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CITIZENS COMMUNICATIONS COMPANY
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2002
-------------
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________to__________
Commission file number 001-11001
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-0619596
- -------------------------------- -----------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
---------------------------
(Address, zip code of principal executive offices)
Registrant's telephone number, including area code (203) 614-5600
-----------------
NONE
----
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve 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 ninety days.
Yes X No
----- -----
The number of shares outstanding of the registrant's class of common stock as of
July 31, 2002 was 282,221,277.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index to Consolidated Financial Statements
Page No.
--------
Part I. Financial Information (Unaudited)
Consolidated Balance Sheets at June 30, 2002 and December 31, 2001 2
Consolidated Statements of Income (Loss) for the three months ended June 30, 2002 and 2001 3
Consolidated Statements of Income (Loss) for the six months ended June 30, 2002 and 2001 4
Consolidated Statements of Shareholders' Equity for the year ended December 31, 2001 and the
six months ended June 30, 2002 5
Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30,
2002 and 2001 5
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001 6
Notes to Condensed Consolidated Financial Statements 7
Management's Discussion and Analysis of Financial Condition and Results of Operations 21
Quantitative and Qualitative Disclosures about Market Risk 30
Part II. Other Information
Legal Proceedings 32
Submission of Matters to a Vote of Security Holders 33
Other Information 33
Exhibits and Reports on Form 8-K 33
Signature 34
1
PART I. FINANCIAL INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)
(Unaudited)
June 30, 2002 December 31, 2001
--------------- -------------------
ASSETS
Current assets:
Cash and cash equivalents $ 421,069 $ 215,869
Accounts receivable, net 307,176 311,878
Other current assets 38,803 150,573
Assets held for sale 1,112,466 1,107,937
Assets of discontinued operations - 746,791
---------------- ------------------
Total current assets 1,879,514 2,533,048
Property, plant and equipment, net 4,488,913 4,512,038
Intangibles, net 2,896,281 2,978,942
Investments 30,020 141,208
Other assets 374,205 388,364
---------------- ------------------
Total assets $ 9,668,933 $ 10,553,600
================ ==================
LIABILITIES AND EQUITY
Current liabilities:
Long-term debt due within one year $ 63,924 $ 483,906
Accounts payable and other current liabilities 613,938 625,575
Liabilities related to assets held for sale 175,469 218,775
Liabilities of discontinued operations - 228,337
---------------- ------------------
Total current liabilities 853,331 1,556,593
Deferred income taxes 416,683 429,544
Customer advances for construction and contributions in aid of construction 170,385 183,319
Other liabilities 236,515 241,846
Equity units 460,000 460,000
Long-term debt 5,339,414 5,534,906
---------------- ------------------
Total liabilities 7,476,328 8,406,208
Company Obligated Mandatorily Redeemable Convertible Preferred Securities* 201,250 201,250
Shareholders' equity
Common stock, $0.25 par value (600,000,000 authorized shares; 282,213,000
and 281,289,000 outstanding and 293,750,000 and 292,840,000 issued at
June 30, 2002 and December 31, 2001, respectively) 73,437 73,210
Additional paid-in capital 1,936,038 1,927,518
Retained earnings 171,531 129,864
Accumulated other comprehensive income (loss) (575) 4,907
Treasury stock (189,076) (189,357)
---------------- ------------------
Total shareholders' equity 1,991,355 1,946,142
---------------- ------------------
Total liabilities and equity $ 9,668,933 $ 10,553,600
================ ==================
* Represents securities of a subsidiary trust, the sole assets of which are
securities of a subsidiary partnership, substantially all the assets of which
are convertible debentures of the Company.
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
2
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR THE THREE MONTHS ENDED JUNE 30, 2002 AND 2001
($ in thousands, except per-share amounts)
(Unaudited)
2002 2001
-------------- ---------------
Revenue $ 662,439 $ 505,741
Operating expenses:
Cost of services 113,786 128,528
Other operating expenses 251,426 202,298
Depreciation and amortization 186,378 114,366
Reserve for telecommunications bankruptcies 10,001 -
Restructuring and other expenses 18,280 -
-------------- ---------------
Total operating expenses 579,871 445,192
-------------- ---------------
Operating income 82,568 60,549
Investment and other income (loss), net (28,076) 10,641
Interest expense 121,059 73,129
-------------- ---------------
Loss from continuing operations before income taxes and dividends
on convertible preferred securities (66,567) (1,939)
Income tax expense (benefit) (26,560) 525
-------------- ---------------
Loss from continuing operations before dividends on convertible preferred securities (40,007) (2,464)
Dividends on convertible preferred securities, net of income tax benefit 1,552 1,552
-------------- ---------------
Loss from continuing operations (41,559) (4,016)
Income from discontinued operations, net of tax - 3,367
-------------- ---------------
Net loss $ (41,559) $ (649)
============== ===============
Carrying cost of equity forward contracts - 12,647
-------------- ---------------
Available for common shareholders $ (41,559) $ (13,296)
============== ===============
Basic income (loss) per common share:
Income (loss) from continuing operations $ (0.15) $ (0.01)
Income from discontinued operations $ - $ 0.01
Available for common shareholders $ (0.15) $ (0.05)
Diluted income (loss) per common share:
Income (loss) from continuing operations $ (0.15) $ (0.01)
Income from discontinued operations $ - $ 0.01
Available for common shareholders $ (0.15) $ (0.05)
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
3
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001
($ in thousands, except per-share amounts)
(Unaudited)
2002 2001
-------------- --------------
Revenue $ 1,341,773 $ 1,130,023
Operating expenses:
Cost of services 242,024 353,893
Other operating expenses 512,280 407,626
Depreciation and amortization 364,552 220,072
Reserve for telecommunications bankruptcies 17,805 -
Restructuring and other expenses 22,185 -
-------------- --------------
Total operating expenses 1,158,846 981,591
-------------- --------------
Operating income 182,927 148,432
Investment and other income (loss), net (76,584) 13,425
Interest expense 243,109 134,581
-------------- --------------
Income (loss) from continuing operations before income taxes, dividends on
convertible preferred securities and cumulative effect of change in accounting principle (136,766) 27,276
Income tax expense (benefit) (53,502) 9,573
-------------- --------------
Income (loss) from continuing operations before dividends on convertible
preferred securities and cumulative effect of change in accounting principle (83,264) 17,703
Dividends on convertible preferred securities, net of income tax benefit 3,105 3,105
-------------- --------------
Income (loss) from continuing operations before cumulative effect of change
in accounting principle (86,369) 14,598
Income (loss) from discontinued operations, net of income tax (benefit) expense of $(920)
and $2,159, respectively (1,478) 4,476
Gain on disposal of water segment, net of income taxes of $139,874 169,326 -
-------------- --------------
Total income from discontinued operations, net of income taxes of $138,954 and $2,159
respectively 167,848 4,476
-------------- --------------
Income before cumulative effect of change in accounting principle 81,479 19,074
Cumulative effect of change in accounting principle (39,812) -
-------------- --------------
Net income $ 41,667 $ 19,074
============== ==============
Carrying cost of equity forward contracts - 12,647
-------------- --------------
Available for common shareholders $ 41,667 $ 6,427
============== ==============
Basic income (loss) per common share:
Income (loss) from continuing operations before cumulative effect of
change in accounting principle $ (0.31) $ 0.05
Income from discontinued operations $ 0.60 $ 0.02
Income before cumulative effect of change in accounting principle $ 0.29 $ 0.07
Loss from cumulative effect of change in accounting principle $ (0.14) $ -
Available for common shareholders $ 0.15 $ 0.02
Diluted income (loss) per common share:
Income (loss) from continuing operations before cumulative effect of
change in accounting principle $ (0.31) $ 0.05
Income from discontinued operations $ 0.59 $ 0.02
Income before cumulative effect of change in accounting principle $ 0.29 $ 0.07
Loss from cumulative effect of change in accounting principle $ (0.14) $ -
Available for common shareholders $ 0.15 $ 0.02
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
4
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2001 AND THE SIX MONTHS ENDED JUNE 30, 2002
( $ in thousands, except per-share amounts)
(Unaudited)
Accumulated
Common Additional Other Total
Stock Paid-In Retained Comprehensive Treasury Shareholders'
($0.25 par) Capital Earnings Income (Loss) Stock Equity
------------ ------------- ------------- -------------- ----------- ---------------
Balances January 1, 2001 $ 66,442 $ 1,471,816 $ 233,196 $ 418 $ (51,871) $ 1,720,001
Common stock offering 6,289 283,272 - - - 289,561
Equity units offering - 4,968 - - - 4,968
Stock plans 479 17,449 - - 12,527 30,455
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 and
reclassifications adjustments - - - 4,489 - 4,489
------------ ------------- ------------- ------------ ------------ ---------------
Balances December 31, 2001 73,210 1,927,518 129,864 4,907 (189,357) 1,946,142
Stock plans 227 8,520 - - 281 9,028
Net income - - 41,667 - - 41,667
Other comprehensive loss, net of tax and
reclassifications adjustments - - - (5,482) - (5,482)
------------ ------------- ------------- ------------ ------------ ---------------
Balances June 30, 2002 $ 73,437 $ 1,936,038 $ 171,531 $ (575) $(189,076) $ 1,991,355
============ ============= ============= ============ ============ ===============
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001
($ in thousands)
(Unaudited)
For the three months ended June 30, For the six months ended June 30,
---------------------------------------- -----------------------------------------
2002 2001 2002 2001
------------------- ------------------- ------------------- --------------------
Net income (loss) $ (41,559) $ (649) $ 41,667 $ 19,074
Other comprehensive loss, net of tax
and reclassifications adjustments (5,189) (5,246) (5,482) (24,869)
------------------- ------------------- ------------------- --------------------
Total comprehensive income (loss) $ (46,748) $ (5,895) $ 36,185 $ (5,795)
=================== =================== =================== ====================
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
5
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001
($ in thousands)
2002 2001
--------------- ---------------
Net cash provided by continuing operating activities $ 442,364 $ 162,929
Cash flows from investing activities:
Capital expenditures (275,765) (217,801)
Securities purchased (450) (1,084)
Securities sold 8,387 1,241
Securities matured 2,014 -
Acquisitions - (3,367,987)
Other 498 787
--------------- ---------------
Net cash used by investing activities (265,316) (3,584,844)
Cash flows from financing activities:
Long-term debt borrowings - 2,781,318
Issuance of equity units - 446,200
Common stock offering - 289,787
Long-term debt principal payments (664,632) (120,008)
Issuance of common stock for employee plans 8,079 17,279
Repayment of customer advances for construction
and contributions in aid of construction (1,597) (3,244)
--------------- ---------------
Net cash used by financing activities (658,150) 3,411,332
Cash provided by (used by) discontinued operations 686,302 (9,925)
--------------- ---------------
(Decrease) increase in cash and cash equivalents 205,200 (20,508)
Cash and cash equivalents at January 1, 215,869 70,086
--------------- ---------------
Cash and cash equivalents at June 30, $ 421,069 $ 49,578
=============== ===============
Non-cash investing and financing activities:
Assets acquired under capital lease $ - $ (33,985)
Change in fair value of interest rate swaps $ 5,758 $ -
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
6
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
(1) Summary of Significant Accounting Policies:
-------------------------------------------
(a) Basis of Presentation and Use of Estimates:
Citizens Communications Company and its subsidiaries are referred to
as "we," "us" or "our" in this report. The unaudited consolidated
financial statements have been prepared in conformity with accounting
principles generally accepted in the United States of America and
should be read in conjunction with the consolidated financial
statements and notes included in our 2001 Annual Report on Form 10-K.
These unaudited consolidated financial statements include all
adjustments, which consist of normal recurring accruals necessary to
present fairly the results for the interim periods shown. Preparing
financial statements in conformity with GAAP requires us to make
estimates and assumptions which affect the amounts of assets,
liabilities, revenue and expenses we have reported and our disclosure
of contingent assets and liabilities at the date of the financial
statements. Certain information and footnote disclosures have been
excluded and/or condensed pursuant to Securities and Exchange
Commission rules and regulations. The results of the interim periods
are not necessarily indicative of the results for the full year.
Certain reclassifications of balances previously reported have been
made to conform to current presentation.
(b) Cash Equivalents:
We consider all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
(c) 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
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.
(d) Revenue Recognition:
Incumbent Local Exchange Carrier (ILEC) - Revenue is recognized when
services are provided or when products are delivered to customers.
Revenue that is billed in advance includes: monthly recurring network
access services, special access services and monthly recurring local
line charges. The unearned portion of this revenue is initially
deferred as a component of accounts payable and other current
liabilities on our balance sheet and recognized in revenue over the
period that the services are provided. Revenue that is billed in
arrears includes: non-recurring network access services, switched
access services, non-recurring local services and long-distance
services. The earned but unbilled portion of this revenue is
recognized in revenue 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.
Electric Lightwave, Inc. (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.
7
(e) Net Income 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) 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.
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 shareholders 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 and
May 2002 related to a portion of our fixed rate debt. These hedge
strategies satisfy the fair value hedging requirements of SFAS 133. As
a result, the fair value of the hedges is carried on the balance sheet
in other current assets and the related underlying liabilities are
also adjusted to fair value by the same amount.
(g) 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 regularly examine the carrying value of our goodwill
and other identifiable intangibles to determine whether there are any
impairment losses (see Note 5).
(2) Property, Plant and Equipment, Net:
-----------------------------------
Property, plant and equipment at June 30, 2002 and December 31, 2001 is as
follows:
($ in thousands) June 30, 2002 December 31, 2001
----------------- --------------------
Property, plant and equipment $ 6,954,708 $ 6,699,928
Less accumulated depreciation (2,465,795) (2,187,890)
----------------- --------------------
Property, plant and equipment, net $ 4,488,913 $ 4,512,038
================= ====================
Depreciation expense, calculated using the straight-line method, is based
upon the estimated service lives of various classifications of property,
plant and equipment. Depreciation expense was $156,050,000 and $101,290,000
for the three months ended June 30, 2002 and 2001, respectively and
$303,870,000 and $193,743,000 for the six months ended June 30, 2002 and
2001, respectively.
8
(3) 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
(Frontier), which owned 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 $3,373,000,000 in cash. This transaction has
been accounted for using the purchase method of accounting. The results of
operations have been included in our financial statements from the date of
acquisition. Our valuation and allocation of purchase price including
adjustments to assets and liabilities for Frontier is final.
The following summarizes the allocation of purchase price and funding for
our Frontier acquisition:
($ in thousands)
Assets acquired:
Property, plant and equipment $ 1,108,514
Current assets 119,016
Goodwill 1,504,694
Customer base 793,936
Trade name 122,058
Other assets 151,172
---------------
Total assets acquired 3,799,390
Liabilities assumed
Current liabilities 146,920
Other liabilities 279,536
---------------
Total liabilities assumed 426,456
---------------
Cash paid $ 3,372,934
===============
The following pro forma financial information for the three and six months
ended June 30, 2001 presents the combined results of our operations and the
Frontier acquisition. The pro forma information presents the combined
results as if the acquisition had occurred at the beginning of the year of
its acquisition. The pro forma financial information does not necessarily
reflect the results of operations that would have occurred had we
constituted a single entity during such periods. The sale of our Louisiana
and Colorado gas operations (see Note 4) are presented on an actual basis.
Included in revenue is approximately $56,400,000 and $215,600,000 of
revenue from our Louisiana and Colorado gas operations for the three and
six months ended June 30, 2001, respectively.
($ in thousands, except per share amounts) For the three months For the six months
ended June 30, 2001 ended June 30, 2001
-------------------- ----------------------
Revenue $ 701,269 $ 1,517,819
Net loss $ (44,872) $ (62,829)
Net loss available to common shareholders per share $ (0.19) $ (0.26)
(4) Discontinued Operations and Net Assets Held for Sale:
-----------------------------------------------------
On August 24, 1999, our Board of Directors approved a plan of divestiture
for our public utilities services businesses, which included gas, electric
and water and wastewater businesses.
Water and Wastewater
--------------------
On January 15, 2002, we completed the sale of our water and wastewater
operations to American Water Works, Inc. for $859,100,000 in cash and
$122,500,000 of assumed debt and other liabilities. The pre-tax gain
on the sale recognized in the first quarter of 2002 was $309,200,000.
Electric
--------
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 by the end of 2002.
9
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 of 2001 was $139,304,000.
On November 30, 2001, we sold our Colorado Gas division to Kinder
Morgan for approximately $8,900,000 in cash after purchase price
adjustments.
Discontinued operations in the consolidated statements of income (loss)
reflect the results of operations of the water/wastewater properties sold
in January 2002 including allocated interest expense for the periods
presented. Interest expense was allocated to the discontinued operations
based on the outstanding debt specifically identified with these
businesses.
Currently, we do not have agreements to sell all of our gas and electric
properties. Our gas and electric assets and their related liabilities are
classified as "assets held for sale" and "liabilities related to assets
held for sale," respectively. Additionally, we no longer record
depreciation expense on the gas assets and electric assets. Such
depreciation expense would have been an additional $10,600,000 and
$14,200,000 for the three months ended June 30, 2002 and 2001, respectively
and $21,200,000 and $28,100,000 for the six months ended June 30, 2002 and
2001, respectively. We continue to actively pursue buyers for our remaining
gas and electric businesses.
Summarized financial information for the water/wastewater operations
(discontinued operations) is set forth below:
($ in thousands) For the three months ended June 30,
--------------------------------------------
2002 2001
-------------------- --------------------
Revenue $ - $ 29,335
Operating income $ - $ 8,183
Income tax expense $ - $ 2,089
Net income $ - $ 3,367
($ in thousands) For the six months ended June 30,
--------------------------------------------
2002 2001
-------------------- --------------------
Revenue $ 4,650 $ 53,429
Operating income (loss) $ (419) $ 11,945
Income tax expense (benefit) $ (920) $ 2,159
Income (loss) from discontinued operations, net of tax $ (1,478) $ 4,476
Gain on disposal of water segment, net of tax $ 169,326 $ -
Summarized financial information for the gas and electric operations
(assets held for sale) is set forth below:
($ in thousands) June 30, 2002 December 31, 2001
-------------------- -------------------
Current assets $ 65,564 $ 66,511
Net property, plant and equipment 827,615 805,653
Other assets 219,287 235,773
-------------------- -------------------
Total assets held for sale $ 1,112,466 $ 1,107,937
==================== ===================
Current liabilities $ 72,197 $ 71,259
Long-term debt - 43,400
Other liabilities 103,272 104,116
-------------------- -------------------
Total liabilities related to assets held for sale $ 175,469 $ 218,775
==================== ===================
10
(5) Intangibles:
------------
Intangibles at June 30, 2002 and December 31, 2001 are as follows:
As of June 30, 2002
----------------------------------------------------------
Gross Carrying Accumulated Net Carrying
($ in thousands) Amount Amortization Amount
------------------- ------------------ -----------------
Goodwill $ 2,046,053 $ (127,318) $ 1,918,735
Customer base and trade name 1,077,398 (99,852) 977,546
------------------- ------------------ -----------------
Total intangibles $ 3,123,451 $ (227,170) $ 2,896,281
=================== ================== =================
As of December 31, 2001
----------------------------------------------------------
Gross Carrying Accumulated Net Carrying
($ in thousands) Amount Amortization Amount
------------------- ------------------ -----------------
Goodwill $ 2,068,032 $ (127,318) $ 1,940,714
Customer base and trade name 1,077,398 (39,170) 1,038,228
------------------- ------------------ -----------------
Total intangibles $ 3,145,430 $ (166,488) $ 2,978,942
=================== ================== =================
Amortization expense was $30,328,000 and $13,076,000 for the three months
ended June 30, 2002 and 2001, respectively and $60,682,000 and $26,329,000
for the six months ended June 30, 2002 and 2001, respectively.
We have reflected assets acquired in purchase transactions at fair market
values in accordance with purchase accounting standards. Our allocations
are primarily 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 stable
revenue 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 sellers) of each of the
businesses acquired in 2000 and 2001. We based our purchase prices on
estimates of 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,
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 reflect the fact
that our purchase price was accepted by the sellers after a competitive
bidding and negotiation process.
We were willing to pay a premium (i.e. goodwill) over the fair value of the
tangible and identifiable intangible assets acquired less liabilities
assumed in order to obtain product cross-selling opportunities, economies
of scale (e.g. cost savings opportunities), and the potential benefit
resident in expected population/demographic trends.
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 (see Note 14). The amortization
of goodwill ceased upon adoption of the statement on January 1, 2002, and
applies to all goodwill recognized in the statement of financial position
at that date, regardless of when the assets were initially recognized.
11
The following table presents a reconciliation between reported net income
and adjusted net income. Adjusted net income excludes amortization expense
recognized in prior periods related to goodwill that is no longer being
amortized.
($ in thousands, except per-share amounts) For the three months ended June 30, For the six months ended June 30,
--------------------------------------- ------------------------------------
2002 2001 2002 2001
------------------- ------------------ ----------------- -----------------
Reported available for common shareholders $ (41,559) $ (13,296) $ 41,667 $ 6,427
Add back: Goodwill amortization, net of tax - 6,110 - 13,356
------------------- ------------------ ----------------- -----------------
Adjusted available for common shareholders $ (41,559) $ (7,186) $ 41,667 $ 19,783
=================== ================== ================= =================
Basic earnings per share:
Reported available for common shareholders $ (0.15) $ (0.05) $ 0.15 $ 0.02
Goodwill amortization, net of tax - 0.02 - 0.05
------------------- ------------------ ----------------- -----------------
Adjusted available for common shareholders $ (0.15) $ (0.03) $ 0.15 $ 0.07
=================== ================== ================= =================
Diluted earnings per share:
Reported available for common shareholders $ (0.15) $ (0.05) $ 0.15 $ 0.02
Goodwill amortization, net of tax - 0.02 - 0.05
------------------- ------------------ ----------------- -----------------
Adjusted available for common shareholders $ (0.15) $ (0.03) $ 0.15 $ 0.07
=================== ================== ================= =================
(6) Restructuring and Other Charges:
--------------------------------
Restructuring and other expenses consist of expenses related to our various
restructurings in 2001 and 2002, $10,200,000 of expenses related to
reductions in personnel at our telecommunications operations, costs that
are being spent at both our Plano, Texas facility and at other locations as
a result of transitioning functions and jobs, and $6,800,000 of costs and
expenses related to our tender offer in June 2002 for all of the publicly
held ELI common shares that we did not already own. These costs were
incurred only temporarily and will not continue.
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. We continue to review our operations and
facilities to achieve greater efficiency.
Plano Restructuring
In the second quarter of 2001, we adopted a plan to close our
operations support center in Plano, Texas by August 2002. In
connection with this plan, we recorded a pre-tax charge of $14,557,000
in the second half of 2001, $839,000 for the three months ended March
31, 2002 and we adjusted our accrual down by $92,000 for the three
months ended June 30, 2002. 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 will result in the termination of 750 employees. We
communicated with all affected employees during July 2001. Certain
employees have been/will be relocated, others have been offered
severance, job training and/or outplacement counseling. As of June 30,
2002, approximately $13,617,000 was paid and 721 employees were
terminated. The restructuring expenses primarily consist of severance
benefits, retention earned through June 30, 2002, early lease
termination costs and other planning and communication costs. We
expect to incur additional costs of approximately $122,000 in the
third quarter of 2002.
Sacramento Call Center Restructuring
In April 2002, we closed our Sacramento Customer Care Center. In
connection with this closing, we recorded a pre-tax charge of $731,000
in the fourth quarter of 2001, $62,000 for the three months ended
March 31, 2002 and $9,000 for the three months ended June 30, 2002. We
redirected the call traffic and other work activities to our Kingman,
Arizona call center. This restructuring resulted in the reduction of
98 employees. We communicated with all affected employees during
November 2001. As of June 30, 2002, approximately $753,000 was paid
and all the employees were terminated.
12
ELI Restructuring
In the first half of 2002, ELI redeployed the internet routers, frame
relay switches and ATM switches from the Atlanta, Cleveland, Denver,
Philadelphia and New York markets to other locations in ELI's network.
ELI ceased leasing the collocation facilities and off-net circuits for
the backbone and local loops supporting the service delivery in these
markets. It was anticipated that this would lead to $4,179,000 of
termination fees which were accrued for but not paid at December 31,
2001. In the first and second quarters of 2002, ELI adjusted its
original accrual down by $2,100,000 and $100,000, respectively, due to
the favorable settlements of termination charges for off-net circuit
agreements. As of June 30, 2002, $1,054,000 has been paid. The
remaining accrual of $925,000 is included in current liabilities at
June 30, 2002.
Tender Offer
During May 2002, we announced a tender offer for all of the shares of
ELI that we did not already own for a price of $0.70 per share. We
completed the tender offer in June 2002, resulting in ELI becoming a
wholly-owned subsidiary, for total costs and expenses of approximately
$6.8 million. We accounted for this transaction as a purchase and
allocated the entire amount to goodwill. We evaluated the
recoverability of this goodwill in accordance with Statement Financial
Accounting Standards No. 142 and determined that a write-down was
necessary based on fair market value as determined by discounted cash
flows. This charge is included in restructuring and other expenses.
1999
----
In the fourth quarter of 1999, we adopted a plan to restructure our
corporate office activities. In connection with this plan, we recorded a
pre-tax charge of $5,760,000 in the fourth quarter of 1999. The
restructuring resulted in the reduction of 49 corporate employees. All
affected employees were communicated with in the early part of November
1999. As of June 30, 2002, approximately $4,602,000 has been paid, 43
employees were terminated and six employees who were expected to be
terminated took other positions within the company. At June 30, 2002,
December 31, 2001 and December 31, 2000, we adjusted our original accrual
down by $11,000, $139,000 and $1,008,000, respectively, and no accrual
remains at June 30, 2002.
13
($ in thousands)
2001 Severance Benefits Retention Other Total
------------------- -------------- ------------- ------------- ---------------
2001 Plano Restructuring
Original accrued amount $ 9,353 $ 1,535 $ 1,178 $ 936 $13,002
Amount paid (1,386) (35) (80) (177) (1,678)
Additional accrual 551 - 1,793 27 2,371
Adjustments (325) (104) (64) (323) (816)
------------------- -------------- ------------- ------------- ---------------
Accrued @ 12/31/2001 8,193 1,396 2,827 463 12,879
------------------- -------------- ------------- ------------- ---------------
Amount paid (4,870) - (2,083) (112) (7,065)
Additional accrual 25 - 923 - 948
Adjustments (63) (28) (18) - (109)
------------------- -------------- ------------- ------------- ---------------
Accrued @ 3/31/2002 3,285 1,368 1,649 351 6,653
------------------- -------------- ------------- ------------- ---------------
Amount paid (2,146) (1,036) (1,458) (234) (4,874)
Additional accrual 40 - 213 - 253
Adjustments (207) - (138) - (345)
------------------- -------------- ------------- ------------- ---------------
Accrued @ 6/30/2002 $ 972 $ 332 $ 266 $ 117 $ 1,687
=================== ============== ============= ============= ===============
2001 Sacramento Call Center Restructuring
Accrued @ 12/31/2001 $ 552 $ 94 $ 85 $ - $ 731
Amount paid (317) - (81) - (398)
Additional accrual 45 - 107 - 152
Adjustments (72) (11) (7) - (90)
------------------- -------------- ------------- ------------- ---------------
Accrued @ 3/31/2002 208 83 104 - 395
------------------- -------------- ------------- ------------- ---------------
Amount paid (202) (67) (86) - (355)
Additional accrual - - 9 - 9
Adjustments - - - - -
------------------- -------------- ------------- ------------- ---------------
Accrued @ 6/30/2002 $ 6 $ 16 $ 27 $ - $ 49
=================== ============== ============= ============= ===============
ELI 2001 Restructuring
Accrued @ 12/31/2001 $ - $ - $ - $4,179 $ 4,179
Amount paid - - - - -
Additional accrual - - - - -
Adjustments - - - (2,100) (2,100)
------------------- -------------- ------------- ------------- ---------------
Accrued @ 3/31/2002 - - - 2,079 2,079
------------------- -------------- ------------- ------------- ---------------
Amount paid - - - (1,054) (1,054)
Additional accrual - - - - -
Adjustments - - - (100) (100)
------------------- -------------- ------------- ------------- ---------------
Accrued @ 6/30/2002 $ - $ - $ - $ 925 $ 925
=================== ============== ============= ============= ===============
Original Accrued Amount Accrual Remaining
1999 Amount Paid to Date Adjustments Accrual
------------------- -------------------------------------------
1999 Corporate Office Restructuring
For the year ended December 31, 1999 $ 5,760 $ (221) $ - $5,539
For the year ended December 31, 2000 5,539 (3,993) (1,008) 538
For the year ended December 31, 2001 538 (199) (139) 200
For the three months ended March 31, 2002 200 - - 200
For the three months ended June 30, 2002 200 (189) (11) -
14
(7) Long-Term Debt:
---------------
The activity in our long-term debt from December 31, 2001 to June 30, 2002
is as follows:
Six Months Ended
----------------------------------------
Interest *Interest
December 31, Rate Swap/ June 30, Rate at
($ in thousands) 2001 Borrowings Reclassification Payments 2002 June 30, 2002
------------- --------------------------------------- ------------ -------------
FIXED RATE
Rural Utilities Service Loan Contracts $ 110,860 $ - $ - $ (79,522) $ 31,338 6.190%
Debentures 850,778 - - (18,650) 832,128 7.472%
2001 Notes 3,700,430 - 5,758 (23,665) 3,682,523 8.470%
Equity Units 460,000 - - - 460,000 7.480%
Senior Unsecured Notes 108,825 - - (37,807) 71,018 8.050%
ELI Notes 325,000 - - (30,000) 295,000 6.232%
ELI Capital Leases 137,382 - - (2,101) 135,281 11.613%
Industrial Development Revenue Bonds 249,205 - - (54,900) 194,305 6.153%
Other 54 - - (7) 47 12.985%
------------- ----------- -------------- ------------ ------------
TOTAL FIXED RATE 5,942,534 - 5,758 (246,652) 5,701,640
------------- ----------- -------------- ------------ ------------
VARIABLE RATE
ELI Bank Credit Facility 400,000 - - (400,000) - 2.391%
Industrial Development Revenue Bonds 136,278 - 43,400 (17,980) 161,698 3.152%
------------- ----------- -------------- ------------ ------------
TOTAL VARIABLE RATE 536,278 - 43,400 (417,980) 161,698
------------- ----------- -------------- ------------ ------------
TOTAL LONG TERM DEBT $ 6,478,812 $ - $ 49,158 $(664,632) $ 5,863,338
------------- =========== ============== ============ ------------
Less: Current Portion (483,906) (63,924)
Less: Equity Units (460,000) (460,000)
------------- ------------
$ 5,534,906 $ 5,339,414
============= ============
*Interest rate includes amortization of debt issuance expenses, debt
premiums or discounts. The interest rate for Rural Utilities Service Loan
Contracts, Debentures, 2001 Notes, ELI's Capital Leases, Senior Unsecured
Notes, and Industrial Development Revenue Bonds represent a weighted
average of multiple issuances.
Total future minimum cash payment commitments over the next 25 years under
ELI's long-term capital leases amounted to $318.6 million as of June 30,
2002.
15
(8) Net Income Per Common Share:
----------------------------
The reconciliation of the net income per common share calculation for the
three and six months ended June 30, 2002 and 2001, respectively, is as
follows:
(In thousands, except per-share amounts) For the three months ended June 30,
--------------------------------------------------------------------------
2002 2001
------------------------------------- -----------------------------------
Weighted Weighted
Average Average
Net Loss Shares Per Share Net Loss Shares Per Share
----------- ----------- ----------- ----------- ------------ ----------
Net loss per common share:
Basic $(41,559) 280,610 $ (649) 269,129
Carrying cost of equity forward contracts - - 12,647 -
----------- ----------- ----------- ------------
Available for common shareholders $(41,559) 280,610 $ (0.15) $(13,296) 269,129 $ (0.05)
Effect of dilutive options - 4,709 - - 6,551 -
----------- ----------- ----------- ------------
Diluted $(41,559) 285,319 $ (0.15) $(13,296) 275,680 $ (0.05)
=========== =========== =========== ============
(In thousands, except per-share amounts) For the six months ended June 30,
--------------------------------------------------------------------------
2002 2001
------------------------------------- -----------------------------------
Weighted Weighted
Average Average
Net Income Shares Per Share Net Income Shares Per Share
------------------------ ----------- ------------------------ ----------
Net income per common share:
Basic $ 41,667 280,432 $ 19,074 266,106
Carrying cost of equity forward contracts - - 12,647 -
----------- ----------- ----------- ------------
Available for common shareholders $ 41,667 280,432 $ 0.15 $ 6,427 266,106 $ 0.02
Effect of dilutive options - 4,833 - - 6,966 -
----------- ----------- ----------- ------------
Diluted $ 41,667 285,265 $ 0.15 $ 6,427 273,072 $ 0.02
=========== =========== =========== ============
All share amounts represent weighted average shares outstanding for each
respective period. The diluted net income per common share calculation
excludes the effect of potentially dilutive shares when their exercise
price exceeds the average market price over the period. At June 30, 2002,
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
12,485,000 potentially dilutive stock options at a range of $10.24 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 1,477,000 shares and
710,000 shares at June 30, 2002 and 2001 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.
(9) 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 unregulated 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."
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.
16
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.
Adjusted 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.
($ in thousands) For the three months ended June 30, 2002
--------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 514,686 $ 45,287 $ 47,856 $ 54,610 $ 662,439
Depreciation and Amortization 154,741 31,591 46 - 186,378
Operating Income (Loss) 100,607 (38,976) 8,416 12,521 82,568
Adjusted EBITDA 255,348 (7,385) 8,462 12,521 268,946
($ in thousands) For the three months ended June 30, 2001
--------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 288,788 $ 59,334 $ 102,155 $ 55,464 $ 505,741
Depreciation and Amortization 88,312 20,099 155 5,800 114,366
Operating Income (Loss) 60,685 (15,278) 9,882 5,260 60,549
Adjusted EBITDA 148,997 4,821 10,037 11,060 174,915
($ in thousands) For the six months ended June 30, 2002
--------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 1,022,717 $ 92,534 $ 119,221 $ 107,301 $ 1,341,773
Depreciation and Amortization 313,031 51,391 130 - 364,552
Operating Income (Loss) 192,828 (55,996) 20,304 25,791 182,927
Adjusted EBITDA 505,859 (4,605) 20,434 25,791 547,479
($ in thousands) For the six months ended June 30, 2001
--------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 576,133 $ 121,059 $ 322,670 $ 110,161 $ 1,130,023
Depreciation and Amortization 174,689 39,278 305 5,800 220,072
Operating Income (Loss) 123,355 (30,378) 38,496 16,959 148,432
Adjusted EBITDA 298,044 8,900 38,801 22,759 368,504
(10) Adelphia Investment:
--------------------
As of June 30, 2002, we owned 3,059,000 shares of Adelphia Communications
Corp. (Adelphia) common stock. As a result of Adelphia's recent price
declines and filing for bankruptcy, we recognized losses of $45,600,000,
$49,700,000 and $79,000,000 on our investment for the three months ended
June 30, 2002, March 31, 2002 and December 31, 2001, respectively, as the
declines were determined to be other than temporary. As of June 30, 2002,
we have written this investment down to zero.
17
(11) Equity Forward Contracts:
-------------------------
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.
(12) Derivative Instruments and Hedging Activities:
----------------------------------------------
Interest rate swap agreements are used to hedge a portion of our debt that
is subject to fixed interest rates. Under our interest rate swap
agreements, we agree to pay an amount equal to a specified variable rate of
interest times a notional principal amount, and to receive in return an
amount equal to a specified fixed rate of interest times the same notional
principal amount. The notional amounts of the contracts are not exchanged.
No other cash payments are made unless the agreement is terminated prior to
maturity, in which case the amount paid or received in settlement is
established by agreement at the time of termination and represents the
market value, at the then current rate of interest, of the remaining
obligations to exchange payments under the terms of the contracts.
The interest rate swap contracts are reflected at fair value in our
consolidated balance sheet and the related portion of fixed-rate debt being
hedged is reflected at an amount equal to the sum of its book value and an
amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. Changes in the fair
value of interest rate swap contracts, and the offsetting changes in the
adjusted carrying value of the related portion of the fixed-rate debt being
hedged, are recognized in the consolidated statements of operations in
interest expense. The notional amounts of fixed-rate indebtedness hedged as
of June 30, 2002 and December 31, 2001 was $250,000,000 and $100,000,000,
respectively. Such contracts required us to pay variable rates of interest
(average pay rate of approximately 4.843% as of June 30, 2002) and receive
fixed rates of interest (average receive rate of 7.65% as of June 30,
2002). The fair value of these derivatives is reflected in other assets as
of June 30, 2002, in the amount of $6,187,812 and the related underlying
debt has been increased by a like amount. The amounts received during the
three and six months ended June 30, 2002 as a result of these contracts
amounted to $0 and $411,897, respectively, and are included as a reduction
to interest expense.
We do not anticipate any nonperformance by counterparties to its derivative
contracts as all counterparties have investment grade credit ratings.
(13) Shareholder Rights Plan:
------------------------
On March 6, 2002, our Board of Directors adopted a Shareholder Rights Plan.
The purpose of the Shareholder Rights Plan is to deter coercive takeover
tactics and to encourage third parties interested in acquiring us to
negotiate with our Board of Directors. It is intended to strengthen the
ability of our Board of Directors to fulfill its fiduciary duties to take
actions which are in the best interest of our shareholders. The rights were
distributed to shareholders as a dividend at the rate of one right for each
share of our common stock held by shareholders of record as of the close of
business on March 26, 2002. Each right initially entitles shareholders to
buy one one-thousandth of a share of a new Series A Participating Preferred
Stock at an exercise price of $47 per right, subject to adjustment. The
rights generally will be exercisable only if a person or group acquires
beneficial ownership of 15 percent or more of our common stock.
18
(14) Change in Accounting Principle and New Accounting Pronouncements:
-----------------------------------------------------------------
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets." This statement requires that goodwill no longer
be amortized to earnings, but instead be reviewed for impairment. The
amortization of goodwill ceased upon adoption of the statement on January
1, 2002. We have no other intangibles with indefinite lives other than
goodwill. We were required to test for impairment of goodwill as of January
1, 2002 and at least annually thereafter. Any transitional impairment loss
at January 1, 2002 is recognized as the cumulative effect of a change in
accounting principle in our statement of operations. As a result of ELI's
adoption of SFAS 142, we recognized a transitional impairment loss of $39.8
million as a cumulative effect of a change in accounting principle in our
statement of operations in the first quarter of 2002. We evaluated the
recoverability of this goodwill in accordance with SFAS 142 and determined
that a write-down was necessary based on fair market value as determined by
discounted cash flows. During the first quarter of 2002, we reassessed the
useful lives of our customer base and trade name and determined no change
was required. The adoption of SFAS 142 did not have a material impact on
our other segments.
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. The adoption
of SFAS 144 has no immediate material impact on our financial statements.
However, at December 31, 2002 we will be required to apply new criteria as
prescribed by SFAS 144 to our assets held for sale properties. If the
criteria is met, we will continue to classify the properties as held for
sale. If the criteria is not met, we would be required to reclassify these
assets to be held and used and record any depreciation expense that would
have been recognized had the assets been continuously held and used.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the requirement that gains and
losses from extinguishment of debt be required to be aggregated and, if
material, classified as an extraordinary item, net of related income tax
effect. The statement requires gains and losses from extinguishment of debt
to be classified as extraordinary items only if they meet the criteria in
Accounting Principles Board Opinion No. 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" which provides guidance for distinguishing transactions that
are part of an entity's recurring operations from those that are unusual or
infrequent or that meet the criteria for classification as an extraordinary
item. We adopted SFAS 145 in the second quarter of 2002. During 2002, we
recognized $4.4 million of gains from early debt retirement as other
income, rather than as an extraordinary item.
(15) Global /WorldCom Receivables:
-----------------------------
During the second quarter 2002, we reserved approximately $21,600,000 of
trade receivables with WorldCom as a result of WorldCom's filing for
bankruptcy. These receivables were generated as a result of providing
ordinary course telecommunications services. This charge was partially
offset in the second quarter with an $11,600,000 settlement with Global as
discussed below.
Concurrent with the acquisition of Frontier, we entered into several
operating agreements with Global. We have ongoing commercial relationships
with Global affiliates. We reserved a total of $29,000,000 of Global
receivables to reflect our best estimate of the net realizable value of
receivables incurred from these commercial relationships during 2001 and
2002 as a result of Global's filing for bankruptcy. We recorded a
write-down of such receivables in the amount of $7,800,000 in the first
quarter 2002 and $21,200,000 in the fourth quarter of 2001. In the second
quarter 2002, as the result of a settlement agreement with Global, we have
reversed $11,600,000 of our previous write-down of the net realizable value
of these receivables. Prior to the date of Global's bankruptcy filing, we
provided ordinary course telecommunications services as well as
transitional services to Global. Global has provided us certain customer
billing and collection functions as well as other transitional services.
These arrangements have continued after the bankruptcy filing. The
Bankruptcy Court has granted relief to us and other telecommunications
companies that provide service to Global by, among other things, directing
a shortened payment period with respect to post-petition invoices, an
expedited court process for post-petition defaults in payments by Global,
and a priority for post-petition expense items over other unsecured debt.
These procedures should minimize future economic loss to us although we
cannot guarantee that additional losses will not occur.
19
(16) Commitments and Contingencies:
------------------------------
On December 21, 2001, we entered into a settlement agreement resolving all
claims in a class action lawsuit pending against the company in Santa Cruz
County, Arizona (Chilcote, et al. v. Citizens Utilities Company, No. CV
98-471). The lawsuit arose from claims by a class of plaintiffs that
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
us, we will pay the class members $5.5 million in satisfaction of all
claims. The court approved the settlement agreement on March 29, 2002, and
the lawsuit against us was dismissed with prejudice. We have accrued the
full settlement amount, plus an additional amount sufficient to cover legal
fees and other related expenses, during the fourth quarter of 2001.
As part of the Frontier acquisition, Global and we agreed to Global's
transfer, effective as of July 1, 2001, of certain liabilities and assets
under the Global pension plan for Frontier employees. Such transfer and
assumption of liabilities would be to a trustee of a trust established
under our pension plan, and would exclude (1) those liabilities relating to
certain current and former Frontier employees who were not considered part
of the Frontier acquisition (calculated using the "safe harbor" methodology
of the Pension Benefit Guaranty Corporation) or (2) those assets
attributable to such liabilities. While all amounts and procedures had been
agreed to by Global and us prior to Global's bankruptcy filing, on the
ground that its obligation to make this transfer might be "executory" under
the Bankruptcy Code, Global has refused 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 and
liabilities. 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 authorization
letter if Global does not do so as required by the Frontier stock purchase
agreement. A decision on dispositive motions filed by us is expected in the
third quarter of 2002.
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
This quarterly report on Form 10-Q contains forward-looking statements that are
subject to risks and uncertainties which could cause actual results to differ
materially from those expressed or implied in the statements. Forward-looking
statements (including oral representations) are only predictions or statements
of current plans, which we review continuously. Forward-looking statements may
differ from actual future results due to, but not limited to, any of the
following possibilities:
* Changes in the number of our access lines;
* Our ability to effectively manage our growth, including the
integration of acquired operations into our operations, and
otherwise monitor our operations, costs, regulatory compliance
and service quality;
* Our ability to divest our public utilities services businesses;
* Our ability to successfully introduce new product offerings
including our ability to offer bundled service packages on terms
attractive to our customers, and our ability to offer second
lines and enhanced and data services to markets currently
under-penetrated;
* Our ability to expand through attractively priced acquisitions;
* The effects of greater than anticipated competition requiring new
pricing, marketing strategies or new product offerings and the
risk that we will not respond on a timely or profitable basis;
* The effects of bankruptcies in the telecommunications industry
which could result in higher network access costs and potential
bad debts.
* The effects of 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 or 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-Q or otherwise made by us or on our behalf. The following information is
unaudited and should be read in conjunction with the consolidated financial
statements and related notes included in this report and as presented in our
2001 Annual Report on Form 10-K. We have no obligation to update or revise these
forward-looking statements.
(a) Liquidity and Capital Resources
-------------------------------
For the six months ended June 30, 2002, we used cash flow from continuing
operations, the proceeds from the sale of discontinued operations and cash and
investment balances to fund capital expenditures and debt repayments. On January
15, 2002, we completed the sale of our water and wastewater operations to
American Water Works for $859.1 million in cash plus the assumption by the buyer
of $122.5 million of our debt and other liabilities. The proceeds are being used
for general corporate purposes including the repayment of outstanding
indebtedness. As of June 30, 2002, we had cash and cash equivalents balances
aggregating $421.1 million.
We have budgeted approximately $407.0 to $432.0 million for our 2002 capital
projects, including approximately $350.0 to $375.0 million for the ILEC segment,
$15.0 million for the ELI segment (excluding the $110 million purchase of
equipment under lease) and $42.0 million for the public utilities services
segment. For the six months ended June 30, 2002, our actual capital expenditures
were $138.7 million for the ILEC segment, $8.1 million for the ELI segment
(excluding the purchase for $110 million in cash of equipment previously under
lease) and $20.2 million for the public utilities services segments which
includes $1.2 million for the water and wastewater segment sold in January 2002.
We anticipate that the funds necessary for our 2002 capital expenditures will be
provided from our ILEC operations and our existing cash and investment balances.
21
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. On April 30, 2002, ELI purchased the facilities at the lease
termination for $110 million. Citizens had guaranteed all of ELI's obligations
under this operating lease and provided the funds for the purchase.
We have an available shelf registration of $825.6 million and we have available
lines of credit with financial institutions in the aggregate amount of $805
million. Associated facility fees vary, depending on our credit ratings, and are
0.25% per annum as of June 30, 2002. The expiration date for the facilities is
October 24, 2006. During the term of the facilities we may borrow, repay and
reborrow funds. As of June 30, 2002, there were no outstanding advances under
these facilities.
Tender Offer
On May 16, 2002, we announced that we were commencing a tender offer, at $0.70
per share, for all of the publicly held Class A common shares of ELI that we did
not already own. The tender offer expired on June 17, 2002, at which time the
total of shares tendered, combined with the ELI shares already owned by us,
represented approximately 95.5% of total outstanding ELI Class A shares. On June
20, 2002, we completed a short-form merger in which ELI became our wholly owned,
not publicly traded, subsidiary and each share of common stock not tendered was
converted into a right to receive $0.70 in cash without interest. The total cost
(including fees and expenses) of the tender was approximately $6.8 million.
Following the completion of the merger with ELI, we repaid and terminated the
entire $400 million outstanding under ELI's committed revolving line of credit
with a syndicate of commercial banks on June 24, 2002.
Debt Reduction
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.
On January 31, 2002, we repaid approximately $76.9 million principal amount of
subsidiary debt from the Rural Utilities Service, Rural Telephone Bank and the
Federal Financing Bank. We paid a premium of $482,000 on these redemptions.
On March 27, 2002, we repaid $40.0 million of Frontier 7.51% Medium Term Notes
at maturity.
On May 1, 2002, we redeemed at par six of our outstanding variable rate
Industrial Development Revenue Bond series aggregating approximately $20.3
million in principal amount.
On June 10, 2002, we called for redemption at par four of our outstanding
Industrial Development Revenue Bond series aggregating approximately $20.4
million in principal amount. These redemptions are expected to occur in the
third quarter.
On June 27, 2002, we redeemed at par $24.8 million principal amount of our 7.05%
Mohave Industrial Development Revenue Refunding Bonds due August 1, 2020.
During the second quarter, we executed a series of purchases in the open market
of a number of our outstanding notes and debentures. The aggregate principal
amount of notes and debentures purchased was $72.3 million and they generated a
pre-tax gain from the early extinguishment of debt at a discount of
approximately $4.4 million.
22
Interest Rate Management
- ------------------------
On December 17, 2001, we entered into two interest rate swap agreements with an
investment grade financial institution, 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.
During May 2002, we entered into three interest rate swap agreements with
investment grade financial institutions, each agreement covering a notional
amount of $50 million. Under the terms of the agreements, we make semi-annual,
floating rate interest payments based on six-month LIBOR and receive a fixed
8.50% rate on the notional amount. Under the terms of two swaps, the underlying
LIBOR rate is set in arrears, while the third agreement is based on each
period's daily average six-month LIBOR. All three swaps terminate on May 15,
2006 and are being accounted for under SFAS 133 as fair value hedges. In
connection with these swaps, on June 26, 2002, we entered into three Forward
Rate Agreements (FRAs), which set the LIBOR rate for the initial period of the
three swaps, which ends November 15, 2002. The average rate of the three FRAs
for the current period is 5.6717%.
Covenants
- ---------
The terms and conditions contained in our indentures and credit facility
agreements are of a general nature, and do not currently impose significant
financial performance criteria on us. These general covenants include the timely
and punctual payment of principal and interest when due, the maintenance of our
corporate existence, keeping proper books and records in accordance with
Generally Accepted Accounting Principles (GAAP), restrictions on the allowance
of liens on our assets, and restrictions on asset sales and transfers, mergers
and other changes in corporate control. We currently have no restrictions on the
payment of dividends by us either by contract, rule or regulation.
The principal financial performance covenant under our $805 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 also be required to maintain an
interest coverage ratio of 2.00 to 1 or greater and a leverage ratio of 6.00 to
1 or lower. We are in compliance with all of our debt covenants.
Acquisitions
- ------------
On June 29, 2001, we purchased from Global Crossing Ltd. (Global) 100% of the
stock of Frontier Corp.'s local exchange carrier subsidiaries, which owned
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 $3,373.0
million in cash. This transaction has been accounted for using the purchase
method of accounting. The results of operations have been included in our
financial statements from the date of acquisition.
Divestitures
- ------------
On August 24, 1999, our Board of Directors approved a plan of divestiture for
our public utilities services businesses, which included gas, electric and water
and wastewater businesses. During 2001, we sold two of our natural gas
operations and in January 2002 we sold all of our water and wastewater treatment
operations.
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 by
the end of 2002.
Currently, we do not have agreements to sell all of our gas and electric
properties. Our gas and electric assets and their related liabilities are
classified as "assets held for sale" and "liabilities related to assets held for
sale," respectively. Additionally, we no longer record depreciation expense on
the gas assets and electric assets. Such depreciation expense would have been an
additional $10.6 million and $14.2 million for the three months ended June 30,
2002 and 2001, respectively and $21.2 million and $28.1 million for the six
months ended June 30, 2002 and 2001, respectively. We continue to actively
pursue buyers for our remaining gas and electric businesses.
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.
23
New Accounting Pronouncements
- -----------------------------
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets." This statement requires that goodwill no longer be amortized to
earnings, but instead be reviewed for impairment. The amortization of goodwill
ceased upon adoption of the statement on January 1, 2002. We have no other
intangibles with indefinite lives other than goodwill. We were required to test
for impairment of goodwill as of January 1, 2002 and at least annually
thereafter. Any transitional impairment loss at January 1, 2002 is recognized as
the cumulative effect of a change in accounting principle in our statement of
operations. As a result of ELI's adoption of SFAS 142, we recognized a
transitional impairment loss of $39.8 million as a cumulative effect of a change
in accounting principle in our statement of operations in the first quarter of
2002. During the first quarter of 2002, we reassessed the useful lives of our
customer base and trade name and determined that no change was required. The
adoption of SFAS 142 did not have a material impact on our other segments.
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. The adoption of SFAS 144 has no immediate material impact on
our financial statements. However, at December 31, 2002 we will be required to
apply new criteria as prescribed by SFAS 144 to our assets held for sale
properties. If the criteria is met, we will continue to classify the properties
as held for sale. If the criteria is not met, we would be required to reclassify
these assets to be held and used and record any depreciation expense that would
have been recognized had the assets been continuously held and used.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This
statement eliminates the requirement that gains and losses from extinguishment
of debt be required to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. The statement requires
gains and losses from extinguishment of debt to be classified as extraordinary
items only if they meet the criteria in Accounting Principles Board Opinion No.
30, "Reporting the Results of Operations - Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" which provides guidance for distinguishing transactions
that are part of an entity's recurring operations from those that are unusual or
infrequent or that meet the criteria for classification as an extraordinary
item. We adopted SFAS 145 in the second quarter of 2002. During 2002, we
recognized $4.4 million of gains from early debt retirement as other income,
rather than as an extraordinary item.
24
(b) Results of Operations
---------------------
REVENUE
Consolidated revenue for the three and six months ended June 30, 2002 increased
$156.7 million, or 31% and $211.8 million or 19%, respectively, as compared with
the prior year period. The increase is primarily due to $211.9 million and
$418.1 million, respectively, of increases in telecommunications revenue,
largely due to the impact of the Frontier acquisition, partially offset by $54.3
million and $203.4 million of decreases in gas revenue for the three and six
months ended June 30, 2002, respectively, largely due to the disposition of the
Louisiana and Colorado gas operations.
TELECOMMUNICATIONS REVENUE
($ in thousands) For the three months ended June 30, For the six months ended June 30,
--------------------------------------------- ----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ----------- ---------- ----------- ------------ ----------- ---------
Access services $ 169,413 $ 117,146 $ 52,267 45% $ 335,168 $ 228,353 $ 106,815 47%
Local services 216,075 117,970 98,105 83% 430,926 239,852 191,074 80%
Long distance and data services 75,658 32,675 42,983 132% 149,330 63,284 86,046 136%
Directory 25,810 10,999 14,811 135% 52,054 21,689 30,365 140%
Other 27,730 9,998 17,732 177% 55,239 22,955 32,284 141%
ELI 45,287 59,334 (14,047) -24% 92,534 121,059 (28,525) -24%
----------- ----------- ----------- ----------- ------------ -----------
$ 559,973 $ 348,122 $ 211,851 61% $1,115,251 $ 697,192 $ 418,059 60%
=========== =========== =========== =========== ============ ===========
We acquired Frontier on June 29, 2001. As a result, the periods ended June 30,
2001 include two days of operating results of Frontier. Revenue for the two day
period was $4.2 million. Frontier contributed $209.5 million and $416.7 million
in revenue for the three and six months ended June 30, 2002, respectively.
Prior to the second quarter of 2002, we reported subscriber line charges (SLC)
in both the access and local revenue categories. Beginning with the second
quarter of 2002, all SLC revenue is reported in the local services category. All
prior periods have been conformed to this presentation. The average amount of
SLC that was previously reported in access is $23.1 million per quarter.
Access services revenue for the three months ended June 30, 2002 increased as
compared with the prior year period primarily due to the impact of Frontier of
$45.9 million. Growth in non-switched access contributed $3.6 million and growth
in subsidies contributed $5.2 million.
Access services revenue for the six months ended June 30, 2002 increased as
compared with the prior year period primarily due to the impact of Frontier of
$92.4 million. Growth in non-switched access contributed $7.6 million and growth
in subsidies contributed $7.6 million.
Local services revenue for the three months ended June 30, 2002 increased as
compared with the prior year period primarily due to the impact of Frontier of
$92.0 million.
Local services revenue for the six months ended June 30, 2002 increased as
compared with the prior year period primarily due to the impact of Frontier of
$184.8 million.
Long distance and data services revenue for the three months ended June 30, 2002
increased as compared with the prior year period primarily due to the impact of
Frontier of $36.2 million, $2.2 million of growth related to data and dedicated
circuits and growth in long distance services of $4.4 million.
Long distance and data services revenue for the six months ended June 30, 2002
increased as compared with the prior year period primarily due to the impact of
Frontier of $72.4 million, $5.8 million of growth related to data and dedicated
circuits and growth in long distance services of $7.8 million.
Directory services revenue for the three and six months ended June 30, 2002
increased as compared with the prior year periods primarily due to the impact of
Frontier of $14.7 million and $30.0 million, respectively.
25
Other revenue for the three and six months ended June 30, 2002 increased as
compared with the prior year periods primarily due to the impact of Frontier of
$16.3 million and $32.8 million, respectively.
ELI revenue for the three and six months ended June 30, 2002 decreased primarily
due to a decrease in reciprocal compensation minutes and price, a decline in
ISDN due to less demand from internet service providers and lower demand and
prices for long haul services. Additionally, ELI revenue for the six months
ended June 30, 2002 decreased due to the expiration of a material data services
contract in February 2001. ELI has experienced six consecutive quarters of
declining revenue.
GAS AND ELECTRIC REVENUE
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------- -----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ----------- -------- ------------- ------------ ----------- ---------
Gas revenue $ 47,856 $ 102,155 $ (54,299) -53% $ 119,221 $ 322,670 $ (203,449) -63%
Electric revenue $ 54,610 $ 55,464 $ (854) -2% $ 107,301 $ 110,161 $ (2,860) -3%
Gas revenue for the three months ended June 30, 2002 decreased as compared with
the prior year period primarily due to the sale of our Louisiana and Colorado
gas operations partially offset by higher purchased gas costs passed on to
customers. Included in gas revenue for 2001 is approximately $56.4 million of
revenue from our Louisiana and Colorado gas operations, which were sold on July
2, 2001 and November 30, 2001, respectively. Under tariff provisions, the cost
of our gas purchases are primarily passed on to customers.
Gas revenue for the six months ended June 30, 2002 decreased as compared with
the prior year period primarily due to the sale of our Louisiana and Colorado
gas operations partially offset by higher purchased gas costs passed on to
customers. Included in gas revenue for 2001 is approximately $215.6 million of
revenue from our Louisiana and Colorado gas operations, which were sold on July
2, 2001 and November 30, 2001, respectively. Under tariff provisions, the cost
of our gas purchases are primarily passed on to customers.
Electric revenue for the three and six months ended June 30, 2002 decreased as
compared with the prior year periods primarily due to lower purchased power
prices. Under tariff provisions, the cost of our electric energy and fuel oil
purchases are primarily passed on to customers.
COST OF SERVICES
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------- ------------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ----------- -------- ------------- ------------ ----------- ---------
Network access $ 58,598 $ 34,645 $ 23,953 69% $ 116,556 $ 67,161 $ 49,395 74%
Gas purchased 26,201 63,914 (37,713) -59% 69,801 227,077 (157,276) -69%
Electric energy and
fuel oil purchased 28,987 29,969 (982) -3% 55,667 59,655 (3,988) -7%
----------- ----------- ----------- ----------- ------------ -----------
$ 113,786 $ 128,528 $(14,742) -11% $ 242,024 $ 353,893 $ (111,869) -32%
=========== =========== =========== =========== ============ ===========
Network access expenses for the three months ended June 30, 2002 increased as
compared with the prior year period primarily due to the impact of Frontier of
$21.3 million and increased costs of $6.7 million in the ILEC sector, partially
offset by decreased costs of $4.2 million in ELI as a result of decreases in
demand.
Network access expenses for the six months ended June 30, 2002 increased as
compared with the prior year period primarily due to the impact of Frontier of
$41.3 million and increased costs of $13.3 million in the ILEC sector, partially
offset by decreased costs of $7.4 million in ELI as a result of decreases in
demand.
Gas purchased for the three months ended June 30, 2002 decreased as compared
with the prior year period primarily due to the sale of our Louisiana and
Colorado gas operations partially offset by an increase in the cost of gas.
Included in gas purchased for 2001 is approximately $40.3 million of gas
purchased by our Louisiana and Colorado gas operations, which were sold on July
2, 2001 and November 30, 2001, respectively. Under tariff provisions, the cost
of our gas purchases are primarily passed on to customers.
26
Gas purchased for the six months ended June 30, 2002 decreased as compared with
the prior year period primarily due to the sale of our Louisiana and Colorado
gas operations partially offset by an increase in the cost of gas. Included in
gas purchased for 2001 is approximately $171.1 million of gas purchased by our
Louisiana and Colorado gas operations.
Electric energy and fuel oil purchased for the three and six months ended June
30, 2002 decreased as compared with the prior year periods primarily due to
lower purchased power prices. Under tariff provisions, the cost of our electric
energy and fuel oil purchases are primarily passed on to customers.
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 $111.3 million through June 30, 2002
have been incurred. We believe that we are allowed to recover these charges from
ratepayers through the Purchase Power Fuel Adjustment clause, that was approved
by the Arizona Corporation Commission and has been in place for several years.
However, in an attempt to limit "rate shock" to our customers, we requested in
September 2001 that our unrecovered power costs, plus interest, be recovered
over a seven-year period. As a result, we have deferred these costs on the
balance sheet in anticipation of recovery through the regulatory process. Parts
of our proposal have been contested by one or more parties to a pending Arizona
Commission proceeding convened to consider the matter. A determination regarding
recovery could be made in 2002 but the timing is not certain.
OTHER OPERATING EXPENSES
($ in thousands) For the three months ended June 30, For the six months ended June 30,
--------------------------------------------- -----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ----------- --------- ------------ ------------ ----------- ---------
Operating expenses $ 191,019 $ 156,901 $ 34,118 22% $ 390,272 $ 315,782 $ 74,490 24%
Taxes other than income taxes 31,384 24,437 6,947 28% 64,748 50,273 14,475 29%
Sales and marketing 29,023 20,960 8,063 38% 57,260 41,571 15,689 38%
----------- ----------- ----------- ----------- ------------ -----------
$ 251,426 $ 202,298 $ 49,128 24% $ 512,280 $ 407,626 $ 104,654 26%
=========== =========== =========== =========== ============ ===========
Operating expenses for the three and six months ended June 30, 2002 increased as
compared with the prior year periods primarily due to increased operating
expenses related to Frontier of $71.4 million and $149.9 million, respectively,
partially offset by increased operating efficiencies and a reduction of
personnel in the ILEC and ELI sectors, decreased operating expenses in the gas
sector due to the sale of our Louisiana and Colorado gas operations on July 2,
2001 and November 30, 2001, respectively, and decreased compensation expense of
$1.7 million and $1.5 million, respectively, related to variable stock plans. In
future periods, as a result of decreases in the value of our pension assets
because of declines in the stock and bond markets, we may have increased pension
expenses.
Taxes other than income taxes increased as compared with the prior year periods
primarily due to the impact of Frontier of $8.4 million for the three month
period and $16.8 million for the six month period.
Sales and marketing expenses increased as compared with the prior year periods
primarily due to the impact of Frontier of $11.7 million for the three month
period and $22.2 million for the six month period, partially offset by decreased
sales and marketing in the ELI sector of $2.8 million and $5.4 million for the
three and six months ended June 30, 2002, respectively, primarily due to a
reduction in personnel and related costs.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------- ------------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ----------- -------- ------------- ------------ ----------- ---------
Depreciation expense $ 156,050 $ 101,290 $ 54,760 54% $ 303,870 $ 193,743 $ 110,127 57%
Amortization expense 30,328 13,076 17,252 132% 60,682 26,329 34,353 130%
----------- ----------- ----------- ----------- ------------ -----------
$ 186,378 $ 114,366 $ 72,012 63% $ 364,552 $ 220,072 $ 144,480 66%
=========== =========== =========== =========== ============ ===========
Depreciation expense for the three and six months ended June 30, 2002 increased
as compared with the prior year periods primarily due to the impact of Frontier
of $40.9 million and $82.6 million, respectively, and $0.9 million and $12.8
million, respectively, of accelerated depreciation related to the closing of our
Plano, Texas administrative facility. Accelerated depreciation has ceased on the
Plano facility since it is now carried at estimated realizable value. The three
and six months were also impacted by $10.4 million of increased depreciation at
ELI due to the purchase of $110.0 million previously leased facilities in April
2002.
27
Amortization expense for the three and six months ended June 30, 2002 increased
as compared with the prior year periods primarily due to the impact of Frontier
of $23.8 million and $47.6 million, respectively, partially offset by the fact
that we ceased amortization of goodwill related to our previous acquisitions as
of January 1, 2002 in accordance with Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets." For the three and six
months ended June 30, 2001 amortization expense included $10.0 million and $20.4
million, respectively, of goodwill amortization.
RESERVE FOR TELECOMMUNICATIONS BANKRUPTCIES / RESTRUCTURING AND OTHER EXPENSES
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------- ------------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ----------- -------- ------------- ------------ ----------- ---------
Reserve for telecommunications
bankruptcies $ 10,001 $ - $ 10,001 100% $ 17,805 $ - $ 17,805 100%
Restructuring and other expenses $ 18,280 $ - $ 18,280 100% $ 22,185 $ - $ 22,185 100%
During the second quarter 2002, we reserved approximately $21.6 million of trade
receivables with WorldCom, as a result of WorldCom's filing for bankruptcy.
These receivables were generated as a result of providing ordinary course
telecommunications services. This charge was partially offset in the second
quarter with an $11.6 million settlement with Global as discussed below.
Concurrent with the acquisition of Frontier, we entered into several operating
agreements with Global. We have ongoing commercial relationships with Global
affiliates. We reserved a total of $29.0 million of Global receivables to
reflect our best estimate of the net realizable value of receivables incurred
from these commercial relationships during 2001 and 2002 as a result of Global's
filing for bankruptcy. We recorded a write-down of such receivables in the
amount of $7.8 million in the first quarter 2002 and $21.2 million in the fourth
quarter of 2001. In the second quarter 2002, as the result of a settlement
agreement with Global, we have reversed $11.6 million of our previous write-down
of the net realizable value of these receivables. Prior to the date of Global's
bankruptcy filing, we provided ordinary course telecommunications services as
well as transitional services to Global. Global has provided us certain customer
billing and collection functions as well as other transitional services. These
arrangements have continued after the bankruptcy filing. The Bankruptcy Court
has granted relief to us and other telecommunications companies that provide
service to Global by, among other things, directing a shortened payment period
with respect to post-petition invoices, an expedited court process for
post-petition defaults in payments by Global, and a priority for post-petition
expense items over other unsecured debt. These procedures should minimize future
economic loss to us although we cannot guarantee that additional losses will not
occur.
Restructuring and other expenses for the six months ended June 30, 2002 consist
of expenses related to our various restructurings in 2001 and 2002, $10.2
million of expenses related to reductions in personnel at our telecommunications
operations, costs that are being spent at both our Plano, Texas facility and at
other locations as a result of transitioning functions and jobs, and $6.8
million of costs and expenses related to our tender offer in June 2002 of all of
the publicly held ELI common shares that we did not already own. These costs
were incurred only temporarily and will not continue. The discussion below
includes our restructuring charges and excludes the other expenses.
Plano Restructuring
In the second quarter of 2001, we adopted a plan to close our
operations support center in Plano, Texas by August 2002. In
connection with this plan, we recorded a pre-tax charge of $14.5
million in the second half of 2001, $0.8 million for the three months
ended March 31, 2002 and we adjusted our accrual down by $92,000 for
the three months ended June 30, 2002. 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 will result in the termination of 750 employees. We
communicated with all affected employees during July 2001. Certain
employees have been/will be relocated others have been offered
severance, job training and/or outplacement counseling. As of June 30,
2002, approximately $13.6 million was paid and 721 employees were
terminated. The restructuring expenses primarily consist of severance
benefits, retention earned through June 30, 2002, early lease
termination costs and other planning and communication costs. We
expect to incur additional costs of approximately $0.1 million in the
third quarter of 2002.
28
Sacramento Call Center Restructuring
In April 2002, we closed our Sacramento Customer Care Center. In
connection with this closing, we recorded a pre-tax charge of
approximately $0.7 million in restructuring expenses in the fourth
quarter of 2001, $0.1 million for the three months ended March 31,
2002 and $9,000 for three months ended June 30, 2002. We redirected
the call traffic and other work activities to our Kingman, Arizona
call center. This restructuring resulted in the reduction of 98
employees. We communicated with all affected employees during November
2001. As of June 30, 2002, approximately $0.8 million was paid and all
the employees were terminated.
ELI Restructuring
In the first half of 2002, ELI redeployed the internet routers, frame
relay switches and ATM switches from the Atlanta, Cleveland, Denver,
Philadelphia and New York markets to other locations in ELI's network.
ELI ceased leasing the collocation facilities and off-net circuits for
the backbone and local loops supporting the service delivery in these
markets. It was anticipated that this would lead to $4,179,000 of
termination fees which were accrued for but not paid at December 31,
2001. In the first and second quarters of 2002, ELI adjusted its
original accrual down by $2,100,000 and $100,000, respectively, due to
the favorable settlement of termination charges for an off-net circuit
agreement. As of June 30, 2002, $1,054,000 has been paid. The
remaining accrual of $925,000 is included in current liabilities at
June 30, 2002.
INVESTMENT AND OTHER INCOME (LOSS), NET /
INTEREST EXPENSE / INCOME TAX EXPENSE (BENEFIT)
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------- -----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ----------- -------- ------------- ------------ ----------- ---------
Investment and
other income (loss), net $ (28,076) $ 10,641 $ (38,717) -364% $ (76,584) $ 13,425 $ (90,009) -670%
Interest expense $ 121,059 $ 73,129 $ 47,930 66% $ 243,109 $ 134,581 $ 108,528 81%
Income tax expense (benefit) $ (26,560) $ 525 $ (27,085) -5159% $ (53,502) $ 9,573 $ (63,075) -659%
Investment and other income, net for the three and six months ended June 30,
2002 decreased as compared with the prior years period primarily due to the
recognition of $45.6 million and $95.3 million of losses, respectively,
resulting from an other than temporary decline in the value of our investment in
Adelphia.
Interest expense for the three months ended June 30, 2002 increased as compared
with the prior year period primarily due to $21.7 million of interest expense on
our $1.75 billion of notes issued in May 2001, $34.0 million of interest expense
on our $1.75 billion of notes issued in August 2001, $6.8 million of interest
expense on our equity units issued in June 2001, $3.7 million of increased
amortization of debt discount expense and $3.1 million of interest expense on
our $200 million Rural Telephone Finance Cooperative note issued in October
2001. These amounts were partially offset by a reduction of $8.8 million of
interest expense on our lines of credit, a $4.2 million decrease in ELI's
interest expense related to decreased interest rates on bank borrowings, and a
$4.7 million decrease in amortization of costs associated with our committed
bank credit facilities. During the three months ended June 30, 2002, we had
average long-term debt outstanding of $5.9 billion compared to $3.7 billion
during the three months ended June 30, 2001. Our composite average borrowing
rate for the three months ended June 30, 2002 as compared with the prior year
period was 94 basis points higher due to the impact of higher interest rates as
a result of our refinancing our variable rate debt with fixed rate long-term
debt.
Interest expense for the six months ended June 30, 2002 increased as compared
with the prior year period primarily due to $60.8 million of interest expense on
our $1.75 billion of notes issued in May 2001, $67.6 million of interest expense
on our $1.75 billion of notes issued in August 2001, $14.6 million of interest
expense on our equity units issued in June 2001, $7.0 million of increased
amortization of debt discount expense and $6.3 million of interest expense on
our $200 million Rural Telephone Finance Cooperative note issued in October
2001. These amounts were partially offset by a reduction of $25.2 million of
interest expense on our lines of credit, a $6.6 million decrease in ELI's
interest expense related to decreased interest rates on bank borrowings, and a
$9.5 million decrease in amortization of costs associated with our committed
bank credit facilities. During the six months ended June 30, 2002, we had
average long-term debt outstanding of $5.9 billion compared to $3.7 billion
during the six months ended June 30, 2001. Our composite average borrowing rate
for the six months ended June 30, 2002 as compared with the prior year period
was 79 basis points higher due to the impact of higher interest rates as a
result of our refinancing our variable rate debt with fixed rate long-term debt.
29
Income taxes for the three and six months ended June 30, 2002 decreased as
compared with the prior year periods primarily due to changes in taxable income.
The estimated annual effective tax rate for 2002 is 39% as compared with 35% for
2001. The change in the effective tax rate is primarily attributable to the
discontinuation of the application of SFAS 71 "Accounting for the Effects of
Certain Types of Regulation," for our local exchange telephone properties.
DISCONTINUED OPERATIONS
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------- ------------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ----------- -------- ------------- ------------ ----------- ---------
Revenue $ - $ 29,335 $ (29,335) -100% $ 4,650 $ 53,429 $ (48,779) -91%
Operating income (loss) $ - $ 8,183 $ (8,183) -100% $ (419) $ 11,945 $ (12,364) -104%
Income (loss) from discontinued
operations, net of tax $ - $ 3,367 $ (3,367) -100% $ (1,478) $ 4,476 $ (5,954) -133%
Gain on disposal of water
segment, net of tax $ - $ - $ - - $169,326 $ - $ 169,326 100%
Revenue, operating income (loss) and net income from discontinued operations for
the three and six months ended June 30, 2002 decreased as compared with the
prior year period primarily due to the sale of our water and wastewater
businesses in January 2002. On January 15, 2002, we completed the sale of our
water and wastewater operations to American Water Works, Inc. for $859.1 million
in cash and $122.5 million of assumed debt and other liabilities. The pre-tax
gain on the sale recognized in the first quarter of 2002 was $309.2 million. The
gain on the disposal of the water segment, net of tax was $169.3 million.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities. Market risk refers to the
potential change in fair value of a financial instrument as a result of
fluctuations in interest rates and equity and commodity prices. We do not hold
or issue derivative instruments, derivative commodity instruments or other
financial instruments for trading purposes. As a result, we do not undertake any
specific actions to cover our exposure to market risks and we are not party to
any market risk management agreements. Our primary market risk exposures are
interest rate risk and equity and commodity price risk as follows:
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest bearing portion of our investment portfolio and interest on our
long term debt and capital lease obligations. The long term debt and capital
lease obligations include various instruments with various maturities and
weighted average interest rates.
Our objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, a majority of our borrowings have
fixed interest rates; variable rate debt is refinanced when advantageous.
Consequently, we have limited material future earnings or cash flow exposures
from changes in interest rates on our long-term debt and capital lease
obligations. A hypothetical 10% adverse change in interest rates would increase
the amount that we pay on our variable obligations and could result in
fluctuations in the fair value of our fixed rate obligations. Based upon our
overall interest rate exposure at June 30, 2002, 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 an
investment grade financial institution, 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 when the underlying debt
matures, and are being accounted for under SFAS 133 as fair value hedges.
30
During May 2002, we entered into three interest rate swap agreements with
investment grade financial institutions, each agreement covering a notional
amount of $50 million. Under the terms of the agreements, we make semi-annual,
floating rate interest payments based on six-month LIBOR and receive a fixed
8.50% rate on the notional amount. Under the terms of two swaps, the underlying
LIBOR rate is set in arrears, while the third agreement is based on each
period's daily average six-month LIBOR. All three swaps terminate on May 15,
2006 and are being accounted for under SFAS 133 as fair value hedges. In
connection with these swaps, on June 26, 2002, we entered into three Forward
Rate Agreements (FRAs), which set the LIBOR rate for the initial period of the
three swaps, which ends November 15, 2002. The average rate of the three FRAs
for the current period is 5.6717%.
Sensitivity analysis of interest rate exposure
At June 30, 2002, the fair value of our long-term debt and capital lease
obligations was estimated to be approximately $4,791.5 million, based on our
overall weighted average rate of 7.9% and our overall weighted maturity of 13
years. There has been no material change in the weighted average maturity
applicable to our obligations since December 31, 2001. The overall weighted
average interest rate has increased by approximately 21 basis points. A
hypothetical increase of 79 basis points (10% of our overall weighted average
borrowing rate) would result in an approximate $270.7 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.
As of June 30, 2002, we owned 3,059,000 shares of Adelphia Communications
(Adelphia) common stock. As a result, of Adelphia's recent price declines and
filing for bankruptcy, we recognized losses of $45.6 million, $49.7 million and
$79.0 million on our investment for the three months ended June 30, 2002, March
31, 2002 and December 31, 2001, respectively, as the declines were determined to
be other than temporary. As of June 30, 2002, we have written this investment
down to zero, and therefore we have no additional exposure related to the market
value of Adelphia stock.
Sensitivity analysis of equity price exposure
At June 30, 2002, the fair value of the equity portion of our investment
portfolio was estimated to be $30.0 million. A hypothetical 10% decrease in
quoted market prices would result in an approximate $3.0 million decrease in the
fair value of the equity portion of our investment portfolio.
Commodity Price Exposure
We purchase monthly gas future contracts, from time to time, to manage
well-defined commodity price fluctuations, caused by weather and other
unpredictable factors, associated with our commitments to deliver natural gas to
customers at fixed prices. Customers pay for gas service based upon prices that
are defined by a tariff. A tariff is an agreement between the public utility
commission and us, which determines the price that will be charged to the
customer. Fluctuations in gas prices are routinely handled through a pricing
mechanism called the purchase gas adjustor (PGA). The PGA allows for a process
whereby any price change from the agreed upon tariff will be settled as a pass
through to the customer. As a result, if gas prices increase, the PGA will
increase and pass more costs on to the customer. If gas prices decrease, the PGA
will decrease and refunds will be provided to the customer. This commodity
activity relates to our gas businesses and is not material to our consolidated
financial position or results of operations. In all instances we take physical
delivery of the gas supply purchased or contracted for. These gas future
contracts and gas supply contracts are considered derivative instruments as
defined by SFAS 133. However, such contracts are excluded from the provisions of
SFAS 133 since they are purchases made in the normal course of business and not
for speculative purposes. Based upon our overall commodity price exposure at
June 30, 2002 a material near-term change in the quoted market price of gas
would not materially affect our consolidated financial position or results of
operations.
Disclosure of limitations of sensitivity analysis
Certain shortcomings are inherent in the method of analysis presented in the
computation of fair value of financial instruments. Actual values may differ
from those presented should market conditions vary from assumptions used in the
calculation of the fair value. This analysis incorporates only those exposures
that exist as of June 30, 2002. It does not consider those exposures or
positions which could arise after that date. As a result, our ultimate exposure
with respect to our market risks will depend on the exposures that arise during
the period and the fluctuation of interest rates and quoted market prices.
31
PART II. OTHER INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Item 1. 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 scheduled to commence in the first quarter of 2003.
On December 21, 2001, we entered into a settlement agreement resolving all
claims in a class action lawsuit pending against the company in Santa Cruz
County, Arizona (Chilcote, et al. v. Citizens Utilities Company, No. CV 98-471).
The lawsuit arose from claims by a class of plaintiffs that 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 us, we will pay the class members $5.5 million in
satisfaction of all claims. The court approved the settlement agreement on March
29, 2002, and the lawsuit against us was dismissed with prejudice. We accrued
the full settlement amount, plus an additional amount sufficient to cover legal
fees and other related expenses, during the fourth quarter of 2001.
As part of the Frontier acquisition, Global and we agreed to Global's transfer,
effective as of July 1, 2001, of certain liabilities and assets under the Global
pension plan for Frontier employees. Such transfer and assumption of liabilities
would be to a trustee of a trust established under our pension plan, and would
exclude (1) those liabilities relating to certain current and former Frontier
employees who were not considered part of the Frontier acquisition (calculated
using the "safe harbor" methodology of the Pension Benefit Guaranty Corporation)
or (2) those assets attributable to such liabilities. While all amounts and
procedures had been agreed to by Global and us prior to Global's bankruptcy
filing, on the ground that its obligation to make this transfer might be
"executory" under the Bankruptcy Code, Global has refused 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 and
liabilities. 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 authorization letter if Global
does not do so as required by the Frontier stock purchase agreement. A decision
on dispositive motions filed by us is expected in the third quarter of 2002.
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.
32
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
(a) The registrant held its 2002 Annual Meeting of the Stockholders on May
16, 2002.
(b) Proxies for the Annual Meeting were solicited pursuant to Regulation
14A; there was no solicitation in opposition to management's nominees
for directors as listed in the Proxy Statement. All such nominees were
elected pursuant to the following votes:
Number of Votes
---------------
DIRECTORS FOR WITHHELD
--------- --- --------
Norman I. Botwinik 237,641,461 11,138,209
Aaron I. Fleischman 235,999,660 12,780,010
Rudy J. Graf 238,101,807 10,677,863
Stanley Harfenist 238,254,625 10,525,045
Andrew N. Heine 238,154,691 10,624,979
Scott N. Schneider 238,362,434 10,417,236
John L. Schroeder 238,153,112 10,626,558
Robert A. Stanger 238,383,272 10,396,398
Edwin Tornberg 238,102,049 10,677,621
Claire L. Tow 234,471,565 14,308,105
Leonard Tow 235,561,322 13,218,348
(c) Ratification of appointment of KPMG LLP as the Company's independent
public accountants for 2002.
Number of votes FOR 243,243,679
Number of votes AGAINST 3,837,778
Number of votes ABSTAINING 1,698,213
Item 5. Other Information
-----------------
As disclosed in our proxy statement for the 2002 Annual Meeting, under our
bylaws, if any stockholder intends to propose any matter at the 2003 annual
meeting, the proponent must give written notice to us not earlier than January
1, 2003 nor later than February 15, 2003. Furthermore, in accordance with the
proxy rules and regulations of the Securities and Exchange Commission, if a
stockholder does not notify us by February 15, 2003 of a proposal, then our
proxies would be able to use their discretionary voting authority if a
stockholder's proposal is raised at the meeting.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a) Exhibits:
None.
b) Reports on Form 8-K:
We filed on Form 8-K on May 14, 2002 under Item 7, "Financial
Statements, Exhibits," a press release announcing earnings for the
quarter ended March 31, 2002.
We filed on Form 8-K on May 16, 2002 under Item 5, "Other Events" and
Item 7, "Financial Statements, Exhibits," a press release announcing
our intent to acquire all outstanding shares of Electric Lightwave,
Inc. not presently owned by us or our subsidiaries.
We filed on Form 8-K on June 18, 2002 under Item 5, "Other Events" and
Item 7, "Financial Statements, Exhibits," a press release announcing
the successful completion of our cash tender offer at $0.70 per share
for all the outstanding publicly-held Class A common shares of shares
of ELI that we did not already own and the prepayment by us of all
$400 million outstanding under ELI's bank facility.
33
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
(Registrant)
By: /s/ Robert J. Larson
---------------------------------------
Robert J. Larson
Vice President and Chief Accounting Officer
Date: August 7, 2002
34