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AP&T CREATING OPPORTUNITIES

AP&T understands that opportunities do not float like clouds. They are firmly attached to individuals. The opportunities that surround us every day reside and resonate within social, economic and geographical circles of people. Robert S. Grimm, President - CEO AP&T To create opportunity requires an alignment of resources with the strategies most suited to goals and strengths. Those with good ideas and information tend to congregate, thereby achieving greater success. This is what we endeavor to do every day with each other, within our industry and externally with our peers. As employee-owners we are proud of what we have accomplished in 2012, and foster a “grounded” confidence in our ability to create opportunities for continued success in the years ahead.

Notice To Stockholders: The annual meeting will be held on Wednesday, May 22nd, 2013, 10:00am PSTD at NW Maritime Center, 431 Water Street, Port Townsend, Washington; with the Board of Directors Meeting following. This annual report was produced by: Mark McCready, Scott Stenehjem, Jessie Stenehjem and Sandy Hershelman Photo Credits: Mark McCready, David Pflaum, Executive Photos, Rick Dahms, Thomas Mills and Perce Dis Disclaimer: The narrative descriptions of the Company’s activities within this annual report contain certain forward-looking statements that involve risks and uncertainties. When used in this annual report, the words “anticipates,” “believes,” “estimates,” “expects,” and similar expressions are intended to identify such forward-looking statements. The Company’s actual results, performance or achievements could differ materially from the results expressed in or implied by these forward-looking statements. Regarding AP&T Stock: For information regarding the acquisition or sale of AP&T stock, please contact: Darrel A. Patrick Cutter & Company 6450 Poe Ave. Suite 510 Dayton, OH 45414 1-937-890-5093 Toll Free 888-586-9288 dpatrick@cutter-co.com www.cutter-co.com Member SIPC


CONTENTS

AP&T BOARD OF DIRECTORS

2-3

CHAIRMANS MESSAGE

4-5

PRESIDENTS MESSAGE

6-9

ENERGY OPERATIONS

11 - 15

TELECOM OPERATIONS

16 - 21

SAMN NETWORK

20

BROADBAND OPERATIONS

21

AP&T SERVICE AREAS

22 - 23

ANNUAL FINANCE REPORT

24 - 27

FIVE YEAR SUMMARY AUDITORS REPORT STOCKHOLDERS NOTICE

28 - 29

30 - 55 Inside Back Cover

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AP&T BOARD OF DIRECTORS

“To Create Opportunity one must first identify need, apply a fresh coat of vision, and then aggregate the resources necessary to achieve success.” Robert S. Grimm, President - CEO AP&T

Of late, many businesses have found themselves struggling to find ways to sustain themselves while mired in a sluggish regional and national economy. The notion of growth is often relegated to the back burner as the challenge of making payroll or deciding how to operate leaner takes center stage.  It can fuel a loss of vision and direction as the emphasis shifts from thrive, to survive.    A broader view of the present economic and political landscapes hint that these challenges may persist as the new business norm.  Thus, a businesses’ ability to Create Opportunity, becomes a key component in the equation for continued success.

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AP&T BOARD OF DIRECTORS

Robert S. Grimm President CEO AP&T Mark A. Foster P.E. Principal Mark A. Foster & Associates

William A. Squires JD Chairman of the Board, AP&T CEO Blackfoot Telephone Cooperative

Mike Barry Independent Director

Tom Ervin VP GM AP&T Telecom Operations and Engineering

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WILLIAM A SQUIRES - AP&T CHAIRMAN OF THE BOARD

“A pessimist sees the difficulty in every opportunity; an optimist sees an opportunity in every difficulty.” -Winston Churchill

As our energy generation and sales remained flat in 2012—and the entire regulatory paradigm of the telecom industry was turned upside down— AP&T remained, and remains today, optimistic about the future. In these difficulties, we see opportunity. Significant efficiency gains in line loss and operations contributed to maintaining shareholder value in our power operations, despite a lagging market. The Company continues to explore and promote new opportunities in energy development. Management is actively pursuing liquefied natural gas and compressed natural gas opportunities, coal production, and new hydro projects. A very important facet to new development is the creation of new market opportunities. The Company plays an active role in promoting new opportunities in the State of Alaska, through participation in strong organizations, such as the SE Conference, Alaska Independent Power Producers Association, and the Alaska Marine Trades Association, to name a few. Biomass, of course, remains an active pursuit. It allows the ability to create jobs in the forest products industry, while providing good stewardship of our natural resources. Opportunities for economic development, and the resulting growth of energy demand, are abundant. If certain opportunities are not readily apparent, AP&T is working hard to bring them to life.

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AP&T CHAIRMAN’S MESSAGE The telecommunications industry is in a state of rebirth—and AP&T is well ahead of the curve. Having seen both the looming pressures on traditional revenue streams and the insatiable appetite for broadband, AP&T seized the opportunity to build the Southeast Alaska Microwave Network (SAMN). This investment continues to thrive and bear fruit for our shareholders. In 2012, additional radio upgrades were completed to accommodate growth. Additional network paths and facilities were engineered and readied for the upcoming construction season. AP&T continues to see opportunities to leverage SAMN to create additional value for our customers and our shareholders. During 2012, the AP&T Board of Directors challenged the Company’s management to dive deep into our operations in an effort to not only mine efficiencies, but to create opportunities for growth. I am proud of the job our management team and employees did in this regard. They have endeavored to imagine and develop new opportunities for our future that will continue to create shareholder value for years to come. We began to see the positive impacts of those labors in 2012, and into 2013.

“AP&T continues to see opportunities to leverage SAMN to create additional value for our customers and our shareholders.” Bill Squires Chairman of the Board AP&T

Creating its own opportunities puts AP&T in control of its own destiny. That is a favorable position to be in. As Milton Berle said, “If opportunity doesn’t knock, build a door.” AP&T is very busy building doors.

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ROBERT S GRIMM - AP&T PRESIDENT - CEO Creating Opportunity

It’s been said, “Opportunity is missed by most people because it is dressed in overalls and looks like work” ...through Results

In a year of financial uncertainty, the solid performance of AP&T during fiscal 2012 was a testament to the resolve of our employee-owners, who donned the overalls of opportunity to implement operational efficiencies and reduce problematic line loss, thereby minimizing the impacts of an economy still struggling to hit its stride. While gross revenues and operating income remained stable at $41.7 million and $9.1 million, respectively, earnings per share rose 8.4% to $2.41; net income improved 2.6% to $3.4 million. ...through Perseverance Although total sales of our energy business segment decreased 1.8%, in 2012, to 65.5Gwh, our renewable hydroelectric generation provided 74% of kilowatts sold—an increase of 3.5% over the previous year and a 3.7% increase over the five-year average. The upside to this equation is increased hydro production comes with a reduced cost of power. When coupled with a 1.7% reduction in operating expenses, the downside impact is diminished, resulting in operating income of $4.9 million for 2012. Significant progress has been made toward the goal of relegating high-cost diesel generation to a back-up role. However, seasonal weather fluctuations and capacity peaking still 6


AP&T PRESIDENT’S MESSAGE result in the use of supplemental diesel generation company-wide. Our Interior Division continues to be solely reliant on diesel generation, which creates further hardship and a barrier to economic growth for the rural Alaskan communities feeling the brunt of the extended economic downturn. The challenge is to identify a viable, affordable and sustainable solution. To that end, several years of studies have moved us closer to our goal, but have yet to yield a winning combination from both a technical and financial standpoint. Generation sources under review include, but are not limited to, hydropower, wind, liquefied natural gas, biomass and solar. We remain cautiously optimistic that the maturation of promising renewable technologies may provide an opportunity to increase our regulated investment in that area, while preserving our existing generation plant as standby and backup. However, hydropower remains the foundation of our renewable-energy portfolio. ...through Innovation With technology permeating every corner of business and society, AP&T has been quick to position, promote and capitalize on the capabilities of its Southeast Alaska Microwave Network (SAMN). It has taken less than five years for the network to secure its role as a vital and strategic industry asset. Recently, an earthquake near Wrangell, Alaska, triggered an undersea slide and severed a competitor’s fiber transport cable. AP&T was able to re-route the crippled carrier’s traffic within 12 hours of the event.

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AP&T CEO - PRESIDENT’S MESSAGE This was an incredible feat, under the best of circumstances—and testament to the resiliency of the network and resolve of our employee-owner technicians. Building on this cornerstone of opportunity, 2013 upgrades planned for our SAMN’s existing 600Mb capacity will allow for greater flexibility in market-driven strategies and pricing. An outgrowth of this investment has been the ability to penetrate the small-business market with customized business data solutions. Our broadband team scored big wins by capitalizing on the prevalence of maritime traffic in SE Alaska, as well as the desire of leisure travellers and working merchant marine tradesmen to stay connected, while sailing the Inside Passage. Similar upgrades were a key component in AP&T’s ability to offer customized data solutions for the education sector, as well. New challenges present us with the ability to create new opportunities: as 2013 progresses, these opportunities will shape AP&T’s future. ...through Collaboration and Leadership A relative bright spot on the horizon of opportunity in our service areas is an uptick in strategic mineral resource exploration. Primarily driven by the needs of the tech and military sectors, this increase in resource-based activity may lead to additional growth opportunities for Alaska’s renewable energy resources. By working closely with regional business organizations, industry partners and research organizations (such as the Alaska Center for Energy and Power), AP&T shares a larger vision of

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AP&T CEO - PRESIDENT’S MESSAGE what is possible for the future of Alaska’s vast untapped energy resources. We see an Alaska full of opportunities yet to be created for those willing to expand their vision beyond the border marked “status quo.” I am proud to be heading up such a talented team at AP&T. We believe we have outstanding future growth prospects. We’re intensely focused on delivering long-term value for our shareholders via strategic assets, such as our SAMN infrastructure, and continued development of sustainable energy technologies designed to provide affordable, clean and reliable power for our customers. By creating and seizing the opportunities best suited to our strengths, AP&T will continue to deliver strong results for years to come. We thank you for your continued support of AP&T.

Robert S. Grimm President - CEO

Alaska Power & Telephone Company

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AP&T OPERATIONS

CREATING OPPORTUNITY The year 2012 represented Alaska Power & Telephone Company’s 55th year of progressive service, innovation and leadership in the Alaskan utility industry. It is a benchmark born of vision, fostered by innovation, and nurtured by creativity and perseverance. At 55 years “young,” we enjoy the benefit of hindsight, while realizing who we are is what we do now—and how we do it. The theme of this year’s annual report, Creating Opportunity, follows a desire to convey AP&T’s approach, not simply viewed from a single year in time, but from an extended vantage, as well. An annual report is basically the interpretation of the immediate past to project how it will affect the future. With that in mind, 2012 set the table for 2013 and beyond: steady progress toward operational and financial goals will help ensure our long-term stability and prosperity.

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Photo: Big Salt inlet, at the mouth of Black Bear Creek, Prince of Wales Island, Alaska.


GREG MICKELSON, AP&T -VP POWER OPERATIONS

ENERGY OPERATIONS Powering Opportunities For the Alaska Power Company, 2012 was a year of perseverance and incremental progress. It was a challenging journey marked by a decline in revenues and an increase in our customers’ conservation efforts. Factors driving the 3% downturn in sales underscore the need for continued development of affordable, sustainable, clean energy in rural Alaskan communities. A bitterly cold winter and high heating oil costs combined to push customers, in the Tok Area and Upper Lynn Canal, toward an increased use of electricity for heating. Sadly, in many cases, it was also a hardlearned lesson in the need for adequate home and business weatherization. It did, however, create the opportunity to deepen the ongoing dialogue and support of customers and local business leaders, regarding APC’s efforts to expand our renewable energy capabilities, most notably in our interior division.

Photo: Greg Mickelson, AP&T - VP Power Operations. Doug Bennett displays new energy efficient LED street lighting.

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AP&T ENERGY OPERATIONS Interior Division A 4.4% decrease in 2012 sales can be attributed to the high cost of energy in Tok, along with the elimination of APC’s Tok Alcan Border Station generation. This has prompted some customers to install supplemental generation, such as solar arrays, in an attempt to help offset costs. A pilot program at the Tok School, using a wood-fired boiler to generate heat and electricity via steam-turbine, has had limited success so far. Despite the complex nature of developing a viable and affordable broad-based alternative to fossil-fuel generation in the Tok Area, APC has demonstrated a willingness to turn over every stone in search of a long-term solution that is “right” for both our customers and our company. The extent of our detailed feasibility studies involving hydro, wind, biomass, liquefied natural gas, solar—and combinations of the aforementioned with solar—emphasize our resolve for implementing a quality energy solution for the area’s needs. We’d like to acknowledge the extraordinary efforts of our line crews, from all locations, in responding to a freakish micro-burst of 70mph winds off the slopes of the Alaska Range. On Monday, September 17,. several homes, in the communities of Tanacross and Dot Lake, as well as the Tanacross School, suffered roof damage. Images of the aftermath showed a mile-wide swath, where trees had been uprooted, broken, or had simply been laid-over, “combed” like hair. Despite the extent of the damage, crews had the majority of the system restored by Wednesday evening; traveling crews returned home by the weekend. The manner in which our personnel pulled together to respond exemplifies the dedication of our employee-owners and the Alaskan Spirit. 12

Photo: Generation technician Aaron Tawney, Tok, Alaska.


AP&T ENERGY OPERATIONS Upper Lynn Canal Generation and sales in the Haines and Skagway region continued to trend downward in 2012, ending the year -2% and -3%, respectively. Conservation, along with a cooler summer, reduced the need for power associated with seasonal cooling in commercial businesses. Record regional snowfalls (more than 360 inches) kept crews busy. A cold spring meant delays in the turn-up of the Kasidaya Creek hydro facility. The dangerous work of penstock refurbishment on one of Alaska’s longest running hydro plants was completed on the Dewey Lakes site. Kudos to Jim Shunn and his crew for completing this job with no injuries. Efforts to move the Connelly Lake project forward continue to be met with resistance at the local level, producing concern that it may take a catastrophic event, similar to the undersea cable break this year in Wrangell, to shift public sentiment in favor of the project. In the meantime, efforts are underway to determine the best options for additional back-up generation in the Haines location. The possibility for increased loads, as a result of an expansion of infrastructure at the Skagway ore terminal, is a bright spot in the region. APC is positioning itself to play an integral part, as mineral exploration and recovery take center stage as one of Southeast Alaska’s most promising economic engines for our communities.

Photo: Vern Neitzer, Winter at Kasidaya Falls. Lance Caldwell installs new LED roadway lighting in downtown Skagway, Alaska

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AP&T ENERGY OPERATIONS Prince of Wales Island Region

A good summer of rainfall may be a bit of an oxymoron in most people’s vocabularies, but it was the very thing that helped our POW division finish the year with generation totals equaling those produced in 2011. Our South Fork hydro facility generated a monthly total of more than one million kilowatt-hours for the first time ever in the month of June. The resulting 8% combined increase in power generation, at the Black Bear Lake and South Fork hydro facilities, yielded a 43.9% reduction in diesel fuel purchases for the year. Supplementing that good news was an increased customer count, plus word the community of Coffman Cove had been awarded a grant to extend our power system to an additional 120 lots east of town. The ongoing three-year road project, connecting the north island communities of Naukati and Coffman Cove with the existing primary island road system, is creating an opportunity for APC. The goal is to not simply displace existing diesel generation in these communities (via extension of our Renewable Energy Grid), but also reduce energy rates, providing fuel for economic growth. At the southern end of the island, progress continues in our work with the Haida Corporation on the 5 MW Reynolds Creek hydroelectric project. We remain cautiously optimistic the project can be completed by 2016. With focused resolve from all parties, this project will become yet another reliable keystone of long-term renewable energy and economic stability for Prince of Wales Island. Other encouraging economic news was the detection of highly sought after, rare-earth minerals on POW

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Photo: A Coffman Cove welcome. City Administrator Misty Fitzpatrick with AP&T’s line supervisor Barry Heatley, Wade Adamson, Doug Bennett and Matt Steffen.


AP&T ENERGY OPERATIONS Island. Limited availability and increasing need, driven by the technology and military sectors, may push ground operations along on a fast track. Mining is a very energy intensive business, so we are keeping a very close eye on these developments. In a similar vein, we continued to mine the day-to-day opportunities that created mutually beneficial outcomes. A prime example: negotiations with Alaska Marine Lines, which netted a contract to power 100-plus shipping containers full of frozen fish, as they awaited weekly transport during the season. This added approx 500kw peak load to the system, equaling about 75,000kwhs by season’s end. AML got cold fish and clean affordable power, while avoiding the headache and costs associated with the operation and maintenance of onsite generation. And it’s no fish story that similar negotiations are also underway, with another fish processor, to convert 1200kw of onsite diesel driven compressors, powering blast freezers, to APC’s clean energy island power grid in 2013. Another priority moving forward is to achieve constructive outcomes in our various rate case proceedings. Although no one likes to pay more for anything, APC needs to adequately and fairly recover the capital investment costs of our operations and attempt to minimize our exposure to downside risk. I’d say 55 years is a pretty good run, but we’ve plenty of ground yet to cover. You can be sure, in the years ahead, APC will focus our perspective toward every chance to create opportunity and drive economic growth, as we continue doing business in a way that’s good for people, the planet and our shareholders. Photo: AP&T’s South Fork hydroelectric project on Prince of Wales Island.

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MICHAEL GARRETT - AP&T COO-VP TELECOM OPERATIONS

Creating Opportunity Connects Us To Our Future For AP&T’s regulated non-regulated business segments and the industry as a whole, 2012 was a year of continued momentum. Such a dynamic environment creates great opportunity, yet requires an intense commitment to innovation, evaluation and a focus on continuous improvement. How can we improve the lives of our customers? How can our resources help local businesses become more efficient? The resources and infrastructure of AP&T’s networks provide a platform for answering these questions, while creating growth opportunities for our company and those whom we serve.

Regulated Telecom Tok Area

The geography and climate in which we operate make AP&T unique among the nation’s telecommunications providers. Extended stretches of sub-zero weather in our Tok location makes planning critical and timing even more so. With a narrower window of outdoor project construction time than other locations, Tok telecom crews fought both the 2012 calendar and manpower issues to accomplish the best laid of plans. Despite these challenges, telecom personnel completed the majority of a 7000-foot right-of-way cable project, requiring extensive brushing and multiple pole re-alignments. Several powering, timing and switching issues were resolved both in the Tok Central Office and in outlying

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Photo: AP&T COO - VP Telecom, Michael Garrett. SAMN Network tower overlooking Kasaan Bay on Prince of Wales Island.


AP&T TELECOM OPERATIONS service areas, such as Jim River and Allakaket. Travelling to Eagle, technicians completed the installation of a new satellite dish, providing greater, more cost-effective internet transport than was previously available.

Haines / Skagway

In preparation for the seasonal flood of visitors and requests for service, Skagway personnel dispatched the old Mitel Central Office switch, while reconfiguring and upgrading both hard and soft components around the new Occam switching equipment. Several T1 transport links were provided to cell providers, cabling between 8th and 13th streets was upgraded. Placement of fiber, between the Dyea SAMN tower and Skagway tower, will provide greater economy of scale and cleaner delivery of transport services to ACS, GCI and AT&T at this site. Beginning the year with record snowfall led to some unexpected maintenance problems for Haines technicians when City and State road crews were unable to see markers and inadvertently sheared off ground-based cable terminations. Taller markers in the 2013 budget‌check. Crews completed splicing fiber to 26 mile and piggybacked Hatteras equipment (equipment used to bond pairs of copper to increase data capacity) to the balance of copper cable out to 39 mile. This provides AP&T the ability to offer Metro Ethernet service, as a transport solution, up the valley to the Canadian border. Kudos to Haines technician Dan Hanson for the 2012 in-house training and on-site support he provided several of our exchanges. Well done, Dan! Photo: AP&T’s Tom Cochran, Skagway. Central Office Technician, Dan Hanson, Haines.

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AP&T TELECOM OPERATIONS Petersburg / Wrangell A Central Office reconfiguration/migration were the centerpiece of the 2012 work accomplished by the Petersburg crew. New Adtran equipment to facilitate delivery of our converged voice services was installed. Customers continue to be migrated from line equipment, behind the GENBAND switch, to the Occam Broadband Loop Carrier, enhancing delivery of next generation IP-based services. Also in the queue of work accomplished was the incremental, ongoing, multi-year installation of a fiber network for the city of Petersburg. Riding the city’s upgraded fiber loop is a new E911 emergency public safety answering point. Its installation kept our techs at the top of their game, both technically and tactfully, as coordination with the manufacturer and public safety personnel became a textbook exercise in Public Relations 101. Similarly, Wrangell personnel spent much of the year involved in an extensive downtown revitalization project that involved a nearly complete re-cabling of the core business district. This proved to be a good deal of work for crew their size. Brent Akers took on the responsibility of leading both Petersburg and Wrangell in 2012 which will be quite a challenge but necessary as we do what we can to be more efficient with resources.

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Photo: Brent Akers, Manager Petersburg Exchange. AP&T Customer Service Team Rhoda Gilbert, Jackie Westcott and Theresa Vick, Petersburg. Creating Opportunities to better connect in Wrangell are telecom technicians Paul Loftus and Lucas Shilts.


AP&T TELECOM OPERATIONS Prince of Wales Island / Metlakatla An optimist will tell you the glass is half full; a pessimist, the glass is half empty. The fiber tech will tell you the ’glass just needs to be spliced. On Prince of Wales Island, 2012 was indeed the year of fiber. First quarter included a re-work of the fiber to Hollis and Hydaburg, as well as placing them into a ring configuration. Second quarter saw additional AP&T personnel on island to assist in the extremely large undertaking of consolidating and terminating five outside plant fiber cables into the fiber frame at the Klawock SAMN hut. Looking ahead: once all Synchronous Optical Network Equipment (SONET) is in place, a redundant high-speed path for voice and data traffic, on and off the island, will reduce the present choke-points now limiting service. At the outset of 2012, our Metlakatla crew’s focus wasn’t on fiber, but on copper; soaring metal prices made our cable an enticing target for thieves. Beyond the rocky start, it was a productive year on Annette Island. Techs completed Central Office upgrade work and shifted focus back to fiber, with the installation of a Passive Optical Network (PON) to a new housing subdivision. Several commercial entrance cabling and terminal projects were accomplished, along with the placement of underground conduit to the island’s new ferry terminal.

Photo: John Moots, Prince of Wales Island, marked his 30th year with AP&T in 2012. SAMN Network infrastructure.

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AP&T TELECOM OPERATIONS Non-Regulated Activities Southeast Alaska Microwave Network

The 2012 customer is not the same person, who looked to AP&T to provide telecom and Internet services in 2006, when we began construction on the SAMN project. Today’s customers want to be able to access mobile content on any screen—TV, personal computer, tablet or cell phone—wherever and whenever it’s convenient for them. As the demand for mobile data grows, so does the need for transport. AP&T’s SAMN is uniquely positioned in the Alaska market to capitalize on the explosive growth in the demand for transport of mobile data services, now and well into the future. Plans to increase 2013 network capacity to 1050Mb and extend its reach are well underway. (See Service Area Map) As a carrier’s carrier, the network’s strategic capabilities were put on full display, when an earthquake near Craig, Alaska, caused GCI to lose all connectivity to Wrangell, Alaska. Crews worked feverishly to provide a redundant path and restore GCI’s connectivity, within 12 hours of the initial contact. The strategic regional value the network brings to wireless carriers has not been overlooked either. SAMN provides a far-reaching footprint, from which new and existing carriers may expand their reach into established and emerging markets. In order to support the burgeoning and complex logistics associated with the maintenance and expansion of the SAMN network, in 2012, our Ketchikan crew moved into new facilities. The expanded warehouse and office space also accommodates room for carrier transport co-location and will allow for more efficient and productive pre-site assembly of SAMN components.

High Capacity Internet

One of the most productive conduits for creating opportunity and driving revenue is the sale of High Capacity Internet. It is a touchpoint, where business, government and education intersect with our empowering technology, to share new ideas, stimulate commerce, solve problems, and enhance our lives in exciting new ways. One catalyst driving the impressive 2012 growth in non regulated revenue was the aggressive addition of E-rate accounts to educational facilities within our exchanges. Bryant Smith’s ability to procure multi-year 20

Photo: Creating Opportunities to grow our Network and build their community, Alaska Telephone Wireless employee-owners dedicated their new Ketchikan office and SAMN Network logistics facility in 2012. Dave Pflaum, ATW Technician, Ketchikan.


AP&T TELECOM OPERATIONS contracts, in both the educational and private business sectors, is to be commended. Creating opportunity in yet another market segment: AP&T gained a foothold with maritime travelers to the Inside Passage, as a deal was struck with MTN Satellite Communications to offer Internet services to cruise passengers, during the May to September sailing season.

Broadband

A snapshot of 2012 Broadband activity shows a total of 3,136 subscribers, with 17.5% opting to utilize the higher-speed 4Mb and 8Mb service tiers. This represents a 39% increase in top-tier subscribers over 2011.

As noted throughout this report, creating opportunity requires investment. At its core, the strength of AP&T’s network has centered on investing capital, aligned with the growth of our industry, trends driving the region and our strategic planning. We are leveraging our investment in the SAMN to maximize opportunities as the center of gravity in the data market shift toward mobility. We anticipate upgrades and expansion of our SAMN investment will facilitate additional competitive initiatives to our broadband products in 2013. Leading the list of key structural accomplishments, underpinning AP&T’s extremely successful year, were several local loop upgrades to fiber-fed Occam Broadband Carrier equipment throughout the company. Additionally the deployment of technology, enabling synchronous Ethernet over existing copper plant, provided improved high-speed services to local businesses, bolstering our market position. Our 2012 results reflect our fundamental financial strategies, our commitment to growing shareholder value and our success in creating and seizing opportunities in key strategic areas of growth.

Photo: Bryant Smith, ATW’s Director of Internet Services. Tim Montgomery, Local Area Network Technician, Ketchikan, AK

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SKAGWAY 1957 • • TOK 1960 • • CRAIG 1962 • • PORT TOWNSEND (Corporate) 1964 • HYDABURG 1965 • TANACROSS 1973 DOT LAKE 1978 TETLIN 1986 HOLLIS 1990 BETTLES & EVANSVILLE 1991 • DRY CREEK 1991 CHISTOCHINA 1991 NAUKATI 1992 WHALE PASS 1992 MENTASTA LAKE 1992 MEYERS CHUCK 1992 COFFMAN COVE 1992 • EDNA BAY 1993 JIM RIVER CAMP 1993 EAGLE & EAGLE VILLAGE 1993 • HEALY LAKE 1994 NORTHWAY & NORTHWAY VILLAGE 1995 ALATNA & ALLAKAKET 1995 CHISANA 1996 HAINES (TEL 2000) 1997 • • KETCHIKAN 1997 • • METLAKATLA (TEL 2000) 1997 • • PETERSBURG (TEL 2000) 1997 • • WRANGELL (TEL 2000) 1997 • • THORNE BAY 1998 • KLAWOCK 1999 • • HYDER 2000 KLUKWAN 2000 ANCHORAGE 2000 • KASAAN 2001 • SLANA 2005 LUTAK 2007

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POWER

TELECOM

WIRELESS

SERVICE CENTER

DATE OF SERVICE

AP&T SERVICE AREA MAP

• • • • • • • • • • • • •

• • • • • •

• •

DELTA JUNCTION

EAGLE

HEALY LAKE DOT LAKE

DRY CREEK

TOK

TANACROSS

• • • • • • • • • • • • • • • • • • • • • • •

FAIRBANKS

• •

• • • •

NORTHWAY

Fiber Interconnect with Copper Val-

MENTASTA SLANA

TETLIN BORDER

CHISTOCHINA

PALMER VALDEZ


AP&T SERVICE AREA MAP SKAGWAY KLUKWAN

MICROWAVE MICROWAVE TOWER

HAINES

FIBER OPTIC FUTURE NETWORK Endicott Mtn

AP&T NON SERVICE LOCATIONS

Auke Mtn

GUSTAVUS

JUNEAU

AP&T SERVICE LOCATIONS

Taku FM Site

BROADBAND - Up to 1Mb

Taku Mtn

HOONAH

BROADBAND - Up to 4Mb

PORTAGE

BROADBAND - Up to 8Mb

TENAKEE

PELICAN

Dry Mtn Moore Mtn

Catherine Island

SITKA Turn Mtn

COSMOS

KAKE

PETERSBURG

Lindenburg Peak

BETTLES & EVANSVILLE

Crystal Mtn

WRANGELL

ALATNA & ALLAKAKET WHALE PASS

HYDER

Burnette Peak

COFFMAN COVE MEYERS CHUCK

EDNA BAY

Kassan Mtn

KLAWOCK

KETCHIKAN

NAUKATI CRAIG

HOLLIS

High Mtn

HYDABURG

METLAKATLA KASAAN THORNE BAY

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CHAD HAGGAR - AP&T VP-CFO TREASURER

Company Overview Alaska Power & Telephone Company was established in 1957 and through its’ subsidiaries, provides regulated electric and telephone service to a combined total of 34 communities. AP&T also has non-regulated operations which include the operation of a microwave communication network as well as offering internet, broadband, long distance and engineering services. Measurable progress was achieved in 2012, as AP&T continued to show how the private sector creates opportunities both in growing market segments, and those which pose more substantial challenges. With the ongoing support and cooperation of employee-owners, financiers and industry partners, AP&T will continue to create shareholder value and opportunities for a healthier local and regional Alaskan economy. During 2012, not only did the Company continue its trend of achieving solid growth and ever improving financial performance, it implemented a quarterly dividend policy of $0.105 per share. The Company also successfully called and refinanced all outstanding bonds associated with Goat Lake Hydro which represents 20% of its outstanding debt, substantially lowering the related cost of funds. The Company experienced total revenues for the year of $41.7 million and resulted in operating income of $9 million. Net income was $3.4 million, an increase of 2.6%. The Company achieved basic earnings per share of $2.41 for the year, an 8.4% increase, on a weighted-average of 1.42 million common shares outstanding. Total assets were reduced by 3.6% to $122.5 million while total longterm debt fell by $5.1 million to a total of $62.5 million, a reduction of 7.6%.

Operations by Segment Electric Operations – Total sales for electric operations during 2012 decreased by 1.8% to 65.5 GWh from a total of 66.7 GWh for 2011. However, hydroelectric resources provided 74% of all generation, an increase of 3.5% over the previous year and 3.7% over the 5 year average. Diesel generation operations provided 18.9 GWh, 13.8% less than the 5 year average. While gross revenue from power operations declined by $1 million to a total of $20 million, the 24


AP&T ANNUAL FINANCE REPORT increase in hydroelectric generation provided for a reduction in the cost of power resulting in net revenue being $318,000 less than the previous year. Operating expenses for the year were reduced by 1.7%, or $200,000, to a total of $12 million. Operating income for the year was $4.9 million, a reduction of $690,000 or 12.3% from the previous year. Telecommunications Operations – Gross revenues for regulated telecommunications operations during 2012 were $15.5 million, representing a 3.1% or $464,000 increase over 2011 results. Operating expenses for 2012 increased by 2% or $164,000 over the previous year to a total of $8.5 million. This was the combined effect of including SE Network plant used to provide regulated services into regulated cost recovery mechanisms. Operating income provided by regulated telecommunications was $2.1 million, an increase of 1.8%. Non-regulated Operations – This segment consists of engineering and construction services, AP&T Long Distance, Inc. and AP&T Wireless, Inc. Gross revenues from nonregulated operations increased by $590,000 or 10.4% over 2011 results to $6.3 million. Engineering and construction services provided $273,000 of revenue for the year while long-distance services provided $284,000. AP&T Wireless experienced a revenue increase of 24.4% to $6.2 million. Operating expenses for the non-regulated business segment increased 3.7% or $166,000, to a total of $4.7 million. Operating income for non-regulated operations was to $2.1 million, a 45% increase from result for 2011 of $1.45 million.

Investment and Other Income

Dividend income of $511,000 for 2012 and $501,000 for 2011 represents patronage from CoBank, the Company’s primary lender, and is based on 1% of the Company average outstanding loan balances. For both years, 65% of this patronage was returned to the Company in cash with the remainder increasing the equity investment in CoBank. During the year, the Company successfully called and refinanced all bonds associated with the Goat Lake Hydro project, reducing the effective interest rate from 5.87% to 4.47% before patronage. As a part of the refinancing, the Company incurred a one-time charge of $329,000 related to unamortized bond issuance costs. Interest income is primarily derived from restricted cash balances held in conjunction with the Goat Lake Hydro Bonds (see note 6 of the audited financial statements). This cash is invested in high quality government securities with varying maturity dates. As these securities mature, they are replaced at current market rates. As the bond markets have remained soft and balances invested have been reduced to nominal amounts, interest income has fallen from $59,000 in 2011 to $33,000 for 2012. Interest expense for the year was $3.6 million, an 8.9% decrease from 2011, the result of the Company’s continued commitment to reduce outstanding loan balances. 25


AP&T ANNUAL FINANCE REPORT

Provision for Income Taxes Income before tax was $5.6 million and $5.2 million for the years 2012 and 2011 respectively. The effective tax rate was 38.7% or $2.2 million for 2012 compared to 36.8% or $1.9 million in 2011. Net income for 2012 was $3.4 million or $2.41 per share compared to $3.3 million or $2.22 per share for 2011.

Financial Condition

The Company increased its gross plant in service 2.7% to $170 million, although depreciation expense exceeded capital expenditures resulting in a 2.2% decrease in net property, plant and equipment. During the year restricted funds related to the Goat Lake Hydro bonds were reduced by $2 million, the proceeds being used to retire a portion of the related debt. Working capital was reduced to $5.3 million, primarily the result of the Company fully utilizing its prepaid income tax balances of $1 million. Interest bearing liabilities were reduced by 7.6%, or $5.1 million, to a total of $62.5 million for the year ending 2012. The Company raised $616,000 of additional equity through the sale of common stock, while the repurchase of shares required the use of $3.9 million resulting in a reduction of $3.3 million in invested capital. The Company’s equity as a percentage of total capital improved slightly from -34.2% at the end of 2011, to 35.1% at yearend 2012. An “other comprehensive loss” adjustment of $1 million was recorded to reflect the fair market value of the interest rate swap that the Company entered into in 2009.

Liquidity and Capital Resources Operating Activities – Cash flows from operating activities decreased Cash flows from operating activities increased by 2% to $13 million, during 2012 from $12.8 million during 2011. The collection of outstanding receivables and an increase in deferred income taxes net of the non-cash effects of the interest rate swap provision were the primary sources. Investing Activities – The Company used $5.5 million of its cash in acquiring property plant and equipment during 2012 compared to $6.3 million the prior year. Net cash used for other assets and investments was $210,000, down from $740,000 in 2011. Net cash used in investing activities decreased by 17.8% to $5.8 million for the year ended 2012 compared to $7 million during 2011.

26


AP&T ANNUAL FINANCE REPORT Financing Activities –The Company obtained financing of $13 million which it used to call all outstanding bond issued by its subsidiary, Goat Lake Hydro. Net cash used for long-term debt payments was $3.3 million during 2012, compared to a total of $4.6 million during 2011. Proceeds from the sale of common stock were $616,000 for 2012 and $615,000 for 2011. Cash used for the repurchase of common stock was $3.9 million and $724,000 for 2012 and 2011 respectively. During 2012, the Company also applied $455,000 of its cash toward dividends. Net cash used for financing activities for 2012 increased by 49.3% or $2.3 million to $7.1 million from $4.8 million for 2011.

Issues, Risks and Challenges

While the economy has fluctuated widely over the past two years, the Company’s risk profile did not change significantly in 2012. However, management recognizes that there will always be risks and challenges facing a business, which include the effects and uncertainties of future events, some of which have been identified and described below. • The continuing unstable economic environment in Alaska could have a negative impact and restrict growth opportunities there. • Our continued reliance on subsidies from government to our regulated electric and telecommunications customers, that help them to pay rates that reflect a fair return to the Company, could be affected by legislative or regulatory changes. • Recently proposed regulatory changes in the telecommunications sector will have negative effects on projected results for the Company. • If the company fails to uphold the financial covenants of its Master Loan Agreement with CoBank, events could cause a default in the terms of the agreements and would adversely affect the Company’s future. • We face risks related to our operations through unexpected changes in compliance regulations, political, legal and economic instability, and seasonal factors that would affect hydrology, and unforeseen adverse tax consequences, all of which could have adverse effects on the Company’s long-term financial projections. Robert S. Grimm President - CEO Michael Garrett, Executive Vice President

Chad A. Haggar, CPA VP, Chief Financial Officer, Treasurer 27


AP&T FINANCE STATEMENTS - 5 YEAR SUMMARY $ Expressed in thousands except per share data

2008

2009

2010

2011

2012

INCOME - ELECTRIC

$ 5,936

$ 6,128

$ 5,975

$ 5,633

$ 4,909

INCOME - TELECOM

$ 2,227

$ 2,220

$ 2,763

$ 2,022

$ 2,059

INCOME - NONREGULATED OPERATIONS

$ (1,575)

$ (843)

$ (445)

$ 1,450

$ 2,105

TOTAL OPERATING INCOME

$ 6,588

$ 7,505

$ 8,293

$ 9,105

$ 9,073

16.4%

19.7%

21.1%

21.9%

21.7%

NET INCOME

$ 2,636

$ 2,639

$ 2,846

$ 3,338

$ 3,425

EBITDA1

$ 15,627

$ 16,655

$ 16,830

$ 16,677

$ 16,611

CASH FLOW FROM OPERATIONS

$ 9,446

$ 6,573

$ 10,515

$ 12,826

$ 13,087

1.79

1.79

1.91

2.22

2.41

OPERATING RESULTS OPERATING INCOME BY SEGMENT

OPERATING MARGIN

EARNINGS (LOSS) PER SHARE - BASIC

1

28

EBITDA is the acronym for: Earnings before Interest Taxes, Depreciation and Amortization, a common financial measure used to determine a company’s cash from operation activites.


AP&T FINANCE STATEMENTS - 5 YEAR SUMMARY - KEY RATIOS $ Expressed in thousands except per share data

FINANCIAL POSITION

2008

2009

2010

2011

2012

TOTAL CAPITALIZATION

$112,649

$108,711

$107,493

$102,817

$ 96,348

WEIGHTED-AVERAGE SHARES OUTSTANDING

1,473,155

1,472,013

1,491,950

1,500,195

1,419,654

BOOK VALUE PER SHARE - BASIC

$ 20.94

$ 22.42

$ 23.46

$ 23.49

$ 25.22

SHARE PRICE (PER VALUATION)

$ 20.26

$ 19.05

$ 18.58

$ 21.13

$ TBD

CASH FROM OPERATIONS / REVENUE

23.5%

17.2%

26.7%

30.8%

31.4%

DEBT / CAPITALIZATION

72.79%

69.46%

67.19%

65.79%

64.87%

EQUITY / CAPITALIZATION

27.21%

30.54%

32.81%

34.21%

35.13%

RETURN ON ASSETS

2.06%

2.06%

2.24%

2.62%

2.79%

RETURN ON EQUITY

8.60%

7.95%

8.07%

9.49%

10.12%

KEY RATIOS

29


MOSS ADAMS - AUDITORS REPORT

Report of Independent Auditors and Consolidated Financial Statements for

Alaska Power & Telephone Company and Subsidiaries December 31, 2012 and 2011

30


MOSS ADAMS - AUDITORS REPORT

CONTENTS ________________________________________________________________________________________________ PAGE REPORT OF INDEPENDENT AUDITORS 32-33

CONSOLIDATED FINANCIAL STATEMENTS

Consolidated balance sheets 34-35 Consolidated statements of income 36

Consolidated statements of comprehensive income 37

Consolidated statements of stockholders’ equity 38

Consolidated statements of cash flows

Notes to consolidated financial statements

39-40 41-55

31


REPORT OF  INDEPENDENT  AUDITORS  

    The  Board  of  Directors   Alaska  Power  &  Telephone  Company     Report  on  the  Financial  Statements   We   have   audited   the   accompanying   consolidated   financial   statements   of   Alaska   Power   &   Telephone   Company   (Company)   and   its   subsidiaries   which   comprise   the   consolidated   balance   sheets   as   of   December  31,  2012  and  2011,  and  the  related  consolidated  statements  of  income,  stockholders’  equity,   and  cash  flows  for  the  years  then  ended,  and  the  related  notes  to  the  financial  statements.         Management’s  Responsibility  for  the  Financial  Statements   Management   is   responsible   for   the   preparation   and   fair   presentation   of   these   consolidated   financial   statements  in  accordance  with  accounting  principles  generally  accepted  in  the  United  States  of  America;   this   includes   the   design,   implementation,   and   maintenance   of   internal   control   relevant   to   the   preparation   and   fair   presentation   of   consolidated   financial   statements   that   are   free   from   material   misstatement,  whether  due  to  fraud  or  error.     Auditor’s  Responsibility   Our   responsibility   is   to   express   an   opinion   on   these   consolidated   financial   statements   based   on   our   audits.    We  conducted  our  audits  in  accordance  with  auditing  standards  generally  accepted  in  the  United   States   of   America.     Those   standards   require   that   we   plan   and   perform   the   audit   to   obtain   reasonable   assurance  about  whether  the  consolidated  financial  statements  are  free  from  material  misstatement.       An   audit   involves   performing   procedures   to   obtain   audit   evidence   about   the   amounts   and   disclosures   in   the   consolidated   financial   statements.     The   procedures   selected   depend   on   the   auditor’s   judgment,   including  the  assessment  of  the  risks  of  material  misstatement  of  the  consolidated  financial  statements,   whether   due   to   fraud   or   error.     In   making   those   risk   assessments,   the   auditor   considers   internal   control   relevant   to   the   entity’s   preparation   and   fair   presentation   of   the   consolidated   financial   statements   in   order  to  design  audit  procedures  that  are  appropriate  for  the  circumstances,  but  not  for  the  purpose  of   expressing  an  opinion  on  the  effectiveness  of  the  entity’s  internal  control.    Accordingly,  we  express  no   such   opinion.     An   audit   also   includes   evaluating   the   appropriateness   of   accounting   policies   used   and   the   reasonableness   of   significant   accounting   estimates   made   by   management,   as   well   as   evaluating   the   overall  presentation  of  the  consolidated  financial  statements.      

32

1


REPORT OF  INDEPENDENT  AUDITORS   (continued)         We  believe  that  the  audit  evidence  we  have  obtained  is  sufficient  and  appropriate  to  provide   a   basis   for   our  audit  opinion.         Opinion   In   our   opinion,   the   consolidated   financial   statements   referred   to   above   present   fairly,   in   all   material   respects,   the   financial   position   of   Alaska   Power   &   Telephone   Company   and   its   subsidiaries   as   of   December   31,   2012   and   2011,   and   the   results   of   their   operations   and   their   cash   flows   for   the   years   then   ended  in  accordance  with  accounting  principles  generally  accepted  in  the  United  States  of  America.        

Spokane,  Washington   April  9,  2013  

33 2


ALASKA POWER & TELEPHONE COMPANY - CONSOLIDATED BALANCE SHEETS

34


ALASKA POWER & TELEPHONE COMPANY - CONSOLIDATED BALANCE SHEETS

See accompanying notes. ___________________________________________________________________________________________________________________________________

35


ALASKA POWER & TELEPHONE COMPANY CONSOLIDATED STATEMENTS OF INCOME

36

See accompanying notes. ______________________________________________________________________________________________________________________ _____________


ALASKA POWER & TELEPHONE COMPANY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

See accompanying notes. ___________________________________________________________________________________________________________________________________

37


ALASKA POWER & TELEPHONE COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

38

See accompanying notes. ______________________________________________________________________________________________________________________ _____________


ALASKA POWER & TELEPHONE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS

39


ALASKA POWER & TELEPHONE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS

40

See accompanying notes. ______________________________________________________________________________________________________________________ _____________


ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 – The Company and Summary of Significant Accounting Policies Description of entity – Alaska Power & Telephone Company and its subsidiaries (AP&T or Company) supply electric and telephone service to several communities in the state of Alaska. AP&T is subject to regulation by the Regulatory Commission of Alaska (RCA), the Federal Communications Commission (FCC), and the Federal Energy Regulatory Commission (Commissions) with respect to rates for service and maintenance of its accounting records. AP&T’s accounting policies conform to accounting principles generally accepted in the United States of America as applied to regulated public utilities and are in accordance with the accounting requirements and rate-making practices of the Commissions.

Consolidation – The accompanying consolidated financial statements include the accounts of AP&T and its wholly-owned energy subsidiaries, Alaska Power Company, BBL Hydro, Inc., and Goat Lake Hydro, Inc.; its wholly-owned telecommunications subsidiaries, Alaska Telephone Company, AP&T Long Distance, Inc., AP&T Wireless, Inc., Bettles Telephone, Inc., and North Country Telephone, Inc. All material intercompany balances and transactions have been eliminated in consolidation.

During 2011, the Company completed a spin-off of Hydro West International, which is discussed in Note 5. The operations of Hydro West International prior to the spin-off date are included in the accompanying consolidated financial statements.

Accounting estimates – 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 contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include depreciation, interstate access revenue settlements, the fair value of goodwill, the fair value of the interest rate swap, unbilled revenue, and deferred income taxes. Actual results could differ from those estimates. Cash and cash equivalents – All highly liquid investments with original maturities of 90 days or less are carried at cost plus accrued interest, which approximates fair value, and are considered to be cash equivalents. All other investments not considered to be cash equivalents are separately categorized as investments or securities available for sale.

Concentration of risks – At various times throughout the year, the cash balances deposited in local institutions exceed federally insured limits. A possible loss exists for those amounts in excess of the federally insured limits. AP&T minimizes this risk by utilizing numerous financial institutions for deposits of cash funds.

In 2012, the Company received $3.6 million, or 8.6% of its revenue from the Federal Universal Service Fund. In 2011, the Company received $3.7 million, or 8.7% of its revenue from the Federal Universal Service Fund.

41


ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 – The Company and Summary of Significant Accounting Policies (continued) Comprehensive income – Accounting principles require that recognized revenues, expenses, gains, and losses be included in net income. In addition, certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities and changes in the fair market value of interest rate swaps, are reported as a separate component of equity. These items, along with net income, are components of comprehensive income, which is reported in a separate consolidated statement of comprehensive income.

Valuation of accounts receivable – Accounts receivable are stated at the amount management expects to collect on outstanding balances. AP&T reviews the collectability of accounts receivable annually based upon an analysis of outstanding receivables, historical collection information, and existing economic conditions. Receivables from power and telecommunications subscribers are due 30 days after issuance of the subscriber bill. Receivables from other customers are typically outstanding 30 to 60 days before payment is received. Management provides for probable uncollectible amounts through a charge to earnings and a credit to a valuation allowance based on its assessment of the current status of individual accounts. Balances that are still outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable. Management believes it has established adequate reserves for any risk associated with these receivables.

Securities available for sale – Securities not classified as held to maturity or trading are classified as available for sale. Available for sale securities are stated at fair value with any material unrealized gains and losses, net of deferred taxes, reported as a separate component of stockholders’ equity. Unrealized gains and losses were not material in 2012 or 2011. Quoted prices in active markets are available for all of the Company’s securities available for sale.

Fuel, supplies, and other inventory – Fuel, supplies, and other inventory are valued at the lower of average cost or market. Cost is determined on a first-in, first-out basis. The supplies and other inventory are primarily held for use in construction projects including repairs and maintenance of AP&T’s delivery systems.

Property, plant, equipment, and depreciation – Property, plant, and equipment are stated at cost. Regulated plant includes assets that are jointly used for regulated and nonregulated activities. The cost of additions to and replacements of property, plant, and equipment are capitalized. This cost includes direct material, labor, and similar items and charges for such indirect costs as engineering, supervision, payroll taxes, and pension benefits. AP&T capitalizes, as an additional cost of utility plant, an allowance for funds used during construction (AFUDC), which represents the allowed cost of capital used to finance a portion of construction work in progress for projects of more than one year in duration. AFUDC consists of debt and equity components that, when capitalized, are credited as noncash items to other income and interest charges. There was no AFUDC recorded in 2012 or 2011.

42


ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 – The Company and Summary of Significant Accounting Policies (continued) Property, plant, equipment, and depreciation (continued) – The cost of current repairs and maintenance is charged to expense, while the cost of betterment is capitalized. The original cost of property, plant, and equipment together with removal cost, less salvage, is charged to accumulated depreciation at such times as assets are retired and removed from service. For financial statement purposes, depreciation is computed on the straight-line method using rates based on average service lives. For income tax purposes, AP&T computes depreciation using accelerated methods where permitted.

Goodwill – In 1999, AP&T purchased certain telecommunications properties of GTE Alaska and in 1995 through 1997 purchased the power assets of three service areas in Alaska from existing power providers. The excess of the purchase price over the assets acquired has been recorded as goodwill in the amount of $8,550,741 for the telecommunications properties and $715,662 for the power properties. The goodwill is tested annually for impairment by management evaluating if current events and circumstances indicate that it is more likely than not that the fair value of the reporting unit is less than its carrying value. If management’s analysis indicates that it is more likely than not that the fair value is less than the carrying value, the fair value of the reporting unit is calculated and compared to the carrying value. Management has reviewed events and circumstances that may indicate decreases in fair value of goodwill and has concluded no impairment exists at December 31, 2012.

Preliminary survey and investigation costs – AP&T defers costs incurred for the preliminary survey and investigation of proposed construction projects in accordance with the rules of the Commissions. These deferred costs are capitalized into utility plant when the preliminary survey and investigation projects are completed or are charged to expense in the period that a proposed project is abandoned.

Income taxes – Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets relate primarily to asset impairment deductions on the books. Deferred tax liabilities relate primarily to the use of accelerated depreciation for income tax purposes. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company records uncertain tax positions if the likelihood the position will be sustained upon examination is less than 50%. As of December 31, 2012 and 2011, the Company had no accrued amounts related to uncertain tax positions. The Company is no longer subject to U.S. federal or state and local income tax examinations by tax authorities for years before 2009.

43


ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 – The Company and Summary of Significant Accounting Policies (continued) Other deferred credits – Other deferred credits consist of customer advances for construction, grant funded projects, and other deferred revenue. Customer advances for construction of additions to the electric distribution systems are recorded as a liability and are amortized through discounted service billings to the customer over a 60-month period. At the end of the amortization period, any remaining balance is recorded as a reduction of the respective utility plant accounts. Customer advances for construction were $440,468 and $292,789 at December 31, 2012 and 2011, respectively.

Revenue recognition – Electric – AP&T utilizes cycle billing and records revenue billed to its customers when the meters are read each month. In addition, AP&T recognizes unbilled revenue from electric power delivered, but not yet billed.

Revenue recognition – Telecommunications – AP&T’s local wireline rates and access revenues (revenues earned for originating and terminating long distance calls) are determined by rates approved by regulators. Other sources of revenues, such as Internet, equipment sales, wireless, and long distance resale are not rate regulated. Pending and future regulatory actions may have a significant impact on AP&T’s future operations and financial condition. Monthly service fees derived from local wireline, data services, and wireless are billed one month in advance, but recognized in the month that service is provided. Usage sensitive revenues such as long distance and other wireless services are generally billed as a per-minute charge.

AP&T also receives significant universal service support revenue based on the higher costs of providing rural telecommunications service. These revenues are included in interstate access revenues and are based on AP&T’s relative level of operating expense and plant investment. The interstate program is governed by the FCC and administered by the Universal Service Administrative Company (USAC).

Telecommunications operating revenues include settlements based on AP&T’s participation in the interstate revenue pools administered by the National Exchange Carrier Association (NECA) and regulated by the FCC. These revenues are determined by annually prepared separations and interstate access cost studies. Revenues for the current year are based on estimates prior to the submission of the cost study reporting actual results of operations. Additionally, the studies are subject to a 24-month pool adjustment period and final review and acceptance by the pool administrators. There was an insignificant revenue impact for 2012 and 2011 for adjustments related to prior year differences between the recorded estimates and actual revenues. Management does not anticipate significant adjustments to recorded revenues for the years ended December 31, 2012 and 2011.

44


ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 – The Company and Summary of Significant Accounting Policies (continued) Revenue recognition – Telecommunications (continued) – Additionally, telecommunications operating revenues include revenues received from intrastate revenue pools administrated by the Alaska Exchange Carriers Association that are based on AP&T’s relative cost of providing intrastate access service. These revenues are based on projections submitted periodically and intrastate access cost studies that are submitted every two years. Management does not anticipate significant adjustments to recorded revenues for the years ended December 31, 2012 and 2011.

In October 2011, the FCC issued an order reforming Intercarrier Compensation and Universal Service Funding (USF) mechanisms and issued a Further Notice of Proposed Rulemaking (FNPRM) on longterm USF reform, transition timing, and implementation. The majority of the new rules took effect, subject to various transition provisions, on July 1, 2012. Major provisions of the order and FNPRM include: • • • • • • •

Limitations on the amount of support received per line Limitations on capital expenditures and operating expenses recoverable from the USF Benchmarks for minimum local rates charged to end users by recipients of support The establishment of the Access Recovery Charge billed to end users The phase out of local switching support and terminating interstate and intrastate switched access charges The establishment of the CAF, a new funding mechanism for investment and expenses related to the switching function The structured reduction of carrier access rates charged by the Company to other carriers using its network to complete long distance calls

Management is monitoring the impacts of the reform on an on-going basis.

Earnings per share – AP&T has calculated its basic earnings per share based on the weighted-average number of shares of common stock outstanding. Diluted earnings per share reflect the impact of the dilution caused by outstanding stock options using the treasury stock method. There was no dilutive effect of any outstanding stock options in 2012 or 2011. Weighted-average shares outstanding for purposes of calculating basic and diluted earnings per share were 1,419,656 in 2012 and 1,500,194 in 2011. Taxes imposed by governmental authorities – The Company’s customers are subject to taxes assessed by various governmental authorities on many different types of revenue transactions with the Company. These specific taxes are charged to and collected from the Company’s customers and subsequently remitted to the appropriate taxing authority. The taxes are accounted for on a net basis and excluded from revenues.

45


ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 – The Company and Summary of Significant Accounting Policies (continued) Advertising costs – AP&T expenses advertising costs as incurred. Advertising expenses during the years ended December 31, 2012 and 2011, were $126,310 and $130,683, respectively.

Fair value measurements – Fair value represents the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. The Company follows the following fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value:

Level 1

Level 2

Quoted prices in active markets for identical assets or liabilities.

Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets.

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

• • •

Goodwill impairment testing Securities available for sale Interest rate swaps

The fair value measurement guidance is applicable to the Company in the following areas:

The Company’s investment in securities available for sale and interest rate swaps are classified as Level 1 in the above hierarchy at December 31, 2012 and 2011.

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets:

Cash and cash equivalents – The carrying amounts approximate fair value because of the short maturity of those instruments.

Long term debt – The fair value of AP&T’s long-term debt is estimated by discounting the future cash flows of the various instruments at rates currently available to AP&T for similar debt instruments of comparable maturities.

The carrying amount of long-term debt approximates the estimated fair value at December 31, 2012, due to the low interest rate environment and the current rates for AP&T’s long-term debt obligations.

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ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 – The Company and Summary of Significant Accounting Policies (continued) Subsequent events – Subsequent events are events or transactions that occur after the balance sheet date but before the financial statements are available to be issued. The Company recognizes in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing the financial statements. The Company’s financial statements do not recognize subsequent events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after the balance sheet date and before the financial statements are available to be issued. The Company has evaluated subsequent events through April 9, 2013, which is the date the financial statements were issued. Note 2 – Rate Stabilization Asset

The Company defers certain costs that would otherwise be charged to expense, if it is probable future rates will permit the recovery of such costs. In September 2000, the Company received approval from the Commissions to defer the billing of a portion of the allowable annual costs as defined by the power sales agreement in place between Alaska Power Company and Goat Lake Hydro. Such amounts are deferred as a regulatory asset and will be billed in future years when the Company’s allowable annual costs decline below certain levels. Management projects the deferred amounts will be recovered through additional billings through 2020. Note 3 – Operating Lease Agreements

AP&T leases a portion of its office space and a portion of its utility plant under noncancellable leases. Rent expense on the noncancellable leases was $253,287 and $374,483 for 2012 and 2011, respectively. Certain leases include renewal provisions at AP&T’s option. Minimum rental commitments under noncancellable operating leases are as follows:

Additional cancellable lease agreements have been secured for the use of the land for hydroelectric operations. The term of the agreements extend for the life of the hydroelectric license of 50 years. Total Company rent expense was $453,798 in 2012 and $422,055 in 2011.

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ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4 – Property, Plant, and Equipment Property, plant, and equipment consist of the following assets at December 31:

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Utility plant under construction includes all direct and indirect costs incurred during the construction of projects that were not complete and in service at the balance sheet date. The balance also includes approximately $2.4 million in construction costs related to Soule River Hydro, LLC (SRH). SRH is a project company formed to construct a hydroelectric facility on the Soule River in Alaska that was not operational as of December 31, 2012.


ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – Investments AP&T’s investments consist of the following at December 31:

CoBank – CoBank is organized similar to a cooperative and is owned by the customers it serves. As such, a portion of CoBank’s earnings is returned to its customers based on their patronage with the bank. This investment is recorded on the cost method. Dividend income was reported in the amounts of $510,815 and $500,887 for 2012 and 2011, respectively, related to these earnings.

Ketchikan Electric Company LLC – AP&T owns a 50% share of Ketchikan Electric Company LLC (KEC) and accounts for the investment using the equity method. The principal purpose and business of KEC is to construct, own, operate, and manage a hydroelectric power system in the Ketchikan Gateway Borough. The investment represents capital contributions to KEC, as the Company is still in the development stage. There was no activity in 2012 or 2011.

Hydro West International and Hydro West Holdings, Inc. – Hydro West International (HWI) is an operating entity that manages and owns interests in hydroelectric projects in central America. As of December 31, 2010, HWI was a wholly-owned subsidiary of the Company and its assets, liabilities, and operations were included in the Company’s consolidated financial statements. During August 2011, the Company completed a spin-off arrangement where it contributed its ownership interest in HWI to Hydro West Holdings, Inc. (Holdings), a newly formed domestic holding company, in exchange for 7.6 million shares of nonvoting preferred stock in Holdings. The common and voting stock of Holdings is held by the individual stockholders of AP&T. The nonvoting preferred stock in Holdings entitles the Company to receive cumulative dividends at a rate of 8% per annum beginning in August 2013 and entitles the Company to distribution preference in the event of a liquidation. The Company’s investment in the preferred stock of Holdings is accounted for using the cost method. The fair value of the preferred shares in Holdings at the date of the spin-off was approximately equal to the fair value of HWI. Management reviews the value of this investment by evaluating if current events and circumstances indicate the fair value is less than the carrying value and has concluded that no impairment exists at December 31, 2012.

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ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 – Investments (continued) HWI’s assets, liabilities, and stockholder’s equity consisted of the following as of the date of the spinoff:

HWI’s 2011 operations prior to the spin-off were not material. Note 6 – Long-Term Debt

The Company’s long-term debt consists of the following at December 31:

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ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6 – Long-Term Debt (continued)

Annual maturities for the five years beginning January 1, 2013, are $ 3,231,721, $4,176,345, $4,428,057, $4,699,378, and $4,991,854, respectively, and $40,973,389 thereafter.

The Company uses variable-rate debt to finance its operations and these debt obligations expose the Company to variability in interest payments due to changes in interest rates. Management believes that it is prudent to limit the variability of a portion of its interest payments as well as the uncertainty associated with interest rates when its balloon payment with CoBank becomes due. To meet this objective, management periodically considers interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate risk. These swaps change the variable-rate cash flow exposure on the debt obligations to fixed cash flows. The Company does not enter into derivative instruments for speculative purposes. Under the terms of the interest rate swaps, the Company receives variable interest rate payments and makes fixed interest rate payments, thereby creating the equivalent of fixed-rate debt. Changes in the fair value of interest rate swaps designated as hedging instruments that effectively offset the variability of cash flows associated with variable-rate debt obligations are reported in accumulated other comprehensive loss.

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ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6 – Long-Term Debt (continued) At December 31, 2009, the Company had entered into an interest rate swap agreement on all of its long-term debt with CoBank. The interest rate swap becomes effective in August 2013 and amortizes over an additional 10-year term at 7.62% per annum. The fair value of the interest rate swap liability was $8,773,644 and $7,076,343 at December 31, 2012 and 2011, respectively, and is classified within Level 2 of the valuation hierarchy.

The note payable by GLH to secure the Power Revenue Bonds Series 1997 was the result of the issuance on December 31, 1997, of a series of tax-exempt bonds by the Alaska Industrial Development and Export Authority (AIDEA). The proceeds were restricted in use for the purpose of financing the acquisition, purchase, construction, improvement, and equipment of the project known as the Upper Lynn Canal Regional Power Supply System. Of these restricted funds, approximately $2 million was required to remain in reserve for the term of the bonds. During 2012, the Company refinanced its remaining outstanding obligations on the GLH note payable by securing a new note payable with CoBank for $13 million. The proceeds of the new note were used to repay the outstanding principal balance on the GLH note. This transaction removed the requirement for the Company to maintain restricted funds related to bond principal and interest.

The loan agreements with CoBank contain provisions and restrictions pertaining to, among other things, limitations on additional debt, and defined amounts related to the Company’s total debt to EBITDA, equity to assets ratio, fixed charge coverage and debt service coverage ratio. The Company has a $3 million line of credit established with CoBank. There were no outstanding balances on the line of credit as of December 31, 2012 and 2011. Note 7 – Income Taxes

The components of the consolidated provision for income taxes are as follows for the years ended December 31:

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ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 7 – Income Taxes (continued) Total tax expense differs from that computed at the statutory federal income tax rate due to the following:

The components of the deferred tax (assets) and liabilities as of December 31 are as follows:

Note 8 – Employee Stock Ownership Plan and Other Benefits AP&T maintains an employee stock ownership plan (Plan). All employees expected to work at least 1,000 hours per year become eligible to participate in the Plan upon attaining the age of 18 and completing 3 months of service. Participants may elect to contribute from 1% to 80% of their wages to the Plan, subject to IRS maximums, which can be invested in the common stock of AP&T or into other investment accounts.

In 2011, a 3% defined matching contribution was made to each eligible participant’s account throughout the year. Additionally, a contribution was made at the discretion of the employer in an amount up to 5% of an eligible participant’s wages. The discretionary contribution was made in cash, Company stock, or a combination of both.

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ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 8 – Employee Stock Ownership Plan and Other Benefits (continued) Beginning in 2012, the defined matching contribution was changed to 5% and is payable in Company stock. The discretionary contribution was replaced with a profit sharing contribution where 7.5% of the prior year’s net income is paid out to the qualified Plan participants in cash.

The Plan provides that participants’ interests in employer-funded contributions become fully vested after the completion of three years of service. The Plan defines a year of service as the completion of not fewer than 1,000 hours of service within the calendar year.

In 2012, employer matching contributions and profit sharing contributions were $449,166 and $250,328, respectively. In 2011, employer matching contributions and discretionary contributions were $270,177 and $137,923, respectively. Note 9 – Business Segment Information

AP&T’s electric segment provides retail and wholesale electric service including both hydro electric and diesel generation facilities in rural portions of Alaska. AP&T’s telecommunications segment provides local telephone service also in rural areas of Alaska. AP&T’s reportable segments are strategic business units managed separately due to their different operating and regulatory environments. The “other nonregulated” category includes the parent company and segments below the quantitative threshold for separate disclosure.

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ALASKA POWER & TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 9 – Business Segment Information (continued)

Note 10 – Special Funds – Restricted

Special funds – restricted consisted of the balance of proceeds from the note payable to secure Power Revenue Bonds Series 1997 at Goat Lake Hydro, Inc. (see Note 6). U.S. Bank Trust National Association in accordance with the Trust Indenture dated December 1, 1997, is holding these funds. The funds were restricted for use according to provisions of the loan agreement and by the Use of Proceeds and Arbitrage Certificate dated December 1, 1997. Restrictions on these funds were released when the Company repaid its remaining obligations on the GLH note payable during 2012. Note 11 – Other Assets

Other assets consist of the following at December 31:

The deferred loan origination fees are related to the note payable to CoBank and are being amortized on a straight-line basis over the 10-year life of the note.

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AP&T CREATING OPPORTUNITIES

AP&T understands that opportunities do not float like clouds. They are firmly attached to individuals. The opportunities that surround us every day reside and resonate within social, economic and geographical circles of people. Robert S. Grimm, President - CEO AP&T To create opportunity requires an alignment of resources with the strategies most suited to goals and strengths. Those with good ideas and information tend to congregate, thereby achieving greater success. This is what we endeavor to do every day with each other, within our industry and externally with our peers. As employee-owners we are proud of what we have accomplished in 2012, and foster a “grounded” confidence in our ability to create opportunities for continued success in the years ahead.

Notice To Stockholders: The annual meeting will be held on Wednesday, May 22nd, 2013, 10:00am PSTD at NW Maritime Center, 431 Water Street, Port Townsend, Washington; with the Board of Directors Meeting following. This annual report was produced by: Mark McCready, Scott Stenehjem, Jessie Stenehjem and Sandy Hershelman Photo Credits: Mark McCready, David Pflaum, Executive Photos, Rick Dahms, Thomas Mills and Perce Dis Disclaimer: The narrative descriptions of the Company’s activities within this annual report contain certain forward-looking statements that involve risks and uncertainties. When used in this annual report, the words “anticipates,” “believes,” “estimates,” “expects,” and similar expressions are intended to identify such forward-looking statements. The Company’s actual results, performance or achievements could differ materially from the results expressed in or implied by these forward-looking statements. Regarding AP&T Stock: For information regarding the acquisition or sale of AP&T stock, please contact: Darrel A. Patrick Cutter & Company 6450 Poe Ave. Suite 510 Dayton, OH 45414 1-937-890-5093 Toll Free 888-586-9288 dpatrick@cutter-co.com www.cutter-co.com Member SIPC


Alaska Power & Telephone Annual Report 2012  

I worked on the layout and graphic design concept for this annual report with design firm Rocketdigital.

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