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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 SEPTEMBER 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 September 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
-----------------
N/A
---
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
The number of shares outstanding of the registrant's class of common stock as of
October 31, 2002 was 282,223,679.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index to Consolidated Financial Statements
Page No.
--------
Part I. Financial Information (Unaudited)
Consolidated Balance Sheets at September 30, 2002 and December 31, 2001 2
Consolidated Statements of Income (Loss) for the three months ended September 30, 2002 and 2001 3
Consolidated Statements of Income (Loss) for the nine months ended September 30, 2002 and 2001 4
Consolidated Statements of Shareholders' Equity for the year ended December 31, 2001 and the
nine months ended September 30, 2002 5
Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended
September 30, 2002 and 2001 5
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30,
2002 and 2001 6
Notes to Condensed Consolidated Financial Statements 7
Management's Discussion and Analysis of Financial Condition and Results of Operations 22
Quantitative and Qualitative Disclosures about Market Risk 34
Part II. Other Information
Legal Proceedings 36
Controls and Procedures 36
Exhibits and Reports on Form 8-K 37
Signature 38
Certifications 39
1
PART I. FINANCIAL INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)
(Unaudited)
September 30, 2002 December 31, 2001
--------------------- -------------------
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 479,236 $ 215,869
Accounts receivable, net 310,834 311,878
Other current assets 47,935 150,573
Assets held for sale 749,154 1,107,937
Assets of discontinued operations - 746,791
--------------------- --------------------
Total current assets 1,587,159 2,533,048
Property, plant and equipment, net 3,736,031 4,512,038
Intangibles, net 2,864,467 2,978,942
Investments 31,298 141,208
Other assets 393,498 388,364
--------------------- --------------------
Total assets $ 8,612,453 $ 10,553,600
===================== ====================
LIABILITIES AND EQUITY
- ----------------------
Current liabilities:
Long-term debt due within one year $ 141,220 $ 483,906
Accounts payable and other current liabilities 607,814 625,575
Liabilities related to assets held for sale 241,329 218,775
Liabilities of discontinued operations - 228,337
--------------------- --------------------
Total current liabilities 990,363 1,556,593
Deferred income taxes 50,253 429,544
Customer advances for construction and contributions in aid of construction 153,955 183,319
Other liabilities 245,181 241,846
Equity units 460,000 460,000
Long-term debt 5,219,346 5,534,906
--------------------- --------------------
Total liabilities 7,119,098 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; 282,220,000
and 281,289,000 outstanding and 293,788,000 and 292,840,000 issued at
September 30, 2002 and December 31, 2001, respectively) 73,447 73,210
Additional paid-in capital 1,936,307 1,927,518
Retained earnings (accumulated deficit) (528,573) 129,864
Accumulated other comprehensive income 221 4,907
Treasury stock (189,297) (189,357)
--------------------- --------------------
Total shareholders' equity 1,292,105 1,946,142
--------------------- --------------------
Total liabilities and equity $ 8,612,453 $ 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 SEPTEMBER 30, 2002 AND 2001
($ in thousands, except per-share amounts)
(Unaudited)
2002 2001
-------------- ---------------
Revenue $ 668,831 $ 661,121
Operating expenses:
Cost of services 115,795 123,214
Other operating expenses 248,678 273,011
Depreciation and amortization 199,611 193,662
Restructuring and other expenses (273) 13,002
Loss on impairment 1,074,058 -
-------------- ---------------
Total operating expenses 1,637,869 602,889
-------------- ---------------
Operating income (loss) (969,038) 58,232
Investment and other income, net 13,859 3,070
Gain on sale of assets 1,901 139,304
Interest expense 116,459 123,452
-------------- ---------------
Income (loss) from continuing operations before income taxes, dividends
on convertible preferred securities and extraordinary expense (1,069,737) 77,154
Income tax expense (benefit) (371,186) 39,610
-------------- ---------------
Income (loss) from continuing operations before dividends
on convertible preferred securities and extraordinary expense (698,551) 37,544
Dividends on convertible preferred securities, net of income tax benefit 1,553 1,553
-------------- ---------------
Income (loss) from continuing operations before extraordinary expense (700,104) 35,991
Income from discontinued operations, net of income tax of $0 and $4,571, respectively - 7,199
-------------- ---------------
Income (loss) before extraordinary expense (700,104) 43,190
Extraordinary expense - discontinuation of Statement of Financial Accounting
Standards No. 71, net of income tax (benefit) of $0 and $(7,292), respectively - 43,631
-------------- ---------------
Net loss $ (700,104) $ (441)
============== ===============
Carrying cost of equity forward contracts - 1,003
-------------- ---------------
Net loss attributable to common shareholders $ (700,104) $ (1,444)
============== ===============
Basic income (loss) per common share:
Income (loss) from continuing operations before extraordinary expense $ (2.49) $ 0.12
Income from discontinued operations $ - $ 0.03
Extraordinary expense $ - $ (0.15)
Net loss attributable to common shareholders $ (2.49) $ (0.01)
Diluted income (loss) per common share:
Income (loss) from continuing operations before extraordinary expense $ (2.49) $ 0.12
Income from discontinued operations $ - $ 0.02
Extraordinary expense $ - $ (0.15)
Net loss attributable to common shareholders $ (2.49) $ (0.01)
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 NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
($ in thousands, except per-share amounts)
(Unaudited)
2002 2001
------------- -------------
Revenue $ 2,010,604 $ 1,791,144
Operating expenses:
Cost of services 357,819 477,107
Other operating expenses 760,958 680,637
Depreciation and amortization 564,163 413,734
Reserve for telecommunications bankruptcies 17,805 -
Restructuring and other expenses 21,912 13,002
Loss on impairment 1,074,058 -
------------- -------------
Total operating expenses 2,796,715 1,584,480
------------- -------------
Operating income (loss) (786,111) 206,664
Investment and other income (loss), net (62,725) 16,495
Gain on sale of assets 1,901 139,304
Interest expense 359,568 258,033
------------- -------------
Income (loss) from continuing operations before income taxes, dividends on convertible
preferred securities, extraordinary expense and cumulative effect of change
in accounting principle (1,206,503) 104,430
Income tax expense (benefit) (424,688) 49,183
------------- -------------
Income (loss) from continuing operations before dividends on convertible preferred
securities, extraordinary expense and cumulative effect of change in accounting principle (781,815) 55,247
Dividends on convertible preferred securities, net of income tax benefit 4,658 4,658
------------- -------------
Income (loss) from continuing operations before extraordinary expense and
cumulative effect of change in accounting principle (786,473) 50,589
Income (loss) from discontinued operations, net of income tax (benefit) of $(920)
and $6,730, respectively (1,478) 11,675
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
$6,730, respectively 167,848 11,675
------------- -------------
Income (loss) before extraordinary expense and cumulative effect of change in
accounting principle (618,625) 62,264
Extraordinary expense - discontinuation of Statement of Financial Accounting
Standards No. 71, net of income tax (benefit) of $0 and $(7,292), respectively - 43,631
Cumulative effect of change in accounting principle (39,812) -
------------- -------------
Net income (loss) $ (658,437) $ 18,633
============= =============
Carrying cost of equity forward contracts - 13,650
------------- -------------
Net income (loss) attributable to common shareholders $ (658,437) $ 4,983
============= =============
Basic income (loss) per common share:
Income (loss) from continuing operations before extraordinary expense
and cumulative effect of change in accounting principle $ (2.80) $ 0.14
Income from discontinued operations $ 0.60 $ 0.04
Income (loss) before extraordinary expense and cumulative effect of change
in accounting principl $ (2.21) $ 0.23
Extraordinary expense $ - $ (0.16)
Loss from cumulative effect of change in accounting principle $ (0.14) $ -
Net loss attributable to common shareholders $ (2.35) $ 0.02
Diluted income (loss) per common share:
Income (loss) from continuing operations before extraordinary expense
and cumulative effect of change in accounting principle $ (2.80) $ 0.13
Income from discontinued operations $ 0.59 $ 0.04
Income (loss) before extraordinary expense and cumulative effect of change
in accounting principle $ (2.21) $ 0.22
Extraordinary expense $ - $ (0.16)
Loss from cumulative effect of change in accounting principle $ (0.14) $ -
Net loss attributable to common shareholders $ (2.35) $ 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 NINE MONTHS ENDED SEPTEMBER 30, 2002
( $ in thousands, except per-share amounts)
(Unaudited)
Retained Accumulated
Common Additional Earnings Other Total
Stock Paid-In (Accumulated Comprehensive Treasury Shareholders'
($0.25 par) Capital Deficit) 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 237 8,789 - - 60 9,086
Net loss - - (658,437) - - (658,437)
Other comprehensive loss, net of tax
and reclassifications adjustments - - - (4,686) - (4,686)
------------ ------------- ------------- ------------ ------------ ---------------
Balances September 30, 2002 $ 73,447 $ 1,936,307 $(528,573) $ 221 $(189,297) $ 1,292,105
============ ============= ============= ============ ============ ===============
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 NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
($ in thousands)
(Unaudited)
For the three months ended September 30, For the nine months ended September 30,
---------------------------------------------------------------------------------------
2002 2001 2002 2001
-------------------- -------------------- -------------------- --------------------
Net income (loss) $ (700,104) $ (441) $ (658,437) $ 18,633
Other comprehensive income (loss), net of
tax and reclassifications adjustments 796 (34,696) (4,686) (59,565)
-------------------- -------------------- -------------------- --------------------
Total comprehensive loss $ (699,308) $ (35,137) $ (663,123) $ (40,932)
==================== ==================== ==================== ====================
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 NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
($ in thousands)
2002 2001
--------------- ---------------
Net cash provided by operating activities $ 459,206 $ 362,567
Cash flows from investing activities:
Acquisitions - (3,369,517)
Proceeds from sale of assets - 363,436
Capital expenditures (354,203) (309,604)
Securities purchased (450) (1,385)
Securities sold 11,681 1,218
Securities matured 2,014 -
Other 912 940
--------------- ---------------
Net cash used by investing activities (340,046) (3,314,912)
Cash flows from financing activities:
Long-term debt borrowings - 3,503,060
Long-term debt principal payments (717,721) (956,821)
Issuance of equity units - 460,000
Common stock offering - 289,561
Issuance of common stock for employee plans 8,389 23,490
Debt issuance cost - (67,499)
Settlement of equity forward contracts - (163,663)
Customer advances for construction
and contributions in aid of construction (5,526) 3,525
--------------- ---------------
Net cash provided by (used by) financing activities (714,858) 3,091,653
Cash provided by (used by) discontinued operations 859,065 (28,976)
--------------- ---------------
Increase in cash and cash equivalents 263,367 110,332
Cash and cash equivalents at January 1, 215,869 70,086
--------------- ---------------
Cash and cash equivalents at September 30, $ 479,236 $ 180,418
=============== ===============
Non-cash investing and financing activities:
Assets acquired under capital lease $ 38,000 $ 33,985
Change in fair value of interest rate swaps $ 16,077 $ -
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. Actual results may differ from those estimates. We believe
that our critical estimates are depreciation rates, pension
assumptions, carrying value of assets held for sale, calculations of
impairment amounts and reserves established for telecommunication
bankruptcies.
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) 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 annually examine the carrying value of our goodwill
and other identifiable intangibles to determine whether there are any
impairment losses (see Note 6).
(e) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
Of:
We adopted Statement of Financial Accounting Standard (SFAS) No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" as of
January 1, 2002. In accordance with SFAS No. 144, we review long-lived
assets to be held and used and long-lived assets to be disposed of for
impairment whenever events or changes in circumstances indicate that
the carrying amount of such assets may not be recoverable.
Recoverability of assets to be held and used is measured by comparing
the carrying amount of the asset to the future undiscounted net cash
flows expected to be generated by the asset. Recoverability of assets
held for sale is measured by comparing the carrying amount of the
assets to their estimated fair market value. If any assets are
considered to be impaired, the impairment is measured by the amount by
which the carrying amount of the assets exceeds the estimated fair
value (see Note 3).
(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.
7
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 during 2001 and 2002
related to a portion of our fixed rate debt. These hedge strategies
satisfy the fair value hedging requirements of SFAS 133. As a result,
the fair value of the hedges is carried on the balance sheet in other
current assets and the related underlying liabilities are also
adjusted to fair value by the same amount.
(g) 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 rights to use (IRU), 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.
(h) 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.
8
(2) Property, Plant and Equipment, Net:
----------------------------------
Property, plant and equipment at September 30, 2002 and December 31, 2001
is as follows:
($ in thousands) September 30, 2002 December 31, 2001
----------------------- ---------------------
Property, plant and equipment $ 6,369,483 $ 6,699,928
Less accumulated depreciation (2,633,452) (2,187,890)
----------------------- ---------------------
Property, plant and equipment, net $ 3,736,031 $ 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 $167,772,000 and $141,709,000
for the three months ended September 30, 2002 and 2001, respectively and
$471,642,000 and $335,452,000 for the nine months ended September 30, 2002
and 2001, respectively. The property, plant and equipment balances above
reflect an impairment write down related to ELI (see Note 3) partially
offset by asset additions.
(3) Losses on Impairment:
--------------------
In the third quarter 2002, we recognized non-cash pre-tax impairment losses
of $656,658,000 related to property, plant and equipment in the ELI sector
and $417,400,000 related to the gas and electric sector assets held for
sale, in each case in accordance with the provisions of SFAS 144.
ELI
---
Prior to the third quarter of 2002, we tested for impairment of ELI and
determined that, based on our assumptions, the sum of the expected future
cash flows, undiscounted and without interest charges, exceeded the
carrying value of its long lived assets and therefore we did not recognize
an impairment. Because sales for the nine months ended September 30, 2002
were lower than those in 2001 and were significantly below our original
2002 budget (which was used in the test for impairment at December 31,
2001), we evaluated the long lived assets of ELI as of September 30, 2002.
At that date, we estimated that our future cash flows were less than the
carrying value of our long-lived assets. As a result we recognized a
non-cash pre-tax impairment loss of $656,658,000, equal to the difference
between the estimated fair value of the assets (which we determined by
calculating the discounted value of the estimated future cash flows
weighting various possible scenarios for management's assessment of
probability of occurrence and discounting the probability-weighted cash
flows at an appropriate rate) and the carrying amount of the assets. Making
the determinations of impairment and the amount of impairment require
significant judgment by management and assumptions with respect to the
future cash flows of the ELI sector. The telecommunications industry in
general and the CLEC sector in particular is undergoing significant change
and disruption, which makes judgments and assumptions with respect to the
future cash flows highly subjective.
Gas and Electric Assets Held for Sale
-------------------------------------
On October 29, 2002, our board approved the sale of our Arizona gas and
electric utility properties for $230,000,000 in cash, subject to customary
adjustments under the terms of the agreements. The board also approved, in
principle, the sale of our remaining two utility properties (Vermont
Electric and The Gas Company in Hawaii) at currently offered prices, which
are below current carrying cost. These two properties are the only utility
properties which do not have a definitive sales contract. Our estimate of
net realizable value is based on current negotiations and may be revised in
future periods. As a result, for the four properties noted above we
recorded a non-cash pre-tax charge of $417,400,000 in the third quarter of
2002 to reduce the carrying value of our assets held for sale to our best
estimate of net realizable value upon sale (see Note 5).
Previously, we believed that the net realizable value of these properties
was equal to or above their carrying values. However, as a result of market
conditions, and the desire to complete the divestiture process in order to
focus on our core telecommunications operations and raise money to further
reduce debt, we made a strategic decision to accept proceeds less than
carrying values.
(4) 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 telephone access lines in Alabama, Florida,
Georgia, Illinois, Indiana, Iowa, Michigan, Minnesota, Mississippi, New
York, Pennsylvania and Wisconsin, for approximately $3,373,000,000 in cash.
This transaction has been accounted for using the purchase method of
accounting. The results of operations of Frontier has been included in our
financial statements from the date of acquisition.
9
The following summarizes the allocation of purchase price for our Frontier
acquisition:
($ 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
Debt 146,920
Other liabilities 279,536
---------------
Total liabilities assumed 426,456
---------------
Cash paid $ 3,372,934
===============
The following pro forma financial information for the nine months ended
September 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.
($ in thousands, except per share amount) For the nine months
ended September 30, 2001
----------------------------
Revenue $ 2,178,940
Net loss $ (53,522)
Net loss available to common shareholders per share $ (0.25)
Included in revenue is approximately $217,200,000 of revenue from our
Louisiana and Colorado gas operations for the nine months ended September
30, 2001. Such assets were sold during 2001 (see Note 5).
(5) 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 and Gas
----------------
On October 29, 2002, we entered into definitive agreements to sell our
Arizona gas and electric divisions to UniSource Energy Corporation for
$230,000,000 in cash, subject to adjustments specified in the
agreements (see Note 3). The transactions, which are subject to
regulatory approvals, are expected to close during the second half of
2003.
On November 1, 2002, we completed the sale of our Kauai electric
division to Kauai Island Utility Cooperative (KIUC) for $215,000,000
in cash, which approximated its book value.
10
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 $8,900,000 in cash after purchase price
adjustments.
Currently, we do not have agreements to sell one of our gas and one of our
electric properties. All of our gas and electric assets (including Arizona
gas and electric and Kauai electric) and their related liabilities are
classified as "assets held for sale" and "liabilities related to assets
held for sale," respectively. These assets have been written down to our
best estimate of the net realizable value upon sale (see Note 3). We
continue to actively pursue buyers for our remaining gas and electric
businesses.
Discontinued operations in the consolidated statements of income (loss)
reflect the results of operations of the water/wastewater properties sold
in January 2002 including allocated interest expense for the periods
presented. Interest expense was allocated to the discontinued operations
based on the outstanding debt specifically identified with these
businesses.
Summarized financial information for the water/wastewater operations
(discontinued operations) is set forth below:
($ in thousands) For the three months ended September 30,
--------------------------------------------
2002 2001
-------------------- ---------------------
Revenue $ - $ 34,451
Operating income $ - $ 14,832
Income tax expense $ - $ 4,571
Income from discontinued operations, net of tax $ - $ 7,199
($ in thousands) For the nine months ended September 30,
--------------------------------------------
2002 2001
-------------------- ---------------------
Revenue $ 4,650 $ 87,880
Operating income (loss) $ (419) $ 26,777
Income tax expense (benefit) $ (920) $ 6,730
Income (loss) from discontinued operations, net of tax $ (1,478) $ 11,675
Gain on disposal of water segment, net of tax $ 169,326 $ -
Summarized balance sheet information for the gas and electric operations
(assets held for sale) is set forth below:
($ in thousands) September 30, 2002 December 31, 2002
------------------ ------------------
Current assets $ 64,710 $ 66,511
Net property, plant and equipment 878,763 805,653
Other assets 223,081 235,773
Allowance for impairment (see Note 3) (417,400) -
-------------------- -------------------
Total assets held for sale $ 749,154 $ 1,107,937
==================== ===================
Current liabilities $ 82,386 $ 71,259
Long-term debt 36,480 43,400
Other liabilities 122,463 104,116
-------------------- -------------------
Total liabilities related to assets held for sale $ 241,329 $ 218,775
==================== ===================
11
(6) Intangibles:
-----------
Intangibles at September 30, 2002 and December 31, 2001 are as follows:
As of September 30, 2002
--------------------------------------------------------------------
Gross Carrying Accumulated Net Carrying
($ in thousands) Amount Amortization Amount
---------------------- --------------------- ---------------------
Goodwill $ 1,991,712 $ (106,426) $ 1,885,286
Customer base, trade name and software 1,127,668 (148,487) 979,181
---------------------- --------------------- ---------------------
Total intangibles $ 3,119,380 $ (254,913) $ 2,864,467
====================== ===================== =====================
As of December 31, 2001
--------------------------------------------------------------------
Gross Carrying Accumulated Net Carrying
($ in thousands) Amount Amortization Amount
---------------------- --------------------- ---------------------
Goodwill $ 2,068,032 $ (110,432) $ 1,957,600
Customer base, trade name and software 1,077,398 (56,056) 1,021,342
---------------------- --------------------- ---------------------
Total intangibles $ 3,145,430 $ (166,488) $ 2,978,942
====================== ===================== =====================
Amortization expense was $31,839,000 and $51,953,000 for the three months
ended September 30, 2002 and 2001, respectively and $92,521,000 and
$78,282,000 for the nine months ended September 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 independent appraisals of the respective
properties acquired.
Our acquisitions were made in order for us to execute upon our business
strategy. Our strategy is to focus exclusively on providing
telecommunications services, primarily in rural, small and medium-sized
towns where we believe we have a competitive advantage because of our
relatively larger size, greater resources, local focus and lower levels of
competition. For ILEC operations we are typically the dominant provider of
independent local exchange carrier services in 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 because we believed there were significant revenue and margin
growth opportunities, economies of scale (e.g. cost savings opportunities),
and the potential benefit resident in expected population/demographic
trends.
In July 2001, the Financial Accounting Standards Board (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 15). 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.
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.
12
For the three months For the nine months
(In thousands, except per-share amounts) ended September 30, ended September 30,
--------------------------------- ------------------------------
2002 2001 2002 2001
------------ -------------- --------------- -------------
Reported attributable to common shareholders $ (700,104) $ (1,444) $ (658,437) $ 4,983
Add back: Goodwill amortization, net of tax - 21,884 - 35,240
------------ -------------- --------------- -------------
Adjusted attributable to common shareholders $ (700,104) $ 20,440 $ (658,437) $ 40,223
============ ============== =============== =============
Basic earnings per share:
Reported attributable to common shareholders $ (2.49) $ (0.01) $ (2.35) $ 0.02
Goodwill amortization, net of tax - 0.08 - 0.13
------------ -------------- --------------- -------------
Adjusted attributable to common shareholders $ (2.49) $ 0.07 $ (2.35) $ 0.15
============ ============== =============== =============
Diluted earnings per share:
Reported attributable to common shareholders $ (2.49) $ (0.01) $ (2.35) $ 0.02
Goodwill amortization, net of tax - 0.07 - 0.13
------------ -------------- --------------- -------------
Adjusted attributable to common shareholders $ (2.49) $ 0.07 $ (2.35) $ 0.14
============ ============== =============== =============
(7) Restructuring and Other Charges:
-------------------------------
Restructuring and other expenses consist of expenses related to our various
restructurings, $10,200,000 of expenses related to reductions in personnel
at our telecommunications operations, costs that were spent at both our
Plano, Texas facility and at other locations as a result of transitioning
functions and jobs, and $6,800,000 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 the original Citizens businesses. We continue to
review our operations, personnel and facilities to achieve greater
efficiency. We are currently evaluating additional headcount reductions,
which may result in a restructuring charge in the fourth quarter of 2002.
Plano Restructuring
Pursuant to a plan adopted in the second quarter of 2001, we closed
our operations support center in Plano, Texas in August 2002. In
connection with this plan, we recorded a pre-tax charge of $14,557,000
in the second half of 2001, $839,000 for the three months ended March
31, 2002 and we adjusted our accrual down by $92,000 and $561,000 for
the three months ended June 30, 2002 and September 30, 2002,
respectively. Our objective is to concentrate our resources in areas
where we have the most customers, to better serve those customers. We
intend to sell our Plano office building. The restructuring resulted
in the termination of 750 employees. We communicated with all affected
employees during July 2001. Certain employees were relocated, others
were offered severance, job training and/or outplacement counseling.
As of September 30, 2002, approximately $14,531,000 was paid and all
affected employees were terminated. The restructuring expenses
primarily consist of severance benefits, retention earned through
September 30, 2002, and other planning and communication costs.
Sacramento Call Center Restructuring
In April 2002, we closed our Sacramento Customer Care Center. In
connection with this closing, we recorded a pre-tax charge of $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 September 30, 2002, approximately $769,000 was
paid and all affected 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, second and third quarters of 2002, ELI adjusted
its original accrual down by $2,100,000, $100,000 and $475,000,
respectively, due to the favorable settlements of termination charges
for off-net circuit agreements. As of September 30, 2002, $1,204,000
has been paid. The remaining accrual of $300,000 is included in
current liabilities at September 30, 2002.
13
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
$6,800,000. We accounted for this transaction as a purchase and
allocated the entire amount to goodwill. We evaluated the
recoverability of this goodwill in accordance with SFAS No. 142 and
determined that a write-off was necessary based on fair market value
as determined by discounted cash flows and other valuation
methodologies. This charge is included in restructuring and other
expenses.
1999
----
In the fourth quarter of 1999, we adopted a plan to restructure our
corporate office activities. In connection with this plan, we recorded a
pre-tax charge of $5,760,000 in the fourth quarter of 1999. The
restructuring resulted in the reduction of 49 corporate employees. All
affected employees were communicated with in the early part of November
1999. As of June 30, 2002, approximately $4,602,000 has been paid, 43
employees were terminated and 6 employees who were expected to be
terminated took other positions within the company. At June 30, 2002,
December 31, 2001 and December 31, 2000, we adjusted our original accrual
down by $11,000, $139,000 and $1,008,000, respectively, and no accrual
remained as of June 30, 2002.
14
($ 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
----------------- -------------- -------------- ------------- ----------
Amount paid (583) (120) (211) - (914)
Additional accrual - - 14 - 14
Adjustments (389) - (69) (117) (575)
----------------- -------------- -------------- ------------- ----------
Accrued @ 9/30/2002 $ - $ 212 $ - $ - $ 212
================= ============== ============== ============= ==========
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
----------------- -------------- -------------- ------------- ----------
Accrued @ 6/30/2002 6 16 27 - 49
----------------- -------------- -------------- ------------- ----------
Amount paid - (16) - - (16)
Adjustments 4 - (4) - -
----------------- -------------- -------------- ------------- ----------
Accrued @ 9/30/2002 $ 10 $ - $ 23 $ - $ 33
================= ============== ============== ============= ==========
ELI 2001 Restructuring
Accrued @ 12/31/2001 $ - $ - $ - $ 4,179 $ 4,179
Adjustments - - - (2,100) (2,100)
----------------- -------------- -------------- ------------- ----------
Accrued @ 3/31/2002 - - - 2,079 2,079
----------------- -------------- -------------- ------------- ----------
Amount paid - - - (1,054) (1,054)
Adjustments - - - (100) (100)
----------------- -------------- -------------- ------------- ----------
Accrued @ 6/30/2002 - - - 925 925
----------------- -------------- -------------- ------------- ----------
Amount paid - - - (150) (150)
Adjustments - - - (475) (475)
----------------- -------------- -------------- ------------- ----------
Accrued @ 9/30/2002 $ - $ - $ - $ 300 $ 300
================= ============== ============== ============= ==========
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) -
15
(8) Long-Term Debt:
--------------
The activity in our long-term debt from December 31, 2001 to September 30,
2002 is as follows:
Nine Months Ended September 30, 2002
--------------------------------------------
Interest Interest Rate* at
December 31, Rate Swap/ September 30, September 30,
($ in thousands) 2001 Borrowings Reclassification Payments*** 2002 2002
----------------------------------------------------------- -------------- ----------------
FIXED RATE
Rural Utilities Service Loan
Contracts $ 110,860 $ - $ - $ (79,782) $ 31,078 6.210%
Debentures 850,778 - - (21,250) 829,528 7.550%
2001 Notes 3,700,430 - 16,077 (23,667) 3,692,840 8.290%
Equity Units 460,000 - - - 460,000 7.480%
Senior Unsecured Notes 108,825 - - (37,825) 71,000 8.050%
ELI Notes 325,000 - - (59,636) 265,364 6.232%
ELI Capital Leases 137,382 - - (2,128) 135,254 11.797%
Industrial Development Revenue Bonds 249,205 - - (62,815) 186,390 6.091%
Other 54 - - (10) 44 12.985%
---------------- ----------- --------------- ------------- --------------
TOTAL FIXED RATE 5,942,534 - 16,077 (287,113) 5,671,498
---------------- ----------- --------------- ------------- --------------
VARIABLE RATE
ELI Bank Credit Facility 400,000 - - (400,000) - 2.391%
Industrial Development Revenue Bonds 136,278 - 43,400 ** (30,610) 149,068 4.267%
---------------- ----------- --------------- ------------- --------------
TOTAL VARIABLE RATE 536,278 - 43,400 (430,610) 149,068
---------------- ----------- --------------- ------------- --------------
TOTAL LONG TERM DEBT $ 6,478,812 $ - $ 59,477 $ (717,723) $ 5,820,566
---------------- =========== =============== ============= --------------
Less: Current Portion (483,906) (141,220)
Less: Equity Units (460,000) (460,000)
---------------- --------------
$ 5,534,906 $ 5,219,346
================ ==============
*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 the
long-term portion of multiple issuances.
**Reclassification from liabilities related to assets held for sale.
***Includes purchases on the open market (see Note 15).
Total future minimum cash payment commitments over the next 25 years under ELI's
long-term capital leases amounted to $318,300,000 as of September 30, 2002.
16
(9) Net Income Per Common Share:
---------------------------
The reconciliation of the net income per common share calculation for the
three and nine months ended September 30, 2002 and 2001, respectively, is
as follows:
(In thousands, except per-share amounts) For the three months ended September 30,
---------------------------------------------------------------------------
2002 2001
------------------------------------- ------------------------------------
Weighted Weighted
Average Average
Net Loss Shares Per Share Net Loss Shares Per Share
------------ ----------- ---------- ------------ ----------- ----------
Net income (loss) per common share:
Basic $(700,104) 280,778 $ (441) 286,175
Carrying cost of equity forward contracts - - 1,003 -
------------ ----------- ------------ -----------
Attributable to common shareholders $(700,104) 280,778 $ (2.49) $ (1,444) 286,175 $ (0.01)
Effect of dilutive options - 3,545 - 5,712
------------ ----------- ------------ -----------
Diluted $(700,104) 284,323 $ (2.49) $ (1,444) 291,887 $ (0.01)
============ =========== ============ ===========
(In thousands, except per-share amounts) For the nine months ended September 30,
---------------------------------------------------------------------------
2002 2001
------------------------------------- ------------------------------------
Weighted Weighted
Average Average
Net Loss Shares Per Share Net Income Shares Per Share
------------ ----------- ---------- ------------ ----------- ----------
Net income (loss) per common share:
Basic $(658,437) 280,540 $ 18,633 271,911
Carrying cost of equity forward contracts - - 13,650 -
------------ ----------- ------------ -----------
Attributable to common shareholders $(658,437) 280,540 $ (2.35) $ 4,983 271,911 $ 0.02
Effect of dilutive options - 4,114 - 6,438
------------ ----------- ------------ -----------
Diluted $(658,437) 284,654 $ (2.35) $ 4,983 278,349 $ 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 September 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 15,325,000 potentially dilutive stock options at a range of $9.18 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 1,362,000 shares and
590,000 shares at September 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.
(10) 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 typically the
incumbent provider in its service areas. Our gas and electric segments are
intended to be sold and are classified as "assets held for sale" and
"liabilities related to assets held for sale."
As an ILEC, we compete with CLECs that may operate in our markets. As a
CLEC, we provide telecommunications services, principally to businesses, in
competition with the incumbent ILEC. As a CLEC, we frequently obtain the
"last mile" access to customers through arrangements with the applicable
ILEC. ILECs and CLECs are subject to different regulatory frameworks of the
Federal Communications Commission (FCC). We do not provide ILEC and CLEC
services in competition with each other in any individual market.
17
EBITDA is a measure commonly used to analyze companies on the basis of
operating performance. Adjusted EBITDA is operating income (loss) plus
depreciation and amortization, the reserve for telecommunications
bankruptcies, restructuring and other expenses and loss on impairment. We
use Adjusted EBITDA 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 September 30, 2002
---------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 519,777 $ 41,311 $ 40,584 $ 67,159 $ 668,831
Depreciation and amortization 148,798 50,587 9 217 199,611
Restructuring and other expenses 138 (411) - - (273)
Loss on impairment - 656,658 152,300 265,100 1,074,058
Operating income (loss) 131,239 (702,326) (148,345) (249,606) (969,038)
Adjusted EBITDA 280,175 4,508 3,964 15,711 304,358
($ in thousands) For the three months ended September 30, 2001
---------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 507,202 $ 52,249 $ 37,717 $ 63,953 $ 661,121
Depreciation and amortization 173,014 20,161 152 335 193,662
Restructuring and other expenses 13,002 - - - 13,002
Operating income (loss) 64,602 (21,735) 3,717 11,648 58,232
Adjusted EBITDA 250,618 (1,574) 3,869 11,983 264,896
($ in thousands) For the nine months ended September 30, 2002
---------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 1,542,494 $ 133,845 $ 159,805 $ 174,460 $ 2,010,604
Depreciation and amortization 461,829 101,978 139 217 564,163
Reserve for telecommunications
bankruptcies 17,371 434 - - 17,805
Restructuring and other expenses 15,350 6,562 - - 21,912
Loss on impairment - 656,658 152,300 265,100 1,074,058
Operating income (loss) 324,067 (758,322) (128,041) (223,815) (786,111)
Adjusted EBITDA 818,617 7,310 24,398 41,502 891,827
($ in thousands) For the nine months ended September 30, 2001
---------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 1,083,335 $ 173,308 $ 360,387 $ 174,114 $ 1,791,144
Depreciation and amortization 347,703 59,439 457 6,135 413,734
Restructuring and other expenses 13,002 - - - 13,002
Operating income (loss) 187,957 (52,113) 42,213 28,607 206,664
Adjusted EBITDA 548,662 7,326 42,670 34,742 633,400
(11) Adelphia Investment:
-------------------
As of September 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 had written this investment down to zero.
18
(12) 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.
(13) 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 September 30, 2002 and December 31, 2001 was $250,000,000 and
$100,000,000, respectively. Such contracts require us to pay variable rates
of interest (average pay rate of approximately 4.854% as of September 30,
2002) and receive fixed rates of interest (average receive rate of 7.65% as
of September 30, 2002). The fair value of these derivatives is reflected in
other assets as of September 30, 2002, in the amount of $16,506,425 and the
related underlying debt has been increased by a like amount. The amounts
received during the three and nine months ended September 30, 2002 as a
result of these contracts amounted to $1,378,599 and $1,790,496,
respectively, and are included as a reduction to interest expense.
We do not anticipate any nonperformance by counter parties to its
derivative contracts as all counter parties have investment grade credit
ratings.
(14) 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.
(15) New Accounting Pronouncements:
-----------------------------
In July 2001, the FASB issued 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 and trade
name. 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
$39,800,000 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
19
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" (see Notes 1(e) and 3).
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 the nine
months ended September 30, 2002, we recognized $6,000,000 of gains from
early debt retirement as other income. There were no similar types of
retirements in 2001. Also, see Note 16.
(16) Settlement of Retained Liabilities:
----------------------------------
We are actively pursuing the settlement of certain retained liabilities at
less than face value, which are associated with customer advances for
construction from our disposed water properties. For the three and nine
months ended September 30, 2002, we recognized $10,800,000 and $20,800,000,
respectively, in investment and other income, net, as a result of these
settlements.
(17) 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 a $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.
Although some of these arrangements have continued after the bankruptcy
filing, we are in the process of changing some services and functions to
provide them ourselves. The Bankruptcy Court has granted relief to us and
other telecommunications companies that provide service to Global by, among
other things, directing a shortened payment period with respect to
post-petition invoices, an expedited court process for post-petition
defaults in payments by Global, and a priority for post-petition expense
items over other unsecured debt. These procedures should minimize future
economic loss to us although we cannot guarantee that additional losses
will not occur.
(18) 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 have paid the class members $5,500,000 in satisfaction of all
claims. The court approved the settlement agreement on March 29, 2002, and
the lawsuit against us was dismissed with prejudice. We accrued the full
settlement amount, plus an additional amount sufficient to cover legal fees
and other related expenses, during the fourth quarter of 2001 and no
accrual remains at September 30, 2002.
20
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. We are waiting for a decision on the motions filed by us.
21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
This quarterly report on Form 10-Q contains forward-looking statements that are
subject to risks and uncertainties that 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;
* The effects of competition from wireless, other wireline carriers
(through Unbundled Network Element (UNE), Unbundled Network Element
Platform (UNEP) or otherwise), high speed cable modems and cable
telephony;
* Our ability to effectively manage 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 sell second lines and enhanced and
data services to markets currently under-penetrated;
* Our ability to manage our operating expenses, capital expenditures and
reduce our debt;
* The effects of greater than anticipated competition requiring new
pricing, marketing strategies or new product offerings and the risk
that we will not respond on a timely or profitable basis;
* The effects of bankruptcies in the telecommunications industry which
could result in higher network access costs and potential bad debts;
* The effects of technological changes, including the lack of assurance
that our ongoing network improvements will be sufficient to meet or
exceed the capabilities and quality of competing networks;
* Effects of increased pension and retiree medical expenses and funding
requirements;
* The effects of changes in regulation in the telecommunications
industry as a result of the Telecommunications Act of 1996 and other
federal and state legislation and regulation, including changes in
subsidy payments;
* The effect of restructuring of portions of the telecommunications
market;
* The effects of possible state regulatory cash management policies on
our ability to transfer cash among our subsidiaries and to the parent
company; 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 nine months ended September 30, 2002, we used cash flow from continuing
operations, the proceeds from the sale of discontinued operations and cash and
investment balances to fund ongoing working capital requirements, 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 September 30, 2002,
we had cash and cash equivalents balances aggregating $479.2 million.
22
Our revised budget is approximately $357.0 to $367.0 million for our 2002
capital projects, including approximately $300.0 to $310.0 million for the ILEC
segment, $15.0 million for the ELI segment (excluding a $110.0 million purchase
of equipment under lease) and $42.0 million for the public utilities services
segment. For the nine months ended September 30, 2002, our actual capital
expenditures were $205.5 million for the ILEC segment, $8.2 million for the ELI
segment (excluding the purchase for $110.0 million in cash of equipment
previously under lease) and $31.7 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 and public services operations and
our existing cash and investment balances.
During 1995, ELI entered into a $110.0 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 $110.0 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 $805.0
million. Associated facility fees vary, depending on our credit ratings, and are
0.25% per annum as of September 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 September 30, 2002, there were no outstanding advances
under these facilities.
Tender Offer
- ------------
On May 16, 2002, we commenced a tender offer, at $0.70 per share, for all of the
publicly held Class A common shares of ELI that we did not already own. The
tender offer expired on June 17, 2002, at which time the 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 $400.0 million outstanding under ELI's committed revolving line of credit
with a syndicate of commercial banks.
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 $0.5 million on these redemptions.
On March 27, 2002, we repaid $40.0 million of Frontier 7.51% Medium Term Notes
at maturity.
On May 1, 2002, we redeemed at par six of our outstanding variable rate
Industrial Development Revenue Bond series aggregating approximately $20.3
million in principal amount.
On June 27, 2002, we redeemed at par $24.8 million principal amount of our 7.05%
Mohave Industrial Development Revenue Refunding Bonds due August 1, 2020.
On July 15, 2002, we redeemed at par three of our outstanding fixed and variable
rate Industrial Development Revenue Bond series aggregating approximately $14.9
million in principal amount.
On August 7, 2002, we redeemed at par one of our outstanding variable rate
Industrial Development Revenue Bond series totaling $5.5 million in principal
amount.
23
During the second and third quarters, 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 $104.6 million and they
generated a pre-tax gain from the early extinguishment of debt at a discount of
approximately $6.0 million.
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 $50.0 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 $50.0 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%. On August 8, 2002, we entered into another
FRA that set the effective rate that we pay on one of the swaps for the period
of November 15, 2002 to May 15, 2003 at 5.310%.
Acquisition
- -----------
On June 29, 2001, we purchased from Global Crossing Ltd. (Global) 100% of the
stock of Frontier Corp.'s local exchange carrier subsidiaries, which owned
telephone access lines in Alabama, Florida, Georgia, Illinois, Indiana, Iowa,
Michigan, Minnesota, Mississippi, New York, Pennsylvania and Wisconsin, for
approximately $3,373.0 million in cash. This transaction has been accounted for
using the purchase method of accounting. The results of operations of Frontier
has 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.
On October 29, 2002, we entered into definitive agreements to sell our Arizona
gas and electric divisions to UniSource Energy Corporation for $230.0 million in
cash, subject to adjustments specified in the agreements (see Note 3). The
transaction, which is subject to regulatory approvals, is expected to close
during the second half of 2003.
On November 1, 2002, we completed the sale of our Kauai electric division to
Kauai Island Utility Cooperative (KIUC) for $215.0 million in cash, which
approximated its book value.
Currently, we do not have agreements to sell one of our gas and one of our
electric properties. All our gas and electric assets (including Arizona gas and
electric and Kauai electric) and their related liabilities are classified as
"assets held for sale" and "liabilities related to assets held for sale,"
respectively. These assets have been written down to our best estimate of the
net realizable value upon sale (see Note 3). We continue to actively pursue
buyers for our remaining gas and electric businesses. During the third quarter
of 2002, we recognized a non-cash pre-tax impairment loss on these assets of
$417.4 million.
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.
Critical Accounting Policies and Estimates
- ------------------------------------------
We review all significant estimates affecting our consolidated financial
statements on a recurring basis and record the effect of any necessary
adjustment prior to their publication. Uncertainties with respect to such
estimates and assumptions are inherent in the preparation of financial
statements; accordingly, it is possible that actual results could differ from
those estimates and changes to estimates could occur in the near term. The
preparation of our financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of the contingent assets and liabilities at the date of the financial
24
statements and the reported amounts of revenue and expenses during the reporting
period. Estimates and judgments are used when accounting for allowance for
doubtful accounts, impairment of long-lived assets, intangible assets,
depreciation and amortization, employee benefit plans, income taxes and
contingencies, among others.
We believe that the accounting estimate related to asset impairment is a
"critical accounting estimate" because with respect to ELI, it is highly
susceptible to change from period to period because it requires management to
make significant judgments and assumptions about future revenue, operating costs
and capital expenditures over the life of the property, plant and equipment
(generally 5 to 15 years) as well as the probability of occurrence of the
various scenarios and appropriate discount rates. With respect to gas and
electric, our estimate is based upon an expected future sales prices.
Management's assumptions about ELI's future revenue, operating costs and capital
expenditures as well as the probability of occurrence of these various scenarios
require significant judgment because the CLEC industry is changing and because
actual revenue, operating costs and capital expenditures have fluctuated
dramatically in the past and may continue to do so in the future. Management has
discussed the development and selection of this critical accounting estimate
with the audit committee of our board of directors and our audit committee has
reviewed the company's disclosure relating to it.
Our estimate of anticipated losses related to telecommunications bankruptcies is
a "critical accounting estimate." We have significant on-going normal course
business relationships with WorldCom and Global Crossing, both of which filed
for bankruptcy. We have reserved approximately 95% of the net outstanding
pre-bankruptcy balances owed to us and believe that our estimate of the net
realizable value of the amounts owed to us by both of these entities is
appropriate. We may realize more or less than that amount upon final
determination of approved creditor claims by the bankruptcy courts.
Our estimates of pension expense, pension assets and related liabilities are
"critical accounting estimates." Our pension expense is based upon a set of
assumptions that include projections of future interest rates and asset returns.
Actual results may vary from these estimates. Additionally, we have made a
judgment that we will prevail in bankruptcy court in obtaining certain pension
assets and the related liabilities we acquired in our purchase of Frontier (see
Note 18). Our pension expense may vary significantly in future periods if we do
not prevail in this matter.
The calculation of depreciation and amortization expense is based on the
estimated economic useful lives of the underlying property, plant and equipment
and identifiable intangible assets. Although we believe it is unlikely that any
significant changes to the useful lives of our tangible or intangible assets
will occur in the near term, rapid changes in technology or changes in market
conditions could result in revisions to such estimates that could affect the
carrying value of these assets and our future consolidated operating results.
Our depreciation expense of the ELI segment will decrease substantially in
future periods as a result of the impairment write down.
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 and trade name. 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.
25
In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-lived Assets." This statement establishes a single accounting
model, based on the framework established in SFAS 121, for impairment of
long-lived assets held and used and for long-lived assets to be disposed of by
sale, whether previously held and used or newly acquired, and broadens the
presentation of discontinued operations to include more disposal transactions.
This statement is effective for fiscal years beginning after December 15, 2001.
In the third quarter 2002, we recognized a non-cash pre-tax loss on impairment
of $656.7 million for the impairment of certain long-lived assets in the ELI
sector and a total of $417.4 million of non-cash pre-tax losses on impairment in
the gas and electric sectors. We have determined that we may not be able to
recover the full value of ELI's property, plant, and equipment and therefore
have taken an impairment charge accordingly. The gas and electric impairment is
associated with the proposed sale of our Arizona gas and electric properties at
a price that is less than the current book carrying cost. We have also written
down the value of our two remaining utilities to our estimate of net realizable
sales price. Our sales price for the Kauai electric division for $215.0 million
approximates the current book value.
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 the nine months
ended September 30, 2002, we recognized $6.0 million of gains from early debt
retirement as other income. There were no similar types of retirements in 2001.
Pension Contingency
- -------------------
The assets of the Global pension plan (see Note 18) are invested primarily in
equity securities. Due to the general decline in the equity markets, during the
first nine months of 2002 the assets have declined in value. We believe that,
unless market conditions change in our favor during the fourth quarter, we will
be required to record a significant adjustment to our minimum pension liability
as of December 31, 2002. Any pension liability would result from the declining
market value of the pension plan assets during 2002 combined with lower market
interest rates used to value the plan's liabilities. This pension liability
would be measured as the amount of the plan's accumulated benefit obligation
that is in excess of the plan's market value of assets at December 31, 2002 plus
any balance remaining in deferred or "prepaid" benefit costs that were recorded
during periods when our pension plan assets exceeded our accumulated benefit
obligation. A charge would be recorded to shareholder's equity, net of income
tax benefits, as a component of comprehensive loss. Although the exact amount of
the charge to shareholder's equity is not known at this time because it will
depend on the value of the plan assets and market interest rates at December 31,
2002, it would approximate $100.0 million (net of tax benefit) based upon market
conditions that existed at October 31, 2002. We estimate that no charge to
equity will be recorded if asset values increase by approximately 3% from the
values at October 31, 2002. However, there would also be no charge to
shareholders' equity if we made a cash contribution to the plan in an amount
equal to the difference at December 31, 2002 between the value of the plan
assets and the accumulated benefit obligation. The adjustment would be computed
separately for each plan that the Company maintains but is mainly attributable
to the actual results of asset performance with respect to the Global pension
plan (see Note 18). This adjustment will not impact current year earnings, or
the funding requirements of the plan. However, we anticipate that pension
expense for 2003 will increase if these market declines continue.
Covenants
- ---------
The terms and conditions contained in our indentures and credit facility
agreements are of a general nature, and do not currently impose significant
financial performance criteria on us. These general covenants include the timely
and punctual payment of principal and interest when due, the maintenance of our
corporate existence, keeping proper books and records in accordance with
Generally Accepted Accounting Principles (GAAP), restrictions on the allowance
of liens on our assets, and restrictions on asset sales and transfers, mergers
and other changes in corporate control. We currently have no restrictions on the
payment of dividends by us either by contract, rule or regulation.
The principal financial performance covenant under our $805.0 million credit
facilities and our $200.0 million term loan facility with the Rural Telephone
Finance Cooperative (RTFC) requires the maintenance of a minimum net worth of
$1.5 billion. These facilities define "net worth" as shareholders' equity plus
equity units plus mandatorily redeemable convertible preferred securities. Under
the RTFC loan, in the event that our credit rating from either Moody's Investors
Service or Standard & Poor's declines below investment grade (Baa3/BBB-,
respectively), we would also be required to maintain an interest coverage ratio
of 2.00 to 1 or greater and a leverage ratio of 6.00 to 1 or lower. We are in
compliance with all of our debt covenants.
26
At September 30, 2002 the amount of our net worth as calculated pursuant to the
credit facilities and the RTFC loan facility was $1.95 billion. This calculation
includes the effect of our loss on impairment in the third quarter of 2002 (see
Note 3). In future periods, we may incur a reduction in shareholders' equity as
a result of certain pension matters described above or for other reasons.
Although the potential amount of future reductions cannot currently be
determined with certainty and assessments of the potential amounts require
considerable assumptions, we currently believe that we will remain in compliance
with all of our debt covenants.
(b) Results of Operations
---------------------
REVENUE
Consolidated revenue for the three and nine months ended September 30, 2002
increased $7.7 million, or 1.2% and $219.5 million or 12.3%, respectively, as
compared with the prior year period. The nine months increase is primarily due
to $419.7 million of increased telecommunications revenue, largely due to the
impact of the Frontier acquisition on June 29, 2001, partially offset by $200.6
million of decreased gas revenue largely due to the disposition of the Louisiana
and Colorado gas operations.
TELECOMMUNICATIONS REVENUE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ------------ --------------------- ----------- ------------ ---------
Access services $ 168,526 $ 165,416 $ 3,110 2% $ 503,694 $ 393,768 $ 109,926 28%
Local services 219,764 218,016 1,748 1% 650,690 457,868 192,822 42%
Long distance and data services 77,918 71,860 6,058 8% 227,248 135,144 92,104 68%
Directory services 26,443 25,253 1,190 5% 78,497 46,942 31,555 67%
Other 27,126 26,657 469 2% 82,365 49,613 32,752 66%
----------- ----------- ------------ ----------- ----------- ------------
ILEC revenue 519,777 507,202 12,575 2% 1,542,494 1,083,335 459,159 42%
ELI 41,311 52,249 (10,938) -21% 133,845 173,308 (39,463) -23%
----------- ----------- ------------ ----------- ----------- ------------
$ 561,088 $ 559,451 $ 1,637 0% $ 1,676,339 $ 1,256,643 $ 419,696 33%
=========== =========== ============ =========== =========== ============
Changes in the number of our access lines is the most fundamental driver of
changes in our revenue. Historically rural local telephone companies have
experienced steady growth in access lines because of positive demographic
trends, steady rural local economies and little competition. In recent quarters
many rural local telephone companies (including the Company) have experienced a
loss of access lines primarily because of difficult economic conditions (which
principally affect business lines but also to a lesser extent residential
lines), increased competition from competitive wireline providers (including
from Unbundled Network Elements), from wireless providers and from cable
companies (currently with respect to the broadband but which may in the future
expand to cable telephony), and by some customers disconnecting second lines
when they add DSL. We lost approximately 30,000 access lines between September
30, 2001 and September 30, 2002 but added approximately 42,000 DSL subscribers
during this period. The line losses were principally non-residential and in our
more urban markets.
Access services revenue for the three months ended September 30, 2002 increased
as compared with the prior year period primarily due to an increase in various
subsidies of $5.9 million and non-switched access revenue of $1.1 million due to
higher circuit sales. Although the amount of subsidies we receive has generally
been increasing over time, the amounts vary from quarter to quarter because of
routine adjustments in subsidy calculations and changes in subsidy rates. These
increases were partially offset by a decrease in switched access revenue of $3.9
million primarily from the effect of tariff rate reductions effective as of July
1, 2002, access line losses and lower switched minutes (minutes that are
originating or terminating traffic for other carriers).
Access services revenue for the nine months ended September 30, 2002 increased
as compared with the prior year period primarily due to the impact of Frontier
of $92.4 million. Increases in subsidies of $14.4 million and non-switched
access revenue of $8.7 million were partially offset by a decrease in switched
access revenue of $5.6 million primarily from the effect of tariff rate
reductions effective as of July 1, 2002, access line losses and lower switched
minutes (minutes that are originating or terminating traffic for other
carriers).
27
Local services revenue for the three months ended September 30, 2002 increased
as compared with the prior year period primarily due to increases in subscriber
line charges and growth in enhanced services for feature packages, partially
offset by line losses. Local services revenue for the nine months ended
September 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 September 30,
2002 increased as compared with the prior year period primarily due to growth of
$2.0 million in long distance and $4.1 million in data services. Long distance
and data services revenue for the nine months ended September 30, 2002 increased
as compared with the prior year period primarily due to the impact of Frontier
of $72.4 million, $9.8 million of growth related to data and dedicated circuits
and growth in long distance services of $9.8 million.
Directory services revenue for the three months ended September 30, 2002
increased as compared with the prior year period primarily due to growth in
yellow pages advertising revenue of $0.8 million. Directory services revenue for
the nine months ended September 30, 2002 increased as compared with the prior
year period primarily due to the impact of Frontier of $30.0 million and growth
in yellow pages advertising revenue of $1.1 million.
Other revenue for the three months ended September 30, 2002 increased $0.5
million as compared with the prior year period. Other revenue for the nine
months ended September 30, 2002 increased as compared with the prior year period
primarily due to the impact of Frontier of $32.8 million.
ELI revenue for the three and nine months ended September 30, 2002 decreased
primarily due to a decrease in reciprocal compensation minutes and price, a
decline in Integrated Service Digital Network (ISDN) services due to less demand
from internet service providers and lower demand and prices for long haul
services. Additionally, ELI revenue for the nine months ended September 30, 2002
decreased due to the expiration of a material data services contract in February
2001. ELI has experienced eight consecutive quarters of declining revenue.
GAS AND ELECTRIC REVENUE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ ---------
Gas revenue $ 40,584 $ 37,717 $ 2,867 8% $ 159,805 $ 360,387 $ (200,582) -56%
Electric revenue $ 67,159 $ 63,953 $ 3,206 5% $ 174,460 $ 174,114 $ 346 0%
Gas revenue for the three months ended September 30, 2002 increased as compared
with the prior year period primarily due to higher purchased gas costs passed on
to customers. Included in gas revenue for 2001 is approximately $1.6 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.
Gas revenue for the nine months ended September 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 $217.2 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 months ended September 30, 2002 increased as
compared with the prior year period primarily due to increased unit sales and
the effect of a rate increase approved in Vermont on July 15, 2002. The rate
increase for the three months period is approximately $1.0 million. Electric
revenue for the nine months ended September 30, 2002 increased as compared with
the prior year period primarily due to increased unit sales, partially offset by
lower purchased power prices. Under tariff provisions, the cost of our electric
energy and fuel oil purchases are primarily passed on to customers.
28
COST OF SERVICES
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ --------
Network access $ 58,218 $ 62,077 $ (3,859) -6% $ 174,774 $ 129,238 $ 45,536 35%
Gas purchased 21,329 24,988 (3,659) -15% 91,130 252,065 (160,935) -64%
Electric energy and
fuel oil purchased 36,248 36,149 99 0% 91,915 95,804 (3,889) -4%
----------- ----------- ------------ ----------- ----------- ------------
$ 115,795 $ 123,214 $ (7,419) -6% $ 357,819 $ 477,107 $ (119,288) -25%
=========== =========== ============ =========== =========== ============
Network access expenses for the three months ended September 30, 2002 decreased
as compared with the prior year period primarily due to decreased costs of $5.1
million in ELI as a result of decreases in demand, partially offset by increased
costs of $1.2 million in the ILEC sector.
Network access expenses for the nine months ended September 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 $14.6 million in the ILEC sector,
partially offset by decreased costs of $10.3 million in ELI as a result of
decreases in demand.
Gas purchased for the three months ended September 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 $1.1 million of gas
purchased by our Louisiana and Colorado gas operations, which were sold on July
2, 2001 and November 30, 2001, respectively.
Gas purchased for the nine months ended September 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 $172.2 million of gas
purchased by our Louisiana and Colorado gas operations.
Electric energy and fuel oil purchased for the three months ended September 30,
2002 increased as compared with the prior year period primarily due to increased
unit sales. Electric energy and fuel oil purchased for the nine months ended
September 30, 2002 decreased as compared with the prior year period primarily
due to lower purchased power prices. In Vermont, where commodity costs are not
passed on to customers, commodity costs decreased as a result of lower power
costs and "locking-in" fixed prices for certain of our load. These prices were
below last year's prices.
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, power costs charged by our power supplier in
the amount of approximately $119.8 million through September 30, 2002 have been
incurred. This balance was reduced by the public service impairment charge
recognized during the third quarter of 2002 (see Note 3). We believe that we are
allowed to recover these charges from ratepayers through the Purchase Power Fuel
Adjustment clause that was approved by the Arizona Corporation Commission and
has been in place for several years. However, in an attempt to limit "rate
shock" to our customers, we requested in September 2001 that our unrecovered
power costs, plus interest, be recovered over a seven-year period. As a result,
we have deferred these costs on the balance sheet in anticipation of recovery
through the regulatory process. Parts of our proposal have been contested by one
or more parties to a pending Arizona Commission proceeding convened to consider
the matter. We expect this matter will be resolved in conjunction with the sale
of our Arizona electric property to UniSource Energy Corporation.
29
OTHER OPERATING EXPENSES
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ --------
Operating expenses $ 189,410 $ 205,544 $ (16,134) -8% $ 570,904 $ 521,326 $ 49,578 10%
Taxes other than income taxes 33,550 37,989 (4,439) -12% 107,076 88,262 18,814 21%
Sales and marketing 25,718 29,478 (3,760) -13% 82,978 71,049 11,929 17%
----------- ----------- ------------ ----------- ----------- ------------
$ 248,678 $ 273,011 $ (24,333) -9% $ 760,958 $ 680,637 $ 80,321 12%
=========== =========== ============ =========== =========== ============
Operating expenses for the three months ended September 30, 2002 decreased as
compared with the prior year period primarily due to increased operating
efficiencies and a reduction of personnel in the ILEC and ELI sectors, partially
offset by increased compensation expense of $0.7 million related to variable
stock plans (under variable stock plans the amount of compensation expense
increases if our stock price increases). In future periods, if the value of our
pension assets declines and/or projected benefit costs increase, we may have
increased pension expenses. Pension expenses may also increase if we do not
prevail in obtaining a transfer of the pension assets that we purchased in
connection with our acquisition of Frontier (see Pension Plan Contingency and
Legal Proceedings). Although the amount of our pension expense and funding
requirements for 2003 will not be determined until next year, based on current
assumptions and plan asset values, we estimate that our pension expense could
increase from approximately $4 million in 2002 to approximately $13 million in
2003 and that a cash payment to our pension plans will be required in 2003 in an
amount currently estimated at $15 - $25 million. In addition, as medical costs
increase the costs of our retiree medical obligations increase. Our current
estimate of medical retiree costs for 2002 is approximately $12 million and for
2003 is approximately $14 million.
Operating expenses for the nine months ended September 30, 2002 increased as
compared with the prior year period primarily due to increased operating
expenses related to Frontier of $149.9 million, 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 $0.8 million related to variable stock
plans.
Taxes other than income taxes for the three months ended September 30, 2002
decreased as compared with the prior year period primarily due to a decrease in
the ILEC sector. Taxes other than income taxes for the nine months ended
September 30, 2002 increased as compared with the prior year period primarily
due to the impact of Frontier of $25.6 million partially offset by decreased
taxes in the ILEC sector and decreased taxes in the gas sector due to the sale
of our Louisiana and Colorado gas operations on July 2, 2001 and November 30,
2001, respectively.
Sales and marketing expenses for the three months ended September 30, 2002
decreased as compared with the prior year period primarily due to decreased
sales and marketing in the ELI sector of $3.1 million primarily due to a
reduction in personnel and related costs. Sales and marketing expenses for the
nine months ended September 30, 2002 increased as compared with the prior year
period primarily due to the impact of Frontier of $22.2 million, partially
offset by decreased sales and marketing in the ELI sector of $8.5 million,
primarily due to a reduction in personnel and related costs.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ --------
Depreciation expense $ 167,772 $ 141,709 $ 26,063 18% $ 471,642 $ 335,452 $ 136,190 41%
Amortization expense 31,839 51,953 (20,114) -39% 92,521 78,282 14,239 18%
----------- ----------- ------------ ----------- ----------- ------------
$ 199,611 $ 193,662 $ 5,949 3% $ 564,163 $ 413,734 $ 150,429 36%
=========== =========== ============ =========== =========== ============
Depreciation expense for the three months ended September 30, 2002 increased as
compared with the prior year period primarily due to increased depreciation of
$30.7 million at ELI due to the purchase of $110.0 million of previously leased
facilities in April 2002 and changes in our estimate of the depreciable lives as
of June 2002, partially offset by $8.8 million of decreased depreciation due to
accelerated depreciation in the prior year period 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. As a
result of the impairment charge recognized during the third quarter of 2002 with
respect to ELI, our depreciation expense for the ELI sector will decrease in
future periods.
30
Depreciation expense for the nine months ended September 30, 2002 increased as
compared with the prior year period primarily due to the impact of Frontier of
$82.6 million and increased depreciation of $43.2 million at ELI due to the
purchase of $110.0 million of previously leased facilities in April 2002 and
changes in our estimate of the depreciable lives as of June 2002. An increase of
$4.0 million as compared to the prior year period in accelerated depreciation
related to the closing of our Plano, Texas administrative facility contributed
to the increase. Accelerated depreciation has ceased on the Plano facility since
it is now carried at estimated realizable value. As a result of the impairment
charge recognized during the third quarter of 2002 with respect to ELI, our
depreciation expense for the ELI sector will decrease in future periods.
Amortization expense for the three months ended September 30, 2002 decreased as
compared with the prior year period primarily due to 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 (SFAS) No.
142, "Goodwill and Other Intangible Assets." For the three months ended
September 30, 2001 amortization expense included $33.2 million of goodwill
amortization. The decrease was partially offset by an increase of $13.1 million
in amortization of customer base resulting from the final valuation report of
our Frontier acquisition.
Amortization expense for the nine months ended September 30, 2002 increased as
compared with the prior year period primarily due to the impact of Frontier of
$47.6 million and $20.2 million in increased amortization of customer base.
These increases were partially offset by the fact that we ceased amortization of
goodwill related to our previous acquisitions as of January 1, 2002 in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." For the
nine months ended September 30, 2001 amortization expense included $53.6
million, of goodwill amortization.
RESERVE FOR TELECOMMUNICATIONS BANKRUPTCIES / RESTRUCTURING AND OTHER EXPENSES
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ------------ -------- ----------- ----------- ------------ ---------
Reserve for telecommunications
bankruptcies $ - $ - $ - - $ 17,805 $ - $ 17,805 100%
Restructuring and other expenses $ (273) $ 13,002 $ (13,275) -102% $ 21,912 $ 13,002 $ 8,910 69%
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.
Although some of these arrangements have continued after the bankruptcy filing,
we are in the process of changing some services and functions to provide them
ourselves. The Bankruptcy Court has granted relief to us and other
telecommunications companies that provide service to Global by, among other
things, directing a shortened payment period with respect to post-petition
invoices, an expedited court process for post-petition defaults in payments by
Global, and a priority for post-petition expense items over other unsecured
debt. These procedures should minimize future economic loss to us although we
cannot guarantee that additional losses will not occur.
Restructuring and other expenses for the nine months ended September 30, 2002
consist of expenses related to our various restructurings, $10.2 million of
expenses related to reductions in personnel at our telecommunications
operations, costs that were spent at both our Plano, Texas facility and at other
locations as a result of transitioning functions and jobs, and $6.8 million 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. We continue to review our
personnel levels in light of current and anticipated business conditions and
operating performance. Additional headcount reductions are currently being
evaluated for the fourth quarter of 2002 and if implemented may result in
additional restructuring charges. The discussion below includes our
restructuring charges and excludes the other expenses.
31
Plano Restructuring
Pursuant to a plan adopted in the second quarter of 2001, we closed
our operations support center in Plano, Texas in August 2002. In
connection with this plan, we recorded a pre-tax charge of $14.6
million in the second half of 2001, $0.8 million for the three months
ended March 31, 2002 and we adjusted our accrual down by $0.1 million
and $0.6 million for the three months ended June 30, 2002 and
September 30, 2002, respectively. Our objective is to concentrate our
resources in areas where we have the most customers, to better serve
those customers. We intend to sell our Plano office building. The
restructuring resulted in the termination of 750 employees. We
communicated with all affected employees during July 2001. Certain
employees were relocated others were offered severance, job training
and/or outplacement counseling. As of September 30, 2002,
approximately $14.5 million was paid and all affected employees were
terminated. The restructuring expenses primarily consist of severance
benefits, retention earned through September 30, 2002, and other
planning and communication costs.
Sacramento Call Center Restructuring
In April 2002, we closed our Sacramento Customer Care Center. In
connection with this closing, we recorded a pre-tax charge of $0.7
million in the fourth quarter of 2001, $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 September 30, 2002, approximately $0.8
million was paid and all affected 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 $4.2 million of
termination fees which were accrued for but not paid at December 31,
2001. In the first, second and third quarters of 2002, ELI adjusted
its original accrual down by $2.1 million, $0.1 million and $0.5
million, respectively, due to the favorable settlements of termination
charges for off-net circuit agreements. As of September 30, 2002, $1.2
million has been paid. The remaining accrual of $0.3 million is
included in current liabilities at September 30, 2002.
LOSS ON IMPAIRMENT
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ------------ -------- ----------- ----------- ------------ ---------
Loss on impairment $ 1,074,058 $ - $ 1,074,058 100% $ 1,074,058 $ - $ 1,074,058 100%
In the third quarter 2002, we recognized non-cash pre-tax impairment losses of
$656.7 million related to property, plant and equipment in the ELI sector and
$417.4 million related to the gas and electric sector assets held for sale. Our
assessment of impairment for ELI was a result of continued losses at ELI and
continued actual revenue declines in excess of projected revenue declines. The
gas and electric sector impairments are associated with the proposed sale of our
Arizona gas and electric properties at a price that is less than the carrying
value and the write down of our two other remaining utilities to our estimate of
net realizable sales prices. Previously, we believed that the net realizable
value of these properties was equal to or above their carrying values. However,
as a result of market conditions, and the desire to complete the divestiture
process in order to focus on our core telecommunications operations and raise
money to further reduce debt, in the third quarter of 2002 we made a strategic
decision to accept proceeds less than carrying values rather than continue to
market these properties for higher prices (See Critical Accounting Policies and
Estimates above).
32
INVESTMENT AND OTHER INCOME (LOSS), NET / GAIN ON SALE OF ASSETS /
INTEREST EXPENSE / INCOME TAX EXPENSE (BENEFIT)
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ------------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ------------ -------- ------------- ----------- ------------ ---------
Investment and
other income (loss), net $ 13,859 $ 3,070 $ 10,789 351% $ (62,725) $ 16,495 $ (79,220) -480%
Gain on sale of assets $ 1,901 $ 139,304 $ (137,403) -99% $ 1,901 $ 139,304 $ (137,403) -99%
Interest expense $ 116,459 $ 123,452 $ (6,993) -6% $ 359,568 $ 258,033 $ 101,535 39%
Income tax expense (benefit) $(371,186) $ 39,610 $ (410,796) -1037% $ (424,688) $ 49,183 $ (473,871) -963%
Investment and other income, net for the three months ended September 30, 2002
increased as compared with the prior year period primarily due to the
recognition of $10.8 million of income from the settlement of certain retained
liabilities at less than face value, which are associated with customer advances
for construction from our disposed water properties. For the three months ended
September 30, 2002, we executed a series of purchases in the open market of a
number of our outstanding notes and debentures and they generated a pre-tax gain
from the early extinguishment of debt of approximately $1.6 million, which also
contributed to the increase.
Investment and other income, net for the nine months ended September 30, 2002
decreased as compared with the prior year period primarily due to the
recognition in 2002 of $95.3 million of losses, resulting from an other than
temporary decline in the value of our investment in Adelphia. This amount was
partially offset by $20.8 million of income from the settlement of certain
retained liabilities at less than face value, which are associated with customer
advances for construction from our disposed water properties. For the nine
months ended September 30, 2002, we executed a series of purchases in the open
market of our outstanding notes and debentures and they generated a pre-tax gain
from the early extinguishment of debt of approximately $6.0 million, which also
contributed to the increase.
Gain on sale of assets for the nine months ended September 30, 2001 represents
the gain recognized from the sale of our Louisiana Gas operations to Atmos
Energy Corporation on July 2, 2001.
Interest expense for the three months ended September 30, 2002 decreased as
compared with the prior year period primarily due to a reduction of $9.3 million
of interest expense on our lines of credit, a $6.0 million decrease in ELI's
interest expense due to the repayment of the $400.0 million revolving line of
credit and a series of purchases in the open market of outstanding notes, a $5.2
million decrease in amortization of costs associated with our committed bank
credit facilities and a $2.3 million decrease resulting from the early
extinguishment of debt. These amounts were partially offset by $16.4 million of
interest expense on our $1.75 billion of notes issued in August 2001 and $3.1
million of interest expense on our $200.0 million Rural Telephone Finance
Cooperative note issued in October 2001. During the three months ended September
30, 2002, we had average long-term debt outstanding excluding our equity units
of $5.3 billion compared to $5.8 billion during the three months ended September
30, 2001. Our composite average borrowing rate for the three months ended
September 30, 2002 as compared with the prior year period was 52 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 nine months ended September 30, 2002 increased as
compared with the prior year period primarily due to $143.7 million of interest
expense on our $1.75 billion of notes issued in May 2001 and our $1.75 billion
of notes issued in August 2001, $14.4 million of interest expense on our equity
units issued in June 2001, $7.5 million of increased amortization of debt
discount expense and $9.4 million of interest expense on our $200.0 million
Rural Telephone Finance Cooperative note issued in October 2001. These amounts
were partially offset by a reduction of $34.5 million of interest expense on our
lines of credit, a $12.7 million decrease in ELI's interest expense due to the
repayment of the $400.0 million revolving line of credit and a series of
purchases in the open market of outstanding notes, a $14.7 million decrease in
amortization of costs associated with our committed bank credit facilities and a
$6.9 million decrease resulting from the early extinguishment of debt. During
the nine months ended September 30, 2002, we had average long-term debt
outstanding excluding our equity units of $5.4 billion compared to $4.4 billion
during the nine months ended September 30, 2001. Our composite average borrowing
rate for the nine months ended September 30, 2002 as compared with the prior
year period was 42 basis points higher due to the impact of higher interest
rates as a result of our refinancing our variable rate debt with fixed rate
long-term debt.
33
Income taxes for the three and nine months ended September 30, 2002 decreased as
compared with the prior year periods primarily due to changes in taxable income.
The estimated annual effective tax rate for 2002 is 35% as compared with 37% for
2001.
DISCONTINUED OPERATIONS
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2002 2001 $ Change % Change 2002 2001 $ Change % Change
----------- ----------- ------------ -------- ----------- ----------- ------------ ---------
Revenue $ - $ 34,451 $ (34,451) -100% $ 4,650 $ 87,880 $ (83,230) -95%
Operating income (loss) $ - $ 14,832 $ (14,832) -100% $ (419) $ 26,777 $ (27,196) -102%
Income (loss) from discontinued
operations, net of tax $ - $ 7,199 $ (7,199) -100% $ (1,478) $ 11,675 $ (13,153) -113%
Gain on disposal of water
segment, net of tax $ - $ - $ - - $169,326 $ - $ 169,326 100%
Revenue, operating income (loss) and income (loss) from discontinued operations,
net of tax, for the three and nine months ended September 30, 2002 decreased as
compared with the prior year period due to the sale of our water and wastewater
businesses in January 2002. On January 15, 2002, we completed the sale of our
water and wastewater operations to American Water Works, Inc. for $859.1 million
in cash and $122.5 million of assumed debt and other liabilities. The gain on
the disposal of the water segment, net of tax was $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 other than in the normal course of
business or to hedge long-term interest rate risk. Our primary market risk
exposures are interest rate risk and equity and commodity price risk as follows:
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest-bearing portion of our investment portfolio and interest on our
long term debt and capital lease obligations. The long term debt and capital
lease obligations include various instruments with various maturities and
weighted average interest rates.
Our objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, a majority of our borrowings have
fixed interest rates; variable rate debt is refinanced when advantageous.
Consequently, we have limited material future earnings or cash flow exposures
from changes in interest rates on our long-term debt and capital lease
obligations. A hypothetical 10% adverse change in interest rates would increase
the amount that we pay on our variable obligations and could result in
fluctuations in the fair value of our fixed rate obligations. Based upon our
overall interest rate exposure at September 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 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%. On August 8, 2002, we entered into another
FRA that set the effective rate that we pay on one of the swaps for the period
of November 15, 2002 to May 15, 2003 at 5.310%.
34
Sensitivity analysis of interest rate exposure
At September 30, 2002, the fair value of our long-term debt and capital lease
obligations excluding our equity units was estimated to be approximately
$4,772.1 million, based on our overall weighted average borrowing rate of 8.0%
and our overall weighted maturity of 13 years. There has been no material change
in the weighted average maturity applicable to our obligations since December
31, 2001. The overall weighted average interest rate has increased by
approximately 28 basis points. A hypothetical increase of 80 basis points (10%
of our overall weighted average borrowing rate) would result in an approximate
$280.6 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 consists of equity securities (principally common stock) of D&E
Communications, Inc. and Hungarian Telephone and Cable Corp.
As of September 30, 2002, we owned 3,059,000 shares of Adelphia common stock. As
a result of Adelphia's price declines and filing for bankruptcy, we recognized
losses of $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 had 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 September 30, 2002, the fair value of the equity portion of our investment
portfolio was estimated to be $31.3 million. A hypothetical 10% decrease in
quoted market prices would result in an approximate $3.1 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
September 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 September 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.
35
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 third quarter of 2003.
On December 21, 2001, we entered into a settlement agreement resolving all
claims in a class action lawsuit pending against the company in Santa Cruz
County, Arizona (Chilcote, et al. v. Citizens Utilities Company, No. CV 98-471).
The lawsuit arose from claims by a class of plaintiffs that 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 have paid the class members $5.5 million in
satisfaction of all claims. The court approved the settlement agreement on March
29, 2002, and the lawsuit against us was dismissed with prejudice. We accrued
the full settlement amount, plus an additional amount sufficient to cover legal
fees and other related expenses, during the fourth quarter of 2001 and no
accrual remains at September 30, 2002.
As part of the Frontier acquisition, Global and we agreed to Global's transfer,
effective as of July 1, 2001, of certain liabilities and assets under the Global
pension plan for Frontier employees. Such transfer and assumption of liabilities
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. We are
waiting for a decision on the motions filed by us.
We are party to proceedings arising in the normal course of our business. The
outcome of individual matters is not predictable. However, we believe that the
ultimate resolution of all such matters, after considering insurance coverage,
will not have a material adverse effect on our financial position, results of
operations, or our cash flows.
Item 4. Controls and Procedures
-----------------------
We have recently reviewed our internal control structure and our disclosure
controls and procedures. As a result of such review we implemented minor
changes, primarily to formalize and document the controls and procedures already
in place. We have designed our disclosure controls and procedures to ensure that
material information related to the Company, including our consolidated
subsidiaries, is made known to our disclosure committee and senior management on
a regular basis, in particular during the period in which the quarterly reports
are being prepared. We will continue to evaluate the effectiveness of our
disclosure controls and procedures on a quarterly basis. We believe that such
controls and procedures are operating effectively as designed.
The Company is currently investigating possible irregularities involving
payments made for services that the Company has to date been unable to verify
were actually received by the Company. The Company is continuing to investigate
the amounts involved but has to date identified at least $2.2 million. Such
amount was reflected in the Company's financial statements as payments were
made. If it is determined that the payments were improperly made, the Company
believes that most of this amount would be covered by insurance. Depending on
the results of the investigation, the Company will evaluate whether to make
changes in its system of internal controls.
36
We presented the results of our most recent evaluation to our independent
auditors, KPMG LLP, and the Audit Committee of the Board of Directors. Based on
such evaluation, our management, including the principal executive officer and
principal financial officer, concluded that our disclosure controls and
procedures are adequate to insure the clarity and material completeness of our
disclosure in our periodic reports required to be filed with the SEC and there
are no significant deficiencies in the design or operation of internal controls,
subject to the matter described in the previous paragraph, which could
significantly affect our ability to record, process, summarize and report
financial data.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a) Exhibits:
10.16.4 Letter agreement, dated as of October 1, 2000, amending the
employment agreement, effective October 1, 2000, between Citizens
Communications Company and Leonard Tow (incorporated by reference
to Exhibit 10 of the Registrant's Forms S-4/A filed February 4,
2002, Registration No. 333-69740).
b) Reports on Form 8-K:
We filed on Form 8-K on August 2, 2002 under Item 5, "Other Events", a
press release announcing that two additional independent directors, Maggie
Wilderotter and William Kraus, had been elected to our Board of Directors.
We filed on Form 8-K on August 9, 2002 furnishing under Item 9, "Regulation
FD Disclosure", in accordance with Order No. 4-460 and pursuant to Section
21 (a) (1) of the Securities Exchange Act of 1934 and Section 906 of the
Sarbanes-Oxley Act of 2002, statements with the Securities and Exchange
Commission by our principal executive officer and the principal financial
officer.
37
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: November 12, 2002
38
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CERTIFICATIONS
I, Leonard Tow, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Citizens Communications
Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
By: /s/ Leonard Tow
--------------------------------------
Leonard Tow
Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
39
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CERTIFICATIONS (continued)
I, Jerry Elliott, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Citizens Communications
Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
By: /s/ Jerry Elliott
--------------------------------------
Jerry Elliott
Chief Financial Officer
(Principal Financial Officer)
40