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CITIZENS COMMUNICATIONS COMPANY
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 2001
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2001 Commission file number 001-11001
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OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
CITIZENS COMMUNICATIONS COMPANY
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(Exact name of registrant as specified in its charter)
Delaware 06-0619596
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
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(Address, zip code of principal executive offices)
Registrant's telephone number, including area code: (203) 614-5600
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Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.25 per share New York Stock Exchange
Guarantee of Convertible Preferred Securities of Citizens Utilities Trust New York Stock Exchange
Citizens Convertible Debentures N/A
Guarantee of Partnership Preferred Securities of Citizens Utilities Capital L.P. N/A
- --------------------------------------------------------------------------------- ---------------------------------------------
(Title of each class) (Name of exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of February 28, 2002 was $2,484,211,184.
The number of shares outstanding of the registrant's Common Stock as of February
28, 2002 was 281,500,477.
DOCUMENTS INCORPORATED BY REFERENCE
The Proxy Statement for the registrant's 2002 Annual Meeting of Stockholders to
be held on May 16, 2002 is incorporated by reference into Part III of this Form
10-K.
TABLE OF CONTENTS
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Page
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PART I
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Item 1. Business 2
Item 2. Properties 14
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to Vote of Security Holders 15
Executive Officers 16
PART II
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Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters 18
Item 6. Selected Financial Data 18
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 37
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 39
PART III Incorporation by Reference to the 2002 Proxy Statement 39
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PART IV
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Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 39
Signatures 44
Index to Consolidated Financial Statements F-1
PART I
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This annual report on Form 10-K contains forward-looking statements that are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed or implied in the statements. Further discussion
regarding forward-looking statements, including the factors which may cause
actual results to differ from such statements, is located in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in this report. Citizens Communications Company and its subsidiaries
(Citizens) will be referred to as "we", "us" or "our" throughout this report.
Item 1. Business Overview
-----------------
We are a telecommunications-focused company providing wireline communications
services to rural areas and small and medium-sized towns and cities, including
the Rochester, New York metropolitan area, as an incumbent local exchange
carrier, or ILEC. In addition, we provide competitive local exchange carrier, or
CLEC, services to business customers and to other communications carriers in
certain metropolitan areas in the western United States through Electric
Lightwave, Inc., or ELI, our 85%-owned subsidiary. We also provide public
utility services including natural gas transmission and distribution and
electric transmission and distribution services to primarily rural and suburban
customers in Vermont, Hawaii and Arizona.
On June 29, 2001, we purchased from Global Crossing Ltd. (Global) 100% of the
stock of Frontier Corp.'s (Frontier) local exchange carrier subsidiaries, which
owned approximately 1.1 million telephone access lines (as of June 29, 2001) in
Alabama, Florida, Georgia, Illinois, Indiana, Iowa, Michigan, Minnesota,
Mississippi, New York, Pennsylvania and Wisconsin, for approximately $3,373.0
million in cash, subject to final purchase price adjustment. On January 28,
2002, Global, including many of its affiliates, filed for bankruptcy protection
with the Bankruptcy Court for the Southern District of New York. We are
monitoring these bankruptcy proceedings to determine the bankruptcy filings'
effect on our operations and financial position. We are integrating the Frontier
telephone business with Citizens' other telecommunications operations and have
ongoing commercial relationships with Global affiliates. We have recorded a
write down of the net realizable value of receivables incurred from these
commercial relationships in the amount of $21.2 million in the fourth quarter of
2001, with an anticipated $8.8 million to be recorded in the first quarter of
2002 for receivables generated after December 31, 2001 and prior to the Global
bankruptcy filing on January 28, 2002.
With approximately 2.5 million telephone access lines in 24 states we were the
seventh largest local access wireline telephone provider in the United States as
of December 31, 2001. Revenue from our ILEC and CLEC services segments was
$1,594.1 million and $226.6 million, respectively in fiscal year 2001.
In 1999 we announced plans to divest our public utilities services segments.
Consistent with this effort, during 2001 we sold two of our natural gas
transmission businesses and in January 2002 we sold our water distribution and
wastewater treatment business. We are presently engaged in the sale of, or are
seeking buyers for, our remaining gas and electric utility services segments.
Pending these divestitures, we continue to provide gas and electric utility
services. Our revenues from the provision of gas and electric utility services
were $411.5 million and $228.0 million, respectively, in 2001. Our water and
wastewater treatment operations were reported as "discontinued operations."
We own all of the Class B Common Stock and 27,571,332 shares of Class A Common
Stock of ELI, a facilities-based integrated communications provider offering a
broad range of communications services in the western United States. This
ownership interest represents 85% of the economic interest and a 96% voting
interest. ELI's Class B Common Stock votes on a 10 to 1 basis with the Class A
Common Stock, which is publicly traded. We also guarantee all of ELI's long-term
debt, one of its capital leases and one of its operating leases, and have
committed to continue to support its cash requirements through March 31, 2003.
Absent our commitment, we do not believe there is currently a market to further
finance or refinance ELI's indebtedness. Consequently, without the financial
support of Citizens, ELI could not fund its future capital requirements or
service its debt and most likely would not remain a going concern. The net loss
of ELI was $171.7 million in fiscal year 2001.
Telecommunications Services
Our telecommunications services are principally ILEC services and also include
CLEC services delivered through ELI. As of December 31, 2001, we operated ILECs
in 24 states, serving approximately 2.5 million access lines. Our CLEC services
segment is marketed under the Electric Lightwave name and provides a variety of
integrated telecommunications products in the western United States.
2
As an ILEC, we are the dominant incumbent carrier in the markets we serve and
provide the "last mile" of telecommunications services to residential and
business customers in these markets. As an ILEC, we compete with CLECs that may
operate in our markets. As a CLEC, we provide telecommunications services,
principally to businesses, in competition with the incumbent ILEC. As a CLEC, we
frequently, obtain the "last mile" access to customers through arrangements with
the applicable ILEC. ILECs and CLECs are subject to different regulatory
frameworks of the Federal Communications Commission (FCC). We do not provide
both ILEC and CLEC services in competition with each other in any individual
market.
ILEC Services
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Our ILEC services segment accounted for $1,594.1 million, or 65%, of our
revenues in fiscal year 2001. Included in ILEC services revenue was $421.5
million of revenue for Frontier which represents revenue for six months from the
date of acquisition in fiscal year 2001. Approximately 33% of our ILEC services
segment revenues came from federal and state universal service charges through
the federal and local governments and regulated access charges paid by long
distance operators and CLECs.
Our ILEC services business is primarily with retail customers and, to a lesser
extent, business customers. Our ILEC services segment provides:
* local network services,
* enhanced services,
* network access services,
* long distance and data services, and
* directory services.
Local network services. We provide telephone wireline access services to all
residential and business customers in our service areas. We are the incumbent
provider of basic telephone services in our service areas. Except for the
Rochester, New York metropolitan area, our present service areas are largely
residential and are generally less densely populated than what we believe to be
the primary service areas of the five largest ILECs. We offer our ILEC services
under the "Citizens" and "Frontier" names, but intend to convert our ILEC
services to operate under the "Frontier" name.
Enhanced services. We provide our ILEC customers the following enhanced service
features: call forwarding, conference calling, caller identification, voicemail
and call waiting. We offer Citizens Select and Citizens Select Plus as well as
Frontier Choices as branded bundles of telecommunications services directed at
our retail customer base in a majority of our markets. These plans permit
customers to bundle their basic telephone line with their choice of enhanced
services, or simply to customize a set of selected enhanced features that fit
their specific needs. We intend to rebrand the Citizens' services to reflect the
Frontier name.
We intend to increase the penetration of existing value-added services, such as
second lines, and enhanced services to our ILEC services segment. At present,
the penetration rates for enhanced services in our ILEC services segment in many
of our rural areas and small and medium-sized towns are below industry averages.
We believe that increased sales of value-added and enhanced services in our ILEC
markets will produce revenue with higher operating margins due to the relatively
low marginal operating costs necessary to offer value-added and enhanced
services in markets we already serve. We believe that our ability to integrate
value-added and enhanced services with our core ILEC services will provide us
with the opportunity to capture an increased percentage of our customers'
telecommunications expenditures.
Network access services. We provide network access services to long distance
carriers and other customers in connection with the use of our facilities to
originate and terminate interstate and intrastate long distance telephone calls.
We provide originating and switched terminating services to long distance
carriers through switched services networks. Such services are generally offered
on a month-to-month basis and the service is billed on a minutes-of-use basis.
Access charges to long distance carriers and other customers are based on access
rates filed with the FCC for interstate services and with the respective state
regulatory agency for intrastate services.
3
Long distance and data services. We sell long distance services in our
territories to our ILEC customers. Long distance network service to and from
points outside of a telephone company's operating territories is provided by
interconnection with the facilities of interexchange carriers, or IXCs. We
believe that many customers prefer the convenience of obtaining their long
distance service through their local telephone company and receiving a single
bill.
We also offer data services including internet access via dial up or digital
subscriber line access (DSL), frame relay and asynchronous transfer mode (ATM)
switching in portions of our system where it is economically feasible. As part
of our integration strategy, we offer a solution whereby other companies resell
our integrated services. We offer this integrated solution to most of our
customers.
Directory services. Directory services involves the provision of white and
yellow page listings of residential and business directories. We provide this
service through a third party contractor who pays us a percentage of revenues
realized from the sale of advertising in these directories. Our directory
service also includes "Frontier Pages", an internet-based directory service
which generates advertising revenue.
ILEC Asset Acquisitions
- -----------------------
We have grown from approximately 1 million access lines in 1999 to approximately
2.5 million access lines in 2001 primarily through acquisitions. We continually
evaluate the possibility of acquiring additional telecommunications assets. Over
the past few years, we have observed that the number and size of available
telecommunications assets has increased substantially. Although our primary
focus will continue to be the acquisition of telephone access lines, exchanges
and operations that are proximate to our existing systems or that serve a
customer base large enough for us to operate efficiently, we may also acquire
other telecommunications interests.
We expect to have fully integrated our recent acquisitions with our existing
core telephone access line holdings by June 2002.
The following table sets forth certain information with respect to our telephone
access lines as of December 31, 2001, following the Frontier acquisition on June
29, 2001. With the exception of 566,700 access lines in metropolitan Rochester,
New York, our access lines are located in primarily rural areas.
State ILEC Access Lines
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at 12/31/01
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New York............ 1,029,300
Minnesota........... 280,100
Arizona............. 185,000
West Virginia....... 156,700
California.......... 149,700
Illinois............ 130,800
Tennessee........... 101,900
Wisconsin........... 73,500
Iowa................ 59,200
All other states (15)... 315,200
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Total 2,481,400
=========
On June 29, 2001, we purchased from Global 100% of the stock of Frontier Corp.'s
local exchange carrier subsidiaries, which owned approximately 1.1 million
telephone access lines (as of June 29, 2001) in Alabama, Florida, Georgia,
Illinois, Indiana, Iowa, Michigan, Minnesota, Mississippi, New York,
Pennsylvania and Wisconsin.
Between May and December 1999, we announced agreements to purchase from Verizon
approximately 381,200 telephone access lines (as of December 31, 2000) for
approximately $1,171.0 million in cash. By November 30, 2000, we had closed on
the purchase of approximately 317,500 telephone access lines. On December 17,
2001, the agreements to acquire the remaining lines from Verizon were
terminated.
In June 1999, we announced agreements to purchase from Qwest approximately
556,800 telephone access lines (as of December 31, 2000) in nine states for
approximately $1,650.0 million in cash and the assumption of certain
liabilities. On October 31, 2000, we closed on the purchase of approximately
17,000 telephone access lines in North Dakota for approximately $38.0 million in
cash. On July 20, 2001, we notified Qwest that we were terminating the remaining
eight acquisition agreements. We have commenced arbitration proceedings with
Qwest concerning the damages, if any, relating to the termination of these
agreements.
4
ILEC Support
We currently receive support services for our ILEC companies from Global and
several of its subsidiaries, all of which have filed for bankruptcy protection.
These services are primarily carried out between certain Frontier subsidiaries
that we acquired from Global and certain subsidiaries of Global. Services
include transitory administrative and support services for our Frontier
operations and network transport, internet and other long distance
telecommunication services to our ILEC operations from Global for resale to our
customers on an exclusive basis, as more fully described below.
Global agreed to provide transition support services to our Frontier operations
through June 2003, including the following: (i) billing and collection of
revenues for Frontier long distance services that remain on Global's billing
platform, and other support for those services including the uCommand
application; (ii) a sublease and license of office and information technology
space at Frontier's regional headquarters building at 180 Clinton Avenue,
Rochester, New York, of which Global is the prime tenant, until Global vacates
the building, at which time Frontier takes over the lease; and (iii)
administrative services which include some security services and access to
certain data and records maintained by Global (iv) and certain long distance
rating services.
Global also agreed to provide our Frontier long distance subsidiary with the
following service on an exclusive basis: (i) interstate and intrastate carrier
domestic termination, (ii) international carrier termination, (iii) interstate
and intrastate toll-free transportation, (iv) national origination services
(NOS), (v) domestic and international toll-free pin, (vi) dedicated internet
access service, and (vii) domestic and international Link Card. This agreement
expires on June 29, 2004, and we may, at our option, renew it for four
consecutive two-year terms.
These agreements with Global may be treated as executory contracts that may be
rejected by Global in the bankruptcy cases. Such rejection would require that
Global file a motion seeking such relief with the Bankruptcy Court for the
Southern District of New York, or other court with jurisdiction. If the court
were to approve such motion, we would need to develop our own resources more
quickly than we have planned or find other providers of all or some of these
support functions. The rejection of the agreements would give rise to a damages
claim by us against Global, which would be treated as a general unsecured claim
in Global's bankruptcy cases, along with other unsecured claims by us and many
other creditors.
In any event, at the termination of any of these agreements we will either enter
into agreements for all or part of the services with other service providers or
Global or perform such services ourselves.
CLEC Services
ELI provides a broad range of wireline communications products and services to
businesses in the western United States. ELI accounted for $226.6 million, or
9%, of our revenue in fiscal year 2001.
ELI's facilities-based network consists of optical fiber, plus voice and data
switches. ELI has a national internet and data network with switches and routers
in key cities, linked by leased transport facilities. At December 31, 2001, ELI
had 6,754 local and long-haul route miles of fiber-optic cable in service. In
addition, ELI has a long-haul, fiber-optic network which utilizes an optically
self-healing Synchronous Optical Network (SONET) architecture. ELI provides the
full range of its services in the following eight cities and their surrounding
areas: Boise, Idaho; Portland, Oregon; Salt Lake City, Utah; Seattle,
Washington; Spokane, Washington; Phoenix, Arizona; Las Vegas, Nevada and
Sacramento, California. This network spans approximately 4,000 miles, crosses
seven states and is one of the largest OC-192 (Optical Carrier Level 192) SONET
systems in the western United States.
During 2001, the economy and the stock market began to highlight the overbuilt
state of the telecommunications markets, especially for long-haul services. ELI
and other CLECs have incurred substantial debt to build their networks for which
demand now appears to be limited. As these conditions became more evident,
competitive and financial pressures on CLECs increased. As a result of these
pressures, we expect that a restructuring of the telecommunications industry
will continue to occur. The nature of the restructuring of the
telecommunications industry that will take place is uncertain and the effect of
such restructuring on our CLEC and ILEC business is uncertain.
5
Our primary focuses in 2002 are increasing new and existing customer usage of
ELI's installed asset base, focusing more on enterprise businesses, company end
users and government entities and diversifying the customer mix to place less
reliance on Internet Service Providers (ISPs) application service providers and
competitive local exchange companies. ELI expects a substantial portion of its
growth to come from increased penetration of existing on-net buildings, a focus
on sales to customers that are connected to its network and an increase in
market share in the eight major cities in which it operates and surrounding
areas. ELI anticipates continued growth in sales to other carriers and will
continue to market its available dark fiber.
We own all of the Class B Common Stock and 27,571,332 shares of Class A Common
Stock (constituting approximately 77% of the outstanding shares of Class A
Common Stock) of ELI. This ownership interest represents 85% of the economic
interest and a 96% voting interest in ELI. ELI's Class B Common Stock votes on a
10 to 1 basis with the Class A Common Stock, which is publicly traded. We also
guarantee all of ELI's long-term debt, one of its capital leases and one of its
operating leases, and have committed to continue to support its cash
requirements through March 31, 2003. ELI is included in our consolidated federal
income tax return. In order to maintain that consolidation, we must maintain an
ownership and voting interest in excess of 80%.
As a result of the financial conditions within the CLEC industry and with ELI's
operations, and the current price of ELI's Class A Common Stock, we believe that
ELI's Class A Common Stock that is currently listed for trading on Nasdaq's
National Market may be subject to delisting from Nasdaq in 2002. On April 2,
2001, ELI received a notice from the Nasdaq Stock Market, Inc. that its stock
would be subject to delisting from the National Market after July 2, 2001
because its Class A Common Stock failed to maintain a minimum bid price. On June
29, 2001, ELI filed an application for its listing to be transferred to the
Nasdaq Small Cap Market. As part of the application process, we converted
approximately 25.3 million shares of Class B Common Stock into the same number
of shares of Class A Common Stock on August 24, 2001. On August 31, 2001, ELI
received a notice from Nasdaq indicating that it had failed to comply with the
shareholders' equity, market capitalization, market value/total assets and
revenue and minimum bid price requirements for continued listing, and that its
stock was, therefore, subject to delisting from the Nasdaq National Market. ELI
was granted a hearing before a Nasdaq Listing Qualifications Panel to review the
delisting. On September 27, 2001, Nasdaq implemented a moratorium on the minimum
bid price and market value of public float requirements for continued listing on
the Nasdaq Stock Market until January 2, 2002. ELI received a notice from Nasdaq
on that date stating that as a result of that action the hearing scheduled
regarding the delisting on its stock had been canceled and its hearing file
closed. On January 2, 2002, compliance with the minimum requirements for listing
on the Nasdaq National and Small Cap Markets started anew. If ELI does not meet
these requirements for 30 consecutive days, and is unable to regain compliance
within 90 days, its stock could be subject to delisting again. It is uncertain
whether ELI will be able to meet the applicable listing requirements. If the
requirements are not met, its Class A Common Stock may not be eligible for
trading on Nasdaq and ELI expects that it would trade in the over-the-counter
market.
Description of CLEC Services Business
- -------------------------------------
ELI offers switched service, including local dial tone, from eight Nortel
Digital Multiplex System (DMS) 500 switches in the eight metropolitan areas that
ELI serves. This permits ELI to offer both voice and data services in these
areas. ELI also has transmission equipment collocated with switches of the
relevant ILEC operators at 56 locations.
ELI has broadband data points of presence in the following cities: Atlanta,
Georgia; Austin, Texas; Chicago, Illinois; Cleveland, Ohio; Dallas, Texas;
Denver, Colorado; Houston, Texas; Los Angeles, California; New York, New York;
Philadelphia, Pennsylvania; San Diego, California; San Francisco, California;
and Washington, D.C. In the first half of 2002, ELI intends to redeploy the
internet routers, frame relay switches and ATM switches from the Atlanta,
Cleveland, Denver, Philadelphia and New York markets to other locations in its
network. ELI intends to cease leasing the collocation facilities and off-net
circuits for the backbone and local loops supporting the service delivery in
these markets (see Note 14).
ELI has developed an internet backbone network that provides internet
connectivity in each of its markets, including presence at all major network
access points, and including "peering arrangements" with other internet backbone
service providers. A peering arrangement is an agreement where internet backbone
service providers agree to allow each other direct access to internet data
contained on their networks. ELI's broadband network consists of frame relay
switches, ATM switches and network-to-network interfaces. ELI provides national
and international coverage to its customers through strategic relationships with
other communications providers.
6
ELI owns or leases broadband, long-haul fiber-optic network connections between
its major cities in the western United States and within strategic markets
across the nation. To the extent that ELI carries traffic on its own facilities,
ELI is able to maximize the utilization of its network facilities and minimize
network access costs as well as other interconnection costs. It aims to increase
new and existing customer usage of its high-capacity, installed, fiber-optic
infrastructure in its eight major cities and surrounding areas by increasing the
penetration of existing on-net buildings and sales to customers that are
connected to the network.
In 1999, ELI entered into a fiber-swap agreement to exchange unused fiber on its
network for unused fiber on another carrier's network. This exchange provides
ELI with a fiber route from Salt Lake City to Dallas, routed through Denver.
Multiple disputes regarding the agreement have arisen. During 2001, both ELI and
the other carrier notified each other of potential breaches of the agreement. If
the breaches are determined to be valid and not cured, the agreement could
terminate by its terms.
Regulatory Environment
ILEC Services Regulation
- ------------------------
The Telecommunications Act of 1996 or the 1996 Act, dramatically changed the
landscape of the telecommunications industry. The main thrust of the 1996 Act
was to open local telecommunications marketplaces to competition while enhancing
universal service. We expect the 1996 Act, subsequent state and federal
regulatory rulings and technological changes to lead to an overall reduction in
the level of regulation for the telecommunications industry. Although the
majority of our operations continues to be regulated extensively by various
state regulatory agencies, often called public service commissions, and the FCC,
we may experience reductions in the level of regulation for some of our ILEC
operations in the future. In any event, we are currently unable to determine the
ultimate degree of reduction or increase in regulation in our operating
territories.
The 1996 Act preempts state and local laws to the extent that they prevent
competitive entry into the provision of any communications service. Under the
1996 Act, however, states retain authority to impose requirements on carriers
necessary to preserve universal service, protect public safety and welfare,
ensure quality of service and protect consumers. States are also responsible for
mediating and arbitrating interconnection agreements between CLECs and ILECs if
voluntary negotiations fail.
In order to create an environment in which local competition is a practical
possibility, the 1996 Act imposes a number of access and interconnection
requirements on all local communications providers. All local carriers must
interconnect with other carriers, permit resale of their services, provide local
telephone number portability and dialing parity, provide access to poles, ducts,
conduits, and rights-of-way, and complete calls originated by competing carriers
under reciprocal compensation or mutual termination arrangements.
As a result of recent legislation enabling regulators to reduce the level of
regulation in certain states and at the federal level, we have elected incentive
regulation plans under which prices are capped in return for the elimination or
relaxation of earnings oversight. Some states also allow us flexibility in price
changes for optional services and relaxed reporting requirements. The goal of
these incentive regulation plans is to provide incentives to improve
efficiencies and increase pricing flexibility for competitive services while
ensuring that customers receive reasonable rates for basic services that
continue to be deemed part of a monopoly while allowing us to continue to
recover our costs.
Our ILEC services segment revenue is subject to regulation including incentive
regulation by the FCC and various state regulatory agencies. We expect state
lawmakers to continue to review the statutes governing the level and type of
regulation for telecommunications services. Over the next few years, legislative
and regulatory actions are expected to provide opportunities to restructure
rates, introduce more flexible incentive regulation programs and possibly reduce
the overall level of regulation. We expect the election of incentive regulation
plans and the expected reduction in the overall level of regulation to allow us
to introduce new services more expeditiously than in the past. In addition, the
FCC has reviewed its regulations implementing the 1996 Act and this review has
been appealed to the Federal courts. The U.S. Supreme Court is also reviewing
the FCC's current wholesale pricing rules, but has not yet issued its decision.
The ultimate outcome cannot be predicted.
7
For interstate services regulated by the FCC, we have elected a form of
incentive regulation known as price caps for most of our subsidiaries. Under
price caps, interstate access rates are capped and adjusted annually by the
difference between the level of inflation and a productivity factor. Most
recently the productivity factor was set at 6.5%. Given the relatively low
inflation rate in recent years, interstate access rates have been adjusted
downward annually. In May 2000, the FCC adopted a revised methodology for
regulating the interstate access rates of price cap companies through May 2005.
The new program, known as the Coalition for Affordable Local and Long Distance
Services, or CALLs plan, establishes a price floor for interstate-switched
access services and phases out many of the subsidies in interstate access rates.
We believe we will be able to offset some of the reduction in interstate access
rates through end-user charges and an expanded universal service program that
benefits rural service providers such as our ILEC services segment. Annual
adjustments based on the difference between inflation and the 6.5% productivity
factor will continue for several years until the price floor for interstate
switched access services is reached.
We believe that the CALLs plan has potential benefits for us in the long term.
Although some of the required rate reductions are front loaded, the price floor
provides a degree of certainty that rate reductions will be curtailed in the
future. We were successful in negotiating a price floor that recognized the
unique cost characteristics of rural telecommunications providers in contrast to
a one size fits all program designed for larger companies. Under the CALLs plan,
for many of our properties, the price floor is higher than the rate level that
would have been required over time under the previous rate programs. In
addition, shifting revenue from interstate access services to end user customers
and universal service programs provides us more control over future revenue as
access customers seek alternatives to switched access services.
In 2001, the FCC accepted most of the recommendations put forth by the
Federal-State Joint Board on Universal Service. In this Order the FCC modified
its rules for providing high-cost universal service support to rural telephone
companies over the next five years; and as proposed by the Rural Task Force
(RTF), the FCC modified the current embedded cost mechanism as an interim
solution. The purpose of this five-year plan is to insure that rural carriers
receive predictable levels of support so they can continue to provide
affordable, quality telecommunications services to rural America. In the
meantime, the Federal-State Joint Board will continue to work on developing a
long-term solution for funding universal service programs that is better
coordinated with the non-rural carrier mechanism, and which relies upon
forward-looking economic cost.
In addition, the FCC established a "safety valve" mechanism to provide support
for additional investment made in acquired exchanges. Provided certain criteria
are met this will allow additional support to the acquired exchanges where none
may have been received prior to the RTF order.
Another goal of the 1996 Act was to remove implicit subsidies from the rates
charged by local telecommunications companies. The CALLs plan addressed this
requirement for interstate services. State legislatures and regulatory agencies
are beginning to reduce the implicit subsidies in intrastate rates. The most
common subsidies are in access rates that historically have been priced above
their costs to allow basic local rates to be priced below cost. Legislation has
been considered in several states to require regulators to eliminate these
subsidies and implement state universal service programs where necessary to
maintain reasonable basic local rates. However, not all the reductions in access
charges are fully offset. In Tennessee for example, as a result of such
legislation, we are reducing intrastate access rates by $1 million per year
through 2003. We anticipate additional state legislative and regulatory pressure
to lower intrastate access rates in the near future. However, regulators are
cognizant of the potential impact on basic local rates and are moving
cautiously. Many states are embracing the need for state universal service funds
to ensure protection for customers while ensuring that local telecommunications
companies continue to have the incentive to recover in rates their investment in
their networks and new services.
State legislatures and regulators are also examining the provision of
telecommunications services to previously unserved areas. Since many unserved
areas are located in rural markets, we may be required to expand our service
territory into some of these areas. Given the start-up costs involved with
territory expansion, we expect legislatures and regulators to continue to move
cautiously and provide some means of recovery for the costs associated with
serving these new areas.
CLEC Services Regulation
- ------------------------
A central focus of the sweeping federal policy reform under the 1996 Act was to
open local communications markets to competition including the encouragement of
the development of CLECs which compete for business with the existing carriers.
As a CLEC, ELI is subject to federal, state and local regulation. However, the
level of regulation is typically less than an ILEC. The FCC exercises
jurisdiction over all interstate communications services. State commissions
retain jurisdiction over all intrastate communications services. Local
governments may require ELI to obtain licenses or franchises regulating the use
of public rights-of-way necessary to install and operate its networks.
8
The FCC exercises regulatory jurisdiction over all facilities of, and services
offered by, communications common carriers to the extent those facilities are
used to provide, originate or terminate interstate communications. The FCC has
established different levels of regulation for "dominant" carriers and
"nondominant" carriers. For domestic interstate communications services, only
the ILEC's are classified as dominant carriers. All other carriers are
classified as non-dominant. Additionally, to the extent a Regional Bell
Operating Company (RBOC) is engaged in out-of-region long distance services it
is also classified as nondominant as to those services. The FCC regulates many
of the rates, charges and services of dominant carriers to a greater degree than
those of nondominant carriers. As a nondominant carrier, ELI may install and
operate facilities for domestic interstate communications without prior FCC
authorization. ELI is no longer required to maintain tariffs for domestic
interstate long distance services. As a provider of international long distance
services, ELI obtained FCC operating authority and maintains an international
tariff. However, the FCC is also eliminating the requirement for international
tariffs. ELI is also required to submit certain periodic reports to the FCC and
to pay regulatory fees.
RBOCs had been barred from participating in the market for interLATA (Local
Access and Transport Area) services, which is primarily long-distance traffic,
in their service territories since the break up of the Bell System in 1984. The
1996 Act provides a mechanism for an RBOC and/or any successors to enter
in-region interLATA markets. Full entry by such companies into interLATA markets
will increase the level of competition faced by our long distance services.
Before an RBOC or its successors can enter an interLATA market it must first
meet specific criteria set out by section 271 of the 1996 Act. These criteria
are commonly referred to as the "14 point checklist." The checklist is meant to
ensure that these companies have opened up their local markets to competition
before they compete in the long-distance markets in their regions. Verizon and
SBC Communications have both successfully filed interLATA applications with the
FCC in many of the states in which they operate. Applications for other states
are pending at the FCC; additional applications are expected in 2002.
Local Government Authorizations
- -------------------------------
ELI has various interconnection agreements in the states in which it operates.
These agreements govern reciprocal compensation relating to the transport and
termination of traffic between the ILEC's and ELI's networks. On April 17, 2001,
the FCC issued an order that will significantly reduce, over a three-year
period, intercarrier compensation for ISP traffic also known as "reciprocal
compensation." This order became effective June 14, 2001 and is expected to
impact our future interconnection agreements.
Most state public service commissions require competitive communications
providers, such as ELI, to obtain operating authority prior to initiating
intrastate services. Most states also require the filing of tariffs or price
lists and/or customer-specific contracts. ELI is not currently subject to
rate-of-return or price regulation. However, ELI is subject to state-specific
quality of service, universal service, periodic reporting and other regulatory
requirements, although the extent of these requirements is generally less than
those applicable to ILECs.
Competition
ILEC Services Competition
- -------------------------
The 1996 Act and subsequent FCC interconnection decisions have established the
relationships between ILECs and CLECs and the mechanisms for competitive market
entry. Though carriers like us, who serve rural markets, did receive a qualified
exemption from some of the technical requirements imposed upon all ILECs for
interconnection arrangements, we did not receive an exemption from
interconnection or local exchange competition in general. The exemption, known
as the rural telephone company exemption, continues until a bona fide request
for interconnection is received from a CLEC and a state public services
commission with jurisdiction determines that discontinuance of the exemption is
warranted. The state commission must determine that discontinuing the exemption
will not adversely impact the availability of universal service in the state nor
impose an undue economic hardship on us and that the requested interconnection
is technically feasible.
Though much of the initial competition in local telecommunications has been in
more densely populated urban areas, we have begun to experience competition in
some of our suburban and rural markets. These competitors mainly serve ISPs and
a few large business customers, but competition for residential customers is
present in isolated areas. We are subject to greater levels of competition in
our Rochester, New York market than in the other markets that we serve.
9
Under the 1996 Act and subsequent FCC and state rules, CLECs can compete using
one or more of three mechanisms:
* Construction of its own local exchange facilities, in which case the
ILEC's sole obligation is interconnection for purposes of traffic
interchange.
* Purchase unbundled network elements, or UNEs, at cost from the ILEC
and assemble them into local exchange services and/or supplement the
facilities it already owns.
* Resale of the ILEC's retail services purchased at wholesale rates from
the ILEC.
Some competitors have taken advantage of an ILEC's requirement to pay the CLEC
reciprocal compensation for traffic delivered to the CLEC. The increase of
traffic over the Internet has provided CLECs with an immediate mechanism to
build traffic and reciprocal compensation revenues. In 2001, our ILECs paid $6.8
million in reciprocal compensation. While our ILECs are reciprocal compensation
payors, ELI is a reciprocal compensation receiver. ELI received $21.3 million in
reciprocal compensation in 2001. We expect the spread of DSL and other high
speed network services that give customers a dedicated link to the Internet, as
well as the rural nature of our markets and expected actions by the FCC and the
United States Congress to limit the future growth of reciprocal compensation.
Beginning in late 1999, the FCC expanded the availability of UNEs by requiring
ILECs to offer subloop unbundling, expanded extended loops, or EELs, and line
sharing. Pursuant to this FCC decision, CLECs can purchase a portion of the
ILECs' loop facilities at cost-based rates as opposed to the entire loop. EELs
allow CLECs to purchase links to customer premises located outside the exchange
where the CLEC is physically located at cost-based rates. Line sharing allows
ILECs to purchase just the high frequency portion of the loop that permits the
CLEC to offer high-speed data services more profitably, but leave the lower
margin voice services for the same customer with the ILEC. In addition to
expanding the availability of UNEs, in August 2000 the FCC expanded collocation
requirements to include cageless collocation in ILEC facilities. These FCC
decisions increase the CLECs' opportunities to reach customers economically
thereby increasing their ability to compete.
Under the 1996 Act, the RBOCs and their successors were precluded from competing
in most long-distance markets until they satisfied the state regulatory
authority and the FCC that their markets had been sufficiently opened to local
exchange competition. Beginning in 1999, state regulators and the FCC began to
allow the RBOCs and their successors to enter the long-distance market in some
states. By the end of January 2002, RBOC long-distance entry was allowed in nine
states, New York, Texas, Oklahoma, Kansas, Massachusetts, Missouri, Arkansas,
Pennsylvania and Connecticut. We expect additional states to follow suit in the
near future. Because we currently offer long-distance service in New York and
other states, it is possible that the entry of the RBOCs and their successors
into this market could adversely impact our long distance operations.
As of December 31, 2001, we had entered into 415 interconnection agreements with
CLECs. These agreements allow CLECs to connect with some of our ILEC networks
and compete in our ILEC markets. In addition, in some markets, our ILEC services
provide reciprocal compensation payments and local number portability. These
competitors are mainly serving large business customers and internet service
providers.
In Rochester, New York, there are several active CLECs targeting small to
medium-size commercial customers. We also experience competition for dial up and
high speed internet services in the Rochester market in addition to competition
from long distance providers for both residential and business customers.
CLEC Services Competition
- -------------------------
ELI's broad range of communication services enables customers to purchase their
telecommunications needs from a single provider allowing the added convenience
of a single monthly bill. As a facilities-based telecommunications carrier, ELI
can deliver a substantial portion of its services on its own network resulting
in higher gross margins and quality of services than competitors who are
resellers of services.
ELI faces significant competition from ILECs in each of its facilities-based
markets. Principal ILEC competitors include Qwest, SBC and Verizon. CLEC service
providers have generally encountered competitive pressures from a number of
sources, including other CLECs, with the result being the failure of a number of
CLECs and substantial financial pressures on others, including ELI.
10
Facility and non-facility based CLEC competitors in ELI's markets include, among
others: AT&T Local Services, Sprint Local, Time Warner Telecom, MCI WorldCom and
XO Communications. In each of the markets in which ELI operates, at least one
other CLEC, and in some cases several other CLECs, offer many of the same local
communications services that ELI provides, generally at similar prices.
Potential and actual new market entrants in the local communications services
business include RBOCs entering new geographic markets, Interexchange Carrier
(IXCs), cable television companies, electric utilities, international carriers,
satellite carriers, teleports, microwave carriers, wireless telephone system
operators and private networks built by large end-users. In addition, the
current trend of business combinations and alliances in the communications
industry, including mergers between RBOCs may increase competition for ELI. With
the passage of the 1996 Act and the entry of RBOCs into the long distance
market, competitors constructed their own local facilities or otherwise acquired
the right to use local facilities and/or resell the local services of ELI's
competitors. Construction of facilities and networks contributed to
overcapacity.
Competition for network services is based on price, quality, network
reliability, customer service, service features and responsiveness to the
customer's needs. As a point of differentiation from the ILECs, ELI's
fiber-optic networks provide both diverse access routing and redundant
electronics, design features not widely deployed within the ILEC's networks.
ELI's competitors for high-speed data services include major IXCs, other CLECs
and various providers of niche services, such as internet access providers,
router management services and systems integrators. The interconnectivity of
ELI's markets may create additional competitive advantages over other data
service providers that must obtain local access from the ILEC or another CLEC in
each market or that cannot obtain intercity transport rates on terms as
favorable as those available to ELI.
The market for internet access and related services in the United States is
extremely competitive, with barriers to entry related to capital costs,
bandwidth capacity and internal provisioning and operations processes. We expect
that competition will intensify as existing services and network providers and
new entrants compete for customers. In addition, new enhanced internet services
such as managed router service and web hosting are constantly under development
in the market and we expect additional innovation in this market by a range of
competitors. ELI's current and future competitors include communications
companies, including the RBOCs, IXCs, CLECs and cable television companies and
other internet access providers.
Many of these competitors have greater market presence and greater financial,
technical, marketing and human resources, more extensive infrastructure and
stronger customer and strategic relationships than are available to us.
Public Utilities Services
We have historically provided public utilities services including natural gas
transmission and distribution, electric transmission and distribution, water
distribution and wastewater treatment services to primarily rural and suburban
customers throughout the United States. In May 1998 we announced a plan of
divestiture for our public utilities services properties. We have divested
approximately two-thirds of our public utility operations for an aggregate of
$1.352 billion. In 1999 we initially accounted for the planned divestiture of
our public utilities services segments as discontinued operations. Because we
have not yet entered into agreements to sell our entire gas and electric
segments, we reclassified all our gas and electric assets and their related
liabilities in the second half of 2000 as "net assets held for sale." As a
result, our discontinued operations only reflect the assets and related
liabilities of the water and wastewater businesses.
Through our public utilities services segments, we provide gas and electric
utility services. In 2001 we sold our Louisiana gas operations for $363.4
million in cash, our Colorado gas division for $8.9 million in cash, and our
water and wastewater services operations in January 2002 for approximately
$855.7 million in cash and $123.8 million in assumed debt and other liabilities.
These transactions are subject to routine purchase price adjustments.
We intend to sell our remaining public utility assets, which include gas
operations in Arizona and Hawaii and electric utility operations in Arizona,
Hawaii and Vermont.
11
Natural Gas
- -----------
Our natural gas segment provides natural gas transmission and distribution
services in Arizona, as well as synthetic natural gas production and propane
service in Hawaii to 188,800 primarily residential customers. Our natural gas
segment accounted for $411.5 million, or 17%, of our revenues in fiscal year
2001. The number of customers by state is as follows:
State Customers
----- ---------
Arizona......... 122,300
Hawaii........... 66,500
---------
Total 188,800
=========
Natural gas services and/or rates charged are subject to the jurisdiction of
federal and state regulatory agencies, except for the non-regulated propane
rates charged to customers in Hawaii. We purchase the gas supply we need, except
for our production of synthetic natural gas in Hawaii. We believe our natural
gas supply is adequate to meet current demands and to provide for additional
sales to new customers. The natural gas industry is subject to seasonal demand,
except in Hawaii, with the peak demand occurring during the heating season of
November 1 through March 31. Our natural gas segment experiences third-party
competition from fuel oil, propane and other gas suppliers for most of our large
consumption customers, of which there are few, and from electric suppliers for
our entire customer base. The competitive position of gas at any given time
depends primarily on the relative prices of gas and these other energy sources.
One of our gas suppliers in Arizona was Enron Corporation (Enron). In November
2001, as a result of the bankruptcy filing of Enron, we entered into a firm
supply contract with BP Energy for our Arizona gas division through April 2005
on terms more favorable than the Enron arrangement.
In October 2001 we received a temporary rate increase from the Hawaiian Public
Utilities Commission (HPUC) of approximately $5.5 million, in the aggregate, for
our Hawaiian gas company representing a 9.87% rate increase beginning in
November 2001. We expect a final order during the first quarter of 2002.
In September 2001 we received regulatory approval to recover approximately $39
million of deferred gas costs beginning October 1, 2001 over a 24 month period
for our Arizona gas division.
Electric
- --------
Our electric segment provides electric transmission and distribution services in
Arizona, Hawaii and Vermont to 128,400 primarily residential customers. We
produce the vast majority of the power that we sell in Hawaii. Our electric
segment accounted for $228.0 million, or 9%, of our revenues in fiscal year
2001. The breakdown per state is as follows:
State Customers
------ ----------
Arizona.......... 76,500
Hawaii........... 31,200
Vermont.......... 20,700
-------
Total 128,400
=======
Electric services and/or rates charged are subject to the jurisdiction of
federal and state regulatory agencies. We purchase approximately 81% of the
electric energy needed to provide services to our customers. Of this amount, we
purchase approximately 98% of the electric energy needed to provide service to
our customers in Vermont and Arizona and 9% for our customers in Hawaii. We
believe our supply is adequate to meet current demands and to provide for
additional sales to new customers. Our primary generating facilities are on
Kauai, Hawaii. We also have generating facilities in Arizona and Vermont, which
are used mainly for back-up power supply. Generally, our electric segment does
not experience material seasonal fluctuations.
The electric utility industry in the United States is undergoing fundamental
changes. For many years electric utilities have been vertically integrated
entities with the responsibility for the generation, transmission and
distribution of electric power in a franchise territory. In return for monopoly
status, electric utilities have been subject to comprehensive regulation at the
state and federal level. The industry is now shifting toward electric customers
being able to choose their energy provider much like telephone customers are
able to choose their long distance provider. Generally, this involves splitting
apart the generation and transmission of power from the remainder of the
business, and having generators compete with one another in the sale of power
directly to retail customers. The interconnected regional transmission grids
will be operated independently, continuing as a federally regulated monopoly.
12
Local transmission and distribution facilities would continue as state-regulated
monopolies. This change in the industry is in various stages of development
around the United States. The pace and degree of regulation vary from state to
state. The bankruptcies in 2001 of major providers of electricity may alter the
nature and level of regulation of electric utilities.
During the past two years, power supply costs have fluctuated substantially
forcing companies in some cases to pay higher operating costs to operate their
electric businesses. In Arizona, excessive power costs charged by our power
supplier in the amount of approximately $100 million through December 31, 2001
have been incurred. We are allowed to recover these charges from ratepayers
through a purchase power fuel adjustment. In an attempt to limit "rate shock" to
our customers, we requested in September 2001 that this amount, plus interest,
be recovered over a seven-year period. As a result, we have deferred these costs
on the balance sheet in anticipation of recovery through the regulatory process.
We anticipate that a determination regarding recovery will be made in 2002.
On July 16, 2001, we terminated our existing contract with Arizona Public
Service and entered into a new seven-year purchase power agreement. This
agreement allows us to purchase all power required for operations at a fixed
rate per kilowatt hour. This agreement is retroactive to June 1, 2001 and will
mitigate further increases in the deferred power cost account.
Our Vermont Electric Division is a member of the Vermont Joint Owners, a
consortium of 14 Vermont utilities that has entered into a purchase power
agreement with a Canadian power generation facility. The agreement provides for
up to 395 MW of power per annum and associated energy to be delivered to
Vermont, in varying amounts, between 1990 and 2020. If any member of the
consortium defaults on its share of power under the agreement, the remaining
members of the consortium are required by "step-up" provisions of the agreement
to assume responsibility for a defaulting member's share on a pro-rata basis.
On February 15, 2000, we announced that we had agreed to sell our electric
services segment. Our Arizona and Vermont electric divisions were under contract
to be sold, but the parties terminated the agreement on March 7, 2001 due to the
failure of the proposed purchaser to raise the required financing and obtain the
required regulatory approval necessary to meet its obligations under the
contract for sale. We intend to pursue the disposition of the Vermont and
Arizona electric divisions with alternative buyers.
In March 2002, we entered into a definitive agreement to sell our Kauai electric
division to Kauai Island Utility Cooperative (KIUC) for $215 million. The
transaction, which is subject to regulatory approvals, is expected to close
within twelve months.
Our Kauai electric division has, historically, received approximately 13% of its
power from a third-party provider, but in 2001, this was reduced to
approximately 4%. As of January 2001 this third-party provider was
restructuring. In February our Kauai electric division was granted an amendment
to the purchase power agreement. The amendment requires power to be provided
until December 31, 2002 unless terminated earlier by us. Current forecasts
report that our service area will require additional electrical generating
capacity in 2002. As a result, we have entered into a 25-year purchase power
agreement with another independent power producer to provide firm power by July
2002. The HPUC has approved this agreement.
In October 2001 the Company filed a rate case in Vermont requesting a 40% rate
increase to produce a total revenue increase of approximately $11 million. The
rate case is expected to be finalized during the third quarter of 2002.
Water and Wastewater
- --------------------
Through subsidiaries, we provided water distribution, wholesale water
transmission, wastewater treatment, public works consulting and marketing and
billing services to approximately 322,200 primarily residential customers in
Arizona, Illinois, California, Pennsylvania, Ohio, and Indiana. On January 15,
2002, we sold our water and wastewater treatment segment for $855.7 million in
cash and $123.8 million in assumed debt. We no longer provide any water or
wastewater treatment services.
Segment Information
Note 18 of the Notes to Consolidated Financial Statements included herein sets
forth financial information about our industry segments for the last three
fiscal years.
Financial Information about Foreign and Domestic Operations and Export Sales
We have no foreign operations, although we have a 19% interest in Hungarian
Telephone and Cable Company (See Note 7), a company that provides wireline
telephone service in Hungary.
13
General
Order backlog is not a significant consideration in our businesses. We have no
contracts or subcontracts that may be subject to renegotiations of profits or
termination at the election of the Federal government. We also hold certificates
granted by various state commissions, which are generally of indefinite
duration. We have no special working capital practices, and our research and
development activities are not significant. We hold no patents, trademarks,
licenses or concessions that are material. As of December 31, 2001, we had
approximately 10,121 employees, of whom 7,920 were associated with ILEC
operations including approximately 3,773 employees associated with the
acquisition of Frontier, 1,210 were associated with public utilities services
operations including 381 associated with the water and wastewater treatment
operations sold in January 2002. We consider our relations with our employees to
be good.
Item 2 - Properties
Our principal corporate offices are located in leased premises at 3 High Ridge
Park, Stamford, CT.
The operations support office for our ILEC segment is currently located at 180
South Clinton Avenue Rochester, New York in a facility that we sub-lease from
Global and which lease we will take over upon Global's vacating the premises. In
conjunction with the Frontier acquisition, we evaluated our facilities to take
advantage of operational and functional synergies between the two companies with
the objective of concentrating our resources in the areas where we have the most
customers, to better serve those customers. We intend to close our operations
support center in Plano, Texas by April 2002 and sell our office space at that
location. In addition, our ILEC segment leases and owns office space in various
markets throughout the United States.
The operations support office for our CLEC segment, ELI, is located at 4400 NE
77th Avenue, Vancouver, Washington. This building, which we own, is fully
occupied. In addition, our CLEC segment leases local office space in various
markets throughout the United States, and also maintains a warehouse facility in
Portland, Oregon. Our CLEC segment also leases network hub and network equipment
installation sites in various locations throughout the areas in which it
provides services.
Our ILEC and CLEC services segments own telephone properties which include:
connecting lines between customers' premises and the central offices; central
office switching equipment; fiber-optic and microwave radio facilities,
buildings and land; and customer premise equipment. The connecting lines,
including aerial and underground cable, conduit, poles, wires and microwave
equipment, are located on public streets and highways or on privately owned
land. We have permission to use these lands pursuant to local governmental
consent or lease, permit, franchise, easement or other agreement.
Our public utilities services segments are administered locally in the principal
states in which they operate. Pending the sale of our public utilities services
segments, we own gas production, transmission and distribution facilities and
electric transmission and distribution facilities in Arizona, Hawaii, and
Vermont.
Item 3 - Legal Proceedings
On July 20, 2001, we notified Qwest Corporation that we were terminating eight
acquisition agreements with Qwest relating to telephone exchanges in Arizona,
Colorado, Idaho/Washington, Iowa, Minnesota, Montana, Nebraska and Wyoming. On
July 23, 2001, Qwest filed a notice of claim for arbitration with respect to the
terminated acquisition agreements. Qwest asserts that we wrongfully terminated
these agreements and is seeking approximately $64 million in damages, which is
the aggregate of liquidated damages under letters of credit established in the
terminated acquisition agreements. On September 7, 2001, we filed a response and
counterclaims in the same arbitration proceeding, contesting Qwest's asserted
claims and asserting substantial claims against Qwest for material breaches of
representations, warranties, and covenants in the terminated acquisition
agreements and in the acquisition agreement relating to North Dakota assets that
we purchased from Qwest. The parties are currently engaged in discovery. An
arbitration hearing has been tentatively scheduled to commence in the fourth
quarter of 2002.
On December 21, 2001, we entered into a settlement agreement that, if approved
by the court, will resolve all claims in a class action lawsuit pending against
the company in Santa Cruz County, Arizona (Chilcote, et al. v. Citizens
Utilities Company, No. CV 98-471). The lawsuit arose from claims by a class of
plaintiffs that includes all of our electric customers in Santa Cruz County for
damages resulting from several power outages that occurred during the period
January 1, 1997, through January 31, 1999. Under the terms of the settlement
agreement, and without any admission of guilt or wrongdoing by the company, we
will pay the class members $5.5 million in satisfaction of all claims. This
settlement must be approved by the court, which is expected to occur sometime
during the first half of 2002. The company has accrued the full settlement
amount, plus an additional amount sufficient to cover legal fees and other
related expenses, during the fourth quarter of 2001.
14
We are party to proceedings arising in the normal course of our business. The
outcome of individual matters is not predictable. However, we believe that the
ultimate resolution of all such matters, after considering insurance coverage,
will not have a material adverse effect on our financial position, results of
operations, or our cash flows.
Item 4 - Submission of Matters to Vote of Security Holders
None in fourth quarter 2001.
15
Executive Officers
- ------------------
Information as to Executive Officers of the Company as of March 1, 2002 follows:
Name Age Current Position and Office
------- --- ---------------------------
Leonard Tow 73 Chairman of the Board and Chief Executive Officer
Rudy J. Graf 53 Vice Chairman of the Board, President and Chief Operating Officer
Scott N. Schneider 44 Vice Chairman of the Board, Executive Vice President and Chairman of Citizens Capital
Ventures
Donald B. Armour 54 Vice President, Finance and Treasurer
Robert Braden 56 Executive Vice President, ILEC Sector and Chief Executive Officer, Electric Lightwave
Sector
John H. Casey, III 45 Vice President; President and Chief Operating Officer, ILEC Sector
Kenneth L. Cohen 36 President and Chief Operating Officer, Public Services Sector
Jean M. DiSturco 38 Vice President, Human Resources
Jerry Elliott 42 Vice President, Chief Financial Officer
Michael G. Harris 55 Vice President, Engineering and New Technology
Edward O. Kipperman 50 Vice President, Tax
Robert J. Larson 42 Vice President and Chief Accounting Officer
Daniel McCarthy 37 President and Chief Operating Officer, Electric Lightwave Sector
L. Russell Mitten 50 Vice President, General Counsel and Secretary
Livingston E. Ross 53 Vice President, Reporting and Audit
Steven D. Ward 35 Vice President, Information Technology
Michael Zarrella 42 Vice President, Strategic Planning and Development
There is no family relationship between any of the officers of Citizens. The
term of office of each of the foregoing officers of Citizens will continue until
the next annual meeting of the Board of Directors and until a successor has been
elected and qualified.
LEONARD TOW has been associated with Citizens since April 1989 as Director. In
June 1990, he was elected Chairman of the Board and Chief Executive Officer. He
was also Chief Financial Officer from October 1991 through November 1997. He is
Director of Hungarian Telephone and Cable Corp., Chairman of the Board of
Electric Lightwave, Inc. and is a Director of the United States Telephone
Association.
RUDY J. GRAF has been associated with Citizens since September 1999. In February
2001, he was elected Vice Chairman of the Board. In July 2000, he was elected
Director of Citizens. He is currently Vice Chairman of the Board, President and
Chief Operating Officer of Citizens. He is also a Director of Electric
Lightwave, Inc. Prior to joining Citizens, he was Director, President and Chief
Operating Officer of Centennial Cellular Corp. and Chief Executive Officer of
Centennial DE Puerto Rico from November 1990 to August 1999.
SCOTT N. SCHNEIDER has been associated with Citizens since October 1999. In
February 2001, he was elected Vice Chairman of the Board. In July 2000, he was
elected Director of Citizens. He is currently Vice Chairman of the Board,
Executive Vice President of Citizens and Chairman of Citizens Capital Ventures,
a wholly owned subsidiary of Citizens. He is currently Director and Executive
Vice President of Electric Lightwave, Inc. Prior to joining Citizens, he was
Director (from October 1994 to October 1999), Chief Financial Officer (from
December 1996 to October 1999), Senior Vice President and Treasurer (from June
1991 to October 1999) of Century Communications Corp. He also served as
Director, Chief Financial Officer, Senior Vice President and Treasurer of
Centennial Cellular from August 1991 to October 1999.
DONALD ARMOUR has been associated with Citizens since October 2000. He is
currently Vice President, Finance and Treasurer. He also currently serves as
Vice President and Treasurer of Electric Lightwave, Inc. Prior to joining
Citizens, he was the Treasurer of the cable television division of Time Warner
Inc. from January 1994 to September 2000.
ROBERT BRADEN has been associated with Citizens since November 1999 and has been
Vice President, Business Development since February 2000. In January 2001, he
also became President, Chief Operating Officer and Director of Electric
Lightwave, Inc. and in December 2001, he became Chief Executive Officer and
Director of Electric Lightwave, Inc. In January 2002, he became Executive Vice
President, ILEC Sector. Prior to joining Citizens, he was Vice President,
Business Development at Century Communications Corp. from January 1999 to
October 1999. He was Senior Vice President, Business Development at Centennial
Cellular Corp. from June 1996 to January 1999 and held other officer positions
with Centennial since November 1993.
16
JOHN H. CASEY, III has been associated with Citizens since November 1999. He is
currently Vice President of Citizens and President and Chief Operating Officer
of our ILEC Sector. Prior to joining Citizens, he was Vice President, Operations
from January 1995 to January 1997 and then Senior Vice President, Administration
of Centennial Cellular until November 1999.
KENNETH L. COHEN has been associated with Citizens since 1996 and was elected
President and Chief Operating Officer, Public Services Sector in January 2002.
He was Vice President and Controller of our Public Services Sector from 1996 to
January 2002. Prior to joining Citizens, he was a senior manager at KPMG LLP
from March 1986 to August 1996.
JEAN M. DISTURCO has been associated with Citizens since 1987 and was elected
Vice President, Human Resources in October 2001. She was Vice President,
Compensation and Benefits since March 2001 and Director of Compensation from
1996 to March 2001.
JERRY ELLIOTT has been associated with Citizens since March 2002. He is
currently Vice President and Chief Financial Officer. He is also Vice President
and Chief Financial Officer of Electric Lightwave, Inc. Prior to joining
Citizens, he was Managing Director of Morgan Stanley's Communications Investment
Banking Group from July 1998. Prior to joining Morgan Stanley, he was a partner
with the law firm of Shearman & Sterling.
MICHAEL G. HARRIS has been associated with Citizens since December 1999. He is
currently Vice President, Engineering and New Technology. Prior to joining
Citizens, he was Senior Vice President, Engineering of Centennial Cellular from
August 1991 to December 1999. He was also Senior Vice President, Engineering of
Century Communications Corp. from June 1991 to October 1999.
EDWARD O. KIPPERMAN has been associated with Citizens since February 1985. He is
currently Vice President, Tax. He was Assistant Treasurer from June 1989 to
September 1991.
ROBERT J. LARSON has been associated with Citizens since July 2000. He is
currently Vice President and Chief Accounting Officer of Citizens and of
Electric Lightwave, Inc. Prior to joining Citizens, he was Vice President and
Controller of Century Communications Corp. from October 1994 to October 1999. He
was also Vice President, Accounting and Administration of Centennial Cellular
from March 1995 to October 1999.
DANIEL MCCARTHY has been associated with Citizens since 1990 and was elected
President and Chief Operating Officer, Electric Lightwave Sector in January
2002. Previously, he was President and Chief Operating Officer, Public Services
Sector from March 2001 to January 2002, Vice President, Citizens Arizona Energy
from April 1998 to March 2001 and Vice President, Citizens Arizona Gas from
February 1997 to April 1998.
L. RUSSELL MITTEN has been associated with Citizens since June 1990. He is
currently Vice President, General Counsel and Secretary. He was Vice President,
General Counsel and Assistant Secretary from June 1991 to September 2000. He was
General Counsel until June 1991.
LIVINGSTON E. ROSS has been associated with Citizens since August 1977. He is
currently Vice President, Reporting and Audit. He was Vice President and Chief
Accounting Officer from December 1999 to July 2000 and Vice President and
Controller from December 1991 to December 1999.
STEVEN D. WARD has been associated with Citizens since January 2000 and was
elected Vice President, Information Technology in February 2000. Prior to
joining Citizens, he was Vice President, Information Systems for Century
Communications Corp. from June 1996 to December 1999 and Director, Information
Services from March 1991 to June 1996.
MICHAEL ZARRELLA has been associated with Citizens since December 1999. He was
elected Vice President, Strategic Planning and Development in October 2000.
Prior to joining Citizens, he was Group Vice President of Finance for Century
Communications Corp. from June 1996 to December 1999 and Director, Financial
Analysis from October 1990 to June 1996.
17
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
PART II
-------
Item 5. Market for the Registrant's Common Equity and Related Stockholder
------------------------------------------------------------------
Matters
-------
PRICE RANGE OF COMMON STOCK
Our Common Stock is traded on the New York Stock Exchange under the symbol CZN.
The following table indicates the high and low prices per share during the
periods indicated.
2001 2000
------------------- ------------------
High Low High Low
---- --- ---- ---
First Quarter $15.88 $12.05 $17.06 $13.75
Second Quarter $15.00 $11.28 $18.00 $14.31
Third Quarter $13.10 $8.95 $19.00 $13.00
Fourth Quarter $11.53 $8.20 $15.31 $12.50
As of February 28, 2002, the approximate number of security holders of record of
our Common Stock was 34,264. This information was obtained from our transfer
agent.
DIVIDENDS
The amount and timing of dividends payable on Common Stock are within the sole
discretion of our Board of Directors. Our Board of Directors discontinued the
payment of dividends after the payment of the December 1998 stock dividend.
RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM
REGISTERED SECURITIES
None
Item 6. Selected Financial Data
------------------------
($ in thousands, except per share amounts) Year Ended December 31,
------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------- ------------ --------------- ------------- -------------
Revenue (1) $ 2,456,993 $ 1,802,358 $ 1,598,236 $ 1,448,588 $ 1,303,901
Income (loss) from continuing operations before
cumulative effect of changes in accounting principles $ (63,926) $ (40,071) $ 136,599 $ 46,444 $ 2,066
and extraordinary expense (2)
Net income (loss) $ (89,682) $ (28,394) $ 144,486 $ 57,060 $ 10,100
Basic income (loss) per share of Common Stock
from continuing operations before cumulative
effect of changes in accounting principles and
extraordinary expense (2)(3) $ (0.28) $ (0.15) $ 0.53 $ 0.18 $ 0.01
Available to common shareholders per basic share (2)(3) $ (0.38) $ (0.11) $ 0.56 $ 0.22 $ 0.04
Available to common shareholders per diluted share (2)(3) $ (0.38) $ (0.11) $ 0.55 $ 0.22 $ 0.04
Stock dividends declared on Common Stock (4) - - - 3.03% 5.30%
As of December 31,
------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------- ------------ --------------- ------------- -------------
Total assets $10,553,600 $ 6,955,006 $ 5,771,745 $ 5,292,932 $ 4,872,852
Long-term debt $ 5,994,906 $ 3,062,289 $ 2,107,460 $ 1,819,555 $ 1,627,388
Shareholders' equity $ 1,946,142 $ 1,720,001 $ 1,919,935 $ 1,792,771 $ 1,679,211
(1) Represents revenue from continuing operations. Revenue from Acquisitions
contributed $569.8 million and $49.5 million for the years ended December
31, 2001 and 2000, respectively. Revenue from gas operations sold
represented $218.8 million, $232.3 million, $175.4 million, $173.1 million
and $184.1 million in 2001, 2000, 1999, 1998 and 1997, respectively.
(2) Extraordinary expense represents an extraordinary after tax expense of
$43.6 million related to our decision to discontinue the application of
Statement of Financial Accounting Standards No. 71 to our local exchange
telephone operations in 2001. The cumulative effect of changes in
accounting principle represents an after tax change of $2.3 million at ELI
in 1998.
(3) 1997 is adjusted for subsequent stock dividends.
(4) Compounded annual rate of quarterly stock dividends.
18
Item 7. Management's Discussion and Analysis of Financial Condition and
----------------------------------------------------------------
Results of Operations
---------------------
This annual report on Form 10-K contains forward-looking statements that are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed or implied in the statements. Statements that
are not historical facts are forward-looking statements made pursuant to the
Safe Harbor Provisions of the Litigation Reform Act of 1995. In addition, words
such as "believes", "anticipates", "expects" and similar expressions are
intended to identify forward-looking statements. Forward-looking statements
(including oral representations) are only predictions or statements of current
plans, which we review continuously. Forward-looking statements may differ from
actual future results due to, but not limited to, any of the following
possibilities:
* Our ability to obtain new financing on favorable terms;
* Our ability to effectively manage our growth, including the
integration of newly acquired operations into our operations, and
otherwise monitor our operations, costs, regulatory compliance and
service quality;
* Our ability to divest the remainder of our public utilities services
businesses;
* Our ability to successfully introduce new product offerings on a
timely and cost effective basis, including our ability to offer
bundled service packages on terms attractive to our customers, and our
ability to offer second lines and enhanced services to markets
currently under-penetrated;
* Our ability to expand through attractively priced acquisitions;
* Our ability to identify future markets and successfully expand
existing ones;
* 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;
* Electric Lightwave, Inc.'s (ELI's) ability to complete a public or
private financing that would provide the funds necessary to finance
its cash requirements;
* The effects of rapid technological changes, including the lack of
assurance that our ongoing network improvements will be sufficient to
meet or exceed the capabilities and quality of competing networks;
* The effects of changes in regulation in the telecommunications
industry as a result of the Telecommunications Act of 1996 and other
similar federal and state legislation and regulation;
* The effect of restructuring of portions of the telecommunications
market; 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 and practices adopted voluntarily or as required by generally
accepted accounting principles.
You should consider these important factors in evaluating any statement in this
Form 10-K or otherwise made by us or on our behalf. The following information
should be read in conjunction with the consolidated financial statements and
related notes included in this report. We have no obligation to update or revise
these forward-looking statements.
(a) Liquidity and Capital Resources
-------------------------------
For the year ended December 31, 2001 we completed the Acquisition of Frontier
and the permanent financings for our Frontier, Verizon and Qwest acquisitions.
We also completed the sale of two of our public utilities services properties
and repaid certain indebtedness and our equity forward contract. A summary of
our primary sources and uses of cash is as follows:
19
($ in thousands) For the year
ended
December 31, 2001
------------------
Primary Sources of Cash
- -------------------------------------
Generated by operating activities $ 520,379
Sale of public utility services properties 372,335
Net proceeds from debt financings 3,650,191
Net proceeds from equity units 445,635
Common stock offering 289,561
------------------
$ 5,278,101
==================
Primary Uses of Cash
- -------------------------------------
Purchase of telephone properties $(3,373,214)
Capital improvements (530,714)
Repay indebtedness (1,077,931)
Repay equity forward contracts (163,662)
------------------
$(5,145,521)
==================
During January 2002, we sold another of our operations and received $855.7
million in cash proceeds and repaid $107.0 million in indebtedness. The details
of these 2001 and 2002 transactions follow.
In May 2001, we filed a $3.8 billion shelf registration statement with the
Securities and Exchange Commission (SEC) on Form S-3 that permits us to offer
from time to time common stock, preferred stock, depositary shares, debt
securities, warrants to purchase these types of securities and units of the
foregoing. The net proceeds from the sale of these securities have been and are
expected to be used to refinance our bank borrowings and other extensions of
credit, to expand our networks, services and related infrastructure, to fund
working capital and pending and future acquisitions, to make further investments
in related telecommunications businesses, as well as for general corporate
purposes. After the offerings discussed below, we have a remaining availability
on this shelf registration statement allowing us to offer $825.6 million.
In May 2001, we issued an aggregate of $1.75 billion of notes consisting of $700
million principal amount of 8.50% notes due May 15, 2006 and $1.05 billion of
9.25% notes due May 15, 2011. This offering was made under the $3.8 billion
shelf registration statement. Net proceeds of $1.726 billion (after underwriting
discounts and commissions and before offering expenses) were used to repay bank
borrowings and the remainder was used for general corporate purposes and to
finance acquisitions.
In June 2001, we issued equity securities in two concurrent public offerings.
The first consisted of 25,156,250 shares of our common stock. The net proceeds
of $289.6 million (after underwriting discounts and commissions and before
offering expenses) were used to fund a portion of the acquisition of Frontier.
The second offering consisted of $460 million of equity units. The net proceeds
of $446.2 million (after underwriting discounts and commissions and before
offering expenses) were also used to fund a portion of the acquisition of
Frontier. Each equity unit initially consists of a senior note and a purchase
contract for our common stock. The price for the common stock under this
purchase contract will be based upon the average trading price of our stock at
the time the contract is exercised and is expected to be paid with the proceeds
of a remarketing of the senior notes. These offerings were also made under the
$3.8 billion shelf registration statement.
In August 2001, we issued an aggregate of $1.75 billion principal amount of
senior notes consisting of $300 million of 6.375% notes due 2004, $750 million
principal amount of 7.625% notes due 2008 and $700 million principal amount of
9.000% notes due 2031. These notes were issued in a private offering. The
proceeds were used to repay our forward equity contract, to refinance
outstanding indebtedness and for general corporate purposes. In September 2001,
we filed a $1.75 billion registration statement with the SEC on Form S-4 that
consists of an exchange offer entitling the holders of the notes issued in
August 2001 to exchange the initial notes for new notes with substantially
identical terms as the initial notes, except for transfer restrictions and
registration rights relating to the initial notes. The registration statement
was declared effective on February 6, 2002, and we commenced our exchange offer
at that time. The exchange offer is expected to terminate on March 11, 2002.
20
In October 2001, we borrowed $200 million on an unsecured basis from the Rural
Telephone Finance Cooperative (RTFC). This note matures on October 24, 2011 and
has a fixed 6.27% interest rate.
We have committed to continue to finance ELI's cash requirements until March 31,
2003. We extended a revolving credit facility to ELI for $450 million with an
interest rate of 15% and a final maturity of October 30, 2005. Funds for general
corporate purposes of $350 million are available to be drawn until December 31,
2002. The remaining balance may be drawn by ELI to pay interest expense due
under the facility. As of December 31, 2001, we have advanced $194.5 million to
ELI under this facility.
In April 2001, we converted and remarketed $14.4 million of 1991 series
industrial development revenue bonds as money market bonds with an initial
interest rate of 5.25% and a maturity date of April 1, 2026.
In May 2001, we converted and remarketed $23.3 million of Illinois 1997 series
of environmental facilities revenue bonds due May 1, 2032 at an initial interest
rate of 5.85%. We also converted and remarketed $18.3 million of Northampton
County, Pennsylvania 1998 series of industrial development revenue bonds due
September 1, 2018 at an initial interest rate of 5.75%. Both series were
remarketed as money market bonds and were associated with our discontinued water
and wastewater treatment operations.
On June 29, 2001, we completed the acquisition of Frontier Corp. from Global for
$3.37 billion in cash. The acquisition was financed on an interim basis by the
draw down of a bank credit facility of $1.78 billion, with the remainder derived
from the proceeds of our registered securities offerings discussed above. The
bank credit facility was repaid in August 2001 with the proceeds of our private
offering of senior notes discussed above.
On July 2, 2001, we completed the sale of our Louisiana gas operations to Atmos
Energy Corp for $363.4 million in cash. The proceeds were used to repay a
portion of our borrowings under our bank credit facility.
During 2000, we entered into an equity forward contract with Citibank, N.A. to
purchase 9,140,000 shares of our common stock. These purchases and others made
by us for cash during 2000 were made in open market transactions. The amount to
be paid under the forward contract included a LIBOR-based carrying cost plus the
dollar amount paid for the shares acquired. This forward contract was a
temporary financing arrangement that provided us the flexibility to effectively
purchase our stock in the current period and to pay for those purchases in a
future period. Pursuant to transition accounting rules, commencing December 31,
2000 through June 30, 2001 we were required to report our equity forward
contract as a reduction in shareholders' equity and as a component of temporary
equity for the gross settlement amount of the contract ($150.0 million). On June
28, 2001, we entered into a master confirmation agreement that amended the
equity forward contract to eliminate the share settlement feature of the
original contract. During 2001, we settled the contract for $150.0 million plus
$13.6 million in associated carrying costs, and took possession of our shares.
On September 4, 2001, $50 million principal amount of our 8.45% debentures
matured and were repaid at par with cash. On October 1, 2001, $99.2 million
principal amount of our $100 million debentures due 2034 were tendered for
redemption at par in accordance with the put option granted to debenture holders
at the time of issuance. These tendered debentures were also repaid with cash.
On November 30, 2001, we completed the sale of our Colorado gas operations to
Kinder Morgan, Inc. for $8.9 million in cash. The proceeds were used for general
corporate purposes.
In December 2001, two of our ILEC subsidiaries, Citizens Telecommunications
Company of West Virginia and Rhinelander Telephone Company, made cash payments
of $12.9 million and $6.7 million, respectively, representing repayment of all
of their outstanding obligations to the Rural Utilities Service and the Rural
Telephone Bank.
On January 7, 2002, we called for redemption at par two of our outstanding 1991
series of industrial development revenue bonds, the $20.0 million 7.15% Mohave
series and the $10.1 million 7.15% Santa Cruz series. Both redemptions were
funded with cash.
On January 15, 2002, we completed the sale of our water and wastewater
operations to American Water Works for $855.7 million in cash plus the
assumption of $123.8 million of debt. The proceeds are being used to continue to
expand our networks, services and related infrastructure, to fund working
capital and pending and future acquisitions, to make further investments in
related telecommunications businesses, as well as for general corporate purposes
(including the repayment of outstanding indebtedness.)
21
On January 31, 2002, we repaid approximately $76.9 million principal amount of
loans outstanding to our subsidiaries from the Rural Utilities Service, Rural
Telephone Bank and the Federal Financing Bank.
For the year ended December 31, 2001, our actual capital expenditures were
$409.3 million for the ILEC segment, $54.5 million for the ELI segment and $89.9
million for the public utilities services segments which includes $23.0 million
for the water and wastewater segment. For 2002, we anticipate that our capital
expenditures will approximate $525.6 million; $412.0 million for the ILEC
segment, $71.6 million for ELI and $42.0 million for the public utility services
segment.
We anticipate that the primary sources of funds in 2002 will come from our ILEC
operations. We have a remaining shelf registration of $825.6 million and we have
available lines of credit with financial institutions in the amount of $705
million and $100 million. The credit facilities have similar terms and
conditions. Associated facility fees vary, depending on our credit ratings, and
are 0.25% per annum as of December 31, 2001. The expiration date for both
facilities is October 24, 2006. During the term of the facilities we may borrow,
repay and reborrow funds. As of December 31, 2001, there were no outstanding
advances under these facilities.
ELI has a $400 million committed revolving line of credit with a syndicate of
commercial banks that expires on November 21, 2002. The ELI credit facility has
an associated facility fee of 0.08% per annum. We have guaranteed all of ELI's
obligations under this revolving line of credit. As of December 31, 2001, $400
million was outstanding under this credit facility.
During 1995, ELI entered into a $110 million construction agency agreement and
an operating lease agreement in connection with the construction of certain
network facilities. In January 2002, ELI exercised its option to purchase the
facilities at the end of the lease term. Payments under the lease depend on
current interest rates. Assuming continuation of current interest rates,
payments would approximate $872,000 from January 1, 2002 through April 30, 2002
and a final payment of approximately $110 million in April 2002. Citizens has
guaranteed all of ELI's obligations under this operating lease.
On December 17, 2001, we entered into two interest rate swap agreements with a
subsidiary of Morgan Stanley Dean Witter, each agreement covering a notional
amount of $50 million. Under the terms of both agreements, we make semi-annual,
floating rate interest payments based on six-month LIBOR and receive a fixed
6.375% rate on the notional amount. Under the terms of one swap, the underlying
LIBOR rate is set in advance, while the second agreement utilizes LIBOR reset in
arrears. Both swaps terminate on August 15, 2004 and are being accounted for
under SFAS 133 as fair value hedges.
A summary of our future contractual obligations and commercial commitments as of
December 31, 2001 is as follows:
Less than After
(in thousands) Total 1 year 2-3 years 4-5 years 5 years
- -------------- ----- ------ --------- --------- -------
Long-term debt $ 6,341,430 $ 476,488 $ 772,250 $ 1,348,043 $ 3,744,649
Capital lease obligations 137,382 7,418 5,804 6,855 157,459
Operating leases 161,817 25,777 43,068 32,123 60,849
Purchase obligation 110,000 110,000 - - -
Other long-term obligations 925,024 115,416 147,425 78,948 583,235
----------- --------- --------- ----------- -----------
Total contractual cash obligations $ 7,675,653 $ 735,099 $ 968,547 $ 1,465,969 $ 4,546,192
=========== ========= ========= =========== ===========
Covenants
- ---------
The terms and conditions contained in our indentures and credit facility
agreements are of a general nature, and do not impose significant financial
performance criteria on us. These general covenants include the timely and
punctual payment of principal and interest when due, the maintenance of our
corporate existence, keeping proper books and records in accordance with
Generally Accepted Accounting Principles (GAAP), restrictions on the allowance
of liens on our assets, and restrictions on asset sales and transfers, mergers
and similar transactions. We currently have no restrictions on the payment of
dividends by us or our subsidiaries either by contract, rule or regulation.
22
The principal financial performance covenant under our $805 million credit
facilities and our $200 million term loan facility with the Rural Telephone
Finance Cooperative (RTFC) requires the maintenance of a minimum net worth of
$1.5 billion. Under the RTFC loan, in the event that our credit rating from
either Moody's Investors Service or Standard & Poor's declines below investment
grade (Baa3/BBB-, respectively), we would be required to maintain an interest
coverage ratio of 2.00 to 1 or greater and a leverage ratio of 6.00 to 1 or
lower.
Acquisitions
- ------------
From May 27, 1999 through July 12, 2000 we entered into several agreements to
acquire telephone access lines. These transactions have been accounted for using
the purchase method of accounting. The results of operations of the acquired
properties have been included in our financial statements from the dates of
acquisition of each property. These agreements and the status of each
transaction are described as follows:
Verizon Acquisition
-------------------
Between May and December 1999, we announced agreements to purchase
from Verizon Communications Inc., formerly GTE Corp. (Verizon),
approximately 381,200 telephone access lines (as of December 31, 2000)
for approximately $1,171.0 million in cash. By November 30, 2000, we
had closed on the purchase of approximately 317,500 telephone access
lines. On December 17, 2001, the agreements to acquire the remaining
telephone access lines were terminated.
Qwest Acquisition - termination
-------------------------------
In June 1999, we announced agreements to purchase from Qwest
approximately 556,800 telephone access lines (as of December 31, 2000)
in nine states for approximately $1,650.0 million in cash and the
assumption of certain liabilities. On October 31, 2000, we closed on
the purchase of approximately 17,000 telephone access lines in North
Dakota for approximately $38.0 million in cash. On July 20, 2001, we
notified Qwest that we were terminating the remaining eight
acquisition agreements. Qwest subsequently filed a notice of claim for
arbitration in Denver, Colorado under the rules of the American
Arbitration Association with respect to the terminated acquisition
agreements. Qwest asserts that we wrongfully terminated these
agreements and is seeking approximately $64.0 million, which is the
aggregate of liquidation damages under letters of credit, established
in the terminated acquisition agreements. We have filed a notice of
claim in the same arbitration proceeding, contesting Qwest's asserted
claims and asserting substantial claims against Qwest for material
breaches of representations, warranties and covenants in the
terminated acquisition agreements and in the acquisition agreement
relating to North Dakota assets that we purchased from Qwest.
Frontier Acquisition
--------------------
On June 29, 2001, we purchased from Global 100% of the stock of
Frontier Corp.'s (Frontier) local exchange carrier subsidiaries, which
owns approximately 1.1 million telephone access lines in Alabama,
Florida, Georgia, Illinois, Indiana, Iowa, Michigan, Minnesota,
Mississippi, New York, Pennsylvania and Wisconsin, for approximately
$3,373.0 million in cash, subject to routine purchase price
adjustment.
Divestitures
- ------------
On August 24, 1999, our Board of Directors approved a plan of divestiture for
our public utilities services businesses, which include gas, electric and water
and wastewater businesses. During 2001 we sold two of our natural gas operations
and in January 2002 we sold all of our water and wastewater treatment
operations.
The Arizona and Vermont electric divisions were under contract to be sold to Cap
Rock Energy Corp. (Cap Rock). The agreement with Cap Rock was terminated on
March 7, 2001. We intend to pursue the disposition of the Vermont and Arizona
electric divisions with alternative buyers. In March 2002, we entered into a
definitive agreement to sell our Kauai electric division to Kauai Island Utility
Cooperative (KIUC) for $215 million. The transaction, which is subject to
regulatory approvals, is expected to close within twelve months.
Currently, we do not have agreements to sell our entire gas and electric
segments. Consequently, we have reflected all of our gas and electric assets and
their related liabilities as "assets held for sale" and "liabilities related to
assets held for sale," respectively. We also reflect the results of these
operations as part of continuing operations. Additionally, we ceased to record
depreciation expense on the gas assets effective October 1, 2000 and on the
electric assets effective January 1, 2001. Such depreciation expense would have
been an additional $50.8 million for the gas operations and $6.8 million for
electric operations for the year ended December 31, 2001. We continue to
actively pursue buyers for our remaining gas and electric business.
23
Discontinued operations in the consolidated statements of income reflect the
results of operations of the water/wastewater properties sold in January 2002
including allocated interest expense for the periods presented. Interest expense
was allocated to the discontinued operations based on the outstanding debt
specifically identified with this business.
Discontinuation of SFAS 71:
- --------------------------
Prior to the 2000 and 2001 acquisitions of the Verizon, Qwest and Frontier
Properties, our incumbent local exchange telephone properties had been
predominantly regulated following a cost of service/rate of return approach.
Accordingly, we applied the provisions of Statement of Financial Accounting
Standards (SFAS) No. 71 in the preparation of our financial statements.
Currently, pricing for a majority of our revenues in our previously existing
incumbent local exchange telephone properties is based upon price cap plans that
limit prices to changes in general inflation and estimates of productivity for
the industry at large or upon market pricing rather than on the specific costs
of operating our business, a requirement for the application of SFAS 71. These
trends in the deregulation of pricing and the introduction of competition are
expected to continue as additional states adopt price cap forms of regulation.
We intend to operate all of our properties as competitive enterprises, to meet
competitive entry and maximize revenue by providing a broad range of products
and services, such as data services. Many of these future services will not be
regulated, further increasing the percentage of our revenue provided by our
networks that is not based upon historical cost/rate of return regulation.
In the third quarter of 2001, we concluded based on the factors mentioned above,
that the provisions of SFAS 71 were no longer applicable to our incumbent local
exchange telephone properties (properties we owned prior to the 2000 and 2001
acquisitions of the Verizon, Qwest and Frontier properties). As part of the
discontinuation of SFAS 71, we will no longer recognize in our financial
statements certain activities of regulators.
As discussed further in Note 19 of the financial statements, we recorded a
non-cash extraordinary charge of $43.6 million net of tax in our income
statement, to write-off regulatory assets and liabilities recorded on our
balance sheet in the past. Based upon our evaluation of the pace of technology
change that is estimated to occur in certain components of our rural telephone
networks, we have concluded that minor modifications in our asset lives are
required for the major network technology assets and expect that depreciation
and amortization expense will not differ significantly from that currently
recorded.
In accordance with the provisions of SFAS 101 and SFAS 121, we performed a test
of the impairment of the property, plant and equipment accounts for our
properties discontinuing SFAS 71 and based upon our expectations of future
changes in sales volumes and prices and the anticipated rate of entry of
additional competition into our markets, we concluded that an asset impairment
is not warranted under SFAS 121 at this time.
New Accounting Pronouncements
- -----------------------------
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS 141,
"Business Combinations." This statement requires that all business combinations
be accounted for under the purchase method of accounting. SFAS 141 requires that
the purchase method of accounting be used for business combinations initiated
after June 30, 2001 and prohibits the use of the pooling-of-interests method of
accounting. We adopted SFAS No. 141 on July 1, 2001. The adoption of SFAS 141
did not have any impact on our financial position or results of operations.
In July 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets."
This statement requires that goodwill no longer be amortized to earnings, but
instead be reviewed for impairment. SFAS 142 is effective January 1, 2002. We
will be required to test for impairment of goodwill as of January 1, 2002 and
annually thereafter. Any transitional impairment loss at January 1, 2002 will be
recognized as the cumulative effect of a change in accounting principle in our
statement of operations. The amortization of goodwill ceases upon adoption of
the statement. As of the date of adoption, we have unamortized goodwill in the
amount of $1,939.3 million and unamortized identifiable intangible assets in the
amount of $1,039.7 million. Amortization expense related to goodwill was $108.1
million, $13.6 million and $2.7 million for the years ended December 31, 2001,
2000 and 1999, respectively. Because of the extensive effort needed to comply
with adopting SFAS 142, it is not practicable to reasonably estimate the impact
of adopting this Statement on our financial statements at the date of this
report, including whether we will be required to recognize any transitional
impairment losses as the cumulative effect of a change in accounting principle.
We are required to make such assessment no later than June 30, 2002 but such
assessment is "as of" January 1, 2002.
24
In August 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligations." This statement addresses the financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. SFAS 143 requires that the fair value of
a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset and reported as a liability. This statement is effective
for fiscal years beginning after June 15, 2002. We are currently evaluating the
impact of the adoption of SFAS 143.
In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-lived Assets." This statement establishes a single accounting
model, based on the framework established in SFAS 121, for long-lived assets to
be disposed of by sale, whether previously held and used or newly acquired, and
broadens the presentation of discontinued operations to include more disposal
transactions. This statement is effective for fiscal years beginning after
December 15, 2001. We are currently evaluating the impact of the adoption of
SFAS 144.
25
(b) Results of Operations
---------------------
REVENUE
ILEC revenue is generated primarily through the provision of local and long
distance telephone service. 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. CLEC usage based revenue includes amounts determined
under reciprocal compensation agreements. While this revenue is governed by
specific contracts with the counterparty, management has deferred recognition of
portions of such revenue until realizability was obtained. Revenue earned from
long-haul contracts, including the fiber swap, is recognized over the term of
the related agreement.
Revenue from the provision of public utility services are recognized based on
usage without significant judgments made by management with the exception of
amounts determined for uncollectible accounts.
Consolidated revenue increased $654.6 million, or 36%, in 2001 and $204.1
million, or 13%, in 2000. The increase in 2001 was primarily due to the impact
of acquisitions in the ILEC sector as well as the pass-through to customers of
the increased cost of gas. The increase in 2000 was primarily due to the
pass-through to customers of the increased cost of gas, electric energy and fuel
oil purchased as well as ILEC acquisitions and increased ELI revenue.
ILEC REVENUE
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ----------- --------- ----------
Network access services $ 654,641 45% $ 451,402 2% $ 444,409
Local network services 582,662 78% 326,878 14% 286,271
Long distance and data services 208,274 95% 106,662 17% 90,978
Directory services 72,375 93% 37,424 11% 33,636
Other 76,101 84% 41,377 -14% 47,943
------------ ----------- ----------
$ 1,594,053 65% $ 963,743 7% $ 903,237
============ =========== ==========
We acquired the Verizon Nebraska access lines on June 30, 2000, the Verizon
Minnesota access lines on August 31, 2000, the Qwest North Dakota access lines
on October 31, 2000 and the Verizon Illinois/Wisconsin access lines on November
30, 2000 and Frontier on June 29, 2001 (collectively referred to as the
Acquisitions). The 2001 impact of the Acquisitions of $569.8 million in the
following revenue and expense discussion represents six months of activity for
Frontier which was acquired on June 29, 2001 and the difference between a full
year in 2001 versus a partial year in 2000 for the Verizon Nebraska, Minnesota
and Illinois/Wisconsin and Qwest North Dakota acquisitions. The 2000 impact of
the Acquisitions of $49.5 million in the following revenue and expense
discussion represents the activity for each acquisition from its respective date
of acquisition.
Network access services revenue increased $203.2 million, or 45%, in 2001
primarily due to the $159.1 million impact of the Acquisitions. Growth in
minutes of use, special access and subsidies revenue contributed $3.1 million,
$17.9 million and $20.0 million, respectively. The increases were partially
offset by $6.5 million from the effect of the FCC's CALLS mandate which reduced
access charges paid by long distance companies and $7.3 million in rate
decreases in effect as of July 1, 2001. Network access also includes a
reclassification of $13.9 million in revenue reported as local network services
revenue in the prior year.
Network access services revenue increased $7.0 million, or 2%, in 2000,
primarily due to the $23.9 million impact of the Acquisitions and $15.4 million
related to growth in minutes of use and special access revenue. These increases
were partially offset by a non-recurring $10.4 million interstate universal
service fund (USF) settlement received in the first quarter of 1999, the effect
of CALLS of $14.8 million, settlements with long distance carriers of $2.3
million in 1999, and the price effect of a July 1999 FCC tariff adjustment of
$1.8 million.
26
Local network services revenue increased $255.8 million, or 78%, in 2001,
primarily due to the impact of the Acquisitions which contributed $260.9 million
and growth in enhanced services of $8.1 million. Local network services also
reflects a reduction for the reclassification of $13.9 million in revenue
reported as network access revenue in the prior year.
Local network services revenue increased $40.6 million, or 14%, in 2000,
primarily due to the impact of the Acquisitions which contributed $23.8 million,
growth in enhanced services of $6.3 million due to increased demand for these
services, access line growth of 26,000 contributed $5.0 million and frame relay,
data and ISDN increased $4.0 million. These increases were partially offset by
an Extended Area Service revenue phase-out in New York of $3.1 million.
Long distance and data services revenue increased $101.6 million, or 95%, in
2001 primarily due to the impact of the Acquisitions of $78.2 million,
principally the long-distance and data revenue associated with Frontier, which
contributed $74.1 million to the increase. Growth in Digital Subscriber Line
(DSL) and Internet services of $7.9 million, growth related to data and
dedicated circuits of $7.0 million and growth in long distance services of $7.7
million also contributed to the increase.
Long distance and data services revenue increased $15.7 million, or 17%, in 2000
primarily due to increased Internet revenue of $6.0 million, increased DSL,
frame relay and ISDN services of $5.5 million and increased remote call
forwarding of $2.7 million.
Directory services revenue increased $35.0 million, or 93%, in 2001 primarily
due to the impact of the Acquisitions which contributed $33.2 million to the
increase and growth of $1.8 million. Directory services revenue increased $3.8
million, or 11%, in 2000 primarily due to increased directory advertising and
listing sales. The Acquisitions contributed $1.0 million to the increase in
2000.
Other revenue increased $34.7 million, or 84%, in 2001 primarily due to the
impact of the Acquisitions of $38.4 million, partially offset by a decrease in
miscellaneous revenue categories. Other revenue decreased $6.6 million, or 14%,
in 2000 primarily due to a decrease in billing and collections revenue of $6.4
million and an increase in the reserve for uncollectibles of $3.9 million. These
decreases were partially offset by increased revenue from the Acquisitions of
$0.8 million, an increase of $2.8 million in conference call revenue and an
increase of $0.3 million in cable revenue.
ELI REVENUE
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ----------- --------- ----------
Network services $ 101,338 31% $ 77,437 45% $ 53,249
Local telephone services 73,291 -26% 98,643 27% 77,591
Long distance services 12,294 -25% 16,318 -39% 26,698
Data services 39,717 -23% 51,579 75% 29,470
------------ ----------- ----------
226,640 -7% 243,977 30% 187,008
Intersegment revenue* (3,249) 2% (3,185) 13% (2,817)
------------ ----------- ----------
$ 223,391 -7% $ 240,792 31% $ 184,191
============ =========== ==========
* Intersegment revenue represents revenue received by ELI from our ILEC
operations related to network services provided by ELI.
Revenue (before intersegment revenue eliminations) decreased $17.3 million, or
7%, in 2001 and increased $57.0 million, or 30%, in 2000. The decline in revenue
for 2001 is primarily due to a downturn in economic conditions that affected
internet service providers and related businesses; a decline in data services
due to the expiration of a material contract; and a decrease in reciprocal
compensation.
Included in revenue for the year ended December 31, 2001 is approximately $4.0
million of revenue representing a "net settlement" of past billing disputes
between ELI and Qwest. Additionally, ELI is currently providing service to
customers that have filed for protection under Chapter 11 of the bankruptcy
code. Of ELI's largest twenty-five customers, two customers are under Chapter 11
protection. These customers contributed approximately $0.3 million of revenue
monthly.
27
Network services revenue increased $23.9 million, or 31%, in 2001 and $24.2
million, or 45%, in 2000. Network services include Private Line Interstate (Long
Haul) and Private Line Intrastate (MAN). The increase is primarily due to
continued growth in our network and sales of additional circuits for MAN
services.
Revenue for 2001 and 2000 from Long Haul services increased $3.9 million,
or 10%, and $12.0 million, or 43%, respectively.
Revenue for 2001 and 2000 from MAN services increased $20.0 million, or
54%, and $12.2 million, or 48%, respectively.
Local telephone services revenue decreased $25.4 million, or 26%, in 2001 and
increased $21.1 million, or 27%, in 2000. Local telephone services include dial
tone, ISDN PRI, carrier access billings and reciprocal compensation.
($ In thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ------------ -------- ----------
ISDN PRI $ 27,299 -19% $ 33,846 53% $ 22,160
Dial tone 16,730 -13% 19,208 40% 13,746
Carrier access billings 7,934 18% 6,714 -4% 7,020
Reciprocal compensation 21,328 -45% 38,875 12% 34,665
------------ ----------- ----------
$ 73,291 -26% $ 98,643 27% $ 77,591
============ =========== ==========
ISDN PRI revenue decreased $6.5 million, or 19%, in 2001 and increased
$11.7 million, or 53%, in 2000. The 2001 decrease in ISDN PRI revenue is
primarily due to the bankruptcy of two customers and decreased revenue
resulting from less demand for ISDN PRI trunks servicing internet routers.
In addition, average access line equivalents decreased 19,245, or 10%, in
2001 compared to 2000. The 2000 increase in ISDN PRI revenue is a result of
an increase in the average access line equivalents of 64,206, or 46% in
2000 over 1999.
Dial tone revenue decreased $2.5 million, or 13%, in 2001 and increased
$5.4 million, or 40%, in 2000. The 2001 decrease is primarily due to the
bankruptcy of two customers and decreased installation fees resulting from
fewer new customers. In addition, average access line equivalents decreased
19,245, or 10% in 2001 compared to 2000. The 2000 increase in dial tone
revenue is the result of an increase in the average access line equivalents
of 64,206, or 46% in 2000 over 1999.
Carrier access billings revenue increased $1.2 million, or 18%, in 2001 and
decreased $0.3 million, or 4%, in 2000. The increase in 2001 is primarily
due to the settlement of disputes with two major customers partially offset
by the effects of a 12% decrease in average rates per minute. The decrease
in 2000 compared to 1999 is due to an increase in average monthly minutes
processed of 15 million, or 77%, offset by the effects of lower average
rates per minute primarily due to competitive pressures in the markets in
which we operate.
Reciprocal compensation revenue decreased $17.5 million, or 45%, in 2001
and increased $4.2 million, or 12%, in 2000. The decrease in 2001 is
primarily due to a 19% decrease in average rates per minute and a 14%
decrease in average monthly minutes processed of 158 million. The decrease
in average minutes is primarily due to less termination-generated minutes
from ISDN-PRI. The increase for 2000 over 1999 is due to interconnection
agreements being in place with Verizon and PacBell during all of 2000 that
were not in place for all 12 months in 1999.
ELI has various interconnection agreements with Qwest (formerly U S WEST),
Verizon (formerly GTE) and SBC (PacBell) and Sprint, the ILECs in the
states in which it operates. These agreements govern reciprocal
compensation relating to the transport and termination of traffic between
the ILEC's networks and ELI's network. The FCC set transitional rates for
reciprocal compensation that exceeds a 3:1 ratio of inbound to outbound
traffic. The rate for above ratio traffic is capped at .15 cents per minute
for the first six months after the effective date of the commission order,
.10 cents per minute for the next 18 months and .07 cents per minute after
that, through June 2004. Below ratio traffic remains at the state
established rate level which is generally higher. Implementation of the
FCC's transitional rates for ISP-bound traffic is taking place via
amendments to existing interconnection agreements. The effect of
implementing the FCC transitional rates resulted in a reduction of the
composite rate of .088 cents per minute, or 43%, from .203 cents per minute
for the six months ended June 30, 2001 to .115 cents per minute. The
Verizon interconnection agreements expired in May and June 2001 for
Washington and Oregon, respectively. We are currently negotiating
agreements with PacBell and Verizon. The existing terms of the
interconnection agreements remain in place during the negotiations. As a
result of recent FCC mandates, we do not anticipate that renewal of the
interconnection agreements will be at terms as favorable to ELI as in the
past.
28
Long distance services revenue decreased $4.0 million, or 25%, in 2001 and $10.4
million, or 39%, in 2000. Long distance services include retail long distance,
wholesale long distance and prepaid services.
Retail long distance decreased $0.6 million, or 7%, in 2001 and increased
$2.3 million, or 35%, in 2000. The 2001 decrease is primarily due to a
decrease in average rates per minute of 6%, partially offset by a 1%
increase in average monthly minutes processed. The increase in 2000 over
1999 is due to an increase in average monthly minutes processed of 3.1
million, or 47% partially offset by lower average rates per minute.
Wholesale long distance decreased $2.4 million, or 39%, in 2001 and
increased $0.1 million, or 2%, in 2000. The decrease in 2001 is primarily
due to a decrease in average monthly minutes processed of 4.8 million, or
28%, as a result of less wholesale long-distance customers. We intend to
focus on higher-margin retail long-distance customers. A decrease of 16% in
the average rate per minute also contributed to the decrease in 2001. The
increase in 2000 is due to an increase in average monthly minutes processed
of 0.9 million, or 6% partially offset by lower average rates per minute.
Prepaid services revenue decreased $1.0 million, or 99%, in 2001 and $12.8
million, or 93%, in 2000. The decreases are attributable to our decision to
exit the prepaid services market in the third quarter of 1999.
Data services include Internet, RSVP and other services. Data services revenue
decreased $11.9 million, or 23%, in 2001 primarily due to loss of a contract
with a significant customer. Data services revenue increased $22.1 million, or
75%, in 2000 primarily due to revenue from the 18-month contract.
GAS REVENUE
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ----------- --------- ----------
Gas revenue $ 411,534 10% $ 374,751 22% $ 306,986
Gas revenue increased $36.8 million, or 10%, in 2001 primarily due to higher
purchased gas costs passed on to customers and increased consumption partially
offset by decreased revenue due to the sale of our Louisiana and Colorado gas
operations. Included in gas revenue for 2001, 2000 and 1999 is approximately
$218.8 million, $232.3 million and $175.4 million, respectively, of revenue from
our Louisiana and Colorado gas operations that will not continue since the sales
closed July 2, 2001 and November 30, 2001, respectively. Gas revenue increased
$67.8 million, or 22%, in 2000 primarily due to higher purchased gas costs
passed on to customers partially offset by a $27 million settlement of a
proceeding with the Louisiana Public Service Commission during the fourth
quarter of 2000. Under tariff provisions, increases in our costs of gas
purchased are largely passed on to customers.
ELECTRIC REVENUE
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ------------- ------- ----------
Electric revenue $ 228,015 2% $ 223,072 9% $ 203,822
Electric revenue increased $4.9 million, or 2%, in 2001 primarily due to
customer growth and increased consumption due to warmer weather conditions.
Electric revenue increased $19.3 million, or 9%, in 2000, primarily due to
higher supplier prices passed on to customers and increased consumption. Under
tariff provisions, increases in our costs of electric energy and fuel oil
purchased are largely passed on to customers.
29
COST OF SERVICES
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ------------- ------- ----------
Gas purchased $ 282,061 23% $ 229,538 50% $ 152,667
Electric energy and fuel oil
purchased 123,223 8% 113,965 16% 98,533
Network access 197,018 40% 141,165 -5% 148,798
Intersegment expense* (2,924) -2% (2,995) 6% (2,817)
------------ ----------- ----------
$ 599,378 24% $ 481,673 21% $ 397,181
============ =========== ==========
* Intersegment expenses represented expenses incurred by our ILEC operations
related to network services provided by ELI.
Gas purchased increased $52.5 million, or 23%, in 2001 primarily due to higher
purchased gas costs partially offset by decreased gas purchased due to the sale
of our Louisiana and Colorado gas operations. Included in gas purchased for
2001, 2000 and 1999 is approximately $173.3 million, $151.4 million and $94.3
million, respectively, of gas purchased by our Louisiana and Colorado gas
operations that will not continue since the sales closed July 2, 2001 and
November 30, 2001, respectively. Gas purchased increased $76.9 million, or 50%,
in 2000 primarily due to higher purchased gas costs. Under tariff provisions,
increases in our costs of gas purchased are largely passed on to customers.
Electric energy and fuel oil purchased increased $9.3 million, or 8%, in 2001
primarily due to higher purchased power prices, customer growth and increased
consumption due to warmer weather conditions. Electric energy and fuel oil
purchased increased $15.4 million, or 16%, in 2000 primarily due to higher
supplier prices and increased consumption. Under tariff provisions, increases in
our costs of electric energy and fuel oil purchased are largely passed on to
customers. Gas, electric energy and fuel oil purchased excludes amounts deferred
for future recovery in rates.
During the past two years, the power supply costs have fluctuated substantially
forcing companies in some cases to pay higher operating costs to operate their
electric businesses. In Arizona, excessive power costs charged by our power
supplier in the amount of approximately $100 million through December 31, 2001
have been incurred. We are allowed to recover these charges from ratepayers
through the Purchase Power Fuel Adjustment clause. However, in an attempt to
limit "rate shock" to our customers, we requested in September 2001 that this
amount, plus interest, be recovered over a seven-year period. As a result, we
have deferred these costs on the balance sheet in anticipation of recovery
through the regulatory process. We anticipate a determination regarding recovery
to be made in 2002.
On July 16, 2001, we terminated our existing contract with Arizona Public
Service and entered into a new seven-year purchase power agreement. This
agreement allows us to purchase all power required for operations at a fixed
rate per kilowatt hour. This agreement is retroactive to June 1, 2001 and will
mitigate further increases in the deferred power cost account.
Network access expenses increased $55.9 million, or 40%, in 2001 primarily due
to the impact of the Acquisitions, increased circuit expense associated with
additional data product introductions and an Internet remote call forwarding
adjustment partially offset by a reduction in long distance access expense
related to rate changes in the ILEC sector and reduced network access expenses
at ELI. Network access expense decreased $7.6 million, or 5%, in 2000 primarily
due to a reduction in costs related to the 2000 exit of ELI's prepaid services
business, partially offset by increased costs related to increased revenue
growth and network expansion at ELI.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ------------- ------- ----------
Depreciation expense $ 488,424 32% $ 369,930 20% $ 307,428
Amortization expense 143,912 714% 17,677 541% 2,757
------------ ----------- ----------
$ 632,336 63% $ 387,607 25% $ 310,185
============ =========== ==========
30
Depreciation expense increased $118.5 million, or 32%, in 2001 primarily due to
the impact of the Acquisitions of $119.1 million and $22.0 million of
accelerated depreciation related to the change in useful lives of our accounting
and human resource systems and our Plano, Texas office building, furniture and
fixtures as a result of our restructuring. The accelerated depreciation will
continue over the next six months. The incremental increase to depreciation is
estimated to be $11.9 million and $.9 million for the first quarter of 2002 and
second quarter of 2002, respectively. Higher property, plant and equipment
balances in the telecommunications and ELI sectors also contributed to the
increase. The increases were partially offset by decreased depreciation expense
related to our classifying our gas and electric sectors as "assets held for
sale" which requires us to cease depreciating these assets. Such depreciation
expense would have been an additional $50.8 million for the year ended December
31, 2001. The increase is also offset by $17.4 million in the prior year period
of accelerated depreciation related to the change in useful life of an operating
system in the telecommunications sector.
Depreciation expense increased $62.5 million, or 20%, in 2000 primarily due to
higher plant in service balances for newly completed communications network
facilities and electronics at ELI, increased property, plant and equipment, the
impact of the Acquisitions of $14.6 million and an increase of $12.6 million in
accelerated depreciation related to the change in useful life of an operating
system in the ILEC sector. Depreciation expense was partially offset by $6.8
million of decreased depreciation expense resulting from the classification of
our gas sector as "assets held for sale." Depreciation on gross gas property,
plant and equipment was discontinued effective October 1, 2000.
Amortization expense increased $126.2 million, or 714%, in 2001 and $14.9
million, or 541%, in 2000 primarily due to amortization of intangibles related
to the Acquisitions of $125.6 million and $13.6 million, respectively.
OTHER OPERATING EXPENSES
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ------------- ------- ----------
Operating expenses $ 724,074 21% $ 597,274 -7% $ 642,300
Taxes other than income taxes 109,478 9% 100,101 -2% 102,357
Sales and marketing 96,778 30% 74,622 15% 64,645
------------ ----------- ----------
$ 930,330 21% $ 771,997 -5% $ 809,302
============ =========== ==========
Operating expenses increased $126.8 million, or 21%, in 2001 primarily due to
the impact of the Acquisitions. The increase was partially offset by decreased
operating expenses at ELI primarily due to a reduction in personnel, decreased
operating expenses in the gas sector primarily due to the sale of the Louisiana
and Colorado gas operations and a decrease in compensation expense related to
variable stock plans. A $1.00 change in our stock price can impact compensation
expense by $1.0 million annually.
Operating expenses decreased $45.0 million, or 7%, in 2000 primarily due to the
following items which were incurred in 1999: asset impairment charges of $36.1
million related to the discontinuation of the development of certain operational
systems and certain regulatory assets deemed to be no longer recoverable, Y2K
expenses of $17.3 million, restructuring charges related to our corporate office
of $5.2 million, costs associated with an executive retirement agreement of $6.0
million and separation costs of $4.6 million. The 2000 amount also decreased due
to $5.1 million of various expense reductions in the ILEC sector resulting from
outsourcing and productivity enhancements. The decreases were partially offset
by $15.1 million of increased operating expenses in 2000 related to the
Acquisitions, increased operating costs of $11.0 million at ELI to support the
expanded delivery of services and legal fees in the gas sector of $2.7 million
associated with the settlement of a proceeding with the Louisiana Public Service
Commission during the fourth quarter of 2000.
Taxes other than income increased $9.4 million, or 9%, in 2001 primarily due to
the impact of the Acquisitions. Taxes other than income taxes decreased $2.3
million, or 2%, in 2000 primarily due to decreased payroll taxes resulting from
a reduction in headcount in the gas and electric sectors, a payroll tax
adjustment in the gas sector in 2000 and a reduction in property taxes.
31
Sales and marketing expenses increased $22.2 million, or 30%, in 2001 primarily
due to the impact of the Acquisitions and increased telemarketing costs in the
telecommunications sector. Sales and marketing expenses increased $10.0 million,
or 15%, in 2000 primarily due to the impact of the Acquisitions and increased
costs associated with new product offerings in the ILEC sector partially offset
by headcount reductions resulting from exiting ELI's prepaid services business
in 1999.
WRITE-DOWN OF GLOBAL CROSSING RECEIVABLES / RESTRUCTURING EXPENSES /
ACQUISITION ASSIMILATION EXPENSE
($ in thousands) 2001 2000 1999
------------ --------- -----------
Amount Amount Amount
------------ --------- -----------
Write-down of Global receivables $ 21,200 $ - $ -
Restructuring expenses $ 19,327 $ (649) $ 7,292
Acquisition assimilation expense $ 21,380 $ 39,929 $ 3,916
Concurrent with the acquisition of Frontier, we entered into several operating
agreements with Global. The write-down of the net realizable value of Global
Crossing receivables of $21.2 million for the year ended December 31, 2001 is a
result of Global's filing for bankruptcy. We are integrating the Frontier
acquisition from Global and have ongoing commercial relationships with Global
affiliates. We will reserve a total of $30 million of Global receivables to
reflect our best estimate of the net realizable value of receivables incurred
from these commercial relationships during 2001 and 2002. We recorded a write
down of such receivables in the amount of $21.2 million in the fourth quarter of
2001, with the remainder recorded in the first quarter of 2002 for receivables
generated after December 31, 2001 and prior to the Global bankruptcy filing on
January 28, 2002. Prior to the date of filing we provided ordinary course
telecommunications services as well as transitional services to Global. Global
has provided us certain customer billing and collection functions as well as
other transitional services. These arrangements have continued after the
bankruptcy filing. The receivables that were outstanding at the date of Global's
bankruptcy filings are subject to potential setoff rights and will be treated as
any other general creditor through the bankruptcy process, including through a
potential chapter 11 plan of reorganization. The Bankruptcy Court has granted
relief to us and other telecommunications companies that provide service to
Global by, among other things, directing a shortened payment period with respect
to post-petition invoices, an expedited court process for post-petition defaults
in payments by Global, and a priority for post-petition expense items over other
unsecured debt. These procedures should minimize future economic loss to the
company although we cannot guarantee that such losses will not occur.
Restructuring expenses of $19.3 million for the year ended December 31, 2001 are
primarily related to our plan to close our operations support center in Plano,
Texas by April 2002 and our Sacramento, California call center by March 2002 and
ELI's decision to exit certain long haul markets. These restructurings are a
result of our evaluation of our facilities to take advantage of operational and
functional synergies.
Plano Restructuring
In the second quarter of 2001, we approved a plan to close our operations
support center in Plano, Texas by April 2002. In connection with this plan,
we recorded a pre-tax charge of $14.5 million in other operating expenses
in 2001. Our objective is to concentrate our resources in areas where we
have the most customers, to better serve those customers. We intend to sell
our Plano office building. The restructuring resulted in the reduction of
750 employees. We communicated with all affected employees during July
2001. Certain employees will be relocated, others have been offered
severance, job training and/or outplacement counseling. As of December 31,
2001, approximately $1.7 million was paid and 161 employees were
terminated. The restructuring expenses primarily consist of severance
benefits, retention earned through December 31, 2001, early lease
termination costs and other planning and communication costs. We expect to
incur additional costs of approximately $1.4 million through the second
quarter of 2002.
Sacramento Call Center Restructuring
In the fourth quarter of 2001, we approved a plan to close our Sacramento
Customer Care Center by the end of March 2002. In connection with this
plan, we recorded a pre-tax charge of approximately $0.7 million in
restructuring expenses in the fourth quarter of 2001. We will redirect the
call traffic and other work activities to our Kingman, Arizona call center.
This restructuring resulted in the reduction of 94 employees. We
communicated with all affected employees during November 2001. These costs
are expected to be paid in the first quarter 2002.
32
ELI Restructuring
In the first half of 2002, ELI intends to redeploy the internet routers,
frame relay switches and ATM switches from the Atlanta, Cleveland, Denver,
Philadelphia and New York markets to other locations in ELI's network. ELI
intends to cease leasing the collocation facilities and off-net circuits
for the backbone and local loops supporting the service delivery in these
markets. It is anticipated that this will lead to $4.2 million of
termination fees which have been accrued for but not paid for the year
ended December 31, 2001.
Restructuring expenses of $7.3 million for the year ended December 31, 1999 were
related to our plan to restructure our corporate office activities of $5.8
million and exit costs at ELI of $1.5 million. In connection with the corporate
office plan, we recorded a pre-tax charge of $5.8 million in restructuring
expenses in the fourth quarter of 1999. The restructuring resulted in the
reduction of 49 corporate employees. All affected employees were communicated
with in the early part of November 1999. As of December 31, 2001, approximately
$4.4 million has been paid, 42 employees were terminated and 6 employees who
were expected to be terminated took other positions within the company. The
remaining employee was terminated in January 2002. At December 31, 2001 and
2000, we adjusted our original accrual down by $.1 million and $1.0 million,
respectively, and the remaining accrual of $.2 million is included in other
current liabilities at December 31, 2001. These costs will be paid in the first
quarter 2002.
In the third quarter of 1999, ELI announced two strategic decisions that led to
$1.5 million in exit costs. On August 24, 1999, ELI announced that it was
eliminating its prepaid calling card and videoconferencing products, effective
November 1, 1999. This initiative was taken as a result of ELI's decision to
focus on its core business strategy. Prepaid calling cards are a high-volume,
low-margin product that ELI determined did not support its strategy of
accelerating profitability. On September 1, 1999, ELI announced that it was
consolidating its national retail sales efforts in Dallas and closing six retail
sales offices in the eastern United States by October 8, 1999. ELI has
maintained all of its data points-of-presence and wholesale sale offices. As a
result of both of these decisions, ELI eliminated 63 sales and sales support
positions, and incurred charges relating to employee severance and facility
shutdown costs. As of December 31, 2000, all costs associated with this decision
were paid and no accrual remained.
Acquisition assimilation expense of $21.4 million and $39.9 million, in 2001 and
2000, respectively, is related to the completed acquisitions. These expenses
represent incremental costs incurred by us in advance of the respective
acquisitions which are solely related to preparation for businesses to be
acquired and have no relationship with then existing operations, and as a
result, have no revenue offset. Costs incurred during 2001 and 2000 were
significant due to the unprecedented level of acquisitions. Material components
of acquisition expenses include incremental pre-staffing and training costs
incurred in anticipation of acquisitions, incremental costs associated with the
integration of the acquired networks into our existing networks and network
operating center, and costs associated with the preparation for the conversion
of billing, accounting and plant records.
INCOME FROM OPERATIONS
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ------------- ------- ----------
Income from operations $ 233,042 91% $ 121,801 73% $ 70,360
Income from operations increased $111.2 million, or 91%, in 2001 primarily due
to the impact of the Acquisitions and decreased depreciation expense related to
our classifying our gas and electric sectors as "assets held for sale" which
requires us to cease depreciating these assets. Such depreciation expense would
have been an additional $50.8 million for the year ended December 31, 2001. The
increase was partially offset by the write-down of our Global Crossing
receivables, restructuring expenses and increased ELI losses. Included in
operating income is approximately $10.4 million and $21.1 million of operating
income for the years ended December 31, 2001 and 2000, respectively, from our
Louisiana and Colorado gas operations that will not continue since the sales
closed on July 2, 2001 and November 30, 2001, respectively. Income from
operations increased $51.4 million, or 73%, in 2000 primarily due to the
Acquisitions, decreased ELI operating losses and decreased operating expenses,
partially offset by increased acquisition assimilation expense, the settlement
of a proceeding with the Louisiana Public Service Commission and increased
depreciation expense. Income from operations for 1999 included a $10.4 million
USF settlement.
33
INVESTMENT INCOME (LOSS), NET/OTHER LOSS, NET/GAIN ON SALE OF ASSETS /
MINORITY INTEREST/INTEREST EXPENSE/INCOME TAX EXPENSE (BENEFIT)
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ------------- ------- ----------
Investment income (loss), net $ (62,408) -1418% $ 4,736 -98% $ 243,885
Other loss, net $ (3,133) 126% $ (1,386) -1475% $ (88)
Gain on sale of assets $ 139,304 100% $ - - $ -
Minority interest $ - -100% $ 12,222 -47% $ 23,227
Interest expense $(379,326) 102% $(187,366) 57% $(119,675)
Income tax expense (benefit) $ (14,805) -8% $ (16,132) -122% $ 74,900
Investment income decreased $67.1 million in 2001 primarily due to the
recognition of a $79.0 million loss resulting from a decline in value of our
Adelphia investment. The decrease was partially offset by increased income from
higher money market balances resulting from the temporary investment of proceeds
from debt issuances. Investment income decreased $239.1 million, or 98%, in 2000
primarily due to the $69.5 million gain on the sale of our investment in
Centennial Cellular Corp. in January 1999, the $67.6 million gain on the sale of
our investment in Century Communication Corp. in October 1999 and the $83.9
million gain on the sale of our investment in the cable joint venture in October
1999. The remaining decrease is primarily due to realized losses of $18.3
million on sales of available for sale securities to partially fund
acquisitions.
Other loss, net increased $1.7 million, or 126%, in 2001 primarily due to a
decrease in miscellaneous income and the allowance for funds used during
construction (AFUDC). Other loss, net decreased $1.3 million, or 1,475%, in 2000
primarily due to a decrease in AFUDC resulting from our conclusion in the third
quarter of 2001 that SFAS 71 was no longer applicable to our ILEC businesses
(see "Discontinuation of SFAS 71").
Gain on sale of assets for the year ended December 31, 2001 represents the gain
recognized from the sale of our Louisiana gas operations to Atmos Energy
Corporation on July 2, 2001.
Minority interest represents the minority's share of ELI's net loss. Since ELI's
public offering, we recorded minority interest on our income statement and
reduced minority interest on our balance sheet by the amount of the minority
interests' share of ELI's losses. As of June 30, 2000, the minority interest on
the balance sheet had been reduced to zero, therefore, from that point going
forward, we discontinued recording minority interest income on our income
statement as there is no obligation for the minority interests to provide
additional funding for ELI. Therefore, we are reflecting ELI's entire loss in
our consolidated results.
Interest expense increased $192.0 million, or 102%, in 2001 primarily due to
$94.4 million of interest expense on our $1.75 billion of notes issued in May
2001, $52.3 million of interest expense on our $1.75 billion of notes issued in
August 2001, $16.6 million of interest expense on our equity units issued in
June, $15.9 million of increased interest expense on our lines of credit, $8.3
million of increased amortization of debt discount expense and a $6.5 million
increase in amortization of costs associated with our committed bank credit
facilities. During the year ended December 31, 2001, we had average long-term
debt outstanding of $4.5 billion compared to $2.6 billion during the year ended
December 31, 2000. Our composite average borrowing rate paid for the year ended
December 31, 2001 as compared with the year ended December 31, 2000 was 49 basis
points higher, increasing from 6.85% to 7.34%, due to the impact of higher
interest rates on our new borrowings.
Interest expense increased $67.7 million, or 57%, in 2000 primarily due to a
$24.8 million increase in ELI's interest expense related to increased borrowings
and higher interest rates, $17.8 million increase due to an increase in our
commercial paper outstanding used to partially and temporarily fund acquisitions
and $14.9 million for amortization of costs associated with our committed bank
credit facilities. A reduction in capitalized interest of $4.0 million due to
lower average capital work in process balances at ELI also contributed to the
increase. During the year ended December 31, 2000, we had average long-term debt
outstanding of $2.6 billion compared to $2.0 billion during the year ended
December 31, 1999.
Income tax expense (benefit) decreased $1.3 million, or 8%, in 2001 primarily
due to changes in taxable income (loss) and the write-off of regulatory assets
related to our sale of our Louisiana gas operations. The estimated annual
effective tax rate for 2001 is 20.4% as compared with an effective tax rate of
32.3% for 2000. Income tax expense (benefit) decreased $91.0 million, or 122%,
in 2000 as compared to 1999 primarily due to changes in taxable income and taxes
on the gains on the sales of our investments in 1999. The estimated annual
effective tax benefit rate for 2000 was 32.3% as compared with an effective tax
rate of 34.4% for 1999.
34
DISCONTINUED OPERATIONS
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ------------- ------- ----------
Revenue $ 116,868 11% $ 105,202 3% $ 102,408
Operating income $ 37,211 36% $ 27,415 38% $ 19,887
Net income $ 17,875 53% $ 11,677 48% $ 7,887
Discontinued operations represents the operations of our water/wastewater
businesses sold in January 2002.
Revenue from discontinued operations increased $11.7 million, or 11%, in 2001
and $2.8 million, or 3%, in 2000 primarily due to increased consumption and
customer growth. The 2001 increase is also due to new water sales related to the
completion of a multi-year $50 million water pipeline project in Illinois in
March 2001. This increase of revenue was approximately $8 million.
Operating income from discontinued operations increased $9.8 million, or 36%, in
2001 primarily due to customer growth and the completion of a water pipeline
project in Illinois in March 2001. Operating income from discontinued operations
increased $7.5 million, or 38%, in 2000 primarily due to increased revenue,
decreased Y2K expenses, decreased corporate overhead charges and lower payroll
costs due to a reduction in the staffing levels of support functions, partially
offset by increased depreciation expense due to increased property, plant and
equipment.
Net income from discontinued operations increased $6.2 million, or 53%, in 2001
and $3.8 million, or 48%, in 2000, primarily due to the respective changes in
operating income net of income taxes.
EXTRAORDINARY EXPENSE
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ------------- ------- ----------
Extraordinary expense - discontinuation
of Statement of Financial Accounting
Standards No. 71, net of tax $ 43,631 100% $ - - $ -
Extraordinary expense - discontinuation of Statement of Financial Accounting
Standards No. 71, net of tax, of $43.6 million for the year ended December 31,
2001, relates to the write off of regulatory assets and liabilities previously
recognized under SFAS 71. Deregulation of most of our local exchange telephone
properties required us to cease application of SFAS 71 in the third quarter,
resulting in a non-cash extraordinary charge of $43.6 million, net of tax, in
our income statement. See discussion in Note 20 of the financial statements.
NET INCOME (LOSS) / AVAILABLE TO COMMON SHAREHOLDERS
AVAILABLE TO COMMON SHAREHOLDERS PER COMMON SHARE
($ in thousands) 2001 2000 1999
---------------------- ---------------------- ----------
Amount % Change Amount % Change Amount
------------ --------- ----------- --------- ----------
Net income (loss) $ (89,682) -216% $ (28,394) -120% $ 144,486
Carrying cost of equity forward contracts 13,650 N/A - N/A -
------------ ----------- ----------
Available to common shareholders $ (103,332) -264% $ (28,394) -120% $ 144,486
============ =========== ==========
Available to common shareholders per
common share $ (0.38) -245% $ (0.11) -120% $ 0.56
35
Net income and net income per share for 2001 were impacted by the following
after-tax items: the gain from the sale of our Louisiana gas operations of $86.0
million, or 31(cent) per share, the recognition of a loss resulting from the
decline in value of our Adelphia investment of $48.8 million, or 18(cent) per
share, extraordinary expense of $43.6 million, or 16(cent) per share, the
write-down of our Global receivables of $13.1 million, or 5(cent) per share, and
restructuring charges of $11.9 million, or 4(cent) per share. Increased interest
expense also contributed to the decrease in net income as compared to the prior
year.
Net loss and net loss per share for 2000 were impacted by the following after
tax-items: assimilation expenses of $24.6 million, or 9(cent) per share, the
settlement of a proceeding with the Louisiana Public Service Commission of $18.4
million, or 7(cent) per share, accelerated depreciation to change the useful
life of an operating system in the ILEC sector of $7.8 million, or 3(cent) per
share, and the impact of the acquisitions of $6.9 million, or 3(cent) per share.
Net income and net income per share for 1999 were impacted by the following
after-tax items: gains on the sales of investments of $136.4 million, or
52(cent) per share, asset impairment charges of $22.3 million, or 9(cent) per
share, an executive retirement agreement of $4.1 million, or 2(cent) per share,
restructuring charges of $3.6 million, or 1(cent) per share, separation costs of
$3.1 million, or 1(cent) per share, accelerated depreciation of $3 million, or
1(cent) per share, and pre-acquisition integration costs of $2.4 million, or
1(cent) per share. 1999 net income and net income per share were also impacted
by after-tax net losses from ELI of $54.1 million, or 21(cent) per share and
after-tax Y2K costs of $12.2 million, or 5(cent) per share.
During 2000, we entered into an equity forward contract for the acquisition of
9,140,000 shares as part of our share repurchase programs. Pursuant to
transition accounting rules, commencing December 31, 2000 through June 30, 2001
we were required to report our equity forward contract as a reduction to
shareholders' equity and a component of temporary equity for the gross
settlement amount of the contract ($150,013,000). On June 28, 2001, we entered
into a master confirmation agreement that amended the equity forward contract to
no longer permit share settlement of the contract. We were required to report
the accrued carrying costs as a reduction of net income available to common
shareholders. In 2001 we settled the contract by paying the redemption amount of
$150,013,000 plus $13,650,000 in associated carrying costs.
36
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities. Market risk refers to the
potential change in fair value of a financial instrument as a result of
fluctuations in interest rates and equity and commodity prices. We do not hold
or issue derivative instruments, derivative commodity instruments or other
financial instruments for trading purposes. As a result, we do not undertake any
specific actions to cover our exposure to market risks and we are not party to
any market risk management agreements. Our primary market risk exposures are
interest rate risk and equity and commodity price risk as follows:
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest bearing portion of our investment portfolio and 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 and variable rate debt is refinanced when advantageous.
Consequently, we have no material future earnings or cash flow exposures from
changes in interest rates on our long-term debt and capital lease obligations. A
hypothetical 10% adverse change in interest rates would increase the amount that
we pay on our variable obligations and could result in fluctuations in the fair
value of our fixed rate obligations. Based upon our overall interest rate
exposure at December 31, 2001, a near-term change in interest rates would not
materially affect our consolidated financial position, results of operations or
cash flows.
On December 17, 2001, we entered into two interest rate swap agreements with a
subsidiary of Morgan Stanley Dean Witter, each agreement covering a notional
amount of $50 million. Under the terms of both agreements, we make semi-annual,
floating rate interest payments based on six-month LIBOR and receive a fixed
6.375% rate on the notional amount. Under the terms of one swap, the underlying
LIBOR rate is set in advance, while the second agreement utilizes LIBOR reset in
arrears. Both swaps terminate on August 15, 2004 and are being accounted for
under SFAS 133 as fair value hedges against our 6.375% notes due August 15,
2004.
Sensitivity analysis of interest rate exposure
At December 31, 2001, the fair value of our long-term debt and capital lease
obligations was estimated to be approximately $6,030.4 million, based on our
overall weighted average rate of 7.68% and our overall weighted maturity of
approximately 10 years. The weighted average maturity applicable to our
obligations has decreased by two years since December 31, 2000. The overall
weighted average interest rate applicable to our obligations has increased by
approximately 73 basis points since December 31, 2000. A hypothetical increase
of 77 basis points (10% of our overall weighted average borrowing rate) would
result in an approximate $297.2 million decrease in the fair value of our fixed
rate obligations.
Equity Price Exposure
Our exposure to market risk for changes in equity prices relate primarily to the
equity portion of our investment portfolio. The equity portion of our investment
portfolio includes marketable equity securities of media and telecommunications
companies.
Sensitivity analysis of equity price exposure
At December 31, 2001, the fair value of the equity portion of our investment
portfolio was estimated to be $139.2 million. A hypothetical 10% decrease in
quoted market prices would result in an approximate $13.9 million decrease in
the fair value of the equity portion of our investment portfolio.
37
Commodity Price Exposure
We purchase monthly gas future contracts, from time to time, to manage
well-defined commodity price fluctuations, caused by weather and other
unpredictable factors, associated with our commitments to deliver natural gas to
customers at fixed prices. Customers pay for gas service based upon prices that
are defined by a tariff. A tariff is an agreement with the public utility
commission that determines the price that we will charge to the customer.
Fluctuations in gas prices are routinely handled through a pricing mechanism
called the purchase gas adjustor (PGA). The PGA allows for a process whereby any
price change from the agreed upon tariff will be settled as a pass through to
the customer. As a result, if gas prices increase, the PGA will increase and
pass more costs on to the customer. If gas prices decrease, the PGA will
decrease and refunds will be provided to the customer. This commodity activity
relates to our gas businesses and is not material to our consolidated financial
position or results of operations. In all instances we take physical delivery of
the gas supply purchased or contracted for. These gas future contracts and gas
supply contracts are considered derivative instruments as defined by SFAS 133.
However, such contracts are excluded from the provisions of SFAS 133 since they
are purchases made in the normal course of business and not for speculative
purposes. At December 31, 2001, we do not have any gas future contracts.
Disclosure of limitations of sensitivity analysis
Certain shortcomings are inherent in the method of analysis presented in the
computation of fair value of financial instruments. Actual values may differ
from those presented should market conditions vary from assumptions used in the
calculation of the fair value. This analysis incorporates only those exposures
that exist as of December 31, 2001. 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.
38
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
The following documents are filed as part of this Report:
1. Financial Statements, See Index on page F-1.
2. Supplementary Data, Quarterly Financial Data is included in
the Financial Statements (see 1. above).
Item 9. Changes in and Disagreements with Accountants on Accounting and
----------------------------------------------------------------
Financial Disclosure
--------------------
None
PART III
--------
We intend to file with the Commission a definitive proxy statement for the 2002
Annual Meeting of Stockholders pursuant to Regulation 14A not later than 120
days after December 31, 2001. The information called for by this Part III is
incorporated by reference to that proxy statement.
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
---------------------------------------------------------------
(a) The exhibits listed below are filed as part of this Report:
Exhibit
No. Description
- ------- -----------
3.200.1 Restated Certificate of Incorporation of Citizens Communications
Company, as restated May 19, 2000 (incorporated by reference to
Exhibit 3.200.1 to the Registrant's Quarterly Report on Form 10-Q
for the six months ended June 30, 2000, File No. 001-11001).
3.200.2 By-laws of Citizens Communications Company, with all amendments
to July 18, 2000 (incorporated by reference to Exhibit 3.200.2 to
the Registrant's Quarterly Report on Form 10-Q for the nine
months ended September 30, 2000, File No. 001-11001).
4.100.1 Certificate of Trust of Citizens Communications Trust dated as of
April 27, 2001, (incorporated by reference to Exhibit 4.5 of the
Registrant's Amendment No.1 to Form S-3 filed May 7, 2001
(Registration No. 333-58044)
4.100.2 Trust Agreement of Citizens Capital Trust I, dated as of April
27, 2001 (incorporated by reference to Exhibit 4.6 of the
Registrant's Amendment No.1 to Form S-3 filed May 7, 2001
(Registration No. 333-58044)
4.100.3 Form of 2006 Note, (incorporated by reference to Exhibit 4.3 of
the Registrant's Current Report on Form 8-K filed on May 24,
2001, File No. 001-11001)
4.100.4 Form of 2011 Note, (incorporated by reference to Exhibit 4.4 of
the Registrant's Current Report on Form 8-K filed on May 24,
2001, File No. 001-11001)
4.100.5 Warrant Agreement, dated as of June 19, 2001, between Citizens
Communications Company and The Chase Manhattan Bank, as Warrant
Agent, (incorporated by reference to Exhibit 4.1 of the
Registrant's Current Report on Form 8-K filed on May 24, 2001,
File No. 001-11001)
4.100.6 Form of Senior Note due 2006, (incorporated by reference to
Exhibit 4.5 of the Registrant's Current Report on Form 8-K filed
on June 21, 2001, File No. 001-11001)
4.100.7 Form of Equity Unit (included in the Warrant Agreement
incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on June 21, 2001, File No.
001-11001)
4.100.8 Form of Treasury Equity Unit (included in the Warrant Agreement
incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on June 21, 2001, File No.
001-11001)
4.100.9 Form of Senior Note due 2004, due 2008 and due 2031,
(incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on August 22, 2001, File No.
001-11001)
4.200.2 First Supplemental Indenture dated as of January 15, 1996,
between Citizens Utilities Company and Chemical Bank, as
indenture trustee (incorporated by reference to Exhibit 4.200.2
to the Registrant's Form 8-K Current Report filed May 28, 1996,
File No. 001-11001).
39
4.200.3 5% Convertible Subordinated Debenture due 2036 (contained as
Exhibit A to Exhibit 4.200.2), (incorporated by reference to
Exhibit 4.200.2 to the Registrant's Form 8-K Current Report filed
May 28, 1996, File No. 001-11001).
4.200.4 Amended and Restated Declaration of Trust dated as of January 15,
1996, of Citizens Utilities Trust (incorporated by reference to
Exhibit 4.200.4 to the Registrant's Form 8-K Current Report filed
May 28, 1996, File No. 001-11001).
4.200.5 Convertible Preferred Security Certificate (contained as Exhibit
A-1 to Exhibit 4.200.4), (incorporated by reference to Exhibit
4.200.4 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.6 Amended and Restated Limited Partnership Agreement dated as of
January 15, 1996 of Citizens Utilities Capital L.P. (incorporated
by reference to Exhibit 4.200.6 to the Registrant's Form 8-K
Current Report filed May 28, 1996, File No. 001-11001).
4.200.7 Partnership Preferred Security Certificate (contained as Annex A
to Exhibit 4.200.6), (incorporated by reference to Exhibit
4.200.6 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.8 Convertible Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Utilities Company and Chemical
Bank, as guarantee trustee (incorporated by reference to Exhibit
4.200.8 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.9 Partnership Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Utilities Company and Chemical
Bank, as guarantee trustee (incorporated by reference to Exhibit
4.200.9 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.10 Letter of Representations, dated January 18, 1996, from Citizens
Utilities Company and Chemical Bank, as trustee, to DTC, for
deposit of Convertible Preferred Securities with DTC
(incorporated by reference to Exhibit 4.200.10 to the
Registrant's Form 8-K Current Report filed May 28, 1996, File No.
001-11001).
4.300 Indenture of Securities, dated as of August 15, 1991, to Chemical
Bank, as Trustee (incorporated by reference to Exhibit 4.100.1
to the Registrant's Quarterly Report on Form 10-Q for the nine
months ended September 30, 1991, File No. 001-11001).
4.300.1 First Supplemental Indenture, dated August 15, 1991 (incorporated
by reference to Exhibit 4.100.2 to the Registrant's Quarterly
Report on Form 10-Q for the nine months ended September 30, 1991,
File No. 001-11001).
4.300.2 Second Supplemental Indenture, dated January 15, 1992, to
Chemical Bank, as Trustee (incorporated by reference to Exhibit
4.100.4 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1991, File No. 001-11001).
4.300.3 Third Supplemental Indenture, dated April 15, 1994, to Chemical
Bank, as Trustee (incorporated by reference to Exhibit 4.100.6 to
the Registrant's Form 8-K Current Report filed July 5, 1994, File
No. 001-11001).
4.300.4 Fourth Supplemental Indenture, dated October 1, 1994, to Chemical
Bank, as Trustee (incorporated by reference to Exhibit 4.100.7 to
Registrant's Form 8-K Current Report filed January 3, 1995, File
No. 001-11001).
4.300.5 Fifth Supplemental Indenture, dated as of June 15, 1995, to
Chemical Bank, as Trustee (incorporated by reference to Exhibit
4.100.8 to Registrant's Form 8-K Current Report filed March 29,
1996, File No. 001-11001).
4.300.6 Sixth Supplemental Indenture, dated as of October 15, 1995, to
Chemical Bank, as Trustee (incorporated by reference to Exhibit
4.100.9 to Registrant's Form 8-K Current Report filed March 29,
1996, File No. 001-11001).
4.300.7 Seventh Supplemental Indenture, dated as of June 1, 1996
(incorporated by reference to Exhibit 4.100.11 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996, File No. 001-11001).
4.300.8 Eighth Supplemental Indenture, dated as of December 1, 1996
(incorporated by reference to Exhibit 4.100.12 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996, File No. 001-11001).
4.400 Senior Indenture, dated as of May 23, 2001, between Citizens
Communications Company and The Chase Manhattan Bank, as trustee,
(incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on May 24, 2001, File No.
001-11001)
4.400.1 First Supplemental Indenture to Senior Indenture, dated as of May
23, 2001, (incorporated by reference to Exhibit 4.2 of the
Registrant's Current Report on Form 8-K filed on May 24, 2001,
File No. 001-11001)
4.400.2 Second Supplemental Indenture, dated as of June 19, 2001, to
Senior Indenture, dated as of May 23, 2001, (incorporated by
reference to Exhibit 4.3 of the Registrant's Current Report on
Form 8-K filed on June 21, 2001, File No. 001-11001)
40
4.400.3 Pledge Agreement, dated as of June 19, 2001, among Citizens
Communications Company and The Bank of New York, as Collateral
Agent, Securities Intermediary and Custodial Agent and The Chase
Manhattan Bank, as Warrant Agent, (incorporated by reference to
Exhibit 4.2 of the Registrant's Current Report on Form 8-K filed
on June 21, 2001, File No. 001-11001).
4.400.4 Remarketing Agreement dated June 19, 2001, among Citizens
Communications Company, Morgan Stanley & Co. Incorporated, as
Remarketing Agent, and The Chase Manhattan Bank, as Warrant Agent
and attorney-in-fact for the Holders of the Equity Units,
(incorporated by reference to Exhibit 4.4 of the Registrant's
Current Report on Form 8-K filed on June 21, 2001, File No.
001-11001)
4.400.5 Indenture, dated as of August 16, 2001, between Citizens
Communications Company and The Chase Manhattan Bank, as Trustee,
(incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on August 22, 2001, File No.
001-11001)
10.5 Participation Agreement between ELI, Shawmut Bank Connecticut,
National Association, the Certificate Purchasers named therein,
the Lenders named therein, BA Leasing & Capital Corporation and
Citizens Utilities Company dated as of April 28, 1995, and the
related operating documents (incorporated by reference to
Exhibit 10.5 of ELI's Registration Statement on Form S-1
effective on November 21, 1997, File No. 333-35227).
10.6 Deferred Compensation Plans for Directors, dated November 26,
1984 and December 10, 1984 (incorporated by reference to Exhibit
10.6 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1984, File No. 001-11001).
10.6.2 Non-Employee Directors' Deferred Fee Equity Plan dated as of June
28, 1994, with all amendments to May 5, 1997 (incorporated by
reference to Exhibit A to the Registrant's Proxy Statement dated
April 4, 1995 and Exhibit A to the Registrant's Proxy Statement
dated March 28, 1997, respectively, File No. 001-11001).
10.16.1 Employment Agreement between Citizens Utilities Company and
Leonard Tow, effective July 11, 1996 (incorporated by reference
to Exhibit 10.16.1 to the Registrant's Quarterly Report on Form
10-Q for the nine months ended September 30, 1996, File No.
001-11001).
10.16.2 Employment Agreement between Citizens Communications Company and
Leonard Tow, effective October 1, 2000.
10.16.3 Letter agreement, dated as of October 1, 2000, amending the
employment agreement, effective October 1, 2000, between
Citizens Communications Company and Leonard Tow (incorporated by
reference to Exhibit 10 of the Registrants' Forms S-4/A filed
February 4, 2002, Registration No. 333-69740)
10.17 1992 Employee Stock Purchase Plan (incorporated by reference to
Exhibit 10.17 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1992, File No. 001-11001).
10.18 Amendments dated May 21, 1993 and May 5, 1997, to the 1992
Employee Stock Purchase Plan (incorporated by reference to the
Registrant's Proxy Statement dated March 31, 1993 and the
Registrant's Proxy Statement dated March 28, 1997, respectively,
File No. 001-11001).
10.19 Citizens Executive Deferred Savings Plan dated January 1, 1996
(incorporated by reference to Exhibit 10.19 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999,
File No. 001-11001).
10.20 Citizens Incentive Plan restated as of March 21, 2000
(incorporated by reference to Exhibit 10.19 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999,
File No. 001-11001).
10.23 Credit Facility Agreement between Citizens Communications Company
and Chase Manhattan Bank dated October 27, 2000 (incorporated by
reference to Exhibit 10.23 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 2000, File No.
001-11001).
10.24.1 Indenture from ELI to Citibank, N.A., dated April 15, 1999, with
respect to ELI's 6.05% Senior Unsecured Notes due 2004
(incorporated by reference to Exhibit 10.24.1 of ELI's Annual
Report on Form 10-K for the year ended December 31, 1999, File
No. 0-23393).
10.24.2 First Supplemental Indenture from ELI, Citizens Utilities Company
and Citizens Newco Company to Citibank, N.A. dated April 15,
1999, with respect to the 6.05% Senior Unsecured Notes due 2004
(incorporated by reference to Exhibit 10.24.2 of ELI's Annual
Report on Form 10-K for the year ended December 31, 1999, File
No. 0-23393).
10.24.3 Form of ELI's 6.05% Senior Unsecured Notes due 2004 (incorporated
by reference to Exhibit 10.24.3 of ELI's Annual Report on Form
10-K for the year ended December 31, 1999, File No. 0-23393).
10.25 Asset Purchase Agreements between Citizens Utilities Company and
GTE Corporation dated May 27 and September 21, 1999 (incorporated
by reference to Exhibit 10.25 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1999, File
No. 001-11001).
41
10.26 Asset Purchase Agreements between Citizens Utilities Company
and US West Communications, Inc. dated June 16, 1999
(incorporated by reference to Exhibit 10.26 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999,
File No. 001-11001).
10.27 Asset Purchase Agreements between Citizens Utilities Company and
American Water Works dated October 15, 1999 (incorporated by
reference to Exhibit 10.27 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1999, File No.
001-11001).
10.28 Asset Purchase Agreement between Citizens Utilities Company and
GTE Incorporated dated December 16, 1999 (incorporated by
reference to Exhibit 10.28 to the Registrant's Quarterly Report
on Form 10-Q for the three months ended March 31, 2000, File No.
001-11001).
10.31 Asset Purchase Agreement between Citizens Utilities Company
and Atmos Energy Corporation dated April 13, 2000(incorporated
by reference to Exhibit 10.31 to the Registrant's Quarterly
Report on Form 10-Q for the six months ended June 30, 2000, File
No. 001-11001).
10.32 Stock Purchase Agreement among Citizens Communications Company,
Global Crossing Ltd. and Global Crossing North America, Inc.
dated July 11, 2000 (incorporated by reference to Exhibit 10.32
to the Registrant's Quarterly Report on Form 10-Q for the nine
months ended September 30, 2000, File No. 001-11001).
10.33 2000 Equity Incentive Plan dated May 18, 2000 (incorporated by
reference to Exhibit 10.33 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2000, File No.
001-11001).
10.35 Intercompany Agreement between Citizens Communications Company
and Electric Lightwave, Inc. dated September 11, 2000
(incorporated by reference to Exhibit 10.28 of ELI's Annual
Report on Form 10-K for the year ended December 31, 2000, File
No. 0-23393).
10.36 Loan Agreement between Citizens Communications Company and
Electric Lightwave, Inc. dated October 30, 2000 (incorporated
by reference to Exhibit 10.29 of ELI's Annual Report on Form
10-K for the year ended December 31, 2000, File No. 0-23393).
10.37 Citizens 401(K) Savings Plan effective as of January 1, 1997
reflecting amendments made through April 2001 (incorporated by
reference to Exhibit 10.37 to the Registrant's Quarterly Report
on Form 10-Q for the six months ended June 30, 2001, File No.
001-11001).
10.38 Competitive Advance and Revolving Credit Facility Agreement for
$680,000,000 dated October 24, 2001 (incorporated by reference to
Exhibit 10.38 to the Registrant's Quarterly Report on Form 10-Q
for the nine months ended September 30, 2001, File No.
001-11001).
10.39 Loan Agreement between Citizens Communications Company and Rural
Telephone Finance Cooperative for $200,000,000 dated October 24,
2001 (incorporated by reference to Exhibit 10.39 to the
Registrant's Quarterly Report on Form 10-Q for the nine months
ended September 30, 2001, File No. 001-11001).
12 Computation of ratio of earnings to fixed charges (this
item is included herein for the sole purpose of incorporation
by reference).
21 Subsidiaries of the Registrant
23 Auditors' Consent
Exhibits 10.6, 10.6.2, 10.16.1, 10.16.2, 10.16.3, 10.17, 10.18, 10.19, 10.20,
and 10.33 are management contracts or compensatory plans or arrangements.
We agree to furnish to the Commission upon request copies of the Realty and
Chattel Mortgage, dated as of March 1, 1965, made by Citizens Utilities Rural
Company, Inc., to the United States of America (the Rural Utilities Services and
Rural Telephone Bank) and the Mortgage Notes which that mortgage secures; and
the several subsequent supplemental Mortgages and Mortgage Notes;copies of
separate loan agreements and indentures governing various Industrial Development
Revenue Bonds; copies of documents relating to indebtedness of subsidiaries
acquired during 1996, 1997 and 1998, and copies of the credit agreement between
Electric Lightwave, Inc. and Citibank, N. A. dated November 21, 1997. We agree
to furnish to the Commission upon request copies of schedules and exhibits to
items 10.25, 10.26, 10.27, 10.28, 10.30, 10.31, and 10.32.
42
(b) Reports on Form 8-K:
We filed on Form 8-K on November 13, 2001 under Item 7 "Financial
Statements, Exhibits," a press release announcing earnings for the
quarter and nine months ended September 30, 2001 and certain financial
and operating data.
We filed on Form 8-K/A on December 12, 2001, in respect of our Form
8-K filed on June 12, 2001, under Item 7 "Financial Statements,
Exhibits," certain agreements related to our offering of equity units.
We filed on Form 8-K on December 13, 2001 under Item 5 "Other Events"
and Item 7 "Financial Statements, Pro Forma Financial Information and
Exhibits," pro forma financial information related to the Frontier
business acquired, the Verizon acquisitions, the Qwest acquisition and
the public utilities services dispositions for the period ended
September 30, 2001 and the year ended December 31, 2000.
We filed on Form 8-K/A on December 13, 2001, in respect of our Form
8-K filed September 17, 2001, under Item 5 "Other Events" and Item 7
"Financial Statements, Pro Forma Financial Information and Exhibits,"
revised pro forma financial information related to the Frontier
business acquired, the Verizon acquisitions, the Qwest acquisition and
the public utilities services dispositions for the period ended June
30, 2001 and the year ended December 31, 2000.
We filed on Form 8-K on December 18, 2001 under Item 5 "Other Events"
and Item 7 "Financial Statements, Exhibits," a press release
announcing that pending agreements with Verizon Communications to
acquire approximately 63,000 telephone access lines in Arizona and
California had been terminated effective immediately.
43
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Leonard Tow
----------------
Leonard Tow
Chairman of the Board; Chief Executive Officer;
Chairman of Executive Committee and Director
March 6, 2002
44
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 6th day of March 2002.
Signature Title
--------- ------
/s/ Robert J. Larson Vice President and Chief Accounting Officer
- -----------------------------------------
(Robert J. Larson)
/s/ Norman I. Botwinik Director
- -----------------------------------------
(Norman I. Botwinik)
/s/ Rudy J. Graf Vice Chairman of the Board, President and Chief
- ----------------------------------------- Operating Officer, and Director
(Rudy J. Graf)
/s/ Aaron I. Fleischman Member, Executive Committee and Director
- -----------------------------------------
(Aaron I. Fleischman)
/s/ Stanley Harfenist Member, Executive Committee and Director
- -----------------------------------------
(Stanley Harfenist)
/s/ Andrew N. Heine Director
- -----------------------------------------
(Andrew N. Heine)
/s/ John L. Schroeder Director
- -----------------------------------------
(John L. Schroeder)
/s/ Robert D. Siff Director
- -----------------------------------------
(Robert D. Siff)
/s/ Scott N. Schneider Vice Chairman of the Board, Executive Vice President,
- ----------------------------------------- Chairman of Citizens Capital Ventures and Director
(Scott N. Schneider)
/s/ Robert A. Stanger Member, Executive Committee and Director
- -----------------------------------------
(Robert A. Stanger)
/s/ Edwin Tornberg Director
- -----------------------------------------
(Edwin Tornberg)
/s/ Claire L. Tow Director
- -----------------------------------------
(Claire L. Tow)
45
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index to Consolidated Financial Statements
Item Page
- ---- ----
Independent Auditors' Report F-2
Consolidated balance sheets as of December 31, 2001 and 2000 F-3
Consolidated statements of income (loss) for the years ended
December 31, 2001, 2000 and 1999 F-4
Consolidated statements of shareholders' equity for the years ended
December 31, 2001, 2000 and 1999 F-5
Consolidated statements of comprehensive income (loss) for the years ended
December 31, 2001, 2000 and 1999 F-5
Consolidated statements of cash flows for the years ended
December 31, 2001, 2000 and 1999 F-6
Notes to consolidated financial statements F-7
Financial Statement Schedule:
Independent Auditors' report on Schedule
Schedule II - Valuation and Qualifying Accounts
F-1
Independent Auditors' Report
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited the accompanying consolidated balance sheets of Citizens
Communications Company and subsidiaries as of December 31, 2001 and 2000 and the
related consolidated statements of income (loss), shareholders' equity,
comprehensive income (loss) and cash flows for each of the years in the
three-year period ended December 31, 2001. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Citizens
Communications Company and subsidiaries as of December 31, 2001 and 2000 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.
/S/KPMG LLP
New York, New York
March 6, 2002
F-2
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
($ in thousands)
2001 2000
------------- ------------
ASSETS
Current assets:
Cash $ 57,667 $ 31,223
Accounts receivable, net 311,878 243,304
Short-term investments 158,202 38,863
Other current assets 150,573 52,545
Assets held for sale 1,107,937 1,282,152
Assets of discontinued operations 746,791 717,602
------------- ------------
Total current assets 2,533,048 2,365,689
Property, plant and equipment, net 4,512,038 3,520,712
Intangibles, net 2,978,942 633,268
Investments 141,208 214,359
Regulatory assets - 62,017
Other assets 388,364 158,961
------------- ------------
Total assets $10,553,600 $ 6,955,006
============= ============
LIABILITIES AND EQUITY
Current liabilities:
Long-term debt due within one year $ 483,906 $ 181,014
Accounts payable 239,676 171,002
Income taxes accrued 96,901 3,429
Other taxes accrued 33,637 31,135
Interest accrued 112,282 36,583
Customer deposits 18,246 18,683
Other current liabilities 124,833 69,551
Liabilities related to assets held for sale 218,775 320,166
Liabilities of discontinued operations 238,738 212,499
------------- ------------
Total current liabilities 1,566,994 1,044,062
Deferred income taxes 429,544 451,312
Customer advances for construction and contributions in aid of construction 172,918 205,604
Other liabilities 241,846 108,321
Regulatory liabilities - 12,154
Equity units 460,000 -
Long-term debt 5,534,906 3,062,289
Equity forward contracts - 150,013
Company Obligated Mandatorily Redeemable Convertible Preferred Securities* 201,250 201,250
Shareholders' equity:
Common stock, $.25 par value (600,000,000 authorized shares; 281,289,000 and 262,661,000
outstanding and 292,840,000 and 265,768,000 issued at December 31, 2001 and 2000,
respectively) 73,210 66,442
Additional paid-in capital 1,927,518 1,471,816
Retained earnings 129,864 233,196
Accumulated other comprehensive income 4,907 418
Treasury stock (189,357) (51,871)
------------- ------------
Total shareholders' equity 1,946,142 1,720,001
------------- ------------
Total liabilities and shareholders' equity $10,553,600 $ 6,955,006
============= ============
* Represents securities of a subsidiary trust, the sole assets of which are
securities of a subsidiary partnership, substantially all the assets of
which are convertible debentures of the Company.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-3
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 and 1999
($ in thousands, except for per-share amounts)
2001 2000 1999
-------------- -------------- --------------
Revenue $2,456,993 $ 1,802,358 $ 1,598,236
Operating expenses:
Cost of services 599,378 481,673 397,181
Depreciation and amortization 632,336 387,607 310,185
Other operating expenses 930,330 771,997 809,302
Write-down of Global Crossing receivables 21,200 - -
Restructuring expenses 19,327 (649) 7,292
Acquisition assimilation expense 21,380 39,929 3,916
-------------- -------------- --------------
Total operating expenses 2,223,951 1,680,557 1,527,876
-------------- -------------- --------------
Operating income 233,042 121,801 70,360
Investment income (loss), net (62,408) 4,736 243,885
Gain on sale of assets 139,304 - -
Minority interest - 12,222 23,227
Other loss, net (3,133) (1,386) (88)
Interest expense (379,326) (187,366) (119,675)
-------------- -------------- --------------
Income (loss) from continuing operations before income taxes, dividends
on convertible preferred securities and extraordinary expense (72,521) (49,993) 217,709
Income tax expense (benefit) (14,805) (16,132) 74,900
-------------- -------------- --------------
Income (loss) from continuing operations before dividends
on convertible preferred securities and extraordinary expense (57,716) (33,861) 142,809
Dividends on convertible preferred securities, net of income tax benefit 6,210 6,210 6,210
-------------- -------------- --------------
Income (loss) from continuing operations before extraordinary expense (63,926) (40,071) 136,599
Income from discontinued operations, net of tax 17,875 11,677 7,887
-------------- -------------- --------------
Income (loss) before extraordinary expense (46,051) (28,394) 144,486
Extraordinary expense - discontinuation of Statement of Financial
Accounting Standards No. 71, net of tax 43,631 - -
-------------- -------------- --------------
Net income (loss) $ (89,682) $ (28,394) $ 144,486
============== ============== ==============
Carrying cost of equity forward contracts 13,650 - -
-------------- -------------- --------------
Available for common shareholders $ (103,332) $ (28,394) $ 144,486
============== ============== ==============
Basic income (loss) per common share:
Earnings (loss) from continuing operations $ (0.28) $ (0.15) $ 0.53
Earnings from discontinued operations $ 0.07 $ 0.04 $ 0.03
Extraordinary expense $ (0.16) $ - $ -
Available for common shareholders $ (0.38) $ (0.11) $ 0.56
Diluted income (loss) per common share:
Earnings (loss) from continuing operations $ (0.28) $ (0.15) $ 0.52
Earnings from discontinued operations $ 0.06 $ 0.04 $ 0.03
Extraordinary expense $ (0.16) $ - $ -
Available for common shareholders $ (0.38) $ (0.11) $ 0.55
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
F-4
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 and 1999
($ in thousands, except for per-share amounts)
Accumulated
Common Additional Other Total
Stock Paid-In Retained Comprehensive Treasury Shareholders'
($0.25) Capital Earnings Income (Loss) Stock Equity
---------- ------------ ---------------------------------------------------
Balance January 1, 1999 $ 64,787 $1,554,188 $ 117,104 $ 56,692 $ - $1,792,771
---------- ------------ ------------- ----------- ----------- -----------
Common stock buybacks to fund EPPICS dividends (157) (6,468) - - - (6,625)
Stock plans 638 20,475 - - - 21,113
Stock issuances to fund EPPICS dividends 251 9,708 - - - 9,959
Net income - - 144,486 - - 144,486
Other comprehensive loss, net
of tax and reclassification adjustment - - - (41,769) - (41,769)
---------- ------------ ------------- ----------- ----------- ----------
Balance December 31, 1999 65,519 1,577,903 261,590 14,923 - 1,919,935
---------- ------------ ------------- ----------- ----------- -----------
Acquisitions 28 1,770 - - 1,861 3,659
Treasury stock acquisitions - - - - (49,209) (49,209)
Stock plans 895 42,156 - - (4,523) 38,528
Equity forward contracts - (150,013) - - - (150,013)
Net loss - - (28,394) - - (28,394)
Other comprehensive loss, net
of tax and reclassification adjustment - - - (14,505) - (14,505)
---------- ------------ ------------- ----------- ------------ -----------
Balance December 31, 2000 66,442 1,471,816 233,196 418 (51,871) 1,720,001
---------- ------------ ------------- ----------- ------------ -----------
Stock plans 479 17,449 12,527 30,455
Common stock offering 6,289 283,272 289,561
Equity units offering 4,968 4,968
Settlement of equity forward contracts 150,013 (13,650) (150,013) (13,650)
Net loss (89,682) (89,682)
Other comprehensive income, net of tax 4,489 4,489
---------- ------------ ------------- ----------- ------------ -----------
Balance December 31, 2001 $ 73,210 $1,927,518 $ 129,864 $ 4,907 $ (189,357) $1,946,142
========== ============ ============= =========== ============ ===========
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 and 1999
($ in thousands, except for per-share amounts)
2001 2000 1999
----------- ------------ -----------
Net income (loss) $ (89,682) $ (28,394) $ 144,486
Other comprehensive income (loss), net of tax 4,489 (14,505) (41,769)
----------- ------------ -----------
Total comprehensive income (loss) $ (85,193) $ (42,899) $ 102,717
=========== ============ ===========
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
F-5
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 and 1999
($ in thousands)
2001 2000 1999
-------------- -------------- --------------
Net cash provided by continuing operating activities $ 520,379 $ 299,503 $ 366,017
Cash flows from investing activities:
Acquisitions (3,373,214) (986,213) -
Proceeds from sale of assets 372,335 - -
Capital expenditures (530,714) (536,639) (573,330)
Securities purchased (120,730) (109,985) (1,074,311)
Securities sold 1,434 381,698 1,084,239
Securities matured - 16,072 7,435
ELI share purchases - (38,748) -
Other 639 104 3,027
-------------- -------------- --------------
Net cash used by investing activities (3,650,250) (1,273,711) (552,940)
Cash flows from financing activities:
Short-term debt borrowings/repayments - - (110,000)
Long-term debt borrowings 3,703,483 1,063,158 340,503
Long-term debt principal payments (1,077,931) (46,972) (46,619)
Issuance of equity units 460,000 - -
Debt issuance cost (67,657) - -
Common stock offering 289,561 - -
Issuance of common stock for employee plans 25,411 19,773 21,113
Settlement of equity forward contracts (163,662) - -
Common stock buybacks - (49,209) (6,625)
Customer advances for construction and contributions
in aid of construction (27,816) 30,684 (6,363)
-------------- -------------- --------------
Net cash provided by financing activities 3,141,389 1,017,434 192,009
Cash used by discontinued operations 14,926 (49,328) 131
Increase (decrease) in cash 26,444 (6,102) 5,217
Cash at January 1, 31,223 37,141 31,922
-------------- -------------- --------------
Cash at December 31, $ 57,667 $ 31,223 $ 37,141
============== ============== ==============
Non-cash activities:
Increase in capital lease asset $ 33,985 $ 102,192 $ 60,321
Equity forward contracts - 150,013 -
Issuance of shares for acquisitions - 3,659 -
Issuance of shares for dividends - - 9,959
Debt assumed from acquisitions 117,630 - -
Adelphia investment writedown 79,114 - -
Non-cash restructuring charges - - 36,136
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
F-6
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Description of Business and Summary of Significant Accounting Policies:
-----------------------------------------------------------------------
(a) Description of Business:
-----------------------
Citizens Communications Company and its subsidiaries are referred to
as "we", "us" or "our" in this report. We are a
telecommunications-focused company providing wireline communications
services to rural areas and small and medium-sized towns and cities,
including the Rochester, New York metropolitan area, as an incumbent
local exchange carrier, or ILEC. In addition, we provide competitive
local exchange carrier, or CLEC, services to business customers and to
other communications carriers in certain metropolitan areas in the
western United States through Electric Lightwave, Inc., or ELI, our
85%-owned subsidiary. We also provide public utility services
including natural gas transmission and distribution and electric
transmission and distribution services to primarily rural and suburban
customers in Vermont, Hawaii and Arizona.
On June 29, 2001, we purchased from Global Crossing LTD. (Global
Crossing) 100% of the stock of Frontier Corp.'s (Frontier) local
exchange carrier subsidiaries, which owns approximately 1.1 million
telephone access lines (as of June 29, 2001) in Alabama, Florida,
Georgia, Illinois, Indiana, Iowa, Michigan, Minnesota, Mississippi,
New York, Pennsylvania and Wisconsin (see Note 4).
We have grown from approximately 1 million access lines in 1999 to
approximately 2.5 million access lines in 2001 primarily through
acquisitions. We continually evaluate the possibility of acquiring
additional telecommunications assets. Over the past few years, the
number and size of available telecommunications assets has increased
substantially. Although our primary focus will continue to be the
acquisition of telephone access lines, exchanges and operations that
are proximate to our existing systems or that serve a customer base
large enough for us to operate efficiently, we may also acquire other
telecommunications interests. We expect to have fully integrated our
recent acquisitions with our existing core telephone access line
holdings by the end of June 2002. Of our 2.5 million telephone access
lines, approximately 41% are located in New York State, including the
Rochester metropolitan area. Another 11% are located in Minnesota.
In 1999 we announced plans to divest our public utilities services
segments. Consistent with this effort, during 2001 we sold two of our
natural gas transmission businesses and in January 2002 we sold our
water distribution and wastewater treatment business. We are presently
engaged in the sale of, or are seeking buyers for, our remaining gas
and electric utility services segments. Pending these divestitures, we
continue to provide gas and electric utility services (see Note 6).
We own all of the Class B Common Stock and 27,571,332 shares of Class
A Common Stock of ELI, a facilities-based integrated communications
provider offering a broad range of communications services in the
western United States. This ownership interest represents 85% of the
economic interest and a 96% voting interest. ELI's Class B Common
Stock votes on a 10 to 1 basis with the Class A Common Stock, which is
publicly traded. We also guarantee all of ELI's long-term debt, one of
its capital leases and one of its operating leases, and have committed
to continue to support its cash requirements through March 31, 2003.
ELI is part of our consolidated federal tax return. In order to
maintain that consolidation, we must maintain an ownership and voting
interest in excess of 80%. During 2000, as a result of the exercise of
employee stock options, our ownership interest decreased and we
purchased 2,288,000 shares in the open market to bring our economic
ownership interest back to 85%.
(b) Principles of Consolidation and Use of Estimates:
-------------------------------------------------
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the U.S. (GAAP).
Certain reclassifications of balances previously reported have been
made to conform to current presentation.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the dates of the
financial statements and the reported amounts of revenue and expenses
during the reporting periods. Actual results could differ from those
estimates.
F-7
(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 accrued expenses on our balance sheet and
recognized in revenue over the period that the services are provided.
Revenue that is billed in arrears includes: non-recurring network
access services, switched access services, non-recurring local
services and long-distance services. The earned but unbilled portion
of this revenue is recognized in revenue on our statement of income
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 exceed
installation fee revenue.
ELI - Revenue is recognized when the services are provided. Revenue
from long-term prepaid network services agreements including
Indefeasible Right to Use (IRU) and Fiber swap agreements are deferred
and recognized on a straight-line basis over the terms of the related
agreements. Installation fees and related costs (up to the amount of
installation revenue) are deferred and recognized over the average
customer term. Installation related costs in excess of installation
fees are expensed when incurred.
Public Utilities Services - Revenue is recognized when services are
provided for public utilities services. Certain revenue is based upon
consumption while other revenue is based upon a flat fee. Earned but
unbilled public services revenue is accrued and included in accounts
receivable and revenue.
(d) Construction Costs and Maintenance Expense:
------------------------------------------
Property, plant and equipment are stated at original cost, including
general overhead and an allowance for funds used during construction
(AFUDC) for regulated businesses and capitalized interest for
unregulated telecommunications businesses. Maintenance and repairs are
charged to operating expenses as incurred. The book value, net of
salvage, of routine property, plant and equipment dispositions is
charged against accumulated depreciation for regulated operations.
AFUDC represents the borrowing costs and a return on common equity of
funds used to finance construction of regulated assets subject to SFAS
71 accounting. AFUDC is capitalized as a component of additions to
property, plant and equipment and is credited to income. AFUDC does
not represent current cash earnings; however, under established
regulatory rate-making practices, after the related plant is placed in
service, we are permitted to include in the rates charged for
regulated services a fair return on and depreciation of such AFUDC
included in plant in service. The amount of AFUDC relating to equity
is included in other loss, net ($2,811,000, $3,257,000 and $4,586,000
for 2001, 2000 and 1999, respectively) and the amount relating to
borrowings is included as a reduction of interest expense $3,493,000,
$3,504,000 and $4,206,000 for 2001, 2000 and 1999, respectively).
Capitalized interest for unregulated construction activities amounted
to $5,675,000, $4,766,000 and $8,681,000 for 2001, 2000 and 1999,
respectively.
(e) Regulatory Assets and Liabilities:
---------------------------------
Certain of our local exchange telephone operations were and all of our
public utilities services operations are subject to the provisions of
Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting
for the Effects of Certain Types of Regulation". For these entities,
regulators can establish regulatory assets and liabilities that are
required to be reflected on the balance sheet in anticipation of
future recovery through the ratemaking process. In the third quarter
of 2001, due to the continued process of deregulation and the
introduction of competition to our rural local exchange telephone
properties and our expectation that these trends will continue, we
concluded it was appropriate to discontinue the application of SFAS 71
(see Note 20) for our local exchange telephone properties. Regulatory
assets and liabilities for our public utility services operations are
included in assets held for sale and liabilities related to assets
held for sale and discontinued operations.
F-8
(f) Impairment of Long-Lived Assets and Long-Lived Assets to
--------------------------------------------------------
Be Disposed Of:
--------------
We review long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset 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 such assets are considered to be
impaired, the impairment is measured by the amount by which the
carrying amount of the assets exceeds the fair value.
(g) Investments:
-----------
We classify our investments at purchase as available-for-sale. We do
not maintain a trading portfolio or held to maturity securities.
Securities classified as available-for-sale are carried at estimated
fair market value. These securities are held for an indefinite period
of time, but might be sold in the future as changes in market
conditions or economic factors occur. Net aggregate unrealized gains
and losses related to such securities, net of taxes, are included as a
separate component of shareholders' equity. Interest, dividends and
gains and losses realized on sales of securities are reported in
Investment income.
We evaluate our investments periodically to determine whether any
decline in fair value, below the cost basis, is other than temporary.
If we determine that a decline in fair value is other than temporary,
the cost basis of the individual investment is written down to fair
value which becomes the new cost basis. The amount of the write down
is transferred from other comprehensive income and included in
earnings as a loss.
(h) Income Taxes, Deferred Income Taxes and Investment Tax Credits:
--------------------------------------------------------------
We file a consolidated federal income tax return. We utilize the asset
and liability method of accounting for income taxes. Under the asset
and liability method, deferred income taxes are recorded for the tax
effect of temporary differences between the financial statement and
the tax bases of assets and liabilities using tax rates expected to be
in effect when the temporary differences are expected to turn around.
Regulatory assets and liabilities (see Note 1(e)) included income tax
benefits previously flowed through to customers and from the AFUDC,
the effects of tax law changes and the tax benefit associated with
unamortized deferred investment tax credits. These regulatory assets
and liabilities represent the probable net increase in revenue that
will be reflected through future ratemaking proceedings. The
investment tax credits relating to regulated operations, as defined by
applicable regulatory authorities, have been deferred and are being
amortized to income over the lives of the related properties.
(i) Employee Stock Plans:
--------------------
We have various employee stock-based compensation plans. Awards under
these plans are granted to eligible officers, management employees and
non-management employees. Awards may be made in the form of incentive
stock options, non-qualified stock options, stock appreciation rights,
restricted stock or other stock based awards. As permitted by current
accounting rules, we recognize compensation expense in the financial
statements only if the market price of the underlying stock exceeds
the exercise price on the date of grant. We provide pro forma net
income (loss) and pro forma net income (loss) per common share
disclosures for employee stock option grants made in 1995 and
thereafter based on the fair value of the options at the date of grant
(see Note 13). Fair value of options granted is computed using the
Black Scholes option pricing model.
(j) Minority Interest and Minority Interest in Subsidiary:
-----------------------------------------------------
Minority interest represents the minority's share of ELI's net loss.
Since ELI's initial public offering in 1997, we recorded minority
interest on our income statement and reduced minority interest on our
balance sheet by the amount of the minority interests' share of ELI's
losses. As of June 30, 2000, the minority interest on the balance
sheet had been reduced to zero, therefore, from that date forward, we
discontinued recording minority interest income on our income
statement as there is no obligation for the minority interests to
provide additional funding for ELI. Therefore, we are recording ELI's
entire loss in our consolidated results.
(k) Net Income (loss) Per Common Share:
----------------------------------
Basic net income per common share is computed using the weighted
average number of common shares outstanding during the period being
reported on. Diluted net income per common share reflects the
potential dilution that could occur if securities or other contracts
to issue common stock were exercised or converted into common stock at
the beginning of the period being reported on.
F-9
(l) Intangibles:
-----------
Intangibles represent the excess of purchase price over the fair value
of identifiable assets acquired. We undertake studies to determine the
fair values of assets acquired and allocate purchase prices to
property, plant and equipment, goodwill and other identifiable
intangibles. We amortize goodwill and other identifiable intangibles
by use of the straight-line method (see Notes 4 and 5). We regularly
examine the carrying value of our goodwill and other identifiable
intangibles to determine whether there are any impairment losses. See
Note 1(f) above related to our impairment policy.
(m) Derivative Instruments and Hedging Activities:
---------------------------------------------
Effective January 1, 2001, we adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended. SFAS No.
133, as amended, requires that all derivative instruments, such as
interest rate swaps, be recognized in the financial statements and
measured at fair value regardless of the purpose or intent of holding
them.
On the date the derivative contract is entered into, we designate the
derivative as either a fair value or cash flow hedge. A hedge of the
fair value of a recognized asset or liability or of an unrecognized
firm commitment is a fair value hedge. A hedge of a forecasted
transaction or the variability of cash flows to be received or paid
related to a recognized asset or liability is a cash flow hedge. We
formally document all relationships between hedging instruments and
hedged items, as well as its risk-management objective and strategy
for undertaking the hedge transaction. This process includes linking
all derivatives that are designated as fair-value or cash-flow, to
specific assets and liabilities on the balance sheet or to specific
firm commitments or forecasted transactions. Changes in the fair value
of a derivative that is highly effective and that is designated and
qualifies as a fair-value hedge, along with the loss or gain on the
hedged asset or liability or unrecognized firm commitment of the
hedged item that is attributable to the hedged risk are recorded in
earnings.
We also formally assess, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. When it is determined that a derivative
is not highly effective as a hedge or that it has ceased to be a
highly effective hedge, we would discontinue hedge accounting
prospectively.
All derivatives are recognized on the balance sheet at their fair
value. Changes in the fair value of derivative financial instruments
are either recognized in income or stockholders equity (as a component
of other comprehensive income), depending on whether the derivative is
being used to hedge changes in fair value or cash flows.
We entered into interest rate swap arrangements in December 2001
related to a portion of our fixed rate debt. This hedge strategy
satisfies the fair value hedging requirements of SFAS 133.
(n) Changes in Accounting Principles:
--------------------------------
In September 2000, the Emerging Issues Task Force (EITF) issued EITF
Issue 00-19, "Determination of Whether Share Settlement Is within the
Control of the Issuer for Purposes of Applying Issue No. 96-13,
Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock." The EITF clarifies
when financial instruments that are indexed to or potentially settled
in a company's own stock are to be classified as an asset or liability
and when they are to be classified as equity. The EITF allowed for a
transition period for contracts existing at the date of the consensus
and remaining outstanding at June 30, 2001 to allow time for contracts
to be modified in order for a company to continue to account for
certain contracts as equity after June 30, 2001 (see Note 12).
F-10
In July 2001, the Financial Accounting Standards Board (FASB) issued
SFAS 141, "Business Combinations." This statement requires that all
business combinations be accounted for under the purchase method of
accounting. SFAS 141 requires that the purchase method of accounting
be used for business combinations initiated after June 30, 2001 and
prohibits the use of the pooling-of-interests method of accounting. We
adopted SFAS No. 141 on July 1, 2001. The adoption of SFAS 141 did not
have any impact on our financial position or results of operations.
(2) Accounts Receivable:
-------------------
The components of accounts receivable, net at December 31, 2001 and 2000
are as follows:
($ in thousands) 2001 2000
-------------- ---------------
Customers $ 343,356 $ 229,911
Other 36,123 37,306
Less: Allowance for doubtful accounts (67,601) (23,913)
-------------- ---------------
Accounts receivable, net $ 311,878 $ 243,304
============== ===============
(3) Property, Plant and Equipment:
-----------------------------
The components of property, plant and equipment at December 31, 2001 and
2000 are as follows:
Estimated
($ in thousands) Useful Lives 2001 2000
------------------- ----------------- -----------------
Telephone outside plant 4 to 59 years $ 3,280,542 $ 2,721,425
Telephone central office equipment 4 to 25 years 2,135,992 1,644,302
Information systems and other administrative assets 7 to 43 years 777,351 635,752
Other 55,065 52,531
Construction work in progress 450,978 253,417
----------------- -----------------
6,699,928 5,307,427
Less: accumulated depreciation (2,187,890) (1,786,715)
----------------- -----------------
Property, plant and equipment, net $ 4,512,038 $ 3,520,712
================= =================
Depreciation expense, calculated using the straight-line method, is based
upon the estimated service lives of various classifications of property,
plant and equipment. Depreciation expense was $488,424,000, $369,930,000
and $307,428,000 for the years ended December 31, 2001, 2000 and 1999,
respectively. We ceased to record depreciation expense on the gas assets
effective October 1, 2000 and on the electric assets effective January 1,
2001 both of which are included in assets held for sale (see Note 6).
During 2001 we recognized accelerated depreciation of $22.0 million related
to the change in useful lives of our accounting and human resource systems
and our Plano, Texas office building, furniture and fixtures as a result of
our restructuring (see Note 14). During 2000 and 1999 we recognized $17.4
million and $4.8 million, respectively, in accelerated depreciation related
to the change in useful life of an operating system in the ILEC segment.
(4) Acquisitions:
------------
From May 27, 1999 through July 12, 2000, we entered into several agreements
to acquire telephone access lines. These transactions have been accounted
for using the purchase method of accounting. The results of operations of
the acquired properties have been included in our financial statements from
the dates of acquisition of each property. These agreements and the status
of each transaction are described as follows:
Verizon Acquisition
-------------------
Between May and December 1999, we announced agreements to purchase
from Verizon Communications Inc., formerly GTE Corp. (Verizon),
approximately 381,200 telephone access lines (as of December 31, 2000)
for approximately $1,171,000,000 in cash. By November 30, 2000, we had
closed on the purchase of approximately 317,500 telephone access
lines. On December 17, 2001 the agreements to acquire the remaining
telephone access lines from Verizon were terminated.
F-11
Qwest Acquisition - termination
-------------------------------
In June 1999, we announced agreements to purchase from Qwest
approximately 556,800 telephone access lines (as of December 31, 2000)
in nine states for approximately $1,650,000,000 in cash and the
assumption of certain liabilities. On October 31, 2000, we had closed
on the purchase of approximately 17,000 telephone access lines in
North Dakota for approximately $38,000,000 in cash. On July 20, 2001,
we notified Qwest that we were terminating eight acquisition
agreements with Qwest for the remaining 539,800 telephone access
lines. Qwest subsequently filed a notice of claim for arbitration in
Denver, Colorado under the rules of the American Arbitration
Association with respect to the terminated acquisition agreements.
Qwest asserts that we wrongfully terminated these agreements and is
seeking approximately $64,000,000, which is the aggregate of
liquidation damages under letters of credit established in the
terminated acquisition agreements. We have filed a notice of claim in
the same arbitration proceeding, contesting Qwest's asserted claims
and asserting substantial claims against Qwest for material breaches
of representations, warranties and covenants in the terminated
acquisition agreements and in the acquisition agreement relating to
North Dakota assets that we purchased from Qwest.
Frontier Acquisition
--------------------
On June 29, 2001, we purchased from Global Crossing Ltd. (Global) 100%
of the stock of Frontier Corp.'s local exchange carrier subsidiaries,
which owns approximately 1,096,700 telephone access lines (as of
December 31, 2000) in Alabama, Florida, Georgia, Illinois, Indiana,
Iowa, Michigan, Minnesota, Mississippi, New York, Pennsylvania and
Wisconsin, for approximately $3,373,000,000 in cash, subject to
routine purchase price adjustment.
The following summarizes the allocation of purchase prices and funding for
our 2001 and 2000 acquisitions. (there were no material acquisitions in
1999):
Verizon 2001 Total
Verizon Verizon Qwest Illinois/ Total 2000 Acquisition Acquisitions from
Nebraska Minnesota North Dakota Wisconsin Acquisitions Frontier January 1, 2000
-------- --------- ------------ ---------- ------------ ----------- ------------------
Acquisition date 6/30/2000 8/31/2000 10/31/2000 11/30/2000 6/29/2001
Assets acquired:
Property, plant and
equipment $ 51,903 $ 137,391 $ 13,910 $ 105,446 $ 308,650 $ 1,127,314 $ 1,435,964
Current assets - 4,960 - - 4,960 120,985 125,945
Goodwill 108,175 174,247 16,619 163,906 462,947 1,532,641 1,995,588
Customer base 46,060 120,742 7,466 34,565 208,833 762,091 970,924
Trade name - - - - - 106,473 106,473
Other assets - 1,557 - - 1,557 9,669 11,226
--------- --------- -------- --------- --------- ----------- ----------
Total assets acquired 206,138 438,897 37,995 303,917 986,947 3,659,173 4,646,120
--------- --------- -------- --------- --------- ----------- -----------
Liabilities assumed:
Debt - - - - - 137,728 137,728
Other liabilities 734 - - - 734 148,231 148,965
--------- --------- -------- --------- --------- ----------- ----------
Total liabilities assumed 734 - - - 734 285,959 286,693
--------- --------- -------- --------- --------- ----------- ----------
Cash paid $ 205,404 $ 438,897 $ 37,995 $ 303,917 $ 986,213 $3,373,214 $ 4,359,427
========= ========= ======== ========= ========= ============ ==========
Status of appraisal
valuation Final Final Final Final Preliminary
The following pro forma financial information for 2001 presents the
combined results of our operations and Frontier acquired on June 29, 2001.
The pro forma financial information for 2000 presents the Verizon Nebraska,
Minnesota and Illinois/Wisconsin properties acquired on June 30, 2000,
August 31, 2000 and November 30, 2000, respectively, the Qwest North Dakota
property acquired on October 31, 2000 and Frontier acquired on June 29,
2001. The pro forma information presents the combined results as if the
acquisitions had occurred at the beginning of the year prior to its
acquisition. The pro forma financial information does not necessarily
reflect the results of operations that would have occurred had we
constituted a single entity during such periods. The sale of our Louisiana
and Colorado gas operations (see Note 6) is not presented on a pro forma
basis.
F-12
($ in thousands, except per share amounts)
2001 2000
---------------- ---------------
Revenue $ 2,844,789 $ 2,693,824
Income before extraordinary expense $ (117,988) $ (148,754)
Net income (loss) $ (161,619) $ (148,754)
Net income (loss) per share $ (0.64) $ (0.56)
(5) Intangibles:
------------
Intangibles at December 31, 2001 and 2000 are as follows:
($ in thousands) 2001 2000
---------------- ----------------
Goodwill $ 2,068,032 $ 508,940
Customer base 970,925 147,437
Tradename 106,473 -
---------------- ----------------
Total intangibles 3,145,430 656,377
Accumulated amortization (166,488) (23,109)
---------------- ----------------
Intangibles, net $ 2,978,942 $ 633,268
================ ================
We have reflected assets acquired at fair market values in accordance with
purchase accounting standards. Our allocations are based upon an
independent appraisal of the respective properties acquired.
Our acquisitions were made in order for us to execute upon our business
strategy. Our strategy is to focus exclusively on providing
telecommunications services, primarily in rural, small and medium-sized
towns where we believe we have a competitive advantage because of our
relatively larger size, greater resources, local focus and lower levels of
competition. For both our existing ILEC operations and those we have
recently acquired, we are the dominant provider of independent local
exchange carrier services in each of the markets in which we operate. We
believe that our operations in these areas will provide us with steady
revenue growth and margin enhancement opportunities. To reach our
objectives, we intend to continue to achieve economies of scale through
clustering and increasing operational efficiencies, among other strategies.
In following our strategy, we selectively pursue acquisitions that we
believe will enhance shareholder value through increased revenue growth and
operational efficiencies consistent with our corporate strategy and
objectives.
We have paid more than the net book values (of the seller) of each of the
businesses acquired in 2000 and 2001. We based our purchase prices on
estimates of future earnings and future cash flows of the businesses
acquired. The "premium" to book value paid, including the allocation to
goodwill for each respective property, reflects the value created by all of
the tangible and intangible operating assets (existing and acquired) of our
businesses coming together to produce earnings, including without
limitation, the fact that we were able to immediately commence operations
as the dominant local exchange carrier in the applicable operating area.
Additionally, the premiums paid were impacted by the fact that our purchase
price was accepted by the sellers after a competitive bidding and
negotiation process.
We were willing to pay a premium (i.e., goodwill) over the fair value of
the tangible and identifiable intangible assets acquired less liabilities
assumed in order to obtain product cross-selling opportunities, economies
of scale (e.g., cost savings opportunities), entry into markets from which
we could expand into new markets (i.e., beachhead), and the potential
benefit resident in expected population/demographic trends.
In July 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible
Assets." This statement requires that goodwill no longer be amortized to
earnings, but instead be reviewed for impairment. Impairment tests are
required to be performed at least annually. The amortization of goodwill
ceases upon adoption of the statement on January 1, 2002, and 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. The amount of any future impairment, if any, cannot
be estimated at this time.
F-13
(6) Discontinued Operations and Assets Held for Sale:
-------------------------------------------------
On August 24, 1999, our Board of Directors approved a plan of divestiture
for our public utilities services businesses, which include gas, electric
and water and wastewater businesses.
Water and Wastewater
--------------------
On January 15, 2002, we completed the sale of our water and wastewater
operations to American Water Works, Inc. for $855,700,000 million in
cash and $123,800,000 million of assumed debt and other liabilities.
The estimated pre-tax gain on the sale is approximately $303,600,000
million and will be recognized in the first quarter 2002.
Electric
--------
Our Arizona and Vermont electric divisions were under contract to be
sold to Cap Rock Energy Corp. (Cap Rock). The agreement with Cap Rock
was terminated on March 7, 2001. We intend to pursue the disposition
of the Vermont and Arizona electric divisions with alternative buyers.
In March 2002, we entered into a definitive agreement to sell our
Kauai electric division to Kauai Island Utility Cooperative (KIUC) for
$215,000,000. The transaction, which is subject to regulatory
approvals, is expected to close within twelve months.
Gas
---
On July 2, 2001, we completed the sale of our Louisiana Gas operations
to Atmos Energy Corporation for $363,436,000 in cash. The pre-tax gain
on the sale recognized in the third quarter was $139,304,000.
On November 30, 2001, we sold our Colorado Gas division to Kinder
Morgan for approximately $8,900,000 million after purchase price
adjustments.
Discontinued operations in the consolidated statements of income (loss)
reflect the results of operations of the water/wastewater properties
including allocated interest expense for the periods presented. Interest
expense was allocated to the discontinued operations based on the
outstanding debt specifically identified with these businesses. The
long-term debt presented in liabilities of discontinued operations
represents the only liability to be assumed by the buyer pursuant to the
water and wastewater asset sale agreements.
We initially accounted for the planned divestiture of all the public
utilities services properties as discontinued operations. Currently, we do
not have agreements to sell our entire gas and electric segments.
Consequently, we reclassified all of our gas (on September 30, 2000) and
electric (on December 31, 2000) assets and their related liabilities to
"assets held for sale" and "liabilities related to assets held for sale,"
respectively. We also reclassified the results of these operations from
discontinued operations to their original income statement captions as part
of continuing operations. Additionally, we ceased to record depreciation
expense on the gas assets effective October 1, 2000 and on the electric
assets effective January 1, 2001. Such depreciation expense would have been
an additional $50,830,000 and $6,770,000 for the years ended December 31,
2001 and 2000, respectively. We continue to actively pursue buyers for our
remaining gas and electric businesses.
F-14
Summarized financial information for the water/wastewater operations
(discontinued operations) is set forth below:
($ in thousands) 2001 2000
------------ -------------
Current assets $ 20,978 $ 18,578
Net property, plant and equipment 671,079 639,994
Other assets 54,734 59,030
------------ -------------
Total assets $ 746,791 $ 717,602
============ =============
Current liabilities $ 11,827 $ 21,062
Long-term debt 90,448 90,546
Other liabilities 136,463 100,891
------------ -------------
Total liabilities $ 238,738 $ 212,499
============ =============
For the years ended December 31,
-----------------------------------------
2001 2000 1999
------------ ------------- -------------
Revenue $ 116,868 $ 105,202 $ 102,408
Operating income 37,211 27,415 19,887
Income taxes 8,947 5,721 3,917
Net income 17,875 11,677 7,887
Summarized financial information for the gas and electric operations
(assets held for sale) is set forth below:
($ in thousands) 2001 2000
-------------- --------------
Current assets $ 66,511 $ 127,495
Net property, plant and equipment 805,653 953,328
Other assets 235,773 201,329
-------------- --------------
Total assets held for sale $ 1,107,937 $ 1,282,152
============== ==============
Current liabilities $ 71,259 $ 169,066
Long-term debt 43,400 43,980
Other liabilities 104,116 107,120
-------------- --------------
Total liabilities related to assets held for sale $ 218,775 $ 320,166
============== ==============
(7) Investments:
-----------
The components of investments at December 31, 2001 and 2000 are as follows:
($ in thousands) 2001 2000
---------------- ----------------
Marketable equity securities $ 139,188 $ 211,086
Other fixed income securities 2,020 3,273
---------------- ----------------
$ 141,208 $ 214,359
================ ================
On October 1, 1999, Adelphia Communication Corp. (Adelphia) was merged with
Century Communications Corp. (Century). We owned 1,807,095 shares of
Century Class A Common Stock. Pursuant to this merger agreement, Century
Class A Common shares were exchanged for $10,832,000 in cash and 1,206,705
shares of Adelphia Class A Common Stock (for a total market value of
$79,600,000 based on Adelphia's October 1, 1999 closing price of $57.00).
As a result of the merger, we realized and reported a pre-tax gain of
approximately $67,600,000 in the fourth quarter of 1999 in Investment
income.
F-15
One of our subsidiaries, in a joint venture with a subsidiary of Century,
owned and operated four cable television systems in southern California
serving over 90,000 basic subscribers. In July 1999, we entered into a
separate agreement with Adelphia to sell our interest in the joint venture.
Pursuant to this agreement on October 1, 1999, we received approximately
$27,700,000 in cash and 1,852,302 shares of Adelphia Class A Common Stock
(for a total market value of $133,300,000 based on Adelphia's October 1,
1999 closing price of $57.00). As a result of the sales, we realized and
reported a pre-tax gain of approximately $83,900,000 in the fourth quarter
of 1999 in Investment income.
We recognized a loss of $79,000,000 in the Adelphia investment as a
reduction to investment income in the fourth quarter of 2001. This non-cash
charge does not impact the carrying value of these securities which were
stated at current market values on prior balance sheets. This charge
reflects a decline in current trading values that have persisted for
greater than a six month period. We have previously reported this decline
as an item of comprehensive loss in the equity section of our balance
sheets. We continue to hold the shares. In addition, during 2001, we
realized approximately $1.6 million of gross gains from the sale of
securities and $.8 million of gross losses associated with the write down
of securities with a decline in value that was determined to be other than
temporary.
Our Chairman and Chief Executive Officer was also Chairman and Chief
Executive Officer of Century prior to its merger with Adelphia. Centennial
was a majority-owned subsidiary of Century until it was sold. Our Chairman
and Chief Executive Officer holds a significant amount of Adelphia shares.
In January 1999, we sold our interest in Centennial. We received
approximately $205,600,000 in cash for all of our equity interests and
approximately $17,500,000 in accrued dividends. We realized and reported a
pre-tax gain of approximately $69,500,000 in the first quarter 1999 in
Investment income related to the disposition.
The following summarizes the adjusted cost, gross unrealized holding gains
and losses and fair market value for investments.
($ in thousands) Adjusted Unrealized Holding Aggregate Fair
---------------------------------
Investment Classification Cost Gains (Losses) Market Value
---------------- ---------------- ---------------- ----------------
As of December 31, 2001
Available-for-Sale $ 132,935 $ 11,896 $ (3,623) $ 141,208
As of December 31, 2000
Available-for-Sale $ 213,681 $ 17,853 $ (17,175) $ 214,359
Marketable equity securities for 2001 and 2000 include 2,305,908 common
shares which represent an investment of 19% of the equity in Hungarian
Telephone and Cable Corp., a company of which our Chairman and Chief
Executive Officer is a member of the Board of Directors. In addition, we
hold 30,000 shares of non-voting convertible preferred stock, each share
having a liquidation value of $70 per share and is convertible at our
option into 10 shares of common stock.
(8) Fair Value of Financial Instruments:
------------------------------------
The following table summarizes the carrying amounts and estimated fair
values for certain of our financial instruments at December 31, 2001 and
2000. For the other financial instruments, representing cash, accounts
receivables, long-term debt due within one year, accounts payable and other
accrued liabilities, the carrying amounts approximate fair value due to the
relatively short maturities of those instruments.
($ in thousands) 2001 2000
--------------------------------- ---------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------------- ---------------- ---------------- ----------------
Investments $ 141,208 $ 141,208 $ 214,359 $ 214,359
Long-term debt $ 5,994,906 $ 6,030,408 $ 3,062,289 $ 2,815,850
EPPICS $ 201,250 $ 179,113 $ 201,250 $ 213,325
The fair value of the above financial instruments are based on quoted
prices at the reporting date for those financial instruments.
F-16
(9) Long-term Debt:
--------------
The activity in our long-term debt from December 31, 2000 to December 31,
2001 is as followed:
Twelve Months Ended
------------------------------------------ Interest *
Interest Rate at
($ in thousands) December 31, Borrowings/ Rate Swap/ Payments/ December 31, December 31,
2000 Acquisitions Remarketing Dispositions 2001 2001
------------- ------------------------------------------------------- -------------
FIXED RATE
Rural Utilities Service Loan
Contracts $ 90,129 $ 44,645 $ - $ (23,914) $ 110,860 6.237%
Debentures 1,000,000 - - (149,222) 850,778 7.464%
2001 Notes
8.500% Due 2006 - 700,000 - - 700,000 8.740%
9.250% Due 2011 - 1,050,000 - - 1,050,000 9.340%
6.375% Due 2004 - 300,000 430 - 300,430 6.649%
7.625% Due 2008 - 750,000 - - 750,000 7.835%
9.000% Due 2031 - 700,000 - - 700,000 9.148%
6.27% RTFC Due 2011 - 200,000 - - 200,000 6.270%
------------- ------------- ------------- ------------- -------------
Subtotal - 3,700,000 430 - 3,700,430
Equity Units 6.750% Due 2006 - 460,000 - - 460,000 7.480%
Senior Unsecured Notes 36,000 74,415 - (1,590) 108,825 7.719%
ELI Notes 325,000 - - - 325,000 6.232%
ELI Capital Leases 132,202 33,985 - (28,805) 137,382 11.774%
Industrial Development Revenue Bonds 263,605 - (14,400) - 249,205 6.435%
Other 344 - - (290) 54 12.986%
------------- ------------- ------------- ------------- -------------
TOTAL FIXED RATE 1,847,280 4,313,045 (13,970) (203,821) 5,942,534
------------- ------------- ------------- ------------- -------------
VARIABLE RATE
Commercial Paper Notes Payable 109,145 - - (109,145) -
Bank Credit Facility 765,000 - - (765,000) -
ELI Bank Credit Facility 400,000 - - - 400,000 2.892%
Industrial Development Revenue Bonds 121,878 - 14,400 - 136,278 4.614%
------------- ------------- ------------- ------------- -------------
TOTAL VARIABLE RATE 1,396,023 - 14,400 (874,145) 536,278
------------- ------------- ------------- ------------- -------------
TOTAL DEBT $3,243,303 $ 4,313,045 $ 430 $(1,077,966) $ 6,478,812
============= ============= =============
Less: Current Portion (181,014) (483,906)
------------- -------------
TOTAL LONG TERM DEBT $3,062,289 $ 5,994,906
============= =============
*Interest rate includes amortization of debt issuance expenses, debt
premiums or discounts. The interest rate for Rural Utilities Service Loan
Contracts, Debentures, ILEC Senior Unsecured Notes, and Industrial
Development Revenue Bonds represent a weighted average of multiple
issuances.
The total principal amounts of industrial development revenue bonds
were $389,535,000 in 2001 and 2000. Funds from industrial development
revenue bond issuances are held by a trustee until qualifying
construction expenditures are made at which time the funds are
released. The amounts presented in the table above represent funds
that have been used for construction through December 31, 2001 and
2000, respectively.
At December 31, 2000, the commercial paper notes payable were
classified as long-term debt because the obligations were expected to
be and were refinanced with long-term debt securities.
F-17
At December 31, 2001, we have available revolving lines of credit with
financial institutions in the amount of $805 million. As of December 31,
2001, no borrowings were outstanding under these credit facilities. On
October 24, 2001, we entered into these lines of credit with financial
institutions in the amounts of $680 million and $100 million having
substantially similar terms. An additional $25 million was provided by a
lender who was added to the credit facilities after October 24, 2001, for
total available commitments of $805 million. The credit facilities have
similar terms and conditions. Associated facility fees vary depending on
our credit ratings and currently are 0.25% per annum. The expiration dates
are October 24, 2006. During the term of the facilities we may borrow repay
and reborrow funds.
In May 2001, we issued an aggregate of $1.75 billion of notes consisting of
$700 million principal amount of 8.50% notes due May 15, 2006 and $1.05
billion principal amount of 9.25% notes due May 15, 2011.
On June 13, 2001, we issued 18,400,000 equity units at $25 per unit for net
proceeds of $446,200,000 (after underwriting discounts and commissions and
before offering expenses). Each equity unit initially consists of a 6.75%
senior note due 2006 and a purchase contract (warrant) of our common stock.
The purchase contract obligates the holder to purchase from us, no later
than August 17, 2004 for a purchase price of $25, the following number of
shares of our common stock:
* 1.7218 shares, if the average closing price of our common stock
over the 20-day trading period ending on the third trading day
prior to August 17, 2004 equals or exceeds $14.52;
* A number of shares having a value, based on the average closing
price over that period, equal to $25, if the average closing
price of our common stock over the same period is less than
$14.25, but greater than $12.10; and
* 2.0661 shares, if the average closing price of our common stock
over the same period is less than or equal to $12.10.
The fair market value of the warrant at the date of issuance was
$4,968,000. This amount was recorded as debt discount and additional
paid-in capital. The equity units trade on The New York Stock Exchange
under the symbol "CZB."
In August 2001, we issued an aggregate of $1.75 billion principal amount of
senior notes consisting of $300 million of 6.375% notes due 2004, $750
million principal amount of 7.625% notes due 2008 and $700 million
principal amount of 9.000% notes due 2031. These notes were issued in a
private offering. The proceeds were used to repay our forward equity
contract, to refinance outstanding indebtedness and for general corporate
purposes. In September 2001, we filed a $1.75 billion registration
statement with the SEC on Form S-4 that consists of an exchange offer
entitling the holders of the notes issued in August 2001 to exchange the
initial notes for new notes with substantially identical terms as the
initial notes, except for transfer restrictions and registration rights
relating to the initial notes. The registration statement was declared
effective on February 6, 2002, and we commenced our exchange offer at that
time. The exchange offer is expected to terminate on March 11, 2002.
In October 2001, we borrowed $200 million on an unsecured basis from the
Rural Telephone Finance Cooperative (RTFC). This note is due on October 24,
2011 and has a fixed 6.27% rate of interest, payable quarterly.
On January 31, 2002, we repaid approximately $76.9 million principal amount
of loans outstanding to our subsidiaries from the Rural Utilities Service,
Rural Telephone Bank and the Federal Financing Bank.
Our principal payments and capital lease payments (principal only) for the
next five years are as follows:
($ in thousands)
----------------
Principal Capital
Payments Lease Payments
--------- --------------
2002 $ 476,488 $7,418
2003 41,092 2,747
2004 731,158 3,057
2005 6,381 3,397
2006 1,341,662 3,458
Holders of certain industrial development revenue bonds may tender at par
prior to maturity. The next tender date is August 1, 2007 for $30,350,000
of principal amount of bonds. We expect to remarket all such bonds which
are tendered. In the years 2001, 2000, and 1999, interest payments on
short- and long-term debt were $302,510,000, $188,955,000 and $127,757,000,
respectively.
F-18
(10) 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 the 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 contract.
The interest rate swap contracts are reflected at fair value in our
consolidated balance sheet and the related portion of fixed-rate debt being
hedged is reflected at an amount equal to the sum of its book value and an
amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. Changes in the fair
value of interest rate swap contracts, and the offsetting changes in the
adjusted carrying value of the related portion of the fixed-rate debt being
hedged, are recognized in the consolidated statements of operations in
interest expense. The notional amounts of fixed-rate indebtedness hedged as
of December 31, 2001 and 2000 was $100,000,000 and $0, respectively. Such
contracts provided for us to pay variable rates of interest (average pay
rate of approximately 4% as of December 31, 2001) and receive fixed rates
of interest (average receive rate of 6.375% as of December 31, 2001). The
fair value of these derivatives is reflected in other assets as of December
31, 2001, in the amount of $430,000.
We do not anticipate any nonperformance by counterparties to its derivative
contracts as all counterparties have investment grade credit ratings.
(11)Company Obligated Mandatorily Redeemable Convertible Preferred Securities:
-------------------------------------------------------------------------
In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust
(the Trust), issued, in an underwritten public offering, 4,025,000 shares
of 5% Company Obligated Mandatorily Redeemable Convertible Preferred
Securities due 2036 (Trust Convertible Preferred Securities or EPPICS),
representing preferred undivided interests in the assets of the Trust, with
a liquidation preference of $50 per security (for a total liquidation
amount of $201,250,000). The proceeds from the issuance of the Trust
Convertible Preferred Securities and a Company capital contribution were
used to purchase $207,475,000 aggregate liquidation amount of 5%
Partnership Convertible Preferred Securities due 2036 from another wholly
owned consolidated subsidiary, Citizens Utilities Capital L.P. (the
Partnership). The proceeds from the issuance of the Partnership Convertible
Preferred Securities and a Company capital contribution were used to
purchase from us $211,756,050 aggregate principal amount of 5% Convertible
Subordinated Debentures due 2036. The sole assets of the Trust are the
Partnership Convertible Preferred Securities and our Convertible
Subordinated Debentures are substantially all the assets of the
Partnership. Our obligations under the agreements related to the issuances
of such securities, taken together, constitute a full and unconditional
guarantee by us of the Trust's obligations relating to the Trust
Convertible Preferred Securities and the Partnership's obligations relating
to the Partnership Convertible Preferred Securities.
In accordance with the terms of the issuances, we paid the 5% interest on
the Convertible Subordinated Debentures in 2001, 2000 and 1999. During 2001
and 2000, only cash was paid to the Partnership in payment of the interest
on the Convertible Subordinated Debentures. The cash was then distributed
by the Partnership to the Trust and then by the Trust to the holders of the
EPPICS. During 1999, 1,004,961 shares of Common Stock were issued to the
Partnership in payment of interest of which 976,464 shares were sold by the
Partnership to satisfy cash dividend payment elections by the holders of
the EPPICS. The sales proceeds and the remaining 28,497 shares of Common
Stock were distributed by the Partnership to the Trust. The Trust
distributed the cash and shares as dividends to the holders of the EPPICS
in 1999.
(12) Capital Stock:
-------------
We are authorized to issue up to 600,000,000 shares of Common Stock. The
amount and timing of dividends payable on Common Stock are within the sole
discretion of our Board of Directors.
Between December 1999 and April 2000, our Board of Directors authorized the
purchase of up to $200,000,000 worth of shares of our common stock. This
share purchase program was completed in July 2000 and resulted in the
acquisition or contract to acquire approximately 12,092,000 shares of our
common stock. Of those shares, 2,952,000 shares were purchased for
approximately $49,209,000 in cash and we entered into an equity forward
contract for the acquisition of the remaining 9,140,000 shares.
F-19
During 2000, we entered into a forward contract to purchase 9,140,000
shares of our common stock with Citibank, N.A. These purchases and others
made by us for cash during 2000 were made in open-market transactions. The
forward amount to be paid in the future included a carrying cost, based on
LIBOR plus a spread, and the dollar amount paid for the shares purchased.
Our equity forward contract was a temporary financing arrangement that gave
us the flexibility to purchase our stock and pay for those purchases in
future periods. Pursuant to transition accounting rules, commencing
December 31, 2000 through June 30, 2001 we were required to report our
equity forward contract as a reduction to shareholders' equity and as a
component of temporary equity for the gross settlement amount of the
contract ($150,013,000). On June 28, 2001, we entered into a master
confirmation agreement that amended the equity forward contract to no
longer permit share settlement of the contract. In 2001, we settled the
contract by paying the redemption amount of $150,013,000 plus $13,650,000
in associated carrying costs and took possession of our shares.
In addition to our share purchase programs described above, in April 2000,
our Board of Directors authorized the purchase, from time to time, of up to
$25,000,000 worth of shares of Class A common stock of ELI, in the open
market or in negotiated transactions. This ELI share purchase program was
completed in August 2000 and resulted in the acquisition of approximately
1,288,000 shares of ELI common stock for approximately $25,000,000 in cash.
In August 2000, our Board of Directors authorized the purchase, from time
to time, of up to an additional 1,000,000 shares of ELI on the open market
or in negotiated transactions. The second ELI share purchase program was
completed in September 2000 and resulted in the acquisition of
approximately 1,000,000 shares of ELI common stock for approximately
$13,748,000 in cash.
We also purchased 631,000 shares of our common stock at a cost of
$6,625,000 in 1999 to fund EPPICS dividends.
The activity in shares of common stock, including treasury stock, during
2001, 2000 and 1999 is summarized as follows:
Number of Shares
--------------------
Balance at January 1, 1999 259,149,000
Common stock buybacks (631,000)
Common stock issued to fund EPPICS dividends 1,005,000
Stock plans 2,553,000
--------------------
Balance at December 31, 1999 262,076,000
Acquisitions 111,000
Stock plans 3,581,000
--------------------
Balance at December 31, 2000 265,768,000
Stock issuances 25,156,000
Stock plans 1,916,000
--------------------
Balance at December 31, 2001 292,840,000
====================
As of December 31, 2001, we had 11,551,000 shares held as treasury stock.
We have 50,000,000 authorized but unissued shares of preferred stock ($.01
par).
(13) Stock Plans:
-----------
At December 31, 2001, we have four stock based compensation plans and ELI
has two stock based plans which are described below. We apply APB Opinion
No. 25 and related interpretations in accounting for the employee stock
plans. No compensation cost has been recognized in the financial statements
for options issued pursuant to the Management Equity Incentive Plan (MEIP),
Equity Incentive Plan (EIP), or ELI Equity Incentive Plan (ELI EIP) as the
exercise price for such options was equal to the market price of the stock
at the time of grant and no transactions or modifications which would
require a compensation charge have occurred subsequent to the grant. No
compensation cost has been recognized in the financial statements related
to the Employee Stock Purchase Plan (ESPP) and ELI Employee Stock Purchase
Plan (ELI ESPP) because the purchase price is 85% of the fair value.
Compensation cost recognized for our Directors' Deferred Fee Equity Plan
was $741,438, $691,956 and $481,540 in 2001, 2000 and 1999, respectively.
We have granted restricted stock awards to key employees in the form of our
Common Stock. The number of shares issued as restricted stock awards during
2001, 2000 and 1999 were 100,000, 3,120,000 and 901,200, respectively. None
of the restricted stock awards may be sold, assigned, pledged or otherwise
transferred, voluntarily or involuntarily, by the employees until the
restrictions lapse. The restrictions are both time and performance based.
At December 31, 2001, 3,149,000 shares of restricted stock were
outstanding. Compensation expense of 8,967,000, 9,084,000 and $2,574,000
for the years ended December 31, 2001, 2000 and 1999, respectively, has
been recorded in connection with these grants.
F-20
Had we determined compensation cost based on the fair value at the grant
date for its MEIP, EIP, ESPP, ELI ESPP and ELI EIP, our pro forma Net
income (loss) and Net income (loss) per common share would have been as
follows:
2001 2000 1999
-------------- ------------- ------------
($ in thousands)
Net Income (loss) As reported $ (89,682) $(28,394) $144,486
Pro forma (118,520) (51,270) 130,613
Net Income (loss) per common share As reported:
Basic $ (.38) $ (.11) $ .56
Diluted (.38) (.11) .55
Pro forma:
Basic $ (.48) $ (.20) $ .50
Diluted (.48) (.20) .50
The full impact of calculating compensation cost for stock options is not
reflected in the pro forma amounts above because pro forma compensation
cost only includes costs associated with the vested portion of options
granted pursuant to the MEIP, EIP, ESPP, ELI ESPP and ELI EIP on or after
January 1, 1995.
Management Equity Incentive Plan
--------------------------------
Under the MEIP, awards of our Common Stock may be granted to eligible
officers, management employees and non-management employees in the form of
incentive stock options, non-qualified stock options, stock appreciation
rights (SARs), restricted stock or other stock-based awards. The
Compensation Committee of the Board of Directors administers the MEIP.
Since the expiration date of the MEIP plan, no awards can be granted under
the MEIP. The exercise price of stock options issued were equal to or
greater than the fair market value of the underlying common stock on the
date of grant. Stock options are generally not exercisable on the date of
grant but vest over a period of time. Under the terms of the MEIP,
subsequent stock dividends and stock splits have the effect of increasing
the option shares outstanding, which correspondingly decreases the average
exercise price of outstanding options.
F-21
The following is a summary of share activity subject to option under the
MEIP.
Shares Weighted
Subject to Average Option
Option Price Per Share
-------------- ---------------
Balance at December 31, 1998 9,435,000 $ 9.91
Options granted 1,844,000 8.00
Options exercised (602,000) 8.20
Options canceled, forfeited or lapsed (396,000) 8.08
--------------
Balance at December 31, 1999 10,281,000
9.73
Options granted 26,000 16.26
Options exercised (3,103,000) 9.96
Options canceled, forfeited or lapsed (283,000) 7.79
---------------
Balance at December 31, 2000 6,921,000 9.72
Options exercised (1,035,000) 8.23
Options canceled, forfeited or lapsed (124,000) 9.81
---------------
Balance at December 31, 2001 5,762,000 $ 9.99
================
The following table summarizes information about shares subject to options
under the MEIP at December 31, 2001.
Options Outstanding Options Exercisable
-------------------------------------------------------------------------------- ---------------------------------
Weighted Average Weighted
Number Range of Weighted Average Remaining Number Average
Outstanding Exercise Prices Exercise Price Life in Years Exercisable Exercise Price
----------- --------------- -------------- ------------- ----------- --------------
13,592 $ 4 - 5 $ 4.29 2.73 13,592 $ 4.29
1,793,571 7 - 8 7.63 5.21 1,485,361 7.65
823,623 8 - 10 8.54 5.71 823,623 8.54
1,739,515 10 - 11 10.68 2.91 1,739,515 10.68
868,436 11 - 14 12.34 2.77 818,444 12.41
497,877 14 - 15 14.24 1.88 497,877 14.24
25,000 15 - 17 16.69 8.46 8,334 16.69
---------------- --------------
5,761,614 $ 4 - 17 $ 9.99 4.24 5,386,746 $ 10.10
================ ==============
The weighted average fair value of options granted during 2000 and 1999
were $7.09 and $3.17, respectively. For purposes of the pro forma
calculation, the fair value of each option grant is estimated on the date
of grant using the Black Scholes option pricing model with the following
weighted average assumptions used for grants in 2000 and 1999:
2000 1999
-------------- -------------
Dividend yield - -
Expected volatility 30% 29%
Risk-free interest rate 6.27% 5.32%
Expected life 6 years 6 years
Equity Incentive Plan
---------------------
In May 1996, our shareholders approved the EIP. Under the EIP, awards of
our Common Stock may be granted to eligible officers, management employees
and non-management employees in the form of incentive stock options,
non-qualified stock options, stock appreciation rights (SARs), restricted
stock or other stock-based awards. The Compensation Committee of the Board
of Directors administers the EIP.
The maximum number of shares of common stock which may be issued pursuant
to awards at any time is 12,858,000 shares, which has been adjusted for
subsequent stock dividends. No awards will be granted more than 10 years
after the effective date (May 23, 1996) of the EIP. The exercise price of
stock options and SARs shall be equal to or greater than the fair market
value of the underlying common stock on the date of grant. Stock options
are generally not exercisable on the date of grant but vest over a period
of time.
F-22
Under the terms of the EIP, subsequent stock dividends and stock splits
have the effect of increasing the option shares outstanding, which
correspondingly decrease the average exercise price of outstanding options.
The following is a summary of share activity subject to option under the
EIP.
Shares Weighted Average
Subject to Option Price Per
Option Share
--------------- ------------------
Balance at December 31, 1998 4,132,000 $ 8.51
Options granted 3,487,000 8.64
Options exercised (361,000) 8.46
Options canceled, forfeited or lapsed (679,000) 8.40
----------------
Balance at December 31, 1999 6,579,000 8.59
Options granted 5,758,000 13.31
Options exercised (1,023,000) 8.21
Options canceled, forfeited or lapsed (614,000) 10.27
----------------
Balance at December 31, 2000 10,700,000 11.37
Options granted 3,969,000 13.62
Options exercised (693,000) 8.27
Options canceled, forfeited or lapsed (680,000) 11.62
----------------
Balance at December 31, 2001 13,296,000 $12.69
================
The following table summarizes information about shares subject to options
under the EIP at December 31, 2001.
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------- -------------------------------
Weighted Average
Number Range of Weighted Average Remaining Number Weighted Average
Outstanding Exercise Prices Exercise Price Life in Years Exercisable Exercise Price
--------------- -------------- ------------- ----------- ---------------
- ----------------
2,302,143 $ 7 - 8 $ 7.63 6.87 1,866,834 $ 7.65
851,256 8 - 9 8.52 5.78 851,256 8.52
73,166 9 - 10 9.29 6.01 73,166 9.29
210,497 10 - 11 10.24 6.26 210,497 10.24
3,819,434 11 - 13 12.62 8.62 1,634,507 12.48
3,849,225 13 - 15 13.68 9.26 556,668 13.50
2,190,000 15 - 21 18.38 8.74 96,668 17.17
- ---------------- -------------
13,295,721 $ 7 - 21 $12.69 7.36 5,289,596 $ 10.20
================ =============
The weighted average fair value of options granted during 2001, 2000 and
1999 was $6.00, $6.31 and $3.46, respectively. For purposes of the pro
forma calculation, the fair value of each option grant is estimated on the
date of grant using the Black Scholes option pricing model with the
following weighted average assumptions used for grants in 2001, 2000 and
1999:
2001 2000 1999
------------- ------------- -------------
Dividend yield - - -
Expected volatility 36% 30% 29%
Risk-free interest rate 5.10% 5.82% 5.47%
Expected life 6 years 6 years 6 years
F-23
Employee Stock Purchase Plan
----------------------------
Our ESPP was approved by shareholders on June 12, 1992 and amended on May
22, 1997. Under the ESPP, eligible employees have the right to subscribe to
purchase shares of our Common Stock at 85% of the average of the high and
low market prices on the last day of the purchase period. An employee may
elect to have up to 20% of annual base pay withheld in equal installments
throughout the designated payroll-deduction period for the purchase of
shares. The value of an employee's subscription may not exceed $25,000 in
any one calendar year and the minimum contribution each purchase period is
$50.00. Active employees are required to hold their shares for three years
from the date of each purchase period. An employee may not participate in
the ESPP if such employee owns stock possessing 5% or more of the total
combined voting power or value of our capital stock. As of December 31,
2001, there were 6,407,000 shares of Common Stock reserved for issuance
under the ESPP. These shares may be adjusted for any future stock dividends
or stock splits. The ESPP will terminate when all shares reserved have been
subscribed for and purchased, unless terminated earlier or extended by the
Board of Directors. The Compensation Committee of the Board of Directors
administers the ESPP. As of December 31, 2001, the number of employees
enrolled and participating in the ESPP was 1,307 and the total number of
shares purchased under the ESPP was 305,969. For purposes of the pro forma
calculation, compensation cost is recognized for the fair value of the
employees' purchase rights, which was estimated using the Black Scholes
option pricing model with the following assumptions for subscription
periods beginning in 2001, 2000 and 1999:
2001 2000 1999
------------- ------------- -------------
Dividend yield - - -
Expected volatility 36% 30% 29%
Risk-free interest rate 2.71% 6.23% 5.24%
Expected life 6 months 6 months 6 months
The weighted average fair value of those purchase rights granted in 2001,
2000 and 1999 was $2.39, $3.26 and $2.47, respectively.
ELI Employee Stock Purchase Plan
--------------------------------
The ELI ESPP was approved by shareholders on May 21, 1998. Under the ELI
ESPP, eligible employees of ELI may subscribe to purchase shares of ELI
Class A Common Stock at the lesser of 85% of the average of the high and
low market prices on the first day of the purchase period or on the last
day of the purchase period. An employee may elect to have up to 20% of
annual base pay withheld in equal installments throughout the designated
payroll-deduction period for the purchase of shares. The value of an
employee's subscription may not exceed $25,000 in any one calendar year. An
employee may not participate in the ELI ESPP if such employee owns stock
possessing 5% or more of the total combined voting power or value of all
classes of capital stock of ELI. As of December 31, 2001, there were
1,950,000 shares of ELI Class A Common Stock reserved for issuance under
the ELI ESPP. These shares may be adjusted for any future stock dividends
or stock splits. The ELI ESPP will terminate when all shares reserved have
been subscribed for and purchased, unless terminated earlier or extended by
the Board of Directors. The ELI ESPP is administered by the Compensation
Committee of ELI's Board of Directors. As of December 31, 2001, the total
number of shares purchased under the ELI ESPP was 1,081,187.
As of December 1, 2001, the ELI ESPP was temporarily suspended for the
December 1, 2001 through May 31, 2002 purchase period. ELI employees were
instead allowed to participate in the Citizens ESPP for that period. As of
December 31, 2001, 42 of ELI's employees were enrolled and participating in
the Citizens ESPP.
For purposes of the pro forma calculation, compensation cost is recognized
for the fair value of the employees' purchase rights, which was estimated
using the Black Scholes option pricing model with the following assumptions
for subscription periods beginning in 2001, 2000 and 1999:
2001 2000 1999
------------- ------------- ------------
Dividend yield - - -
Expected volatility 98% 87% 66%
Risk-free interest rate 2.70% 6.29% 5.25%
Expected life 6 months 6 months 6 months
The weighted average fair value of those purchase rights granted in 2001,
2000 and 1999 was $0.42, $4.59 and $4.97, respectively.
F-24
ELI Equity Incentive Plan
-------------------------
In October 1997, the Board of Directors of ELI approved the ELI EIP. Under
the ELI EIP, awards of ELI's Class A Common Stock may be granted to
eligible directors, officers, management employees, non-management
employees and consultants of ELI in the form of incentive stock options,
non-qualified stock options, SARs, restricted stock or other stock-based
awards. The Compensation Committee of the ELI Board of Directors
administers the ELI EIP. The exercise price for such awards shall not be
less than 85% or more than 110% of the average of the high and low stock
prices on the date of grant. The exercise period for such awards is
generally 10 years from the date of grant. ELI has reserved 6,670,600
shares for issuance under the terms of this plan.
The following is a summary of share activity subject to option under the
ELI EIP.
Shares Weighted
Subject to Average Option
Option Price Per Share
---------------- -------------------
Balance at January 1, 1999 2,331,000 $ 12.14
Options granted 1,989,000 9.51
Options exercised (116,000) 9.73
Options canceled, forfeited or lapsed (680,000) 10.12
----------------
Balance at December 31, 1999 3,524,000 10.96
Options granted 2,720,000 19.08
Options exercised (456,000) 11.00
Options canceled, forfeited or lapsed (1,017,000) 13.63
----------------
Balance at December 31, 2000 4,771,000 15.05
Options granted 86,000 4.36
Options canceled, forfeited or lapsed (1,087,000) 15.38
----------------
Balance at December 31, 2001 3,770,000 $ 14.73
================
The following table summarizes information about shares subject to options
under the ELI EIP at December 31, 2001.
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------- ------------------------------
Weighted- Average
Number Range of Weighted Average Remaining Number Weighted Average
Outstanding Exercise Prices Exercise Price Life in Years Exercisable Exercise Price
- ------------- --------------- -------------- ------------- ----------- ---------------
93,133 $ 2 - 8 $ 3.66 8.84 88,135 $ 3.55
1,313,269 8 - 9 8.81 6.76 1,103,534 8.80
622,402 13 - 19 15.80 6.29 599,971 15.78
1,741,636 19 - 23 19.40 8.53 640,532 19.40
- -------------- -------------
3,770,440 $ 2 - 23 $ 14.73 7.55 2,432,172 $ 13.13
============== =============
For purposes of the pro forma calculation, compensation cost is recognized
for the fair value of the employees' purchase rights, which was estimated
using the Black Scholes option pricing model with the following assumptions
for subscription periods beginning in 2001, 2000 and 1999:
2001 2000 1999
------------- ------------- -------------
Dividend yield - - -
Expected volatility 98% 87% 66%
Risk-free interest rate 5.82% 7.23% 5.34%
Expected life 6 years 6 years 6 years
The weighted-average fair value of those options granted in 2001, 2000 and
1999 were $2.48, $14.75 and $6.16, respectively.
F-25
ELI has granted 775,000 restricted stock awards to key employees in the
form of Class A Common Stock since its IPO. These restrictions lapse based
on meeting specific performance targets. At December 31, 2001, 629,668
shares of this stock were outstanding, of which 571,335 shares are no
longer restricted. Compensation expense was recorded in connection with
these grants in the amounts of $281,000, $1,422,000 and $2,559,000 for the
years ended December 31, 2001, 2000 and 1999, respectively.
Directors' Deferred Fee Equity Plan
-----------------------------------
Effective June 30, 2000, the annual retainer paid to non-employee directors
was eliminated. In replacement, each non-employee director elected, by
August 1, 2000, to receive either 2,500 stock units or 10,000 stock
options. Starting in 2001, each non-employee director will elect, by
December 1 of the prior year, to receive either 5,000 stock units or 20,000
stock options. Directors making a stock unit election must also elect to
receive payment in either stock or cash upon retirement from the Board of
Directors. Stock options have an exercise price of the fair market value on
the date of grant, are exercisable six months after the date of grant and
have a 10-year term. Options granted pursuant to the June 30, 2000 plan are
subject to shareholder approval in 2001. The Formula Plan described below
also remains in effect until its expiration in 2002.
From January 1, 2000 through June 30, 2000, the non-employee directors had
the choice to receive 50% or 100% of their fees paid in either stock or
stock units. If stock was elected, the stock was granted at the average of
the high and low on the first trading date of the year (Initial Market
Value). If stock units were elected, they were purchased at 85% of the
Initial Market Value. Stock units (except in an event of hardship) are held
by us until retirement or death.
Our original Non-Employee Directors' Deferred Fee Equity Plan (the
Directors' Plan) was approved by shareholders on May 19, 1995 and
subsequently amended. The Directors' Plan included an Option Plan, a Stock
Plan and a Formula Plan. On December 31, 1999, the Option Plan and the
Stock Plan expired in accordance with the Plan's terms.
Through the Option Plan, an eligible director could have elected to receive
up to $30,000 per annum of his or her director's fee retainer, for a period
of up to five years, in the form of options to purchase our common stock.
The number of options granted was calculated by dividing the dollar amount
elected by 20% of the fair market value of our common stock on the
effective date of the options. The options are exercisable at 90% of the
fair market value of our common stock on the effective date of the options.
Through the Stock Plan, an eligible director elected to receive all or a
portion of his or her director's fees in the form of Plan Units, the number
of such Plan Units being equal to such fees divided by the fair market
value of our common stock on certain specified dates. In the event of
termination of Directorship, a Stock Plan participant will receive the
value of such Plan Units in either stock or cash or installments of cash as
selected by the Participant at the time of the related Stock Plan election.
The Formula Plan provides each Director options to purchase 5,000 shares of
common stock on the first day of each year beginning in 1997 and continuing
through 2002 regardless of whether the Director is participating in the
Option Plan or Stock Plan. In addition, on September 1, 1996, options to
purchase 2,500 shares of common stock were granted to each Director. The
exercise price of the options are 100% of the fair market value on the date
of grant and the options are exercisable six months after the grant date
and remain exercisable for ten years after the grant date.
As of any date, the maximum number of shares of common stock which the Plan
was obligated to deliver pursuant to the Directors' Plan shall not be more
than one percent (1%) of the total outstanding shares of our Common Stock
as of such date, subject to adjustment in the event of changes in our
corporate structure affecting capital stock. There were 10 directors
participating in the Directors' Plan in 2001. In 2001, the total options,
plan units and stock earned were 90,000, 52,307 and 1,321, respectively. In
2000, the total Options, Plan Units and stock earned were 203,969, 52,521,
and 2,860, respectively. In 1999, the total Options and Plan Units earned
were 153,969 and 15,027, respectively. At December 31, 2001 925,447 options
were exercisable at a weighted average exercise price of $11.33.
We had also maintained a Non-Employee Directors' Retirement Plan providing
for the payment of specified sums annually to our non-employee directors,
or their designated beneficiaries, starting at their retirement, death or
termination of directorship of each individual director. In 1999, we
terminated this Plan. In connection with the termination, the value as of
May 31, 1999, of the vested benefit of each non-employee director was
credited to him/her in the form of stock units. Such benefit will be
payable upon retirement, death or termination of the directorship. Each
participant had until July 15, 1999 to elect whether the value of the stock
units awarded would be payable in our common stock (convertible on a one
F-26
for one basis) or in cash. As of December 31, 2001, the liability for such
payments was $2.7 million of which $1.5 million will be payable in stock
(based on the July 15, 1999 stock price) and $1.2 million will be payable
in cash. While the number of shares of stock payable to those directors
electing to be paid in stock was fixed, the amount of cash payable to those
directors electing to be paid in cash will be based on the number of stock
units awarded times the stock price at the payment date.
(14) Restructuring Charges:
---------------------
2001
----
During 2001, we examined all aspects of our business operations and our
facilities to take advantage of operational and functional synergies
between Frontier and us. Accordingly, we recorded the following
restructuring expenses during 2001:
Plano Restructuring
In the second quarter of 2001, we approved a plan to close our
operations support center in Plano, Texas by April 2002. In connection
with this plan, we recorded a pre-tax charge of $14,557,000 in 2001.
Our objective is to concentrate our resources in areas where we have
the most customers, to better serve those customers. We intend to sell
our Plano office building. The restructuring resulted in the reduction
of 750 employees. We communicated with all affected employees during
July 2001. Certain employees will be relocated, others have been
offered severance, job training and/or outplacement counseling. As of
December 31, 2001, approximately $1,678,000 was paid and 161 employees
were terminated. The restructuring expenses primarily consist of
severance benefits, retention earned through December 31, 2001, early
lease termination costs and other planning and communication costs. We
expect to incur additional costs of approximately $1,426,000 through
the second quarter of 2002.
Sacramento Call Center Restructuring
In the fourth quarter of 2001, we approved a plan to close our
Sacramento Customer Care Center by the end of March 2002. In
connection with this plan, we recorded a pre-tax charge of $731,000 in
the fourth quarter of 2001. We will redirect the call traffic and
other work activities to our Kingman, Arizona call center. This
restructuring resulted in the reduction of 94 employees. We
communicated with all affected employees during November 2001. These
costs are expected to be paid in the first quarter 2002.
ELI Restructuring
In the first half of 2002, ELI intends to redeploy the internet
routers, frame relay switches and ATM switches from the Atlanta,
Cleveland, Denver, Philadelphia and New York markets to other
locations in ELI's network. ELI intends to cease leasing the
collocation facilities and off-net circuits for the backbone and local
loops supporting the service delivery in these markets. It is
anticipated that this will lead to $4,179,000 of termination fees
which have been accrued for but not paid for the year ended December
31, 2001.
1999
----
In the fourth quarter of 1999, we approved a plan to restructure our
corporate office activities. In connection with this plan, we recorded a
pre-tax charge of $5,760,000 in the fourth quarter of 1999. The
restructuring resulted in the reduction of 49 corporate employees. All
affected employees were communicated with in the early part of November
1999.
As of December 31, 2001, approximately $4,413,000 has been paid, 42
employees were terminated and six employees who were expected to be
terminated took other positions within the company. The remaining employee
was terminated in January 2002. At December 31, 2001 and 2000, we adjusted
our original accrual down by $139,000 and $1,008,000, respectively, and the
remaining accrual of $200,000 is included in other current liabilities at
December 31, 2001. These costs will be paid in the first quarter 2002.
In the third quarter of 1999, ELI announced two strategic decisions that
led to $1,480,000 in exit costs. On August 24, 1999, ELI announced that it
was eliminating its prepaid calling card and videoconferencing products,
effective November 1, 1999. This initiative was taken as a result of ELI's
decision to focus on its core business strategy. Prepaid calling cards are
a high-volume, low-margin product that ELI determined did not support its
strategy of accelerating profitability. On September 1, 1999, ELI announced
that it was consolidating its national retail sales efforts in Dallas and
closing six retail sales offices in the eastern United States by October 8,
1999. ELI has maintained all of its data points-of-presence and wholesale
sale offices. As a result of both of these decisions, ELI eliminated 63
sales and sales support positions, and incurred charges relating to
employee severance and facility shutdown costs. As of December 31, 2000,
all costs associated with this decision were paid and no accrual remained.
F-27
Original Accrued Amount Additional Remaining
Amount Paid to Date Accrual Adjustments Accrual
------------------ -------------- --------------- -------------- ----------------
2001 Plano Restructuring
Severance $ 9,352,532 $(1,385,577) $ 550,595 $ (324,833) $ 8,192,717
Benefits 1,535,322 (35,408) - (103,693) 1,396,221
Retention 1,178,210 (80,080) 1,792,531 (64,143) 2,826,518
Other 936,032 (177,010) 26,937 (322,925) 463,034
------------------ -------------- --------------- ----------------
Total $ 13,002,096 $(1,678,075) $ 2,370,063 $ (815,594) $ 12,878,490
================== ============== =============== ============== ================
2001 Sacramento Call Center Restructuring
Severance $ 551,805 $ - $ - $ - $ 551,805
Benefits 93,829 - - - 93,829
Retention 85,243 - - - 85,243
------------------ -------------- --------------- -------------- ----------------
Total $ 730,877 $ - $ - $ - $ 730,877
================== ============== =============== ============== ================
ELI 2001 Restructuring $ 4,179,000 $ - $ - $ - $ 4,179,000
1999 Corporate Office Restructuring
For the year ended December 31, 1999 $ 5,760,000 $ (221,000) $ - $ - $ 5,539,000
For the year ended December 31, 2000 5,539,000 (3,993,000) (1,008,000) - 538,000
For the year ended December 31, 2001 538,000 (199,000) (139,000) - 200,000
ELI 1999 Restructuring
For the year ended December 31, 1999 $ 1,480,000 $(1,398,000) $ 52,000 $ - $ 134,000
For the year ended December 31, 2000 134,000 (493,000) 359,000 - -
(15) Income Taxes:
------------
The following is a reconciliation of the provision for income taxes for
continuing operations computed at federal statutory rates to the effective
rates:
2001 2000 1999
--------------- -------------- --------------
Consolidated tax provision at federal statutory rate 35.0% 35.0% 35.0%
State income tax provisions (benefit), net of federal income tax -10.8% -6.4% 1.1%
Write-off of regulatory assets -11.7% 0.0% 0.0%
Nontaxable investment income 2.6% 5.4% -1.2%
Flow through depreciation -0.5% -8.5% 2.8%
Tax reserve adjustment 1.0% -5.6% 0.6%
Minority interest 0.0% 8.7% -3.8%
All other, net 4.8% 3.7% -0.1%
--------------- -------------- --------------
20.4% 32.3% 34.4%
=============== ============== ==============
F-28
As of December 31, 2001 and 2000, accumulated deferred income taxes
amounted to $423,486,000 and $443,103,000, respectively, and the
unamortized deferred investment tax credits amounted to $6,058,000 and
$8,209,000, respectively. Net income taxes paid (refunded) during the year
were ($41,126,000), $37,935,000 and $885,000 for 2001, 2000 and 1999,
respectively.
The components of the net deferred income tax liability at December 31 are
as follows:
($ in thousands) 2001 2000
--------------- --------------
Deferred income tax liabilities:
Property, plant and equipment basis differences $ 421,130 $ 424,378
Regulatory assets - 21,135
Other, net 10,830 10,597
--------------- --------------
431,960 456,110
--------------- --------------
Deferred income tax assets:
Regulatory liabilities - 1,641
Deferred investment tax credits 2,416 3,157
--------------- --------------
2,416 4,798
--------------- --------------
Net deferred income tax liability $ 429,544 $ 451,312
=============== ==============
F-29
The provision (benefit) for federal and state income taxes, as well as the
taxes charged or credited to shareholders' equity, includes amounts both
payable currently and deferred for payment in future periods as indicated
below:
($ in thousands) 2001 2000 1999
--------------- -------------- --------------
Income taxes charged (credited) to the income statement for
continuing operations:
Current:
Federal $ (37,003) $ (66,759) $ 45,922
State 5,168 (2,588) 2,334
--------------- -------------- --------------
Total current (31,835) (69,347) 48,256
Deferred:
Federal 10,791 46,647 26,584
Investment tax credits (649) (931) (1,366)
State 6,888 7,499 1,426
--------------- -------------- --------------
Total deferred 17,030 53,215 26,644
--------------- -------------- --------------
Subtotal (14,805) (16,132) 74,900
Income taxes charged (credited) to the income statement for
discontinued operations:
Current:
Federal 5,093 2,749 (17)
State 774 418 (3)
--------------- -------------- --------------
Total current 5,867 3,167 (20)
Deferred:
Federal 2,726 2,260 3,595
Investment tax credits (332) (326) (320)
State 686 620 662
--------------- -------------- --------------
Total deferred 3,080 2,554 3,937
--------------- -------------- --------------
Subtotal 8,947 5,721 3,917
Income tax benefit on dividends on convertible preferred securities:
Current:
Federal (3,344) (3,344) (3,344)
State (508) (508) (508)
--------------- -------------- --------------
Subtotal (3,852) (3,852) (3,852)
Income taxes charged (credited) to the income statement for
extraordinary expense - Discontinuation of Statement of Financial
Accounting Standards No. 71:
Deferred:
Federal 15,500 - -
State 6,157 - -
--------------- -------------- --------------
Subtotal 21,657 - -
--------------- -------------- --------------
Total income taxes charged to the income statement (a) 11,947 (14,263) 74,965
Income taxes charged (credited) to shareholders' equity:
Deferred income taxes (benefits) on unrealized gains or losses on
securities classified as available-for-sale 2,908 (8,997) (25,906)
Current benefit arising from stock options exercised (3,001) (7,392) (1,262)
--------------- -------------- --------------
Income taxes charged (credited) to shareholders' equity (b) (93) (16,389) (27,168)
--------------- -------------- --------------
Total income taxes: (a) plus (b) $ 11,854 $ (30,652) $ 47,797
=============== ============== ==============
Our alternative minimum tax credit as of December 31, 2001 is $69,836,000,
which can be carried forward indefinitely to reduce future regular tax
liability. This benefit is presented as a reduction of accrued income
taxes.
F-30
(16) Net Income (Loss) Per Common Share:
----------------------------------
The reconciliation of the net income (loss) per common share calculation
for the years ended December 31, 2001, 2000 and 1999 is as follows:
(In thousands, except per-share amounts)
2001 2000 1999
------------------------------- --------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Loss Shares Per Share Loss Shares Per Share Income Shares Per Share
---------- --------- ---------- --------------------------- --------- ------------------
Net income (loss) per common share:
Basic $ (89,682) 273,721 $ (28,394) 260,767 $ 144,486 259,335
Carrying cost of equity forward
contracts 13,650 - - - - -
---------- --------- ---------- -------- --------- ---------
Available for common shareholders $(103,332) 273,721 $ (0.38) $ (28,394) 260,767 $ (0.11) $ 144,486 259,335 $ 0.56
========== ========= ========== ========== ======== ========
Effect of dilutive options 5,831 10,149 - 2,925 -
--------- ---------
Diluted $ 144,486 262,260 $ 0.55
========= =========
All share amounts represent weighted average shares outstanding for each
respective period. The diluted net income (loss) per common share
calculation excludes the effect of potentially dilutive shares when their
exercise price exceeds the average market price over the period. We have
4,025,000 shares of potentially dilutive Mandatorily Redeemable Convertible
Preferred Securities which are convertible into common stock at a 3.76 to 1
ratio at an exercise price of $13.30 per share and 7,779,000 potentially
dilutive stock options at a range of $12.37 to $21.47 per share. These
items were not included in the diluted net income (loss) per common share
calculation for any of the above periods as their effect was antidilutive.
Restricted stock awards of 829,000 shares and 1,232,000 shares at December
31, 2001 and 2000 respectively, are excluded from our basic weighted
average shares outstanding and included in our dilutive shares until the
shares are no longer contingent upon the satisfaction of all specified
conditions.
F-31
(17) Comprehensive Income (Loss):
---------------------------
Our other comprehensive income (loss) for the years ended December 31,
2001, 2000 and 1999 is as follows:
2001
------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
------------- --------------- ------------
Net unrealized losses on securities:
Net unrealized holding losses arising during period $ (70,771) $ (27,015) $ (43,756)
Add: Reclassification adjustments for net losses
realized in net loss 78,168 29,923 48,245
------------- --------------- ------------
Other comprehensive income $ 7,397 $ 2,908 $ 4,489
============= =============== ============
2000
------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
------------- --------------- ------------
Net unrealized losses on securities:
Net unrealized holding losses arising during period $ (40,377) $ (15,457) $ (24,920)
Add: Reclassification adjustments for net losses
realized in net loss 16,875 6,460 10,415
------------- --------------- ------------
Other comprehensive loss $ (23,502) $ (8,997) $ (14,505)
============= =============== ============
1999
------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
------------- --------------- ------------
Net unrealized gains on securities:
Net unrealized holding gains arising during period $ 56,746 $ 21,722 $ 35,024
Less: Reclassification adjustments for net gains
realized in net income 124,421 47,628 76,793
------------- --------------- ------------
Other comprehensive loss $ (67,675) $ (25,906) $ (41,769)
============= =============== ============
(18) Segment Information:
-------------------
We operate in four segments, Incumbent Local Exchange Carrier (ILEC), ELI
(a competitive local exchange carrier, or CLEC), gas and electric. The ILEC
segment provides both regulated and competitive communications services to
residential, business and wholesale customers and is the incumbent carrier
in its service areas. Our gas and electric segments are intended to be sold
and are classified as "assets held for sale" and "liabilities related to
assets held for sale."
Adjusted EBITDA is operating income (loss) plus depreciation and
amortization. EBITDA is a measure commonly used to analyze companies on the
basis of operating performance. We use this measure to evaluate the
operating performance of and allocate resources to our operating segments.
EBITDA is a simple estimate of financial performance that is easily
calculated by our operating managers. It is not a measure of financial
performance under generally accepted accounting principles and should not
be considered as an alternative to net income as a measure of performance
nor as an alternative to cash flow as a measure of liquidity and may not be
comparable to similarly titled measures of other companies.
F-32
($ in thousands) For the year ended December 31, 2001
---------------------------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Eliminations Segments
-------------- -------------- -------------- ------------- -------------- --------------
Revenue $1,594,053 $ 226,640 $ 411,534 $ 228,015 $ (3,249)1 $ 2,456,993
Depreciation & Amortization 545,273 79,022 609 6,434 998 2 632,336
Operating Income (Loss) 220,956 (73,193) 47,916 35,335 2,028 2,3 233,042
Adjusted EBITDA 766,229 5,829 48,525 41,769 3,026 3 865,378
Capital Expenditures, net 408,464 54,589 4 34,138 32,706 - 529,897
Assets 7,072,288 902,348 441,654 666,283 - 9,082,573
($ in thousands) For the year ended December 31, 2000
---------------------------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Eliminations Segments
-------------- -------------- -------------- ------------- -------------- --------------
Revenue $ 963,743 $ 243,977 $ 374,751 $ 223,072 $ (3,185)1 $ 1,802,358
Depreciation & Amortization 276,250 61,663 19,228 28,629 1,837 2 387,607
Operating Income (Loss) 157,896 (59,876) 8,268 15,226 287 2,3 121,801
Adjusted EBITDA 434,146 1,787 27,496 43,855 2,124 3 509,408
Capital Expenditures, net 345,395 108,909 4 51,457 29,482 - 535,243
Assets 3,558,562 949,774 692,351 589,801 - 5,790,488
($ in thousands) For the year ended December 31, 1999
---------------------------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Eliminations Segments
-------------- -------------- -------------- ------------- -------------- --------------
Revenue $ 903,237 $ 187,008 $ 306,986 $ 203,822 $ (2,817)1 $ 1,598,236
Depreciation & Amortization 226,141 36,505 22,203 25,552 (216)2 310,185
Operating Income (Loss) 100,910 (94,066) 32,024 30,268 1,224 2,3 70,360
Adjusted EBITDA 327,051 (57,561) 54,227 55,820 1,008 3 380,545
Capital Expenditures, net 275,804 180,342 66,951 43,634 - 566,731
1 Represents revenue received by ELI from our ILEC operations.
2 Represents amortization of the capitalized portion of intercompany interest
related to our guarantees of ELI debt and leases and amortization of
goodwill related to our purchase of ELI stock (see Note 12).
3 Represents the administrative services fee charged to ELI pursuant to the
management services agreement between ELI and us.
4 Does not include approximately, $33,985,000, $102,192,000 and $60,321,000
of non-cash capital lease additions in 2001, 2000 and 1999, respectively.
F-33
The reconciliation of income from continuing operations to adjusted EBITDA
for the years ended December 31, 2001, 2000 and 1999 is as follows:
($ in thousands) For the year ended December 31,
2001 2000 1999
-------------- -------------- -------------
Income (loss) from continuing operations
before extraordinary expense $ (63,926) $ (40,071) $ 136,599
Add back:
Interest expense (379,326) (187,366) (119,675)
Dividends on convertible preferred
securities, net of income tax benefit 6,210 6,210 6,210
Income tax expense (benefit) (14,805) (16,132) 74,900
Other loss, net (3,133) (1,386) (88)
Subtract:
Gain on sale of assets 139,304 - -
Investment income (loss), net (62,408) 4,736 243,885
Minority interest - 12,222 23,227
-------------- -------------- -------------
Operating income 233,042 121,801 70,360
Add back:
Depreciation 632,336 387,607 310,185
-------------- -------------- -------------
Adjusted EBITDA $ 865,378 $ 509,408 $ 380,545
============== ============== =============
The following tables are reconciliations of certain sector items to the
total consolidated amount.
($ in thousands) For the year ended December 31,
2001 2000 1999
-------------- -------------- -------------
Capital Expenditures
Total segment capital expenditures $ 529,897 $ 535,243 $ 566,731
General capital expenditures 817 1,396 6,599
-------------- -------------- -------------
Consolidated reported capital expenditures $ 530,714 $ 536,639 $ 573,330
============== ============== =============
December 31,
Assets 2001 2000
-------------- --------------
Total segment assets $ 9,082,573 $ 5,790,488
General assets 724,236 446,916
Discontinued operations assets 746,791 717,602
-------------- --------------
Consolidated reported assets $ 10,553,600 $ 6,955,006
============== ==============
F-34
(19) Supplemental Segment Information:
--------------------------------
Supplemental segment income statement information for the year ended
December 31, 2001 is as follows:
For the year ended December 31, 2001
------------------------------------------------------------------------------------
( $ in thousands) Discontinued Corporate and Consolidated
ILEC ELI Gas Electric Operations Eliminations Total
------------------------- ---------------------- ----------- -----------------------
Revenue $ 1,594,053 $ 226,640 $ 411,534 $228,015 $ - $ (3,249) $ 2,456,993
Operating expenses:
Cost of services 129,408 67,610 282,061 123,223 - (2,924) 599,378
Depreciation and amortization 545,273 79,022 609 6,434 - 998 632,336
Other operating expenses 640,688 149,022 80,948 63,023 - (3,351) 930,330
Write-down of Global receivables 21,200 - - - - - 21,200
Restructuring expenses 15,148 4,179 - - - - 19,327
Acquisition assimilation expense 21,380 - - - - - 21,380
------------------------- ---------------------- ----------- ----------- -----------
Total operating expenses 1,373,097 299,833 363,618 192,680 - (5,277) 2,223,951
------------------------- ---------------------- ----------- ----------- -----------
Operating income (loss) 220,956 (73,193) 47,916 35,335 - 2,028 233,042
Investment income (loss), net (64,287) - 1,625 254 - - (62,408)
Other income (loss), net (3,052) 311 24 (416) - - (3,133)
Gain on sale of assets - - - - - 139,304 139,304
Interest expense (302,516) (97,656) (8,902) (16,276) - 46,024 (379,326)
------------------------- ---------------------- ----------- ----------- -----------
Income (loss) from continuing operations
before income taxes, dividends on convertible
preferred securities and extraordinary
expense (148,899) (170,538) 40,663 18,897 - 187,356 (72,521)
Income tax expense (benefit) (55,107) 1,154 15,616 7,007 - 16,525 (14,805)
------------------------- ---------------------- ----------- ----------- -----------
Income (loss) from continuing operations
before dividends on convertible preferred
securities and extraordinary expense (93,792) (171,692) 25,047 11,890 - 170,831 (57,716)
Dividends on convertible preferred
securities, net of income tax benefit 6,210 - - - - - 6,210
------------------------- ---------------------- ----------- ----------- -----------
Income (loss) from continuing operations
before extraordinary expense (100,002) (171,692) 25,047 11,890 - 170,831 (63,926)
Income from discontinued operations,
net of tax - - - - 17,875 - 17,875
------------------------- ---------------------- ----------- ----------- -----------
Net income (loss) before extraordinary
expense (100,002) (171,692) 25,047 11,890 17,875 170,831 (46,051)
Extraordinary expense - discontinuation
of Statement of Financial Accounting
Standards No. 71, net of tax - - - - - 43,631 43,631
------------------------- ---------------------- ----------- ----------- -----------
Net income (loss) $ (100,002) $ (171,692) $ 25,047 $ 11,890 $ 17,875 $ 127,200 $ (89,682)
========================= ====================== =========== =========== ===========
F-35
(20) Discontinuation of SFAS 71:
--------------------------
We historically applied SFAS 71 in the preparation of our financial
statements because our incumbent local exchange telephone properties
(properties we owned prior to the 2000 and 2001 acquisitions of the
Verizon, Qwest and Frontier properties) were predominantly regulated in the
past following a cost of service/rate of return approach. Beginning in the
third quarter of 2001, these properties no longer met the criteria for
application of SFAS 71 due to the continuing process of deregulation and
the introduction of competition to our existing rural local exchange
telephone properties, and our expectation that these trends will continue
for all our properties.
Currently, pricing for a majority of our revenues is based upon price cap
plans that limit prices to changes in general inflation and estimates of
productivity for the industry at large, or upon market pricing, rather than
on the specific costs of operating our business, a requirement for the
application of SFAS 71. These trends in the deregulation of pricing and the
introduction of competition are expected to continue in the near future as
additional states adopt price cap forms of regulation.
Discontinued application of SFAS 71 required us to write off all of the
regulatory assets and liabilities of our incumbent local exchange telephone
operations. As a result we recognized a non-cash extraordinary charge in
our financial statements in the third quarter of 2001 as follows:
($ in thousands)
Assets:
Deferred income tax assets $ 31,480
Deferred cost of extraordinary plant retirements 25,348
Deferred charges 6,885
Liabilities:
Plant related (10,259)
Deferred income tax liabilities (2,531)
-------
Pre-tax charge 50,923
Income tax benefit 7,292
--------
Extraordinary expense $ 43,631
========
Under SFAS 71, we depreciated our telephone plant for financial reporting
purposes over asset lives approved by the regulatory agencies setting
regulated rates. As part of the discontinuance of SFAS 71, we revised the
depreciation lives of our core technology assets to reflect their estimated
economic useful lives. Based upon our evaluation of the pace of technology
change that is estimated to occur in certain components of our rural
telephone networks, we have concluded that minor modifications are required
in our asset lives for the major network technology assets as follows:
Average Remaining Life in Years
-------------------------------
Regulated Economic
Life Life
---- ------
Switching Equipment 6.4 5.6
Circuit Equipment 4.3 4.9
Copper Cable 8.5 7.7
Upon discontinuation of SFAS 71, we tested the balances of property, plant
and equipment associated with the incumbent local exchange telephone
properties for impairment under SFAS 121 (as required by SFAS 101). No
impairment charge was required.
To reflect the expectation that competitive entry will occur over time for
certain of our properties acquired in prior purchase business combinations,
we have shortened the amortization life for previously acquired franchise
rights related to these properties to 20 years. This action was taken to
reflect the fact that our dominant position in the market related to the
existence of the prior monopoly in incumbent local exchange telephone
service may be reduced over time as competitors enter our markets.
F-36
(21) Quarterly Financial Data (unaudited):
------------------------------------
($ in thousands, except per share amounts)
First quarter Second quarter Third quarter Fourth quarter
2001
Revenue $ 624,281 $ 505,741 $ 661,121 $ 665,850
Income (loss) before extraordinary expense 19,723 (649) 43,190 (108,315)
Net income (loss) 19,723 (649) (441) (108,315)
Income (loss) before extraordinary expense available to
common shareholders per basic share $ 0.08 $ (0.05) $ 0.15 $ (0.39)
Income (loss) before extraordinary expense available to
common shareholders per diluted share $ 0.07 $ (0.05) $ 0.15 $ (0.39)
Net income (loss) available to common shareholders per basic share $ 0.08 $ (0.05) $ (0.01) $ (0.39)
Net income (loss) available to common shareholders per diluted
share $ 0.07 $ (0.05) $ (0.01) $ (0.39)
2000
Revenue $ 448,702 $ 418,607 $ 452,710 $ 482,339
Net income (loss) 7,326 3,012 1,467 (40,199)
Net income (loss) per basic share $ 0.03 $ 0.01 $ 0.01 $ (0.15)
Net income (loss) per diluted share $ 0.03 $ 0.01 $ 0.01 $ (0.15)
The quarterly net income (loss) per common share amounts are rounded to the
nearest cent. Annual net income (loss) per common share may vary depending
on the effect of such rounding. Quarterly revenue has been retroactively
revised from their original presentations to conform to current
presentation.
On July 2, 2001, we completed on the sale of our Louisiana Gas operations
to Atmos Energy Corporation for $363.4 million in cash. The pre-tax gain on
the sale recognized in the third quarter was $139.3 million.
Concurrent with the acquisition of Frontier, we entered into several
operating agreements with Global. The write-down of the net realizable
value of Global receivables of $21.2 million for the year ended December
31, 2001 is related to the write-down of receivables from Global as a
result of Global's filing for bankruptcy. We are integrating the Frontier
acquisition from Global and have ongoing commercial relationships with
Global affiliates. We will reserve a total of $30 million of Global
receivables to reflect our best estimate of the net realizable value of
receivables incurred from these commercial relationships during 2001 and
2002. We recorded a write down of such receivables in the amount of $21.2
million in the fourth quarter of 2001, with the remainder recorded in the
first quarter of 2002 for receivables generated after December 31, 2001 and
prior to the Global bankruptcy filing on January 28, 2002.
Restructuring expenses of $13.0 million for the third quarter and $6.3
million for the fourth quarter of 2001 are primarily related to our plan to
close our operations support center in Plano, Texas by April 2002 and our
Sacramento, California call center by March 2002 and ELI's decision to exit
certain long haul markets. These restructurings are a result of our
evaluation of our facilities to take advantage of operational and
functional synergies.
We recognized a loss of $79.0 million in the Adelphia investment as a
reduction to investment income in the fourth quarter of 2001. This non-cash
charge does not impact the carrying value of these securities which were
stated at current market values on prior balance sheets. This charge
reflects a decline in current trading values that have persisted for
greater than a six month period.
Deregulation of most of our local exchange telephone properties required us
to cease application of SFAS 71 in the third quarter of 2001, resulting in
a non-cash extraordinary charge of $43.6 million, net of tax, in our income
statement.
In the fourth quarter of 2000, we settled a proceeding with the Louisiana
Public Service Commission. Louisiana Gas Service, our former subsidiary,
refunded approximately $27 million to ratepayers during the month of
January 2001, effected as a credit on customers' bills. As a result, we
recorded approximately $29.7 million of charges to earnings in the fourth
quarter of 2000. This amount included a reduction to revenue for the refund
to customers of approximately $27 million and legal fees of approximately
$2.7 million.
F-37
(22) Supplemental Cash Flow Information:
----------------------------------
The following is a schedule of net cash provided by operating activities
for the years ended December 31, 2001, 2000 and 1999:
($ in thousands) 2001 2000 1999
------------- ------------- -------------
Income (loss) from continuing operations $(107,557) $ (40,071) $ 136,599
Extraordinary item 43,631 - -
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization expense 632,336 387,607 310,185
Non-cash restructuring charge - - 36,136
Investment write down 79,114 - -
Investment (gains)/losses 660 18,314 (221,088)
Gain on sale of gas operations, net (137,849) - -
Allowance for equity funds used during construction (2,811) (3,257) (4,586)
Deferred income tax and investment tax credit 17,030 53,215 26,644
Change in operating accounts receivable 57,145 (11,685) (1,966)
Change in accounts payable and other (156,860) (32,451) 52,066
Change in accrued taxes and interest 166,815 (28,944) 29,867
Change in other assets (71,275) (43,225) 2,160
------------- ------------- -------------
Net cash provided by continuing operating activities $ 520,379 $ 299,503 $ 366,017
============= ============= =============
F-38
(23) Retirement Plans:
-----------------
Pension Plan
------------
We have a noncontributory pension plan covering all employees who have met
certain service and age requirements. The benefits are based on years of
service and final average pay or career average pay. Contributions are made
in amounts sufficient to fund the plan's net periodic pension cost while
considering tax deductibility. Plan assets are invested in a diversified
portfolio of equity and fixed-income securities.
The following tables set forth the plan's benefit obligations and fair
values of plan assets as of December 31, 2001 and 2000 and net periodic
benefit cost for the years ended December 31, 2001, 2000 and 1999.
($ in thousands) 2001 2000
------------- --------------
Change in benefit obligation
Benefit obligation at beginning of year $ 282,024 $ 227,602
Service cost 14,065 12,286
Interest cost 37,680 18,772
Amendments (3,679) 275
Actuarial (gain)/loss 16,771 23,223
Acquisitions 447,279 11,300
Benefits paid (34,213) (11,434)
------------- --------------
Benefit obligation at end of year $ 759,927 $ 282,024
============= ==============
Change in plan assets
Fair value of plan assets at beginning of year $ 249,400 $ 238,886
Actual return on plan assets (13,337) 7,155
Acquisitions 583,190 12,622
Employer contribution 13,253 2,171
Benefits paid (34,213) (11,434)
------------- --------------
Fair value of plan assets at end of year $ 798,293 $ 249,400
============= ==============
(Accrued)/Prepaid benefit cost
Funded status $ 38,366 $ (32,624)
Unrecognized net liability 60 103
Unrecognized prior service cost (1,599) 1,795
Unrecognized net actuarial (gain)/loss 96,860 21,900
------------- --------------
(Accrued)/Prepaid benefit cost $ 133,687 $ (8,826)
============= ==============
For the years ended December 31,
2001 2000 1999
------------- -------------- -------------
Components of net periodic benefit cost
Service cost $ 14,065 $ 12,286 $ 13,234
Interest cost on projected benefit obligation 37,680 18,772 17,200
Return on plan assets (44,852) (19,743) (19,081)
Net amortization and deferral (242) 196 175
------------- -------------- -------------
Net periodic benefit cost $ 6,651 $ 11,511 $ 11,528
============= ============== =============
F-39
Assumptions used in the computation of pension costs/ year-end benefit
obligations were as follows:
2001 2000
---- ----
Discount rate 7.5%/7.25% 8.0%/7.5%
Expected long-term rate of return on plan assets 8.25%/N/A 8.25%/N/A
Rate of increase in compensation levels 4.0%/4.0% 4.0%/4.0%
In November 2000 and June 2001, we acquired Verizon Illinois and Frontier,
respectively, including their pension benefit plans. The Illinois
acquisition increased the pension benefit obligation by $4,665,000 and the
fair value of plan assets by $6,378,000 of December 31, 2001.
Included in pension benefit obligation is $442,614,000 and in the fair
value of plan assets is $576,812,000 as of December 31, 2001, each
attributable to the Frontier acquisition. As part of the Frontier
acquisition, Global and we agreed to the transfer, effective as of July 1,
2001, to a trust established under our pension plan of liabilities and
assets, other than liabilities relating to certain current and former
Frontier employees who were not considered part of the Frontier acquisition
and assets attributable to such liabilities (calculated using the "safe
harbor" methodology of the Pension Benefit Guaranty Corporation). While all
amounts and procedures had been agreed to by Global and us prior to
Global's bankruptcy filing, Global has failed to execute and deliver an
authorization letter to the Frontier plan trustee directing the trustee to
transfer to our pension plan record ownership of the transferred assets. We
have initiated an adversary proceeding with the Bankruptcy Court
supervising Global's bankruptcy proceeding, in which we believe we will
prevail, to require Global to execute and deliver such letter if Global
does not do so as required by the Frontier stock purchase agreement.
Postretirement Benefits Other Than Pensions
-------------------------------------------
We provide certain medical, dental and life insurance benefits for retired
employees and their beneficiaries and covered dependents. The following
table sets forth the plan's benefit obligations and the postretirement
benefit liability recognized on our balance sheets at December 31, 2001 and
2000 and net periodic postretirement benefit costs for the years ended
December 31, 2001, 2000 and 1999:
($ in thousands) 2001 2000
------------- --------------
Change in benefit obligation
Benefit obligation at beginning of year $ 59,191 $ 45,528
Service cost 937 652
Interest cost 8,812 3,943
Plan participants' contributions 1,023 700
Curtailments/settlements (14,223) (812)
Actuarial (gain)/loss 20,321 8,733
Acquisitions 119,611 3,441
Amendments 20 -
Benefits paid (5,350) (2,994)
------------- --------------
Benefit obligation at end of year $ 190,342 $ 59,191
============= ==============
Change in plan assets
Fair value of plan assets at beginning of year $ 25,412 $ 20,460
Actual return on plan assets 310 1,093
Benefits paid (1,464) -
Employer contribution 1,498 1,498
Acquisitions 3,334 2,361
------------- --------------
Fair value of plan assets at end of year $ 29,090 $ 25,412
============= ==============
Accrued benefit cost
Funded status $(161,252) $(33,779)
Unrecognized transition obligation 258 281
Unrecognized prior service cost 18 -
Unrecognized (gain) 18,174 (4,832)
------------- --------------
Accrued benefit cost $(142,802) $(38,330)
============= ==============
F-40
For the years ended December 31,
2001 2000 1999
------------- -------------- -------------
Components of net periodic postretirement benefit costs
Service cost $ 937 $ 652 $ 781
Interest cost on projected benefit obligation 8,812 3,943 3,431
Return on plan assets (2,227) (1,688) (1,544)
Net amortization and deferral 229 (770) (828)
Curtailment (gain)/loss - (757) -
Settlement (gain)/loss 491 - -
Acquisition (gain)/loss - 581 -
------------- -------------- -------------
Net periodic postretirement benefit cost $ 8,242 $ 1,961 $ 1,840
============= ============== =============
For purposes of measuring year end benefit obligations, we used the same
discount rates as were used for the pension plan and a 9% annual rate of
increase in the per-capita cost of covered medical benefits, gradually
decreasing to 5% in the year 2020 and remaining at that level thereafter.
The effect of a 1% increase in the assumed medical cost trend rates for
each future year on the aggregate of the service and interest cost
components of the total postretirement benefit cost would be $835,000 and
the effect on the accumulated postretirement benefit obligation for health
benefits would be $17,188,000. The effect of a 1% decrease in the assumed
medical cost trend rates for each future year on the aggregate of the
service and interest cost components of the total postretirement benefit
cost would be $(689,000) and the effect on the accumulated postretirement
benefit obligation for health benefits would be $(14,821,000).
In August 1999, our Board of Directors approved a plan of divestiture for
the public services properties. As such, any pension and/or postretirement
gain or loss associated with the divestiture of these properties will be
recognized when realized.
In November 2000 and June 2001, we acquired Verizon Illinois and Frontier
Corp., respectively, including their postretirement benefit plans. The
Illinois acquisition increased the accumulated postretirement benefit
obligation by $792,000 as of December 31, 2001. The Frontier Corp.
acquisition increased the accumulated postretirement benefit obligation by
$118,819,000 and the fair value of plan assets by $3,334,000 as of June 29,
2001.
401(k) Savings Plans
--------------------
We sponsor employee savings plans under section 401(k) of the Internal
Revenue Code. The plans cover substantially all full-time employees. Under
the plans, we provide matching contributions in our stock based on
qualified employee contributions. Matching contributions were $6,878,000,
$5,973,000 and $5,850,000 for 2001, 2000 and 1999, respectively.
(24) Commitments and Contingencies:
-----------------------------
We have budgeted capital expenditures in 2002 of approximately $525.6
million, including $483.6 million for ILEC and ELI and $42.0 million for
gas and electric. Certain commitments have been entered into in connection
therewith.
In December 1999, we entered into a three-year agreement with Nortel to
outsource elements of DMS central office engineering and commissioning of
our network. Our commitment under this agreement is $35,000,000 for 2002.
The 2002 capital cost of this contract is included in the 2002 budgeted
capital expenditures, presented above.
F-41
We conduct certain of our operations in leased premises and also lease
certain equipment and other assets pursuant to operating leases. Future
minimum rental commitments for all long-term noncancelable operating leases
for continuing operations are as follows:
($ in thousands) Year Amount
-------------- --------------
2002 $ 25,777
2003 23,933
2004 19,135
2005 16,602
2006 15,521
thereafter 60,849
--------------
Total $ 161,817
==============
Total rental expense included in our results of operations for the years
ended December 31, 2001, 2000 and 1999 was $38,829,000, $33,042,000 and
$30,855,000, respectively. We sublease, on a month to month basis, certain
office space in our corporate office to a charitable foundation formed by
our Chairman.
In 1995, ELI entered into a $110 million construction agency agreement and
an operating lease agreement in connection with the construction of certain
communications networks and fiber cable links. ELI served as agent for the
construction of these projects and, upon completion of each project, leased
the facilities for a three-year term, with one-year renewals available
through April 30, 2002. At December 31, 2001, 2000 and 1999, ELI was
leasing assets under this agreement with an original cost of approximately
$108,541,000. In January 2002, ELI exercised its option to purchase the
facilities at the end of the lease term for the amount of the lessor's
average investment in the facilities. Payments under the lease depend on
current interest rates, and assuming continuation of current interest
rates, payments would approximate $6.7 million annually through April 30,
2002 and, a final payment of approximately $110 million in 2002. We have
guaranteed all obligations of ELI under this operating lease.
ELI has entered into various capital and operating leases for fiber optic
cable to interconnect ELI's local networks with long-haul fiber optic
routes. The terms of the various agreements covering these routes range
from 20 to 25 years, with varying optional renewal periods. For certain
contracts, rental payments are based on a percentage of ELI's leased
traffic, and are exclusive, subject to certain minimums. For other
contracts, certain minimum payments are required.
ELI has also entered into certain operating and capital leases in order to
develop ELI's local networks, including an operating lease to develop a
local network in Phoenix and a capital lease in San Francisco. The
operating lease in Phoenix provides for rental payments based on a
percentage of the network's operating income for a period of 15 years. The
capital lease in San Francisco is a 30-year indefeasible and exclusive
right to use agreement for optical fibers in the San Francisco Bay Area.
F-42
Minimum payments on operating leases are included in the table above. For
payments on capital leases, see Note 9.
We are a party to contracts with several unrelated long distance carriers.
The contracts provide fees based on leased traffic subject to minimum
monthly fees. We also purchase capacity and associated energy from various
electric energy and natural gas suppliers. Some of these contracts obligate
us to pay certain capacity costs whether or not energy purchases are made.
These contracts are intended to complement the other components in our
power supply to achieve the most economic mix reasonably available. At
December 31, 2001, the estimated future payments for long distance
contracts, and capacity and energy that we are obligated for are as
follows:
Public
($ in thousands) Year ILEC / ELI Services Total
-------------- -------------- -------------- --------------
2002 $ 68,627 $ 36,726 $ 105,353
2003 43,040 33,040 76,080
2004 17,678 33,541 51,219
2005 - 29,116 29,116
2006 - 29,706 29,706
thereafter - 281,345 281,345
-------------- -------------- --------------
Total $129,345 $443,474 $ 572,819
============== ============== ==============
The Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities,
including us, have entered into a purchase power agreement with
Hydro-Quebec. The agreement contains "step-up" provisions that state that
if any VJO member defaults on its purchase obligation under the contract to
purchase power from Hydro-Quebec the other VJO participants will assume
responsibility for the defaulting party's share on a pro-rata basis. As of
December 31, 2001, 2000 and 1999, our obligation under the agreement is
approximately 10% of the total contract. If any member of the VJO defaults
on its obligations under the Hydro-Quebec agreement, the remaining members
of the VJO, including us, may be required to pay for a substantially larger
share of the VJO's total power purchase obligation for the remainder of the
agreement. Such a result could have a materially adverse effect on our
financial results.
At December 31, 2001, we have outstanding performance letters of credit as
follows:
($ in thousands)
Qwest $ 64,280
Insurance Letters of credit to CNA 16,238
Water/wastewater projects 2,360
ELI projects 60
------------
Total $ 82,938
========
None of the above letters of credit restrict our cash balances. In
addition, we have issued $281,680 of letters of credit where we are
required to maintain restricted cash balances in the same amount. This
amount has been segregated from cash on our balance sheet and is included
as a component of other current assets.
On July 20, 2001, we notified Qwest Corporation that we were terminating
eight acquisition agreements with Qwest relating to telephone exchanges in
Arizona, Colorado, Idaho/ Washington, Iowa, Minnesota, Montana, Nebraska
and Wyoming. On July 23, 2001, Qwest filed a notice of claim for
arbitration with respect to the terminated acquisition agreements. Qwest
asserts that we wrongfully terminated these agreements and is seeking
approximately $64 million in damages, which is the aggregate of liquidated
damages under letters of credit established in the terminated acquisition
agreements. On September 7, 2001, we filed a response and counterclaims in
the same arbitration proceeding, contesting Qwest's asserted claims and
asserting substantial claims against Qwest for material breaches of
representations, warranties, and covenants in the terminated acquisition
agreements and in the acquisition agreement relating to North Dakota assets
that we purchased from Qwest. The parties are currently engaged in
discovery. An arbitration hearing has been tentatively scheduled to
commence in the fourth quarter of 2002.
F-43
On December 21, 2001, we entered into a settlement agreement that, if
approved by the court, will resolve all claims in a class action lawsuit
pending against the company in Santa Cruz County, Arizona (Chilcote, et al.
v. Citizens Utilities Company, No. CV 98-471). The lawsuit arose from
claims by a class of plaintiffs that includes all of our electric customers
in Santa Cruz County for damages resulting from several power outages that
occurred during the period January 1, 1997, through January 31, 1999. Under
the terms of the settlement agreement, and without any admission of guilt
or wrongdoing by the company, we will pay the class members $5.5 million in
satisfaction of all claims. This settlement must be approved by the court,
which is expected to occur sometime during the first half of 2002. The
company has accrued the full settlement amount, plus an additional amount
sufficient to cover legal fees and other related expenses, during the
fourth quarter of 2001.
We are involved in various other claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters, after considering insurance coverages, will
not have a material adverse effect on our consolidated financial position,
results of operations or liquidity.
F-44
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited and reported separately herein on the balance sheets of Citizens
Communications Company and subsidiaries as of December 31, 2001 and 2000 and the
related statements of income (loss), shareholders' equity, comprehensive income
(loss) and cash flows for each of the years in the three-year period ended
December 31, 2001.
Our audits were made for the purpose of forming an opinion on the basic
financial statements of Citizens Communications Company and subsidiaries taken
as a whole. The supplementary information included in Schedule II is presented
for purposes of additional analysis and is not a required part of the basic
financial statements. Such information has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, is fairly stated in all material respects in relation to the basic
financial statements taken as a whole.
/S/KPMG LLP
New York, New York
March 6, 2002
F-45
Schedule II
Citizens Communications
Valuation and Qualifying Accounts
($ In thousands)
Balance at Charged to Balance at
Beginning of Revenue or Frontier End of
Accounts Period Expense Acquisition Deductions Period
------------ ---------- ----------- ------------- ----------
Allowance for doubtful accounts
1999 $18,348 $19,145 $ - $ (9,215) 28,278
2000 28,278 16,719 - (21,084) 23,913
2001 23,913 41,233 10,709 (8,254) 67,601
F-46