CITIZENS COMMUNICATIONS COMPANY
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2004
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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
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-0619596
- ------------------------------ ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
- ---------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
(203) 614-5600
--------------------------------------------------
(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
--- ---
The number of shares outstanding of the registrant's Common Stock as of July 30,
2004 was 291,447,809.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index
Page No.
--------
Part I. Financial Information (Unaudited)
Financial Statements
Consolidated Balance Sheets at June 30, 2004 and December 31, 2003 2
Consolidated Statements of Operations for the three months ended June 30, 2004 and 2003 3
Consolidated Statements of Operations for the six months ended June 30, 2004 and 2003 4
Consolidated Statements of Shareholders' Equity for the year ended
December 31, 2003 and the six months ended June 30, 2004 5
Consolidated Statements of Comprehensive Income for the three and six
months ended June 30, 2004 and 2003 5
Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003 6
Notes to Consolidated Financial Statements 7
Management's Discussion and Analysis of Financial Condition and Results of Operations 22
Quantitative and Qualitative Disclosures about Market Risk 35
Controls and Procedures 37
Part II. Other Information
Legal Proceedings 38
Submission of Matters to a Vote of Security Holders 39
Other Information 39
Exhibits and Reports on Form 8-K 39
Signature 41
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)
(Unaudited)
June 30, 2004 December 31, 2003
-------------- -----------------
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 740,359 $ 583,671
Accounts receivable, less allowances of $31,114 and
$47,332, respectively 224,281 248,473
Other current assets 38,312 40,984
Assets held for sale - 23,130
-------------- -----------------
Total current assets 1,002,952 896,258
Property, plant and equipment, net 3,437,099 3,525,640
Goodwill, net 1,940,318 1,940,318
Other intangibles, net 749,147 812,407
Investments 63,654 53,383
Other assets 447,428 461,104
-------------- -----------------
Total assets $ 7,640,598 $ 7,689,110
============== =================
LIABILITIES AND EQUITY
- ----------------------
Current liabilities:
Long-term debt due within one year $ 6,490 $ 88,002
Accounts payable 128,902 161,640
Other current liabilities 324,501 322,805
Liabilities related to assets held for sale - 11,128
-------------- -----------------
Total current liabilities 459,893 583,575
Deferred income taxes 481,632 447,056
Customer advances for construction and contributions in aid
of construction 94,830 122,035
Other liabilities 264,746 264,382
Equity units 460,000 460,000
Long-term debt 4,378,131 4,195,629
Company Obligated Mandatorily Redeemable Convertible Preferred
Securities* - 201,250
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares;
287,661,000 and 284,709,000 outstanding at June 30, 2004
and December 31, 2003, respectively, and 295,434,000 issued
at June 30, 2004 and Decemember 31, 2003) 73,858 73,858
Additional paid-in capital 1,925,663 1,953,317
Accumulated deficit (298,521) (365,181)
Accumulated other comprehensive loss (72,716) (71,676)
Treasury stock (126,918) (175,135)
-------------- ------------------
Total shareholders' equity 1,501,366 1,415,183
-------------- ------------------
Total liabilities and equity $ 7,640,598 $ 7,689,110
============== ==================
* 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 consolidation of this item
changed effective January 1, 2004 as a result of the application of a newly
mandated accounting standard "FIN 46R." Please see footnote 14 for a complete
discussion.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
2
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003
($ in thousands, except per-share amounts)
(Unaudited)
2004 2003
-------------- --------------
Revenue $544,091 $ 643,954
Operating expenses:
Cost of services (exclusive of depreciation and amortization) 48,295 113,537
Other operating expenses 211,648 232,493
Depreciation and amortization 144,412 150,359
Reserve for telecommunications bankruptcies - 2,260
Restructuring and other expenses - 10,113
Strategic alternatives and management succession expenses (see Note 12) 11,561 -
-------------- --------------
Total operating expenses 415,916 508,762
-------------- --------------
Operating income 128,175 135,192
Investment and other income, net 5,213 31,237
Interest expense 97,652 106,436
-------------- --------------
Income before income taxes, dividends on convertible preferred
securities 35,736 59,993
Income tax expense 11,944 24,384
-------------- --------------
Income before dividends on convertible preferred securities 23,792 35,609
Dividends on convertible preferred securities, net of tax benefit
of $0 and $(963), respectively* - 1,552
-------------- --------------
Net income available to common shareholders $ 23,792 $ 34,057
============== ==============
Basic and diluted income per common share $ 0.08 $ 0.12
============== ==============
* The consolidation of this item changed effective January 1, 2004 as a result
of the application of a newly mandated accounting standard "FIN 46R." Please see
footnote 14 for a complete discussion.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
3
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
($ in thousands, except per-share amounts)
(Unaudited)
2004 2003
-------------- --------------
Revenue $ 1,102,559 $ 1,295,816
Operating expenses:
Cost of services (exclusive of depreciation and amortization) 105,359 226,756
Other operating expenses 424,457 468,314
Depreciation and amortization 288,270 288,907
Reserve for telecommunications bankruptcies - 2,260
Restructuring and other expenses - 10,092
Strategic alternatives and management succession expenses (see Note 12) 16,492 -
-------------- --------------
Total operating expenses 834,578 996,329
-------------- --------------
Operating income 267,981 299,487
Investment and other income, net 30,507 79,409
Interest expense 195,434 215,712
-------------- --------------
Income before income taxes, dividends on convertible preferred
securities, and cumulative effect of change in accounting principle 103,054 163,184
Income tax expense 36,394 64,360
-------------- --------------
Income before dividends on convertible preferred securities and
cumulative effect of change in accounting principle 66,660 98,824
Dividends on convertible preferred securities, net of tax benefit
of $0 and $(1,926), respectively* - 3,105
-------------- --------------
Income before cumulative effect of change in accounting principle 66,660 95,719
Cumulative effect of change in accounting principle, net of tax
of $0 and $41,591, respectively - 65,769
-------------- --------------
Net income available to common shareholders $ 66,660 $ 161,488
============== ==============
Basic income per common share:
Income before cumulative effect of change in accounting principle $ 0.23 $ 0.34
Cumulative effect of change in accounting principle - 0.23
-------------- --------------
Net income available to common shareholders $ 0.23 $ 0.57
============== ==============
Diluted income per common share:
Income before cumulative effect of change in accounting principle $ 0.23 $ 0.33
Cumulative effect of change in accounting principle - 0.22
-------------- --------------
Net income available to common shareholders $ 0.23 $ 0.55
============== ==============
* The consolidation of this item changed effective January 1, 2004 as a result
of the application of a newly mandated accounting standard "FIN 46R." Please see
footnote 14 for a complete discussion.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
4
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2003 AND THE SIX MONTHS ENDED JUNE 30, 2004
($ in thousands)
(Unaudited)
Accumulated
Common Stock Additional Other Treasury Stock Total
------------------- Paid-In Accumulated Comprehensive -------------------- Shareholders'
Shares Amount Capital Deficit Loss Shares Amount Equity
--------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balances January 1, 2003 294,080 $73,520 $ 1,943,406 $ (553,033) $(102,169) (11,598) $ (189,585) $1,172,139
Stock plans 1,354 338 9,911 - - 873 14,450 24,699
Net income - - - 187,852 - - - 187,852
Other comprehensive income, net
of tax and reclassifications
adjustments - - - - 30,493 - - 30,493
--------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balances December 31, 2003 295,434 73,858 1,953,317 (365,181) (71,676) (10,725) (175,135) 1,415,183
Stock plans - - (27,654) - - 2,952 48,217 20,563
Net income - - - 66,660 - - - 66,660
Other comprehensive loss, net
of tax and reclassifications
adjustments - - - - (1,040) - - (1,040)
--------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balances June 30, 2004 295,434 $73,858 $ 1,925,663 $ (298,521) $ (72,716) (7,773) $ (126,918) $1,501,366
========= ========= =========== ============ ============ ======== =========== ===========
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003
($ in thousands)
(Unaudited)
For the three months ended June 30, For the six months ended June 30,
-------------------------------------- --------------------------------------
2004 2003 2004 2003
------------------ ------------------ ------------------ ------------------
Net income $ 23,792 $ 34,057 $ 66,660 $ 161,488
Other comprehensive income (loss), net of
tax and reclassifications adjustments* (282) 908 (1,040) 4,798
------------------ ------------------ ------------------ ------------------
Total comprehensive income $ 23,510 $ 34,965 $ 65,620 $ 166,286
================== ================== ================== ==================
* Consists of unrealized holding gains/(losses) of
marketable securities.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
5
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
($ in thousands)
(Unaudited)
2004 2003
-------------- -------------
Income before cumulative effect of change in accounting principle $ 66,660 $ 95,719
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization expense 288,270 288,907
Gain on expiration/settlement of customer advances (25,345) (6,165)
Gain on capital lease termination/restructuring - (65,724)
Other non-cash adjustments 8,928 (5,117)
Deferred taxes 42,307 104,591
Change in accounts receivable 18,730 39,407
Change in accounts payable and other liabilities (37,567) (118,337)
Change in other current assets 2,672 10,479
-------------- --------------
Net cash provided by operating activities 364,655 343,760
Cash flows from investing activities:
Proceeds from sale of assets, net of selling expenses 13,992 54,900
Capital expenditures (133,434) (115,602)
Securities purchased - (605)
-------------- --------------
Net cash used by investing activities (119,442) (61,307)
Cash flows from financing activities:
Long-term debt payments (99,786) (301,583)
Issuance of common stock 13,121 15,706
Repayment of customer advances for
construction and contributions in aid of construction (1,860) (4,715)
-------------- --------------
Net cash used by financing activities (88,525) (290,592)
Increase (decrease) in cash and cash equivalents 156,688 (8,139)
Cash and cash equivalents at January 1, 583,671 393,177
-------------- --------------
Cash and cash equivalents at June 30, $ 740,359 $ 385,038
============== ==============
Cash paid during the period for:
Interest $ 204,293 $ 212,634
Income taxes $ 1,126 $ 1,243
Non-cash investing and financing activities:
Change in fair value of interest rate swaps $ (10,980) $ 864
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
6
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
(1) Summary of Significant Accounting Policies:
------------------------------------------
(a) Basis of Presentation and Use of Estimates:
Citizens Communications Company and its subsidiaries are referred to
as "we," "us" "our" or the "Company" in this report. Our unaudited
consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (GAAP) and should be read in conjunction with the consolidated
financial statements and notes included in our 2003 Annual Report on
Form 10-K. Certain reclassifications of balances previously reported
have been made to conform to current presentation. All significant
intercompany balances and transactions have been eliminated in
consolidation. These unaudited consolidated financial statements
include all adjustments, which consist of normal recurring accruals
necessary to present fairly the results for the interim periods shown.
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,
reserves established for receivables, income taxes and contingencies.
Certain information and footnote disclosures have been excluded and/or
condensed pursuant to Securities and Exchange Commission rules and
regulations. The results of the interim periods are not necessarily
indicative of the results for the full year.
(b) Cash Equivalents:
We consider all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
(c) 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 liabilities on our consolidated
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.
Electric Lightwave, LLC. (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.
(d) Goodwill and Other 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 and liabilities acquired and
allocate purchase prices to assets and liabilities, including
property, plant and equipment, goodwill and other identifiable
intangibles. On January 1, 2002, we adopted Statement of Financial
Accounting Standards (SFAS) No. 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
7
Statement requires that goodwill and other intangibles with indefinite
useful lives no longer be amortized to earnings, but instead be tested
for impairment, at least annually. In performing this test, the
Company first compares the carrying amount of its reporting units to
their respective fair values. If the carrying amount of any reporting
unit exceeds its fair value, the Company is required to perform step
two of the impairment test by comparing the implied fair value of the
reporting unit's goodwill with its carrying amount. The amortization
of goodwill and other intangibles with indefinite useful lives ceased
upon adoption of the Statement on January 1, 2002. We annually (during
the fourth quarter) examine the carrying value of our goodwill and
trade name to determine whether there are any impairment losses.
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 of Long-Lived Assets" to determine whether any changes to
these lives are required. We periodically reassess the useful life of
our intangible assets with estimated useful lives to determine whether
any changes to those lives are required.
(e) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
of:
We adopted 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. 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.
(f) Derivative Instruments and Hedging Activities:
We account for derivative instruments and hedging activities in
accordance with SFAS No. 149, "Accounting for Derivative Instruments
and Hedging Activities," as amended. SFAS No. 149, 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.
We have interest rate swap arrangements related to a portion of our
fixed rate debt. These hedge strategies satisfy the fair value hedging
requirements of SFAS No. 133. As a result, the fair value of the
hedges is carried on the balance sheet in other assets and the related
underlying liabilities are also adjusted to fair value by the same
amount.
(g) 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 apply Accounting Principles Board Opinions (APB)
No. 25 and related interpretations in accounting for the employee
stock plans resulting in the use of the intrinsic value to value the
stock.
SFAS No. 123, "Accounting for Stock-Based Compensation" and SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of SFAS No. 123," established accounting and
disclosure requirements using a fair-value-based method of accounting
for stock-based employee compensation plans. As permitted by existing
accounting standards, the Company has elected to continue to apply the
intrinsic-valued-based method of accounting described above, and has
adopted only the disclosure requirements of SFAS No. 123, as amended.
We provide pro forma net income and pro forma net income per common
share disclosures for employee stock option grants on the fair value
of the options at the date of grant. For purposes of presenting pro
forma information, the fair value of options granted is computed using
the Black Scholes option-pricing model.
8
Had we determined compensation cost based on the fair value at the
grant date for the Management Equity Incentive Plan (MEIP), Equity
Incentive Plan (EIP), Employee Stock Purchase Plan (ESPP) and
Directors' Deferred Fee Equity Plan, our pro forma net income and net
income per common share available for common shareholders would have
been as follows:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- ----------------------------
2004 2003 2004 2003
----------- ----------- ------------ ------------
($ in thousands)
Net income available for
common shareholders As reported $ 23,792 $ 34,057 $ 66,660 $ 161,488
Add: Stock-based employee
compensation expense
included in reported net
income, net of related tax
effects 1,726 2,721 3,817 3,748
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects (3,764) (5,208) (7,854) (8,508)
--------- --------- ---------- ---------
Pro forma $ 21,754 $ 31,570 $ 62,623 $ 156,728
========= ========= ========== =========
Net income per common
share available for common
shareholders As reported:
Basic $ 0.08 $ 0.12 $ 0.23 $ 0.57
Diluted $ 0.08 $ 0.12 $ 0.23 $ 0.55
Pro forma:
Basic $ 0.08 $ 0.11 $ 0.22 $ 0.56
Diluted $ 0.07 $ 0.11 $ 0.22 $ 0.53
(h) Net Income Per Common Share Available for Common Shareholders:
Basic net income per common share is computed using the weighted
average number of common shares outstanding during the period being
reported on. Except when the effect would be antidilutive, diluted net
income per common share reflects the dilutive effect of the assumed
exercise of stock options using the treasury stock method at the
beginning of the period being reported on as well as common shares
that would result from the conversion of convertible preferred stock.
In addition, the related interest on preferred stock dividends (net of
tax) is added back to income since it would not be paid if the
preferred stock was converted to common stock.
(2) Recent Accounting Literature and Changes in Accounting Principles:
-----------------------------------------------------------------
Accounting for Asset Retirement Obligations
-------------------------------------------
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 143, "Accounting for Asset Retirement Obligations." We adopted SFAS No.
143 effective January 1, 2003. As a result of our adoption of SFAS No. 143,
we recognized an after tax non-cash gain of approximately $65,769,000. This
gain resulted from the elimination of the cumulative cost of removal
included in accumulated depreciation as a cumulative effect of a change in
accounting principle in our statement of operations in the first quarter of
2003 as the Company has no legal obligation to remove certain of its
long-lived assets.
9
Exit or Disposal Activities
---------------------------
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
adopted SFAS No. 146 on January 1, 2003. The adoption of SFAS No. 146 did
not have any material impact on our financial position or results of
operations.
Guarantees
----------
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Guarantees of Indebtedness of Others." FIN 45 requires that a
guarantor be required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation assumed under the guarantee.
FIN 45 also requires additional disclosures by a guarantor in its interim
and annual financial statements about the obligations associated with the
guarantee. The provisions of FIN 45 are effective for guarantees issued or
modified after December 31, 2002, whereas the disclosure requirements were
effective for financial statements for periods ending after December 15,
2002. The adoption of FIN 45 on January 1, 2003 did not have any material
impact on our financial position or results of operations (see Note 16).
Variable Interest Entities
--------------------------
In December 2003, the FASB issued FASB Interpretation No. 46 (revised
December 2003) ("FIN 46R"), "Consolidation of Variable Interest Entities,"
which addresses how a business enterprise should evaluate whether it has a
controlling financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. FIN 46R replaces FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities," which
was issued in January 2003. We are required to apply FIN 46R to variable
interests in variable interest entities or VIEs created after December 31,
2003. For any VIEs that must be consolidated under FIN 46R that were
created before January 1, 2004, the assets, liabilities and noncontrolling
interests of the VIE initially would be measured at their carrying amounts
with any difference between the net amount added to the balance sheet and
any previously recognized interest being recognized as the cumulative
effect of an accounting change. If determining the carrying amounts is not
practicable, fair value at the date FIN 46R first applies may be used to
measure the assets, liabilities and noncontrolling interest of the VIE. We
reviewed all of our investments and determined that the Trust Convertible
Preferred Securities (EPPICS), issued by our consolidated wholly-owned
subsidiary, Citizens Utilities Trust and the related Citizens Utilities
Capital L.P., were our only VIEs. The adoption of FIN 46R on January 1,
2004 did not have any material impact on our financial position or results
of operations.
Derivative Instruments and Hedging
----------------------------------
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging," which clarifies financial accounting
and reporting for derivative instruments including derivative instruments
embedded in other contracts. This Statement is effective for contracts
entered into or modified after June 30, 2003. We adopted SFAS No. 149 on
July 1, 2003. The adoption of SFAS No. 149 did not have any material impact
on our financial position or results of operations.
Financial Instruments with Characteristics of Both Liabilities and Equity
-------------------------------------------------------------------------
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity."
The Statement establishes standards for the classification and measurement
of certain financial instruments with characteristics of both liabilities
and equity. Generally, the Statement is effective for financial instruments
entered into or modified after May 31, 2003 and is otherwise effective at
the beginning of the first interim period beginning after June 15, 2003. We
adopted the provisions of the Statement on July 1, 2003. The adoption of
SFAS No. 150 did not have any material impact on our financial position or
results of operations.
Pension and Other Postretirement Benefits
-----------------------------------------
In December 2003, the FASB issued SFAS No. 132 (revised), "Employers'
Disclosures about Pensions and Other Postretirement Benefits." This
Statement retains and revises the disclosure requirements contained in the
original Statement. It requires additional disclosures including
information describing the types of plan assets, investment strategy,
measurement date(s), plan obligations, cash flows, and components of net
periodic benefit cost recognized in interim periods. This Statement is
effective for fiscal years ending after December 15, 2003. We have adopted
the expanded disclosure requirements of SFAS No. 132 (revised).
10
The FASB also recently issued an Exposure Draft that would require
stock-based employee compensation to be recorded as a charge to earnings
beginning in 2005. We will continue to monitor the progress on the issuance
of this standard.
(3) Accounts Receivable:
-------------------
The components of accounts receivable, net at June 30, 2004 and December
31, 2003 are as follows:
($ in thousands) June 30, 2004 December 31, 2003
----------------- ---------------------
Customers $ 223,415 $ 250,515
Other 31,980 45,290
Less: Allowance for doubtful accounts (31,114) (47,332)
----------------- ---------------------
Accounts receivable, net $ 224,281 $ 248,473
================= =====================
The Company maintains an allowance for estimated bad debts based on its
estimate of collectibility of its accounts receivables. Bad debt expense,
which is recorded as a reduction of revenue, was $4,339,000 and $5,788,000
for the three months ended June 30, 2004 and 2003, respectively and
$6,558,000 and $10,798,000 for the six months ended June 30, 2004 and 2003,
respectively. Additional reserves are provided for known or impending
telecommunications bankruptcies, disputes or other significant collection
issues.
(4) Property, Plant and Equipment, Net:
----------------------------------
Property, plant and equipment, net at June 30, 2004 and December 31, 2003
is as follows:
($ in thousands) June 30, 2004 December 31, 2003
---------------- --------------------
Property, plant and equipment $ 6,361,161 $ 6,221,307
Less: Accumulated depreciation (2,924,062) (2,695,667)
---------------- --------------------
Property, plant and equipment, net $ 3,437,099 $ 3,525,640
================ ====================
Depreciation expense is principally based on the composite group method.
Depreciation expense was $112,782,000 and $118,729,000 for the three months
ended June 30, 2004 and 2003, respectively and $225,010,000 and
$225,565,000 for the six months ended June 30, 2004 and 2003, respectively.
Effective January 1, 2003, as a result of the adoption of SFAS No. 143,
"Accounting for Asset Retirement Obligations," we ceased recognition of the
cost of removal provision in depreciation expense and eliminated the
cumulative cost of removal included in accumulated depreciation. In
addition, we increased the average depreciable lives for certain of our
equipment in our ILEC segment. As part of the preparation and adoption of
SFAS No. 143, we analyzed depreciation rates for the ILEC segment and
compared them to industry averages and historical expense data. Based on
this review, the Company identified certain assets for which the Company's
analysis of historical/estimated lives indicated that the existing
estimated depreciable life was shorter than such revised estimates.
(5) Dispositions:
------------
On April 1, 2003, we completed the sale of approximately 11,000 access
lines in North Dakota for approximately $25,700,000 in cash. The pre-tax
gain on the sale was $2,274,000.
On April 4, 2003, we completed the sale of our wireless partnership
interest in Wisconsin for approximately $7,500,000 in cash. The pre-tax
gain on the sale was $2,173,000.
(6) 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 our water, gas
and electric businesses. All of these properties have been sold.
11
Electric and Gas
----------------
On August 8, 2003, we completed the sale of The Gas Company in Hawaii
division for $119,290,000 in cash and assumed liabilities. The pre-tax loss
on the sale recognized in 2003 was $19,180,000.
On August 11, 2003, we completed the sale of our Arizona gas and electric
divisions for $224,100,000 in cash. The pre-tax loss on the sale recognized
in 2003 was $18,491,000.
On December 2, 2003, we completed the sale of substantially all of our
Vermont electric division's transmission assets for $7,344,000 in cash
(less $1,837,000 in refunds to customers as ordered by the Vermont Public
Service Board).
On April 1, 2004, we completed the sale of our Vermont electric
distribution operations for approximately $13,992,000 in cash, net of
selling expenses.
Losses on the sales of our Vermont properties were included in the
impairment charges recorded during 2003.
Summarized balance sheet information for the electric operations (assets
held for sale) is set forth below (no data for June 30, 2004 because all of
the properties had been sold as of that date).
($ in thousands) December 31, 2003
--------------------
Current assets $ 4,688
Net property, plant and equipment 7,225
Other assets 11,217
--------------------
Total assets held for sale $ 23,130
====================
Current liabilities $ 3,651
Other liabilities 7,477
--------------------
Total liabilities related to assets held
for sale $ 11,128
====================
(7) Intangibles:
-----------
Intangibles at June 30, 2004 and December 31, 2003 are as follows:
($ in thousands) June 30, 2004 December 31, 2003
------------------------ ---------------------
Customer base - amortizable over 96 months $ 995,853 $ 995,853
Trade name - non-amortizable 122,058 122,058
------------------------ ---------------------
Other intangibles 1,117,911 1,117,911
Accumulated amortization (368,764) (305,504)
------------------------ ---------------------
Total other intangibles, net $ 749,147 $ 812,407
======================== =====================
Amortization expense was $31,630,000 for the three months ended June 30,
2004 and 2003, respectively and $63,260,000 and $63,342,000 for the six
months ended June 30, 2004 and 2003, respectively. Amortization expense for
each of the next five years, based on our estimate of useful lives, is
estimated to be $126,520,000 per year.
12
(8) Long-Term Debt:
--------------
The activity in our long-term debt from December 31, 2003 to June 30, 2004
is as follows:
Six Months Ended June 30, 2004
----------------------------------------
Interest
Rate* at
December 31, Interest June 30, June 30,
($ in thousands) 2003 Payments Rate Swap Other 2004 2004
-------- ---------- --------- --------- ----------- --------
Rural Utilities Service Loan
Contracts $ 30,010 $ (456) $ - $ - $ 29,554 6.120%
Senior Unsecured Debt $ 4,167,123 (80,955) (10,980) - 4,075,188 8.139%
EPPICS** (reclassified as a
result of adopting FIN 46R) - - - 211,756 211,756 5.000%
Equity Units 460,000 - - - 460,000 7.480%
ELI Notes 5,975 (5,975) - - - -
ELI Capital Leases 10,061 (91) - - 9,970 9.745%
Industrial Development Revenue
Bonds 70,440 (12,300) - - 58,140 5.559%
Other 22 (9) - - 13 12.985%
------------ ----------- ----------- --------- ----------
TOTAL LONG TERM DEBT $ 4,743,631 $ (99,786) $ (10,980) $ 211,756 $4,844,621
------------ =========== =========== ========= ----------
Less: Current Portion (88,002) (6,490)
Less: Equity Units (460,000) (460,000)
------------ ----------
$ 4,195,629 $4,378,131
============ ==========
* Interest rate includes amortization of debt issuance expenses, debt premiums
or discounts. The interest rate for Rural Utilities Service Loan Contracts,
Senior Unsecured Debt, and Industrial Development Revenue Bonds represent a
weighted average of multiple issuances.
** In accordance with FIN 46R, the Trust holding the EPPICS and the related
Citizens Utilities Capital L.P. are now deconsolidated (see Note 14). No new
debt has been issued and our debt to outside third parties remains unchanged at
$201,250,000.
On January 15, 2004 we repaid at maturity the remaining outstanding
$80,955,000 of our 7.45% Debentures.
On January 15, 2004, we redeemed at 101% the remaining outstanding
$12,300,000 of our Hawaii Special Purpose Revenue Bonds, Series 1993A and
Series 1993B.
On May 17, 2004, we repaid at maturity the remaining outstanding $5,975,000
of Electric Lightwave, LLC's 6.05% Notes. These Notes had been guaranteed
by Citizens.
Total future minimum cash payment commitments over the next 23 years under
ELI's long-term capital leases amounted to $29,362,000 as of June 30, 2004.
In July 2004, we retired, in full, an ELI capital lease obligation of
$5,524,000. This reduced the length of ELI's future cash payment
commitments to 20 years and the amount to $10,185,000.
13
(9) Net Income Per Common Share:
---------------------------
The reconciliation of the income per common share calculation for the three
and six months ended June 30, 2004 and 2003, respectively, is as follows:
For the three For the six
($ in thousands, except per-share amounts) months ended June 30 months ended June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------------- --------------- -------------- ---------------
Net income used for basic and diluted earnings
- ----------------------------------------------
per common share:
----------------
Income before cumulative effect of change in accounting
principle $ 23,792 $ 34,057 $ 66,660 $ 95,719
Cumulative effect of change in accounting principle - - - 65,769
-------------- --------------- -------------- ---------------
Total basic net income available to common shareholders $ 23,792 $ 34,057 $ 66,660 $ 161,488
============== =============== ============== ===============
Effect of conversion of preferred securities - 1,552 3,255 3,105
-------------- --------------- -------------- ---------------
Total diluted net income available to common shareholders $ 23,792 $ 35,609 $ 69,915 $ 164,593
============== =============== ============== ===============
Basic earnings per common share:
- -------------------------------
Weighted-average shares outstanding - basic 284,782 282,180 284,378 281,934
============== =============== ============== ===============
Income before cumulative effect of change in accounting
principle $ 0.08 $ 0.12 $ 0.23 $ 0.34
Cumulative effect of change in accounting principle - - - 0.23
-------------- --------------- -------------- ---------------
Net income available to common shareholders $ 0.08 $ 0.12 $ 0.23 $ 0.57
============== =============== ============== ===============
Diluted earnings per common share:
- ---------------------------------
Weighted-average shares outstanding 284,782 282,180 284,378 281,934
Effect of dilutive shares 6,572 5,389 5,921 4,763
Effect of conversion of preferred securities - 15,134 15,134 15,134
-------------- --------------- -------------- ---------------
Weighted-average shares outstanding - diluted 291,354 302,703 305,433 301,831
============== =============== ============== ===============
Income before cumulative effect of change in accounting
principle $ 0.08 $ 0.12 $ 0.23 $ 0.33
Cumulative effect of change in accounting principle - - - 0.22
-------------- --------------- -------------- ---------------
Net income available to common shareholders $ 0.08 $ 0.12 $ 0.23 $ 0.55
============== =============== ============== ===============
For the three and six months ended June 30, 2004, 7,267,000 options at
exercise prices ranging from $12.91 to $21.47 issuable under employee
compensation plans were excluded from the computation of diluted EPS for
those periods because the exercise prices were greater than the average
market price of common shares and, therefore, the effect would be
antidilutive.
For the three and six months ended June 30, 2003, options of 10,505,000 and
11,284,000, respectively, at exercise prices ranging from $11.09 to $21.47
issuable under employee compensation plans were excluded from the
computation of diluted EPS for those periods because the exercise prices
were greater than the average market price of common shares and, therefore,
the effect would be antidilutive.
For the three and six months ended June 30, 2004 and 2003, restricted stock
awards of 2,639,000 and 1,553,000 shares, 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.
We also have 18,400,000 potentially dilutive equity units with each equity
unit consisting 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
$14.52, 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.
14
These securities have no impact on the computation of diluted EPS for all
periods reflected above.
On August 17, 2004, we will issue $460,000,000 of common stock to our
equity unit holders (see Note 9 for a more complete description of the
equity units). Of this amount, $300,000,000 is held in escrow and will be
distributed to us on August 17, 2004. The remaining $160,000,000 will be
settled in cash by current equity unit holders, or if not in cash by
settlements of their notes. In July 2004 we retired $300,000,000 of such
senior notes. As a condition to the retirement, the note holders placed
$300,000,000 in escrow which will be used to settle their common stock
purchase obligation on August 17, 2004. This retirement will result in a
pre-tax charge of approximately $15,000,000 in the third quarter of 2004
but will reduce interest expense by $20,000,000 annually. We expect to
remarket the remaining outstanding senior notes on August 12, 2004. Our
interest expense on the remaining notes could increase if, as a result of
such remarketing, the interest rate increases from the current rate of
6.75%. If the remarketing is not successful then we would retire the notes
in satisfaction of the purchase price.
We also 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 $13.30 per share
that have been included in the diluted income per common share calculation
for the six months ended June 30, 2004 and the three and six months ended
June 30, 2003. These securities have not been included in the diluted
income per share calculation for the three months ended June 30, 2004
because their inclusion would have had an antidilutive effect.
(10) Segment Information:
-------------------
As of April 1, 2004, we operate in two segments, ILEC and ELI (a
competitive local exchange carrier (CLEC)). The ILEC segment provides both
regulated and unregulated communications services to residential, business
and wholesale customers and is typically the incumbent provider in its
service areas. Our remaining electric property was sold on April 1, 2004.
As an ILEC, we compete with CLECs that may operate in our markets. As a
CLEC, we provide telecommunications services, principally to businesses, in
competition with the ILEC. As a CLEC, we frequently obtain the "last mile"
access to customers through arrangements with the applicable ILEC. ILECs
and CLECs are subject to different regulatory frameworks of the Federal
Communications Commission (FCC) and state regulatory agencies. Our ILEC
operations and ELI do not compete with each other.
As permitted by SFAS No. 131, we have utilized the aggregation criteria in
combining our markets because all of the Company's ILEC properties share
similar economic characteristics: they provide the same products and
services to similar customers using comparable technologies in all the
states we operate. The regulatory structure is generally similar.
Differences in the regulatory regime of a particular state do not
materially impact the economic characteristics or operating results of a
particular property.
($ in thousands) For the three months ended June 30, 2004
------------------------------------------------------------
Total
ILEC ELI Electric (1) Segments
-------------- -------------- --------------- -------------
Revenue $ 505,789 $ 38,302 $ - $ 544,091
Depreciation and amortization 138,467 5,945 - 144,412
Strategic alternatives and
management succession expenses 11,133 428 - 11,561
Operating income (loss) 127,237 1,957 (1,019) 128,175
Capital expenditures 73,678 4,397 - 78,075
15
For the three months ended June 30, 2003
---------------------------------------------------------------------------
($ in thousands) Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 510,153 $ 43,719 $ 56,150 $ 33,932 $ 643,954
Depreciation and amortization 144,374 5,985 - - 150,359
Reserve for telecommunications
bankruptcies 1,113 1,147 - - 2,260
Restructuring and other expenses 9,482 631 - - 10,113
Operating income 121,814 2,350 6,159 4,869 135,192
Capital expenditures 56,415 2,254 4,296 4,827 67,792
(1) Consists principally of post-sale activities associated with the
completion of our utility divestiture program. These costs could not be
accrued as a selling cost at the time of sale. The Company believes it has
an adequate provision for its remaining post-divestiture liabilities. We do
not anticipate any material future costs associated with these activities.
For the six months ended June 30, 2004
------------------------------------------------------------
($ in thousands) Total
ILEC ELI Electric Segments
-------------- -------------- --------------- -------------
Revenue $ 1,014,757 $ 78,067 $ 9,735 $ 1,102,559
Depreciation and amortization 276,490 11,780 - 288,270
Strategic alternatives and
management succession expenses 15,882 610 - 16,492
Operating income (loss) 265,955 4,347 (2,321) 267,981
Capital expenditures 126,531 6,159 573 133,263
For the six months ended June 30, 2003
---------------------------------------------------------------------------
($ in thousands) Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 1,023,762 $ 84,812 $ 119,681 $ 67,561 $ 1,295,816
Depreciation and amortization 276,729 12,178 - - 288,907
Reserve for telecommunications
bankruptcies 1,113 1,147 - - 2,260
Restructuring and other expenses 9,482 610 - - 10,092
Operating income 268,729 2,885 18,010 9,863 299,487
Capital expenditures 94,292 3,401 7,465 9,972 115,130
The following table reconciles sector capital expenditures to total
consolidated capital expenditures.
For the three months ended For the six months ended
($ in thousands) June 30, June 30,
------------------------------ -----------------------------
2004 2003 2004 2003
-------------- -------------- --------------- -------------
Total segment capital expenditures $ 78,075 $ 67,792 $ 133,263 $ 115,130
General capital expenditures 171 58 171 472
-------------- -------------- --------------- -------------
Consolidated reported capital
expenditures $ 78,246 $ 67,850 $ 133,434 $ 115,602
============== ============== =============== =============
(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.
16
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 June 30, 2004 and December 31, 2003 were $550,000,000 and $400,000,000,
respectively. Such contracts require us to pay variable rates of interest
(estimated average pay rates of approximately 6.02% as of June 30, 2004 and
approximately 5.46% as of December 31, 2003) and receive fixed rates of
interest (average receive rates of 8.47% and 8.38% as of June 30, 2004 and
December 31, 2003, respectively). The fair value of these derivatives is
reflected in other assets as of June 30, 2004, in the amount of $(379,000)
and the related underlying debt has been decreased by a like amount. The
net amounts received during the three and six months ended June 30, 2004 as
a result of these contracts amounted to $4,021,000 and $5,516,000,
respectively, and are included as a reduction of interest expense.
We do not anticipate any nonperformance by counterparties to our derivative
contracts as all counterparties have investment grade credit ratings.
(12) Strategic Alternatives and Management Succession Expenses:
---------------------------------------------------------
On July 11, 2004, our Board of Directors announced that it had completed
its review of the Company's financial and strategic alternatives. Through
the first six months of 2004, we expensed approximately $16,500,000 related
to our exploration of financial and strategic alternatives and management
succession costs. We are evaluating the costs that will be incurred as a
result of these matters and the final amount of some of these costs has not
yet been determined. Our best estimate, at this time, indicates that we
will record approximately $80,000,000 - $85,000,000 of such expenses in the
second half of 2004, most of which will be recorded in the third quarter.
Compensation arrangements entered into in connection with these matters
will result in stock compensation expense of approximately $5,100,000 in
2005, $5,000,000 in 2006 and $1,000,000 in 2007.
(13) Investment and Other Income, Net:
--------------------------------
The components of investment and other income, net are as follows:
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- ------------------------------
($ in thousands) 2004 2003 2004 2003
-------------- -------------- -------------- --------------
Investment income $ 2,576 $ 2,246 $ 5,611 $ 5,303
Gain on capital lease termination/restructuring - 25,021 - 65,724
Gain on expiration/settlement of customer advances 1,163 - 25,345 6,165
Gain (loss) on sale of assets - 6,671 (1,370) 5,021
Other, net 1,474 (2,701) 921 (2,804)
-------------- -------------- -------------- --------------
Total investment and other income, net $ 5,213 $ 31,237 $ 30,507 $ 79,409
============== ============== ============== ==============
During 2003 and 2004, we recognized income in connection with certain
retained liabilities associated with customer advances for construction
from our disposed water properties, as a result of some of these
liabilities terminating. During 2003, we recognized gains in connection
with the termination/restructuring of capital leases at ELI. Loss on sale
of assets represents the loss recognized on the sale of fixed assets in
2004, and in 2003 is attributable to the sale of our Plano office building.
(14) 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 (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 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
17
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 annual 5%
interest in quarterly installments on the Convertible Subordinated
Debentures in the first and second quarters of 2004 and the four quarters
of 2003. Only cash was paid (net of investment returns) 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.
During July 2004, EPPICS representing a total principal amount of
$4,854,000 were converted into 364,990 shares of Citizens common stock.
We have adopted the provisions of FIN 46R (revised December 2003) ("FIN
46R"), "Consolidation of Variable Interest Entities," effective January 1,
2004. We have not restated prior periods.
We have included the following description to provide readers a comparative
analysis of the accounting impact of this standard. Both the Trust and the
Partnership have been consolidated from the date of their creation through
December 31, 2003. As a result of the new consolidation standards
established by FIN 46R, the Company, effective January 1, 2004,
deconsolidated the activities of the Trust and the Partnership. We have
highlighted the comparative effect of this change in the following table:
Balance Sheet
- -------------
($ in thousands) As of
---------------------------------------------------------
December 31, 2003 June 30, 2004 Change
--------------------- ---------------- --------------
Assets:
Cash $ 2,103 $ - $(2,103) (1)
Investments - 12,645 12,645 (2)
Liabilities:
Long-term debt - 211,756 (3) 10,506 (3)
EPPICS 201,250 - (3)
Statement of Operations
- -----------------------
($ in thousands) As reported for the six months ended
---------------------------------------------------------
June 30, 2003 June 30, 2004 Change
--------------------- ---------------- --------------
Investment income $ - $ 316 $ 316 (4)
Interest expense - 5,294 5,294 (5)
Dividends on EPPICS (before tax) 5,032 - (5,032) (6)
--------------------- ---------------- --------------
Net $ 5,032 $ 4,978 $ (54)
===================== ================ ==============
(1) Represents a cash balance on the books of the Partnership that is
removed as a result of the deconsolidation.
(2) Represents Citizens' investments in the Partnership and the Trust. At
December 31, 2003, these investments were eliminated in consolidation
against the equity of the Partnership and the Trust.
(3) As a result of the deconsolidation, the Trust and the Partnership
balance sheets are removed, leaving debt issued by Citizens to the
Partnership in the amount of $211,756,000. The nominal effect of an
increase in debt of $10,506,000 is debt that is "intercompany." FIN
46R does not impact the economics of the EPPICS structure. Citizens
continues to have $201,250,000 of debt outstanding to third parties
and will continue to pay interest on that amount at 5%.
18
(4) Represents interest income to be paid by the Partnership and the Trust
to Citizens for its investments noted in (2) above. The Partnership
and the Trust have no source of cash except as provided by Citizens.
Interest is payable at the rate of 5% per annum.
(5) Represents interest expense on the convertible debentures issued by
Citizens to the Partnership in the amount of $211,756,000. Interest is
payable at the rate of 5% per annum.
(6) As a result of the deconsolidation of the Trust, previously reported
dividends on the convertible preferred securities issued to the public
by the Trust are removed and replaced by the interest accruing on the
debt issued by Citizens to the Partnership. Citizens remains the
guarantor of the EPPICS debt and continues to be the sole source of
cash for the Trust to pay dividends.
(15) Retirement Plans:
----------------
The following tables provides the components of net periodic benefit cost
for the three and six months ended June 30, 2004 and 2003:
Pension Benefits
--------------------------------------------------------
For the three months ended For the six months ended
June 30, June 30,
---------------------------- -------------------------
($ in thousands) 2004 2003 2004 2003
------------- ------------- ------------ ------------
Components of net periodic benefit cost
- ---------------------------------------
Service cost $ 1,589 $ 1,922 $ 3,178 $ 3,844
Interest cost on projected benefit obligation 11,496 14,569 22,992 29,138
Return on plan assets (14,308) (16,021) (28,616) (32,042)
Amortization of prior service cost and
unrecognized net obligation (61) (51) (122) (102)
Amortization of unrecognized loss 1,854 3,271 3,708 6,542
------------- ------------- ------------ ------------
Net periodic benefit cost $ 570 $ 3,690 $ 1,140 $ 7,380
============= ============= ============ ============
Other Postretirement Benefits
--------------------------------------------------------
For the three months ended For the six months ended
June 30, June 30,
---------------------------- -------------------------
($ in thousands) 2004 2003 2004 2003
------------- ------------- ------------ ------------
Components of net periodic benefit cost
- ---------------------------------------
Service cost $ 399 $ 292 $ 798 $ 584
Interest cost on projected benefit obligation 3,157 2,863 6,314 5,728
Return on plan assets (530) (449) (1,060) (898)
Amortization of prior service cost and
unrecognized net obligation 6 5 12 10
Amortization of unrecognized loss 1,559 838 3,118 1,677
------------- ------------- ------------ ------------
Net periodic benefit cost $ 4,591 $ 3,549 $ 9,182 $ 7,101
============= ============= ============ ============
We expect that our pension expense for 2004 will be $2,000,000 - $4,000,000
(it was $12,400,000 in 2003) and no contribution will be required to be
made by us to the pension plan in 2004. No contribution was made, or
required, for 2003.
In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) became law. The Act introduces a
prescription drug benefit under Medicare as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that
is at least actuarially equivalent to the Medicare benefit. The amount of
the federal subsidy will be based on 28 percent of an individual
beneficiary's annual eligible prescription drug costs ranging between $250
and $5,000. Currently, the Company does not believe it will need to amend
its plan to receive the federal subsidy. The Company has not fully
quantified the effects, if any, that the Act will have on its future
benefits costs or accumulated postretirement benefit obligation and
accordingly, the effects of the Act have not been reflected in the
accompanying unaudited consolidated financial statements.
19
(16) Commitments and Contingencies:
-----------------------------
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). We intend to
defend ourselves vigorously against the City's lawsuit. 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 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 counterclaims
against the City. In addition, we have identified a number of other
potentially responsible parties that may be liable for the damages alleged
by the City and have joined them as parties to the lawsuit. These
additional parties include Honeywell Corporation, the Army Corps of
Engineers, Guilford Transportation (formerly Maine Central Railroad), UGI
Utilities, Inc., and Centerpoint Energy Resources Corporation. On March 11,
2004, the Magistrate in charge of the case granted our motion for partial
summary judgment with respect to the City's CERCLA claims, and that
decision was affirmed by the District Court on May 5, 2004. In an order
issued on July 6, 2004, the Magistrate dismissed the City's claim for
punitive damages. The City is currently appealing that decision to the
District Court. We have demanded that various of our insurance carriers
defend and indemnify us with respect to the City's lawsuit, and on 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 this lawsuit to obtain from our insurance
carriers indemnification for any damages that may be assessed against us in
the City's lawsuit as well as to recover the costs of our defense of that
lawsuit.
On June 7, 2004, representatives of Robert A. Katz Technology Licensing,
LP, contacted us regarding possible infringement of several patents held by
that firm. The patents cover a wide range of operations in which telephony
is supported by computers, including obtaining information from databases
via telephone, interactive telephone transactions, and customer and
technical support applications. We are cooperating with the patent holder
to determine if we are currently using any of the processes that are
protected by its patents. If we determine that we are utilizing the patent
holder's intellectual property, we expect to commence negotiations on a
license agreement.
On June 24, 2004, one of our subsidiaries, Frontier Subsidiary Telco Inc.,
received a "Notice of Indemnity Claim" from Citibank, N.A., that is related
to a complaint pending against Citibank and others in the U.S. Bankruptcy
Court for the Southern District of New York as a part of the Global
Crossing Bankruptcy proceeding. Citibank bases its claim for indemnity on
the provisions of a credit agreement that was entered into in October 2000
between Citibank and our subsidiary. We purchased Frontier Subsidiary
Telco, Inc., in June 2001 as part of our acquisition of the Frontier
telephone companies. The complaint against Citibank, for which it seeks
indemnification, alleges that the seller improperly used a portion of the
proceeds from the Frontier transaction to pay off the Citibank credit
agreement, thereby defrauding certain debt holders of Global Crossing North
America Inc. Although the credit agreement was paid off at the closing of
the Frontier transaction, Citibank claims the indemnification obligation
survives. Damages sought against Citibank and its co-defendants could
exceed $1,000,000,000. We are currently reviewing Citibank's claims to
determine what action we should take to respond to those claims.
We are party to other legal 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.
We have budgeted capital expenditures in 2004 of approximately
$276,000,000, including $265,000,000 for ILEC (approximately $10,300,000 of
which relates to our billing system conversion) and $11,000,000 for ELI.
Capitalized costs during 2004 associated with our billing system conversion
amounted to $3,939,000.
20
The Company has sold all of its utility businesses as of April 1, 2004.
However, we have retained a potential payment obligation associated with
our previous electric utility activities in the state of Vermont. The
Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities, including
us, entered into a purchase power agreement with Hydro-Quebec in 1987. 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. Our pro-rata share of the
purchase power obligation was 10%. 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 (which runs through 2015). Paragraph 13 of FIN 45 requires that
we disclose "the maximum potential amount of future payments (undiscounted)
the guarantor could be required to make under the guarantee." Paragraph 13
also states that we must make such disclosure "... even if the likelihood
of the guarantor's having to make any payments under the guarantee is
remote..." As noted above, our obligation only arises as a result of
default by another VJO member such as upon bankruptcy. Therefore, to
satisfy the "maximum potential amount" disclosure requirement we must
assume that all members of the VJO simultaneously default, a highly
unlikely scenario given that the two members of the VJO that have the
largest potential payment obligations are publicly traded with credit
ratings of BBB or better, and that all VJO members are regulated utility
providers with regulated cost recovery. Regardless, despite the remote
chance that such an event could occur, or that the State of Vermont could
or would allow such an event, assuming that all the members of the VJO
defaulted by January 1, 2005 and remained in default for the duration of
the contract (another 10 years), we estimate that our undiscounted purchase
obligation for 2005 through 2015 would be approximately $1,600,000,000. In
such a scenario the Company would then own the power and could seek to
recover its costs. We would do this by seeking to recover our costs from
the defaulting members and/or reselling the power to other utility
providers or the northeast power grid. There is an active market for the
sale of power. We believe that we would receive full recovery of our costs
through sales to others. If pricing became more favorable we could
potentially sell the power on the open market at a profit. We could
potentially lose money if we were unable to sell the power at cost.
We caution that all of the above-described scenarios are unlikely to occur
and we cannot predict with any degree of certainty any potential outcome.
(17) Subsequent Events:
-----------------
On July 11, 2004, the Company announced that on September 2, 2004 it will
pay a special dividend of $2 per common share and a quarterly dividend of
$0.25 per common share to shareholders of record on August 18, 2004.
Concurrently, Leonard Tow decided to step down from his position as chief
executive officer, effective immediately, and resign his position as
chairman of the board by the end of 2004. The Board of Directors named Rudy
J. Graf, currently a director and former president and chief operating
officer of Citizens, to serve as CEO and President on an interim basis
until a new CEO is named.
In July 2004, we retired, in full, an ELI capital lease obligation of
$5,524,000.
In July 2004, we purchased $300,000,000 of the 6.75% notes that are a
component of our equity units at 105.075% of par, plus accrued interest.
During July 2004, EPPICS representing a total principal amount of
$4,854,000 were converted into 364,990 shares of Citizens common stock.
In July 2004, our independent directors elected David H. Ward as the Lead
Director.
21
Item 2. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
This quarterly report on Form 10-Q contains forward-looking statements that
are subject to risks and uncertainties, which could cause actual results to
differ materially from those expressed or implied in the 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, and our future results may be materially affected by,
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), voice over internet protocol (VOIP) or
otherwise), high speed cable modems and cable telephony;
* The effects of general and local economic and employment
conditions on our revenues;
* Our ability to effectively manage and otherwise monitor our
operations, costs, regulatory compliance and service quality;
* Our ability to successfully introduce new product offerings
including our ability to offer bundled service packages on terms
that are both profitable to us and attractive to our customers,
and our ability to sell enhanced and data services;
* 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
potential changes in access charges and subsidy payments and
regulatory network upgrade requirements;
* Our ability to successfully renegotiate certain ILEC state
regulatory plans as they expire or come up for renewal from time
to time;
* Our ability to manage our operating expenses, capital
expenditures, pay dividends and reduce or refinance 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 more price competition and potential bad
debts;
* The effects of technological changes on our capital expenditures
and product and service offerings, 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 medical expenses and related funding
requirements;
* The effect of changes in the telecommunications market, including
the likelihood of significantly increased price and service
competition;
* Our ability to successfully convert the billing system for
approximately 770,000 of our access lines on a timely basis and
within our expected amount for 2004 of $18.0 - $20.0 million (a
portion of which is expected to be capitalized and amortized)
and, beginning in 2005, to achieve our expected cost savings from
conversion;
* The effects of state regulatory cash management policies on our
ability to transfer cash among our subsidiaries and to the parent
company;
22
* Our ability to successfully renegotiate expiring union contracts
covering approximately 900 employees that are scheduled to expire
during the remainder of 2004;
* Our ability to pay a $1.00 per common share dividend annually may
be affected by our cash flow from operations, amount of capital
expenditures, debt service requirements and cash taxes and our
liquidity; and
* 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-Q or otherwise made by us or on our behalf. The following information is
unaudited and should be read in conjunction with the consolidated financial
statements and related notes included in this report and as presented in our
2003 Annual Report on Form 10-K. We have no obligation to update or revise these
forward-looking statements.
Overview
- --------
We are a telecommunications company providing wireline communications services
to rural areas and small and medium-sized towns and cities 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, LLC, or ELI, our
wholly-owned subsidiary. We also provided (through March 31, 2004), electric
distribution services to primarily rural customers in Vermont.
Competition in the telecommunications industry is increasing. We experience
competition from other wireline local carriers through Unbundled Network
Elements (UNE), VOIP and potentially in the future through Unbundled Network
Elements Platform (UNEP), from other long distance carriers (including Regional
Bell Operating Companies), from cable companies and internet service providers
with respect to internet access and cable telephony, and from wireless carriers.
Most of the wireline competition we face is in our Rochester, New York market,
with competition also present in a few other areas. Time Warner Cable is selling
VOIP service in our Rochester market and other portions of our New York markets.
Competition from cable companies and other internet service providers with
respect to internet access is intense. Competition from wireless companies and
other long distance companies is increasing in all of our markets.
The telecommunications industry is undergoing significant changes and
difficulties. The market for internet access, long distance, long-haul and
related services in the United States is extremely competitive, with substantial
overcapacity in the market. Demand and pricing for certain CLEC services (such
as long-haul services) have decreased substantially. There is also increasing
price pressure on certain of our ILEC services such as long distance and
internet access. These trends are likely to continue and result in a challenging
revenue environment. These factors could also result in more bankruptcies in the
sector and therefore affect our ability to collect money owed to us by carriers.
Several long distance and Interexchange Carriers (IXCs) 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.
Our ILEC business has been experiencing declining access lines, switched minutes
of use and revenues because of economic conditions, unemployment levels,
increasing competition (as described above), changing consumer behavior (such as
wireless displacement of wireline use, email use, instant messaging and
increasing use of VOIP) and regulatory constraints. During the six months ended
June 30, 2004, our access lines declined 2.3%, our switched minutes of use
declined 1.8% and our ILEC revenues declined 0.7%, in each case as compared to
the first six months of 2003. These factors are likely to cause our local
network service, switched network access, long distance and subsidy revenues to
continue to decline during the remainder of 2004. During the six months ended
June 30, 2004, our switched network access revenue declined 8.1%, our long
distance revenue declined 9.8% and our subsidy revenue declined 6.4%, in each
case as compared to 2003. One of the ways we are responding to competition is by
bundling services and products and offering them for a single price, which
results in lower pricing than purchasing the services separately. During the six
months ended June 30, 2004, approximately 37,700 customers started buying one of
our bundled packages and we increased our revenue from enhanced services by
7.3%. In addition, we added approximately 43,700 DSL subscribers during the six
months ended June 30, 2004 and increased our data revenue by 25.2%. Our average
ILEC revenue per month per average number of ILEC access lines during the six
months ended June 30, 2004 was $71.24 compared to $70.20 during the six months
ended June 30, 2003. The above discussion excludes the sale of approximately
11,000 access lines in North Dakota on April 1, 2003.
23
Revenues from data services such as DSL continue to increase as a percentage of
our total revenues and revenues from high margin services such as local line and
access charges and subsidies are decreasing as a percentage of our revenues.
These factors, along with increasing operating and employee costs may cause our
profitability to decrease. In addition, costs we will incur during the remainder
of 2004 to convert the billing system for some of our access lines, to enable
our systems to be capable of LNP and to retain certain employees will affect our
profitability and capital expenditures during the remainder of 2004.
In July 2004, our Board of Directors concluded a review of financial and
strategic alternatives. After analysis of alternatives by the Board of Directors
and its financial and legal advisors, the Board determined to pay a special
dividend of $2 per common share and institute a regular annual dividend of $1
per common share which will be paid quarterly. The special dividend and first
quarterly dividend will be payable on September 2, 2004 to shareholders of
record on August 18, 2004, utilizing the Company's available cash on hand.
(a) Liquidity and Capital Resources
-------------------------------
For the six months ended June 30, 2004, we used cash flow from operations, cash
and cash equivalents to fund capital expenditures, interest payments and debt
repayments. As of June 30, 2004, we maintained cash and cash equivalents
aggregating $740.4 million.
We have budgeted approximately $276.0 million for our 2004 capital projects,
including $265.0 million for the ILEC segment (approximately $10.3 million of
which relates to our billing system conversion) and $11.0 million for the ELI
segment. Capitalized costs during 2004 associated with our billing system
conversion amount to $3.9 million through June 30.
For the six months ended June 30, 2004, our capital expenditures were $133.4
million, including $126.5 million for the ILEC segment, $6.2 million for the ELI
segment, $0.6 million for the public utilities segment and $0.1 million for
general capital expenditures. Our capital spending has been trending lower over
the last several years as we continue to closely scrutinize all of our capital
projects, emphasize return on investment and focus our capital expenditures on
areas and services that have the greatest opportunities with respect to revenue
growth and cost reduction. We will continue to focus on managing our costs while
increasing our investment in certain new product areas such as DSL and VOIP.
We have an available shelf registration for $825.6 million. 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 June 30, 2004. As a result of the downgrades in our credit
ratings described below, these fees will increase to 0.40% per annum. The
expiration date for these facilities is October 24, 2006. During the term of the
facilities we may borrow, repay and reborrow funds. As of June 30, 2004, there
were no outstanding borrowings under these facilities.
As a result of our dividend policy, Standard and Poor's lowered its ratings on
Citizens debt from "BBB" to "BB-plus", Moody's Investors Service lowered its
ratings from "Baa3" to "Ba3" and Fitch Ratings lowered its ratings from "BBB" to
"BB".
We believe our operating cash flows, existing cash balances, and the current
credit facilities will be adequate to finance our working capital requirements,
make required debt payments through 2005, pay dividends to our shareholders in
accordance with our dividend policy, and support our short-term and long-term
operating strategies. Our credit facilities expire, and we have approximately
$1,035.0 million of debt that matures in 2006 (including the $160.0 million of
debt that remains part of our Equity Units). We are likely to refinance a
significant amount of this debt prior to maturity and to extend the term of our
credit facilities prior to expiration.
The payment of the $2.00 special dividend per common share will significantly
reduce our cash balances and liquidity. In addition, our ongoing annual
dividends will reduce our operating and financial flexibility and ability to
significantly increase our capital expenditures. While we believe that the
amount of our dividends will allow for adequate amounts of cash flow for other
purposes, any reduction in cash generated by operations and any increases in
capital expenditures, interest expense or cash taxes would reduce the amount of
cash generated in excess of dividends. Increases in competition, lower subsidy
and access revenues and the other factors described above may reduce our cash
generated by operations and require us to increase capital expenditures. The
downgrades in our credit ratings described above may make it more difficult and
expensive to refinance our maturing debt. We have in recent years paid
relatively low amounts of cash taxes. We expect that over time our cash taxes
will increase.
24
Issuance of Common Stock
- ------------------------
On August 17, 2004, we will issue $460.0 million of common stock to our equity
unit holders (see Note 9 for a more complete description of the equity units).
Of this amount, $300.0 million is held in escrow and will be distributed to us
on August 17, 2004. The remaining $160 million will be settled in cash by
current equity unit holders, or if not in cash by settlements of their note. In
July 2004 we retired $300.0 million of such senior notes. As a condition to the
retirement, the note holders placed $300.0 million in escrow which will be used
to settle their common stock purchase obligation on August 17, 2004. This
retirement will result in a pre-tax charge of approximately $15.0 million in the
third quarter of 2004 but will reduce interest expense by $20.0 million
annually. We expect to remarket the remaining outstanding senior notes on August
12, 2004. Our interest expense on the remaining notes could increase if, as a
result of such remarketing, the interest rate increases from the current rate of
6.75%. If the remarketing is not successful then we would retire the notes in
satisfaction of the purchase price.
Debt Reduction
- --------------
On January 15, 2004, we repaid at maturity the remaining outstanding $81.0
million of our 7.45% Debentures.
On January 15, 2004, we redeemed at 101% the remaining outstanding $12.3 million
of our Hawaii Special Purpose Revenue Bonds, Series 1993A and Series 1993B.
On May 17, 2004, we repaid at maturity the remaining outstanding $6.0 million of
Electric Lightwave, LLC's 6.05% Notes. These Notes had been guaranteed by
Citizens.
In July 2004, we purchased $300.0 million of the 6.75% notes that are a
component of our equity units at 105.075% of par, plus accrued interest.
We may from time to time repurchase our debt in the open market, through tender
offers or privately negotiated transactions.
Interest Rate Management
- ------------------------
In order to manage our interest expense, we have entered into interest swap
agreements. Under the terms of these agreements, we make semi-annual, floating
rate interest payments based on six month LIBOR and receive a fixed rate on the
notional amount. The underlying variable rate on these swaps is set either in
advance, in arrears or, based on each period's daily average six-month LIBOR.
The notional amounts of fixed-rate indebtedness hedged as of June 30, 2004 and
December 31, 2003 was $550.0 million and $400.0 million, respectively. Such
contracts require us to pay variable rates of interest (estimated average pay
rates of approximately 6.02% as of June 30, 2004 and approximately 5.46% as of
December 31, 2003) and receive fixed rates of interest (average receive rates of
8.47% and 8.38% as of June 30, 2004 and December 31, 2003, respectively). All
swaps are accounted for under SFAS No. 133 as fair value hedges. For the three
and six months ended June 30, 2004, the cash interest savings resulting from
these interest rate swaps was approximately $4.0 million and $5.5 million,
respectively, and is reflected as a reduction of interest expense in the
accompanying statements of operations.
Off-Balance Sheet Arrangements
- ------------------------------
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationships with unconsolidated entities that would be expected to
have a material current or future effect upon our financial statements.
Strategic Alternatives and Management Succession Expenses
- ---------------------------------------------------------
On July 11, 2004, our Board of Directors announced that it completed its review
of the Company's financial and strategic alternatives. Through the first six
months of 2004, we expensed approximately $16.5 million related to our
exploration of financial and strategic alternatives and related management
succession costs. We are evaluating the costs that will be incurred as a result
of these matters and the final amount of some of these costs has not yet been
determined. Our best estimate, at this time, indicates that we will record
approximately $80.0 million - $85.0 million of such expenses in the second half
of 2004, most of which will be recorded in the third quarter. Compensation
arrangements entered into in connection with these matters will result in
compensation expense of approximately $5.1 million in 2005, $5.0 million in 2006
and $1.0 million in 2007.
25
EPPICS
- ------
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 $201.3 million). The
proceeds from the issuance of the Trust Convertible Preferred Securities and a
Company capital contribution were used to purchase $207.5 million aggregate
liquidation amount of 5% Partnership Convertible Preferred Securities due 2036
from another wholly owned consolidated subsidiary, Citizens Utilities Capital
L.P. (the Partnership). These securities have a conversion price of $13.30 per
share and are convertible into a total of 15,134,000 common shares. Immediately
prior to the opening of business on the ex-dividend date of August 16, 2004, any
EPPICS not previously converted will be convertible at a reduced price
determined by a formula contained in the First Supplemental Indenture dated as
of January 15, 1996 between Citizens Utilities Company and Chemical Bank. The
proceeds from the issuance of the Partnership Convertible Preferred Securities
and a Company capital contribution were used to purchase from us $211.8 million
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 annual 5% interest in
quarterly installments on the Convertible Subordinated Debentures in the first
and second quarters of 2004 and the four quarters of 2003. Only cash was paid
(net of investment returns) 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.
During July 2004, EPPICS representing a total principal amount of $4.9 million
were converted into 364,990 shares of Citizens common stock.
We have adopted the provisions of FASB Interpretation No. 46R (revised December
2003) ("FIN 46R"), "Consolidation of Variable Interest Entities," effective
January 1, 2004. We have not restated prior periods.
We have included the following description to provide readers a comparative
analysis of the accounting impact of this standard. Both the Trust and the
Partnership have been consolidated from the date of their creation through
December 31, 2003. As a result of the new consolidation standards established by
FIN 46R, the Company, effective January 1, 2004, deconsolidated the activities
of the Trust and the Partnership. We have highlighted the comparative effect of
this change in the following table:
Balance Sheet
- -------------
($ in thousands) As of
---------------------------------------------------------
December 31, 2003 June 30, 2004 Change
--------------------- ---------------- --------------
Assets:
Cash $ 2,103 $ - $(2,103) (1)
Investments - 12,645 12,645 (2)
Liabilities:
Long-term debt - 211,756 (3) 10,506 (3)
EPPICS 201,250 - (3)
Statement of Operations
- -----------------------
($ in thousands) As reported for the six months ended
---------------------------------------------------------
June 30, 2003 June 30, 2004 Change
--------------------- ---------------- --------------
Investment income $ - $ 316 $ 316 (4)
Interest expense - 5,294 5,294 (5)
Dividends on EPPICS (before tax) 5,032 - (5,032) (6)
--------------------- ---------------- --------------
Net $ 5,032 $ 4,978 $ (54)
===================== ================ ==============
26
(1) Represents a cash balance on the books of the Partnership that is
removed as a result of the deconsolidation.
(2) Represents Citizens' investments in the Partnership and the
Trust. At December 31, 2003, these investments were eliminated in
consolidation against the equity of the Partnership and the
Trust.
(3) As a result of the deconsolidation, the Trust and the Partnership
balance sheets are removed, leaving debt issued by Citizens to
the Partnership in the amount of $211.8 million. The nominal
effect of an increase in debt of $10.5 million is debt that is
"intercompany." FIN 46R does not impact the economics of the
EPPICS structure. Citizens continues to have $201.3 million of
debt outstanding to third parties and will continue to pay
interest on that amount at 5%.
(4) Represents interest income to be paid by the Partnership and the
Trust to Citizens for its investments noted in (2) above. The
Partnership and the Trust have no source of cash except as
provided by Citizens. Interest is payable at the rate of 5% per
annum.
(5) Represents interest expense on the convertible debentures issued
by Citizens to the Partnership in the amount of $211.8 million.
Interest is payable at the rate of 5% per annum.
(6) As a result of the deconsolidation of the Trust, previously
reported dividends on the convertible preferred securities issued
to the public by the Trust are removed and replaced by the
interest accruing on the debt issued by Citizens to the
Partnership. Citizens remains the guarantor of the EPPICS debt
and continues to be the sole source of cash for the Trust to pay
dividends.
Covenants
- ---------
The terms and conditions contained in our indentures and credit facilities
agreements 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 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.
Our $805.0 million credit facilities and our $200.0 million term loan facility
with the Rural Telephone Finance Cooperative (RTFC) contain a maximum leverage
ratio covenant. Under the leverage ratio covenant, we are required to maintain a
ratio of (i) total indebtedness minus cash and cash equivalents in excess of
$50.0 million to (ii) consolidated adjusted EBITDA (as defined in the
agreements) over the last four quarters no greater than 4.25 to 1 through
December 30, 2004, and 4.00 to 1 thereafter. We are in compliance with all of
our material debt and credit facility covenants.
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. As of April 1, 2004, we have sold all of these
properties. All of the agreements relating to the sales provide that we will
indemnify the buyer against certain liabilities (typically liabilities relating
to events that occurred prior to sale), including environmental liabilities, for
claims made by specified dates and that exceed threshold amounts specified in
each agreement.
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 31, 2002, we completed the sale of approximately 4,000 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 April 1, 2003, we completed the sale of approximately 11,000 access lines in
North Dakota for approximately $25.7 million in cash.
On April 4, 2003, we completed the sale of our wireless partnership interest in
Wisconsin for approximately $7.5 million in cash.
On August 8, 2003, we completed the sale of The Gas Company in Hawaii division
for $119.3 million in cash and assumed liabilities.
27
On August 11, 2003, we completed the sale of our Arizona gas and electric
divisions for $224.1 million in cash.
On December 2, 2003, we completed the sale of our electric transmission
facilities in Vermont for $7.3 million in cash.
On April 1, 2004, we completed the sale of our electric distribution facilities
in Vermont for $14.0 million in cash, net of selling expenses.
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,
contingencies, and pension and postretirement benefits expenses among others.
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 disclosures relating to them.
There have been no material changes to our critical accounting policies and
estimates from the information provided in Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations included in our 2003
Form 10-K.
New Accounting Pronouncements
- -----------------------------
Accounting for Asset Retirement Obligations
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
143, "Accounting for Asset Retirement Obligations." We adopted SFAS No. 143
effective January 1, 2003. As a result of our adoption of SFAS No. 143, we
recognized an after tax non-cash gain of approximately $65.8 million. This gain
resulted from the elimination of the cumulative cost of removal included in
accumulated depreciation as a cumulative effect of a change in accounting
principle in our statement of operations in the first quarter of 2003 as the
Company has no legal obligation to remove certain of its long-lived assets.
Exit or Disposal Activities
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 adopted SFAS No. 146 on January 1, 2003.
The adoption of SFAS No. 146 did not have any material impact on our financial
position or results of operations.
Guarantees
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Guarantees of Indebtedness of Others." FIN 45 requires that a guarantor be
required to recognize, at the inception of a guarantee, a liability for the fair
value of the obligation assumed under the guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with the guarantee. The provisions
of FIN 45 are effective for guarantees issued or modified after December 31,
2002, whereas the disclosure requirements were effective for financial
statements for period ending after December 15, 2002. The adoption of FIN 45 on
January 1, 2003 did not have any material impact on our financial position or
results of operations.
28
The Company has sold all of its utility businesses as of April 1, 2004. However,
we have retained a potential payment obligation associated with our previous
electric utility activities in the state of Vermont. The Vermont Joint Owners
(VJO), a consortium of 14 Vermont utilities, including us, entered into a
purchase power agreement with Hydro-Quebec in 1987. 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. Our pro-rata share of the purchase power obligation was 10%. 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 (which runs through 2015).
Paragraph 13 of FIN 45 requires that we disclose, "the maximum potential amount
of future payments (undiscounted) the guarantor could be required to make under
the guarantee." Paragraph 13 also states that we must make such disclosure "...
even if the likelihood of the guarantor's having to make any payments under the
guarantee is remote..." As noted above, our obligation only arises as a result
of default by another VJO member such as upon bankruptcy. Therefore, to satisfy
the "maximum potential amount" disclosure requirement we must assume that all
members of the VJO simultaneously default, a highly unlikely scenario given that
the two members of the VJO that have the largest potential payment obligations
are publicly traded with credit ratings of BBB or better, and that all VJO
members are regulated utility providers with regulated cost recovery.
Regardless, despite the remote chance that such an event could occur, or that
the State of Vermont could or would allow such an event, assuming that all the
members of the VJO defaulted by January 1, 2005 and remained in default for the
duration of the contract (another 10 years), we estimate that our undiscounted
purchase obligation for 2005 through 2015 would be approximately $1.6 billion.
In such a scenario the Company would then own the power and could seek to
recover its costs. We would do this by seeking to recover our costs from the
defaulting members and/or reselling the power to other utility providers or the
northeast power grid. There is an active market for the sale of power. We
believe that we would receive full recovery of our costs through sales to
others. If pricing became more favorable we could potentially sell the power on
the open market at a profit. We could potentially lose money if we were unable
to sell the power at cost.
We caution that all of the above-described scenarios are unlikely to occur and
we cannot predict with any degree of certainty any potential outcome.
Variable Interest Entities
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003) ("FIN 46R"), "Consolidation of Variable Interest Entities," which
addresses how a business enterprise should evaluate whether it has a controlling
financial interest in an entity through means other than voting rights and
accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation
No. 46, "Consolidation of Variable Interest Entities," which was issued in
January 2003. We are required to apply FIN 46R to variable interests in variable
interest entities or VIEs created after December 31, 2003. For any VIEs that
must be consolidated under FIN 46R that were created before January 1, 2004, the
assets, liabilities and noncontrolling interests of the VIE initially would be
measured at their carrying amounts with any difference between the net amount
added to the balance sheet and any previously recognized interest being
recognized as the cumulative effect of an accounting change. If determining the
carrying amounts is not practicable, fair value at the date FIN 46R first
applies may be used to measure the assets, liabilities and noncontrolling
interest of the VIE. We reviewed all of our investments and determined that the
EPPICS, issued by our consolidated wholly-owned subsidiary, Citizens Utilities
Trust, was our only VIE. The adoption of FIN 46R on January 1, 2004 did not have
any material impact on our financial position or results of operations.
Derivative Instruments and Hedging
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging," which clarifies financial accounting and
reporting for derivative instruments including derivative instruments embedded
in other contracts. This Statement is effective for contracts entered into or
modified after June 30, 2003. We adopted SFAS No. 149 on July 1, 2003. The
adoption of SFAS No. 149 did not have any material impact on our financial
position or results of operations.
Financial Instruments with Characteristics of Both Liabilities and Equity
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." The Statement
establishes standards for the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity.
Generally, the Statement is effective for financial instruments entered into or
modified after May 31, 2003 and is otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. We adopted the provisions of
the Statement on July 1, 2003. The adoption of SFAS No. 150 did not have any
material impact on our financial position or results of operations.
29
Pension and Other Postretirement Benefits
In December 2003, the FASB issued SFAS No. 132 (revised), "Employers'
Disclosures about Pensions and Other Postretirement Benefits." This Statement
retains and revises the disclosure requirements contained in the original
Statement. It requires additional disclosures including information describing
the types of plan assets, investment strategy, measurement date(s), plan
obligations, cash flows, and components of net periodic benefit cost recognized
in interim periods. This Statement is effective for fiscal years ending after
December 15, 2003. We have adopted the expanded disclosure requirements of SFAS
No. 132 (revised).
The FASB also recently issued an Exposure Draft that would require stock-based
employee compensation to be recorded as a charge to earnings beginning in 2005.
We will continue to monitor the progress on the issuance of this standard.
(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.
Consolidated revenue for the three and six months ended June 30, 2004 decreased
$99.9 million, or 16% and $193.3 million, or 15%, and as compared with the prior
year periods. The decrease for the three months ended June 30, 2004 is due to a
$4.4 million decrease in ILEC revenue, a $5.4 million decrease in ELI revenue
and a $90.1 million decrease in gas and electric revenue. The decrease for the
six months ended June 30, 2004 is due to a $9.0 million decrease in ILEC
revenue, a $6.8 million decrease in ELI revenue and a $177.5 million decrease in
gas and electric revenue.
On April 1, 2003, we sold approximately 11,000 access lines in North Dakota. The
revenues related to these access lines totaled $1.9 million for the six months
ended June 30, 2003.
TELECOMMUNICATIONS REVENUE
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------- ----------------------------------------------
2004 2003 $ Change % Change 2004 2003 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ --------
Access services $ 155,224 $ 167,025 $ (11,801) -7% $ 316,707 $ 336,196 $ (19,489) -6%
Local services 213,417 213,889 (472) 0% 426,159 428,162 (2,003) 0%
Long distance and data services 79,170 76,487 2,683 4% 158,175 154,170 4,005 3%
Directory services 28,201 26,736 1,465 5% 55,675 53,779 1,896 4%
Other 29,777 26,016 3,761 14% 58,041 51,455 6,586 13%
----------- ----------- ------------ ----------- ----------- ------------
ILEC revenue 505,789 510,153 (4,364) -1% 1,014,757 1,023,762 (9,005) -1%
ELI 38,302 43,719 (5,417) -12% 78,067 84,812 (6,745) -8%
----------- ----------- ------------ ----------- ----------- ------------
$ 544,091 $ 553,872 $ (9,781) -2% $1,092,824 $1,108,574 $ (15,750) -1%
=========== =========== ============ =========== =========== ============
Change in the number of our access lines is the most fundamental driver of
changes in our telecommunications revenue. Many rural local telephone companies
(including us) have been experiencing a loss of access lines primarily because
of difficult economic conditions, increased competition from competitive
wireline providers, from wireless providers and from cable companies (with
respect to broadband and cable telephony), and by some customers disconnecting
second lines when they add DSL or cable modem service. We lost approximately
24,200 access lines during the six months ended June 30, 2004 but added
approximately 43,700 DSL subscribers during this period. The loss of lines
during the first six months of 2004 was primarily 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 2004. A continued decrease in access lines, combined with increased
competition and the other factors discussed in this MD&A, may cause our revenues
to decrease during the remainder of 2004.
30
Access Services
Access services revenue for the three months ended June 30, 2004 decreased $11.8
million or 7%, as compared with the prior year period. Switched access revenue
decreased $6.9 million, as compared with the prior year period, primarily due to
the $3.8 million effect of federally mandated access rate reductions effective
as of July 1, 2003, $2.7 million associated with prospective state intrastate
access rate reductions and $1.4 million attributable to a decline in minutes of
use partially offset by collections on accounts previously reserved. Special
access revenue for the three months ended June 30, 2004 decreased $1.8 million
as compared with the prior year period resulting from a reclassification in the
first quarter of 2004 related to the clearing of affiliate revenue among revenue
categories partially offset by growth in high-capacity sales of $0.5 million.
Subsidies revenue decreased $3.1 million, as compared with the prior year
period, primarily due to lower federal universal service fund support because of
true ups related to 2002 and increases in the national average cost per loop.
Access services revenue for the six months ended June 30, 2004 decreased $19.5
million or 6%, as compared with the prior year period. Switched access revenue
decreased $13.0 million, as compared with the prior year period, primarily due
to the $7.4 million effect of federally mandated access rate reductions
effective as of July 1, 2003, $2.7 million associated with prospective state
intrastate access rate reductions, a $1.4 million decrease related to carrier
disputes and other rate reductions effective July 2003 resulting in a decrease
of $0.9 million. Special access revenue for the six months ended June 30, 2004
decreased $0.7 million as compared with the prior year period due to a $4.1
million decrease resulting from a reclassification in the first quarter of 2004
related to the clearing of affiliate revenue among revenue categories partially
offset by growth in high-capacity sales of $3.2 million. Subsidies revenue
decreased $5.7 million, as compared with the prior year period, primarily due to
lower federal universal service fund support because of true ups related to 2002
and increases in the national average cost per loop.
We expect our subsidy revenue to be approximately $8.0 million lower in 2004
than in 2003 primarily because of increases implemented during 2003 and 2004 in
the ceiling on national average loop costs that is compared to our costs to
determine the amount of subsidy payments we receive. Our switched access
revenues are impacted by the program, known as the Coalition for Affordable
Local and Long Distance Services, or CALLS plan, which establishes a price floor
for interstate-switched access services. We have been able to offset some of the
reduction in interstate access rates through end-user charges. There are no
material increases in end-user charges scheduled to take effect during the
remainder of 2004 or 2005. We believe the net effect of reductions in interstate
access rates and increases in end-user charges will reduce our revenues by
approximately $10.0 million in 2004 compared to 2003 assuming constant
interstate switched access minutes of use (which have been declining). Annual
reductions in interstate switched access rates will continue through 2005. Our
switched access revenues have also been adversely affected by declining switched
access minutes of use, which we expect to continue. Our subsidy and switched
access revenues are very profitable so any reductions in those revenues will
reduce our profitability.
Local Services
Local services revenue for the three months ended June 30, 2004 was essentially
unchanged as compared with the prior year period. Local revenue decreased $3.3
million primarily due to the termination of an operator services contract of
$1.5 million and $1.2 million related to continued losses of access lines.
Enhanced services revenue increased $2.9 million, as compared with the prior
year period, primarily due to $5.5 million attributable to sales of additional
feature packages partially offset by lower individual calling feature revenue of
$1.9 million and a decrease of $0.7 million in inside wire revenue.
Local services revenue for the six months ended June 30, 2004 decreased $2.0
million as compared with the prior year period. Local revenue decreased $7.1
million primarily due to the termination of an operator services contract of
$1.6 million, $2.8 million related to continued losses of access lines, $1.4
million in decreased local measured service revenue and $1.2 million in lower
Centrex and PBX revenue. Enhanced services revenue increased $5.1 million, as
compared with the prior year period, due primarily to sales of additional
feature packages ($10.1 million comparative increase), partially offset by lower
individual calling feature revenue of $3.8 million and a decrease of $1.2
million in inside wire revenue. Economic conditions or increasing competition
could make it more difficult to sell our packages and bundles and cause us to
lower our prices for those products and services, which would adversely affect
our revenues.
31
Long Distance and Data Services
Long distance and data services revenue for the three months ended June 30, 2004
increased $2.7 million or 4%, as compared with the prior period primarily due to
growth of $7.2 million related to data services (data includes DSL) partially
offset by decreased long distance revenue of $4.6 million primarily attributable
to a 20% decline in the average rate per minute. Long distance revenue also
reflects an increase of $2.0 million as a result of a reclassification in the
first quarter of 2004 related to the clearing of affiliate revenue among revenue
categories.
Long distance and data services revenue for the six months ended June 30, 2004
increased $4.0 million or 3%, as compared with the prior period primarily due to
growth of $14.2 million related to data services (data includes DSL) partially
offset by decreased long distance revenue of $10.1 million primarily
attributable to an 18% decline in the average rate per minute. Long distance
revenue also reflects an increase of $3.2 million as a result of a
reclassification in the first quarter of 2004 related to the clearing of
affiliate revenue among revenue categories. Our long distance revenues could
decrease in the future due to lower long distance minutes of use because
consumers are increasingly using their wireless phones or calling cards to make
long distance calls and lower average rates per minute because of unlimited and
packages of minutes for long distance plans. We expect these factors will
continue to adversely affect our long distance revenues during the remainder of
2004.
Directory Services
Directory revenue for the three months ended June 30, 2004 increased $1.5
million or 5%, as compared with the prior period primarily due to growth in
yellow pages and internet advertising.
Directory revenue for the six months ended June 30, 2004 increased $1.9 million
or 4%, as compared with the prior period primarily due to modest growth in
yellow pages and internet advertising.
Other
Other revenue for the three months ended June 30, 2004 increased $3.8 million or
14%, as compared with the prior period primarily due to a $3.9 million carrier
dispute settlement, a decline in bad debt expense of $1.2 million, and $1.1
million in increased conferencing revenue, partially offset by decreases of $1.0
million in sales of customer premise equipment and $0.5 million in paystation
revenue.
Other revenue for the six months ended June 30, 2004 increased $6.6 million or
13%, as compared with the prior period primarily due to a $3.9 million carrier
dispute settlement, a decline in bad debt expense of $4.5 million, and $1.9
million in increased conferencing revenue, partially offset by a decrease of
$2.1 million in sales of customer premise equipment.
ELI revenue for the three and six months ended June 30, 2004 decreased $5.4
million, or 12%, and $6.7 million, or 8%, respectively, as compared to the prior
year period primarily due to lower demand and prices for long-haul services.
GAS AND ELECTRIC REVENUE
($ in thousands) For the three months ended June 30, For the six months ended June 30,
--------------------------------------------- ----------------------------------------------
2004 2003 $ Change % Change 2004 2003 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ --------
Gas revenue $ - $ 56,150 $ (56,150) -100% $ - $ 119,681 $ (119,681) -100%
Electric revenue $ - $ 33,932 $ (33,932) -100% $ 9,735 $ 67,561 $ (57,826) -86%
We did not have any gas or electric operations in the quarter ended June 30,
2004 due to the sales of our Vermont Electric division, The Gas Company in
Hawaii, and our Arizona gas and electric divisions.
Electric revenue for the six months ended June 30, 2004 decreased $57.8 million,
or 86%, as compared with the prior year period. We completed the sale of our
remaining electric utility property on April 1, 2004. We have sold all of our
electric operations and as a result will have no operating results in future
periods for these businesses.
32
COST OF SERVICES
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------- ----------------------------------------------
2004 2003 $ Change % Change 2004 2003 $ Change % Change
----------- ----------- ------------ ------- ------------- ----------- ------------ -------
Network access $ 48,295 $ 58,168 $ (9,873) -17% $ 99,836 $ 114,683 $ (14,847) -13%
Gas purchased - 34,041 (34,041) -100% - 69,987 (69,987) -100%
Electric energy and
fuel oil purchased - 21,328 (21,328) -100% 5,523 42,086 (36,563) -87%
----------- ----------- ------------ ----------- ----------- ------------
$ 48,295 $ 113,537 $ (65,242) -57% $ 105,359 $ 226,756 $(121,397) -54%
=========== =========== ============ =========== =========== ============
Network access expenses for the three months ended June 30, 2004 decreased $9.9
million, or 17%, as compared with the prior year period primarily due to
decreased costs in long distance access expense related to rate changes
partially offset by increased circuit expense associated with additional data
product sales in the ILEC sector. ELI costs have declined due to a drop in
demand coupled with improved network cost efficiencies.
Network access expenses for the six months ended June 30, 2004 decreased $14.8
million, or 13%, as compared with the prior year period primarily due to
decreased costs in long distance access expense related to rate changes
partially offset by increased circuit expense associated with additional data
product sales in the ILEC sector. If we continue to increase our sales of data
products such as DSL or expand the availability of our unlimited calling plans,
our network access expense could increase.
We did not have any gas or electric operations in the quarter ended June 30,
2004 due to the sales of our Vermont Electric division, The Gas Company in
Hawaii, and our Arizona gas and electric divisions.
Electric energy and fuel oil purchased for the six months ended June, 2004
decreased $36.6 million, or 87%, as compared with the prior year period. We
completed the sale of our remaining electric utility property on April 1, 2004.
We have sold all of our electric operations and as a result will have no
operating results in future periods for these businesses.
OTHER OPERATING EXPENSES
($ in thousands) For the three months ended June 30, For the six months ended June 30,
--------------------------------------------- ----------------------------------------------
2004 2003 $ Change % Change 2004 2003 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ --------
Operating expenses $ 155,833 $ 178,038 $ (22,205) -12% $ 315,104 $ 355,618 $ (40,514) -11%
Taxes other than income taxes 25,729 28,566 (2,837) -10% 52,065 58,887 (6,822) -12%
Sales and marketing 30,086 25,889 4,197 16% 57,288 53,809 3,479 6%
----------- ----------- ------------ ----------- ----------- ------------
$ 211,648 $ 232,493 $ (20,845) -9% $ 424,457 $ 468,314 $ (43,857) -9%
=========== =========== ============ =========== =========== ============
Operating expenses for the three months ended June 30, 2004 decreased $22.2
million, or 12%, as compared with the prior year period primarily due to
increased operating efficiencies and a reduction of personnel in the ILEC and
ELI sectors and decreased operating expenses in the public services sector due
to the sales of our Vermont Electric division, The Gas Company in Hawaii, and
our Arizona gas and electric divisions. Expenses were negatively impacted by
$11.6 million of expenses related to our exploration of financial and strategic
alternatives and related compensation arrangements.
Operating expenses for the six months ended June 30, 2004 decreased $40.5
million, or 11%, as compared with the prior year period primarily due to
increased operating efficiencies and a reduction of personnel in the ILEC and
ELI sectors and decreased operating expenses in the public services sector due
to the sales of our Vermont Electric division, The Gas Company in Hawaii, and
our Arizona gas and electric divisions. Expenses were negatively impacted by
$16.5 million of expenses related to our exploration of financial and strategic
alternatives and related compensation arrangements. 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.
33
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 decrease from $12.4 million in
2003 to approximately $2 - $4 million in 2004 and that no contribution to our
pension plans will be required to be made by us to the pension plan in 2004. In
addition, as medical costs increase the costs of our postretirement benefit
costs also increase. Our retiree medical costs for 2003 were $16.9 million and
our current estimate for 2004 is $19 - $20 million.
Taxes other than income taxes for the three months ended June 30, 2004 decreased
$2.8 million, or 10%, as compared with the prior year period primarily due to
decreased property taxes in the public services sector due to the sales of The
Gas Company in Hawaii and our Arizona gas and electric divisions of $4.3 million
partially offset by increased state unemployment, franchise and gross receipts
taxes of $2.1 million in the ILEC sector.
Taxes other than income taxes for the six months ended June 30, 2004 decreased
$6.8 million, or 12%, as compared with the prior year period primarily due to
decreased property taxes in the public services sector due to the sales of our
Vermont Electric division, The Gas Company in Hawaii, and our Arizona gas and
electric divisions of $9.2 million partially offset by increased state
unemployment, gross receipts, property and franchise taxes of $3.1 million in
the ILEC sector.
Sales and marketing expenses for the three months ended June 30, 2004 increased
$4.2 million, or 16%, as compared with the prior year period primarily due to
increased costs in the ILEC sector.
Sales and marketing expenses for the six months ended June 30, 2004 increased
$3.5 million, or 6%, as compared with the prior year period primarily due to
increased costs in the ILEC sector.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) For the three months ended June 30, For the six months ended June 30,
--------------------------------------------- ----------------------------------------------
2004 2003 $ Change % Change 2004 2003 $ Change % Change
----------- ----------- ------------ -------- ----------- ----------- ------------ ---------
Depreciation expense $ 112,782 $ 118,729 $ (5,947) -5% $ 225,010 $ 225,565 $ (555) 0%
Amortization expense 31,630 31,630 - 0% 63,260 63,342 (82) 0%
----------- ----------- ------------ ----------- ----------- ------------
$ 144,412 $ 150,359 $ (5,947) -4% $ 288,270 $ 288,907 $ (637) 0%
=========== =========== ============ =========== =========== ============
Depreciation expense for the three and six months ended June 30, 2004 decreased
$6.0 million, or 5%, as compared to the prior year because the net asset base is
declining.
RESERVE FOR TELECOMMUNICATIONS BANKRUPTCIES / RESTRUCTURING AND OTHER EXPENSES /
STRATEGIC ALTERNATIVES AND MANAGEMENT SUCCESSION EXPENSES
($ in thousands) For the three months ended June 30, For the six months ended June 30,
--------------------------------------------- ----------------------------------------------
2004 2003 $ Change % Change 2004 2003 $ Change % Change
----------- ----------- ------------ -------- ----------- ----------- ------------ ---------
Reserve for telecommunications
bankruptcies $ - $ 2,260 $ (2,260) -100% $ - $ 2,260 $ (2,260) -100%
Restructuring and other expenses $ - $ 10,113 $ (10,113) -100% $ - $ 10,092 $ (10,092) -100%
Strategic alternatives and
management succession expenses $11,561 $ - $ 11,561 100% $ 16,492 $ - $ 16,492 100%
During the second quarter 2003, we reserved approximately $2.3 million of trade
receivables with Touch America as a result of Touch America's filing for
bankruptcy. These receivables were generated as a result of providing ordinary
course telecommunication services. If other telecommunications companies file
for bankruptcy we may have additional significant reserves in future periods.
Restructuring and other expenses for 2003 primarily consist of expenses related
to reductions in personnel at our telecommunications operations and the write
off of software no longer useful.
Strategic alternatives and management succession expenses in 2004 include a mix
of cash retention payments, equity awards and severance agreements (see Note 12
for a complete discussion).
34
INVESTMENT AND OTHER INCOME, NET / INTEREST EXPENSE / INCOME TAX EXPENSE
($ in thousands) For the three months ended June 30, For the six months ended June 30,
--------------------------------------------- ----------------------------------------------
2004 2003 $ Change % Change 2004 2003 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ --------
Investment and
other income, net $ 5,213 $ 31,237 $ (26,024) -83% $ 30,507 $ 79,409 $ (48,902) -62%
Interest expense $ 97,652 $106,436 $ (8,784) -8% $195,434 $215,712 $ (20,278) -9%
Income tax expense $ 11,944 $ 24,384 $ (12,440) -51% $ 36,394 $ 64,360 $ (27,966) -43%
Investment and other income, net for the three months ended June 30, 2004
decreased $26.0 million, or 83%, as compared with the prior year period
primarily due to the recognition in 2003 of a $25.0 million non-cash pre-tax
gain related to a capital lease restructuring at ELI and net gains on sales of
assets of $6.7 million.
Investment and other income, net for the six months ended June 30, 2004
decreased $48.9 million, or 62%, as compared with the prior year period
primarily due to the recognition in 2003 of $65.7 million in non-cash pre-tax
gains related to a capital lease termination and a capital lease restructuring
at ELI, $6.2 million of income from the expiration of certain retained
liabilities at less than face value, which are associated with customer advances
for construction from our disposed water properties, and net gains on sales of
assets of $5.0 million, partially offset by $25.3 million of income in 2004 from
the expiration of certain retained liabilities at less than face value.
Interest expense for the three months ended June 30, 2004 decreased $8.8
million, or 8%, as compared with the prior year period primarily due to the
retirement of debt. During the three months ended June 30, 2004, we had average
long-term debt (excluding equity units and convertible preferred stock)
outstanding of $4.2 billion compared to $4.7 billion during the three months
ended June 30, 2003. Our composite average borrowing rate for the three months
ended June 30, 2004 as compared with the prior year period was 6 basis points
lower, decreasing from 8.03% to 7.97%, due to the inclusion in 2004 of the
EPPICS, partially offset by the repayment of debt with interest rates below our
average rate.
Interest expense for the six months ended June 30, 2004 decreased $20.3 million,
or 9%, as compared with the prior year period primarily due to the retirement of
debt. During the six months ended June 30, 2004, we had average long-term debt
(excluding equity units and convertible preferred stock) outstanding of $4.2
billion compared to $4.8 billion during the six months ended June 30, 2003. Our
composite average borrowing rate for the six months ended June 30, 2004 as
compared with the prior year period was 2 basis points lower, decreasing from
8.04% to 8.02%, due to the inclusion in 2004 of the EPPICS, partially offset by
the repayment of debt with interest rates below our average rate.
Income taxes for the three and six months ended June 30, 2004 decreased $12.4
million, or 51%, and $28.0 million, or 43%, respectively, as compared with the
prior year period primarily due to changes in taxable income. The effective tax
rate for the first six months of 2004 was 35.3% as compared with 39.4% for the
first six months of 2003. Our effective tax rate has declined as a result of the
sales of our utility properties and changes in the structure of certain of our
subsidiaries.
Our income tax expense is computed utilizing an estimated annual effective
income tax rate in accordance with Accounting Principles Board Opinions (APB)
No. 28, "Interim Financial Reporting." The tax rate is computed using estimates
as to the Company's net income before income taxes for the entire year and the
impact of estimated permanent book tax differences relative to that forecast. We
expect to reach conclusion on various state and federal income tax audits during
the remainder of 2004. Our 2004 effective income tax rate may vary from that of
prior periods as a result of the conclusion of these audits.
Item 3. 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:
35
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. 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 June 30, 2004, 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 have entered into
interest rate swap agreements. 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.
Sensitivity analysis of interest rate exposure
At June 30, 2004, the fair value of our long-term debt and capital lease
obligations was estimated to be approximately $4.3 billion, based on our overall
weighted average rate of 7.9% and our overall weighted maturity of 13 years.
There has been no material change in the weighted average maturity applicable to
our obligations since December 31, 2003. The overall weighted average interest
rate decreased approximately 14 basis points during the first six months of
2004. A hypothetical increase of 79 basis points (10% of our overall weighted
average borrowing rate) would result in an approximate $230.0 million decrease
in the fair value of our fixed rate obligations.
Equity Price Exposure
Our exposure to market risks 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. (D & E) and Hungarian Telephone and Cable
Corp. (HTCC).
As of June 30, 2004 and December 31, 2003, we owned 3,059,000 shares of Adelphia
common stock. The stock price of Adelphia was $0.51 and $0.55 at June 30, 2004
and December 31, 2003, respectively.
As of June 30, 2004 and December 31, 2003, we owned 2,305,908 common shares,
which represent an ownership of 19% of the equity in HTCC, a company of which
our Chairman 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 are convertible at our option into 10
shares of common stock. The stock price of HTCC was $9.66 and $9.86 at June 30,
2004 and December 31, 2003, respectively.
As of June 30, 2004 and December 31, 2003, we owned 1,333,500 shares of D & E
common stock. The stock price of D & E was $13.42 and $14.51 at June 30, 2004
and December 31, 2003, respectively.
Sensitivity analysis of equity price exposure
At June 30, 2004, the fair value of the equity portion of our investment
portfolio was estimated to be $54.9 million. A hypothetical 10% decrease in
quoted market prices would result in an approximate $5.5 million decrease in the
fair value of the equity portion of our investment portfolio.
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 June 30, 2004. 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.
36
Item 4. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures
We carried out an evaluation, under the supervision and with the participation
of our management, regarding the effectiveness of the design and operation of
our disclosure controls and procedures. Based upon this evaluation, our
principal executive officer and principal financial officer concluded, as of the
end of the period covered by this report, June 30, 2004, that our disclosure
controls and procedures are effective.
(b) Changes in internal control over financial reporting
We reviewed our internal control over financial reporting at June 30, 2004.
There have been no changes in our internal control over financial reporting
identified in an evaluation thereof that occurred during the first six months of
2004, that materially affected or is reasonably likely to materially affect our
internal control over financial reporting.
37
PART II. OTHER INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Item 1. Legal Proceedings
-----------------
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). We intend to defend
ourselves vigorously against the City's lawsuit. 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 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 counterclaims against the City. In addition, we have identified a
number of other potentially responsible parties that may be liable for the
damages alleged by the City and have joined them as parties to the lawsuit.
These additional parties include Honeywell Corporation, the Army Corps of
Engineers, Guilford Transportation (formerly Maine Central Railroad), UGI
Utilities, Inc., and Centerpoint Energy Resources Corporation. On March 11,
2004, the Magistrate in charge of the case granted our motion for partial
summary judgment with respect to the City's CERCLA claims, and that decision was
affirmed by the District Court on May 5, 2004. In an order issued on July 6,
2004, the Magistrate dismissed the City's claim for punitive damages. The City
is currently appealing that decision to the District Court. We have demanded
that various of our insurance carriers defend and indemnify us with respect to
the City's lawsuit, and on 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 this lawsuit to
obtain from our insurance carriers indemnification for any damages that may be
assessed against us in the City's lawsuit as well as to recover the costs of our
defense of that lawsuit.
On June 18, 2004, we received a notice from the Securities and Exchange
Commission (SEC) stating that it is conducting an informal investigation
regarding the methodologies used by numerous communications companies to count
access lines and/or customers. We are cooperating with the SEC in this informal
investigation and have provided information requested by the SEC and have agreed
to preserve records that the SEC believes may be relevant to the inquiry.
On June 7, 2004, representatives of Robert A. Katz Technology Licensing, LP,
contacted us regarding possible infringement of several patents held by that
firm. The patents cover a wide range of operations in which telephony is
supported by computers, including obtaining information from databases via
telephone, interactive telephone transactions, and customer and technical
support applications. We are cooperating with the patent holder to determine if
we are currently using any of the processes that are protected by its patents.
If we determine that we are utilizing the patent holder's intellectual property,
we expect to commence negotiations on a license agreement.
On June 24, 2004, one of our subsidiaries, Frontier Subsidiary Telco Inc.,
received a "Notice of Indemnity Claim" from Citibank, N.A., that is related to a
complaint pending against Citibank and others in the U.S. Bankruptcy Court for
the Southern District of New York as part of the Global Crossing bankruptcy
proceeding. Citibank bases its claim for indemnity on the provisions of a credit
agreement that was entered into in October 2000 between Citibank and our
subsidiary. We purchased Frontier Subsidiary Telco, Inc., in June 2001 as part
of our acquisition of the Frontier telephone companies. The complaint against
Citibank, for which it seeks indemnification, alleges that the seller improperly
used a portion of the proceeds from the Frontier transaction to pay off the
Citibank credit agreement, thereby defrauding certain debt holders of Global
Crossing North America Inc. Although the credit agreement was paid off at the
closing of the Frontier transaction, Citibank claims the indemnification
obligation survives. Damages sought against Citibank and its co-defendants could
exceed $1 billion. We are currently reviewing Citibank's claims to determine
what action we will take to respond to those claims.
We are party to other legal 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.
38
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
(a) The registrant held its 2004 Annual Meeting of the Stockholders on May
18, 2004.
(b) Proxies for the Annual Meeting were solicited pursuant to Regulation
14A; there was no solicitation in opposition to management's nominees
for directors as listed in the Proxy Statement. All such nominees were
elected pursuant to the following votes:
Number of Votes
---------------
DIRECTORS FOR WITHHELD
--------- --- --------
Aaron I. Fleischman 242,341,613 13,784,408
Rudy J. Graf 247,326,699 8,799,322
Stanley Harfenist 248,900,403 7,225,618
Andrew N. Heine 249,021,785 7,104,236
William M. Kraus 249,052,179 7,073,842
Scott N. Schneider 247,527,709 8,598,312
John L. Schroeder 248,836,063 7,289,958
Robert A. Stanger 249,525,992 6,600,029
Edwin Tornberg 248,889,390 7,236,631
Claire L. Tow 238,817,873 17,308,148
Leonard Tow 242,868,145 13,257,876
David H. Ward 249,766,699 6,359,323
(c) Other matters voted upon:
Ratification of appointment of KPMG LLP as the Company's independent
public accountants for 2004.
Number of votes FOR 251,277,520
Number of votes AGAINST/WITHHELD 2,165,664
Number of votes ABSTAINING 2,682,837
Number of BROKER NON-VOTES 0
Shareholder approval of severance agreements.
Number of votes FOR 115,864,958
Number of votes AGAINST/WITHHELD 83,880,905
Number of votes ABSTAINING 3,524,251
Number of BROKER NON-VOTES 52,855,907
Item 5. Other Information
-----------------
As disclosed in our Proxy Statement for the 2004 Annual Meeting under our
bylaws, if any stockholder intends to propose any matter at the 2005 annual
meeting, the proponent must give written notice to us not earlier than January
19, 2005 nor later than February 18, 2005. Furthermore, in accordance with the
proxy rules and regulations of the Securities and Exchange Commission, if a
stockholder does not notify us by February 18, 2005 of a proposal, then our
proxies would be able to use their discretionary voting authority if a
stockholder's proposal is raised at the meeting.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a) Exhibits:
10.1.2 Amended and Restated Non-Employee Directors' Deferred Fee
Equity Plan dated as of May 18, 2004.
10.2.4 Separation Agreement between Citizens Communications Company
and Leonard Tow, effective July 10, 2004.
31.1 Certification of Principal Executive Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934.
39
31.2 Certification of Principal Financial Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K:
We filed on Form 8-K on April 14, 2004 under Item 5 "Other Events," a
press release announcing the completion of the sales of our Vermont
Electric division.
We filed on Form 8-K on April 28, 2004 under Item 5 "Other Events," a
press release announcing that the remarketing of our 6-3/4% senior
notes due 2006 issued in June 2001 would not occur on May 12, 2004.
We furnished on Form 8-K on May 6, 2004 under Item 12 "Disclosure of
Results of Operations and Financial Condition," a press release
announcing our earnings for the quarter ended March 31, 2004.
40
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Robert J. Larson
-------------------------
Robert J. Larson
Senior Vice President and
Chief Accounting Officer
Date: August 4, 2004
41