommunications Act of 1996 (the 1996 Act) and other similar federal and
state legislation and the federal and state rules and regulations enacted
pursuant to that legislation; regulatory limitations on the Companys ability
to change its pricing for communications services; the possible future
unavailability of SFAS No. 71, Accounting for the Effects of Certain Types of
Regulation,to the Companys wireline subsidiaries; and possible changes in the
demand for the Companys products and services. In addition to these factors,
actual future performance, outcomes and results may differ materially because
of other, more general, factors including (without limitation) changes in
general industry and market conditions and growth rates; changes in interest
rates or other general national, regional or local economic conditions;
governmental and public policy changes; changes in accounting policies or
practices adopted voluntarily or as required by accounting principles generally
accepted in the United States of America; and the continued availability of
financing in the amounts, at the terms and on the conditions necessary to
support the Companys future business. Investors should also be aware that while the Company does, at various
times, communicate with securities analysts, it is against the Companys policy
to disclose to them any material non-public information or other confidential
information.Accordingly, investors should not assume that the Company agrees
with any statement or report issued by an analyst irrespective of the content
of the statement or report. To the extent that reports issued by securities
analysts contain any projections, forecasts or opinions, such reports are not
the responsibility of the Company. 21




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##### Table of Contents



INTRODUCTION The Company generates revenue primarily through:  
    
    the provision of local telephone services, including:  
    
    basic local service to retail customers within the Companys service areas,
    
    wholesale service to competitive local exchange carriers (CLECs),
    
    network access services to interexchange
carriers for origination and termination of interstate and
intrastate long distance phone calls,
    
    enhanced services,
    
    ancillary services, such as billing and collection, and
    
    universal service payments;  
    
    the provision of wireless services;
    
    the provision of Internet services; and
    
    the provision of interexchange network long-distance and data services. In addition, the Company provides video entertainment services through its
partnership with the satellite operator, DISH Network. Local Telephone The Company is the largest local exchange carrier
(LEC) in Alaska and the 13th largest in the United States. Basic local
service is generally provided at a flat monthly rate and allows the user to
place unlimited calls within a defined local calling area. Access revenues are
generated in part by billing interexchange carriers for access to the LECs
local network and its customers and in part by billing the local customers
themselves. Universal service revenues are a subsidy paid to rural LECs to
support the high cost of providing service in rural markets. Changes in revenue are largely attributable to changes in the number of
access lines, local service rates and minutes of use. Other factors can also
impact revenue, including:  
    
    intrastate and interstate revenue settlement methodologies,
    
    authorized rates of return for regulated services,
    
    whether an access line is used by a business or consumer subscriber,
    
    intrastate and interstate calling patterns,
    
    customers selection of various local rate plan options,
    
    selection of enhanced calling services, such as voice mail, and
    
    other subscriber usage characteristics. LECs have three basic tiers of customers:  
    
    consumer and business customers located in their
local service areas that pay for local phone service and a
portion of network access,
    
    interexchange carriers that pay for access to long
distance calling customers located within its local service
areas and
    
    CLECs that pay for wholesale access to the Companys
network in order to provide competitive local service on either
a wholesale or unbundled network element (UNE) basis as
prescribed under the 1996 Act. LECs provide access service to numerous interexchange carriers and may
also bill and collect long distance charges from interexchange carrier
customers on behalf of the interexchange carriers. The amount of access charge
revenue associated with a particular interexchange carrier varies depending
upon long distance calling patterns and the relative market share of each long
distance carrier. The Companys local service rates for end users are authorized by the RCA.
Authorized rates are set by the FCC and the RCA for interstate and intrastate
access charges, respectively, and may change from time to time. 22




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##### Table of Contents



Wireless- The Company is one of the largest statewide providers of
wireless services in Alaska, currently serving approximately 88,000
subscribers. Its wireless network covers over 480,000 residents, including all
major population centers and highway corridors. The Company operates a TDMA
digital network in substantially all of its service areas, and plans to upgrade
this network to a new generation of digital network known as CDMA 1xRTT over
the course of 2004. 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 42,000 customers in Alaska. The traffic from these
customers is carried over the Companys owned or leased facilities. Satellite
Television -The Company provides video entertainment services
on a resale basis through the Companys partnership with the satellite
provider, Dish Network. The Company entered into this agreement in August 2003. Critical Accounting Policies and Accounting Estimates Management is responsible for the financial statements presented elsewhere
in this 10-Q and has evaluated the accounting policies used in their
preparation.Management believes these policies to be reasonable and
appropriate. The Companys significant accounting policies are described in
Note 1 in the Notes to the Consolidated Financial Statements included in the
Companys Annual Report on Form 10-K for the year ended December 31, 2003. The
following discussion identifies those accounting policies that management
believes are critical in the preparation of the Companys financial statements,
the judgments and uncertainties affecting the application of those policies,
and the possibility that materially different amounts would be reported under
different conditions or using different assumptions. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of commitments and contingencies at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Among the significant estimates affecting
the financial statements are those related to the realizable value of accounts
receivable, long-lived assets, income taxes, network access revenue reserves
and litigation reserves. Actual results may differ from those estimates. 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
March 31, 2004 the Company had recorded liabilities of $13.1 million related to
its estimate of refundable access revenue. Actual results could vary from this
estimate. The Company utilizes the liability method of accounting for income taxes.
Under the liability method, deferred taxes reflect the temporary differences
between the financial and tax bases of assets and liabilities using the enacted
tax rates in effect in the years in which the differences are expected to
reverse.Deferred tax assets are reduced by a valuation allowance to the extent
that it is more likely than not that such deferred tax assets will not be
realized. The cumulative valuation allowance against deferred tax assets was
$97.5 million as of March 31, 2004. 23




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##### Table of Contents



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, 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 $21.9 million as of March 31, 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 $0.5 million at March 31, 2004.
If the Company were not following SFAS No. 71, it would have recorded
additional depreciation expense of $21.9 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 $51.7 million at March 31, 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 March 31, 2004 the
Company had recorded goodwill of $38.4 million applicable to its local
telephone and wireless segments. The Company is involved in various claims, legal actions and regulatory
proceedings arising in the ordinary course of business, and has recorded
litigation reserves of $3.4 million against certain claims and legal actions as
of March 31, 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. RESULTS OF OPERATIONS Three Months Ended March 31, 2004 Compared to Three Months Ended March 31,
2003 All amounts are discussed at the consolidated level after the elimination
of intercompany revenue and expense. Operating Revenue Operating revenue decreased $8.4 million, or 10.0%, for the three months
ended March 31, 2004 compared to the three months ended March 31, 2003. Local
telephone and wireless revenue increased compared to the corresponding period
of 2003, while Internet and interexchange revenue decreased compared to the
corresponding period of 2003. On May 8, 2003, the Company completed the sale of
a 24




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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 $8.3 million of revenues from this business for the
three months ended March 31, 2003. Local Telephone Local telephone revenue, which consists of local network service, network
access and deregulated and other revenue, increased $1.8 million, or 3.3%, for
the three months ended March 31, 2004 compared to the same period in 2003. The
following table summarizes the Companys consolidated local telephone revenue
by category: Three Months EndedMarch 31,2004
    
    2003(in thousands)Local telephone revenue:Local network service
    
    $
    22,753
    
    
    $
    24,129Network access
    
    
    27,695
    
    
    
    25,061Deregulated and other
    
    
    5,334
    
    
    
    4,811Total local telephone revenue
    
    $
    55,782
    
    
    $
    54,001
 The following table summarizes the Companys local telephone access lines: As of March 31,2004
    
    2003Local telephone access lines:Retail
    
    
    217,054
    
    
    
    231,832Wholesale
    
    
    20,066
    
    
    
    19,619Unbundled network elements  platform (UNE  P)
    
    
    5,177
    
    
    
    4,275Unbundled network elements  loop (UNE  L)
    
    
    69,622
    
    
    
    64,821Total local telephone access lines
    
    
    311,919
    
    
    
    320,547
 Local network service revenue decreased $1.4 million or 5.7% from the
prior year, while access lines in service decreased 2.7% to 311,919. The
decrease reflects the net effect of retail market share losses offset by
increases in unbundled network element revenue. Also contributing to the
decrease in local network service is a decrease in feature, directory
assistance and cellular access revenue. The Company experienced a loss of direct retail customers during the year
as customers cancelled second lines they were not using or switched to
competing service providers. This reduction in direct retail customers was
partially offset by an increase in wholesale lines. Generally, if a retail
local network service customer of the Company switches to a competitor, the
Company continues to provide the line to the competitor on a wholesale basis at
reduced revenue per line. Management believes that the continuing loss of
retail market share it has experienced in certain of its markets is partially
attributable to below cost interconnection rates mandated by the RCA for UNEs.
During the first quarter of 2000, the Company reopened interconnection
proceedings for its Anchorage market and during the second quarter of 2001
filed for an interim and refundable UNE rate increase of approximately $10 per
month per loop. On October 25, 2001, the RCA granted ACSA an interim UNE rate
increase of $1.07, bringing the UNE rate up from $13.85 to $14.92.The interim
and refundable 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. The
issue of a new interconnection agreement between ACSA and GCI is expected to be
adjudicated by the RCA during the second quarter of 2004. The Company cannot
predict what the outcome will be. On April 18, 2004, ACSF and ACSAK settled a dispute with GCI concerning
their claim to a rural exemption. As part of that agreement the parties also
agreed to new interconnection agreements between: 25




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(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 believed it was earning less than its authorized rate of
return for local network service in several of its markets and in compliance
with Alaska Public Utilities Commission (APUC) orders related to the approval
of the acquisition of the four LECs in 1999, filed local service rate cases for
all of its LEC businesses with the RCA on July 2, 2001 aimed at making up this
deficiency. 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 and refundable local
service rates in Anchorage in order to expedite a partial recovery of the 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 and
refundable 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. The RCA has scheduled rate hearings during December 2004. On March 25, 2003, the RCA issued an order approving new revenue
requirements for ACSF, ACSAK, and ACSN. The RCA found over earnings by ACSF and
ACSN and under earnings by ACSAK. In compliance with RCA orders, ACSF, ACSAK,
ACSN filed cost of service and rate design studies, and supporting testimony,
consistent with the RCA revenue requirements orders. A stipulated rate
settlement for ACSF, ACSAK and ACSN was approved by the RCA on April 8, 2004. Network access revenue increased $2.6 million to $27.7 million for the
three months ended March 31, 2004. The increase in network access revenue is
due to ongoing true-ups to prior years interstate access and universal service
fund studies. Network access revenue is based on a regulated return on rate
base and recovery of allowable expense associated with the origination and
termination of toll calls for the Companys retail and resale customers.
Management expects that network access revenue will decline as a component of
local telephone revenue for the foreseeable future. Deregulated and other revenue, which increased $0.5 million to $5.3
million for the three months ended March 31, 2004, consists principally of
billing and collection (B&C) services, space and power rents, deregulated
equipment sales, paystation revenue, regulated directory listing revenue, and
other miscellaneous telephone revenue. The increase in deregulated and other
revenue is due principally to an increase in B&C services. Wireless Wireless revenue increased $1.3 million, or 12.3%, to $11.6 million for
the three months ended March 31, 2004 compared to $10.3 million for the three
months ended March 31, 2003. This increase is due primarily to growth in
average subscribers of 6.4% from 82,223 for the three months ended March 31,
2003 to 87,504 for the three months ended March 31, 2004. The monthly average
revenue per unit, or ARPU, increased 5.5% from $41.88 for the three months
ended March 31, 2003 to $44.19 for the three months ended March 31, 2004
primarily as a result of increased minutes of use over calling plan allotments.
Subscriber average minutes of use increased from 191 minutes for the three
months ended March 31, 2003 to 225 minutes for the three months ended March 31,
2004. Internet Internet revenue decreased from $7.2 million, or 35.5%, for the three
months ended March 31, 2003 to $4.6 million for the three months ended March
31, 2004. This decrease is primarily due to the loss of $3.6 million in revenue
associated with the Companys contract with the State of Alaska which was
terminated in October 2003 offset by $1.0 million of revenue increases
primarily as a result of growth in DSL subscribers of 39.7% from 13,910 at
March 31, 2003 to 19,429 at March 31, 2004. 26




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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 from $4.0 million for the three months
ended March 31, 2003 to $3.4 million for the three months ended March 31, 2004.
Both intrastate and interstate revenue declined from the previous year. Long
distance subscribers decreased from 57,677 in 2003 to 42,053 in 2004, primarily
due to database grooming to remove approximately 20,000 non-revenue generating
inactive subscribers from the subscriber list in connection with the conversion
of long distance billing from an outside service bureau to an in-house system
during the first and second quarters of 2003. Also contributing to the decrease
was the termination of services to the State of Alaska, as discussed under
Internet above. Total minutes of use decreased from 37.8 million in 2003 to
32.1 million in 2004. The decline in minutes of use was due to increased
competition in the marketplace, and the popularity of discount long distance
calling cards. The Company expects the overall trend of declining minutes to
continue. Operating Expense Operating expense decreased $4.9 million, or 6.3%, from $77.2 million for
the three months ended March 31, 2003 to $72.3 million for the three months
ended March 31, 2004. Depreciation and amortization associated with the
operation of each of the Companys segments has been included in total
depreciation and amortization. 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 expenses from operations from the Directories Business after this
date, but had recorded $3.4 million of expenses from this business for the
three months ended March 31, 2003. Local Telephone The components of local telephone expense are plant specific operations,
plant non-specific operations, customer operations, corporate operations and
property and other operating tax expense.Local telephone expense increased to
$32.5 million for the three months ended March 31, 2004 from $27.3 million for
the three months ended March 31, 2003.The increase in local telephone expense
was primarily attributable to employee severance and recruiting costs and
consulting fees. Wireless Wireless expense increased $1.0 million, or 14.7%, for the three months
ended March 31, 2004 compared to the three months ended March 31, 2003. This
increase is due substantially to an increase in minutes of use from 47.2
million minutes in the three months ended March 31, 2003 to 59.1 million
minutes in the three months ended March 31, 2004 and an increase in cost of
goods sold for cell phones as the Company gained 974 subscribers for the three
months ended March 31, 2004 compared to 5 subscribers for three months ended
March 31, 2003. The Company also incurred costs associated with the planned
launch in selected regions of its CDMA 1x RTT and EVDO networks in May 2004. Internet Internet expense decreased by $3.1 million, or 29.3%, from $10.6 million
in 2003 to $7.5 million in 2004. The decrease in Internet expense was due
principally to the elimination of the operating costs associated with the
Companys contract with the State of Alaska. As discussed above, this contract
with the State of Alaska was terminated effective October 2003. 27




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Interexchange Interexchange expenses decreased by $0.6 million, or 10.7% to $5.0 million
for the three months ended March 31, 2004 compared to the three months ended
March 31, 2003. The majority of this decrease
was the result of the decline in long distance minutes of use as discussed
under interexchange service revenue above and is primarily attributable to the
loss of the contract with the State of Alaska. Depreciation and Amortization Depreciation and amortization expense decreased $3.5 million, or 15.5%, to
$19.1 million for the three months ended March 31, 2004 compared to the three
months ended March 31, 2003. The decrease in depreciation is due principally to
depreciation rate decreases ordered by the RCA for ACSA which the Company
adopted for the intrastate and local jurisdictions during the fourth quarter of
2003, retroactive to January 1, 2003. Loss on Disposal of Assets For the quarter ended March 31, 2004, the Company recorded non-cash losses
on disposal of assets of $0.2 million. The Company recorded non-cash losses on
disposal of certain wireless assets of $0.7 million during the quarter ended
March 31, 2003 as a result of retiring or otherwise disposing of non-regulated
assets which had not been fully recovered through depreciation expense. Interest Expense Interest expense decreased $1.2 million to $11.5 million for the three
months ended March 31, 2004 compared to $12.7 million for the three months
ended March 31, 2003. The Companys interest expense declined due to lower term
loan balances, market interest rate effects on the Companys variable interest
rate debt, and the early extinguishment of its interest rate swap contract
during the fourth quarter of 2003 partially offset by additional interest
expense in 2004 resulting from the $182 million aggregate principal amount of 9
7/8% senior unsecured notes due 2011 issued by the Company in August 2003. 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 three months ended March 31, 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 three months ended March 31, 2004 the
Companys cash flows from operating activities were $5.7 million. At March 31,
2004, the Company had approximately $94.8 million in net working capital, with
approximately $92.3 million represented by cash and cash equivalents. As of
March 31, 2004 the Company had $50.0 million of remaining capacity under its
revolving credit facility, representing 100% of available capacity. 28




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The Company has outstanding a $199.5 million bank credit agreement
(Senior Credit Facility), $150.0 million in 9.375% senior subordinated notes
due 2009 and $182.0 million in 9.875% senior notes due 2011 representing
substantially all of the Companys long-term debt of $534.3 million as of March
31, 2004. In addition, $17.3 million in senior discount debentures are recorded
at ACS Group and are
collateralized by substantially all assets of the Company. Interest on the
Companys senior subordinated notes, senior notes and ACS Groups senior
discount debentures 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, the senior unsecured notes and ACS Groups senior discount debentures
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. On July 15, 2002 the Company fulfilled a commitment to Neptune to provide
a loan for the aggregate principal amount of $15.0 million in return for
certain consideration. The Company has an agreement that enables it to purchase
additional fiber optic capacity in future years from Neptune, the expenditures
for which are expected to be significant and may exceed $25 million over the
next four years. While the Company has an agreement with Neptune, certain
material terms of the agreement remain subject to continued renegotiation. The
significant provisions of this agreement are: (i) purchase commitments by the
Company for capacity in 2005 and 2007, the final price and quantity of which
are subject to future events, (ii) Neptunes restoration of the Companys
traffic carried on another cable system, (iii) interconnection arrangements
between the Company and Neptune, should the Company exercise its option to
purchase certain network assets from Neptune. The Company is currently
negotiating open elements of its agreement with Neptune and renegotiating other
terms and conditions of the agreement. It is impossible to determine the
ultimate outcome of these negotiations at this time. The loan was written down
to zero, its estimated fair value, during the quarter ended September 30, 2003. The local telephone network requires the timely maintenance of plant and
infrastructure. The Companys historical capital expenditures have been
significant. The construction and geographic expansion of the Companys
wireless network has required significant capital. The implementation of the
Companys interexchange network and data services strategy is also capital
intensive. Capital expenditures for 2003 were $50.7 million, of which $11.5
million was expended on CDMA 1x RTT build out and $3.5 million was expended on
the TPA. The Company anticipates capital spending of between $50 million and
$55 million for 2004 and has spent $10.3 million in the first quarter of 2004.
The Company intends to fund its future capital expenditures with cash on hand,
through internally generated cash flows, and if necessary, through borrowings
under the revolving credit facility. The Companys capital requirements may change due to, among other things:
impacts of regulatory decisions that affect the Companys ability to recover
its investments, changes in technology, the effects of competition, changes in
the Companys business strategy, and the Companys decision to pursue specific
acquisition opportunities. The Company believes that it will have sufficient working capital provided
by operations and available borrowing capacity under the existing revolving
credit facility to service its debt and fund its operations, capital
expenditures and other obligations over the next 12 months.The Companys
ability to service its debt and fund its operations, capital expenditures and
other obligations will be dependent upon its future financial performance,
which is, in turn, subject to future economic conditions and to financial,
business, regulatory and other factors, many of which are beyond the Companys
control. ACS Group filed preliminary registration statements with the Securities
and Exchange Commission on April 9, 2004 for a proposed initial public offering
of its Income Deposit Securities, a separate proposed offering of its senior
subordinated notes and the proposed reclassification of its existing common
stock into cash and shares of new class B common stock. An IDS is a unit
containing one share of new class A common stock of ACS Group and a fixed
principal amount of senior subordinated notes of ACS Group. The senior
subordinated notes to be sold in the separate offering will be identical to
those senior subordinated notes included in the IDSs. A majority of the shares
of class B common stock issued in 29




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the reclassification would be subject to a
mandatory exchange for IDSs within approximately 12 days following the offering
with the remaining shares of class B common stock issued in the
reclassification subject to a mandatory exchange for IDSs on the second
anniversary of the offering provided certain conditions are met. The completion
of the proposed offerings and reclassification is subject to a number of
conditions, including the approval of the reclassification by the holders of a
majority of ACS Groups outstanding existing common stock. ACS Group plans to
use the net proceeds of the proposed offerings,
together with available cash, to refinance certain outstanding
indebtedness and to finance the cash portion of the proposed reclassification
of ACS Groups outstanding existing common stock, including shares held by its
majority shareholders, affiliates of Fox Paine & Company, LLC. Outlook The Company expects that, overall, the demand for telecommunications
services in Alaska will grow, particularly as a result of:  
    
    increasing demand for private network services by
government and business on a statewide basis on either a circuit
switched or IP basis,
    
    increasing demand for wireless voice and data
services, and
    
    growth in demand for DSL and Internet access services
due to higher business and consumer bandwidth needs. The Company believes that it will be able to capitalize on this demand
through its diverse service offerings on its owned circuit switched and IP
facilities, new sales and marketing initiatives directed toward basic voice,
enhanced and data services, and offering customers an integrated bundle of
telecommunications services including local telephone, wireless, Internet, long
distance, messaging and video entertainment. There are currently a number of regulatory proceedings underway at the
state and federal levels that could have a significant impact on the Companys
operations.The Company cannot predict with certainty the impact of current or
future regulatory developments on any of its businesses. The telecommunications industry is extremely competitive, and the Company
expects competition to intensify in the future. As an incumbent local exchange
carrier (ILEC), the Company faces competition mainly from resellers, local
providers who lease its UNEs and, to a lesser degree, from providers of local
telephone services over separate facilities. Moreover, while wireless telephone
services have historically complemented traditional LEC services, the Company
anticipates that existing and emerging wireless technologies may increasingly
compete with LEC services. Similarly, local and interexchange service
competition may come from cable television providers and voice over IP
providers. In wireless services, the Company currently competes with at least
one other wireless provider in each of its wireless service areas. In the
highly competitive business for Internet access services, the Company currently
competes with a number of established online service companies, interexchange
carriers and cable companies. In the interexchange market, the Company believes
it currently has less than 5% of total revenue in Alaska and faces competition
from the two major interexchange providers. The telecommunications industry is subject to continuous technological
change. The Company expects that new technological developments in the future
will generally serve to enhance its ability to provide service to its
customers.However, these developments may also increase competition or require
the Company to make significant capital investments to maintain its leadership
position in Alaska. Impact of Inflation The effect of inflation on the Companys financial results has not been
significant in the periods presented. 30




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has issued senior subordinated notes, 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. There have been no material changes to the Companys
outstanding debt instruments since December 31, 2003. 
 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. 31




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PART II OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS. A class action lawsuit was filed against the Company on March 14, 2001.
The litigation alleges various contract and statutory claims concerning the
Companys decision to terminate its Infinite Minutes long distance plan.A
trial is scheduled for September 2004. A class of approximately 24,000
plaintiffs is expected to be certified. The Company believes this suit to be
without merit and intends to maintain a vigorous defense. GCI filed a complaint against the Company with the FCC regarding various
service ordering and provisioning issues. The parties have negotiated a
resolution of this matter. The Company has ongoing disputes with Dobson Communications concerning
certain reciprocal requirements and the ownership of a tower. The Company
cannot predict when or how these matters will be resolved. The Company was named as a defendant in an action brought by Fireweed
Communications regarding its use of the Companys Eagles Nest communications
tower. The parties have settled the matter. With minor exceptions, retail rates for ACSF, ACSAK and ACSN were approved
by the RCA on April 8, 2004. A hearing to establish retail rates for ACSA is
scheduled for the fourth quarter of 2004. On April 18, 2004, ACSF and ACSAK settled a dispute with GCI concerning
their claim to a rural exemption and the RCA dismissed the rural exemption
proceeding. As part of that agreement the parties also agreed to new
interconnection agreements between: (1) ACSF and GCI and; (2) ACSAK and GCI.
The issue of a new interconnection agreement between ACSA and GCI is expected
to be resolved by the RCA during the second quarter of 2004. The Company is involved in various other claims, legal actions and
regulatory proceedings arising in the ordinary course of business.In the
opinion of management, the ultimate disposition of these matters will not have
a material adverse effect on the Companys consolidated financial position,
results of operations or cash flows. 32




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ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES. None. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 
 ITEM 5. OTHER INFORMATION. None. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits:  31.1
    
    Certification of Liane Pelletier, Chief Executive Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act if 2002.31.2
    
    Certification of David Wilson, Chief Financial Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act if 2002.32.1
    
    Certification of Liane Pelletier, Chief Executive Officer,
pursuant to 18 U.S.C. Section 1350, as adopted to Section 906 of the
Sarbanes-Oxley Act if 2002.32.2
    
    Certification of David Wilson, Chief Financial Officer,
pursuant to 18 U.S.C. Section 1350, as adopted to Section 906 of The
Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K: None. 33




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report on Form 10-Q to be signed on its behalf
by the undersigned, thereunto duly authorized. Date: May 12, 2004
    
    ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC./s/ Liane PelletierLiane PelletierChief Executive Officer,Chairman of the Board and President/s/ David WilsonDavid WilsonSenior Vice President andChief Financial Officer(Principal Accounting Officer)
 34