CITIZENS COMMUNICATIONS COMPANY
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
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OF THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE YEAR ENDED DECEMBER 31, 2002
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CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to ___________
Commission file number 001-11001
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CITIZENS COMMUNICATIONS COMPANY
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(Exact name of registrant as specified in its charter)
Delaware 06-0619596
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 614-5600
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Securities registered pursuant to Section 12(b) of the Act:
(Title of each class) (Name of each exchange on which registered)
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Common Stock, par value $.25 per share New York Stock Exchange
Guarantee of Convertible Preferred Securities of Citizens Utilities Trust New York Stock Exchange
Equity Units New York Stock Exchange
Citizens Convertible Debentures N/A
Guarantee of Partnership Preferred Securities of Citizens Utilities Capital L.P. N/A
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
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The aggregate market value of common stock held by non-affiliates of the
registrant on June 30, 2002 was approximately $2,282,096,740, based on the
closing price of $8.36.
The number of shares outstanding of the registrant's Common Stock as of February
28, 2003 was 282,913,758.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the registrant's 2003 Annual Meeting of
Stockholders to be held on May 13, 2003 are incorporated by reference into Part
III of this Form 10-K.
TABLE OF CONTENTS
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Page
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PART I
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Item 1. Business 2
Item 2. Properties 9
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to Vote of Security Holders 11
Executive Officers 11
PART II
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Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters 14
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 30
Item 8. Financial Statements and Supplementary Data 32
Item 9. Changes in and Disagreements with Accountants on Accounting 32
and Financial Disclosure
PART III
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Item 10. Directors and Executive Officers of the Registrant 32
Item 11. Executive Compensation 32
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholders Matters 32
Item 13. Certain Relationships and Related Transactions 33
Item 14. Controls and Procedures 33
PART IV
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Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 34
Signatures 38
Certifications 40
Index to Consolidated Financial Statements F-1
PART I
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This annual report on Form 10-K contains forward-looking statements that are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed or implied in the statements. Further discussion
regarding forward-looking statements, including the factors which may cause
actual results to differ from such statements, is located in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in this report. Citizens Communications Company and its subsidiaries
(Citizens) will be referred to as the "Company", "we", "us" or "our" throughout
this report.
Item 1. Business Overview
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We are a telecommunications-focused company providing wireline communications
services to rural areas and small and medium-sized towns and cities, including
the Rochester, New York metropolitan area as an incumbent local exchange
carrier, or ILEC. We offer our ILEC services under the "Frontier" name. In
addition, we provide competitive local exchange carrier, or CLEC, services to
business customers and to other communications carriers in certain metropolitan
areas in the western United States through Electric Lightwave, Inc., or ELI, our
wholly-owned subsidiary. We also provide public utility services including
natural gas transmission and distribution and electric transmission and
distribution services to primarily rural and suburban customers in Vermont,
Hawaii and Arizona. We currently have contracts to sell all of our public
utility operations in Hawaii and Arizona. These sales are expected to close
during the second half of 2003.
Revenue from our ILEC, CLEC and public utility operations was $2,062.9 million,
$175.1 million, and $431.3 million, respectively, in 2002.
Our ILEC segment has grown substantially over the last three years, primarily as
a result of acquisitions. During 2001, we purchased from Global Crossing Ltd.
(Global) the 1.1 million access lines of the Frontier local exchange business
for approximately $3,373.0 million in cash. During 2000, we acquired
approximately 334,500 telephone access lines for approximately $986.2 million in
cash.
In June 2002, we acquired all of the common stock of ELI that we did not
previously own for $0.70 per share in cash. Total cost (including fees and
expenses) of the acquisition was approximately $6.8 million.
In 1999, we announced plans to divest our public utilities services segments. As
a result, in 2001 we sold two of our four natural gas transmission and
distribution businesses and during 2002 we sold our entire water distribution
and wastewater treatment business and one of our three electric businesses.
In October 2002, we entered into definitive agreements to sell our Arizona gas
and electric divisions for $230.0 million in cash ($220.0 million if we close by
July 28, 2003) subject to adjustments specified in the agreements. In December
2002, we entered into a definitive agreement to sell our Hawaiian gas division
for $115.0 million in cash, subject to adjustments specified in the agreement.
These transactions, which are subject to regulatory approvals, are expected to
close during the second half of 2003. Currently, we do not have an agreement to
sell our Vermont electric division, but we continue to actively pursue a buyer.
All of our public utility assets have been written down to our best estimate of
the net realizable value upon sale (see Note 4 to Consolidated Financial
Statements). Pending these divestitures, we continue to provide gas and electric
utility services.
Telecommunications Services
Our telecommunications services are principally ILEC services and also include
CLEC services delivered through ELI. As of December 31, 2002, we operated ILECs
in 24 states, serving approximately 2.4 million access lines and 71,000 digital
subscriber line (DSL) customers. Our CLEC services are marketed under the
Electric Lightwave name and consist of a variety of integrated
telecommunications products.
As an ILEC, we are typically the dominant incumbent carrier in the markets we
serve and provide the "last mile" of telecommunications services to residential
and business customers in these markets. As an ILEC, we compete with CLECs that
may operate in our markets. As a CLEC, we provide telecommunications services to
businesses and other carriers in competition with the incumbent ILEC. As a CLEC,
we frequently obtain the "last mile" access to customers through arrangements
with the applicable ILEC. ILECs and CLECs are subject to different regulatory
frameworks of the Federal Communications Commission (FCC). ELI does not compete
with our ILEC business.
2
The telecommunications industry in general, and the CLEC sector in particular,
are undergoing significant changes and difficulties. Demand and pricing for CLEC
services have decreased substantially, particularly for long haul services, and
economic and competitive pressures are likely to cause these trends to continue.
These factors result in a challenging environment with respect to revenues for
our CLEC business and to a lesser extent our ILEC business. These factors could
also result in more bankruptcies in the sector and therefore affect our ability
to collect money owed to us by bankrupt carriers. We reserved approximately
$10.9 million and $21.2 million of receivables owed to us from bankrupt telecom
companies in 2002 and 2001, respectively.
ILEC Services
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Our ILEC services segment accounted for $2,062.9 million, or 77%, of our total
Company revenues in 2002. Approximately 25% of our ILEC services segment
revenues came from federal and state subsidies and regulated access charges.
Our ILEC services business is primarily with residential customers and, to a
lesser extent, non-residential customers. Our ILEC services segment provides:
* local network services,
* enhanced services,
* network access services,
* long distance and data services, and
* directory services.
Local network services. We provide telephone wireline access services to
residential and non-residential customers in our service areas. Our service
areas are largely residential and are generally less densely populated than what
we believe to be the primary service areas of the five largest ILECs.
Enhanced services. We provide our ILEC customers a number of calling features
including call forwarding, conference calling, caller identification, voicemail
and call waiting. We offer packages of telecommunications services. These
packages permit customers to bundle their basic telephone line with their choice
of enhanced services, or to customize a set of selected enhanced features that
fit their specific needs.
We intend to increase the penetration of existing enhanced services. We believe
that increased sales of such services in our ILEC markets will produce revenue
with higher operating margins due to the relatively low marginal operating costs
necessary to offer such services. We believe that our ability to integrate these
services with our core ILEC services will provide us with the opportunity to
capture an increased percentage of our customers' telecommunications
expenditures.
Network access services. We provide network access services to long distance
carriers and other carriers in connection with the use of our facilities to
originate and terminate interstate and intrastate telephone calls. Such services
are generally offered on a month-to-month basis and the service is billed on a
minutes-of-use basis. Access charges to long distance carriers and other
customers are based on access rates filed with the FCC for interstate services
and with the respective state regulatory agency for intrastate services.
Long distance and data services. Long distance network service to and from
points outside of a telephone company's operating territories is provided by
interconnection with the facilities of interexchange carriers, or IXCs. We offer
long distance services in our territories to our ILEC customers. We believe that
many customers prefer the convenience of obtaining their long distance service
through their local telephone company and receiving a single bill.
We also offer data services including Internet access via dial up or DSL access,
frame relay and asynchronous transfer mode (ATM) switching in portions of our
system.
Directory services. Directory services involves the provision of white and
yellow page listings of residential and business directories. We provide this
service through a third party contractor who pays us a percentage of revenues
realized from the sale of advertising in these directories. Our directory
service also includes "Frontier Pages", an internet-based directory service
which generates advertising revenue.
3
We have grown from approximately 1.0 million access lines in 1999 to
approximately 2.4 million access lines primarily through acquisitions. From time
to time we are offered the opportunity to evaluate the possibility of acquiring
additional telecommunications assets.
The following table sets forth certain information with respect to our telephone
access lines as of December 31, 2002. With the exception of 547,900 access lines
in the greater Rochester, New York area, our access lines are located in
primarily rural areas.
State ILEC Access
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Lines at 12/31/02
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New York............ 1,009,700
Minnesota........... 272,800
Arizona............. 167,100
West Virginia....... 158,600
California.......... 153,400
Illinois............ 131,600
Tennessee........... 97,600
Wisconsin........... 73,800
Iowa................ 62,800
All other states (15)... 317,000
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Total 2,444,400
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CLEC Services
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ELI provides a broad range of wireline communications products and services to
businesses and other carriers in the western United States. ELI accounted for
$175.1 million, or 7%, of our total Company revenue in 2002.
ELI's facilities-based network consists of optical fiber and voice and data
switches. ELI has a national Internet and data network with switches and routers
in key cities, linked by leased transport facilities. In addition, ELI has a
long-haul, fiber-optic network connecting the cities it serves in the Western
United States which utilizes an optically self-healing Synchronous Optical
Network (SONET) architecture. ELI currently provides the full range of its
services in the following cities and their surrounding areas: Boise, Idaho;
Portland, Oregon; Salt Lake City, Utah; Seattle, Washington; Spokane,
Washington; Phoenix, Arizona; and Sacramento, California.
ELI's primary focus in 2003 is obtaining new customers, increasing customer
usage of ELI's existing products and services, focusing more on company end
users and government entities and diversifying the customer mix to place less
reliance on Internet Service Providers (ISPs), application service providers and
other carriers. ELI expects to continue to emphasize increased penetration of
existing on-net buildings, a focus on sales to customers that are connected to
its network and an increase in market share in the cities in which it operates
and surrounding areas. ELI will also continue to market its available dark
fiber.
Regulatory Environment
ILEC Services Regulation
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The Telecommunications Act of 1996, or the 1996 Act, dramatically changed the
telecommunications industry. The main thrust of the 1996 Act was to open local
telecommunications marketplaces to competition while enhancing universal
service. The majority of our operations are regulated extensively by various
state regulatory agencies, often called public service commissions, and the FCC.
4
The 1996 Act preempts state and local laws to the extent that they prevent
competitive entry into the provision of any switched communications service.
Under the 1996 Act, however, states retain authority to impose requirements on
carriers necessary to preserve universal service, protect public safety and
welfare, ensure quality of service and protect consumers. States are also
responsible for mediating and arbitrating interconnection agreements between
CLECs and ILECs if voluntary negotiations fail. In order to create an
environment in which local competition is a practical possibility, the 1996 Act
imposes a number of access to network facilities and interconnection
requirements on all local communications providers. All local carriers must
interconnect with other carriers, permit resale of their services, provide local
telephone number portability and dialing parity, provide access to poles, ducts,
conduits, and rights-of-way, and complete calls originated by competing carriers
under termination arrangements.
We are subject to incentive regulation plans under which prices are capped in
return for the elimination or relaxation of earnings oversight. Some states also
allow us flexibility in price changes for optional services and relaxed
reporting requirements. The goal of these plans is to provide incentives to
improve efficiencies and increased pricing flexibility for competitive services
while ensuring that customers receive reasonable rates for basic services that
continue to be deemed part of a monopoly while allowing us to continue to
recover our costs.
Our ILEC services segment revenue is subject to regulation by the FCC and
various state regulatory agencies. We expect federal and state lawmakers to
continue to review the statutes governing the level and type of regulation for
telecommunications services.
For interstate services regulated by the FCC, we have elected a form of
incentive regulation known as price caps for most of our operations. Under price
caps, interstate access rates are capped and adjusted annually by the difference
between the level of inflation and a productivity factor. Most recently the
productivity factor was set at 6.5%. Given the relatively low inflation rate in
recent years, interstate access rates have been adjusted downward annually. In
May 2000, the FCC adopted a revised methodology for regulating the interstate
access rates of price cap companies through May 2005. The program, known as the
Coalition for Affordable Local and Long Distance Services, or CALLS plan,
establishes a price floor for interstate-switched access services and phases out
many of the subsidies in interstate access rates. We believe we will be able to
offset some of the reduction in interstate access rates through end-user charges
and an expanded universal service program that benefits rural service providers
such as our ILEC services segment. Annual adjustments based on the difference
between inflation and the productivity factor will continue for several years
until the price floor for interstate switched access services is reached.
Another goal of the 1996 Act was to remove implicit subsidies from the rates
charged by local telecommunications companies. The CALLS plan addressed this
requirement for interstate services. State legislatures and regulatory agencies
are beginning to reduce the implicit subsidies in intrastate rates. The most
common subsidies are in access rates that historically have been priced above
their costs to allow basic local rates to be priced below cost. Legislation has
been considered in several states to require regulators to eliminate these
subsidies and implement state universal service programs where necessary to
maintain reasonable basic local rates. However, not all the reductions in access
charges are fully offset. In Tennessee for example, as a result of such
legislation, we are reducing intrastate access rates by $1.0 million per year
through 2003. We anticipate additional state legislative and regulatory pressure
to lower intrastate access rates in the near future. However, regulators are
cognizant of the potential impact on basic local rates and are moving
cautiously. Many states are embracing the need for state universal service funds
to ensure protection for customers while ensuring that local telecommunications
companies continue to have the incentive to recover in rates their investment in
their networks and new services.
State legislatures and regulators are also examining the provision of
telecommunications services to previously unserved areas. Since many unserved
areas are located in rural markets, we may be required to expand our service
territory into some of these areas. Given the start-up costs involved with
territory expansion, we expect legislatures and regulators to continue to move
cautiously and provide some means of recovery for the costs associated with
serving these new areas.
ILEC Unbundling Obligations
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The FCC recently completed its triennial review of the 1996 Act. Although the
FCC's order describing its decisions in detail has not yet been published, the
FCC has provided a summary of its findings and order. The summary essentially
keeps in place the existing regulatory regime with respect to Unbundled Network
Elements Platform (UNEP) competition, provides significant authority to state
regulators to implement UNEP competition and pricing, and eliminated a previous
requirement of ILECs to share their DSL lines with competitors. Because we do
not currently have UNEP competition or competitors providing DSL service, the
FCC's order is not expected to have a material affect on us in the near term. We
will continue to evaluate the affect on us when the final order is published and
as litigation with respect to the order occurs.
5
Some state regulators (including New York and Illinois) have recently considered
imposing on regulated companies (including us) cash management practices that
could limit the ability of companies to transfer cash between subsidiaries or to
the parent company. None of the existing state requirements materially affect
our cash management but future changes by state regulators could affect our
ability to freely transfer cash within our consolidated companies.
CLEC Services Regulation
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A central focus of the sweeping federal policy reform under the 1996 Act was to
open local communications markets to competition including the encouragement of
the development of CLECs, which compete for business with the existing carriers.
As a CLEC, ELI is subject to federal, state and local regulation. However, the
level of regulation is typically less than that experienced by an ILEC. The FCC
exercises jurisdiction over all interstate communications services. State
commissions retain jurisdiction over all intrastate communications services.
Local governments may require ELI to obtain licenses or franchises regulating
the use of public rights-of-way necessary to install and operate its networks.
ELI has various interconnection agreements in the states in which it operates.
These agreements govern reciprocal compensation relating to the transport and
termination of traffic between the ILEC's and ELI's networks. The FCC is
significantly reducing intercarrier compensation for ISP traffic also known as
"reciprocal compensation."
Most state public service commissions require competitive communications
providers, such as ELI, to obtain operating authority prior to initiating
intrastate services. Most states also require the filing of tariffs or price
lists and/or customer-specific contracts. ELI is not currently subject to
rate-of-return or price regulation. However, ELI is subject to state-specific
quality of service, universal service, periodic reporting and other regulatory
requirements, although the extent of these requirements is generally less than
those applicable to ILECs.
Competition
ILEC Services Competition
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Competition in the telecommunications industry is increasing. Although we have
not faced as much competition as larger, more urban telecom companies, we do
experience competition from other wireline local carriers through Unbundled
Network Elements (UNE) and potentially in the future through UNEP, from other
long distance carriers (including Regional Bell Operating Companies), from cable
companies and internet service providers with respect to internet access and
potentially in the future cable telephony, and from wireless carriers.
Competition may result in a greater loss of access lines and minutes of use and
the conversion of retail lines to wholesale lines, which negatively affects
revenues and margins from those lines. Competition also puts pressure on the
prices we are able to charge for some services, particularly for some
non-residential services. Most of the wireline competition we face is in our
Rochester market, with limited competition in a few other areas. Competition
from cable companies with respect to high-speed Internet access is intense in
Rochester and a few of our more suburban markets such as Elk Grove, California
(which is near Sacramento). Competition from wireless companies, other long
distance companies and Internet service providers is present in varying degrees
in all of our markets.
The 1996 Act and subsequent FCC interconnection decisions have established the
relationships between ILECs and CLECs and the mechanisms for competitive market
entry. Though carriers like us, who serve rural markets, did receive a qualified
exemption from some of the technical requirements imposed upon all ILECs for
interconnection arrangements, we did not receive an exemption from
interconnection or local exchange competition in general. The exemption, known
as the rural telephone company exemption, continues until a bona fide request
for interconnection is received from a CLEC and a state public services
commission with jurisdiction determines that discontinuance of the exemption is
warranted. The state commission must determine that discontinuing the exemption
will not adversely impact the availability of universal service in the state nor
impose an undue economic hardship on us and that the requested interconnection
is technically feasible.
As of December 31, 2002, we had entered into 334 interconnection agreements with
CLECs. These agreements allow CLECs to connect with some of our ILEC networks
and compete in our ILEC markets. In addition, in some markets, our ILEC services
provide reciprocal compensation payments and local number portability. These
competitors are mainly serving business customers and Internet service
providers.
6
CLEC Services Competition
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ELI faces significant competition from ILECs in each of its markets. Principal
ILEC competitors include Qwest, SBC and Verizon. ELI also competes with all of
the major Interexchange Carriers (IXCs), Internet access providers and other
CLECs. CLEC service providers have generally encountered intense competitive
pressures, the result of which is the failure of a number of CLECs and
substantial financial pressures on others.
Competitors in ELI's markets include, in addition to the incumbent providers:
AT&T, Sprint, Time Warner Telecom, MCI WorldCom, Broadwing, Integra and XO
Communications. In each of the markets in which ELI operates, at least one other
CLEC, and in some cases several other CLECs, offer many of the same local
communications services that ELI provides, generally at similar prices.
Competition is based on price, quality, network reliability, customer service,
service features and responsiveness to the customer's needs.
The market for Internet access, long-haul and related services in the United
States is extremely competitive, with substantial overcapacity in the market. We
expect that competition will intensify. In addition, new enhanced Internet
services such as managed router service and web hosting are constantly under
development in the market and we expect additional innovation in this market by
a range of competitors. Several IXC's have filed for bankruptcy protection,
which will allow them to substantially reduce their cost structure and debt.
This could enable such companies to further reduce prices and increase
competition.
Many of these competitors have greater market presence and greater financial,
technical, marketing and human resources, more extensive infrastructure and
stronger customer and strategic relationships than are available to us.
Public Utilities Services
We have historically provided public utilities services including natural gas
transmission and distribution, electric transmission and distribution, water
distribution and wastewater treatment services to primarily rural and suburban
customers throughout the United States. In 1999, we announced a plan of
divestiture for our public utilities services properties. Since then, we have
divested or entered into contracts to divest almost all of our public utility
operations for an aggregate of $1.9 billion. In 1999, we initially accounted for
the planned divestiture of our public utilities services segments as
discontinued operations. Because we had not yet entered into agreements to sell
our entire gas and electric segments, we reclassified all our gas and electric
assets and their related liabilities in the second half of 2000 as "net assets
held for sale." As a result, our discontinued operations only reflected the
assets and related liabilities of the water and wastewater businesses.
In 2001, we sold our Louisiana gas operations for $363.4 million in cash and our
Colorado gas division for $8.9 million in cash. In 2002, we sold our water and
wastewater services operations for $859.1 million in cash and $122.5 million in
assumed debt and other liabilities, and our Kauai electric division for $215.0
million in cash. These transactions are subject to routine purchase price
adjustments.
In October 2002, we entered into definitive agreements to sell our Arizona gas
and electric operations for $230.0 million in cash ($220.0 million if we close
by July 28, 2003) and in December 2002, we entered into a definitive agreement
to sell our Hawaiian gas division for $115.0 million in cash, in each case
subject to adjustments specified in the agreement. These transactions, which are
subject to regulatory approvals, are expected to close during the second half of
2003.
We intend to sell our one remaining public utility asset, which is an electric
utility operation in Vermont.
Natural Gas
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Our natural gas segment provides natural gas transmission and distribution
services in Arizona, as well as synthetic natural gas production and propane
service in Hawaii to primarily residential customers. Our natural gas segment
accounted for $216.5 million, or 8%, of our total Company revenues in 2002. At
December 31, 2002, the number of customers by state is as follows:
7
State Customers
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Arizona......... 126,925
Hawaii........... 66,494
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Total 193,419
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Natural gas services and/or rates charged are subject to the jurisdiction of
federal and state regulatory agencies, except for the non-regulated propane
rates charged to customers in Hawaii. We purchase the gas supply we need, except
for our production of synthetic natural gas in Hawaii. We entered into a firm
supply contract with BP Energy for our Arizona gas division. We believe our
natural gas supply is adequate to meet current demands and to provide for
additional sales to new customers. The natural gas industry is subject to
seasonal demand, except in Hawaii, with the peak demand occurring during the
heating season of November 1 through March 31. Our natural gas segment
experiences third-party competition from fuel oil, propane and other gas
suppliers for most of our large consumption customers, of which there are few,
and from electric suppliers for our entire customer base. The competitive
position of gas at any given time depends primarily on the relative prices of
gas and these other energy sources.
Electric
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Our electric segment provides electric transmission and distribution services in
Arizona and Vermont to primarily residential customers. Our electric segment
accounted for $214.8 million, or 8%, of our total Company revenues in 2002. At
December 31, 2002, the number of customers per state is as follows:
State Customers
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Arizona ......... 77,818
Vermont.......... 20,603
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Total 98,421
========
Electric services and/or rates charged are subject to the jurisdiction of
federal and state regulatory agencies. We purchased approximately 99% of the
electric energy needed to provide service to our customers in Vermont and
Arizona. We believe our supply is adequate to meet current demands and to
provide for additional sales to new customers. We have generating facilities in
Arizona and Vermont, which are used mainly for back-up power supply. Generally,
our electric segment does not experience material seasonal fluctuations.
The electric utility industry in the United States is undergoing fundamental
changes. For many years electric utilities have been vertically integrated
entities with the responsibility for the generation, transmission and
distribution of electric power in a franchise territory. In return for monopoly
status, electric utilities have been subject to comprehensive regulation at the
state and federal level. The industry continues its shift toward electric
customers being able to choose their energy provider much like telephone
customers are able to choose their long distance provider. Generally, this
involves separating the generation and transmission of power from the remainder
of the business, and having generators compete with one another in the sale of
power directly to retail customers. The interconnected regional transmission
grids will be operated independently, continuing as a federally regulated
monopoly. Local transmission and distribution facilities would continue as
state-regulated monopolies. This change in the industry is in various stages of
development around the United States. The pace and degree of regulation vary
from state to state. The bankruptcies in 2001 and financial difficulties in 2002
of major providers of electricity may alter the nature and level of regulation
of electric utilities.
Our Vermont Electric Division is a member of the Vermont Joint Owners, a
consortium of 14 Vermont utilities that has entered into a purchase power
agreement with a Canadian power generation facility. The agreement provides for
up to 395 MW of power per annum and associated energy to be delivered to
Vermont, in varying amounts, between 1990 and 2020. If any member of the
consortium defaults on its share of power under the agreement, the remaining
members of the consortium are required by "step-up" provisions of the agreement
to assume responsibility for a defaulting member's share on a pro-rata basis.
In July 2002, the Vermont Public Service Board approved a rate increase of
17.45% for services rendered on or after July 15, 2002.
On November 1, 2002, we completed the sale of our Kauai electric division to
Kauai Island Utility Cooperative (KIUC) for $215.0 million in cash.
8
Segment Information
Note 23 to Consolidated Financial Statements provides financial information
about our industry segments for the last three fiscal years.
Financial Information about Foreign and Domestic Operations and Export Sales
We have no foreign operations, although we have a 19% interest in Hungarian
Telephone and Cable Company (See Note 8 to Consolidated Financial Statements), a
company that provides wireline telephone service in Hungary.
General
Order backlog is not a significant consideration in our businesses. We have no
contracts or subcontracts that may be subject to renegotiations of profits or
termination at the election of the Federal government. We also hold certificates
granted by various state commissions, which are generally of indefinite
duration. We have no special working capital practices, and our research and
development activities are not significant. We hold no patents, licenses or
concessions that are material. As of December 31, 2002, we had approximately
7,684 employees, of whom 6,206 were associated with ILEC operations, 565 were
associated with ELI and 750 were associated with public utilities services
operations. We consider our relations with our employees to be good.
Available Information
We make available free of charge on or through our Internet website our annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K and all amendments to those reports as soon as reasonably practicable after
such material is electronically filed with or furnished to the Securities and
Exchange Commission. Our Internet address is http://www.czn.net.
Item 2. Properties
----------
Our principal corporate offices are located in leased premises at 3 High Ridge
Park, Stamford, Connecticut.
The operations support office for our ILEC segment is currently located in
leased premises at 180 South Clinton Avenue, Rochester, New York. In conjunction
with the Frontier acquisition, we evaluated our facilities to take advantage of
operational and functional synergies between the two companies with the
objective of concentrating our resources in the areas where we have the most
customers, to better serve those customers. In connection with that objective,
we closed our operations support center in Plano, Texas in April 2002 and sold
the building at that location in 2003. In addition, our ILEC segment leases and
owns office space in various markets throughout the United States.
The operations support office for ELI is located in a building we own at 4400 NE
77th Avenue, Vancouver, Washington. In addition, our CLEC segment leases local
office space in various markets throughout the United States, and also maintains
a warehouse facility in Portland, Oregon. Our CLEC segment also leases network
hub and network equipment installation sites in various locations throughout the
areas in which it provides services.
Our ILEC and CLEC services segments own telephone properties which include:
connecting lines between customers' premises and the central offices; central
office switching equipment; fiber-optic and microwave radio facilities;
buildings and land; and customer premise equipment. The connecting lines,
including aerial and underground cable, conduit, poles, wires and microwave
equipment, are located on public streets and highways or on privately owned
land. We have permission to use these lands pursuant to local governmental
consent or lease, permit, franchise, easement or other agreement.
Our public utilities services segments are administered locally in the states in
which they operate. Pending the sale of our public utilities services segments,
we own gas production, transmission and distribution facilities in Arizona and
Hawaii and electric transmission and distribution facilities in Arizona and
Vermont.
9
Item 3. Legal Proceedings
-----------------
On July 20, 2001, we notified Qwest Corporation (Qwest) that we were terminating
eight acquisition agreements. On July 23, 2001, Qwest filed a notice of claim
for arbitration with respect to the terminated acquisition agreements. Qwest
asserts that we wrongfully terminated theses agreements and is seeking
approximately $64.0 million in damages, which is the aggregate of liquidated
damages under letters of credit established in the terminated acquisition
agreements. On September 7, 2001, we filed a response and counterclaims in the
same arbitration proceedings, contesting Qwest's asserted claims and asserting
substantial claims against Qwest for material breaches of representations,
warranties, and covenants in the terminated acquisition agreements and in the
acquisition agreement relating to North Dakota assets that we purchased from
Qwest. The parties are currently engaged in discovery. An arbitration hearing
has been scheduled to commence in the third quarter of 2003.
On December 21, 2001, we entered into a settlement agreement resolving all
claims in a class action lawsuit pending against the Company in Santa Cruz
County, Arizona (Chilcote, et al. v. Citizens Utilities Company, No. CV 98-471).
The lawsuit arose from claims by a class of plaintiffs that included all of our
electric customers in Santa Cruz County for damages resulting from several power
outages that occurred during the period January 1, 1997, through January 31,
1999. Under the terms of the settlement agreement, and without any admission of
guilt or wrongdoing by us, we have paid the class members $5.5 million in
satisfaction of all claims. The court approved the settlement agreement on March
29, 2002, and the lawsuit against us was dismissed with prejudice. We accrued
the full settlement amount, plus an additional amount sufficient to cover legal
fees and other related expenses, during the fourth quarter of 2001 and no
accrual remains at December 31, 2002.
As part of the Frontier acquisition, Global and we agreed to Global's transfer,
effective as of July 1, 2001, of certain liabilities and assets under the Global
pension plan for Frontier employees. Such transfer and assumption of liabilities
was to be to a trustee of a trust established under our pension plan, and would
exclude (1) those liabilities relating to certain current and former Frontier
employees who were not considered part of the Frontier acquisition (calculated
using the "safe harbor" methodology of the Pension Benefit Guaranty Corporation)
and (2) those assets attributable to such excluded liabilities. After filing for
bankruptcy on January 28, 2002, Global claimed that its obligation to transfer
the Global pension plan's transferred assets and liabilities remained
"executory" under the Bankruptcy Code, and refused to execute and deliver an
authorization letter to the Frontier plan trustee (who was also the Global plan
trustee) directing the trustee to transfer to our pension plan record ownership
of such assets and liabilities. We initiated an adversary proceeding with the
Bankruptcy Court supervising Global's bankruptcy proceeding to determine and
declare that Global's obligation was not "executory," and to compel Global to
execute and deliver such authorization letter. On December 18, 2002 we entered
into a stipulation with Global and other parties, which was approved by the
Bankruptcy Court, fully and finally settling the adversary proceeding. Pursuant
to the stipulation and order, on February 3, 2003, among other things, Global
instructed the Frontier plan trustee to transfer record ownership of the
transferred assets and liabilities to our pension plan, and the transfer in fact
took place on that date.
The City of Bangor, Maine, filed suit against us on November 22, 2002, in the
U.S. District Court for the District of Maine (City of Bangor v. Citizens
Communications Company, Civ. Action No. 02-183-B-S). The City has alleged, among
other things, that we are responsible for the costs of cleaning up environmental
contamination alleged to have resulted from the operation of a manufactured gas
plant by Bangor Gas Company, which we owned from 1948-1963. The City alleged the
existence of extensive contamination of the Penobscot River and nearby land
areas and has asserted that money damages and other relief at issue in the
lawsuit could exceed $50.0 million. The City also requested that punitive
damages be assessed against us. We have filed an answer denying liability to the
City, and have asserted a number of counter claims against the City. We intend
to defend ourselves vigorously against the City's lawsuit. In addition, we have
identified a number of other potentially responsible parties that may be
responsible for the damages alleged by the City. We expect to initiate legal
action within the next few weeks to bring those parties into the lawsuit.
We also have demanded that various of our insurance carriers defend and
indemnify us with respect to the City's lawsuit. On or about December 26, 2002,
we filed a declaratory judgment action against those insurance carriers in the
Superior Court of Penobscot County, Maine, for the purpose of establishing their
obligations to us with respect to the City's lawsuit. We intend to vigorously
pursue insurance coverage for the City's lawsuit.
On February 7, 2003, we received a letter from counsel representing Enron North
America Corporation (formerly known as Enron Gas Marketing, Inc.) demanding
payment of an "early termination liability" of approximately $12.5 million that
Enron claims it is owed under a gas supply agreement that we lawfully terminated
in November 2001. The demand was made in connection with Enron's ongoing
bankruptcy proceeding in the United States Bankruptcy Court for the Southern
District of New York. We believe Enron's claim lacks any merit and have so
advised that company's counsel. Enron has threatened to initiate an adversary
proceeding in the bankruptcy court to recover the amount of its demand plus
applicable interest and attorney's fees. If that occurs, we will vigorously
defend against any such action.
10
During the fourth quarter of 2002 we became aware of irregularities involving
payments made by certain of our public utilities operations for services or
benefits that we did not receive. The payments do not involve our current
operations in Arizona, Vermont, or Hawaii. With the assistance of forensic
specialists, outside auditors, and counsel, we investigated these irregularities
and identified a total of $7.8 million that had been embezzled from the Company.
These payments were reflected in our financial statements as charges to earnings
(primarily during 2002). The U.S. Government has recovered approximately $6.0
million (which we believe will be turned over to us) and we believe that most of
the remaining funds outstanding will be reimbursed by insurance.
We have provided detailed information regarding the results of our investigation
to federal prosecutors and the Securities and Exchange Commission, including the
names of two of our former officers (Kenneth Cohen and Livingston Ross, who were
the President and Chief Operating Officer of the Public Services Sector and the
Vice President of Reporting and Audit, respectively) who approved the payments.
We have been advised by federal prosecutors that these individuals have admitted
their involvement in these schemes and we have terminated the employment of
these individuals.
In connection with an inquiry that we believe has arisen as a result of
allegations made to federal authorities during their investigation of the
embezzlement, we and our employees are cooperating fully with the Office of the
U.S. Attorney for the Southern District of New York and with the New York office
of the Securities and Exchange Commission. We have provided requested documents
to the SEC and we have agreed to comply with an SEC request that, in connection
with the informal inquiry that it has initiated, we preserve financial, audit,
and accounting records.
We are party to proceedings arising in the normal course of our business. The
outcome of individual matters is not predictable. However, we believe that the
ultimate resolution of all such matters, after considering insurance coverage,
will not have a material adverse effect on our financial position, results of
operations, or our cash flows.
Item 4. Submission of Matters to Vote of Security Holders
-------------------------------------------------
None in fourth quarter 2002.
Executive Officers of the Registrant
- ------------------------------------
Information as to Executive Officers of the Company as of March 1, 2003 follows:
Name Age Current Position and Office
---- --- ---------------------------
Leonard Tow 74 Chairman of the Board and Chief Executive Officer
Scott N. Schneider 45 Vice Chairman of the Board, President and Chief Operating Officer
Donald B. Armour 55 Senior Vice President, Finance and Treasurer
Robert Braden 57 Executive Vice President, ILEC Sector
John H. Casey, III 46 President and Chief Operating Officer of the ILEC Sector and
Executive Vice President
Jean M. DiSturco 39 Senior Vice President, Human Resources
Jerry Elliott 43 Senior Vice President and Chief Financial Officer
Michael G. Harris 56 Senior Vice President, Engineering and New Technology
Edward O. Kipperman 51 Vice President, Tax
Robert J. Larson 43 Senior Vice President and Chief Accounting Officer
Daniel J. McCarthy 38 President and Chief Operating Officer, Public Services Sector and
Vice President
L. Russell Mitten 51 Senior Vice President, General Counsel and Secretary
Michael A. Zarrella 43 Vice President, Strategic Planning and Development
There is no family relationship between any of the officers of Citizens. The
term of office of each of the foregoing officers of Citizens will continue until
the next annual meeting of the Board of Directors and until a successor has been
elected and qualified.
11
LEONARD TOW has been associated with Citizens since April 1989 as a Director. In
June 1990, he was elected Chairman of the Board and Chief Executive Officer. He
was also Chief Financial Officer from October 1991 through November 1997. He is
a Director of Hungarian Telephone and Cable Corp., and is a Director of the
United States Telephone Association.
SCOTT N. SCHNEIDER has been associated with Citizens since November 1999. In
January 2001, he was elected Vice Chairman of the Board. In July 2000, he was
elected a Director of Citizens. He has served as Vice Chairman of the Board,
President and Chief Operating Officer of Citizens since July 2002. Previously he
was Vice Chairman, Executive Vice President from May 2001 to July 2002 and
Executive Vice President Strategic Planning and Development from May 2000 to May
2001 and Executive Vice President of Electric Lightwave, Inc. from October 1999
to May 2000. Prior to joining Citizens, he was Director from October 1994 to
October 1999, Chief Financial Officer from December 1996 to October 1999, Senior
Vice President and Treasurer from June 1991 to October 1999 of Century
Communications Corp. He also served as Director, Chief Financial Officer, Senior
Vice President and Treasurer of Centennial Cellular from August 1991 to October
1999.
DONALD B. ARMOUR has been associated with Citizens since October 2000. He was
elected Senior Vice President, Finance and Treasurer in December 2002.
Previously, he was Vice President, Finance and Treasurer from October 2000 to
December 2002. Prior to joining Citizens, he was the Treasurer of the cable
television division of Time Warner Inc. from January 1994 to September 2000.
ROBERT BRADEN has been associated with Citizens since December 1999. In January
2002, he became Executive Vice President, ILEC Sector. Previously he was Chief
Executive Officer from January 2002 to November 2002, Director from May 2001 to
November 2002, Vice President and Chief Operating Officer from February 2001 to
January 2002 and Vice President, Business Development from February 2000 to
February 2001 of Electric Lightwave, Inc. Prior to joining Citizens, he was Vice
President, Business Development at Century Communications Corp. from January
1999 to October 1999. He was Senior Vice President, Business Development at
Centennial Cellular Corp. from June 1996 to January 1999 and held other officer
positions with Centennial since November 1993.
JOHN H. CASEY, III has been associated with Citizens since November 1999. He is
currently Executive Vice President of Citizens and President and Chief Operating
Officer of our ILEC Sector. Previously he was Vice President of Citizens,
President and Chief Operating Officer, ILEC Sector January 2002 to July 2002,
Vice President and Chief Operating Officer, ILEC Sector February 2000 to January
2002 and Vice President, ILEC Sector December 1999 to February 2000. Prior to
joining Citizens, he was Vice President, Operations from January 1995 to January
1997 and then Senior Vice President, Administration of Centennial Cellular until
November 1999.
JEAN M. DISTURCO has been associated with Citizens since 1987. She was elected
Senior Vice President, Human Resources in December 2002. Previously, she was
Vice President, Human Resources since October 2001, Vice President, Compensation
and Benefits since March 2001 and Director of Compensation from 1996 to March
2001.
JERRY ELLIOTT has been associated with Citizens since March 2002. He was elected
Senior Vice President and Chief Financial Officer in December 2002. Previously,
he was Vice President and Chief Financial Officer from March 2002 to December
2002. Prior to joining Citizens, he was Managing Director of Morgan Stanley's
Communications Investment Banking Group from July 1998 to March 2002. Prior to
joining Morgan Stanley, he was a partner with the law firm of Shearman &
Sterling.
MICHAEL G. HARRIS has been associated with Citizens since December 1999. He was
elected Senior Vice President, Engineering and New Technology in December 2002.
Previously, he was Vice President, Engineering and New Technology from December
1999 to December 2002. Prior to joining Citizens, he was Senior Vice President,
Engineering of Centennial Cellular from August 1991 to December 1999. He was
also Senior Vice President, Engineering of Century Communications Corp. from
June 1991 to October 1999.
EDWARD O. KIPPERMAN has been associated with Citizens since February 1985. He
has served as Vice President, Tax since October 1991.
ROBERT J. LARSON has been associated with Citizens since July 2000. He was
elected Senior Vice President and Chief Accounting Officer of Citizens in
December 2002. Previously, he was Vice President and Chief Accounting Officer
from July 2000 to December 2002. Prior to joining Citizens, he was Vice
President and Controller of Century Communications Corp. from October 1994 to
October 1999. He was also Vice President, Accounting and Administration of
Centennial Cellular from March 1995 to October 1999.
12
DANIEL McCARTHY has been associated with Citizens since December 1990. He was
elected President and Chief Operating Officer, Electric Lightwave in January
2002. Previously, he was President and Chief Operating Officer, Public Services
Sector from November 2001 to January 2002, Vice President and Chief Operating
Officer, Public Services Sector from March 2001 to November 2001, Vice
President, Citizens Arizona Energy from April 1998 to March 2001 and Vice
President, Citizens Arizona Gas from February 1997 to April 1998.
L. RUSSELL MITTEN has been associated with Citizens since June 1990. He was
elected Senior Vice President, General Counsel and Secretary in December 2002.
Previously, he was Vice President, General Counsel and Secretary from September
2000 to December 2002. He was also Vice President, General Counsel and Assistant
Secretary from June 1991 to September 2000. He was General Counsel from June
1990 to June 1991.
MICHAEL ZARRELLA has been associated with Citizens since December 1999. He was
elected Vice President, Strategic Planning and Development in October 2000.
Previously he was Director, Strategic Planning and Development from December
1999 to October 2000. Prior to joining Citizens, he was Group Vice President of
Finance for Century Communications Corp. from June 1996 to December 1999 and
Director, Financial Analysis from October 1990 to June 1996.
13
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
---------------------------------------------------------------------
PRICE RANGE OF COMMON STOCK
Our Common Stock is traded on the New York Stock Exchange under the symbol CZN.
The following table indicates the high and low prices per share during the
periods indicated.
2002 2001
------------------ -----------------
High Low High Low
---- --- ---- ---
First Quarter $11.30 $8.91 $15.88 $12.05
Second Quarter $11.52 $8.22 $15.00 $11.28
Third Quarter $ 8.80 $2.51 $13.10 $ 8.95
Fourth Quarter $10.99 $5.44 $11.53 $ 8.20
As of February 28, 2003, the approximate number of security holders of record of
our Common Stock was 31,752. This information was obtained from our transfer
agent.
DIVIDENDS
The amount and timing of dividends payable on Common Stock are within the sole
discretion of our Board of Directors. Our Board of Directors discontinued the
payment of dividends after the payment of the December 1998 stock dividend.
RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM REGISTERED
SECURITIES
None
Item 6. Selected Financial Data
-----------------------
($ in thousands, except per share amounts) Year Ended December 31,
---------------------------------------- ---------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------ ----------- ----------- ------------
Revenue (1) $2,669,332 $ 2,456,993 $1,802,358 $ 1,598,236 $ 1,448,588
Income (loss) from continuing operations before
extraordinary expense and cumulative effect of $ (822,976) $ (63,926) $ (40,071) $ 136,599 $ 46,444
changes in accounting principle (2)
Net income (loss) $ (682,897) $ (89,682) $ (28,394) $ 144,486 $ 57,060
Basic income (loss) per share of Common Stock
from continuing operations before extraordinary expense
and cumulative effect of changes in accounting
principle (2) $ (2.93) $ (0.28) $ (0.15) $ 0.53 $ 0.18
Available for common shareholders per basic share $ (2.43) $ (0.38) $ (0.11) $ 0.56 $ 0.22
Available for common shareholders per diluted share $ (2.43) $ (0.38) $ (0.11) $ 0.55 $ 0.22
Stock dividends declared on Common Stock (3) - - - - 3.03%
As of December 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------ ----------- ----------- ------------
Total assets $8,146,742 $ 10,553,600 $6,955,006 $ 5,771,745 $ 5,292,932
Long-term debt $4,957,361 $ 5,534,906 $3,062,289 $ 2,107,460 $ 1,775,338
Equity units $ 460,000 $ 460,000 $ - $ - $ -
Shareholders' equity $1,172,139 $ 1,946,142 $1,720,001 $ 1,919,935 $ 1,792,771
(1) Represents revenue from continuing operations. Revenue from acquisitions
contributed $569.8 million and $49.5 million for the years ended December
31, 2001 and 2000, respectively. Revenue from gas operations sold
represented $218.8 million, $232.3 million, $175.4 million and $173.1
million in 2001, 2000, 1999 and 1998, respectively. Revenue from an
electric operation sold represented $76.6 million, $94.3 million, $95.1
million, $78.7 million and $72.6 million in 2002, 2001, 2000, 1999 and
1998, respectively.
(2) Extraordinary expense represents an extraordinary after tax expense of
$43.6 million related to the discontinuance of the application of Statement
of Financial Accounting Standards No. 71 to our local exchange telephone
operations in 2001. The cumulative effect of changes in accounting
principle represents write-off of ELI's goodwill of $39.8 million resulting
from the adoption of Statement of Financial Accounting Standards No. 142 in
2002 and an after tax charge of $2.3 million at ELI in 1998 resulting from
the adoption of Statement of Position 98-5.
(3) Compounded annual rate of quarterly stock dividends.
14
Item 7. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
This annual report on Form 10-K contains forward-looking statements that are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed or implied in the statements. Statements that
are not historical facts are forward-looking statements made pursuant to the
Safe Harbor Provisions of the Litigation Reform Act of 1995. In addition, words
such as "believes", "anticipates", "expects" and similar expressions are
intended to identify forward-looking statements. Forward-looking statements
(including oral representations) are only predictions or statements of current
plans, which we review continuously. Forward-looking statements may differ from
actual future results due to, but not limited to, any of the following
possibilities:
* Changes in the number of our access lines;
* The effects of competition from wireless, other wireline carriers
(through Unbundled Network Elements (UNE), Unbundled Network Elements
Platform (UNEP) or otherwise), high speed cable modems and cable
telephony;
* The effects of general and local economic conditions on our revenues;
* Our ability to effectively manage and otherwise monitor our
operations, costs, regulatory compliance and service quality;
* Our ability to divest our remaining public utilities services
businesses and the effect of the timing of the divestitures on the
capital expenditures we make with respect to such businesses;
* Our ability to successfully introduce new product offerings including
our ability to offer bundled service packages on terms attractive to
our customers, and our ability to sell enhanced and data services;
* Our ability to manage our operating expenses, capital expenditures and
reduce our debt;
* The effects of greater than anticipated competition requiring new
pricing, marketing strategies or new product offerings and the risk
that we will not respond on a timely or profitable basis;
* The effects of bankruptcies in the telecommunications industry which
could result in higher network access costs and potential bad debts;
* The effects of technological changes, including the lack of assurance
that our ongoing network improvements will be sufficient to meet or
exceed the capabilities and quality of competing networks;
* The effects of increased pension and retiree medical expenses and
related funding requirements;
* The effects of changes in regulation in the telecommunications
industry as a result of the Telecommunications Act of 1996 and other
federal and state legislation and regulation, including changes in
access charges and subsidy payments;
* The effect of restructuring of portions of the telecommunications
market;
* The effects of possible state regulatory cash management policies on
our ability to transfer cash among our subsidiaries and to the parent
company;
* Our ability to successfully renegotiate expiring union contracts,
including the contract covering the Communications Workers of America
members in Rochester that is scheduled to expire in January 2004; and
15
* The effects of more general factors, including changes in economic
conditions; changes in the capital markets; changes in industry
conditions; changes in our credit ratings; and changes in accounting
policies or practices adopted voluntarily or as required by generally
accepted accounting principles or regulators.
You should consider these important factors in evaluating any statement in this
Form 10-K or otherwise made by us or on our behalf. The following information
should be read in conjunction with the consolidated financial statements and
related notes included in this report. We have no obligation to update or revise
these forward-looking statements.
(a) Liquidity and Capital Resources
-------------------------------
For the year ended December 31, 2002, we used cash flows from continuing
operations, the proceeds from the sale of utility properties, cash and cash
equivalents and investment balances to fund capital expenditures, interest
payments and debt repayments. On January 15, 2002, we completed the sale of our
water and wastewater operations for $859.1 million in cash plus the assumption
by the buyer of $122.5 million of our debt and other liabilities. On November 1,
2002 we completed the sale of Kauai Electric division for $215.0 million in
cash. The proceeds were used for general corporate purposes, including the
repayment of outstanding indebtedness. As of December 31, 2002, we had cash and
cash equivalents aggregating $393.2 million.
For the year ended December 31, 2002, our actual capital expenditures were
$468.7 million, including $288.8 million for the ILEC segment, $12.0 million for
the ELI segment (excluding the purchase of equipment previously under lease for
$110.0 million in cash), $39.7 million for the public utilities services
segments and $18.2 million for general capital expenditures.
We have budgeted approximately $333.6 million for our 2003 capital projects;
including $275.0 million for the ILEC segment, $13.4 million for the ELI segment
and $45.2 million for the public utilities segment. In the ordinary course of
business, capital expenditures for the public utilities segment would increase
the amount of assets that would be reflected on the balance sheet. However, most
of the capital expenditures with respect to our public utilities segment during
2003 will be expensed as incurred instead of capitalized (see "Loss on
Impairment" below and Note 28).
During 1995, ELI entered into a construction agency agreement and an operating
lease agreement in connection with the construction of certain network
facilities. On April 30, 2002, ELI purchased the facilities at the lease
termination for $110.0 million in cash. Citizens had guaranteed all of ELI's
obligations under this operating lease and provided the funds for the purchase.
We have an available shelf registration of $825.6 million and we have available
lines of credit with financial institutions in the aggregate amount of $805.0
million. Associated facility fees vary, depending on our credit ratings, and are
0.25% per annum as of December 31, 2002. The expiration date for the facilities
is October 24, 2006. During the term of the facilities we may borrow, repay and
reborrow funds. As of December 31, 2002, there were no outstanding advances
under these facilities.
Tender Offer
- ------------
On May 16, 2002, we commenced a tender offer, at $0.70 per share, for all of the
publicly held Class A common shares of ELI that we did not already own. The
tender offer expired on June 17, 2002, at which time the shares tendered,
combined with the ELI shares already owned by us, represented approximately
95.5% of total outstanding ELI Class A shares. On June 20, 2002, we completed a
short-form merger in which ELI became our wholly owned subsidiary and each share
of common stock not tendered was converted into a right to receive $0.70 in cash
without interest. The total cost (including fees and expenses) of the tender was
approximately $6.8 million.
Debt Reduction
- --------------
For the year ended December 31, 2002, we retired an aggregate principal amount
of $1.06 billion of debt. We intend to continue to reduce debt balances from the
proceeds from the sale of our public service utilities and cash flows from
continuing operations and may use current cash and cash equivalent balances. If
the sale of our Arizona utility businesses to UniSource is completed, the sale
agreement requires us to promptly redeem $111.8 million principal amount of
industrial revenue bonds.
On January 7, 2002, we redeemed at par two of our outstanding 1991 series of
industrial development revenue bonds, the $20.0 million 7.15% Mohave series and
the $10.1 million 7.15% Santa Cruz series.
16
On January 31, 2002, we repaid approximately $76.9 million principal amount of
debt from the Rural Utilities Service, Rural Telephone Bank and the Federal
Financing Bank. We paid a premium of $0.5 million on these redemptions.
On March 27, 2002, we repaid $40.0 million of Frontier 7.51% Medium Term Notes
at maturity.
On May 1, 2002, we redeemed at par six of our outstanding variable rate
industrial development revenue bond series aggregating approximately $20.3
million in principal amount.
On June 27, 2002, we redeemed at par $24.8 million principal amount of our 7.05%
Mohave Industrial Development Revenue Refunding Bonds due August 1, 2020.
On July 15, 2002, we redeemed at par three of our outstanding fixed and variable
rate industrial development revenue bond series aggregating approximately $14.9
million in principal amount.
On August 7, 2002, we redeemed at par one of our outstanding variable rate
industrial development revenue bond series totaling $5.5 million in principal
amount.
Following the completion of the merger with ELI, we repaid and terminated the
entire $400.0 million outstanding under ELI's committed revolving line of credit
with a syndicate of commercial banks.
During the last three quarters of 2002, we executed a series of purchases in the
open market of a number of our outstanding notes and debentures. The aggregate
principal amount of notes and debentures purchased was $106.9 million and the
purchases generated a pre-tax gain from the early extinguishment of debt at a
discount of approximately $6.0 million. We may from time to time repurchase our
debt in the open market.
During December 2002, we completed a tender offer with respect to our 6.80%
Debentures due 2026 (puttable at par in 2003) and ELI's 6.05% Guaranteed Notes
due 2004. As a result of the tender, $82.3 million and $259.4 million,
respectively, of these securities were purchased and retired at a premium of
$12.8 million in excess of the principal amount of the securities purchased.
Interest Rate Management
- ------------------------
In order to manage our interest rate risk exposure, we entered into five
interest swap agreements in 2001 and 2002 with investment grade financial
institutions. Each agreement covered a notional amount of $50.0 million. Under
the terms of the agreements, we make semi-annual, floating interest rate
interest payments based on six month LIBOR and receive a fixed rate on the
notional amount. There are two interest rate swap agreements that were executed
in 2001 that receive a 6.375% fixed rate until the swaps' termination date of
August 15, 2004, and there are three swaps executed in 2002 that receive an
8.500% fixed rate until their termination date of May 15, 2006. The underlying
variable rate on the swaps is set either in advance, in arrears or, as in the
case of one agreement, based on each period's daily average six-month LIBOR. In
connection with these swaps, the Company entered into a series of supplemental
rate agreements which had the effect of setting the floating rate portion of the
swaps in advance of the contractually agreed upon rate determination date.
The net effect of the two 2001 interest rate swaps and supplemental rate
agreements was to reduce the effective interest rate on $100.0 million of fixed
rate debt from 6.375% to 3.665% during 2002. The net effect of the three 2002
swaps and supplemental rate agreements was to reduce the effective interest rate
on $150.0 million of fixed rate debt from 8.500% to 6.864% through November 15,
2002, the latest rate reset date. All swaps and associated supplemental rate
agreements are accounted for under SFAS 133 as fair value hedges.
17
Future Commitments
- ------------------
A summary of our future contractual obligations and commercial commitments as of
December 31, 2002 is as follows:
Less than After
($ in thousands) Total 1 year(2) 2-3 years 4-5 years 5 years
-------------- ---------- ---------- --------- --------- ----------
Long-term debt (See Note 10) (1) $5,476,272 $ 58,911 $392,390 $885,023 $4,139,948
Operating leases (See Note 28) 157,975 26,790 41,152 34,578 55,455
Long-term contracts (See Note 28) 388,752 100,812 117,591 44,599 125,750
Equity Providing Preferred
Income Convertible Securities
(EPPICS)(See Note 16) 201,250 - - - 201,250
----------- --------- -------- -------- ----------
Total contractual cash obligations $6,224,249 $186,513 $551,133 $964,200 $4,522,403
=========== ========= ======== ======== ==========
(1) Includes the debt portion of the equity units ($460.0 million) and the net
present value of payments under capital leases ($135.2 million).
(2) If the sale of our Arizona utility business to UniSource is completed, we
will redeem $111.8 million principal amount of long-term debt.
Covenants
- ---------
The terms and conditions contained in our indentures and credit facility
agreements are of a general nature, and do not currently impose significant
financial performance criteria on us. These general covenants include the timely
and punctual payment of principal and interest when due, the maintenance of our
corporate existence, keeping proper books and records in accordance with
Generally Accepted Accounting Principles (GAAP), restrictions on the allowance
of liens on our assets, and restrictions on asset sales and transfers, mergers
and other changes in corporate control. We currently have no restrictions on the
payment of dividends by us either by contract, rule or regulation.
The principal financial performance covenant under our $805.0 million credit
facilities and our $200.0 million term loan facility with the Rural Telephone
Finance Cooperative (RTFC) requires the maintenance of a minimum net worth of
$1.5 billion. These facilities define "net worth" as shareholders' equity plus
equity units plus mandatorily redeemable convertible preferred securities. Under
the RTFC loan, in the event that our credit rating from either Moody's Investors
Service or Standard & Poor's declines below investment grade (Baa3/BBB-,
respectively), we would also be required to maintain an interest coverage ratio
of 2.00 to 1 or greater and a leverage ratio of 6.00 to 1 or lower. We are in
compliance with all of our debt covenants.
At December 31, 2002 the amount of our net worth as calculated pursuant to the
credit facilities and the RTFC loan facility was $1.83 billion. In future
periods, we may incur a reduction in shareholders' equity as a result of certain
pension matters described under "Critical Accounting Policies and Estimates" or
for other reasons. Although the potential amount of future reductions cannot
currently be determined with certainty and assessments of the potential amounts
require considerable assumptions, we believe that we will remain in compliance
with all of our debt covenants.
Acquisitions
- ------------
In 1999 and 2000 we entered into several agreements to acquire telephone access
lines. These transactions have been accounted for using the purchase method of
accounting. The results of operations of the acquired properties have been
included in our consolidated financial statements from the dates of acquisition
of each property.
In 2000, we acquired from Verizon Communications Inc. approximately 317,500
telephone access lines for $948.2 million in cash, and we acquired from Qwest
approximately 17,000 telephone access lines in North Dakota for approximately
$38.0 million in cash.
On June 29, 2001, we purchased Frontier for approximately $3,373.0 million in
cash.
Divestitures
- ------------
On August 24, 1999, our Board of Directors approved a plan of divestiture for
our public utilities services businesses, which included gas, electric and water
and wastewater businesses. During 2001 we sold two of our natural gas operations
and in 2002 we sold all of our water and wastewater treatment operations and one
electric business (see Note 7 to Consolidated Financial Statements).
18
On January 15, 2002, we sold our water and wastewater services operations for
$859.1 million in cash and $122.5 million in assumed debt and other liabilities.
On October 29, 2002, we entered into definitive agreements to sell our Arizona
gas and electric divisions to UniSource Energy Corporation for $230.0 million in
cash ($220.0 million if we close by July 28, 2003) subject to adjustments
specified in the agreements (see Note 7 to Consolidated Financial Statements).
The transaction, which is subject to regulatory and other customary approvals,
is expected to close during the second half of 2003.
On October 31, 2002, we completed the sale of approximately 4,000 telephone
access lines in North Dakota for approximately $9.7 million in cash.
On November 1, 2002, we completed the sale of our Kauai electric division for
$215.0 million in cash.
On December 19, 2002, we entered into a definitive agreement to sell our
Hawaiian gas division to K-1 USA Ventures, Inc. for $115.0 million in cash,
subject to adjustments under the terms of the agreement. The transaction, which
is subject to regulatory and other customary approvals, is expected to close
during the fourth quarter of 2003.
Currently, we do not have an agreement to sell our Vermont electric division,
but we continue to actively pursue a buyer. All our gas and electric assets
(including Arizona gas and electric and Hawaii gas) and their related
liabilities are classified as "assets held for sale" and "liabilities related to
assets held for sale," respectively. These assets have been written down to our
best estimate of the net realizable value upon sale (see Note 4 to Consolidated
Financial Statements). During the third quarter of 2002, we recognized a
non-cash pre-tax impairment loss on these assets of $417.4 million. As discussed
below under "Loss on Impairment" we will record additional impairment losses
during 2003.
Discontinued operations in the consolidated statements of operations reflect the
results of operations and the gain on sale of the water/wastewater properties
sold in January 2002 including allocated interest expense for the periods
presented. Interest expense was allocated to the discontinued operations based
on the outstanding debt specifically identified with this business.
Discontinuation of SFAS 71
- --------------------------
Prior to the 2000 and 2001 acquisitions, our incumbent local exchange telephone
properties had been predominantly regulated following a cost of service/rate of
return approach. Accordingly, we applied the provisions of Statement of
Financial Accounting Standards (SFAS) No. 71 in the preparation of our
consolidated financial statements.
Currently, pricing for a majority of our revenues in our previously existing
incumbent local exchange telephone properties is based upon price cap plans that
limit prices to changes in general inflation and estimates of productivity for
the industry at large or upon market pricing rather than on the specific costs
of operating our business, a requirement for the application of SFAS 71. These
trends in the deregulation of pricing and the introduction of competition are
expected to continue. We intend to operate all of our properties as competitive
enterprises, to meet competitive entry and maximize revenue by providing a broad
range of products and services, such as data services. Many of these future
services will not be regulated, further increasing the percentage of our revenue
provided by our networks that is not based upon historical cost/rate of return
regulation.
In the third quarter of 2001, we concluded based on the factors mentioned above,
that the provisions of SFAS 71 were no longer applicable to our incumbent local
exchange telephone properties (properties we owned prior to the acquisitions in
2000 and 2001).
As discussed further in Note 24 to Consolidated Financial Statements, in 2001 we
recorded a non-cash extraordinary charge of $43.6 million net of tax in our
statement of operations, to write-off regulatory assets and liabilities recorded
on our balance sheet in the past. Based upon our evaluation of the pace of
technological change that is estimated to occur in certain components of our
rural telephone networks, we concluded that minor modifications in our asset
lives were required for the major network technology assets. In accordance with
the provisions of SFAS 101 and SFAS 121, we performed a test of the impairment
of the property, plant and equipment accounts for our properties discontinuing
SFAS 71 and based upon our expectations of future changes in sales volumes and
prices and the anticipated rate of entry of additional competition into our
markets, we concluded that an asset impairment was not warranted.
19
Critical Accounting Policies and Estimates
- ------------------------------------------
We review all significant estimates affecting our consolidated financial
statements on a recurring basis and record the effect of any necessary
adjustment prior to their publication. Uncertainties with respect to such
estimates and assumptions are inherent in the preparation of financial
statements; accordingly, it is possible that actual results could differ from
those estimates and changes to estimates could occur in the near term. The
preparation of our financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of the contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Estimates and judgments are used when accounting for allowance for
doubtful accounts, impairment of long-lived assets, intangible assets,
depreciation and amortization, employee benefit plans, income taxes and
contingencies, among others.
Our estimate of anticipated losses related to telecommunications bankruptcies is
a "critical accounting estimate." We have significant on-going normal course
business relationships with many telecom providers, some of which have filed for
bankruptcy. We generally reserve approximately 95% of the net outstanding
pre-bankruptcy balances owed to us and believe that our estimate of the net
realizable value of the amounts owed to us by bankrupt entities is appropriate.
We believe that the accounting estimate related to asset impairment is a
"critical accounting estimate". With respect to ELI, the estimate is highly
susceptible to change from period to period because it requires management to
make significant judgments and assumptions about future revenue, operating costs
and capital expenditures over the life of the property, plant and equipment
(generally 5 to 15 years) as well as the probability of occurrence of the
various scenarios and appropriate discount rates. Management's assumptions about
ELI's future revenue, operating costs and capital expenditures as well as the
probability of occurrence of these various scenarios require significant
judgment because the CLEC industry is changing and because actual revenue,
operating costs and capital expenditures have fluctuated dramatically in the
past and may continue to do so in the future. The calculation of depreciation
and amortization expense is based on the estimated economic useful lives of the
underlying property, plant and equipment and identifiable intangible assets.
Although we believe it is unlikely that any significant changes to the useful
lives of our tangible or intangible assets will occur in the near term, rapid
changes in technology or changes in market conditions could result in revisions
to such estimates that could affect the carrying value of these assets and our
future consolidated operating results. Our depreciation expense of the ELI
segment will decrease substantially in future periods as a result of the
impairment write down. With respect to our remaining gas and electric
properties, our estimate is based upon expected future sales prices of these
properties. (See Notes 4 and 7 to Consolidated Financial Statements).
In the third quarter 2002, we recognized a non-cash pre-tax loss on impairment
of $656.7 million for the impairment of long-lived assets in the ELI sector and
a total of $417.4 million of non-cash pre-tax losses on impairment in the gas
and electric sectors. We determined that we may not be able to recover the
previously recorded carrying value of ELI's property, plant, and equipment and
therefore recorded the impairment charge accordingly. The gas and electric
impairment is associated with the proposed sales of our Arizona gas and electric
and Hawaiian gas properties at a price that was less than the book carrying
value. We have also written down the value of our remaining utility to our
estimate of net realizable sale price.
Our indefinite lived intangibles consist of goodwill and trade name, which
resulted from the purchase of ILEC properties. We test for impairment of these
assets annually, or more frequently, as circumstances warrant. All of our ILEC
properties share similar economic characteristics and as a result, our reporting
unit is the ILEC segment. In determining fair value during 2002 we utilized two
tests. One test utilized recent trading prices for completed ILEC acquisitions
of similarly situated properties. A second test utilized current trading values
for the Company's publicly traded common stock. We reviewed the results of both
tests for consistency to insure that our conclusions were appropriate.
Additionally, we utilized a range of prices to gauge sensitivity. Our tests
determined that fair values exceeded book value. Unless economic conditions
change significantly (i.e. we experience unanticipated declines in revenue, and
or declines in both our stock price and ILEC property values) we do not believe
that a charge for impairment is reasonably likely to occur in the near future.
Our estimates of pension expense, other post retirement benefits including
retiree medical benefits and related liabilities are "critical accounting
estimates". Our pension and other post retirement benefits expenses are based
upon a set of assumptions that include projections of future interest rates and
asset returns. Actual results may vary from these estimates. If future market
conditions cause either a decline in interest rates used to value our pension
plan liabilities or reductions to the value of our pension plan assets we
potentially could incur additional charges to our shareholder's equity at the
end of 2003. Based upon market conditions existing at the end of February 2003,
an additional charge of approximately $30 - $35 million would be required at the
end of 2003 should market conditions remain unchanged.
20
Management has discussed the development and selection of these critical
accounting estimates with the audit committee of our board of directors and our
audit committee has reviewed our disclosure relating to them.
New Accounting Pronouncements
- -----------------------------
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets." This statement requires that goodwill and other intangibles with
indefinite useful lives no longer be amortized to earnings, but instead be
reviewed for impairment. We have no intangibles with indefinite useful lives
other than goodwill and trade name. The amortization of goodwill and trade name
ceased upon adoption of the statement on January 1, 2002. We were required to
test for impairment of goodwill and other intangibles with indefinite useful
lives as of January 1, 2002 and at least annually thereafter. Any transitional
impairment loss at January 1, 2002 is recognized as the cumulative effect of a
change in accounting principle in our statement of operations. As a result of
our adoption of SFAS 142, we recognized a transitional impairment loss related
to ELI of $39.8 million as a cumulative effect of a change in accounting
principle in our statement of operations in the first quarter of 2002. We
annually examine the carrying value of our goodwill and other intangibles with
estimated useful lives to determine whether there are any impairment losses and
have determined for the year ended December 31, 2002 that there was no
impairment.
SFAS No. 142 also requires that intangible assets with estimated useful lives be
amortized over those lives and be reviewed for impairment in accordance with
SFAS No. 144, "Accounting for Impairment or Disposal or Long-Lived Assets."
During the first quarter of 2002, we reassessed the useful life of our
intangible assets with estimated useful lives and determined that no change was
required. The impact of the adoption of SFAS No. 142 is discussed in Note 6 to
Consolidated Financial Statements.
In August 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligations." This statement addresses the financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. SFAS 143 requires that the fair value of
a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset and reported as a liability. This statement is effective
for fiscal years beginning after June 15, 2002. We are currently evaluating the
impact of adoption of SFAS 143.
In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement establishes a single accounting
model, based on the framework established in SFAS 121, for impairment of
long-lived assets held and used and for long-lived assets to be disposed of by
sale, whether previously held and used or newly acquired, and broadens the
presentation of discontinued operations to include more disposal transactions.
We adopted this statement on January 1, 2002.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This
statement eliminates the requirement that gains and losses from extinguishment
of debt be aggregated and, if material, classified as an extraordinary item, net
of related income tax effect. The statement requires gains and losses from
extinguishment of debt to be classified as extraordinary items only if they meet
the criteria in Accounting Principles Board Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" which provides guidance for distinguishing transactions that are
part of an entity's recurring operations from those that are unusual or
infrequent or that meet the criteria for classification as an extraordinary
item. We adopted SFAS 145 in the second quarter of 2002. During the year ended
December 31, 2002, we recognized $32.3 million of gains from early debt
retirement as other income. There were no similar types of retirements in 2001.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which nullified Emerging Issues Task Force
(EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity." SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred, rather than on the date of commitment to an exit
plan. This Statement is effective for exit or disposal activities that are
initiated after December 31, 2002. We are currently evaluating the impact of the
adoption of SFAS 146.
21
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure for Stock-Based Compensation." SFAS No.
148 provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based compensation and amends
the disclosure requirements of SFAS No. 123. This statement is effective for
fiscal years ending after December 15, 2002. We have adopted the expanded
disclosure requirements of SFAS No. 148.
(b) Results of Operations
---------------------
REVENUE
ILEC revenue is generated primarily through the provision of local, network
access, long distance and data services. Such services are provided under either
a monthly recurring fee or based on usage at a tariffed rate and is not
dependent upon significant judgments by management, with the exception of a
determination of a provision for uncollectible amounts.
CLEC revenue is generated through local, long distance, data and long haul
services. These services are primarily provided under a monthly recurring fee or
based on usage at agreed upon rates and are not dependent upon significant
judgments by management with the exception of the determination of a provision
for uncollectible amounts and realizability of reciprocal compensation. CLEC
usage based revenue includes amounts determined under reciprocal compensation
agreements. While this revenue is governed by specific contracts with the
counterparty, management defers recognition of portions of such revenue until
realizability is assured. Revenue earned from long-haul contracts is recognized
over the term of the related agreement.
Revenue from the provision of public utility services are recognized based on
usage without significant judgments made by management with the exception of a
provision for uncollectible accounts.
Consolidated revenue increased $212.3 million, or 9%, in 2002 and $654.6
million, or 36%, in 2001. The increase in 2002 was primarily due to $420.5
million of increased telecommunications revenue, largely due to the impact of
the Frontier acquisition on June 29, 2001, partially offset by $195.0 million of
decreased gas revenue largely due to the disposition of the Louisiana and
Colorado gas operations and the disposition of the Kauai electric division. The
increase in 2001 was primarily due to the impact of acquisitions in the ILEC
sector as well as the pass-through to customers of the increased cost of gas
offset by the disposition of the Louisiana and Colorado gas operations.
TELECOMMUNICATIONS REVENUE
($ in thousands) 2002 2001 2000
-------------- --------------------------- ----------------------------- ----------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------- --------- ------------------ ----------
Access services $ 673,456 $ 108,786 19% $ 564,670 $ 182,136 48% $ 382,534
Local services 869,907 196,587 29% 673,320 277,574 70% 395,746
Long distance and data service 305,455 97,181 47% 208,274 101,612 95% 106,662
Directory services 104,383 32,008 44% 72,375 34,951 93% 37,424
Other 109,704 34,290 45% 75,414 34,037 82% 41,377
--------- --------- ---------- ---------- ----------
ILEC revenue 2,062,905 468,852 29% 1,594,053 630,310 65% 963,743
ELI 175,079 (48,312) -22% 223,391 (17,401) -7% 240,792
--------- --------- ---------- ---------- ----------
$2,237,984 $ 420,540 23% $1,817,444 $ 612,909 51% $1,204,535
========= ========= ========== ========== ==========
Changes in the number of our access lines is the most fundamental driver of
changes in our telecommunications revenue. Historically, rural local telephone
companies experienced steady growth in access lines because of positive
demographic trends, steady rural local economies and little competition. In
recent quarters many rural local telephone companies (including us) have
experienced a loss of access lines primarily because of difficult economic
conditions, increased competition from competitive wireline providers (including
from Unbundled Network Elements), from wireless providers and from cable
companies (currently with respect to broadband but which may in the future
expand to cable telephony), and by some customers disconnecting second lines
when they add DSL or cable modem service. We lost approximately 37,000 access
lines during 2002 but added approximately 41,100 DSL subscribers during this
period. The loss of lines during 2002 was equally weighted between residential
and non-residential customers. The non-residential line losses were principally
in Rochester, while the residential losses were throughout our markets. We
expect to continue to lose access lines during 2003. A continued decrease in
access lines, combined with continuing difficult economic conditions and
increased competition, may cause our revenues to decrease in 2003.
22
Prior to 2002, we reported subscriber line charges (SLC) in both the access and
local revenue categories. Beginning in the second quarter 2002, all SLC revenue
is reported in the local services category. All prior periods have been
conformed to this presentation. The average amount of SLC that was previously
reported in access services is $22.9 million per quarter.
Access services revenue for the year ended December 31, 2002 increased $108.8
million, or 19%, as compared with the prior year period primarily due to the
full year impact of Frontier of $92.4 million. Increases in subsidies of $20.3
million and non-switched access revenue of $12.5 million due to higher circuit
sales were partially offset by a decrease in switched access revenue of $16.5
million primarily from the effect of tariff rate reductions effective as of July
1, 2002. Our subsidy revenues in 2003 are expected to be slightly lower than
2002.
Access services revenue for the year ended December 31, 2001 increased $182.1
million, or 48%, as compared with the prior year period primarily due to
additional revenues of $159.1 million resulting from acquisitions. Growth in
minutes of use, special access and subsidies revenue contributed $3.1 million,
$17.9 million and $20.0 million, respectively. The increases were partially
offset by $6.5 million from the effect of the FCC's CALLS mandate which reduced
access charges paid by long distance companies and $7.3 million in rate
decreases in effect as of July 1, 2001. Access services revenue in 2001 also
includes a reclassification of $13.9 million in revenue that was classified as
local services revenue in 2000.
Local services revenue for the year ended December 31, 2002 increased $196.6
million, or 29%, as compared with the prior year period primarily due to the
full year impact of Frontier of $184.8 million. Increases of $8.0 million in
enhanced services for feature packages and $12.5 million from SLC were partially
offset by an $8.6 million decrease resulting from rate changes and line losses.
Although we continue to increase our penetration of enhanced services, in
current economic conditions the rate of increase in sales is lower than in prior
periods and we expect this trend to continue. Local services revenue for the
year ended December 31, 2001 increased $277.6 million, or 70%, as compared with
the prior year period primarily due to acquisitions, which contributed $260.9
million and growth in enhanced services of $8.1 million. Local services revenue
in 2001 also reflects a reduction for the reclassification of $13.9 million in
revenue that was classified as access revenue in 2000.
Long distance and data services revenue for the year ended December 31, 2002
increased $97.2 million, or 47%, as compared with the prior year period
primarily due to the full year impact of Frontier of $72.4 million, $13.7
million growth related to data and dedicated circuits and growth in long
distance services of $11.0 million. The rate of increases in our data and long
distance revenues has been slowing recently because of economic conditions and
intense competition in some of our markets. We expect these factors will
continue to affect our long distance and data services revenues during 2003.
Long distance and data services revenue for the year ended December 31, 2001
increased $101.6 million, or 95%, as compared with the prior year period
primarily due to the impact of acquisitions of $78.2 million, principally the
long-distance and data revenue associated with Frontier, which contributed $74.1
million. Growth in data and dedicated circuits of $14.9 million and growth in
long distance services of $7.7 million also contributed to the increase.
Directory services revenue for the year ended December 31, 2002 increased $32.0
million, or 44%, as compared with the prior year period primarily due to the
full year impact of Frontier of $30.0 million and growth in yellow pages
advertising revenue of $2.0 million. Directory services revenue for the year
ended December 31, 2001 increased $35.0 million, or 93%, as compared with the
prior year period primarily due to the impact of acquisitions, which contributed
$33.2 million, and growth of $1.8 million.
Other revenue for the year ended December 31, 2002 increased $34.3 million, or
45%, as compared with the prior year period primarily due to the full year
impact of Frontier of $32.8 million. Other revenue for the year ended December
31, 2001 increased $34.0 million, or 82%, as compared with the prior year period
primarily due to the impact of acquisitions of $38.4 million, partially offset
by a decrease in miscellaneous revenue categories.
ELI revenue for the years ended December 31, 2002 and 2001 decreased $48.3
million, or 22% and $17.4 million, or 7%, respectively, primarily due to lower
reciprocal compensation minutes and prices, a decline in Integrated Service
Digital Network (ISDN) services due to less demand from internet service
providers and lower demand and prices for long haul services. The decrease in
2001 was also attributable to the expiration of a material data services
contract in February 2001. ELI has experienced eight consecutive quarters of
declining revenue.
23
GAS AND ELECTRIC REVENUE
($ in thousands)
-------------- 2002 2001 2000
----------------------------- ------------------------------- ----------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------- ---------- -------------------- ----------
Gas revenue $ 216,517 $ (195,017) -47% $ 411,534 $ 36,783 10% $ 374,751
Electric revene $ 214,831 $ (13,184) -6% $ 228,015 $ 4,943 2% $ 223,072
Gas revenue for the year ended December 31, 2002 decreased $195.0 million, or
47%, as compared with the prior year period primarily due to the sale of our
Louisiana and Colorado gas operations partially offset by higher purchased gas
costs passed on to consumers. Gas revenue for the year ended December 31, 2001
increased $36.8 million, or 10%, as compared with the prior year period
primarily due to higher purchased gas costs passed on to customers and increased
consumption partially offset by decreased revenue due to the sale of our
Louisiana and Colorado gas operations. Included in gas revenue for 2001 and 2000
is approximately $218.8 million and $232.3 million, respectively, of revenue
from our Louisiana and Colorado gas operations that ceased upon the sale of
those operations on July 2, 2001 and November 30, 2001, respectively. Under
tariff provisions, the cost of our gas purchases are primarily passed on to
customers.
Electric revenue for the year ended December 31, 2002 decreased $13.2 million,
or 6%, as compared with the prior year period primarily due to the sale of our
Kauai electric division partially offset by increased unit sales and the effect
of a rate increase approved in Vermont on July 15, 2002. Electric revenue for
the year ended December 31, 2001 increased $4.9 million, or 2%, as compared with
the prior year period primarily due to customer growth and increased consumption
due to warmer weather conditions. Included in electric revenue for 2002, 2001
and 2000 is approximately $76.2 million, $94.3 million and $95.1 million,
respectively, of revenue for our Kauai electric operation that ceased upon its
sale on November 1, 2002. Under tariff provisions, the cost of our electric
energy and fuel oil purchases are primarily passed on to customers.
COST OF SERVICES
($ in thousands) 2002 2001 2000
-------------- ----------------------------- ----------------------------- ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------- ---------- ------------------ ---------
Network access $ 235,462 $ 41,368 21% $ 194,094 $ 55,924 40% $ 138,170
Gas purchased 122,915 (159,146) -56% 282,061 52,523 23% 229,538
Electric energy and fuel
oil purchased 118,543 (4,680) -4% 123,223 9,258 8% 113,965
--------- --------- ---------- ---------- ---------
$ 476,920 $(122,458) -20% $ 599,378 $117,705 24% $ 481,673
========= ========= ========== ========== =========
Network access expenses for the year ended December 31, 2002 increased $41.4
million, or 21%, as compared with the prior year period primarily due to the
full year impact of Frontier of $41.3 million and increased costs of $16.6
million in the ILEC sector, partially offset by decreased costs of $16.5 million
in ELI as a result of decreases in demand.
Network access expenses for the year ended December 31, 2001 increased $55.9
million, or 40%, as compared with the prior year period primarily due to the
impact of acquisitions and increased circuit expense associated with additional
data product introductions partially offset by a reduction in long distance
access expense related to rate changes in the ILEC sector and reduced network
access expenses at ELI.
Gas purchased for the year ended December 31, 2002 decreased $159.1 million, or
56%, as compared with the prior year period primarily due to the sale of our
Louisiana and Colorado gas operations partially offset by an increase in the
cost of gas due to higher commodity pricing. Gas purchased for the year ended
December 31, 2001 increased $52.5 million, or 23%, as compared with the prior
year period primarily due to higher purchased gas costs partially offset by
decreased gas purchased due to the sale of our Louisiana and Colorado gas
operations. Included in gas purchased for 2001 and 2000 is approximately $173.3
million and $151.4 million, respectively, of gas purchased by our Louisiana and
Colorado gas operations that ceased upon the sale of those operations on July 2,
2001 and November 30, 2001, respectively.
Electric energy and fuel oil purchased for the year ended December 31, 2002
decreased $4.7 million, or 4%, as compared with the prior year period primarily
due to the sale on November 1, 2002 of Kauai electric partially offset by
increased purchased power costs. Included in electric energy and fuel oil
purchased for 2002, 2001 and 2000 is approximately $27.5 million, $37.9 million
and $37.9 million, respectively, of electricity purchased by our Kauai electric
operation that ceased upon its sale on November 1, 2002.
24
Electric energy and fuel oil purchased for the year ended December 31, 2001
increased $9.3 million, or 8%, as compared with prior year period primarily due
to higher purchased power prices, customer growth and increased consumption due
to warmer weather conditions. Gas, electric energy and fuel oil purchased
excludes amounts deferred for future recovery in rates.
In Arizona, power costs charged by our supplier were in excess of the rates we
charged our customers by approximately $123.6 million through December 31, 2002.
We believe that we are allowed to recover these charges from ratepayers through
the Purchase Power Fuel Adjustment clause that was approved by the Arizona
Corporation Commission and has been in place for several years. However, in an
attempt to limit "rate shock" to our customers, we requested in September 2001
that our unrecovered power costs, plus interest, be recovered over a seven-year
period. As a result, we deferred these costs on the balance sheet in
anticipation of recovery through the regulatory process. This balance was
effectively reduced by the public service impairment charge recorded during the
third quarter of 2002 which reduced the net assets of these businesses to their
estimated sale value (See Note 4 to Consolidated Financial Statements). In
January 2003, the Commission agreed to consolidate this matter with the
application for approval of the sale of our Arizona electric property.
OTHER OPERATING EXPENSES
($ in thousands) 2002 2001 2000
-------------- ------------------------------ ----------------------------- ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------- ---------- ------------------ ----------
Operating expenses $ 762,053 $ 22,931 3% $ 739,122 $ 101,919 16% $ 637,203
Taxes other than income taxes 131,258 15,448 13% 115,810 15,709 16% 100,101
Sales and marketing 109,044 12,266 13% 96,778 22,156 30% 74,622
---------- --------- ---------- ---------- ---------
$1,002,355 $ 50,645 5% $ 951,710 $ 139,784 17% $ 811,926
========== ========= ========== ========== =========
Operating expenses for the year ended December 31, 2002 increased $22.9 million,
or 3%, as compared with prior year period primarily due to increased operating
expenses related to the full year impact of Frontier of $149.9 million partially
offset by increased operating efficiencies and a reduction of personnel in the
ILEC and ELI sectors, and decreased operating expenses in the gas sector due to
the sale of our Louisiana and Colorado gas operations on July 2, 2001 and
November 30, 2001, respectively. The increase was also offset by the fact that
there were no acquisition assimilation costs in 2002 compared to $21.4 million
of such costs in 2001. We routinely review our operations, personnel and
facilities to achieve greater efficiencies. These reviews may result in
reductions in personnel and an increase in severance costs.
Included in operating expenses is pension expense. In future periods, if the
value of our pension assets decline and/or projected benefit costs increase, we
may have increased pension expenses. Based on current assumptions and plan asset
values, we estimate that our pension expense will increase from $4.3 million in
2002 to approximately $13.0 - $15.0 million in 2003 and that a contribution to
our pension plans will be required in 2003 in an amount currently estimated at
$16.0 - $18.0 million. In addition, as medical costs increase the costs of our
retiree medical obligations also increase. Our retiree medical costs for 2002
were $15.1 million and our current estimate for 2003 is approximately $15 - $16
million.
Operating expenses for the year ended December 31, 2001 increased $101.9
million, or 16%, as compared with the prior year period primarily due to the
impact of acquisitions. The increase was partially offset by decreased operating
expenses at ELI primarily due to a reduction in personnel, decreased operating
expenses in the gas sector primarily due to the sale of the Louisiana and
Colorado gas operations and a decrease in compensation expense related to
variable stock plans.
In future periods, compensation expense related to variable stock plans may be
materially affected by our stock price. A $1.00 change in our stock price
impacts compensation expense by approximately $1.0 million. There was no
material impact for the year ended December 31, 2002.
Taxes other than income taxes for the year ended December 31, 2002 increased
$15.4 million, or 13%, as compared to prior year period primarily due to the
full year impact of Frontier of $25.6 million partially offset by decreased
payroll taxes in the ILEC sector related to workforce reductions and decreased
taxes in the gas sector due to the sale of our Louisiana and Colorado gas
operations on July 2, 2001 and November 30, 2001, respectively. Taxes other than
income for the year ended December 31, 2001 increased $15.7 million, or 16%, as
compared to prior year period primarily due to the impact of acquisitions.
25
Sales and marketing expenses for the year ended December 31, 2002 increased
$12.3 million, or 13%, as compared to prior year period primarily due to the
full year impact of Frontier of $22.2 million, partially offset by decreased
sales and marketing in the ELI sector of $10.0 million, primarily due to a
reduction in personnel and related costs. Sales and marketing expenses for year
ended December 31, 2001 increased $22.2 million, or 30%, as compared to prior
year period primarily due to the impact of acquisitions and increased
telemarketing costs in the telecommunications sector.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) 2002 2001 2000
-------------- --------------------------- ----------------------------- ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ----------------- ---------- ------------------ ---------
Depreciation expense $ 630,113 $ 141,156 29% $ 488,957 $ 118,838 32% $ 370,119
Amortization expense 125,409 (17,970) -13% 143,379 125,891 720% 17,488
--------- --------- ---------- ---------- ---------
$ 755,522 $ 123,186 19% $ 632,336 $ 244,729 63% $ 387,607
========= ========= ========== ========== =========
Depreciation expense for the year ended December 31, 2002 increased $141.2
million, or 29%, as compared to prior year period primarily due to the full year
impact of Frontier of $82.6 million and increased depreciation of $35.6 million
at ELI. The increase at ELI was primarily due to the purchase of $110.0 million
of previously leased facilities in April 2002 and changes in our estimates of
the depreciable lives as of June 2002 offset by a decrease related to the ELI
impairment charge recognized during the third quarter of 2002. As a result of
the ELI impairment, we expect 2003 depreciation and amortization expense to
decline 10% - 15%.
Depreciation expense for the year ended December 31, 2001 increased $118.8
million, or 32%, as compared to prior year period primarily due to the impact of
acquisitions of $119.1 million and $22.0 million of accelerated depreciation
related to the change in useful lives of our accounting and human resource
systems and our Plano, Texas office building, furniture and fixtures. Higher
property, plant and equipment balances in the telecommunications and ELI sectors
also contributed to the increase. The increases were partially offset by
decreased depreciation expense related to our classifying our gas and electric
sectors as "assets held for sale" which requires us to cease depreciating these
assets. Such depreciation expense would have been an additional $50.8 million
for the year ended December 31, 2001. The increase is also offset by $17.4
million in the prior year period of accelerated depreciation related to the
change in useful life of an operating system in the telecommunications sector.
Amortization expense for the year ended December 31, 2002 decreased $18.0
million, or 13%, as compared to the prior year period primarily due to the fact
that we ceased amortization of goodwill and trade name related to our previous
acquisitions as of January 1, 2002 in accordance with SFAS No. 142, "Goodwill
and Other Intangible Assets." As a result of ELI's adoption of SFAS 142, we
recognized a transitional impairment loss of $39.8 million as a cumulative
effect of a change in accounting principle in our statement of operations in the
first quarter of 2002. For the year ended December 31, 2001 amortization expense
included $91.2 million of goodwill and trade name amortization. This decrease
was offset by the impact of additional amortization of customer base of Frontier
of $47.6 million and $24.1 million in 2002 and 2001, respectively. Amortization
expense for the year ended December 31, 2001 increased $125.9 million as
compared to prior year period primarily due to amortization of intangibles
related to acquisitions.
RESERVE FOR TELECOMMUNICATIONS BANKRUPTCIES / RESTRUCTURING AND OTHER EXPENSES
($ in thousands) 2002 2001 2000
-------------- --------------------------- ----------------------------- ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ----------------- ---------- ------------------ ---------
Reserve for telecommunications
bankruptcies $ 10,880 $ (10,320) -49% $ 21,200 $ 21,200 100% $ -
Restructuring and other expenses $ 37,186 $ 17,859 92% $ 19,327 $ 19,976 3078% $ (649)
26
During the second quarter 2002, we reserved approximately $21.6 million of trade
receivables with WorldCom as a result of WorldCom's filing for bankruptcy. These
receivables were generated as a result of providing ordinary course
telecommunications services. The $21.6 million charge was partially offset by
reversals in our Global reserve as discussed below.
Concurrent with the acquisition of Frontier, we entered into several operating
agreements with Global. We have ongoing commercial relationships with Global
affiliates. We reserved a total of $29.0 million of Global receivables to
reflect our best estimate of the net realizable value of receivables incurred
from these commercial relationships during 2001 and 2002 as a result of Global's
filing for bankruptcy. We recorded a write-down of such receivables in the
amount of $7.8 million in the first quarter 2002 and $21.2 million in the fourth
quarter of 2001. In 2002, as the result of a settlement agreement with Global,
we reversed $17.9 million of our previous reserve of the net realizable value of
these receivables. Prior to the date of Global's bankruptcy filing, we provided
ordinary course telecommunications services as well as transitional services to
Global. Global has provided us certain customer billing and collection functions
as well as other transitional services. Although some of these arrangements have
continued after the bankruptcy filing, we are in the process of changing some
services and functions to provide them ourselves. The Bankruptcy Court has
granted relief to us and other telecommunications companies that provide service
to Global by, among other things, directing a shortened payment period with
respect to post-petition invoices, an expedited court process for post-petition
defaults in payments by Global, and a priority for post-petition expense items
over other unsecured debt. These procedures should minimize future economic loss
to us although we cannot guarantee that additional losses will not occur.
Restructuring and other expenses for the year ended December 31, 2002 primarily
consist of $33.0 million related to reductions in personnel at our
telecommunications operations, costs that were spent at both our Plano, Texas
facility and at other locations as a result of transitioning functions and jobs,
and $6.8 million related to our tender offer in June 2002 for all of the ELI
common shares that we did not already own. These costs were partially offset by
a $2.8 million reversal of a 2001 ELI accrual discussed below.
Plano Restructuring
Pursuant to a plan adopted in the third quarter of 2001, we closed our
operations support center in Plano, Texas in August 2002. In connection
with this plan, we recorded a pre-tax charge of $14.6 million in the second
half of 2001, $0.8 million in the first quarter of 2002 and we adjusted our
accrual down by $0.1 million and $0.6 million in the second and third
quarter of 2002, respectively. Our objective is to concentrate our
resources in areas where we have the most customers, to better serve those
customers. We sold our Plano office building in 2003. The restructuring
resulted in the termination of 750 employees. We communicated with all
affected employees during July 2001. Certain employees were relocated
whereas others were offered severance, job training and/or outplacement
counseling. As of December 31, 2002, approximately $14.7 million had been
paid and all affected employees had been terminated. The restructuring
expenses primarily consist of severance benefits, retention payments earned
through December 31, 2002, and other planning and communication costs.
Sacramento Call Center Restructuring
In April 2002, we closed our Sacramento Customer Care Center. In connection
with this closing, we recorded a pre-tax charge of $0.7 million in the
fourth quarter of 2001, and $0.1 million and $9,000 in the first and second
quarters of 2002, respectively. We redirected the call traffic and other
work activities to our Kingman, Arizona call center. This restructuring
resulted in the elimination of 98 employees. We communicated with all
affected employees during November 2001. As of December 31, 2002,
approximately $0.8 million was paid, all affected employees were terminated
and no accrual remained.
ELI Restructuring
In the first half of 2002, ELI redeployed the internet routers, frame relay
switches and ATM switches from the Atlanta, Cleveland, Denver, Philadelphia
and New York markets to other locations in ELI's network. ELI ceased
leasing the collocation facilities and off-net circuits for the backbone
and local loops supporting the service delivery in these markets. It was
anticipated that this would lead to $4.2 million of termination fees which
were accrued for but not paid at December 31, 2001. During 2002, ELI
adjusted its original accrual down by $2.8 million due to the favorable
settlements of termination charges for off-net circuit agreements. As of
December 31, 2002, $1.4 million has been paid and no accrual remained.
27
LOSS ON IMPAIRMENT
($ in thousands) 2002 2001 2000
-------------- ---------- ------- --------
Amount Amount Amount
---------- ------- --------
Loss on impairment $1,074,058 $ - $ -
In the third quarter 2002, we recognized non-cash pre-tax impairment losses of
$656.7 million related to property, plant and equipment in the ELI sector and
$417.4 million related to the gas and electric sector assets held for sale. Our
assessment of impairment for ELI was a result of continued losses at ELI and
continued actual revenue declines in excess of projected revenue declines. The
gas and electric sector impairments are associated with the proposed sale of our
Arizona and Hawaiian gas and electric properties at prices that are less than
the previous carrying values and the write down of our remaining utility to our
estimate of net realizable sales price. Previously, we believed that the net
realizable value of these properties was equal to or above their carrying
values. However, as a result of market conditions, and the desire to complete
the divestiture process quickly in order to focus on our core telecommunications
operations and raise money to further reduce debt, in the third quarter of 2002
we made a strategic decision to accept proceeds less than carrying values rather
than continue to market these properties for higher prices (See Critical
Accounting Policies and Estimates above).
We expect to incur additional impairment losses during 2003 with respect to our
public utility properties. These properties are carried at our estimates of net
realizable values. Under the terms of the definitive agreements relating to the
sale of our Arizona and Hawaiian properties, most of the capital expenditures we
will make during 2003 for these properties will not be recovered. As a result,
the amount of these expenditures (currently estimated at $28 million through the
expected closing dates) will be expensed as incurred and not capitalized. These
expenditures are of a normal recurring nature and are necessary to provide safe,
reliable utility service to customers. We generally do not enter into firm,
committed contracts for such activities. If the closing dates for the sales of
our Arizona and Hawaiian properties actually occur later than the currently
expected dates, the actual amount of capital expenditures expensed will exceed
this estimate.
INVESTMENT AND OTHER INCOME (LOSS), NET / GAIN ON SALE OF ASSETS /
MINORITY INTEREST / INTEREST EXPENSE / INCOME TAX BENEFIT
($ in thousands) 2002 2001 2000
-------------- ------------------------------ -------------------------------- ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------ ----------- ------------------- ---------
Investment income (loss), net $ (98,359) $ (35,951) 58% $ (62,408) $ (67,144) -1418% $ 4,736
Other income (loss), net $ 15,806 $ 18,939 605% $ (3,133) $ (1,747) 126% $ (1,386)
Gain on sale of assets $ 9,798 $(129,506) -93% $ 139,304 $ 139,304 100% $ -
Minority interest $ - $ - 0% $ - $ (12,222) -100% $ 12,222
Interest expense $ 471,296 $ 91,970 24% $ 379,326 $ 191,960 102% $187,366
Income tax benefit $(414,874) $(400,069) 2702% $ (14,805) $ 1,327 -8% $(16,132)
Investment loss for the year ended December 31, 2002 increased $36.0 million, or
58%, as compared to prior year period primarily due to the recognition of a
$95.3 million loss, resulting from an other than temporary decline in the value
of our investment in Adelphia Communications Corp. (Adelphia), an increase of
$16.3 million compared to the loss of $79.0 million recorded on our Adelphia
investment in 2001. As of June 30, 2002, we had written this investment down to
zero, and therefore we have no additional exposure related to the market value
of Adelphia stock. We also recognized during 2002 a loss of $16.4 million
resulting from an other than temporary decline in the value of our investment in
D & E Communications, Inc.
Investment income for the year ended December 31, 2001 decreased $67.1 million
as compared to the prior year period primarily due to the recognition of a $79.0
million loss resulting from a decline in value of our Adelphia investment. The
decrease was partially offset by increased income from higher money market
balances resulting from the temporary investment of proceeds from debt
issuances.
28
Other income, net for the year ended December 31, 2002 increased $18.9 million
as compared to prior year period primarily due to $26.3 million of income from
the settlement of certain retained liabilities at less than face value, which
are associated with customer advances for construction from our disposed water
properties. During 2002, we executed a series of purchases in the open market of
our outstanding notes and debentures that generated a pre-tax gain from the
early extinguishment of debt of approximately $6.0 million, which also
contributed to the increase. The increase was partially offset by the $12.8
million cost for a tender offer completed in December 2002 with respect to our
6.80% Debentures due 2026 (puttable at par in 2003) and ELI's 6.05% Guaranteed
Notes due 2004. Other loss, net increased $1.7 million in 2001 primarily due to
a decrease in miscellaneous income and capitalized interest.
Gain on sale of assets for the year ended December 31, 2002 represents the gain
recognized from the sale of our Kauai electric division on November 1, 2002 as
well as an adjustment of the gain on the 2001 sale of our Louisiana gas
operation. Gain on sale of assets for the year ended December 31, 2001
represents the initial gain on the sale of the Louisiana gas operation to Atmos
Energy Corporation on July 2, 2001. The gain recognized on our water sale is
classified in discontinued operations.
Minority interest represents the former minority shareholders' share of ELI's
net loss. Subsequent to ELI's public offering, we recorded minority interest on
our income statement and reduced minority interest on our balance sheet by the
amount of the former minority interests' share of ELI's losses. As of June 30,
2000, the minority interest on the balance sheet had been reduced to zero,
therefore, from that point going forward, we discontinued recording minority
interest income on our statement of operations.
Interest expense for 2002 increased compared to 2001 primarily because of the
full year impact of $3.5 billion of notes, $460.0 million of equity units and
$200.0 million of Rural Telephone Finance Cooperative notes issued during 2001
to refinance debt incurred in connection with our acquisitions, and higher
amortization of debt issuance costs. These increases were partially offset by
the repayment of bank debt and repurchases of debt described under "Liquidity
and Capital Resources - Debt Reduction." During the year ended December 31,
2002, we had average long-term debt outstanding excluding our equity units of
$5.2 billion compared to $4.3 billion during the year ended December 31, 2001.
Our composite average borrowing rate for the year ended December 31, 2002 as
compared with the year ended December 31, 2001 was 53 basis points higher,
increasing from 7.34% to 7.87% due to the impact of higher interest rates as a
result of our refinancing our variable rate debt with fixed rate long-term debt.
Interest expense increased for 2001 compared to 2000 primarily because of the
issuance of the securities described in the preceding paragraph, borrowings
under bank facilities and higher amortization of debt issuance costs. During the
year ended December 31, 2001, we had average long-term debt outstanding
excluding our equity units of $4.3 billion compared to $2.6 billion during the
year ended December 31, 2000. Our composite average borrowing rate paid for the
year ended December 31, 2001 as compared with the year ended December 31, 2000
was 49 basis points higher, increasing from 6.85% to 7.34%, due to the impact of
higher interest rates on our new borrowings.
Income tax benefit for the year ended December 31, 2002 increased $400.1 million
as compared with prior year period primarily due to changes in taxable income
(loss). Income tax benefit for the year ended December 31, 2001 decreased $1.3
million, or 8%, as compared with prior year period primarily due to changes in
taxable income (loss) and the write-off of regulatory assets related to our sale
of our Louisiana gas operations. The estimated annual effective tax rate for
2002 is 33.7% as compared with an effective tax rate of 20.4% for 2001.
DISCONTINUED OPERATIONS
($ in thousands) 2002 2001 2000
-------------- ----------------------------- ------------------------------ ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------- ---------- ------------------- ---------
Revenue $ 4,650 $ (112,218) -96% $ 116,868 $ 11,666 11% $ 105,202
Operating income (loss) $ (415) $ (37,626) -101% $ 37,211 $ 9,796 36% $ 27,415
Income (loss) from discontinued
operations, net of tax $ (1,478) $ (19,353) -108% $ 17,875 $ 6,198 53% $ 11,677
Gain on disposal of water segment,
net of tax $181,369 $ 181,369 100% $ - $ - 0% $ -
29
Revenue, operating income (loss) and income (loss) from discontinued operations,
net of tax, for the year ended December 31, 2002 decreased as compared with the
prior year period due to the sale of our water and wastewater businesses in
January 2002. On January 15, 2002, we completed the sale of our water and
wastewater operations to American Water Works, Inc. for $859.1 million in cash
and $122.5 million of assumed debt and other liabilities. The gain on the
disposal of the water segment, net of tax was $181.4 million.
EXTRAORDINARY EXPENSE
($ in thousands) 2002 2001 2000
-------------- ----------------------------
Amount Amount Amount
--------- -------- ---------
Extraordinary expense - discontinuation of
Statement of Financial Accounting Standards
No. 71, net of tax $ - $ 43,631 $ -
Extraordinary expense - discontinuation of Statement of Financial Accounting
Standards No. 71, net of tax, of $43.6 million for the year ended December 31,
2001, relates to the write off of regulatory assets and liabilities previously
recognized under SFAS 71. Deregulation of most of our local exchange telephone
properties required us to cease application of SFAS 71 in the third quarter,
resulting in a non-cash extraordinary charge of $43.6 million, net of tax, in
our statement of operations. See discussion in Note 24 of Consolidated Financial
Statements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities. Market risk refers to the
potential change in fair value of a financial instrument as a result of
fluctuations in interest rates and equity and commodity prices. We do not hold
or issue derivative instruments, derivative commodity instruments or other
financial instruments for trading purposes. As a result, we do not undertake any
specific actions to cover our exposure to market risks and we are not party to
any market risk management agreements other than in the normal course of
business or to hedge long-term interest rate risk. Our primary market risk
exposures are interest rate risk and equity and commodity price risk as follows:
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest-bearing portion of our investment portfolio and interest on our
long term debt and capital lease obligations. The long-term debt and capital
lease obligations include various instruments with various maturities and
weighted average interest rates.
Our objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, a majority of our borrowings have
fixed interest rates; variable rate debt is refinanced when advantageous.
Consequently, we have limited material future earnings or cash flow exposures
from changes in interest rates on our long-term debt and capital lease
obligations. A hypothetical 10% adverse change in interest rates would increase
the amount that we pay on our variable obligations and could result in
fluctuations in the fair value of our fixed rate obligations. Based upon our
overall interest rate exposure at December 31, 2002, a near-term change in
interest rates would not materially affect our consolidated financial position,
results of operations or cash flows.
In order to manage our interest rate risk exposure, we entered into five
interest swap agreements in 2001 and 2002 with investment grade financial
institutions. Each agreement covered a notional amount of $50.0 million. Under
the terms of the agreements, we make semi-annual, floating interest rate
interest payments based on six month LIBOR and receive a fixed rate on the
notional amount. There are two interest rate swap agreements that were executed
in 2001 that receive a 6.375% fixed rate until the swaps' termination date of
August 15, 2004, and there are three swaps executed in 2002 that receive an
8.500% fixed rate until their termination date of May 15, 2006. The underlying
variable rate on the swaps is set either in advance, in arrears or, as in the
case of one agreement, based on each period's daily average six-month LIBOR. In
connection with these swaps, the Company entered into a series of supplemental
rate agreements which had the effect of setting the floating rate portion of the
swaps in advance of the contractually agreed upon rate determination date.
The net effect of the two 2001 interest rate swaps and supplemental rate
agreements was to reduce the effective interest rate on $100.0 million of fixed
rate debt from 6.375% to 3.665% during 2002. The net effect of the three 2002
swaps and supplemental rate agreements was to reduce the effective interest rate
on $150.0 million of fixed rate debt from 8.500% to 6.864% through November 15,
2002, the latest rate reset date. All swaps and associated supplemental rate
agreements are accounted for under SFAS 133 as fair value hedges.
30
Sensitivity analysis of interest rate exposure
At December 31, 2002, the fair value of our long-term debt and capital lease
obligations excluding our equity units was estimated to be approximately $5.4
billion, based on our overall weighted average borrowing rate of 8.0% and our
overall weighted maturity of 13 years. There has been no material change in the
weighted average maturity since December 31, 2001. The overall weighted average
interest rate has increased by approximately 37 basis points. A hypothetical
increase of 80 basis points in our weighted average interest rate (10% of our
overall weighted average borrowing rate) would result in an approximate $272.3
million decrease in the fair value of our fixed rate obligations.
Equity Price Exposure
Our exposure to market risk for changes in equity prices is minimal and relates
primarily to the equity portion of our investment portfolio. The equity portion
of our investment portfolio consists of equity securities (principally common
stock) of D&E Communications, Inc. and Hungarian Telephone and Cable Corp.
As of December 31, 2002, we owned 3,059,000 shares of Adelphia common stock. As
a result of Adelphia's price declines and filing for bankruptcy, we recognized
losses of $95.3 million and $79.0 million on our investment for the years ended
December 31, 2002 and 2001, respectively, as the declines were determined to be
other than temporary. As of June 30, 2002, we had written this investment down
to zero, and therefore we have no additional exposure related to the market
value of Adelphia stock.
As of December 31, 2002, we owned 1,333,500 shares of D & E Communications
common stock. As the result of an other than temporary decline in D & E's stock
price, we recognized a loss of $16.4 million on our investment for the year
ended December 31, 2002.
Sensitivity analysis of equity price exposure
At December 31, 2002, the fair value of the equity portion of our investment
portfolio was estimated to be $29.8 million. A hypothetical 10% decrease in
quoted market prices would result in an approximate $3.0 million decrease in the
fair value of the equity portion of our investment portfolio.
Commodity Price Exposure
We purchase monthly gas future contracts, from time to time, to manage
well-defined commodity price fluctuations, caused by weather and other
unpredictable factors, associated with our commitments to deliver natural gas to
customers at fixed prices. Customers pay for gas service based upon prices that
are defined by a tariff. A tariff is an agreement between the public utility
commission and us, which determines the price that will be charged to the
customer. Fluctuations in gas prices are routinely handled through a pricing
mechanism called the purchase gas adjustor (PGA). The PGA allows for a process
whereby any price change from the agreed upon tariff will be settled as a pass
through to the customer. As a result, if gas prices increase, the PGA will
increase and pass more costs on to the customer. If gas prices decrease, the PGA
will decrease and refunds will be provided to the customer. This commodity
activity relates to our gas businesses and is not material to our consolidated
financial position or results of operations. In all instances we take physical
delivery of the gas supply purchased or contracted for. These gas future
contracts and gas supply contracts are considered derivative instruments as
defined by SFAS 133. However, such contracts are excluded from the provisions of
SFAS 133 since they are purchases made in the normal course of business and not
for speculative purposes. Based upon our overall commodity price exposure at
December 31, 2002, a material near-term change in the quoted market price of gas
would not materially affect our consolidated financial position or results of
operations.
Disclosure of limitations of sensitivity analysis
Certain shortcomings are inherent in the method of analysis presented in the
computation of fair value of financial instruments. Actual values may differ
from those presented should market conditions vary from assumptions used in the
calculation of the fair value. This analysis incorporates only those exposures
that exist as of December 31, 2002. It does not consider those exposures or
positions, which could arise after that date. As a result, our ultimate exposure
with respect to our market risks will depend on the exposures that arise during
the period and the fluctuation of interest rates and quoted market prices.
31
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
The following documents are filed as part of this Report:
1. Financial Statements, See Index on page F-1.
2. Supplementary Data, Quarterly Financial Data is included in the
Financial Statements (see 1. above).
Item 9. Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
--------------------
None
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
--------------------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2003 Annual Meeting of Stockholders to be
held May 13, 2003 to be filed with the Commission pursuant to Regulation 14A
within 120 days after December 31, 2002. See "Executive Officer of the
Registrant" in Part I of this Report following Item 4 for information relating
to executive officers.
Item 11. Executive Compensation
----------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2003 Annual Meeting of Stockholders to be
held May 13, 2003.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
------------------------------------------------------------------
Related Stockholder Matters
---------------------------
The following table provides information as of December 31, 2002 regarding
compensation plans (including individual compensation arrangements) under which
equity securities of Citizens Communications Company are authorized for
issuance.
(a) (b) (c)
Number of securities remaining
Number of securities to Weighted-average available for future issuance
be issued upon exercise exercise price of under equity compensation plans
of outstanding options, outstanding options, (excluding securities reflected in
Plan category warrants and rights warrants and rights column (a))
- ------------------------- -------------------------- ----------------------- -------------------------------------
Equity compensation
plans approved by
security holders 23,051,350 $ 11.80 7,515,751
Equity compensation
plans not approved
by security holders - - -
-------------------------- ----------------------- -------------------------------------
Total 23,051,350 $ 11.80 7,515,751
========================== ======================= =====================================
See Note 18 to Consolidated Financial Statements for information regarding the
material features of the above plans.
The other information required by this Item is incorporated by reference from
our definitive proxy statement for the 2003 Annual Meeting of Stockholders to be
held May 13, 2003.
32
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2003 Annual Meeting of Stockholders to be
held May 13, 2003.
Item 14. Controls and Procedures
-----------------------
Within 90 days prior to the date of this report, we carried out an evaluation,
under the supervision and with the participation of our management, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on this evaluation, our principal executive officer and
principal financial officer concluded that our disclosure controls and
procedures are effective in timely alerting them to material information
required to be included in our periodic SEC reports. It should be noted that the
design of any system of controls is based in part upon certain assumptions, and
there can be no assurance that any design will succeed in achieving its stated
goals.
In addition, we reviewed our internal controls, and there have been no
significant changes in our internal controls or in other factors that could
significantly affect those controls subsequent to the date of their last
evaluation.
During the fourth quarter of 2002 we became aware of irregularities involving
payments made by certain of our public utilities operations for services or
benefits that we did not receive. The payments do not involve our current
operations in Arizona, Vermont, or Hawaii. With the assistance of forensic
specialists, outside auditors, and counsel, we investigated these irregularities
and identified a total of $7.8 million that had been embezzled from the Company.
These payments were reflected in our financial statements as charges to earnings
(primarily during 2002). The U.S. Government has recovered approximately $6.0
million (which we believe will be turned over to us) and we believe that most of
the remaining funds outstanding will be reimbursed by insurance.
We presented the results of our most recent evaluation to our independent
auditors, KPMG LLP, and the Audit Committee of the Board of Directors. Based on
such evaluation, our management, including the principal executive officer and
principal financial officer, concluded that our disclosure controls and
procedures are adequate to insure the clarity and material completeness of our
disclosure in our periodic reports required to be filed with the SEC and there
are no significant deficiencies in the design or operation of internal controls,
which could significantly affect our ability to record, process, summarize and
report financial data. As a result of the matters described in the preceding
paragraph, during 2002 we made changes to our internal controls, procedures and
policies relating to our public services sector.
33
PART IV
-------
Item 15. Exhibits, Financial Statement Schedule and Reports on Form 8-K
--------------------------------------------------------------
(a) List of Documents Filed as a Part of This Report:
(1) Index to Consolidated Financial Statements:
Independent Auditors' Report
Consolidated balance sheets as of December 31, 2002 and 2001
Consolidated statements of operations for the years ended
December 31, 2002, 2001 and 2000
Consolidated statements of shareholders' equity for the
years ended December 31, 2002, 2001 and 2000
Consolidated statements of comprehensive income (loss) for
the years ended December 31, 2002, 2001 and 2000
Consolidated statements of cash flows for the years ended
December 31, 2002, 2001 and 2000
Notes to consolidated financial statements
(2) Index to Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts
All other schedules have been omitted because the required information is
included in the consolidated financial statements or the notes thereto, or is
not applicable or required.
(3) Index to Exhibits:
Exhibit
No. Description
- ------- -----------
3.200.1 Restated Certificate of Incorporation of Citizens Communications
Company, as restated May 19, 2000 (incorporated by reference to
Exhibit 3.200.1 to the Registrant's Quarterly Report on Form 10-Q
for the six months ended June 30, 2000, File No. 001-11001).
3.200.2 By-laws of Citizens Communications Company, with all amendments
to March 22, 2002 (incorporated by reference to Exhibits 3.1 and
3.2 to the Registrants Form 8-K filed March 22, 2002, File No.
001-11001).
3.200.3 Amendment to the By-laws of Citizens Communications Company
(effective July 30, 2002).
4.100.1 Certificate of Trust of Citizens Communications Trust dated as of
April 27, 2001 (incorporated by reference to Exhibit 4.5 of the
Registrant's Amendment No.1 to Form S-3 filed May 7, 2001
(Registration No. 333-58044).
4.100.2 Trust Agreement of Citizens Capital Trust I, dated as of April
27, 2001 (incorporated by reference to Exhibit 4.6 of the
Registrant's Amendment No.1 to Form S-3 filed May 7, 2001
(Registration No. 333-58044).
4.100.3 Form of 2006 Note (incorporated by reference to Exhibit 4.3 of
the Registrant's Current Report on Form 8-K filed on May 24,
2001, File No. 001-11001).
4.100.4 Form of 2011 Note (incorporated by reference to Exhibit 4.4 of
the Registrant's Current Report on Form 8-K filed on May 24,
2001, File No. 001-11001).
4.100.5 Warrant Agreement, dated as of June 19, 2001, between Citizens
Communications Company and The Chase Manhattan Bank, as Warrant
Agent (incorporated by reference to Exhibit 4.1 of the
Registrant's Current Report on Form 8-K filed on May 24, 2001,
File No. 001-11001).
4.100.6 Form of Senior Note due 2006 (incorporated by reference to
Exhibit 4.5 of the Registrant's Current Report on Form 8-K filed
on June 21, 2001, File No. 001-11001).
34
4.100.7 Form of Equity Unit (included in the Warrant Agreement
incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on June 21, 2001, File No.
001-11001).
4.100.8 Form of Treasury Equity Unit (included in the Warrant Agreement
incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on June 21, 2001, File No.
001-11001).
4.100.9 Form of Senior Notes due 2004, due 2008 and due 2031
(incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on August 22, 2001, File No.
001-11001).
4.200.1 First Supplemental Indenture dated as of January 15, 1996,
between Citizens Utilities Company and Chemical Bank, as
indenture trustee (incorporated by reference to Exhibit 4.200.2
to the Registrant's Form 8-K Current Report filed May 28, 1996,
File No. 001-11001).
4.200.2 5% Convertible Subordinated Debenture due 2036 (contained as
Exhibit A to Exhibit 4.200.2), (incorporated by reference to
Exhibit 4.200.2 to the Registrant's Form 8-K Current Report filed
May 28, 1996, File No. 001-11001).
4.200.3 Amended and Restated Declaration of Trust dated as of January 15,
1996, of Citizens Utilities Trust (incorporated by reference to
Exhibit 4.200.4 to the Registrant's Form 8-K Current Report filed
May 28, 1996, File No. 001-11001).
4.200.4 Convertible Preferred Security Certificate (contained as Exhibit
A-1 to Exhibit 4.200.4), (incorporated by reference to Exhibit
4.200.4 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.5 Amended and Restated Limited Partnership Agreement dated as of
January 15, 1996 of Citizens Utilities Capital L.P. (incorporated
by reference to Exhibit 4.200.6 to the Registrant's Form 8-K
Current Report filed May 28, 1996, File No. 001-11001).
4.200.6 Partnership Preferred Security Certificate (contained as Annex A
to Exhibit 4.200.6), (incorporated by reference to Exhibit
4.200.6 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.7 Convertible Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Utilities Company and Chemical
Bank, as guarantee trustee (incorporated by reference to Exhibit
4.200.8 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.8 Partnership Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Utilities Company and Chemical
Bank, as guarantee trustee (incorporated by reference to Exhibit
4.200.9 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.9 Letter of Representations dated January 18, 1996, from Citizens
Utilities Company and Chemical Bank, as trustee, to DTC, for
deposit of Convertible Preferred Securities with DTC
(incorporated by reference to Exhibit 4.200.10 to the
Registrant's Form 8-K Current Report filed May 28, 1996, File No.
001-11001).
4.300 Indenture of Securities, dated as of August 15, 1991, to Chemical
Bank, as Trustee (incorporated by reference to Exhibit 4.100.1 to
the Registrant's Quarterly Report on Form 10-Q for the nine
months ended September 30, 1991, File No. 001-11001).
4.300.1 Second Supplemental Indenture, dated January 15, 1992, to
Chemical Bank, as Trustee (incorporated by reference to Exhibit
4.100.4 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1991, File No. 001-11001).
4.300.2 Third Supplemental Indenture, dated April 15, 1994, to Chemical
Bank, as Trustee (incorporated by reference to Exhibit 4.100.6 to
the Registrant's Form 8-K Current Report filed July 5, 1994, File
No. 001-11001).
4.300.3 Fourth Supplemental Indenture, dated October 1, 1994, to Chemical
Bank, as Trustee (incorporated by reference to Exhibit 4.100.7 to
Registrant's Form 8-K Current Report filed January 3, 1995, File
No. 001-11001).
4.300.4 Fifth Supplemental Indenture, dated as of June 15, 1995, to
Chemical Bank, as Trustee (incorporated by reference to Exhibit
4.100.8 to Registrant's Form 8-K Current Report filed March 29,
1996, File No. 001-11001).
4.300.5 Sixth Supplemental Indenture, dated as of October 15, 1995, to
Chemical Bank, as Trustee (incorporated by reference to Exhibit
4.100.9 to Registrant's Form 8-K Current Report filed March 29,
1996, File No. 001-11001).
4.300.6 Seventh Supplemental Indenture, dated as of June 1, 1996
(incorporated by reference to Exhibit 4.100.11 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996, File No. 001-11001).
4.300.7 Eighth Supplemental Indenture, dated as of December 1, 1996
(incorporated by reference to Exhibit 4.100.12 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996, File No. 001-11001).
35
4.400 Senior Indenture, dated as of May 23, 2001, between Citizens
Communications Company and The Chase Manhattan Bank, as trustee
(incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on May 24, 2001, File No.
001-11001).
4.400.1 First Supplemental Indenture to Senior Indenture, dated as of May
23, 2001 (incorporated by reference to Exhibit 4.2 of the
Registrant's Current Report on Form 8-K filed on May 24, 2001,
File No. 001-11001).
4.400.2 Second Supplemental Indenture, dated as of June 19, 2001, to
Senior Indenture, dated as of May 23, 2001 (incorporated by
reference to Exhibit 4.3 of the Registrant's Current Report on
Form 8-K filed on June 21, 2001, File No. 001-11001).
4.400.3 Pledge Agreement, dated as of June 19, 2001, among Citizens
Communications Company and The Bank of New York, as Collateral
Agent, Securities Intermediary and Custodial Agent and The Chase
Manhattan Bank, as Warrant Agent (incorporated by reference to
Exhibit 4.2 of the Registrant's Current Report on Form 8-K filed
on June 21, 2001, File No. 001-11001).
4.400.4 Remarketing Agreement dated June 19, 2001, among Citizens
Communications Company, Morgan Stanley & Co. Incorporated, as
Remarketing Agent, and The Chase Manhattan Bank, as Warrant Agent
and attorney-in-fact for the Holders of the Equity Units
(incorporated by reference to Exhibit 4.4 of the Registrant's
Current Report on Form 8-K filed on June 21, 2001, File No.
001-11001).
4.400.5 Indenture, dated as of August 16, 2001, between Citizens
Communications Company and The Chase Manhattan Bank, as Trustee
(incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on August 22, 2001, File No.
001-11001).
10.1 Non-Employee Directors' Deferred Fee Equity Plan dated as of June
28, 1994, with all amendments to May 5, 1997 (incorporated by
reference to Exhibit A to the Registrant's Proxy Statement dated
April 4, 1995 and Exhibit A to the Registrant's Proxy Statement
dated March 28, 1997, respectively, File No.001-11001).
10.2 Employment Agreement between Citizens Utilities Company and
Leonard Tow, effective July 11, 1996 (incorporated by reference
to Exhibit 10.16.1 to the Registrant's Quarterly Report on Form
10-Q for the nine months ended September 30, 1996, File No.
001-11001).
10.2.1 Employment Agreement between Citizens Communications Company and
Leonard Tow, effective October 1, 2000 (incorporated by reference
to Exhibit 10.16.2 of the Registrants Annual Report on Form 10-K
for the year ended December 31, 2000, File No. 001-11001).
10.2.2 Letter agreement, dated as of April 10, 2001, amending the
employment agreement, effective October 1, 2000, between Citizens
Communications Company and Leonard Tow (incorporated by reference
to Exhibit 10 of the Registrants' Forms S-4/A filed February 4,
2002, Registration No. 333-69740).
10.2.3 Letter agreement, dated as of May 16, 2002, amending the
employment agreement, effective October 1, 2000, between Citizens
Communications Company and Leonard Tow (incorporated by reference
to Exhibit 10.16.4 of the Registrants' Quarterly Report on Form
10-Q for the nine months ended September 30, 2002, File No.
001-11001).
10.4 Citizens Executive Deferred Savings Plan dated January 1, 1996
(incorporated by reference to Exhibit 10.19 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999,
File No. 001-11001).
10.5 Citizens Incentive Plan restated as of March 21, 2000
(incorporated by reference to Exhibit 10.19 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999,
File No. 001-11001).
10.6 Indenture from ELI to Citibank, N.A., dated April 15, 1999, with
respect to ELI's 6.05% Senior Unsecured Notes due 2004
(incorporated by reference to Exhibit 10.24.1 of ELI's Annual
Report on Form 10-K for the year ended December 31, 1999, File
No. 0-23393).
10.6.1 First Supplemental Indenture from ELI, Citizens Utilities Company
and Citizens Newco Company to Citibank, N.A. dated April 15,
1999, with respect to the 6.05% Senior Unsecured Notes due 2004
(incorporated by reference to Exhibit 10.24.2 of ELI's Annual
Report on Form 10-K for the year ended December 31, 1999, File
No. 0-23393).
10.6.2 Form of ELI's 6.05% Senior Unsecured Notes due 2004 (incorporated
by reference to Exhibit 10.24.3 of ELI's Annual Report on Form
10-K for the year ended December 31, 1999, File No. 0-23393).
10.7 2000 Equity Incentive Plan dated May 18, 2000 (incorporated by
reference to Exhibit 10.33 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2000, File No.
001-11001).
36
10.8 Citizens 401(K) Savings Plan effective as of January 1, 1997
reflecting amendments made through April 2001 (incorporated by
reference to Exhibit 10.37 to the Registrant's Quarterly Report
on Form 10-Q for the six months ended June 30, 2001, File No.
001-11001).
10.9 Competitive Advance and Revolving Credit Facility Agreement for
$705,000,000 dated October 24, 2001 (incorporated by reference to
Exhibit 10.38 to the Registrant's Quarterly Report on Form 10-Q
for the nine months ended September 30, 2001, File No.
001-11001).
10.10 Loan Agreement between Citizens Communications Company and Rural
Telephone Finance Cooperative for $200,000,000 dated October 24,
2001 (incorporated by reference to Exhibit 10.39 to the
Registrant's Quarterly Report on Form 10-Q for the nine months
ended September 30, 2001, File No. 001-11001).
10.11 Asset Purchase Agreement between Citizens Communications Company
and Kauai Island Utility CO-OP dated March 5, 2002.
10.12 Asset Purchase Agreement between Citizens Communications Company
and K-1 USA Ventures, Inc., dated December 19, 2002.
10.13 Asset Purchase Agreement between Citizens Communications Company
and UniSource Energy Corporation dated October 29, 2002, relating
to the sale of a gas utility business.
10.14 Asset Purchase Agreement between Citizens Communications Company
and UniSource Energy Corporation dated October 29, 2002, relating
to the sale of an electric utility buiness.
10.15 Sale agreement between Citizens Telecom Services Company LLC and
Pepsico, Inc., dated January 31, 2003.
12 Computation of ratio of earnings to fixed charges (this item
is included herein for the sole purpose of incorporation by
reference).
21 Subsidiaries of the Registrant
23 Auditors' Consent
99 Certifications pursuant to 18 U.S.C Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibits 10.1, 10.2, 10.2.1, 10.2.2, 10.2.3, 10.4, 10.5, 10.7 and 10.8 are
management contracts or compensatory plans or arrangements.
We agree to furnish to the Commission upon request copies of the Realty and
Chattel Mortgage, dated as of March 1, 1965, made by Citizens Utilities Rural
Company, Inc., to the United States of America (the Rural Utilities Services and
Rural Telephone Bank) and the Mortgage Notes which that mortgage secures; and
the several subsequent supplemental Mortgages and Mortgage Notes; copies of
separate loan agreements and indentures governing various Industrial Development
Revenue Bonds; copies of documents relating to indebtedness of subsidiaries
acquired during 1996, 1997 and 1998. We agree to furnish to the Commission upon
request copies of schedules and exhibits to items 10.11, 10.12, 10.13, 10.14 and
10.15.
(b) Reports on Form 8-K:
We filed on Form 8-K on October 30, 2002 under Item 5 "Other Events", a
press release announcing the definitive agreements to sell the Arizona Gas
and Arizona Electric divisions to UniSource Energy Corporation for $230
million in cash, subject to adjustments under the term of the agreements.
We filed on Form 8-K on November 6, 2002 under Item 5 "Other Events", a
press release announcing the completion of the sale of the Kauai Electric
division to the Kauai Island Utility Cooperative.
We filed on Form 8-K on November 12, 2002 under Item 9 "Regulation FD
Disclosure", information relating to the furnishing of certifications to
the SEC pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
We filed on Form 8-K on November 25, 2002 under Item 5 "Other Events",
information regarding the investigation of possible irregularities
involving payments made by the Company's public utilities division for
services or benefits that the Company did not receive.
We filed on Form 8-K on December 20, 2002 under Item 5 "Other Events" and
Item 7 "Financial Statements and Exhibits", a press release announcing the
definitive agreement to sell the Hawaiian Gas division to K-1 USA Ventures,
Inc. for $115 million in cash, subject to adjustments under the terms of
the agreement and the conclusion of the internal investigation of a theft
of $7.8 million by two former officers of the Company.
37
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Leonard Tow
-----------------
Leonard Tow
Chairman of the Board; Chief Executive Officer;
Chairman of Executive Committee and Director
March 24, 2003
38
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 24th day of March 2003.
Signature Title
--------- -----
/s/ Robert J. Larson Senior Vice President and Chief Accounting Officer
- -----------------------------------------
(Robert J. Larson)
/s/ Jerry Elliott Senior Vice President and Chief Financial Officer
- -----------------------------------------
(Jerry Elliott)
/s/ Norman I. Botwinik Director
- -----------------------------------------
(Norman I. Botwinik)
/s/ Aaron I. Fleischman Member, Executive Committee and Director
- -----------------------------------------
(Aaron I. Fleischman)
/s/ Rudy J. Graf Member, Executive Committee and Director
- -----------------------------------------
(Rudy J. Graf)
/s/ Stanley Harfenist Member, Executive Committee and Director
- -----------------------------------------
(Stanley Harfenist)
/s/ Andrew N. Heine Director
- -----------------------------------------
(Andrew N. Heine)
/s/ William Kraus Director
- -----------------------------------------
(William Kraus)
/s/ Scott N. Schneider Vice Chairman of the Board, President and
- ----------------------------------------- Chief Operating Officer, and Director
(Scott N. Schneider)
/s/ John L. Schroeder Director
- -----------------------------------------
(John L. Schroeder)
/s/ Robert A. Stanger Member, Executive Committee and Director
- -----------------------------------------
(Robert A. Stanger)
/s/ Edwin Tornberg Director
- -----------------------------------------
(Edwin Tornberg)
/s/ Claire L. Tow Director
- -----------------------------------------
(Claire L. Tow)
39
CERTIFICATIONS
--------------
I, Leonard Tow, certify that:
1. I have reviewed this annual report on Form 10-K of Citizens Communications
Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 24, 2003
By: /s/ Leonard Tow
-------------------
Leonard Tow
Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
40
CERTIFICATIONS (continued)
--------------------------
I, Jerry Elliott, certify that:
1. I have reviewed this annual report on Form 10-K of Citizens Communications
Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 24, 2003
By: /s/ Jerry Elliott
---------------------
Jerry Elliott
Chief Financial Officer
(Principal Financial Officer)
41
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index to Consolidated Financial Statements
Item Page
- ---- ----
Independent Auditors' Report F-2
Consolidated balance sheets as of December 31, 2002 and 2001 F-3
Consolidated statements of operations for the years ended
December 31, 2002, 2001 and 2000 F-4
Consolidated statements of shareholders' equity for the years ended
December 31, 2002, 2001 and 2000 F-5
Consolidated statements of comprehensive income (loss) for the years ended
December 31, 2002, 2001 and 2000 F-5
Consolidated statements of cash flows for the years ended
December 31, 2002, 2001 and 2000 F-6
Notes to consolidated financial statements F-7
F-1
Independent Auditors' Report
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited the accompanying consolidated balance sheets of Citizens
Communications Company and subsidiaries as of December 31, 2002 and 2001 and the
related consolidated statements of operations, shareholders' equity,
comprehensive income (loss) and cash flows for each of the years in the
three-year period ended December 31, 2002. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with 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 financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Citizens
Communications Company and subsidiaries as of December 31, 2002 and 2001 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America. As discussed in
Note 13 to the consolidated financial statements, the Company adopted Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets" as of January 1, 2002.
KPMG LLP
New York, New York
March 4, 2003
F-2
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
($ in thousands)
2002 2001
-------------- --------------
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 393,177 $ 215,869
Accounts receivable, net 310,929 311,878
Other current assets 49,114 150,573
Assets held for sale 447,764 1,107,937
Assets of discontinued operations - 746,791
-------------- --------------
Total current assets 1,200,984 2,533,048
Property, plant and equipment, net 3,690,056 4,512,038
Goodwill, net 1,869,348 1,957,600
Other intangibles, net 942,970 1,021,342
Investments 29,846 141,208
Other assets 413,538 388,364
-------------- --------------
Total assets $ 8,146,742 $ 10,553,600
============== ==============
LIABILITIES AND EQUITY
- ----------------------
Current liabilities:
Long-term debt due within one year $ 58,911 $ 483,906
Accounts payable 195,278 239,676
Income taxes accrued 83,065 96,901
Other taxes accrued 41,068 33,637
Interest accrued 105,668 112,282
Customer deposits 2,632 18,246
Other current liabilities 134,191 124,833
Liabilities related to assets held for sale 150,053 218,775
Liabilities of discontinued operations - 228,337
-------------- --------------
Total current liabilities 770,866 1,556,593
Deferred income taxes 137,116 429,544
Customer advances for construction and contributions in aid of construction 146,661 183,319
Other liabilities 301,349 241,846
Equity units 460,000 460,000
Long-term debt 4,957,361 5,534,906
Company Obligated Mandatorily Redeemable Convertible Preferred Securities* 201,250 201,250
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares; 282,482,000 and 281,289,000
outstanding and 294,080,000 and 292,840,000 issued at December 31, 2002 and 2001,
respectively) 73,520 73,210
Additional paid-in capital 1,943,406 1,927,518
Retained earnings (accumulated deficit) (553,033) 129,864
Accumulated other comprehensive income (loss) (102,169) 4,907
Treasury stock (189,585) (189,357)
-------------- --------------
Total shareholders' equity 1,172,139 1,946,142
-------------- --------------
Total liabilities and equity $ 8,146,742 $ 10,553,600
============== ==============
* Represents securities of a subsidiary trust, the sole assets of which are
securities of a subsidiary partnership, substantially all the assets of which
are convertible debentures of the Company.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-3
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 and 2000
($ in thousands, except for per-share amounts)
2002 2001 2000
--------------- -------------- --------------
Revenue $ 2,669,332 $ 2,456,993 $ 1,802,358
Operating expenses:
Cost of services 476,920 599,378 481,673
Other operating expenses 1,002,355 951,710 811,926
Depreciation and amortization 755,522 632,336 387,607
Reserve for telecommunications bankruptcies 10,880 21,200 -
Restructuring and other expenses 37,186 19,327 (649)
Loss on impairment 1,074,058 - -
--------------- -------------- --------------
Total operating expenses 3,356,921 2,223,951 1,680,557
--------------- -------------- --------------
Operating income (loss) (687,589) 233,042 121,801
Investment income (loss), net (98,359) (62,408) 4,736
Gain on sale of assets 9,798 139,304 -
Minority interest - - 12,222
Other income (loss), net 15,806 (3,133) (1,386)
Interest expense 471,296 379,326 187,366
--------------- -------------- --------------
Loss from continuing operations before income taxes, dividends on
convertible preferred securities, extraordinary expense and
cumulative effect of change in accounting principle (1,231,640) (72,521) (49,993)
Income tax benefit (414,874) (14,805) (16,132)
--------------- -------------- --------------
Loss from continuing operations before dividends on convertible
preferred securities, extraordinary expense and cumulative
effect of change in accounting principle (816,766) (57,716) (33,861)
Dividends on convertible preferred securities, net of income tax
benefit of $(3,853) 6,210 6,210 6,210
--------------- -------------- --------------
Loss from continuing operations before extraordinary expense and
cumulative effect of change in accounting principle (822,976) (63,926) (40,071)
Income (loss) from discontinued operations, net of income tax
(benefit) of $(554), $8,947 and $5,721, respectively (1,478) 17,875 11,677
Gain on disposal of water segment, net of income taxes of $135,303 181,369 - -
--------------- -------------- --------------
Total income from discontinued operations, net of income taxes
of $134,749, $8,947 and $5,721, respectively 179,891 17,875 11,677
--------------- -------------- --------------
Loss before extraordinary expense and cumulative effect of
change in accounting principle (643,085) (46,051) (28,394)
Extraordinary expense - discontinuation of Statement of Financial
Accounting Standards No. 71, net of tax - 43,631 -
Cumulative effect of change in accounting principle 39,812 - -
--------------- -------------- --------------
Net loss $ (682,897) $ (89,682) $ (28,394)
=============== ============== ==============
Carrying cost of equity forward contracts - 13,650 -
--------------- -------------- --------------
Available for common shareholders $ (682,897) $ (103,332) $ (28,394)
=============== ============== ==============
Basic income (loss) per common share:
Loss from continuing operations before extraordinary expense
and cumulative effect of change in accounting principle $ (2.93) $ (0.28) $ (0.15)
Income from discontinued operations $ 0.64 $ 0.06 $ 0.04
Loss before extraordinary expense and cumulative effect of
change in accounting principle $ (2.29) $ (0.22) $ (0.11)
Extraordinary expense $ - $ (0.16) $ -
Loss from cumulative effect of change in accounting principle $ (0.14) $ - $ -
Available for common shareholders $ (2.43) $ (0.38) $ (0.11)
Diluted income (loss) per common share:
Loss from continuing operations before extraordinary expense
and cumulative effect of change in accounting principle $ (2.93) $ (0.28) $ (0.15)
Income from discontinued operations $ 0.64 $ 0.06 $ 0.04
Loss before extraordinary expense and cumulative effect of
change in accounting principle $ (2.29) $ (0.22) $ (0.11)
Extraordinary expense $ - $ (0.16) $ -
Loss from cumulative effect of change in accounting principle $ (0.14) $ - $ -
Available for common shareholders $ (2.43) $ (0.38) $ (0.11)
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-4
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 and 2000
($ in thousands, except for per-share amounts)
Accumulated
Common Stock Additional Retained Other Treasury Stock Total
----------------- Paid-In Earnings Comprehensive -------------- Shareholders'
Shares Amount Capital (Deficit) Income (Loss) Shares Amount Equity
-------- -------- ----------- ------------- --------------- --------------- ----------
Balance January 1, 2000 262,076 $65,519 $1,577,903 $ 261,590 $ 14,923 - $ - $1,919,935
-------- -------- ----------- ------------- ------------ -------- ---------- ----------
Acquisitions 112 28 1,770 - - 114 1,861 3,659
Treasury stock acquisitions - - - - - (2,952) (49,209) (49,209)
Stock plans 3,580 895 42,156 - - (269) (4,523) 38,528
Equity forward contracts - - (150,013) - - - - (150,013)
Net loss - - - (28,394) - - - (28,394)
Other comprehensive loss, net
of tax and reclassifications
adjustments - - - - (14,505) - - (14,505)
-------- -------- ----------- ------------- ------------ -------- ---------- ----------
Balance December 31, 2000 265,768 66,442 1,471,816 233,196 418 (3,107) (51,871) 1,720,001
-------- -------- ----------- ------------- ------------ -------- ---------- ----------
Stock plans 1,916 479 17,449 - - 696 12,527 30,455
Common stock offering 25,156 6,289 283,272 - - - - 289,561
Equity units offering - - 4,968 - - - - 4,968
Settlement of equity forward
contracts - - 150,013 (13,650) - (9,140) (150,013) (13,650)
Net loss - - - (89,682) - - - (89,682)
Other comprehensive income,
net of tax and reclassifications
adjustments - - - - 4,489 - - 4,489
-------- -------- ----------- ------------- ------------ -------- ---------- ----------
Balance December 31, 2001 292,840 73,210 1,927,518 129,864 4,907 (11,551) (189,357) 1,946,142
-------- -------- ----------- ------------- ------------ -------- ---------- ----------
Stock plans 1,240 310 15,888 - - (47) (228) 15,970
Net loss - - - (682,897) - - - (682,897)
Other comprehensive loss, net
of tax and reclassifications
adjustments - - - - (107,076) - - (107,076)
-------- -------- ----------- ------------- ------------ -------- ---------- ----------
Balance December 31, 2002 294,080 $73,520 $1,943,406 $ (553,033) $ (102,169) (11,598) $(189,585) $1,172,139
======== ======== =========== ============= ============ ======== ========== ==========
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 and 2000
($ in thousands, except for per-share amounts)
2002 2001 2000
-------------- ------------- -------------
Net loss $ (682,897) $ (89,682) $ (28,394)
Other comprehensive income (loss), net of tax
and reclassifications adjustments* (107,076) 4,489 (14,505)
-------------- ------------- -------------
Total comprehensive loss $ (789,973) $ (85,193) $ (42,899)
============== ============= =============
* Consists of unrealized holding (losses)/gains of marketable securities and
minimum pension liability (see Note 22).
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-5
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 and 2000
($ in thousands)
2002 2001 2000
-------------- -------------- --------------
Net cash provided by continuing operating activities $ 636,867 $ 476,936 $ 307,693
Cash flows from investing activities:
Acquisitions - (3,373,214) (986,029)
Proceeds from sale of assets 224,678 372,335 -
Capital expenditures (468,742) (487,271) (544,829)
Securities purchased (1,175) (1,391) (71,122)
Securities sold 8,212 1,434 381,698
Securities matured 2,014 - 16,072
ELI share purchases (6,800) - (38,748)
Other 727 639 104
-------------- -------------- --------------
Net cash used by investing activities (241,086) (3,487,468) (1,242,854)
Cash flows from financing activities:
Long-term debt borrowings - 3,703,483 1,063,158
Long-term debt principal payments (1,062,169) (1,077,931) (46,972)
Issuance of equity units - 460,000 -
Debt issuance cost - (67,657) -
Common stock offering - 289,561 -
Issuance of common stock for employee plans 14,943 25,411 19,773
Settlement of equity forward contracts - (163,662) -
Common stock buybacks - - (49,209)
Repayment of customer advances for construction
and contributions in aid of construction (4,895) (27,816) 30,684
-------------- -------------- --------------
Net cash (used) provided by financing activities (1,052,121) 3,141,389 1,017,434
Cash provided (used) by discontinued operations
Proceeds from the sale of discontinued operations 859,064 - -
Net cash provided (used) by discontinued operations (25,416) 14,926 (49,328)
Increase in cash and cash equivalents 177,308 145,783 32,945
Cash and cash equivalents at January 1, 215,869 70,086 37,141
-------------- -------------- --------------
Cash and cash equivalents at December 31, $ 393,177 $ 215,869 $ 70,086
============== ============== ==============
Supplemental cash flow information:
Cash paid during the year for:
Interest $ 470,175 $ 302,510 $ 188,955
Income taxes (refunds) (17,621) (41,126) 37,935
Non-cash investing and financing activities:
Assets acquired under capital lease $ 38,000 $ 33,985 $ 102,192
Change in fair value of interest rate swaps 16,229 430 -
Investment writedown 117,455 79,114 -
Equity forward contracts - - 150,013
Issuance of shares for acquisitions - - 3,659
Debt assumed from acquisitions - 117,630 -
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-6
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Description of Business and Summary of Significant Accounting Policies:
-----------------------------------------------------------------------
(a) Description of Business:
------------------------
Citizens Communications Company and its subsidiaries are referred to
as "we", "us", the "Company" or "our" in this report. We are a
telecommunications-focused company providing wireline communications
services to rural areas and small and medium-sized towns and cities,
including the Rochester, New York metropolitan area, as an incumbent
local exchange carrier, or ILEC. In addition, we provide competitive
local exchange carrier, or CLEC, services to business customers and to
other communications carriers in certain metropolitan areas in the
western United States through Electric Lightwave, Inc., or ELI, our
wholly-owned subsidiary. We also provide public utility services
including natural gas transmission and distribution and electric
transmission and distribution services to primarily rural and suburban
customers in Vermont, Hawaii and Arizona.
Our ILEC segment has grown substantially over the last three years,
primarily as a result of acquisitions. During 2001, we purchased from
Global Crossing Ltd. (Global) the 1.1 million access lines of the
Frontier local exchange carrier business for approximately $3.4
billion in cash (see Note 5). During 2000, we acquired approximately
334,500 telephone access lines for approximately $986,200,000 in cash.
Of our 2.4 million telephone access lines as of December 31, 2002,
approximately 41% are located in New York State, including the greater
Rochester metropolitan area, another 11% are located in Minnesota.
In 1999 we announced plans to divest our public utilities services
segments. During 2001 we sold two of our four natural gas transmission
and distribution businesses and during 2002 we sold our entire water
distribution and wastewater treatment business and one of our three
electric businesses. We have contracts to sell three of our four
remaining properties. We are seeking a buyer for our one remaining
utility property, which provides electricity to approximately 21,000
customers in Vermont. Pending these divestitures, we continue to
provide gas and electric utility services (see Note 7).
In June 2002, we acquired all the common stock of ELI that we did not
previously own and as a result ELI became our wholly-owned subsidiary.
(b) Principles of Consolidation and Use of Estimates:
-------------------------------------------------
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (GAAP). Certain reclassifications of balances previously
reported have been made to conform to the current presentation.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions which affect the
amounts of assets, liabilities, revenue and expenses we have reported
and our disclosure of contingent assets and liabilities at the date of
the financial statements. Actual results may differ from those
estimates. We believe that our critical estimates are depreciation
rates, pension assumptions, calculations of impairment amounts and
reserves established for telecommunication bankruptcies.
(c) Cash Equivalents:
-----------------
We consider all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
(d) Revenue Recognition:
--------------------
Incumbent Local Exchange Carrier (ILEC) - Revenue is recognized when
services are provided or when products are delivered to customers.
Revenue that is billed in advance includes: monthly recurring network
access services, special access services and monthly recurring local
line charges. The unearned portion of this revenue is initially
deferred as a component of other current liabilities on our balance
sheet and recognized in revenue over the period that the services are
provided. Revenue that is billed in arrears includes: non-recurring
network access services, switched access services, non-recurring local
services and long-distance services. The earned but unbilled portion
of this revenue is recognized in revenue in our statement of
operations and accrued in accounts receivable in the period that the
services are provided. Excise taxes are recognized as a liability when
billed. Installation fees and their related direct and incremental
costs are initially deferred and recognized as revenue and expense
over the average term of a customer relationship. We recognize as
current period expense the portion of installation costs that exceeds
installation fee revenue.
F-7
ELI - Revenue is recognized when the services are provided. Revenue
from long-term prepaid network services agreements including
Indefeasible Rights to Use (IRU), are deferred and recognized on a
straight-line basis over the terms of the related agreements.
Installation fees and their related direct and incremental costs are
initially deferred and recognized as revenue and expense over the
average term of a customer relationship. We recognize as current
period expense the portion of installation costs that exceeds
installation fee revenue.
Public Utilities Services - Revenue is recognized when services are
provided for public utilities services. Certain revenue is based upon
consumption while other revenue is based upon a flat fee. Earned but
unbilled public services revenue is accrued and included in accounts
receivable and revenue.
(e) Construction Costs and Maintenance Expense:
-------------------------------------------
Property, plant and equipment are stated at original cost, including a
portion of related overhead and an allowance for funds used during
construction (AFUDC) for regulated businesses and capitalized interest
for unregulated telecommunications businesses. Maintenance and repairs
are charged to operating expenses as incurred. The book value, net of
salvage, of routine property, plant and equipment dispositions is
charged against accumulated depreciation for regulated operations.
Capitalized interest for unregulated construction activities amounted
to $7,390,000, $5,675,000 and $4,766,000 for 2002, 2001 and 2000,
respectively.
(f) Intangibles:
------------
Intangibles represent the excess of purchase price over the fair value
of identifiable tangible assets acquired. We undertake studies to
determine the fair values of assets acquired and allocate purchase
prices to property, plant and equipment, goodwill and other
identifiable intangibles. On January 1, 2002, we adopted SFAS 142,
"Goodwill and Other Intangible Assets," which applies to all goodwill
and other intangible assets recognized in the statement of financial
position at that date, regardless of when the assets were initially
recognized. This statement requires that goodwill and other
intangibles with indefinite useful lives no longer be amortized to
earnings, but instead be reviewed for impairment, at least annually.
The amortization of goodwill and other intangibles with indefinite
useful lives ceased upon adoption of the statement on January 1, 2002.
We annually examine the carrying value of our goodwill and other
intangibles with indefinite useful lives to determine whether there
are any impairment losses and have determined for the year ended
December 31, 2002 that there was no impairment except for ELI (see
Notes 6, 13 and 19).
(g) Impairment of Long-Lived Assets and Long-Lived Assets to Be
--------------------------------------------------------------
Disposed Of:
------------
We adopted Statement of Financial Accounting Standard (SFAS) No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" as of
January 1, 2002. In accordance with SFAS No. 144, we review long-lived
assets to be held and used and long-lived assets to be disposed of,
including intangible assets with estimated useful lives, for
impairment whenever events or changes in circumstances indicate that
the carrying amount of such assets may not be recoverable.
Recoverability of assets to be held and used is measured by comparing
the carrying amount of the asset to the future undiscounted net cash
flows expected to be generated by the asset. Recoverability of assets
held for sale is measured by comparing the carrying amount of the
assets to their estimated fair market value. If any assets are
considered to be impaired, the impairment is measured by the amount by
which the carrying amount of the assets exceeds the estimated fair
value (see Note 4).
(h) Derivative Instruments and Hedging Activities:
----------------------------------------------
Effective January 1, 2001, we adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended. SFAS No.
133, as amended, requires that all derivative instruments, such as
interest rate swaps, be recognized in the financial statements and
measured at fair value regardless of the purpose or intent of holding
them.
On the date the derivative contract is entered into, we designate the
derivative as either a fair value or cash flow hedge. A hedge of the
fair value of a recognized asset or liability or of an unrecognized
firm commitment is a fair value hedge. A hedge of a forecasted
transaction or the variability of cash flows to be received or paid
related to a recognized asset or liability is a cash flow hedge. We
formally document all relationships between hedging instruments and
hedged items, as well as its risk-management objective and strategy
F-8
for undertaking the hedge transaction. This process includes linking
all derivatives that are designated as fair-value or cash flow hedges
to specific assets and liabilities on the balance sheet or to specific
firm commitments or forecasted transactions.
We also formally assess, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. If it is determined that a derivative
is not highly effective as a hedge or that it has ceased to be a
highly effective hedge, we would discontinue hedge accounting
prospectively.
All derivatives are recognized on the balance sheet at their fair
value. Changes in the fair value of derivative financial instruments
are either recognized in income or stockholders equity (as a component
of other comprehensive income), depending on whether the derivative is
being used to hedge changes in fair value or cash flows.
We entered into interest rate swap arrangements during 2001 and 2002
related to a portion of our fixed rate debt. These hedge strategies
satisfy the fair value hedging requirements of SFAS 133. As a result,
the fair value of the hedges is carried on the balance sheet in other
current assets and the related underlying liabilities are also
adjusted to fair value by the same amount.
(i) Investments:
------------
We classify our investments at purchase as available-for-sale. We do
not maintain a trading portfolio or held to maturity securities.
Securities classified as available-for-sale are carried at estimated
fair market value. These securities are held for an indefinite period
of time, but might be sold in the future as changes in market
conditions or economic factors occur. Net aggregate unrealized gains
and losses related to such securities, net of taxes, are included as a
separate component of shareholders' equity. Interest, dividends and
gains and losses realized on sales of securities are reported in
Investment income.
We evaluate our investments periodically to determine whether any
decline in fair value, below the cost basis, is other than temporary.
If we determine that a decline in fair value is other than temporary,
the cost basis of the individual investment is written down to fair
value which becomes the new cost basis. The amount of the write down
is transferred from other comprehensive income (loss) and included in
the statement of operations as a loss.
(j) Income Taxes, Deferred Income Taxes and Investment Tax Credits:
---------------------------------------------------------------
We file a consolidated federal income tax return. We utilize the asset
and liability method of accounting for income taxes. Under the asset
and liability method, deferred income taxes are recorded for the tax
effect of temporary differences between the financial statement basis
and the tax basis of assets and liabilities using tax rates expected
to be in effect when the temporary differences are expected to
reverse. The investment tax credits relating to regulated operations,
as defined by applicable regulatory authorities, have been deferred
and are being amortized to income over the lives of the related
properties.
(k) Employee Stock Plans:
---------------------
We have various employee stock-based compensation plans. Awards under
these plans are granted to eligible officers, management employees and
non-management employees. Awards may be made in the form of incentive
stock options, non-qualified stock options, stock appreciation rights,
restricted stock or other stock based awards. As permitted by current
accounting rules, we recognize compensation expense in the financial
statements only if the market price of the underlying stock exceeds
the exercise price on the date of grant. We provide pro forma net
income (loss) and pro forma net income (loss) per common share
disclosures for employee stock option grants made in 1995 and
thereafter based on the fair value of the options at the date of grant
(see Note 18). Fair value of options granted is computed using the
Black Scholes option-pricing model.
(l) Minority Interest and Minority Interest in Subsidiary:
------------------------------------------------------
Minority interest represents the former minority's share of ELI's net
loss. Subsequent to ELI's initial public offering in 1997, we recorded
minority interest on our statement of operations and reduced minority
interest on our balance sheet by the amount of the former minority
interests' share of ELI's losses. As of June 30, 2000, the former
minority interest on the balance sheet had been reduced to zero,
therefore, from that date forward, we discontinued recording minority
interest income on our statement of operations.
F-9
(m) Net Income (loss) Per Common Share:
-----------------------------------
Basic net income per common share is computed using the weighted
average number of common shares outstanding during the period being
reported on. Diluted net income per common share reflects the
potential dilution that could occur if securities or other contracts
to issue common stock that are in the money were exercised or
converted into common stock at the beginning of the period being
reported on.
(2) Accounts Receivable:
--------------------
The components of accounts receivable, net at December 31, 2002 and 2001
are as follows:
($ in thousands) 2002 2001
-------------- -------------- ---------------
Customers $ 258,165 $ 292,345
Other 91,710 87,134
Less: Allowance for doubtful accounts (38,946) (67,601)
-------------- ---------------
Accounts receivable, net $ 310,929 $ 311,878
============== ===============
(3) Property, Plant and Equipment:
------------------------------
The components of property, plant and equipment at December 31, 2002 and
2001 are as follows:
Estimated
($ in thousands) Useful Lives 2002 2001
-------------- ------------------- ----------------- -----------------
Telephone outside plant 6 to 55 years $ 3,199,676 $ 3,280,542
Telephone central office equipment 7 to 11 years 1,893,169 2,135,992
Information systems and other administrative assets 5 to 17 years 762,709 777,351
Other 67,073 55,065
Construction work in progress 217,145 450,978
----------------- -----------------
6,139,772 6,699,928
Less: accumulated depreciation (2,449,716) (2,187,890)
----------------- -----------------
Property, plant and equipment, net $ 3,690,056 $ 4,512,038
================= =================
Depreciation expense, calculated using the straight-line method, is based
upon the estimated service lives of various classifications of property,
plant and equipment. Depreciation expense was $630,113,000, $488,957,000
and $370,119,000 for the years ended December 31, 2002, 2001 and 2000,
respectively. We ceased to record depreciation expense on the gas assets
effective October 1, 2000 and on the electric assets effective January 1,
2001, both of which are included in assets held for sale (see Note 7).
During 2002 and 2001, we recognized accelerated depreciation of $23,379,000
and $22,000,000 related to the change in useful lives of our accounting and
human resource systems and our Plano, Texas office building, furniture and
fixtures as a result of our restructuring (see Note 19). During 2000, we
recognized $17,400,000 in accelerated depreciation related to the change in
useful life of an operating system in the ILEC segment.
(4) Losses on Impairment:
---------------------
In the third quarter 2002, we recognized non-cash pre-tax impairment losses
of $656,658,000 related to property, plant and equipment in the ELI sector
and $417,400,000 related to the gas and electric sector assets held for
sale, in each case in accordance with the provisions of SFAS 144.
ELI
---
Prior to the third quarter of 2002, we tested for impairment of ELI and
determined that, based on our assumptions, the sum of the expected future
cash flows, undiscounted and without interest charges, exceeded the
carrying value of its long-lived assets and therefore we did not recognize
an impairment. Because sales for the nine months ended September 30, 2002
were lower than those in 2001 and were significantly below our original
2002 budget (which was used in the test for impairment at December 31,
2001), we evaluated the long-lived assets of ELI as of September 30, 2002.
At that date, we estimated that our undiscounted future cash flows were
less than the carrying value of our long-lived assets. As a result we
recognized a non-cash pre-tax impairment loss of $656,658,000, equal to the
difference between the estimated fair value of the assets (which we
determined by calculating the discounted value of the estimated future cash
F-10
flows weighting various possible scenarios for management's assessment of
probability of occurrence and discounting the probability-weighted cash
flows at an appropriate rate) and the carrying amount of the assets. Making
the determinations of impairment and the amount of impairment require
significant judgment by management and assumptions with respect to the
future cash flows of the ELI sector. The telecommunications industry in
general and the CLEC sector in particular is undergoing significant change
and disruption, which makes judgments and assumptions with respect to the
future cash flows highly subjective.
Gas and Electric Assets Held for Sale
-------------------------------------
On October 29, 2002, our board approved the sale of our Arizona gas and
electric utility properties for $230,000,000 in cash ($220,000,000 if we
close by July 28, 2003), subject to adjustments under the terms of the
agreements. On December 19, 2002, our board approved the sale of our Hawaii
gas property for $115,000,000 in cash, subject to adjustments under the
terms of the agreement. The board also approved, in principle, the sale of
Vermont Electric, our only remaining utility property at currently offered
prices, which were below their then book carrying value. This property is
the only utility property that does not have a definitive sales contract.
Previously, we believed that the net realizable value of these properties
was equal to or above their carrying values. However, as a result of market
conditions, and the desire to complete the divestiture process quickly in
order to focus on our core telecommunications operations and raise money to
further reduce debt, we made a strategic decision to accept proceeds less
than carrying values. Our estimate of net realizable value with respect to
Vermont is based on current negotiations and may be revised in future
periods. As a result, for the four properties noted above we recorded a
non-cash pre-tax charge of $417,400,000 in the third quarter of 2002 to
reduce the carrying value of our assets held for sale to our best estimate
of net realizable value upon sale (see Note 7).
(5) Acquisitions:
-------------
In 2000, we acquired from Verizon Communications Inc. (Verizon)
approximately 317,500 telephone access lines for $948,200,000 in cash, and
we acquired from Qwest Communications (Qwest) approximately 17,000
telephone access lines for approximately $38,000,000 in cash. On June 29,
2001, we purchased Frontier for approximately $3,373,000,000 in cash. These
acquisitions have been accounted for using the purchase method of
accounting. The results of operations of the acquired properties have been
included in our financial statements from the date of acquisition.
F-11
The following summarizes the allocation of purchase prices for our 2001 and
2000 acquisitions:
Total
($ in thousands) Qwest Verizon 2001 Acquisitions
-------------- Verizon Verizon North Illinois/ Total 2000 Acquisition since
Nebraska Minnesota Dakota Wisconsin Acquisitions of Frontier January 2000
------------ ------------- ------------- ------------- -------------- --------------- ---------------
Acquisition date 6/30/2000 8/31/2000 10/31/2000 11/30/2000 6/29/2001
Assets acquired:
Property, plant and
equipment $ 51,903 $ 137,391 $ 13,910 $ 105,446 $ 308,650 $ 1,108,514 $ 1,417,164
Current assets - 4,960 - - 4,960 119,016 123,976
Goodwill 108,175 174,247 16,619 163,906 462,947 1,506,647 1,969,594
Customer base 46,060 120,742 7,466 34,565 208,833 791,983 1,000,816
Trade name - - - - - 122,058 122,058
Other assets - 1,557 - - 1,557 151,172 152,729
------------ ------------- ------------- ------------- -------------- --------------- ---------------
Total assets acquired 206,138 438,897 37,995 303,917 986,947 3,799,390 4,786,337
------------ ------------- ------------- ------------- -------------- --------------- ---------------
Liabilities assumed:
Debt - - - - - 146,920 146,920
Other liabilities 734 - - - 734 279,536 280,270
------------ ------------- ------------- ------------- -------------- --------------- ---------------
Total liabilities assumed 734 - - - 734 426,456 427,190
------------ ------------- ------------- ------------- -------------- --------------- ---------------
Cash paid $205,404 $ 438,897 $ 37,995 $ 303,917 $ 986,213 $ 3,372,934 $ 4,359,147
============ ============= ============= ============= ============== =============== ===============
Status of appraisal
valuation Final Final Final Final Final Final Final
The following pro forma financial information for the years ended December
31, 2001 and 2000 represents the combined results of our operations and
acquisitions as if the acquisition had occurred at the beginning of the
year of its acquisition. The pro forma financial information does not
necessarily reflect the results of operations that would have occurred had
we constituted a single entity during such periods.
($ in thousands, except per share amounts)
----------------------------------------
2001 2000
--------------- ----------------
Revenue $ 2,844,789 $ 2,693,824
Net loss $ (161,619) $ (148,754)
Net loss per share $ (0.64) $ (0.56)
Included in revenue for the years ended December 31, 2001 and 2000 is
approximately $313,070,000 and $327,300,000, respectively, of revenue from
our Louisiana and Colorado gas operations sold during 2001, and our Kauai
electric division sold during 2002 (see Note 7).
(6) Intangibles:
------------
Intangibles at December 31, 2002 and 2001 are as follows:
($ in thousands)
-------------- 2002 2001
--------------- ----------------
Customer base - amortizable $1,000,816 $ 970,925
Trade name - non-amortizable 122,058 106,473
--------------- ----------------
Other intangibles 1,122,874 1,077,398
Accumulated amortization (179,904) (56,056)
--------------- ----------------
Total other intangibles, net $ 942,970 $ 1,021,342
=============== ================
Amortization expense was $125,409,000, $143,379,000 and $17,488,000 for the
years ended December 31, 2002, 2001 and 2000, respectively.
F-12
We have recorded assets acquired at estimates of fair market values as of
the acquisition dates in accordance with SFAS No. 141, "Business
Combinations". Our allocations of purchase prices are based upon
independent appraisals of the respective properties acquired.
Our acquisitions were made in order for us to execute upon our business
strategy. Our strategy is to focus exclusively on providing
telecommunications services, primarily in rural, small and medium-sized
towns and cities where we believe we have a competitive advantage because
of our relatively larger size, greater resources, local focus and lower
levels of competition.
Our ILEC operations are typically the dominant provider of independent
local exchange carrier services in each of the markets in which we operate.
We believe that our operations in these areas will provide us with steady
revenue and margin enhancement opportunities. To reach our objectives, we
intend to continue to achieve economies of scale through increasing
operational efficiencies, among other strategies. In following our
strategy, we selectively pursue acquisitions that we believe will enhance
shareholder value through increased revenue growth and operational
efficiencies consistent with our corporate strategy and objectives.
We have paid more than the net book values (of the seller) of each of the
businesses acquired in 2001 and 2000. We based our purchase prices on
estimates of future earnings and future cash flows of the businesses
acquired. The "premium" to book value paid, including the allocation to
goodwill for each respective property, reflects the value created by all of
the tangible and intangible operating assets (existing and acquired) of our
businesses coming together to produce earnings, including without
limitation, the fact that we were able to immediately commence operations
as the dominant local exchange carrier in the applicable operating area.
Additionally, the premiums paid were impacted by the fact that our purchase
price was accepted by the sellers after a competitive bidding and
negotiation process.
We were willing to pay a premium (i.e., goodwill) over the fair value of
the tangible and identifiable intangible assets acquired less liabilities
assumed in order to obtain product cross-selling opportunities, economies
of scale (e.g., cost savings opportunities) and the potential benefit
resident in expected population/demographic trends.
The following table presents a reconciliation between reported net loss and
adjusted net loss. Adjusted net loss excludes amortization expense
recognized in prior periods related to goodwill and trade name that are no
longer being amortized as required by SFAS No. 142.
(In thousands, except per-share amounts) 2002 2001 2000
-------------------------------------- --------------- ---------------- ---------------
Reported attributable to common shareholders $ (682,897) $ (103,332) $ (28,394)
Add back: Goodwill and trade name amortization, net of tax - 61,938 9,202
--------------- ---------------- ---------------
Adjusted attributable to common shareholders $ (682,897) $ (41,394) $ (19,192)
=============== ================ ===============
Basic earnings per share:
- -------------------------
Reported attributable to common shareholders $ (2.43) $ (0.38) $ (0.11)
Goodwill and trade name amortization, net of tax - 0.23 0.04
--------------- ---------------- ---------------
Adjusted attributable to common shareholders $ (2.43) $ (0.15) $ (0.07)
=============== ================ ===============
Diluted earnings per share:
- ---------------------------
Reported attributable to common shareholders $ (2.43) $ (0.38) $ (0.11)
Goodwill and trade name amortization, net of tax - 0.22 0.03
--------------- ---------------- ---------------
Adjusted attributable to common shareholders $ (2.43) $ (0.16) $ (0.08)
=============== ================ ===============
(7) Discontinued Operations and Net Assets Held for Sale:
-----------------------------------------------------
On August 24, 1999, our Board of Directors approved a plan of divestiture
for our public utilities services businesses, which included gas, electric
and water and wastewater businesses.
F-13
Water and Wastewater
--------------------
On January 15, 2002, we completed the sale of our water and wastewater
operations to American Water Works, Inc. for $859,100,000 in cash and
$122,500,000 of assumed debt and other liabilities. The pre-tax gain
on the sale recognized in 2002 was $316,672,000.
Electric and Gas
----------------
On October 29, 2002, we entered into definitive agreements to sell our
Arizona gas and electric divisions to UniSource Energy Corporation for
$230,000,000 in cash ($220,000,000 if we close by July 28, 2003),
subject to adjustments specified in the agreements (see Note 4). The
transactions, which are subject to regulatory and other customary
approvals, are expected to close during the second half of 2003.
On November 1, 2002, we completed the sale of our Kauai electric
division to Kauai Island Utility Cooperative (KIUC) for $215,000,000
in cash. The pre-tax gain on the sale recognized in 2002 was
$8,273,000.
On December 19, 2002, we entered into a definitive agreement to sell
The Gas Company in Hawaii to K-1 USA Ventures, Inc for $115,000,000 in
cash, subject to adjustments under the terms of the agreement. The
transaction, which is subject to regulatory and other customary
approvals, is expected to close during the fourth quarter of 2003.
On July 2, 2001, we completed the sale of our Louisiana Gas operations
to Atmos Energy Corporation for $363,436,000 in cash. The pre-tax gain
on the sale recognized in 2001 was $139,304,000.
On November 30, 2001, we sold our Colorado Gas division to Kinder
Morgan for approximately $8,900,000 in cash after purchase price
adjustments.
Currently, we do not have an agreement to sell our remaining electric
property, Vermont Electric. We continue to actively pursue a buyer for our
remaining electric business. All of our gas and electric assets (including
Arizona gas and electric and Hawaii gas) and their related liabilities are
classified as "assets held for sale" and "liabilities related to assets
held for sale," respectively. These assets have been written down to our
best estimate of the net realizable value upon sale (see Note 4).
Discontinued operations in the consolidated statements of operations
reflect the results of operations of the water/wastewater properties sold
in January 2002 including allocated interest expense for the periods
presented. Interest expense was allocated to the discontinued operations
based on the outstanding debt specifically identified with these
businesses.
We initially accounted for the planned divestiture of all the public
utilities services properties as discontinued operations. Subsequently, we
reclassified all of our gas (on September 30, 2000) and electric (on
December 31, 2000) assets and their related liabilities to "assets held for
sale" and "liabilities related to assets held for sale," respectively. We
also reclassified the results of these operations from discontinued
operations to their original income statement captions as part of
continuing operations. Additionally, we ceased to record depreciation
expense on the gas assets effective October 1, 2000 and on the electric
assets effective January 1, 2001. Such depreciation expense would have been
an additional $41,340,000 and $50,830,000 for the years ended December 31,
2002 and 2001, respectively.
Summarized financial information for the water/wastewater operations
(discontinued operations) is set forth below:
($ in thousands) For the years ended December 31,
-------------- ----------------------------------
2002 2001 2000
---------- ---------- ----------
Revenue $ 4,650 $ 116,868 $ 105,202
Operating income (loss) (415) 37,211 27,415
Income taxes (benefit) (554) 8,947 5,721
Net income (loss) (1,478) 17,875 11,677
Gain on disposal of water segment,
net of tax 181,369 - -
F-14
Summarized balance sheet information for the gas and electric operations
(assets held for sale) is set forth below:
($ in thousands)
-------------- 2002 2001
-------------- ---------------
Current assets $ 49,549 $ 66,511
Net property, plant and equipment 358,135 805,653
Other assets 40,080 235,773
-------------- ---------------
Total assets held for sale $ 447,764 $ 1,107,937
============== ===============
Current liabilities $ 83,278 $ 71,259
Long-term debt - 43,400
Other liabilities 66,775 104,116
-------------- ---------------
Total liabilities related to assets held for sale $ 150,053 $ 218,775
============== ===============
(8) Investments:
------------
The components of investments at December 31, 2002 and 2001 are as follows:
($ in thousands)
-------------- 2002 2001
---------------- ----------------
Marketable equity securities $ 29,844 $ 139,188
Other fixed income securities 2 2,020
---------------- ----------------
$ 29,846 $ 141,208
================ ================
As of December 31, 2002, we owned 3,059,000 shares of Adelphia
Communications Corp. (Adelphia) common stock. As a result of Adelphia's
price declines and filing for bankruptcy, we recognized losses of
$95,300,000 and $79,000,000 on our investment for the years ended December
31, 2002 and 2001, respectively, as the declines were determined to be
other than temporary. As of June 30, 2002, we had written this investment
down to zero, and therefore we have no additional exposure related to the
market value of Adelphia stock.
As of December 31, 2002, we owned 1,333,500 shares of D & E Communications
common stock. As the result of an other than temporary decline in D & E's
stock price, we recognized a loss of $16,400,000 on our investment for the
year ended December 31, 2002.
The following summarizes the adjusted cost, gross unrealized holding gains
and losses and fair market value for investments.
($ in thousands)
-------------- Adjusted Unrealized Holding Aggregate Fair
---------------------------------
Investment Classification Cost Gains (Losses) Market Value
---------------- ---------------- ---------------- ----------------
As of December 31, 2002
- -----------------------
Available-for-Sale $ 14,452 $ 15,394 $ - $ 29,846
As of December 31, 2001
- -----------------------
Available-for-Sale $ 132,935 $ 11,896 $ (3,623) $ 141,208
Marketable equity securities for 2002 and 2001 include 2,305,908 common
shares which represent an ownership of 19% of the equity in Hungarian
Telephone and Cable Corp., a company of which our Chairman and Chief
Executive Officer is a member of the Board of Directors. In addition, we
hold 30,000 shares of non-voting convertible preferred stock, each share
having a liquidation value of $70 per share and is convertible at our
option into 10 shares of common stock.
(9) Fair Value of Financial Instruments:
------------------------------------
The following table summarizes the carrying amounts and estimated fair
values for certain of our financial instruments at December 31, 2002 and
2001. For the other financial instruments, representing cash, accounts
receivables, long-term debt due within one year, accounts payable and other
accrued liabilities, the carrying amounts approximate fair value due to the
relatively short maturities of those instruments.
F-15
($ in thousands)
-------------- 2002 2001
----------------------------------- ---------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------------- ------------------ ---------------- ----------------
Investments $ 29,846 $ 29,846 $ 141,208 $ 141,208
Long-term debt (1) $ 4,957,361 $ 5,411,069 $ 5,534,906 $ 5,605,368
Equity Providing Preferred
Income Convertible Securities (EPPICS) $ 201,250 $ 191,188 $ 201,250 $ 179,113
The fair value of the above financial instruments is based on quoted prices at
the reporting date for those financial instruments.
(1) Excludes the $460,000,000 debt portion of the equity units.
(10) Long-term Debt:
---------------
The activity in our long-term debt from December 31, 2001 to December 31,
2002 is summarized as follows:
Twelve Months Ended
--------------------------------------------
Interest Rate*
Interest at
December 31, Rate Swap/ December 31, December 31,
($ in thousands) 2001 Borrowings Reclassification Payments*** 2002 2002
-------------- ------------ ---------- ---------------- ----------- ------------ -------------
FIXED RATE
Rural Utilities Service Loan $ 110,860 $ - $ - $ (79,986) $ 30,874 6.210%
Contracts
Debentures 850,778 - - (103,881) 746,897 7.538%
2001 Notes 3,700,430 - 16,229 (25,676) 3,690,983 8.267%
Equity Units 460,000 - - - 460,000 7.480%
Senior Unsecured Notes 108,825 - - (37,825) 71,000 8.050%
ELI Notes 325,000 - - (319,025) 5,975 6.232%
ELI Capital Leases 137,382 1,512 - (3,694) 135,200 11.798%
Industrial Development Revenue
Bonds 249,205 - - (62,815) 186,390 6.091%
Other 54 - - (14) 40 12.985%
--------- ------- ------- --------- ---------
TOTAL FIXED RATE 5,942,534 1,512 16,229 (632,916) 5,327,359
--------- ------- ------- --------- ---------
VARIABLE RATE
ELI Bank Credit Facility 400,000 - - (400,000) - 2.391%
Industrial Development Revenue Bonds 136,278 - 43,400 ** (30,765) 148,913 3.563%
--------- ------- ------- --------- ---------
TOTAL VARIABLE RATE 536,278 - 43,400 (430,765) 148,913
--------- ------- ------- --------- ---------
TOTAL LONG TERM DEBT $6,478,812 $ 1,512 $ 59,629 $(1,063,681) $5,476,272
---------- ======= ========= ============ ----------
Less: Current Portion (483,906) (58,911)
Less: Equity Units (460,000) (460,000)
--------- ---------
$5,534,906 $4,957,361
========== ==========
* Interest rate includes amortization of debt issuance expenses, debt premiums
or discounts. The interest rate for Rural Utilities Service Loan Contracts,
Debentures, ILEC Senior Unsecured Notes, and Industrial Development Revenue
Bonds represent a weighted average of multiple issuances.
** Reclassification from liabilities related to assets held for sale for
liabilities retained after sale of certain public utilities operations.
*** Includes purchases on the open market (see Note 13).
Total future minimum cash payment commitments over the next 25 years under
ELI's long-term capital leases amounted to $317,800,000 as of December 31,
2002.
F-16
The total outstanding principal amounts of industrial development revenue
bonds were $335,303,000 and $385,483,000 at December 31, 2002 and 2001,
respectively. The earliest maturity date for these bonds is in August 2015.
We have an available shelf registration of $825,600,000 and we have
available lines of credit with financial institutions in the aggregate
amount of $805,000,000. Associated facility fees vary, depending on our
credit ratings, and are 0.25% per annum as of December 31, 2002. The
expiration date for the facilities is October 24, 2006. During the term of
the facilities we may borrow, repay and reborrow funds. As of December 31,
2002, there were no outstanding advances under these facilities.
During the last three quarters of 2002, we executed a series of purchases
in the open market of a number of our outstanding notes and debentures. The
aggregate principal amount of notes and debentures purchased was
$106,906,000 and they generated a pre-tax gain from the early
extinguishment of debt at a discount of approximately $6,000,000 recorded
in other income (loss), net.
During December 2002, we completed a tender offer with respect to our 6.80%
Debentures due 2026 (puttable at par in 2003) and ELI's 6.05% Guaranteed
Notes due 2004. As a result of the tender, $82,286,000 and $259,389,000,
respectively, of these securities were purchased and retired at a pretax
cost of $12,800,000 in excess of the principal amount of the securities
purchased.
For the year ended December 31, 2002, we retired an aggregate principal
amount of $1,063,681,000 of debt.
In May 2001, we issued an aggregate of $1.75 billion of notes consisting of
$700,000,000 principal amount of 8.50% notes due May 15, 2006 and $1.05
billion principal amount of 9.25% notes due May 15, 2011.
On June 13, 2001, we issued 18,400,000 equity units at $25 per unit for net
proceeds of $446,200,000 (after underwriting discounts and commissions and
before offering expenses). Each equity unit initially consists of a 6.75%
senior note due 2006 and a purchase contract (warrant) for our common
stock. The purchase contract obligates the holder to purchase from us, no
later than August 17, 2004 for a purchase price of $25, the following
number of shares of our common stock:
* 1.7218 shares, if the average closing price of our common stock
over the 20-day trading period ending on the third trading day
prior to August 17, 2004 equals or exceeds $14.52;
* A number of shares having a value, based on the average closing
price over that period, equal to $25, if the average closing
price of our common stock over the same period is less than
$14.25, but greater than $12.10; and
* 2.0661 shares, if the average closing price of our common stock
over the same period is less than or equal to $12.10.
The fair market value of the warrants at the date of issuance was
$4,968,000. This amount was recorded as debt discount and additional
paid-in capital. The equity units trade on The New York Stock Exchange
under the symbol "CZB."
In August 2001, we issued an aggregate of $1.75 billion of notes consisting
of $300,000,000 of 6.375% notes due 2004, $750,000,000 principal amount of
7.625% notes due 2008 and $700,000,000 principal amount of 9.000% notes due
2031.
In October 2001, we borrowed $200,000,000 on an unsecured basis from the
Rural Telephone Finance Cooperative (RTFC). This note is due on October 24,
2011 and has a fixed 6.27% rate of interest, payable quarterly.
F-17
Our principal payments and capital lease payments (principal only) for the
next five years are as follows:
($ in thousands)
--------------
Principal Capital
--------- --------------
Payments Lease Payments
--------- --------------
2003 $ 50,939 $ 7,972
2004 385,005 3,061
2005 933 3,391
2006 875,992 3,772
2007 1,056 4,203
Holders of certain industrial development revenue bonds may tender at par
prior to maturity. The next tender date is August 1, 2007 for $30,350,000
of principal amount of bonds. We expect to remarket all such bonds which
are tendered. If the proposed sale of our Arizona electric and gas
properties to UniSource is completed we will be required to redeem
$111,760,000 of industrial development revenue bonds promptly after the
sale is completed.
(11) Derivative Instruments and Hedging Activities:
----------------------------------------------
Interest rate swap agreements are used to hedge a portion of our debt that
is subject to fixed interest rates. Under our interest rate swap
agreements, we agree to pay an amount equal to a specified variable rate of
interest times a notional principal amount, and to receive in return an
amount equal to a specified fixed rate of interest times the same notional
principal amount. The notional amounts of the contracts are not exchanged.
No other cash payments are made unless the agreement is terminated prior to
maturity, in which case the amount paid or received in settlement is
established by agreement at the time of termination and represents the
market value, at the then current rate of interest, of the remaining
obligations to exchange payments under the terms of the contracts.
The interest rate swap contracts are reflected at fair value in our
consolidated balance sheet and the related portion of fixed-rate debt being
hedged is reflected at an amount equal to the sum of its book value and an
amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. Changes in the fair
value of interest rate swap contracts, and the offsetting changes in the
adjusted carrying value of the related portion of the fixed-rate debt being
hedged, are recognized in the consolidated statements of operations in
interest expense. The notional amounts of fixed-rate indebtedness hedged as
of December 31, 2002 and December 31, 2001 was $250,000,000 and
$100,000,000, respectively. Such contracts require us to pay variable rates
of interest (average pay rate of approximately 4.85% as of December 31,
2002) and receive fixed rates of interest (average receive rate of 7.65% as
of December 31, 2002). The fair value of these derivatives is reflected in
other assets as of December 31, 2002, in the amount of $16,658,000 and the
related underlying debt has been increased by a like amount. The amounts
received during the year ended December 31, 2002 as a result of these
contracts amounted to $3,820,000 and are included as a reduction of
interest expense.
We do not anticipate any nonperformance by counter parties to our
derivative contracts as all counter parties have investment grade credit
ratings.
(12) Shareholder Rights Plan:
------------------------
On March 6, 2002, our Board of Directors adopted a Shareholder Rights Plan.
The purpose of the Shareholder Rights Plan is to deter coercive takeover
tactics and to encourage third parties interested in acquiring us to
negotiate with our Board of Directors. It is intended to strengthen the
ability of our Board of Directors to fulfill its fiduciary duties to take
actions which are in the best interest of our shareholders. The rights were
distributed to shareholders as a dividend at the rate of one right for each
share of our common stock held by shareholders of record as of the close of
business on March 26, 2002. Initially, the rights generally were
exercisable only if a person or group acquired beneficial ownership of 15
percent or more of our common stock (the "Acquiror") without the consent of
our independent directors. On January 21, 2003, our Board of Directors
amended the terms of our Rights agreement increasing the level at which
these rights will become exercisable to 20 percent of our common stock.
Each right not owned by an Acquiror becomes the right to purchase our
common stock at a 50 percent discount.
F-18
(13) Changes in Accounting Principles:
---------------------------------
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
141, "Business Combinations." This statement requires that all business
combinations be accounted for under the purchase method of accounting. SFAS
141 requires that the purchase method of accounting be used for business
combinations initiated after June 30, 2001 and prohibits the use of the
pooling-of-interests method of accounting. We adopted SFAS No. 141 on July
1, 2001. The adoption of SFAS 141 did not have any impact on our financial
position or results of operations.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." This statement requires that goodwill and other intangibles with
indefinite useful lives no longer be amortized to earnings, but instead be
reviewed for impairment. The amortization of goodwill and other intangibles
with indefinite useful lives ceased upon adoption of the statement on
January 1, 2002. We have no other intangibles with indefinite lives other
than goodwill and trade name. We were required to test for impairment of
goodwill and trade name as of January 1, 2002 and at least annually
thereafter. Any transitional impairment loss at January 1, 2002 was
recognized as the cumulative effect of a change in accounting principle in
our statement of operations. During the first quarter of 2002, we
reassessed the useful lives of our intangible assets with estimated useful
lives and determined no change was required. We annually examine the
carrying value of our goodwill and other identifiable intangibles (customer
base and trade name) to determine whether there are any impairment losses
and have determined for the year ended December 31, 2002 that there was no
impairment except for goodwill related to ELI. SFAS No. 142 also requires
that intangible assets with estimated useful lives be amortized over those
lives and be reviewed for impairment in accordance with SFAS No. 144,
"Accounting for Impairment or Disposal or Long-Lived Assets." The impact of
the adoption of SFAS 142 is discussed in Note 6 to Consolidated Financial
Statements.
As a result of our adoption of SFAS 142, we recognized a transitional
impairment loss of $39,800,000 on ELI as a cumulative effect of a change in
accounting principle in our statement of operations in the first quarter of
2002.
In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment
or Disposal of Long-lived Assets" (see Notes 1(g) and 4).
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the requirement that gains and
losses from extinguishment of debt be required to be aggregated and, if
material, classified as an extraordinary item, net of related income tax
effect. The statement requires gains and losses from extinguishment of debt
to be classified as extraordinary items only if they meet the criteria in
Accounting Principles Board Opinion No. 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" which provides guidance for distinguishing transactions that
are part of an entity's recurring operations from those that are unusual or
infrequent or that meet the criteria for classification as an extraordinary
item. We adopted SFAS 145 in the second quarter of 2002. For the year ended
December 31, 2002, we recognized $32,330,000 of gains from early debt
retirement as well as a $12,800,000 loss due to a tender offer related to
certain debt securities. There were no similar types of retirements in
2001.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure for Stock-Based Compensation."
SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based
compensation and amends the disclosure requirements of SFAS No. 123. This
statement is effective for fiscal years ending after December 15, 2002. We
adopted the expanded disclosure requirements of SFAS No. 148.
(14) Settlement of Retained Liabilities:
-----------------------------------
We were actively pursuing the settlement of certain retained liabilities at
less than face value, which are associated with customer advances for
construction from our disposed water properties. For the year ended
December 31, 2002, we recognized $26,330,000 in other income (loss), net,
as a result of these settlements.
(15) Global /WorldCom Receivables:
-----------------------------
During the second quarter 2002, we reserved approximately $21,600,000 of
trade receivables with WorldCom as a result of WorldCom's filing for
bankruptcy. These receivables were generated as a result of providing
ordinary course telecommunications services. The $21,600,000 charge was
partially offset by reversals in our Global reserve as discussed below.
F-19
Concurrent with the acquisition of Frontier, we entered into several
operating agreements with Global. We have ongoing commercial relationships
with Global affiliates. We reserved a total of $29,000,000 of Global
receivables to reflect our best estimate of the net realizable value of
receivables incurred from these commercial relationships during 2001 and
2002 as a result of Global's filing for bankruptcy. We recorded a
write-down of such receivables in the amount of $7,800,000 in the first
quarter 2002 and $21,200,000 in the fourth quarter of 2001. In 2002, as the
result of a settlement agreement with Global, we reversed $17,900,000 of
our previous reserve of the net realizable value of these receivables.
Prior to the date of Global's bankruptcy filing, we provided ordinary
course telecommunications services as well as transitional services to
Global. Global has provided us certain customer billing and collection
functions as well as other transitional services. Although some of these
arrangements have continued after the bankruptcy filing, we are in the
process of changing some services and functions to provide them ourselves.
The Bankruptcy Court has granted relief to us and other telecommunications
companies that provide service to Global by, among other things, directing
a shortened payment period with respect to post-petition invoices, an
expedited court process for post-petition defaults in payments by Global,
and a priority for post-petition expense items over other unsecured debt.
These procedures should minimize future economic loss to us although we
cannot guarantee that additional losses will not occur.
(16) Company Obligated Mandatorily Redeemable Convertible Preferred
--------------------------------------------------------------
Securities:
-----------
In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust
(the Trust), issued, in an underwritten public offering, 4,025,000 shares
of 5% Company Obligated Mandatorily Redeemable Convertible Preferred
Securities due 2036 (Trust Convertible Preferred Securities or EPPICS),
representing preferred undivided interests in the assets of the Trust, with
a liquidation preference of $50 per security (for a total liquidation
amount of $201,250,000). The proceeds from the issuance of the Trust
Convertible Preferred Securities and a Company capital contribution were
used to purchase $207,475,000 aggregate liquidation amount of 5%
Partnership Convertible Preferred Securities due 2036 from another wholly
owned consolidated subsidiary, Citizens Utilities Capital L.P. (the
Partnership). The proceeds from the issuance of the Partnership Convertible
Preferred Securities and a Company capital contribution were used to
purchase from us $211,756,000 aggregate principal amount of 5% Convertible
Subordinated Debentures due 2036. The sole assets of the Trust are the
Partnership Convertible Preferred Securities and our Convertible
Subordinated Debentures are substantially all the assets of the
Partnership. Our obligations under the agreements related to the issuances
of such securities, taken together, constitute a full and unconditional
guarantee by us of the Trust's obligations relating to the Trust
Convertible Preferred Securities and the Partnership's obligations relating
to the Partnership Convertible Preferred Securities.
In accordance with the terms of the issuances, we paid the 5% interest on
the Convertible Subordinated Debentures in 2002, 2001 and 2000. During 2002
and 2001, only cash was paid to the Partnership in payment of the interest
on the Convertible Subordinated Debentures. The cash was then distributed
by the Partnership to the Trust and then by the Trust to the holders of the
EPPICS.
(17) Capital Stock:
--------------
We are authorized to issue up to 600,000,000 shares of Common Stock. The
amount and timing of dividends payable on Common Stock are within the sole
discretion of our Board of Directors.
Between December 1999 and April 2000, our Board of Directors authorized the
purchase of up to $200,000,000 worth of shares of our common stock. This
share purchase program was completed in July 2000 and resulted in the
acquisition or contract to acquire approximately 12,092,000 shares of our
common stock. Of those shares, 2,952,000 shares were purchased for
approximately $49,209,000 in cash and we entered into an equity forward
contract for the acquisition of the remaining 9,140,000 shares.
During 2000, we entered into a forward contract to purchase 9,140,000
shares of our common stock with Citibank, N.A. These purchases and others
made by us for cash during 2000 were made in open-market transactions. The
forward amount to be paid in the future included a carrying cost, based on
LIBOR plus a spread, and the dollar amount paid for the shares purchased.
Our equity forward contract was a temporary financing arrangement that gave
us the flexibility to purchase our stock and pay for those purchases in
future periods. Pursuant to transition accounting rules, commencing
December 31, 2000 through June 30, 2001 we were required to report our
equity forward contract as a reduction to shareholders' equity and as a
component of temporary equity for the gross settlement amount of the
contract ($150,013,000). On June 28, 2001, we entered into a master
confirmation agreement that amended the equity forward contract to no
longer permit share settlement of the contract. In 2001, we settled the
contract by paying the redemption amount of $150,013,000 plus $13,650,000
in associated carrying costs and took possession of our shares.
F-20
In addition to our share purchase programs described above, in April 2000,
our Board of Directors authorized the purchase, from time to time, of up to
$25,000,000 worth of shares of Class A common stock of ELI, in the open
market or in negotiated transactions. This ELI share purchase program was
completed in August 2000 and resulted in the acquisition of approximately
1,288,000 shares of ELI common stock for approximately $25,000,000 in cash.
In August 2000, our Board of Directors authorized the purchase, from time
to time, of up to an additional 1,000,000 shares of ELI on the open market
or in negotiated transactions. The second ELI share purchase program was
completed in September 2000 and resulted in the acquisition of
approximately 1,000,000 shares of ELI common stock for approximately
$13,748,000 in cash.
(18) Stock Plans:
------------
At December 31, 2002, we have four stock based compensation plans which are
described below. We apply APB Opinion No. 25 and related interpretations in
accounting for the employee stock plans resulting in the use of the
intrinsic value to value the stock option. Compensation cost has not
generally been recognized in the financial statements for options issued
pursuant to the Management Equity Incentive Plan (MEIP), or Equity
Incentive Plan (EIP), as the exercise price for such options was equal to
the market price of the stock at the time of grant. However, during 2002
the expiration date of approximately 79,000 options was extended and
compensation cost of approximately $219,700 was recognized. No compensation
cost has been recognized in the financial statements related to the
Employee Stock Purchase Plan (ESPP) because the purchase price is 85% of
the fair value. Compensation cost, recognized in operating expense, for our
Directors' Deferred Fee Equity Plan was $607,151, $741,438 and $691,956 in
2002, 2001 and 2000, respectively.
We have granted restricted stock awards to key employees in the form of our
Common Stock. The number of shares issued as restricted stock awards during
2002, 2001 and 2000 were 538,000, 100,000 and 3,120,000, respectively. None
of the restricted stock awards may be sold, assigned, pledged or otherwise
transferred, voluntarily or involuntarily, by the employees until the
restrictions lapse. The restrictions are both time and performance based.
At December 31, 2002, 3,171,000 shares of restricted stock were
outstanding. Compensation expense, recognized in operating expense, of
$7,029,000, $8,967,000 and $9,084,000 for the years ended December 31,
2002, 2001 and 2000, respectively, has been recorded in connection with
these grants.
Had we determined compensation cost based on the fair value at the grant
date for the MEIP, EIP and ESPP, our pro forma net loss and net loss per
common share would have been as follows:
2002 2001 2000
($ in thousands) --------------- --------------- --------------
--------------
Net loss As reported $ (682,897) $ (89,682) $ (28,394)
Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects 4,660 7,136 6,150
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (16,665) (35,971) (29,026)
----------- ---------- ----------
Pro forma (694,902) (118,517) (51,270)
=========== ========== ==========
Net loss per common share As reported:
Basic $ (2.43) $ (0.38) $ (0.11)
Diluted (2.43) (0.38) (0.11)
Pro forma:
Basic $ (2.48) $ (0.48) $ (0.20)
Diluted (2.48) (0.48) (0.20)
F-21
The full impact of calculating compensation cost for stock options is not
reflected in the pro forma amounts above because pro forma compensation
cost only includes costs associated with the vested portion of options
granted pursuant to the MEIP, EIP and ESPP on or after January 1, 1995.
Management Equity Incentive Plan
--------------------------------
Under the MEIP, awards of our Common Stock may be granted to eligible
officers, management employees and non-management employees in the form of
incentive stock options, non-qualified stock options, stock appreciation
rights (SARs), restricted stock or other stock-based awards. The
Compensation Committee of the Board of Directors administers the MEIP.
Since the expiration date of the MEIP plan on June 21, 2000, no awards can
be granted under the MEIP. The exercise price of stock options issued were
equal to or greater than the fair market value of the underlying common
stock on the date of grant. Stock options are generally not exercisable on
the date of grant but vest over a period of time. Under the terms of the
MEIP, subsequent stock dividends and stock splits have the effect of
increasing the option shares outstanding, which correspondingly decreases
the average exercise price of outstanding options.
F-22
Equity Incentive Plan
---------------------
In May 1996, our shareholders approved the 1996 EIP and in May 2001, our
shareholders approved the 2001 EIP. Under the EIP plans, awards of our
Common Stock may be granted to eligible officers, management employees and
non-management employees in the form of incentive stock options,
non-qualified stock options, SARs, restricted stock or other stock-based
awards. The Compensation Committee of the Board of Directors administers
the EIP.
The maximum number of shares of common stock which may be issued pursuant
to awards at any time for both plans is 25,358,000 shares, which has been
adjusted for subsequent stock dividends. No awards will be granted more
than 10 years after the effective dates (May 23, 1996 and May 17, 2001) of
the EIP plans. The exercise price of stock options and SARs shall be equal
to or greater than the fair market value of the underlying common stock on
the date of grant. Stock options are generally not exercisable on the date
of grant but vest over a period of time.
Under the terms of the EIP, subsequent stock dividends and stock splits
have the effect of increasing the option shares outstanding, which
correspondingly decrease the average exercise price of outstanding options.
The following is a summary of share activity subject to option under the
MEIP and EIP.
Weighted
Shares Average
Subject to Option Price
Option Per Share
------------------------------------------------------------ ------------------- -----------------
Balance at January 1, 2000 16,860,000 $ 9.29
Options granted 5,784,000 13.32
Options exercised (4,126,000) 9.53
Options canceled, forfeited or lapsed (897,000) 9.49
------------------------------------------------------------ -------------------
Balance at December 31, 2000 17,621,000 10.72
Options granted 3,969,000 13.62
Options exercised (1,728,000) 8.25
Options canceled, forfeited or lapsed (805,000) 11.45
------------------------------------------------------------ -------------------
Balance at December 31, 2001 19,057,000 11.87
Options granted 3,065,000 9.53
Options exercised (812,000) 7.90
Options canceled, forfeited or lapsed (2,178,000) 11.94
------------------------------------------------------------ -------------------
Balance at December 31, 2002 19,132,000 $ 11.66
============================================================ ===================
The following table summarizes information about shares subject to options
under the MEIP and EIP at December 31, 2002.
Options Outstanding Options Exercisable
--------------------------------------------------------------------------------- ---------------------------------
Weighted Average Weighted
Number Range of Weighted Average Remaining Number Average
Outstanding Exercise Prices Exercise Price Life in Years Exercisable Exercise price
------------------ -------------------- -------------------- -------------------- ----------------- ---------------
14,000 $ 4.00 - 5.00 $ 4.29 1.73 14,000 $ 4.29
1,479,000 6.00 - 7.50 7.50 6.25 1,464,000 7.50
3,248,000 7.72 - 8.53 8.09 4.25 3,227,000 8.09
110,000 9.18 - 9.38 9.26 6.29 70,000 9.31
2,834,000 9.52 - 9.52 9.52 9.37 503,000 9.52
2,182,000 10.24 - 11.41 10.79 4.11 2,182,000 10.79
1,451,000 12.37 - 12.91 12.62 4.29 1,138,000 12.61
2,069,000 12.97 - 12.97 12.97 7.09 1,514,000 12.97
545,000 13.06 - 13.47 13.44 7.77 524,000 13.45
2,408,000 13.71 - 13.71 13.71 8.33 621,000 13.71
2,792,000 13.75 - 21.47 17.42 6.51 941,000 14.92
------------------ -----------------
19,132,000 $ 4.00 - 21.47 $ 11.66 6.00 12,198,000 $ 10.63
================== =================
The number of options exercisable at December 31, 2001 and 2000 were
10,676,342 and 8,839,000, respectively.
F-23
The weighted average fair value of options granted during 2002, 2001 and
2000 were $4.98, $6.00 and $6.31, respectively. For purposes of the pro
forma calculation, the fair value of each option grant is estimated on the
date of grant using the Black Scholes option-pricing model with the
following weighted average assumptions used for grants in 2002, 2001 and
2000:
2002 2001 2000
--------------------------- --------------- -------------- --------------
Dividend yield - - -
Expected volatility 44% 36% 30%
Risk-free interest rate 4.94% 5.10% 5.82%
Expected life 7 years 6 years 6 years
--------------------------- --------------- -------------- --------------
Employee Stock Purchase Plan
----------------------------
Our ESPP was approved by shareholders on June 12, 1992 and amended on May
22, 1997. Under the ESPP, eligible employees have the right to subscribe to
purchase shares of our Common Stock at 85% of the average of the high and
low market prices on the last day of the purchase period. An employee may
elect to have up to 50% of annual base pay withheld in equal installments
throughout the designated payroll-deduction period for the purchase of
shares. The value of an employee's subscription may not exceed $25,000 in
any one calendar year and the minimum contribution each purchase period is
$50.00. Active employees are required to hold their shares for three years
from the date of each purchase period. An employee may not participate in
the ESPP if such employee owns stock possessing 5% or more of the total
combined voting power or value of our capital stock. As of December 31,
2002, there were 6,407,000 shares of Common Stock reserved for issuance
under the ESPP. These shares may be adjusted for any future stock dividends
or stock splits. The ESPP will terminate when all shares reserved have been
subscribed for and purchased, unless terminated earlier or extended by the
Board of Directors. The Compensation Committee of the Board of Directors
administers the ESPP.
Effective November 30, 2002, the employee stock purchase plan was
temporarily suspended for future purchase periods. In 2002, 146,406 shares
were purchased under the ESPP and 4,072,647 shares were outstanding as of
date of suspension. For purposes of the pro forma calculation, compensation
cost is recognized for the fair value of the employees' purchase rights,
which was estimated using the Black Scholes option pricing model with the
following assumptions for subscription periods beginning in 2002, 2001 and
2000:
2002 2001 2000
------------- ------------- -------------
Dividend yield - - -
Expected volatility 44% 36% 30%
Risk-free interest rate 1.93% 2.71% 6.23%
Expected life 6 months 6 months 6 months
The weighted average fair value of those purchase rights granted in 2002,
2001 and 2000 was $2.57, $2.39, and $3.26, respectively.
Directors' Deferred Fee Equity Plan
-----------------------------------
Effective June 30, 2000, the annual cash retainer paid to non-employee
directors was eliminated. Instead, each non-employee director was required
to elect, by August 1, 2000, to receive as an annual retainer either 2,500
stock units or 10,000 stock options. Starting in July 2001, the Board of
Directors restored the ability of the non-employee directors to receive the
annual retainer in cash. Each non-employee director must now elect, by
December 1 of the prior year, to receive either $30,000 cash, 5,000 stock
units or 20,000 stock options as an annual retainer. Directors making a
stock unit election must also elect to receive payment in either stock or
cash upon retirement from the Board of Directors. Stock options have an
exercise price of the fair market value on the date of grant, are
exercisable six months after the date of grant and have a 10-year term. The
Formula Plan described below also remains in effect until its expiration in
2012.
For 2002, each non-employee director received fees of $2,000 for each Board
of Directors and committee meeting attended. In addition, committee chairs
receive an additional fee of $5,000 per annum, paid quarterly.
From January 1, 2000 through June 30, 2000, the non-employee directors
could choose to receive their fees in either stock or stock units or a
combination of those two options. Effective July 2001, non-employee
directors have the choice to receive their fees paid in cash, stock, or
stock units or a combination of two of those three options. If stock was
elected, the stock was granted at the average of the high and low on the
first trading date of the year (Initial Market Value). If stock units were
elected, they were purchased at 85% of the Initial Market Value. Stock
units (except in an event of hardship) are held by us until retirement or
death. If Final Market Value (the average of the high and low prices of the
stock on the last trading day of November) is less than Initial Market
Value, the number of shares of stock or stock units will be adjusted based
on Final Market Value.
F-24
The Formula Plan, which commenced in 1997 and continues through 2012,
provides each Director options to purchase 5,000 shares of common stock.
The exercise price of the options granted under the Formula Plan is 100% of
the average of the fair market values on the third, fourth, fifth, and
sixth trading days of the year in which the options are granted. The
options are exercisable six months after the grant date and remain
exercisable for ten years after the grant date. In addition, on September
1, 1996, each non-employee director was granted options to purchase 2,500
shares of common stock.
As of any date, the maximum number of shares of common stock which the Plan
was obligated to deliver pursuant to the Directors' Plan shall not be more
than one percent (1%) of the total outstanding shares of our common stock
as of such date, subject to adjustment in the event of changes in our
corporate structure affecting capital stock. There were 11 directors
participating in the Directors' Plan during all or part of 2002. In 2002,
the total options, plan units and stock earned were 99,583, 43,031 and
1,514, respectively. In 2001, the total options, plan units and stock
earned were 90,000, 55,285 and 1,321, respectively. In 2000, the total
Options, Plan Units and stock earned were 100,000, 42,017 and 2,860,
respectively. At December 31, 2002, 1,538,868 options were exercisable at a
weighted average exercise price of $10.70.
We had also maintained a Non-Employee Directors' Retirement Plan providing
for the payment of specified sums annually to our non-employee directors,
or their designated beneficiaries, starting at the director's retirement,
death or termination of directorship. In 1999, we terminated this Plan. The
vested benefit of each non-employee director, as of May 31, 1999, was
credited in the form of stock units. Such benefit will be payable to each
director upon retirement, death or termination of directorship. Each
participant had until July 15, 1999 to elect whether the value of the stock
units awarded would be payable in our common stock (convertible on a one
for one basis) or in cash. As of December 31, 2002, the liability for such
payments was $2,425,000 of which $1,294,000 will be payable in stock (based
on the July 15, 1999 stock price) and $1,131,000 will be payable in cash.
While the number of shares of stock payable to those directors electing to
be paid in stock is fixed, the amount of cash payable to those directors
electing to be paid in cash will be based on the number of stock units
awarded multiplied by the stock price on the payment date.
(19) Restructuring and Other Expenses:
---------------------------------
2002
----
Restructuring and other expenses primarily consist of expenses related to
our various restructurings, $32,985,000 related to reductions in personnel
at our telecommunications operations, costs that were spent at our Plano,
Texas facility and at other locations as a result of transitioning
functions and jobs, and $6,800,000 related to our tender offer in June 2002
for all of the publicly held ELI common shares that we did not already own.
These costs were partially offset by a $2,825,000 reversal of a 2001 ELI
accrual discussed below.
2001
----
During 2001, we examined all aspects of our business operations and our
facilities to take advantage of operational and functional synergies
between Frontier and the original Citizens businesses. We continue to
review our operations, personnel and facilities to achieve greater
efficiency.
Plano Restructuring
Pursuant to a plan adopted in the third quarter of 2001, we closed our
operations support center in Plano, Texas in August 2002. In
connection with this plan, we recorded a pre-tax charge of $14,557,000
in the second half of 2001, $839,000 in the first quarter of 2002 and
we adjusted our accrual down by $92,000 and $561,000 in the second and
third quarter of 2002, respectively. Our objective is to concentrate
our resources in areas where we have the most customers, to better
serve those customers. We sold our Plano office building in 2003. The
restructuring resulted in the termination of 750 employees. We
communicated with all affected employees during July 2001. Certain
employees were relocated, others were offered severance, job training
and/or outplacement counseling. As of December 31, 2002, approximately
$14,730,000 was paid and all affected employees were terminated. The
restructuring expenses primarily consist of severance benefits,
retention earned through December 31, 2002, and other planning and
communication costs.
F-25
Sacramento Call Center Restructuring
In April 2002, we closed our Sacramento Customer Care Center pursuant
to a plan adopted in the fourth quarter of 2001. In connection with
this closing, we recorded a pre-tax charge of $731,000 in the fourth
quarter of 2001, $62,000 and $9,000 in the first and second quarter of
2002, respectively. We redirected the call traffic and other work
activities to our Kingman, Arizona call center. This restructuring
resulted in the elimination of 98 employees. We communicated with all
affected employees during November 2001. As of December 31, 2002,
approximately $802,000 was paid and all affected employees were
terminated and no accrual remained.
ELI Restructuring
In the first half of 2002, ELI redeployed the Internet routers, frame
relay switches and ATM switches from the Atlanta, Cleveland, Denver,
Philadelphia and New York markets to other locations in ELI's network
pursuant to a plan adopted in the fourth quarter of 2001. ELI ceased
leasing the collocation facilities and off-net circuits for the
backbone and local loops supporting the service delivery in these
markets. It was anticipated that this would lead to $4,179,000 of
termination fees which were accrued for but not paid at December 31,
2001. During 2002, ELI adjusted its original accrual down by
$2,825,000 due to the favorable settlements of termination charges for
off-net circuit agreements. As of December 31, 2002, $1,354,000 has
been paid and no accrual remained.
Tender Offer
During May 2002, we announced a tender offer for all of the shares of
ELI that we did not already own for a price of $0.70 per share. We
completed the tender offer in June 2002. As a result, ELI became a
wholly-owned subsidiary, for total costs and expenses of approximately
$6,800,000. We accounted for this transaction as a purchase and
allocated the entire amount to goodwill. We evaluated the
recoverability of this goodwill in accordance with SFAS No. 142 and
determined that a write-off was necessary based on fair market value
as determined by discounted cash flows and other valuation
methodologies. This charge is included in restructuring and other
expenses.
1999
----
In the fourth quarter of 1999, we adopted a plan to restructure our
corporate office activities. In connection with this plan, we recorded a
pre-tax charge of $5,760,000 in the fourth quarter of 1999. The
restructuring resulted in the reduction of 49 corporate employees. All
affected employees were communicated with in the early part of November
1999. As of June 30, 2002, approximately $4,602,000 has been paid, 43
employees were terminated and 6 employees who were expected to be
terminated took other positions within the Company. At June 30, 2002,
December 31, 2001 and December 31, 2000, we adjusted our original accrual
down by $11,000, $139,000 and $1,008,000, respectively, and no accrual
remained as of June 30, 2002.
F-26
The following tables display rollforwards of the accruals established for
restructuring expenses by plan:
($ in thousands)
-------------- 2001 Severance Benefits Retention Other Total
----------------- ------------ ------------------------ -------------
2001 Plano Restructuring
Original accrued amount $ 9,353 $ 1,535 $ 1,178 $ 936 $ 13,002
Amount paid (1,386) (35) (80) (177) (1,678)
Additional accrual 551 - 1,793 27 2,371
Adjustments (325) (104) (64) (323) (816)
----------------- ------------ ------------------------ -------------
Accrued @ 12/31/2001 8,193 1,396 2,827 463 12,879
----------------- ------------ ------------------------ -------------
Amount paid (7,599) (1,355) (3,752) (346) (13,052)
Additional accrual 65 - 1,150 - 1,215
Adjustments (659) (28) (225) (117) (1,029)
----------------- ------------ ------------------------ -------------
Accrued @ 12/31/2002 $ - $ 13 $ - $ - $ 13
================= ============ ======================== =============
2001 Sacramento Call Center Restructuring
Accrued @ 12/31/2001 $ 552 $ 94 $ 85 $ - $ 731
Amount paid (529) (83) (190) - (802)
Additional accrual 45 - 116 - 161
Adjustments (68) (11) (11) - (90)
----------------- ------------ ------------------------ -------------
Accrued @ 12/31/2002 $ - $ - $ - $ - $ -
================= ============ ======================== =============
ELI 2001 Restructuring
Accrued @ 12/31/2001 $ - $ - $ - $ 4,179 $ 4,179
Amount paid - - - (1,354) (1,354)
Additional accrual - - - - -
Adjustments - - - (2,825) (2,825)
----------------- ------------ ------------------------ -------------
Accrued @ 12/31/2002 $ - $ - $ - $ - $ -
================= ============ ======================== =============
Original Accrued Amount Accrual Remaining
1999 Amount Paid to Date Adjustments Accrual
----------------- ------------- ------------ ------------
1999 Corporate Office Restructuring
For the year ended December 31, 2000 5,539 (3,993) (1,008) 538
For the year ended December 31, 2001 538 (199) (139) 200
For the year ended December 31, 2002 200 (189) (11) -
(20) Income Taxes:
-------------
The following is a reconciliation of the provision for income taxes for
continuing operations computed at federal statutory rates to the effective
rates:
2002 2001 2000
------------- ------------ ------------
Consolidated tax provision at federal statutory rate 35.0% 35.0% 35.0%
State income tax (provisions) benefit, net of federal
income tax benefit 1.3% -10.8% -6.4%
Write-off of regulatory assets -2.6% -11.7% 0.0%
Nontaxable investment income 0.0% 2.6% 5.4%
Flow through depreciation -0.1% -0.5% -8.5%
Tax reserve adjustment 0.0% 1.0% -5.6%
Minority interest 0.0% 0.0% 8.7%
All other, net 0.1% 4.8% 3.7%
------------- ------------ ------------
33.7% 20.4% 32.3%
============= ============ ============
As of December 31, 2002 and 2001, accumulated deferred income taxes
amounted to $136,356,000 and $423,486,000, respectively, and the
unamortized deferred investment tax credits amounted to $760,000 and
$6,058,000, respectively.
F-27
The components of the net deferred income tax liability (asset) at December
31 are as follows:
($ in thousands) 2002 2001
-------------- ------------- ------------
Deferred income tax liabilities:
Property, plant and equipment basis differences $ 229,135 $ 492,712
Deferred energy commodity charges 51,633 30,421
Gain on subsidiary stock IPO - 30,246
Other, net 50,055 97,087
------------- ------------
330,823 650,466
------------- ------------
Deferred income tax assets:
Minimum pension liability 69,209 -
Tax operating loss carryforward 193,329 126,597
Alternate minimum tax credit carryforward 49,864 69,836
Other, net 57,242 82,167
------------- ------------
369,644 278,600
------------- ------------
Net deferred income tax liability (asset) $ (38,821) $ 371,866
============= ============
Deferred tax assets and liabilities are reflected in the following
captions on the balance sheet:
Income taxes accrued $ (8,708) $ 46,186
Deferred income taxes 137,116 429,544
Other current assets - (103,864)
Other assets (167,229) -
------------- ------------
Net deferred income tax liability (asset) $ (38,821) $ 371,866
============= ============
Our federal and state tax operating loss carryforwards as of December 31,
2002 are $477,798,000 and $344,194,000, respectively. Our federal loss
carryforward will begin to expire in the year 2020. A portion of our state
loss carryforward will begin to expire in 2006. Our alternative minimum tax
credit as of December 31, 2002 can be carried forward indefinitely to
reduce future regular tax liability. This benefit is presented as a
reduction of accrued income taxes.
F-28
The provision (benefit) for federal and state income taxes, as well as the
taxes charged or credited to shareholders' equity, includes amounts both
payable currently and deferred for payment in future periods as indicated
below:
($ in thousands)
-------------- 2002 2001 2000
------------- ------------ ------------
Income taxes charged (credited) to the income statement for
continuing operations:
Current:
Federal $ (159,844) $ (37,003) $ (66,759)
State (2,562) 5,168 (2,588)
------------- ------------ ------------
Total current (162,406) (31,835) (69,347)
Deferred:
Federal (230,388) 10,791 46,647
Investment tax credits (352) (649) (931)
State (21,728) 6,888 7,499
------------- ------------ ------------
Total deferred (252,468) 17,030 53,215
------------- ------------ ------------
Subtotal (414,874) (14,805) (16,132)
Income taxes charged (credited) to the income statement for
discontinued operations:
Current:
Federal 169,246 5,093 2,749
State 11,328 774 418
------------- ------------ ------------
Total current 180,574 5,867 3,167
Deferred:
Federal (39,904) 2,726 2,260
Investment tax credits - (332) (326)
State (5,921) 686 620
------------- ------------ ------------
Total deferred (45,825) 3,080 2,554
------------- ------------ ------------
Subtotal 134,749 8,947 5,721
Income tax benefit on dividends on convertible preferred
securities:
Current:
Federal (3,344) (3,344) (3,344)
State (508) (508) (508)
------------- ------------ ------------
Subtotal (3,852) (3,852) (3,852)
Income taxes charged (credited) to the income statement for
extraordinary expense - Discontinuation of Statement of
Financial Accounting Standards No. 71:
Deferred:
Federal - 15,500 -
State - 6,157 -
------------- ------------ ------------
Subtotal - 21,657 -
------------- ------------ ------------
Total income taxes charged to the income statement (a) (283,977) 11,947 (14,263)
Income taxes charged (credited) to shareholders' equity:
Deferred income taxes (benefits) on unrealized gains or losses on
securities classified as available-for-sale 2,726 2,908 (8,997)
Current benefit arising from stock options exercised (720) (3,001) (7,392)
Deferred income taxes (benefits) arising from recognition of
a minimum pension liability (69,209) - -
------------- ------------ ------------
Income taxes charged (credited) to shareholders'
equity (b) (67,203) (93) (16,389)
------------- ------------ ------------
Total income taxes: (a) plus (b) $ (351,180) $ 11,854 $ (30,652)
============= ============ ============
F-29
(21) Net Income (Loss) Per Common Share:
-----------------------------------
The reconciliation of the net income (loss) per common share calculation
for the years ended December 31, 2002, 2001 and 2000 is as follows:
(In thousands, except per-share amounts)
--------------------------------------
2002 2001
------------------------------------- -------------------------------------
Weighted Weighted
Average Average
Loss Shares Per Share Loss Shares Per Share
------------------------------------- ------------- ----------- -----------
Net loss per common share:
Basic $(682,897) 280,686 $ (89,682) 273,721
Carrying cost of equity forward contracts - - 13,650 -
-------------------------- ------------- -----------
Available for common shareholders $(682,897) 280,686 $ (2.43) $(103,332) 273,721 $ (0.38)
Effect of dilutive shares - 3,887 - 5,859
-------------------------- ------------- -----------
Diluted $(682,897) 284,573 $ (2.43) $(103,332) 279,580 $ (0.38)
========================== ============= ===========
2000
-----------------------------------
Weighted
Average
Loss Shares Per Share
-----------------------------------
Net loss per common share:
Basic $(28,394) 260,767
Carrying cost of equity forward contracts - -
----------------------
Available for common shareholders $(28,394) 260,767 $ (0.11)
Effect of dilutive shares - 10,149
----------------------
Diluted $(28,394) 270,916 $ (0.11)
========================
All share amounts represent weighted average shares outstanding for each
respective period. The diluted net income (loss) per common share
calculation excludes the effect of potentially dilutive shares when their
exercise price exceeds the average market price over the period. We have
4,025,000 shares of potentially dilutive Mandatorily Redeemable Convertible
Preferred Securities which are convertible into common stock at a 3.76 to 1
ratio at an exercise price of $13.30 per share and 14,391,000 potentially
dilutive stock options at a range of $9.18 to $21.47 per share. We also
have 18,400,000 potentially dilutive equity units. Each equity unit
initially consists of a 6.75% senior note due 2006 and a purchase contract
(warrant) for our common stock. These items were not included in the
diluted net income (loss) per common share calculation for any of the above
periods as their effect was antidilutive. Restricted stock awards of
1,004,000, 1,232,000 and 829,000 shares at December 31, 2002, 2001 and 2000
respectively, are excluded from our basic weighted average shares
outstanding and included in our dilutive shares until the shares are no
longer contingent upon the satisfaction of all specified conditions.
(22) Comprehensive Income (Loss):
----------------------------
Comprehensive income consists of net income and other gains and losses
affecting shareowners' investment and minimum pension liability that, under
GAAP, are excluded from net income.
F-30
Our other comprehensive income (loss) for the years ended December 31,
2002, 2001 and 2000 is as follows:
2002
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
-------------- ------------- -------------- -------------
Net unrealized losses on securities:
Net unrealized holding losses arising during period $(101,137) $ (38,078) $ (63,059)
Minimum pension liability (180,799) (69,210) (111,589)
Add: Reclassification adjustments for net gain/
losses realized in net loss 108,376 40,804 67,572
------------- -------------- -------------
Other comprehensive loss $(173,560) $ (66,484) $(107,076)
============= ============== =============
2001
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
-------------- ------------- -------------- -------------
Net unrealized losses on securities:
Net unrealized holding losses arising during period $ (70,771) $ (27,015) $ (43,756)
Add: Reclassification adjustments for net losses
realized in net loss 78,168 29,923 48,245
------------- -------------- -------------
Other comprehensive income $ 7,397 $ 2,908 $ 4,489
============= ============== =============
2000
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
-------------- ------------- -------------- -------------
Net unrealized gains on securities:
Net unrealized holding gains arising during period $ (40,377) $ (15,457) $ (24,920)
Less: Reclassification adjustments for net gains
realized in net income 16,875 6,460 10,415
------------- -------------- -------------
Other comprehensive loss $ (23,502) $ (8,997) $ (14,505)
============= ============== =============
(23) Segment Information:
--------------------
We operate in four segments, ILEC, ELI (a CLEC), gas and electric. The ILEC
segment provides both regulated and unregulated communications services to
residential, business and wholesale customers and is typically the
incumbent provider in its service areas. Our gas and electric segments are
intended to be sold and are classified as "assets held for sale" and
"liabilities related to assets held for sale."
As an ILEC, we compete with CLECs that may operate in our markets. As a
CLEC, we provide telecommunications services, principally to businesses, in
competition with the incumbent ILEC. As a CLEC, we frequently obtain the
"last mile" access to customers through arrangements with the applicable
ILEC. ILECs and CLECs are subject to different regulatory frameworks of the
Federal Communications Commission (FCC). Our ILEC operations and ELI do not
compete with each other in any individual market.
F-31
($ in thousands) For the year ended December 31, 2002
-------------- --------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
--------- --------- --------- --------- ---------
Revenue $2,062,905 $ 175,079 $ 216,517 $ 214,831 $ 2,669,332
Depreciation and Amortization 643,123 112,035 148 216 755,522
Reserve for Telecommunications
Bankruptcies 10,446 434 - - 10,880
Restructuring and Other Expenses 30,054 7,132 - - 37,186
Loss on Impairment - 656,658 152,300 265,100 1,074,058
Operating Income (Loss) 413,241 (759,161) (119,579) (222,090) (687,589)
Capital Expenditures, net 288,823 122,003 (1) 21,035 18,625 (3) 450,486
Assets 6,675,928 214,252 389,737 58,027 7,337,944
($ in thousands) For the year ended December 31, 2001
-------------- --------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
--------- --------- --------- ---------- ----------
Revenue $1,594,053 $ 223,391 $ 411,534 $ 228,015 $ 2,456,993
Depreciation and Amortization 545,273 80,020 609 6,434 632,336
Reserve for Telecommunications
Bankruptcies 21,200 - - - 21,200
Restructuring and Other Expenses 15,148 4,179 - - 19,327
Operating Income (Loss) 220,956 (71,165) 47,916 35,335 233,042
Capital Expenditures, net 391,377 28,233 (2) 34,138 32,706 486,454
Assets 7,072,288 902,348 441,654 666,283 9,082,573
($ in thousands) For the year ended December 31, 2000
-------------- ---------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
--------- --------- --------- ---------- ------------
Revenue $ 963,743 $ 240,792 $ 374,751 $ 223,072 $ 1,802,358
Depreciation and Amortization 276,250 63,500 19,228 28,629 387,607
Restructuring and Other Expenses (649) - - - (649)
Operating Income (Loss) 157,896 (59,589) 8,268 15,226 121,801
Capital Expenditures, net 350,209 112,285 (2) 51,457 29,482 543,433
Assets 3,558,562 949,774 692,351 589,801 5,790,488
(1) Includes $110,000,000 of previously leased facilities purchased by ELI
in April 2002.
(2) Does not include approximately $33,985,000 and $102,192,000 of non-cash
ELI capital lease additions in 2001 and 2000, respectively.
(3) Does not include approximately $38,000,000 of non-cash capital lease
additions.
F-32
The following tables are reconciliations of certain sector items to the
total consolidated amount.
($ in thousands) For the years ended December 31,
-------------- 2002 2001 2000
--------- --------- ---------
Capital expenditures
Total segment capital expenditures $ 450,486 $ 486,454 $ 543,433
General capital expenditures 18,256 817 1,396
--------- --------- ---------
Consolidated reported capital expenditures $ 468,742 $ 487,271 $ 544,829
========= ========= =========
Assets 2002 2001
----------- -----------
Total segment assets $ 7,337,944 $ 9,082,573
General assets 808,798 724,236
Discontinued operations assets - 746,791
----------- ------------
Consolidated reported assets $ 8,146,742 $10,553,600
=========== ============
(24) Discontinuation of SFAS 71:
---------------------------
We historically applied SFAS 71 in the preparation of our financial
statements because our incumbent local exchange telephone properties
(properties we owned prior to the 2000 and 2001 acquisitions of the
Verizon, Qwest and Frontier properties) were predominantly regulated in the
past following a cost of service/rate of return approach. Beginning in the
third quarter of 2001, these properties no longer met the criteria for
application of SFAS 71 due to the continuing process of deregulation and
the introduction of competition to our existing rural local exchange
telephone properties, and our expectation that these trends will continue
for all our properties.
F-33
Currently, pricing for a majority of our revenues is based upon price cap
plans that limit prices to changes in general inflation and estimates of
productivity for the industry at large, or upon market pricing, rather than
on the specific costs of operating our business, a requirement for the
application of SFAS 71. These trends in the deregulation of pricing and the
introduction of competition are expected to continue in the near future as
additional states adopt price cap forms of regulation.
Discontinued application of SFAS 71 required us to write off all of the
regulatory assets and liabilities of our incumbent local exchange telephone
operations. As a result we recognized a non-cash extraordinary charge in
our financial statements in the third quarter of 2001 as follows:
($ in thousands)
--------------
Assets:
Deferred income tax assets $31,480
Deferred cost of extraordinary plant retirements 25,348
Deferred charges 6,885
Liabilities:
Plant related (10,259)
Deferred income tax liabilities (2,531)
-----------
Pre-tax charge 50,923
Income tax benefit 7,292
-----------
Extraordinary expense $43,631
===========
Under SFAS 71, we depreciated our telephone plant for financial reporting
purposes over asset lives approved by the regulatory agencies setting
regulated rates. As part of the discontinuance of SFAS 71, we revised the
depreciation lives of our core technology assets to reflect their estimated
economic useful lives. Based upon our evaluation of the pace of technology
change that is estimated to occur in certain components of our rural
telephone networks, we concluded that minor modifications as of the date of
discontinuance were required in our asset lives for the major network
technology assets as follows:
Average Remaining Life in Years
-------------------------------
Regulated Economic
Life Life
---- ----
Switching Equipment 6.4 5.6
Circuit Equipment 4.3 4.9
Copper Cable 8.5 7.7
Upon discontinuation of SFAS 71, we tested the balances of property, plant
and equipment associated with the incumbent local exchange telephone
properties for impairment under SFAS 121 (as required by SFAS 101). No
impairment charge was required.
To reflect the expectation that competitive entry will occur over time for
certain of our properties acquired in prior purchase business combinations,
we have shortened the amortization life for previously acquired franchise
rights related to these properties to 20 years. This action was taken to
reflect the fact that our dominant position in the market related to the
existence of the prior monopoly in incumbent local exchange telephone
service may be reduced over time as competitors enter our markets.
F-34
(25) Quarterly Financial Data (unaudited):
-------------------------------------
($ in thousands, except per share amounts)
----------------------------------------
First quarter Second quarter Third quarter Fourth quarter
2002 ------------- -------------- ------------- --------------
Revenue $ 679,334 $ 662,439 $ 668,831 $ 658,728
Income (loss) before cumulative effect of changes in
accounting principle 123,038 (41,559) (700,104) (24,460)
Net income (loss) 83,226 (41,559) (700,104) (24,460)
Income (loss) before cumulative effect of changes in
accounting principle available for common shareholders per
basic share $ 0.44 $ (0.15) $ (2.49) $ (0.09)
Income (loss) before cumulative effect of changes in accounting
principle available for common shareholders per diluted share $ 0.43 $ (0.15) $ (2.49) $ (0.09)
Net income (loss) available for common shareholders per basic
share $ 0.30 $ (0.15) $ (2.49) $ (0.09)
Net income (loss) available for common shareholders per diluted
share $ 0.29 $ (0.15) $ (2.49) $ (0.09)
2001
Revenue $ 624,281 $ 505,741 $ 661,121 $ 665,850
Net income (loss) 19,723 (649) (441) (108,315)
Net income (loss) per basic share $ 0.08 $ (0.05) $ (0.01) $ (0.39)
Net income (loss) per diluted share $ 0.07 $ (0.05) $ (0.01) $ (0.39)
The quarterly net income (loss) per common share amounts are rounded to the
nearest cent. Annual net income (loss) per common share may vary depending
on the effect of such rounding. Quarterly revenue has been retroactively
revised from their original presentations to conform to current
presentation.
On January 15, 2002, we completed the sale of our water and wastewater
operations to American Water Works, Inc. for $859,100,000 in cash and
$122,500,000 of assumed debt and other liabilities. The pre-tax gain on the
sale recognized in 2002 was $316,672,000.
In the third quarter 2002, we recognized non-cash pre-tax impairment losses
of $656,658,000 related to property, plant and equipment in the ELI sector
and $417,400,000 related to the gas and electric sector assets held for
sale, in each case in accordance with the provisions of SFAS 144.
In the third quarter of 2002, we recognized an additional $1,525,000
pre-tax gain on the 2001 sale of our Louisiana gas operation to Atmos
Energy Corporation. The initial gain was recognized at the close of the
sale in the third quarter of 2001.
On October 31, 2002, we completed the sale of approximately 4,000 telephone
access lines in North Dakota for $9,700,000 in cash. The pre-tax loss on
the sale recognized in the fourth quarter of 2002 was $2,803,000.
On November 1, 2002, we completed the sale of our Kauai electric division
to KIUC for $215,000,000 in cash. The pre-tax gain on the sale recognized
in the fourth quarter of 2002 was $8,273,000.
Restructuring and other expenses are primarily related to various
restructurings, $32,985,000 of pre-tax expenses related to reductions in
personnel at our telecommunications operations, cost that were spent at our
Plano, Texas facility and at other locations as a result of transitioning
functions and jobs and $6,800,000 of pre-tax costs and expenses related to
our tender offer in the second quarter of 2002 for all of the ELI common
shares that we did not already own. These costs were partially offset by a
$2,825,000 pre-tax reversal of an ELI accrual.
As a result of Adelphia's price declines and filing for bankruptcy, we
recognized pre-tax losses of $95,300,000 to be other than temporary. As of
June 30, 2002, we had written this investment down to zero, and therefore
we have no additional exposure related to the market value of Adelphia
stock.
As of December 31, 2002, we owned 1,333,500 shares of D & E Communications
common stock. As the result of an other than temporary decline in D & E's
stock price, we recognized a pre-tax loss of $16,400,000 on our investment
during the quarter ended December 31, 2002.
F-35
Concurrent with the acquisition of Frontier, we entered into several
operating agreements with Global. We have ongoing commercial relationships
with Global affiliates. We reserved a total of $29,000,000 of Global
receivables to reflect our best estimate of the net realizable value of
receivables incurred from these commercial relationships during 2001 and
2002 as a result of Global's filing for bankruptcy. We recorded a pre-tax
write-down of such receivables in the amount of $7,800,000 in the first
quarter 2002 and $21,200,000 in the fourth quarter of 2001. In 2002, as the
result of a settlement agreement with Global, we reversed $17,900,000 of
our previous reserve of the net realizable value of these receivables.
Prior to the date of Global's bankruptcy filing, we provided ordinary
course telecommunications services as well as transitional services to
Global. Global has provided us certain customer billing and collection
functions as well as other transitional services. Although some of these
arrangements have continued after the bankruptcy filing, we are in the
process of changing some services and functions to provide them ourselves.
The Bankruptcy Court has granted relief to us and other telecommunications
companies that provide service to Global by, among other things, directing
a shortened payment period with respect to post-petition invoices, an
expedited court process for post-petition defaults in payments by Global,
and a priority for post-petition expense items over other unsecured debt.
These procedures should minimize future economic loss to us although we
cannot guarantee that additional losses will not occur.
On July 2, 2001, we completed the sale of our Louisiana Gas operations to
Atmos Energy Corporation for $363,400,000 in cash. The pre-tax gain on the
sale recognized in the third quarter was $139,300,000.
Pre-tax restructuring expenses of $13,000,000 for the third quarter and
$6,300,000 for the fourth quarter of 2001 are primarily related to the
closing of our operations support center in Plano, Texas and our
Sacramento, California call center and ELI's decision to exit certain long
haul markets. These restructurings are a result of our evaluation of our
facilities to take advantage of operational and functional synergies.
We recognized a pre-tax loss of $79,000,000 in the Adelphia investment as a
reduction to investment income in the fourth quarter of 2001.
Deregulation of most of our local exchange telephone properties required us
to cease application of SFAS 71 in the third quarter of 2001, resulting in
a non-cash extraordinary charge of $43,600,000, net of tax, in our
statement of operations.
(26) Supplemental Cash Flow Information:
-----------------------------------
The following is a schedule of net cash provided by operating activities
for the years ended December 31, 2002, 2001 and 2000:
($ in thousands) 2002 2001 2000
-------------- --------------- -------------- -------------
Loss from continuing operations before extraordinary expense
and cumulative effect of change in accounting principle $ (822,976) $ (63,926) $ (40,071)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization expense 755,522 632,336 387,607
Investment write-down 117,455 79,114 -
Gain on extinguishment of debt (26,330) - -
Investment (gains)/losses (3,363) 660 18,314
Gain on sale of assets (9,798) (139,304) -
Loss on impairment 1,074,058 - -
Allowance for equity funds used during construction (1,346) (2,811) (3,257)
Deferred income tax and investment tax credit (387,771) 17,030 53,215
Change in operating accounts receivable 1,373 57,145 (11,685)
Change in accounts payable and other (152,358) (198,848) (24,261)
Change in accrued taxes and interest (8,975) 166,815 (28,944)
Change in other current assets 101,376 (71,275) (43,225)
--------------- -------------- -------------
Net cash provided by continuing operating activities $ 636,867 $ 476,936 $ 307,693
=============== ============== =============
F-36
(27) Retirement Plans:
-----------------
Pension Plan
------------
We have a noncontributory pension plan covering all employees who have met
certain service and age requirements. The benefits are based on years of
service and final average pay or career average pay. Contributions are made
in amounts sufficient to meet ERISA funding requirements while considering
tax deductibility. Plan assets are invested in a diversified portfolio of
equity and fixed-income securities.
Effective February 1, 2003, the pension plan was frozen for all non-union
plan participants. The vested benefit earned through that date is protected
by law and will be available upon retirement. No additional benefit
accruals for service will occur after February 1, 2003 for those
participants.
The following tables set forth the plan's benefit obligations and fair
values of plan assets as of December 31, 2002 and 2001 and net periodic
benefit cost for the years ended December 31, 2002, 2001 and 2000.
F-37
($ in thousands) 2002 2001
-------------- ------------- --------------
Change in benefit obligation
- ----------------------------
Benefit obligation at beginning of year $ 759,927 $ 282,024
Service cost 12,159 14,065
Interest cost 53,320 37,680
Amendments - (3,679)
Actuarial loss 28,948 16,771
Acquisitions/Divestitures (6,239) 447,279
Plant closings/Reduction in force (5,609) -
Benefits paid (62,269) (34,213)
------------- --------------
Benefit obligation at end of year $ 780,237 $ 759,927
============= ==============
Change in plan assets
- ---------------------
Fair value of plan assets at beginning of year $ 798,293 $ 249,400
Actual return on plan assets (60,026) (13,337)
Acquisitions - 583,190
Employer contribution 16,363 13,253
Benefits paid (62,269) (34,213)
------------- --------------
Fair value of plan assets at end of year $ 692,361 $ 798,293
============= ==============
(Accrued)/Prepaid benefit cost
- ------------------------------
Funded status $ (87,876) $ 38,366
Unrecognized net liability 17 60
Unrecognized prior service cost (1,450) (1,599)
Unrecognized net actuarial loss 235,107 96,860
------------- --------------
Prepaid benefit cost $ 145,798 $ 133,687
============= ==============
Amounts recognized in the statement of financial position
- ---------------------------------------------------------
Prepaid benefit cost $ 6,874 $ 133,687
Accrued benefit liability (41,874) -
Other comprehesive income 180,798 -
------------- --------------
Net amount recognized $ 145,798 $ 133,687
============= ==============
2002 2001 2000
------------- -------------- ---------------
Components of net periodic benefit cost
- ---------------------------------------
Service cost $ 12,159 $ 14,065 $ 12,286
Interest cost on projected benefit obligation 53,320 37,680 18,772
Return on plan assets (63,258) (44,852) (19,743)
Amortization of prior service cost and unrecognized
net obligation (106) (242) 196
Amortization of unrecognized loss 2,137 - -
------------- -------------- ---------------
Net periodic benefit cost $ 4,252 $ 6,651 $ 11,511
============= ============== ===============
F-38
Assumptions used in the computation of pension costs/year-end benefit
obligations were as follows:
2002 2001
---- ----
Discount rate 7.25%/6.75% 7.5%/7.25%
Expected long-term rate of return on plan assets 8.25%/N/A 8.25%/N/A
Rate of increase in compensation levels 4.0%/4.0% 4.0%/4.0%
In June 2001, we acquired Frontier, including substantially all their
pension assets and benefit obligation. This acquisition increased the
pension benefit obligation by $447,279,000 and the fair value of plan
assets by $583,190,000 as of June 29, 2001.
As part of the Frontier acquisition, Global and we agreed to the transfer
of pension liabilities and assets related to substantially all Frontier
employees. The liabilities associated with the Frontier employees retained
by Global were valued following the Pension Benefit Guaranty Corporation's
"safe harbor" rules. Prior to Global's bankruptcy filing, Global and we
reached agreement on the value of the pension assets and liabilities to be
retained by Global as well as the time frame and procedures by which the
remainder of the assets were to transfer to a pension trust held by
Citizens. Global failed to execute and deliver an authorization letter to
the Frontier plan trustee directing the trustee to transfer to our pension
plan record ownership of the transferred assets. We initiated an adversary
proceeding with the Bankruptcy Court supervising Global's bankruptcy
proceeding, to determine and declare that Global's obligation was not
"executory", and to compel Global to execute and deliver such authorization
letter. On December 18, 2002 we entered into a stipulation with Global and
other parties, "so ordered" by the bankruptcy court, fully and finally
settling the adversary proceeding. Pursuant to the stipulation and order,
on February 3, 2003 Global instructed the Frontier Plan Trustee to transfer
record ownership of the transferred assets with a market value of
$447,800,000 to our pension plan, and the transfer in fact took place on
that date.
The assets of the Global pension plan are invested primarily in equity
securities. Due to the general decline in the equity markets, the assets have
declined in value. We recorded an adjustment to our minimum pension liability as
of December 31, 2002 in the amount of $180,798,000. The pension liability
resulted from the declining market value of the pension plan assets during 2002
combined with a lower market interest rate used to value the plan's liabilities.
As of December 31, 2002, the minimum pension liability is measured as the amount
of the plan's accumulated benefit obligation that is in excess of the plan's
market value of assets at December 31, 2002 plus any balance remaining in
deferred or "prepaid" benefit costs that was recorded during periods when our
pension plan assets exceeded our accumulated benefit obligation. A charge was
recorded to shareholder's equity, net of income tax benefits, as a component of
comprehensive loss in the amount of $111,589,000. The adjustment was computed
separately for each plan that we maintain but is mainly attributable to the
actual results of asset performance with respect to the Global pension plan (see
Note 28). This adjustment does not impact current year earnings, or the funding
requirements of the plan. However, pension expense for 2003 will increase as a
result of these market declines and lower interest rates. If future market
conditions cause either a decline in interest rates used to value our pension
plan liabilities or reductions to the value of our pension plan assets we
potentially could incur additional charges to our shareholder's equity at the
end of 2003. Based upon market conditions existing at the end of February 2003,
an additional charge of approximately $30,000,000 - $35,000,000 would be
required at the end of 2003 should market conditions remain unchanged.
F-39
Postretirement Benefits Other Than Pensions
-------------------------------------------
We provide certain medical, dental, life insurance and telephone concession
benefits for retired employees and their beneficiaries and covered
dependents. The following table sets forth the plan's benefit obligations
and the postretirement benefit liability recognized on our balance sheets
at December 31, 2002 and 2001 and net periodic postretirement benefit costs
for the years ended December 31, 2002, 2001 and 2000:
($ in thousands) 2002 2001
-------------- ------------- --------------
Change in benefit obligation
- ----------------------------
Benefit obligation at beginning of year $ 190,342 $ 59,191
Service cost 1,350 937
Interest cost 13,753 8,812
Plan participants' contributions 3,771 1,023
Curtailments/settlements - (14,223)
Actuarial loss 21,406 20,321
Acquisitions/Divestitures (4,348) 119,611
Plant closings/Reduction in force (1,950) -
Amendments - 20
Benefits paid (13,641) (5,350)
------------- --------------
Benefit obligation at end of year $ 210,683 $ 190,342
============= ==============
Change in plan assets
- ---------------------
Fair value of plan assets at beginning of year $ 29,090 $ 25,412
Actual return on plan assets (1,711) 310
Benefits paid (9,870) (1,464)
Employer contribution 9,541 1,498
Acquisitions - 3,334
------------- --------------
Fair value of plan assets at end of year $ 27,050 $ 29,090
============= ==============
Accrued benefit cost
- --------------------
Funded status $(183,633) $(161,252)
Unrecognized transition obligation 234 258
Unrecognized prior service cost 16 18
Unrecognized loss 35,048 18,174
------------- --------------
Accrued benefit cost $(148,335) $(142,802)
============= ==============
2002 2001 2000
------------- -------------- ---------------
Components of net periodic postretirement benefit cost
- ------------------------------------------------------
Service cost $ 1,350 $ 937 $ 652
Interest cost on projected benefit obligation 13,753 8,812 3,943
Return on plan assets (2,438) (2,227) (1,688)
Amortization of prior service cost and transition obligation 26 25 23
Amortization of unrecognized (gain)/loss 2,383 204 (793)
Curtailment gain - - (757)
Settlement loss - 491 -
Acquisition loss - - 581
------------- -------------- ---------------
Net periodic postretirement benefit cost $ 15,074 $ 8,242 $ 1,961
============= ============== ===============
For purposes of measuring year end benefit obligations, we used the same
discount rates as were used for the pension plan and, depending on medical
plan coverage for different retiree groups, an 8 - 12% annual rate of
increase in the per-capita cost of covered medical benefits, gradually
decreasing to 5% in the year 2010 and remaining at that level thereafter.
The effect of a 1% increase in the assumed medical cost trend rates for
each future year on the aggregate of the service and interest cost
components of the total postretirement benefit cost would be $2,134,000 and
the effect on the accumulated postretirement benefit obligation for health
benefits would be $27,361,000. The effect of a 1% decrease in the assumed
medical cost trend rates for each future year on the aggregate of the
service and interest cost components of the total postretirement benefit
cost would be $(1,759,000) and the effect on the accumulated postretirement
benefit obligation for health benefits would be $(22,882,000).
F-40
In August 1999, our Board of Directors approved a plan of divestiture for
the public services properties. Any pension and/or postretirement gain or
loss associated with the divestiture of these properties will be recognized
when realized. During 2002, we sold our entire water distribution and
wastewater treatment business and one of our three electric businesses. The
pension plan has been frozen from the date of sale and we have retained
those liabilities. In both transactions, the buyer assumed the retiree
medical liabilities for those properties.
In June 2001, we acquired Frontier Corp., including their postretirement
benefit plans. This acquisition increased the accumulated postretirement
benefit obligation by $118,819,000 and the fair value of plan assets by
$3,334,000 as of June 29, 2001.
401(k) Savings Plans
--------------------
We sponsor an employee retirement savings plan under section 401(k) of the
Internal Revenue Code. The Plan covers substantially all full-time
employees. Under the Plan, we provide matching and certain profit-sharing
contributions. Effective May 1, 2002, the Plan was amended to provide for
employer contributions to be made in cash rather than Company stock,
impacting all non-union employees and most union employees. Employer
contributions were $10,331,000, $6,878,000 and $5,973,000 for 2002, 2001
and 2000, respectively.
(28) Commitments and Contingencies:
------------------------------
We have budgeted capital expenditures in 2003 of approximately
$333,600,000, including $288,400,000 for ILEC and ELI and $45,200,000 for
gas and electric. Certain commitments have been entered into in connection
therewith. We expect to incur additional impairment losses during 2003 with
respect to our public utility properties. These properties are carried at
our estimates of net realizable values. Under the terms of the definitive
agreements relating to the sale of our Arizona and Hawaiian properties,
most of the capital expenditures we will make during 2003 for these
properties will not be recovered. As a result, the amount of these
expenditures (currently estimated at $28,000,000 through the expected
closing dates) will be expensed as incurred and not capitalized. These
expenditures are of a normal recurring nature and are necessary to provide
safe, reliable utility service to customers. We generally do not enter into
firm, committed contracts for such activities. If the closing dates for the
sales of our Arizona and Hawaiian properties actually occur later than the
currently expected dates, the actual amount of capital expenditures
expensed will exceed these estimates. If the sale of our Arizona utility
businesses to UniSource is completed, the sale agreement requires us to
promptly redeem $111,760,000 principal amount of industrial revenue bonds.
We conduct certain of our operations in leased premises and also lease
certain equipment and other assets pursuant to operating leases. Future
minimum rental commitments for all long-term noncancelable operating leases
for continuing operations are as follows:
($ in thousands) Year Amount
-------------- -------------- --------------
2003 $ 26,790
2004 22,234
2005 18,918
2006 17,385
2007 17,193
thereafter 55,455
--------------
Total $ 157,975
==============
Total rental expense included in our results of operations for the years
ended December 31, 2002, 2001 and 2000 was $36,550,000, $38,829,000 and
$33,042,000 respectively. We sublease, on a month-to-month basis, certain
office space in our corporate office to a charitable foundation formed by
our Chairman.
Minimum payments on operating leases are included in the table above. For
payments on capital leases, see Note 9.
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We are a party to contracts with several unrelated long distance carriers.
The contracts provide fees based on leased traffic subject to minimum
monthly fees. We also purchase capacity and associated energy from various
electric energy and natural gas suppliers. Some of these contracts obligate
us to pay certain capacity costs whether or not energy purchases are made.
These contracts are intended to complement the other components in our
power supply to achieve the most economic mix reasonably available. At
December 31, 2002, the estimated future payments for long distance
contracts, and capacity and energy that we are obligated for are as
follows:
Public
($ in thousands) Year ILEC / ELI Services Total
-------------- -------------- -------------- -------------- --------------
2003 $ 72,317 $ 28,495 $ 100,812
2004 49,578 28,147 77,725
2005 16,781 23,085 39,866
2006 - 23,236 23,236
2007 - 21,363 21,363
thereafter - 125,750 125,750
-------------- -------------- --------------
Total $138,676 $ 250,076 $ 388,752
============== ============== ==============
The Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities,
including us, have entered into a purchase power agreement with
Hydro-Quebec. The agreement contains "step-up" provisions that state that
if any VJO member defaults on its purchase obligation under the contract to
purchase power from Hydro-Quebec the other VJO participants will assume
responsibility for the defaulting party's share on a pro-rata basis. As of
December 31, 2002, 2001 and 2000, our obligation under the agreement is
approximately 10% of the total contract. If any member of the VJO defaults
on its obligations under the Hydro-Quebec agreement, the remaining members
of the VJO, including us, may be required to pay for a substantially larger
share of the VJO's total power purchase obligation for the remainder of the
agreement. Such a result could have a materially adverse effect on our
financial results.
At December 31, 2002, we have outstanding performance letters of credit as
follows:
($ in thousands)
--------------
Qwest $ 64,280
Pinnacle West Capital Corporation 40,000
CNA 20,027
Water projects 1,809
ELI projects 50
----------
Total $ 126,166
==========
None of the above letters of credit restrict our cash balances.
On July 20, 2001, we notified Qwest that we were terminating eight acquisition
agreements. On July 23, 2001, Qwest filed a notice of claim for arbitration with
respect to the terminated acquisition agreements. Qwest asserts that we
wrongfully terminated theses agreements and is seeking approximately $64,000,000
in damages, which is the aggregate of liquidated damages under letters of credit
established in the terminated acquisition agreements. On September 7, 2001, we
filed a response and counterclaims in the same arbitration proceedings,
contesting Qwest's asserted claims and asserting substantial claims against
Qwest for material breaches of representations, warranties, and covenants in the
terminated acquisition agreements and in the acquisition agreement relating to
North Dakota assets that we purchased from Qwest. The parties are currently
engaged in discovery. An arbitration hearing has been scheduled to commence in
the third quarter of 2003.
On December 21, 2001, we entered into a settlement agreement resolving all
claims in a class action lawsuit pending against the Company in Santa Cruz
County, Arizona (Chilcote, et al. v. Citizens Utilities Company, No. CV 98-471).
The lawsuit arose from claims by a class of plaintiffs that included all of our
electric customers in Santa Cruz County for damages resulting from several power
outages that occurred during the period January 1, 1997, through January 31,
1999. Under the terms of the settlement agreement, and without any admission of
guilt or wrongdoing by us, we have paid the class members $5,500,000 in
satisfaction of all claims. The court approved the settlement agreement on March
29, 2002, and the lawsuit against us was dismissed with prejudice. We accrued
the full settlement amount, plus an additional amount sufficient to cover legal
fees and other related expenses, during the fourth quarter of 2001 and no
accrual remains at December 31, 2002.
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As part of the Frontier acquisition, Global and we agreed to Global's transfer,
effective as of July 1, 2001, of certain liabilities and assets under the Global
pension plan for Frontier employees. Such transfer and assumption of liabilities
was to be to a trustee of a trust established under our pension plan, and would
exclude (1) those liabilities relating to certain current and former Frontier
employees who were not considered part of the Frontier acquisition (calculated
using the "safe Harbor" methodology of the Pension Benefit Guaranty Corporation)
and (2) those assets attributable to such excluded liabilities. After filing for
bankruptcy on January 28, 2002, Global claimed that its obligation to transfer
the Global pension plan's transferred assets and liabilities remained
"executory" under the Bankruptcy Code, and refused to execute and deliver an
authorization letter to the Frontier plan trustee (who was also the Global plan
trustee) directing the trustee to transfer to our pension plan record ownership
of such assets and liabilities. We initiated an adversary proceeding with the
Bankruptcy Court supervising Global's bankruptcy proceeding to determine and
declare that Global's obligation was not "executory," and to compel Global to
execute and deliver such authorization letter. On December 18, 2002 we entered
into a stipulation with Global and other parties, "so ordered" by the Bankruptcy
Court, fully and finally setting the adversary proceeding. Pursuant to the
stipulation and order, on February 3, 2003, among other things, Global
instructed the Frontier plan trustee to transfer record ownership of the
transferred assets and liabilities to our pension plan, and the transfer in fact
took place on that date.
The City of Bangor, Maine, filed suit against us on November 22, 2002, in the
U.S. District Court for the District of Maine (City of Bangor v. Citizens
Communications Company, Civ. Action No. 02-183-B-S). The City has alleged, among
other things, that we are responsible for the costs of cleaning up environmental
contamination alleged to have resulted from the operation of a manufactured gas
plant by Bangor Gas Company, which we owned from 1948-1963. The City alleged the
existence of extensive contamination of the Penobscot River and nearby land
areas and has asserted that money damages and other relief at issue in the
lawsuit could exceed $50,000,000. The City also requested that punitive damages
be assessed against us. We have filed an answer denying liability to the City,
and have asserted a number of counter claims against the City. We intend to
defend ourselves vigorously against the City's lawsuit.
We also have demanded that various of our insurance carriers defend and
indemnify us with respect to the City's lawsuit. On or about December 26, 2002,
we filed suit against those insurance carriers in the Superior Court of
Penobscot County, Maine, for the purpose of establishing their obligations to us
with respect to the City's lawsuit. We intend to vigorously pursue insurance
coverage for the City's lawsuit. In addition, we have identified a number of
other potentially responsible parties that may be responsible for the damages
alleged by the City. We expect to initiate legal action within the next few
weeks to bring those parties into the lawsuit.
On February 7, 2003, we received a letter from counsel representing Enron North
America Corporation (formerly known as Enron Gas Marketing, Inc.) demanding
payment of an "early termination liability" of approximately $12,500,000 that
Enron claims it is owed under a gas supply agreement that we lawfully terminated
in November 2001. The demand was made in connection with Enron's ongoing
bankruptcy proceeding in the United States Bankruptcy Court for the Southern
District of New York. We believe Enron's claim lacks any merit and have so
advised that company's counsel. Enron has threatened to initiate an adversary
proceeding in the bankruptcy court to recover the amount of its demand plus
applicable interest and attorney's fees. If that occurs, we will vigorously
defend against any such action.
During the fourth quarter of 2002 we became aware of irregularities involving
payments made by certain of our public utilities operations for services or
benefits that we did not receive. The payments do not involve our current
operations in Arizona, Vermont, or Hawaii. With the assistance of forensic
specialists, outside auditors, and counsel, we investigated these irregularities
and identified a total of $7,800,000 that had been embezzled from the Company.
These payments were reflected in our financial statements as charges to earnings
(primarily during 2002). The U.S. Government has recovered approximately
$6,000,000 (which we believe will be turned over to us) and we believe that most
of the remaining funds outstanding will be reimbursed by insurance.
We have provided detailed information regarding the results of our investigation
to federal prosecutors and the Securities and Exchange Commission, including the
names of two of our former officers (Ken Cohen and Livingston Ross, who were the
President and Chief Operating Officer of the Public Services Sector and the Vice
President of Reporting and Audit, respectively) who approved the payments. We
have been advised by federal prosecutors that these two individuals have
admitted their involvement in these schemes and we have terminated the
employment of these individuals.
F-43
In connection with an inquiry that we believe has arisen as a result of
allegations made to federal authorities during their investigation of the
embezzlement, we and our employees are cooperating fully with the Office of the
U.S. Attorney for the Southern District of New York and with the New York office
of the Securities and Exchange Commission. We have provided requested documents
to the SEC and we have agreed to comply with an SEC request that, in connection
with the informal inquiry that it has initiated, we preserve financial, audit,
and accounting records.
We are party to proceedings arising in the normal course of our business. The
outcome of individual matters is not predictable. However, we believe that the
ultimate resolution of all such matters, after considering insurance coverage,
will not have a material adverse effect on our financial position, results of
operations, or our cash flows.
F-44
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited and reported separately herein on the balance sheets of Citizens
Communications Company and subsidiaries as of December 31, 2002 and 2001 and the
related consolidated statements of operations, shareholders' equity,
comprehensive income (loss) and cash flows for each of the years in the
three-year period ended December 31, 2002. Our report refers to the adoption of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangibles Assets" as of January 1, 2002.
Our audits were made for the purpose of forming an opinion on the basic
financial statements of Citizens Communications Company and subsidiaries taken
as a whole. The supplementary information included in Schedule II is presented
for purposes of additional analysis and is not a required part of the basic
financial statements. Such information has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, is fairly stated in all material respects in relation to the basic
financial statements taken as a whole.
KPMG LLP
New York, New York
March 4, 2003
F-45
Schedule II
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Valuation and Qualifying Accounts
($ In thousands)
Balance at Charged to Balance at
Beginning of Revenue or Frontier End of
Accounts Period Expense Acquisition Deductions Period
- ---------------------------------------- ---------------- ----------------- ------------- -------------- ------------
Allowance for doubtful accounts
2000 28,278 16,719 - (21,084) 23,913
2001 23,913 41,233 (1) 10,709 (8,254) 67,601
2002 67,601 66,935 (2) - (95,590) (3) 38,946
(1) Includes the reserve for Global receivables (See Note 15 to Consolidated Financial Statements).
(2) Net of recoveries of amounts previously written off.
(3) Includes the sale of WorldCom receivables.
F-46