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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, 2003
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2003
------------------
or
--
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________to__________
Commission file number: 001-11001
---------
CITIZENS COMMUNICATIONS COMPANY
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-0619596
------------------------------ ----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
-------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(203) 614-5600
--------------------------------------------------
(Registrant's telephone number, including area code)
N/A
--------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
--- ---
The number of shares outstanding of the registrant's Common Stock as of October
31, 2003 was 284,436,272.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index
Page No.
--------
Part I. Financial Information (Unaudited)
Financial Statements
Consolidated Balance Sheets at September 30, 2003 and December 31, 2002 2
Consolidated Statements of Operations for the three months ended September 30, 2003 and 2002 3
Consolidated Statements of Operations for the nine months ended September 30, 2003 and 2002 4
Consolidated Statements of Shareholders' Equity for the year ended December 31, 2002 and
the nine months ended September 30, 2003 5
Consolidated Statements of Comprehensive Income for the three and nine months ended
September 30, 2003 and 2002 5
Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
Management's Discussion and Analysis of Financial Condition and Results of Operations 21
Quantitative and Qualitative Disclosures About Market Risk 33
Controls and Procedures 34
Part II. Other Information
Legal Proceedings 35
Exhibits and Reports on Form 8-K 36
Signature 37
PART I. FINANCIAL INFORMATION
Item 1.Financial Statements
--------------------
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)
(Unaudited)
September 30, 2003 December 31, 2002
------------------- -------------------
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 597,124 $ 393,177
Accounts receivable, less allowances of $43,487 and $38,946, respectively 262,609 310,929
Other current assets 35,628 49,114
Assets held for sale 25,709 447,764
------------------- ------------------
Total current assets 921,070 1,200,984
Property, plant and equipment, net 3,568,816 3,690,056
Goodwill, net 1,940,316 1,869,348
Other intangibles, net 844,038 942,970
Investments 41,702 29,846
Other assets 387,671 413,538
------------------- ------------------
Total assets $ 7,703,613 $ 8,146,742
=================== ==================
LIABILITIES AND EQUITY
- ----------------------
Current liabilities:
Long-term debt due within one year $ 89,769 $ 58,911
Accounts payable and other current liabilities 534,487 565,986
Liabilities related to assets held for sale 3,546 145,969
------------------- ------------------
Total current liabilities 627,802 770,866
Deferred income taxes 316,910 137,116
Customer advances for construction and contributions in aid of construction 130,095 146,661
Other liabilities 293,836 301,349
Equity units 460,000 460,000
Long-term debt 4,302,862 4,957,361
Company Obligated Manditorily Redeemable Convertible Preferred Securities* 201,250 201,250
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares; 284,362,000
and 282,482,000 outstanding and 295,434,000 and 294,080,000 issued at
September 30, 2003 and December 31, 2002, respectively) 73,858 73,520
Additional paid-in capital 1,952,786 1,943,406
Accumulated deficit (380,133) (553,033)
Accumulated other comprehensive loss (94,851) (102,169)
Treasury stock (180,802) (189,585)
------------------- ------------------
Total shareholders' equity 1,370,858 1,172,139
------------------- ------------------
Total liabilities and equity $ 7,703,613 $ 8,146,742
=================== ==================
* 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 OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
($ in thousands, except per-share amounts)
(Unaudited)
2003 2002
-------------- --------------
Revenue $ 595,037 $ 668,831
Operating expenses:
Cost of services 85,869 115,795
Other operating expenses 220,276 248,678
Depreciation and amortization 151,878 199,611
Restructuring and other expenses (142) (273)
Loss on impairment 4,000 1,074,058
-------------- --------------
Total operating expenses 461,881 1,637,869
-------------- --------------
Operating income (loss) 133,156 (969,038)
Investment and other income (loss), net (7,464) 13,111
Gain (loss) on sales of assets, net (16,813) 1,901
Interest expense 103,124 115,711
-------------- --------------
Income (loss) before income taxes and dividends on
convertible preferred securities 5,755 (1,069,737)
Income tax benefit (7,210) (371,186)
-------------- --------------
Income (loss) before dividends on convertible preferred securities 12,965 (698,551)
Dividends on convertible preferred securities, net of income tax benefit of $(963) 1,553 1,553
-------------- --------------
Net income (loss) attributable to common shareholders $ 11,412 $ (700,104)
============== ==============
Basic and diluted income (loss) per common share $ 0.04 $ (2.49)
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
3
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
($ in thousands, except per-share amounts)
(Unaudited)
2003 2002
-------------- --------------
Revenue $1,890,853 $2,010,604
Operating expenses:
Cost of services 312,625 357,819
Other operating expenses 688,590 760,958
Depreciation and amortization 440,785 564,163
Reserve for telecommunications bankruptcies 2,260 17,805
Restructuring and other expenses 9,950 21,912
Loss on impairment 4,000 1,074,058
-------------- --------------
Total operating expenses 1,458,210 2,796,715
-------------- --------------
Operating income (loss) 432,643 (786,111)
Investment and other income (loss), net 66,924 (65,028)
Gain (loss) on sales of assets, net (11,792) 1,901
Interest expense 318,836 357,265
-------------- --------------
Income (loss) from continuing operations before income taxes, dividends on
convertible preferred securities and cumulative effect of change
in accounting principle 168,939 (1,206,503)
Income tax expense (benefit) 57,150 (424,688)
-------------- --------------
Income (loss) from continuing operations before dividends on convertible
securities and cumulative effect of change in accounting principle 111,789 (781,815)
Dividends on convertible preferred securities, net of income tax benefit of $(2,889) 4,658 4,658
-------------- --------------
Income (loss) from continuing operations before cumulative effect of
change in accounting principle 107,131 (786,473)
Loss from discontinued operations, net of income tax benefit of $(920) - (1,478)
Gain on disposal of water segment, net of tax of $139,874 - 169,326
-------------- --------------
Total income from discontinued operations, net of tax of $138,954 - 167,848
Income (loss) before cumulative effect of change in accounting principle 107,131 (618,625)
Cumulative effect of change in accounting principle, net of tax of
$41,591 and $0, respectively 65,769 (39,812)
-------------- --------------
Net income (loss) attributable to common shareholders $ 172,900 $ (658,437)
============== ==============
Basic income (loss) per common share:
Income (loss) from continuing operations before cumulative effect of
change in accounting principle $ 0.38 $ (2.80)
Income from discontinued operations $ - $ 0.60
Income (loss) before cumulative effect of change in accounting principle $ 0.38 $ (2.21)
Cumulative effect of change in accounting principle $ 0.23 $ (0.14)
Net income (loss) attributable to common shareholders $ 0.61 $ (2.35)
Diluted income (loss) per common share:
Income (loss) from continuing operations before cumulative effect of
change in accounting principle $ 0.37 $ (2.80)
Income from discontinued operations $ - $ 0.59
Income (loss) before cumulative effect of change in accounting principle $ 0.37 $ (2.21)
Cumulative effect of change in accounting principle $ 0.22 $ (0.14)
Net income (loss) attributable to common shareholders $ 0.59 $ (2.35)
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, 2002 AND THE NINE MONTHS ENDED SEPTEMBER 30, 2003
($ in thousands)
(Unaudited)
Retained Accumulated
Common Stock Additional Earnings Other Treasury Stock Total
------------------- Paid-In (Accumulated Comprehensive ------------------- Shareholders'
Shares Amount Capital Deficit) Income (Loss) Shares Amount Equity
--------- --------- ----------- ------------ -------------- ------- ----------- -----------
Balances January 1, 2002 292,840 $73,210 $1,927,518 $ 129,864 $ 4,907 (11,551) $ (189,357) $1,946,142
Stock plans 1,240 310 15,888 - - (47) (228) 15,970
Net loss - - - (682,897) - - - (682,897)
Other comprehensive income,
net of tax and
reclassifications adjustments - - - - (107,076) - - (107,076)
--------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balances December 31, 2002 294,080 73,520 1,943,406 (553,033) (102,169) (11,598) (189,585) 1,172,139
Stock plans 1,354 338 9,380 - - 526 8,783 18,501
Net income - - - 172,900 - - - 172,900
Other comprehensive income,
net of tax and
reclassifications adjustments - - - - 7,318 - - 7,318
--------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balances September 30, 2003 295,434 $73,858 $1,952,786 $(380,133) $(94,851) (11,072) $ (180,802) $1,370,858
========= ========= =========== ============ ============ ======== =========== ===========
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
($ in thousands)
(Unaudited)
For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ---------------------------------------
2003 2002 2003 2002
------------------ -------------------- ------------------- ------------------
Net income (loss) $ 11,412 $ (700,104) $ 172,900 $ (658,437)
Other comprehensive income (loss), net of
tax and reclassifications adjustments* 2,520 796 7,318 (4,686)
------------------ -------------------- ------------------- ------------------
Total comprehensive income (loss) $ 13,932 $ (699,308) $ 180,218 $ (663,123)
================== ==================== =================== ==================
* Consists of unrealized gains/(losses) of marketable securities.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
5
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
($ in thousands)
2003 2002
--------------- ---------------
Income (loss) from continuing operations before cumulative
effect of change in accounting principle $ 107,131 $ (786,473)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization expense 440,785 564,163
Investment write-downs - 100,377
Gain on extinguishment of debt (71,889) (20,797)
Investment (gains)/losses - (3,363)
(Gain)/loss on sales of assets, net 11,792 (1,901)
Loss on impairment 4,000 1,074,058
Allowance for equity funds used during construction (129) (1,168)
Deferred and accrued income taxes 97,935 (374,312)
Change in accounts receivable 57,091 4,191
Change in accounts payable, accrued expenses and
other liabilities (88,790) (158,267)
Change in other current assets 6,547 102,387
--------------- ---------------
Net cash provided by continuing operating activities 564,473 498,895
Cash flows from investing activities:
Proceeds from sales of assets, net of selling expenses 380,735 -
Capital expenditures (191,658) (354,203)
Securities purchased (787) (450)
Securities sold - 11,681
Securities matured - 2,014
ELI share purchases - (6,800)
Other 17 912
--------------- ---------------
Net cash provided from (used by) investing activities 188,307 (346,846)
Cash flows from financing activities:
Long-term debt principal payments (551,425) (717,721)
Issuance of common stock 10,357 8,389
Customer advances for construction
and contributions in aid of construction (7,765) (5,526)
--------------- ---------------
Net cash used by financing activities (548,833) (714,858)
Cash provided by (used by) discontinued operations
Proceeds from sale of discontinued operations - 859,065
Net cash used by discontinued operations - (32,889)
Increase in cash and cash equivalents 203,947 263,367
Cash and cash equivalents at January 1, 393,177 215,869
--------------- ---------------
Cash and cash equivalents at September 30, $ 597,124 $ 479,236
=============== ===============
Cash paid during the period for:
Interest $ 303,913 $ 349,177
Income taxes (refunds) $ 2,425 $ (19,472)
Non-cash investing and financing activities:
Assets acquired under capital lease $ - $ 38,000
Change in fair value of interest rate swaps $ (1,238) $ 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
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies:
------------------------------------------
(a) Basis of Presentation and Use of Estimates:
Citizens Communications Company and its subsidiaries are referred to
as "we," "us" "our" or the "Company" in this report. Our unaudited
consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (GAAP) and should be read in conjunction with the consolidated
financial statements and notes included in our 2002 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.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions which affect the
amounts of assets, liabilities, revenue and expenses we have reported
and our disclosure of contingent assets and liabilities at the date of
the financial statements. Actual results may differ from those
estimates. We believe that our critical estimates are depreciation
rates, pension assumptions, calculations of impairment amounts,
intangible assets, income taxes and contingencies, and allowance for
doubtful accounts, including reserves established for receivables from
companies that are bankrupt.
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) Goodwill and Other Intangibles:
Intangibles represent the excess of purchase price over the fair value
of identifiable tangible assets acquired. We undertake studies to
determine the fair values of assets acquired and allocate purchase
prices to property, plant and equipment, goodwill and other
identifiable intangibles. On January 1, 2002, we adopted Statement of
Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other
Intangible Assets," which applies to all goodwill and other intangible
assets recognized in the statement of financial position at that date,
regardless of when the assets were initially recognized. This
statement requires that goodwill and other intangibles with indefinite
useful lives no longer be amortized to earnings, but instead be
reviewed for impairment, at least annually. The amortization of
goodwill and other intangibles with indefinite useful lives ceased
upon adoption of the statement on January 1, 2002. We annually (during
the fourth quarter) examine the carrying value of our goodwill and
other intangibles with indefinite useful lives to determine whether
there are any impairment losses, or whenever events or changes in
circumstances indicate that the carrying amount is not recoverable.
(d) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
of:
We adopted SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" as of January 1, 2002. In accordance with SFAS No.
144, we review long-lived assets to be held and used and long-lived
assets to be disposed of, including intangible assets with estimated
useful lives, for impairment whenever events or changes in
circumstances indicate that the carrying amount of such assets may not
be recoverable. Recoverability of assets to be held and used is
measured by comparing the carrying amount of the asset to the future
undiscounted net cash flows expected to be generated by the asset.
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.
7
(e) Derivative Instruments and Hedging Activities:
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 hedges
to specific assets and liabilities on the balance sheet or to specific
firm commitments or forecasted transactions.
We also formally assess, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. If it is determined that a derivative
is not highly effective as a hedge or that it has ceased to be a
highly effective hedge, we would discontinue hedge accounting
prospectively.
All derivatives are recognized on the balance sheet at their fair
value. Changes in the fair value of derivative financial instruments
are either recognized in income or shareholders equity (as a component
of other comprehensive income (loss)), depending on whether the
derivative is being used to hedge changes in fair value or cash flows.
We have entered into interest rate swap arrangements related to a
portion of our fixed rate debt. These hedge strategies satisfy the
fair value hedging requirements of SFAS No. 133. As a result, the fair
value of the hedges is carried on the balance sheet in other assets
and the related underlying liabilities are also adjusted to fair value
by the same amount.
(f) Employee Stock Plans:
We have various employee stock-based compensation plans. Awards under
these plans are granted to eligible employees. Awards may be made in
the form of incentive stock options, non-qualified stock options,
stock appreciation rights, restricted stock or other stock based
awards. As permitted by current accounting rules, we recognize
compensation expense in the financial statements only if the market
price of the underlying stock exceeds the exercise price on the date
of grant.
At September 30, 2003, we have four stock based compensation plans:
the Management Equity Incentive Plan (MEIP), the Equity Incentive Plan
(EIP), the Employee Stock Purchase Plan (ESPP) and our Directors'
Deferred Fee Equity Plan. We apply Accounting Principles Board
Opinions (APB) No. 25 and related interpretations in accounting for
the employee stock plans resulting in the use of the intrinsic value
to value the stock option. In addition, we grant restricted stock
awards to key employees in the form of our Common Stock. Compensation
expense is recognized as a component of operating expense for our
Directors' Deferred Fee Equity Plan and restricted stock grants.
Compensation cost is not generally recognized in the financial
statements for options issued pursuant to the MEIP or EIP, as the
exercise price for such options was equal to the market price of the
stock at the time of grant. Compensation cost is also not recognized
in the financial statements related to the ESPP because the purchase
price is 85% of the fair value. For purposes of presenting pro forma
information the fair value of options granted is computed using the
Black Scholes option-pricing model.
8
Had we determined compensation cost based on the fair value at the
grant date for the MEIP, EIP and ESPP, our pro forma net income (loss)
and net income (loss) per common share would have been as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2003 2002 2003 2002
------------- ------------- -------------- -------------
($ in thousands)
Net income (loss)
attributable to common
shareholders As reported $ 11,412 $ (700,104) $ 172,900 $ (658,437)
Add: Stock-based employee
compensation expense
included in reported net
income, net of related tax
effects 220 160 3,785 1,764
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects (3,165) (3,049) (11,729) (11,447)
----------- ----------- ----------- -----------
Pro forma $ 8,467 $ (702,993) $ 164,956 $ (668,120)
=========== =========== ============ ===========
Net income (loss)
attributable to common
shareholders per common
share As reported:
Basic $ 0.04 $ (2.49) $ 0.61 $ (2.35)
Diluted $ 0.04 $ (2.49) $ 0.59 $ (2.35)
Pro forma:
Basic $ 0.03 $ (2.50) $ 0.58 $ (2.38)
Diluted $ 0.03 $ (2.50) $ 0.56 $ (2.38)
(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 other current liabilities on our balance
sheet and recognized in revenue over the period that the services are
provided. Revenue that is billed in arrears includes: non-recurring
network access services, switched access services, non-recurring local
services and long-distance services. The earned but unbilled portion
of this revenue is recognized in revenue in our statement of
operations and accrued in accounts receivable in the period that the
services are provided. Excise taxes are recognized as a liability when
billed. Installation fees and their related direct and incremental
costs are initially deferred and recognized as revenue and expense
over the average term of a customer relationship. We recognize as
current period expense the portion of installation costs that exceeds
installation fee revenue.
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 their related direct and incremental
costs are initially deferred and recognized as revenue and expense
over the average term of a customer relationship. We recognize as
current period expense the portion of installation costs that exceeds
installation fee revenue.
9
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 (Loss) Per Common Share:
Basic net income per common share is computed using the weighted
average number of common shares outstanding during the period being
reported on. Diluted net income per common share reflects the
potential dilution that could occur if securities or other contracts
to issue common stock that are in the money were exercised or
converted into common stock at the beginning of the period being
reported on.
(2) Property, Plant and Equipment, Net:
----------------------------------
Property, plant and equipment at September 30, 2003 and December 31, 2002
is as follows:
($ in thousands) September 30, 2003 December 31, 2002
---------------------- ---------------------
Property, plant and equipment $ 6,166,072 $ 6,139,772
Less accumulated depreciation (2,597,256) (2,449,716)
---------------------- ---------------------
Property, plant and equipment, net $ 3,568,816 $ 3,690,056
====================== =====================
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 $120,012,000 and $167,772,000
for the three months ended September 30, 2003 and 2002, respectively and
$345,577,000 and $471,642,000 for the nine months ended September 30, 2003
and 2002, respectively. Effective January 1, 2003, as a result of the
adoption of SFAS No. 143, "Accounting for Asset Retirement Obligations," we
ceased recognition of the cost of removal provision in depreciation expense
and eliminated the cumulative cost of removal included in accumulated
depreciation. In addition, we increased the average depreciable lives for
certain of our equipment. This change in estimate reduced depreciation
expense by $9,956,000 and $30,054,000, or $0.03 and $0.07 per share for the
three and nine months ended September 30, 2003, respectively. For the nine
months ended September 30, 2002, we recognized accelerated depreciation of
$12,800,000 related to the closing of our Plano, Texas facility.
(3) Dispositions:
------------
On April 1, 2003, we completed the sale of approximately 11,000 telephone
access lines in North Dakota for approximately $25,700,000 in cash. The
pre-tax gain on the sale was $2,274,000.
On April 4, 2003, we completed the sale of our wireless partnership
interest in Wisconsin for approximately $7,500,000 in cash. The pre-tax
gain on the sale was $2,173,000.
(4) Discontinued Operations and Net Assets Held for Sale:
----------------------------------------------------
On August 24, 1999, our Board of Directors approved a plan of divestiture
for our public utilities services businesses, which included gas, electric
and water and wastewater businesses.
Water and Wastewater
--------------------
On January 15, 2002, we completed the sale of our water and wastewater
operations for $859,100,000 in cash and $122,500,000 of assumed debt
and other liabilities. The pre-tax gain on the sale was $316,672,000.
Electric and Gas
----------------
On November 1, 2002, we completed the sale of our Kauai Electric
division for $215,000,000 in cash. The pre-tax gain on the sale was
$8,273,000.
On August 8, 2003, we completed the sale of The Gas Company in Hawaii
division for $119,290,000 in cash and assumed liabilities. The pre-tax
loss on the sale recognized in the third quarter of 2003 was
$18,480,000.
10
On August 11, 2003, we completed the sale of our Arizona gas and
electric divisions for $224,100,000 in cash. The pre-tax loss on the
sale recognized in the third quarter of 2003 was $12,791,000.
We have entered into definitive agreements to sell the assets of our
Vermont electric division to Vermont Electric Power Company, Inc. and
Vermont Electric Cooperative, Inc. for an aggregate of approximately
$25,000,000 in cash, subject to adjustments (currently estimated to be
a reduction of approximately $3,000,000) under the terms of the
agreements. The transactions, which are subject to regulatory and
other customary approvals, are expected to close by mid-2004.
All the assets of our Vermont electric division and their related
liabilities are classified as "assets held for sale" and "liabilities
related to assets held for sale," respectively. An additional $4,000,000
impairment charge has been recognized in the third quarter of 2003, such
that the net assets have been written down to our best estimate of the net
realizable value upon sale.
Discontinued operations in the consolidated statements of operations
reflect the results of operations of the water/wastewater properties sold
in January 2002 including allocated interest expense for the periods
presented. Interest expense was allocated to the discontinued operations
based on the outstanding debt specifically identified with these
businesses.
Summarized financial information for the water/wastewater operations
(discontinued operations) is set forth below:
($ in thousands) For the nine months ended September 30,
-------------------------------------------
2003 2002
------------------- --------------------
Revenue $ - $ 4,650
Operating loss $ - $ (419)
Income tax benefit $ - $ (920)
Loss from discontinued operations, net of tax $ - $ (1,478)
Gain on disposal of water segment, net of tax $ - $ 169,326
Summarized financial information for the gas and electric operations
(assets held for sale) is set forth below:
($ in thousands) September 30, 2003 December 31, 2002
--------------------------------------------
Current assets $ 4,801 $ 49,549
Net property, plant and equipment 9,530 358,135
Other assets 11,378 40,080
---------------------- --------------------
Total assets held for sale $ 25,709 $ 447,764
====================== ====================
Current liabilities $ 3,546 $ 79,194
Other liabilities - 66,775
---------------------- --------------------
Total liabilities related to assets held for sale $ 3,546 $ 145,969
====================== ====================
(5) Other Intangibles:
-----------------
Other intangibles at September 30, 2003 and December 31, 2002 are as
follows:
($ in thousands) September 30, 2003 December 31, 2002
------------------------ ---------------------
Customer base - amortizable over 96 months $ 995,853 $ 1,000,816
Trade name - non-amortizable 122,058 122,058
------------------------ ---------------------
Other intangibles 1,117,911 1,122,874
Accumulated amortization (273,873) (179,904)
------------------------ ---------------------
Total other intangibles, net $ 844,038 $ 942,970
======================== =====================
11
We have reflected assets acquired at fair market values at the time of
acquisition in accordance with purchase accounting standards. Our
allocations are based upon an independent appraisal of the respective
properties acquired.
Amortization expense was $31,866,000 and $31,839,000 for the three months
ended September 30, 2003 and 2002, respectively and $95,208,000 and
$92,521,000 for the nine months ended September 30, 2003 and 2002,
respectively. The decline in customer base at September 30, 2003 is due to
the April 1, 2003 sale of access lines in North Dakota.
(6) Restructuring Charges and Other Expenses:
----------------------------------------
2003
----
Restructuring and other expenses primarily consist of expenses related to
reductions in personnel at our telecommunications operations and the write
off of software no longer useful. We continue to review our operations,
personnel and facilities to achieve greater efficiency.
2002
----
Restructuring and other expenses primarily consist of expenses related to
our various restructurings, including reductions in personnel at our
telecommunications operations, costs that were spent at our Plano, Texas
facility and at other locations as a result of transitioning functions and
jobs, and $6,800,000 of costs and expenses related to our tender offer in
June 2002 for all ELI common shares that we did not own.
2001
----
During 2001, we examined all aspects of our business operations and our
facilities to take advantage of operational and functional synergies among
all our telecommunications operations.
Plano Restructuring
Pursuant to a plan adopted in the third quarter of 2001, we closed our
operations support center in Plano, Texas in August 2002. In
connection with this plan, we recorded a pre-tax charge of $839,000
for the three months ended March 31, 2002 and we adjusted our accrual
down by $92,000 for the three months ended June 30, 2002. The
restructuring expenses primarily consist of severance benefits,
retention earned through March 31, 2002 and other planning and
communication costs. We sold our Plano office building in March 2003.
($ 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 (8,985) (1,390) (3,832) (523) (14,730)
Additional accrual 616 - 2,943 27 3,586
Adjustments (984) (132) (289) (440) (1,845)
----------------- -------------- -------------- ------------- ----------
Accrued @ 12/31/2002 - 13 - - 13
----------------- -------------- -------------- ------------- ----------
Amount paid - (13) - - (13)
Additional accrual - - - - -
Adjustments - - - - -
----------------- -------------- -------------- ------------- ----------
Accrued @ 9/30/2003 $ - $ - $ - $ - $ -
================= ============== ============== ============= ==========
Sacramento Call Center Restructuring
In April 2002, we closed our Sacramento Customer Care Center pursuant
to a plan adopted in the fourth quarter of 2001. In connection with
this closing, we recorded a pre-tax charge of $62,000 for the three
months ended March 31, 2002 and $9,000 for the three months ended June
30, 2002.
12
ELI Restructuring
In the first half of 2002, ELI redeployed the internet routers, frame
relay switches and ATM switches from the Atlanta, Cleveland, Denver,
Philadelphia and New York markets to other locations in ELI's network
pursuant to a plan adopted in the fourth quarter of 2001. ELI ceased
leasing the collocation facilities and off-net circuits for the
backbone and local loops supporting the service delivery in these
markets. It was anticipated that this would lead to $4,179,000 of
termination fees, which were accrued for but not paid at December 31,
2001. In the first and second quarters of 2002, ELI adjusted its
original accrual down by $2,100,000 and $100,000, respectively, due to
the favorable settlement of termination charges for an off-net circuit
agreement. As of December 31, 2002, this accrual was adjusted down by
$625,000, $1,354,000 was paid and no accrual remained.
Tender Offer
During May 2002, we announced a tender offer for all of the shares of
ELI that we did not already own for a price of $0.70 per share. We
completed the tender offer in June 2002, resulting in ELI becoming a
wholly-owned subsidiary, for total costs and expenses of approximately
$6,800,000. We accounted for this transaction as a purchase and
allocated the entire amount to goodwill. We evaluated the
recoverability of this goodwill in accordance with SFAS No. 142 and
determined that a write-down was necessary based on fair market value
as determined by discounted cash flows. This charge is included in
restructuring and other expenses.
13
(7) Long-Term Debt:
--------------
The activity in our long-term debt from December 31, 2002 to September 30,
2003 is as follows:
Nine Months Ended September 30, 2003
-------------------------------------
Interest Rate*
December 31, Interest September 30, September 30,
($ in thousands) 2002 Payments** Rate Swap Other 2003 2003
-------- ---------- --------- ------- ------------- -------------
FIXED RATE
Rural Utilities Service Loan
Contracts $ 30,874 $ (647) $ - $ - $ 30,227 6.210%
Senior Unsecured Debt 4,508,880 (335,700) (1,238) - 4,171,942 8.187%
Equity Units 460,000 - - - 460,000 7.480%
ELI Notes 5,975 - - - 5,975 6.232%
ELI Capital Leases 135,200 (7,940) - (53,385) 73,875 10.267%
Industrial Development Revenue Bonds 186,390 (75,805) - - 110,585 5.846%
Other 40 (13) - - 27 12.986%
--------- --------- --------- -------- ----------
TOTAL FIXED RATE 5,327,359 (420,105) (1,238) (53,385) 4,852,631
--------- --------- --------- -------- -----------
VARIABLE RATE
Industrial Development Revenue Bonds 148,913 (131,320) - (17,593) -
--------- --------- --------- -------- -----------
TOTAL VARIABLE RATE 148,913 (131,320) - (17,593) -
--------- --------- --------- -------- -----------
TOTAL $5,476,272 $(551,425) $ (1,238) $ (70,978) $4,852,631
--------- ========= ========= ======== -----------
Less: Current Portion (58,911) (89,769)
Less: Equity Units (460,000) (460,000)
--------- -----------
TOTAL LONG TERM DEBT $4,957,361 $4,302,862
========= ===========
* Interest rate includes amortization of debt issuance expenses, debt premiums
or discounts. The interest rate for Rural Utilities Service Loan Contracts,
Senior Unsecured Debt, and Industrial Development Revenue Bonds represent a
weighted average of multiple issuances.
** Includes purchases on the open market.
On August 13, 2003, following the completion of the sale of our Arizona gas
and electric divisions, we called for redemption the entire $232,600,000
outstanding of our 6.375% Senior Notes due 2004. These notes were redeemed
with cash on September 17, 2003, at a premium of approximately $10,300,000.
In connection with this redemption, we terminated two interest rate swaps
involving an aggregate $100,000,000 notional amount of indebtedness that
were designated as fair value hedges against these notes. The proceeds from
the settlement of the swaps of approximately $3,000,000 were applied
against the cost to retire resulting in a net premium of $7,300,000.
In connection with the August 8, 2003 sale of our Hawaii gas operations,
the buyer assumed $17,593,000 of our special purpose development bonds.
During June 2003, we redeemed five separate issues of the Company's
Industrial Development Revenue Bonds aggregating $75,500,000, and seven
issues of the Company's Special Purpose Revenue Bonds aggregating
$88,800,000. All of these redemptions were funded with cash. In addition,
we called for redemption two additional Industrial Development Revenue Bond
series aggregating $13,500,000, $12,400,000 of which was redeemed with cash
on July 2, 2003, and the remaining $1,100,000 issue was redeemed with cash
on August 1, 2003.
During the first nine months of 2003, we executed a series of purchases in
the open market of our outstanding debt securities. The aggregate principal
amount of debt securities purchased was $94,900,000 at a premium of
approximately $3,100,000.
14
In March 2003, we terminated a capital lease obligation at ELI, which
resulted in a non-cash pre-tax gain of $40,703,000 included in investment
and other income (loss), net. In addition, in June 2003, ELI reduced the
number of optical fibers leased under another capital lease, which resulted
in a non-cash pre-tax gain of approximately $25,021,000 included in
investment and other income (loss), net. Total future minimum cash payment
commitments over the next 24 years under ELI's long-term capital leases
amounted to $177,097,000 as of September 30, 2003.
On February 1, 2003, we repaid at maturity $35,000,000 of Frontier
Communications of Minnesota 7.61% Senior Notes.
(8) Income (Loss) Per Common Share:
------------------------------
The reconciliation of the income (loss) per common share calculation for
the three and nine months ended September 30, 2003 and 2002, respectively,
is as follows:
For the three months For the nine months
($ in thousands, except per-share amounts) ended September 30, ended September 30,
------------------------------------ ------------------------------------
2003 2002 2003 2002
----------------- ----------------- ----------------- -----------------
Net income (loss) used for basic and diluted
earnings per common share
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle $ 11,412 $ (700,104) $ 107,131 $ (786,473)
Income from discontinued operations - - - 167,848
----------------- ----------------- ----------------- -----------------
Income (loss) before cumulative effect of change
in accounting principle 11,412 (700,104) 107,131 (618,625)
Cumulative effect of change in accounting
principle - - 65,769 (39,812)
----------------- ----------------- ----------------- -----------------
Total basic net income (loss) $ 11,412 $ (700,104) $ 172,900 $ (658,437)
================= ================= ================= =================
Effect of conversion of preferred securities - - 4,658 -
----------------- ----------------- ----------------- -----------------
Total diluted net income (loss) $ 11,412 $ (700,104) $ 177,558 $ (658,437)
================= ================= ================= =================
Basic earnings (loss) per common share
Weighted-average shares outstanding - basic 282,838 280,778 282,217 280,540
----------------- ----------------- ----------------- -----------------
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle $ 0.04 $ (2.49) $ 0.38 $ (2.80)
Income from discontinued operations - - - 0.60
----------------- ----------------- ----------------- -----------------
Income (loss) before cumulative effect of change
in accounting principle 0.04 (2.49) 0.38 (2.21)
Cumulative effect of change in accounting
principle - - 0.23 (0.14)
----------------- ----------------- ----------------- -----------------
Net income (loss) attributable to common
shareholders $ 0.04 $ (2.49) $ 0.61 $ (2.35)
================= ================= ================= =================
Diluted earnings (loss) per common share
Weighted-average shares outstanding 282,838 280,778 282,217 280,540
Effect of dilutive shares 5,264 - 4,900 -
Effect of conversion of preferred securities - - 15,134 -
----------------- ----------------- ----------------- -----------------
Weighted-average shares outstanding - diluted 288,102 280,778 302,251 280,540
================= ================= ================= =================
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle $ 0.04 $ (2.49) $ 0.37 $ (2.80)
Income from discontinued operations - - - 0.59
----------------- ----------------- ----------------- -----------------
Income (loss) before cumulative effect of change
in accounting principle 0.04 (2.49) 0.37 (2.21)
Cumulative effect of change in accounting
principle - - 0.22 (0.14)
----------------- ----------------- ----------------- -----------------
Net income (loss) attributable to common
shareholders $ 0.04 $ (2.49) $ 0.59 $ (2.35)
================= ================= ================= =================
15
For the three and nine months ended September 30, 2003, options of
10,420,894 and 10,770,894, respectively, at exercise prices ranging from
$11.41 to $21.47 issuable under employee compensation plans were excluded
from the computation of diluted EPS for those periods because the exercise
prices were greater than the average market price of common shares and,
therefore, the effect would be antidilutive.
In addition, for the three and nine months ended September 30, 2003,
restricted stock awards of 385,333 and 363,566 shares, respectively, are
excluded from our basic weighted average shares outstanding and included in
our dilutive shares until the shares are no longer contingent upon the
satisfaction of all specified conditions.
We also have 18,400,000 potentially dilutive equity units with each equity
unit consisting of a 6.75% senior note due 2006 and a purchase contract
(warrant) for our common stock. These securities were excluded from the
computation of diluted EPS for all periods reflected above because their
inclusion would have had an antidilutive effect.
We also have 4,025,000 shares of potentially dilutive Mandatorily
Redeemable Convertible Preferred Securities which are convertible into
common stock at a 3.76 to 1 ratio at an exercise price of $13.30 per share
that have been included in the diluted income (loss) per common share
calculation for the period ended September 30, 2003.
As a result of our loss from continuing operations for the three and nine
months ended September 30, 2002, dilutive securities of 3,625,118 and
3,936,054 issuable under employee compensation plans were excluded from the
computation of diluted EPS for those periods, respectively, because their
inclusion would have had an antidilutive effect.
In addition, for the three and nine months ended September 30, 2002,
options of 20,458,775 and 15,324,607, respectively, at exercise prices
ranging from $9.18 to $21.47 issuable under employee compensation plans
were excluded from the computation of diluted EPS for those periods because
the exercise prices were greater than the average market price of common
shares and, therefore, the effect would be antidilutive.
(9) Segment Information:
-------------------
We operate in three segments, ILEC, ELI (a competitive local exchange
carrier (CLEC)), and electric. The ILEC segment provides both regulated and
unregulated communications services to residential, business and wholesale
customers and is typically the incumbent provider in its service areas. Our
remaining electric property is intended to be sold and is classified as
"assets held for sale" and "liabilities related to assets held for sale."
As an ILEC, we compete with CLECs that may operate in our markets. As a
CLEC, we provide telecommunications services, principally to businesses, in
competition with the incumbent ILEC. As a CLEC, we frequently obtain the
"last mile" access to customers through arrangements with the applicable
ILEC. ILECs and CLECs are subject to different regulatory frameworks of the
Federal Communications Commission (FCC). Our ILEC operations and ELI do not
compete with each other.
16
($ in thousands) For the three months ended September 30, 2003
---------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 511,574 $ 40,416 $ 18,005 $ 25,042 $ 595,037
Depreciation and amortization 146,261 5,617 - - 151,878
Restructuring and other expenses (142) - - (142)
Loss on impairment - - - 4,000 4,000
Operating income 133,807 3,773 (2,806) (1,618) 133,156
Capital expenditures, net 66,968 3,113 2,412 3,515 76,008
($ 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)
Capital expenditures, net 67,601 2,547 5,920 5,577 81,645
($ in thousands) For the nine months ended September 30, 2003
---------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
-------------- -------------- --------------- ------------- --------------
Revenue $ 1,535,336 $ 125,228 $ 137,686 $ 92,603 $ 1,890,853
Depreciation and amortization 422,990 17,795 - - 440,785
Reserve for telecommunications
bankruptcies 1,113 1,147 - - 2,260
Restructuring and other expenses 9,482 468 - - 9,950
Loss on impairment - - - 4,000 4,000
Operating income 402,536 6,658 15,204 8,245 432,643
Capital expenditures, net 161,260 6,514 9,877 13,487 191,138
($ 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)
Capital expenditures, net 205,005 118,203 15,239 15,281 353,728
The following table reconciles sector capital expenditures to total
consolidated capital expenditures.
($ in thousands) For the three months ended For the nine months ended
September 30, September 30,
------------------------------ -----------------------------
2003 2002 2003 2002
-------------- -------------- --------------- -------------
Total segment capital expenditures $ 76,008 $ 81,645 $ 191,138 $ 353,728
General capital expenditures 48 - 520 475
-------------- -------------- --------------- -------------
Consolidated reported capital
expenditures $ 76,056 $ 81,645 $ 191,658 $ 354,203
============== ============== =============== =============
17
(10) Adelphia Investment:
-------------------
We recognized losses of $95,300,000 on our Adelphia Communications Corp.
(Adelphia) investment for the nine months ended September 30, 2002. This
non-cash charge reflected an other than temporary decline in Adelphia's
stock price. As of June 30, 2002, we had written this investment down to
zero.
(11) Derivative Instruments and Hedging Activities:
---------------------------------------------
Interest rate swap agreements are used to hedge a portion of our debt that
is subject to fixed interest rates. Under our interest rate swap
agreements, we agree to pay an amount equal to a specified variable rate of
interest times a notional principal amount, and to receive in return an
amount equal to a specified fixed rate of interest times the same notional
principal amount. The notional amounts of the contracts are not exchanged.
No other cash payments are made unless the agreement is terminated prior to
maturity, in which case the amount paid or received in settlement is
established by agreement at the time of termination and represents the
market value, at the then current rate of interest, of the remaining
obligations to exchange payments under the terms of the contracts.
The interest rate swap contracts are reflected at fair value in our
consolidated balance sheet and the related portion of fixed-rate debt being
hedged is reflected at an amount equal to the sum of its book value and an
amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. Payments made and/or
received as a result of interest rate swap contracts are recognized in the
consolidated statements of operations in interest expense. The notional
amounts of fixed-rate indebtedness hedged as of September 30, 2003 and
December 31, 2002 was $350,000,000 and $250,000,000, respectively. Such
contracts require us to pay variable rates of interest (average pay rate of
approximately 5.30% as of September 30, 2003) and receive fixed rates of
interest (average receive rate of 8.25% as of September 30, 2003). The fair
value of these derivatives is reflected in other assets as of September 30,
2003, in the amount of $15,420,000 and the related underlying debt has been
increased by a like amount. The amounts received during the three and nine
months ended September 30, 2003 as a result of these contracts amounted to
$1,534,000 and $5,651,000 and are included as a reduction of interest
expense. We do not anticipate any nonperformance by counterparties to its
derivative contracts as all counterparties have investment grade credit
ratings.
(12) Shareholder Rights Plan:
-----------------------
On March 6, 2002, our Board of Directors adopted a Shareholder Rights Plan.
The purpose of the Shareholder Rights Plan is to deter coercive takeover
tactics and to encourage third parties interested in acquiring us to
negotiate with our Board of Directors. It is intended to strengthen the
ability of our Board of Directors to fulfill its fiduciary duties to take
actions which are in the best interest of our shareholders. The rights were
distributed to shareholders as a dividend at the rate of one right for each
share of our common stock held by shareholders of record as of the close of
business on March 26, 2002. The rights generally are exercisable only if a
person or group acquired beneficial ownership of 20 percent or more of our
common stock (an "Acquiror") without the consent of our independent
directors. Each right not owned by an Acquiror becomes the right to
purchase our common stock at a 50 percent discount.
(13) Settlement of Retained Liabilities:
----------------------------------
We were during 2002 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 nine
months ended September 30, 2003 and 2002, we recognized income of
$6,165,000 and $20,800,000, respectively, which is reflected in investment
and other income (loss), net, as a result of these settlements.
(14) Change in Accounting Principle and New Accounting Pronouncements:
----------------------------------------------------------------
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 143, "Accounting for Asset Retirement Obligations." We adopted SFAS No.
143 effective January 1, 2003. As a result of our adoption of SFAS No. 143,
we recognized an after tax non-cash gain of approximately $65,769,000. This
gain resulted from the elimination of the cumulative cost of removal
included in accumulated depreciation as a cumulative effect of a change in
accounting principle in our statement of operations in the first quarter of
2003 as the Company has no legal obligation to remove certain of its
long-lived assets.
18
The following table presents a reconciliation between reported net income
(loss) and adjusted net income (loss). Adjusted net income (loss) excludes
depreciation expense recognized in prior periods related to the cost of
removal provision as required by SFAS No. 143.
For the three months For the nine months
ended September 30, ended September 30,
------------------------------ ------------------------------
(In thousands, except per-share amounts) 2003 2002 2003 2002
-------------- -------------- -------------- --------------
Reported attributable to common shareholders $ 11,412 $ (700,104) $ 172,900 $ (658,437)
Add back: Cost of removal in depreciation expense, net
of tax - 4,417 - 11,719
-------------- -------------- -------------- --------------
Adjusted attributable to common shareholders $ 11,412 $ (695,687) $ 172,900 $ (646,718)
============== ============== ============== ==============
Basic earnings (loss) per share:
- -------------------------------
Reported attributable to common shareholders $ 0.04 $ (2.49) $ 0.61 $ (2.35)
Cost of removal in depreciation expense - 0.01 - 0.04
-------------- -------------- -------------- --------------
Adjusted attributable to common shareholders $ 0.04 $ (2.48) $ 0.61 $ (2.31)
============== ============== ============== ==============
Diluted earnings (loss) per share:
- ---------------------------------
Reported attributable to common shareholders $ 0.04 $ (2.49) $ 0.59 $ (2.35)
Cost of removal in depreciation expense - 0.01 - 0.04
-------------- -------------- -------------- --------------
Adjusted attributable to common shareholders $ 0.04 $ (2.48) $ 0.59 $ (2.31)
============== ============== ============== ==============
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." As a result of our adoption of SFAS No. 142, we recognized a
transitional impairment loss of $39,800,000 for goodwill related to ELI as
a cumulative effect of a change in accounting principle in our statement of
operations in the first quarter of 2002.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which nullified Emerging
Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity." SFAS
No. 146 requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred, rather than
on the date of commitment to an exit plan. This Statement is effective for
exit or disposal activities that are initiated after December 31, 2002. We
adopted SFAS No. 146 on January 1, 2003. The adoption of SFAS No. 146 did
not have any material impact on our financial position or results of
operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging," which clarifies financial accounting
and reporting for derivative instruments including derivative instruments
embedded in other contracts. This Statement is effective for contracts
entered into or modified after June 30, 2003. We adopted SFAS No. 149 on
July 1, 2003. The adoption of SFAS No. 149 did not have any material impact
on our financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity."
The Statement requires issuers to classify as liabilities (or assets in
some circumstance) certain financial instruments that embody obligations of
the issuer. Generally, the Statement is effective for financial instruments
entered into or modified after May 31, 2003 and is otherwise effective at
the beginning of the first interim period beginning after June 15, 2003. We
adopted the provisions of the Statement on July 1, 2003. The adoption of
SFAS No. 150 did not have any material impact on our financial position or
results of operations.
The FASB also recently indicated that it would require stock-based employee
compensation to be recorded as a charge to earnings beginning in 2004. We
will continue to monitor the progress on the issuance of this standard.
19
(15) Commitments and Contingencies:
-----------------------------
We expect capital expenditures in 2003 to be approximately $260,000,000 for
ILEC and ELI and $25,000,000 for gas and electric. Our remaining public
utility property is currently carried at an amount that approximates our
current estimate of its net realizable value upon sale. Under the terms of
the definitive agreements relating to this sale, there will be no
adjustment to the sales prices for most of the capital expenditures we will
make prior to the sale. To the extent that the carrying amount of this
property increases above its realizable value upon sale as a result of
capital expenditures or for any other reason, we would record an impairment
charge for such excess. We currently estimate we will make approximately
$1,000,000 of capital expenditures for this property from October 1, 2003
through the expected date of sale.
In connection with the sale of our Arizona utility businesses, we called
for redemption in November 2003, approximately $31,240,000 of the Company's
Arizona industrial development revenue bonds. In addition, we agreed to
call at their first call dates in 2007 another three Arizona industrial
development revenue bond series totaling approximately $33,400,000.
The City of Bangor, Maine, filed suit against us on November 22, 2002, in
the U.S. District Court for the District of Maine (City of Bangor v.
Citizens Communications Company, Civ. Action No. 02-183-B-S). The City has
alleged, among other things, that we are responsible for the costs of
cleaning up environmental contamination alleged to have resulted from the
operation of a manufactured gas plant by Bangor Gas Company, which we owned
from 1948-1963. The City alleged the existence of extensive contamination
of the Penobscot River and nearby land areas and has asserted that money
damages and other relief at issue in the lawsuit could exceed $50.0
million. The City also requested that punitive damages be assessed against
us. We have filed an answer denying liability to the City, and have
asserted a number of counter claims against the City. We intend to defend
ourselves vigorously against the City's lawsuit. In addition, we have
identified a number of other potentially responsible parties that may be
responsible for the damages alleged by the City and joined them as parties
to the lawsuit. These additional parties include Honeywell Corporation, the
Army Corps of Engineers, Guilford Transportation (formerly Maine Central
Railroad), UGI Utilities, Inc., and Centerpoint Energy Resources
Corporation. We also have demanded that various of our insurance carriers
defend and indemnify us with respect to the City's lawsuit. On or about
December 26, 2002, we filed a declaratory judgment action against those
insurance carriers in the Superior Court of Penobscot County, Maine, for
the purpose of establishing their obligations to us with respect to the
City's lawsuit. We intend to vigorously pursue insurance coverage for the
City's lawsuit.
(16) Subsequent Event:
----------------
On October 1, 2003, ELI settled all of its outstanding liabilities under a
capital lease with a cash payment of $44,500,000, representing a discount
from the carrying value of the capital lease obligation of approximately
$2,100,000.
20
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
This quarterly report on Form 10-Q contains forward-looking statements that are
subject to risks and uncertainties, which could cause actual results to differ
materially from those expressed or implied in the statements. Forward-looking
statements (including oral representations) are only predictions or statements
of current plans, which we review continuously. Forward-looking statements may
differ from actual future results due to, but not limited to, and our future
results may be materially affected by, any of the following possibilities:
* Changes in the number of our access lines;
* The effects of competition from wireless, other wireline carriers
(through Unbundled Network Elements (UNE), Unbundled Network Elements
Platform (UNEP), voice over internet protocol (VOIP) or otherwise),
high speed cable modems and cable telephony;
* The effects of general and local economic conditions on our revenues;
* Our ability to effectively manage and otherwise monitor our
operations, costs, regulatory compliance and service quality;
* Our ability to successfully introduce new product offerings including
our ability to offer bundled service packages on terms attractive to
our customers, and our ability to sell enhanced and data services;
* Our ability to manage our operating expenses, capital expenditures and
reduce our debt;
* The effects of greater than anticipated competition requiring new
pricing, marketing strategies or new product offerings and the risk
that we will not respond on a timely or profitable basis;
* The effects of bankruptcies in the telecommunications industry which
could result in higher network access costs and potential bad debts;
* The effects of technological changes, including the lack of assurance
that our ongoing network improvements will be sufficient to adequately
serve our customers or to match the capabilities and pricing of
competing networks;
* The effects of increased pension and retiree medical expenses and
related funding requirements;
* The effects of changes in regulation in the telecommunications
industry as a result of the Telecommunications Act of 1996 and other
federal and state legislation and regulation, including changes in
access charges and subsidy payments;
* The effect of changes in the telecommunications market, including the
likelihood of significantly increased price and service competition;
* Our ability to successfully convert the billing system for
approximately 775,000 of our access lines on a timely basis and within
our expected budgeted amount for 2004 of $20.0 - $25.0 million (a
significant portion of which is expected to be capitalized and
amortized) and, beginning in 2005, to achieve our expected cost
savings;
* The effects of possible state regulatory cash management policies on
our ability to transfer cash among our subsidiaries and to the parent
company;
* Our ability to successfully renegotiate expiring union contracts
covering approximately 1,500 employees that are scheduled to expire
during 2004; and
* The effects of more general factors, including changes in economic
conditions; changes in the capital markets; changes in industry
conditions; changes in our credit ratings; and changes in accounting
policies or practices adopted voluntarily or as required by generally
accepted accounting principles or regulators.
21
Competition in the telecommunications industry is increasing. Although we have
not faced as much competition as larger, more urban telecommunications
companies, we do experience competition from other wireline local carriers
through Unbundled Network Elements (UNE), VOIP and potentially in the future
through Unbundled Network Elements Platform (UNEP), from other long distance
carriers (including Regional Bell Operating Companies), from cable companies and
internet service providers with respect to internet access and potentially in
the future cable telephony, and from wireless carriers. Most of the wireline
competition we face is in our Rochester, New York market, with competition also
present in a few other areas. Competition from cable companies with respect to
high-speed internet access is intense in Rochester and some of our other markets
such as Elk Grove, California (which is near Sacramento). Competition from
wireless companies, other long distance companies and internet service providers
is increasing in all of our markets.
Our ILEC business has been experiencing declining access lines, minutes of use
and revenues because of economic conditions, high unemployment levels,
increasing competition (as described above), changing consumer behavior such as
wireless displacement of wireline use and email use and regulatory constraints.
These factors are likely to cause our local service, network access, long
distance and subsidy revenues to continue to decline during the remainder of
2003 and into 2004. One of the ways we are responding to actual and potential
competition is by bundling services and products and offering them for a single
price, which in many cases results in lower pricing than purchasing the services
separately. Revenues from data services such as DSL continue to increase as a
percentage of our total revenues and revenues from high margin services such as
local line and access charges and subsidies are decreasing as a percentage of
our revenues. These factors, along with increasing operating costs may cause our
profitability to decrease. In addition, costs we will incur during 2004 to
convert the billing system for some of our access lines will affect our
profitability during 2004.
The telecommunications industry in general, and the CLEC sector in particular,
are undergoing significant changes and difficulties. The market for internet
access, long-haul and related services in the United States is extremely
competitive, with substantial overcapacity in the market. Demand and pricing for
CLEC services have decreased substantially, particularly for long haul services.
These trends are likely to continue. These factors result in a challenging
environment with respect to revenues for our CLEC business and to a lesser
extent our ILEC business. These factors could also result in more bankruptcies
in the sector and therefore affect our ability to collect money owed to us by
bankrupt carriers. In addition, new and enhanced internet services are
constantly under development in the market and we expect additional innovation
in this market by a range of competitors. Several Interexchange Carriers (IXC's)
have filed for bankruptcy protection, which will allow them to substantially
reduce their cost structure and debt. This could enable such companies to
further reduce prices and increase competition.
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
2002 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, 2003, we used cash flow from continuing
operations, proceeds from the sale of gas and electric properties and cash and
investment balances to fund debt repayments, capital expenditures and interest
payments. As of September 30, 2003, we maintained cash and short-term investment
balances aggregating $597.1 million.
We expect to spend in 2003 for capital projects approximately $250.0 million for
the ILEC segment, $10.0 million for the ELI segment and $25.0 million for the
public utilities segment, most of which had been sold by mid-August 2003. In the
ordinary course of business, capital expenditures for the public utilities
segment would increase the amount of assets that would be reflected on the
balance sheet. However, we may expense certain of our capital expenditures with
respect to our one remaining public utility property if book value exceeds our
estimate of expected net realizable sales price (see Note 16 to Consolidated
Financial Statements).
For the nine months ended September 30, 2003, our actual capital expenditures
were $161.3 million for the ILEC segment, $6.5 million for the ELI segment,
$23.4 million for the public utilities segments and $0.5 million for general
capital expenditures. Funds necessary for our 2003 capital expenditures were,
and are expected to continue to be, provided from our operations and our
existing cash and investment balances.
22
We have an available shelf registration for $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, 2003. The expiration date for these
facilities is October 24, 2006. During the term of the facilities we may borrow,
repay and reborrow funds. As of September 30, 2003, there were no outstanding
borrowings under these facilities.
In connection with the sale of our Arizona utility businesses, we called for
redemption in November 2003, approximately $31.2 million of the Company's
Arizona industrial development revenue bonds. In addition, we agreed to call at
their first call dates in 2007 another three Arizona industrial development
revenue bond series totaling approximately $33.4 million. We intend to fund
these redemptions using cash flows from continuing operations, the proceeds from
the sale of the remaining utility property, and/or cash and cash equivalents and
investment balances.
Debt Reduction
- --------------
On February 1, 2003, we repaid at maturity $35.0 million of Frontier
Communications of Minnesota 7.61% Senior Notes.
In March 2003, we terminated a capital lease obligation at ELI, which resulted
in a non-cash pre-tax gain of $40.7 million included in investment and other
income (loss), net. In addition, in June 2003, ELI reduced the number of optical
fibers leased under another capital lease, which resulted in a non-cash pre-tax
gain of $25.0 million included in investment and other income (loss), net.
During June 2003, we redeemed five separate issues of the Company's Industrial
Development Revenue Bonds aggregating $75.5 million, and seven issues of the
Company's Special Purpose Revenue Bonds aggregating $88.8 million. All of these
redemptions were funded with cash. In addition, we called for redemption two
additional Industrial Development Revenue Bond series aggregating $13.5 million,
$12.4 million of which was redeemed with cash on July 2, 2003, and the remaining
$1.1 million issue was redeemed with cash on August 1, 2003.
During the first nine months of 2003, we executed a series of purchases in the
open market of our outstanding debt securities. The aggregate principal amount
of debt securities purchased was $94.9 million at a premium of approximately
$3.1 million.
During the period between June 15, 2003 and July 15, 2003, holders of the
Company's outstanding $15.1 million principal amount of 6.80% Debentures due
August 15, 2026 had the option to put the Debentures to the Company for
mandatory redemption at par on August 15, 2003. As a result, the entire
outstanding principal amount of these debentures had been classified as debt due
within one year on the Company's balance sheet since the third quarter of 2002.
By July 15, 2003 holders of just $2.5 million of the debentures had exercised
their right to put the debentures to us on August 15, 2003. Accordingly, the
$11.6 million of debentures that were not put to us for redemption or otherwise
repurchased by us has been reclassified as long-term debt on the balance sheet,
with a final maturity of August 15, 2026.
On August 13, 2003, we called for redemption the entire $232.6 million
outstanding of our 6.375% Senior Notes due 2004. These notes were redeemed with
cash on September 17, 2003 at a premium of approximately $10.3 million. In
connection with this redemption, we terminated two interest rate swaps involving
an aggregate $100 million notional amount of indebtedness. The proceeds from the
settlement of the swaps of approximately $3.0 million were applied against the
cost to retire resulting in a net premium of $7.3 million.
On October 1, 2003, ELI settled all of its outstanding liabilities under a
capital lease with a cash payment of $44.5 million, representing a discount from
the carrying value of the capital lease obligation of approximately $2.1
million.
Interest Rate Management
- ------------------------
In order to manage our interest expense, we have entered into interest swap
agreements. Under the terms of the agreements, we make semi-annual, floating
rate interest payments based on six month LIBOR and receive a fixed rate on the
notional amount. The underlying variable rate on these swaps is set either in
advance, in arrears or, based on each period's daily average six-month LIBOR.
23
The notional amounts of fixed-rate indebtedness hedged as of September 30, 2003
and December 31, 2002 was $350,000,000 and $250,000,000, respectively. Such
contracts require us to pay variable rates of interest (average pay rate of
approximately 5.30% as of September 30, 2003) and receive fixed rates of
interest (average receive rate of 8.25% as of September 30, 2003). All swaps are
accounted for under SFAS No. 133 as fair value hedges. For the first nine months
of 2003, the interest savings resulting from these interest rate swaps totaled
approximately $5.7 million.
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 GAAP,
restrictions on the allowance of liens on our assets, and restrictions on asset
sales and transfers, mergers and other changes in corporate control. We
currently have no restrictions on the payment of dividends by us either by
contract, rule or regulation.
Our $805.0 million credit facilities and our $200.0 million term loan facility
with the Rural Telephone Finance Cooperative (RTFC) contain a maximum leverage
ratio covenant. Under the leverage ratio covenant, we are required to maintain a
ratio of (i) total indebtedness minus cash and cash equivalents in excess of $50
million to (ii) consolidated adjusted EBITDA (as defined in the agreements) over
the last four quarters no greater than 4.50 to 1 through December 30, 2003, 4.25
to 1 from then until December 30, 2004, and 4.00 to 1 thereafter. We are in
compliance with all of our debt covenants.
Divestitures
- ------------
On August 24, 1999, our Board of Directors approved a plan of divestiture for
our public utilities services businesses, which included gas, electric and water
and wastewater businesses. We have sold all of those properties except for one
electric utility in Vermont.
On January 15, 2002, we sold our water and wastewater services operations for
$859.1 million in cash and $122.5 million in assumed debt and other liabilities.
On October 31, 2002, we completed the sale of approximately 4,000 telephone
access lines in North Dakota for approximately $9.7 million in cash.
On November 1, 2002, we completed the sale of our Kauai Electric division for
$215.0 million in cash.
On April 1, 2003, we completed the sale of approximately 11,000 telephone access
lines in North Dakota for approximately $25.7 million in cash.
On April 4, 2003, we completed the sale of our wireless partnership interest in
Wisconsin for approximately $7.5 million in cash.
On August 8, 2003, we completed the sale of The Gas Company in Hawaii division
for $119.3 million in cash and assumed liabilities.
On August 11, 2003, we completed the sale of our Arizona gas and electric
divisions for $224.1 million in cash.
We have entered into definitive agreements to sell the assets of our Vermont
electric division to Vermont Electric Power Company, Inc. and Vermont Electric
Cooperative, Inc. for an aggregate of approximately $25.0 million in cash
subject to adjustments (currently estimated to be a reduction of approximately
$3.0 million) under the terms of the agreements. The transactions, which are
subject to regulatory and other customary approvals, are expected to close
during the first half of 2004.
All of the assets of our Vermont electric division 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. As discussed in Note 15 to
Consolidated Financial Statements we may record additional impairment losses
during 2003.
24
Discontinued operations in the consolidated statements of operations reflect the
results of operations and the gain on sale of the water/wastewater properties
sold in January 2002 including allocated interest expense for the periods
presented. Interest expense was allocated to the discontinued operations based
on the outstanding debt specifically identified with this business.
Critical Accounting Policies and Estimates
- ------------------------------------------
We review all significant estimates affecting our consolidated financial
statements on a recurring basis and record the effect of any necessary
adjustment prior to their publication. Uncertainties with respect to such
estimates and assumptions are inherent in the preparation of financial
statements; accordingly, it is possible that actual results could differ from
those estimates and changes to estimates could occur in the near term. The
preparation of our financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of the contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Estimates and judgments are used when accounting for allowance for
doubtful accounts, impairment of long-lived assets, intangible assets,
depreciation and amortization, employee benefit plans, income taxes and
contingencies, among others.
Our estimate of anticipated losses related to telecommunications bankruptcies is
a "critical accounting estimate." We have significant on-going normal course
business relationships with many telecom providers, some of which have filed for
bankruptcy. We generally reserve approximately 95% of the net outstanding
pre-bankruptcy balances owed to us and believe that our estimate of the net
realizable value of the amounts owed to us by bankrupt entities is appropriate.
We believe that the accounting estimate related to asset impairment is a
"critical accounting estimate." With respect to ELI, the estimate is highly
susceptible to change from period to period because it requires management to
make significant judgments and assumptions about future revenue, operating costs
and capital expenditures over the life of the property, plant and equipment
(generally 5 to 15 years) as well as the probability of occurrence of the
various scenarios and appropriate discount rates. Management's assumptions about
ELI's future revenue, operating costs and capital expenditures as well as the
probability of occurrence of these various scenarios require significant
judgment because the CLEC industry is changing and because actual revenue,
operating costs and capital expenditures have fluctuated dramatically in the
past and may continue to do so in the future.
The calculation of depreciation and amortization expense is based on the
estimated economic useful lives of the underlying property, plant and equipment
and identifiable intangible assets. 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 has decreased substantially from prior periods
as a result of the impairment write down we recorded during 2002, the adoption
of SFAS No. 143 and the increase in the average depreciable lives for certain of
our equipment.
With respect to our remaining electric property, our estimate of net realizable
value is based upon the expected future sales price of this property.
Our indefinite lived intangibles consist of goodwill and trade name, which
resulted from the purchase of ILEC properties. We test for impairment of these
assets annually, or more frequently, as circumstances warrant. All of our ILEC
properties share similar economic characteristics and as a result, our reporting
unit is the ILEC segment. In determining fair value during 2002 we utilized two
tests. One test utilized recent trading prices for completed ILEC acquisitions
of similarly situated properties. A second test utilized current trading values
for the Company's publicly traded common stock. We reviewed the results of both
tests for consistency to ensure that our conclusions were appropriate.
Additionally, we utilized a range of prices to gauge sensitivity. Our tests
determined that fair values exceeded book value.
Our estimates of pension expense, other post retirement benefits including
retiree medical benefits and related liabilities are "critical accounting
estimates." Our pension and other post retirement benefits expenses are based
upon a set of assumptions that include projections of future interest rates and
asset returns. Actual results may vary from these estimates. We are assuming a
long-term rate of return on plan assets of 8.25% and a discount rate of 6.75%
for 2003. Actual returns have been negative in recent years. If future market
conditions cause either a decline in interest rates used to value our pension
plan liabilities or reductions to the value of our pension plan assets we
potentially could incur additional charges to our shareholder's equity.
25
Our income tax expense is computed utilizing an estimated annual effective
income tax rate in accordance with Accounting Principles Board Opinions (APB)
No. 28, "Interim Financial Reporting." The tax rate is computed using estimates
as to the Company's net income before income taxes for the entire year and the
impact of estimated permanent book-tax differences relative to that forecast.
Management has discussed the development and selection of these critical
accounting estimates with the audit committee of our board of directors and our
audit committee has reviewed our disclosures relating to them.
New Accounting Pronouncements
- -----------------------------
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 applies to fiscal years beginning after June 15,
2002, and addresses financial accounting and reporting obligations associated
with the retirement of tangible long-lived assets and the associated asset
retirement costs. We adopted SFAS No. 143 effective January 1, 2003. The
standard applies to legal obligations associated with the retirement of
long-lived assets that result from acquisition, construction, development or
normal use of the assets and requires that a legal liability for an asset
retirement obligation be recognized when incurred, recorded at fair value and
classified as a liability in the balance sheet. When the liability is initially
recorded, the entity will capitalize the cost and increase the carrying value of
the related long-lived asset. The liability is then accreted to its present
value each period and the capitalized cost is depreciated over the estimated
useful life of the related asset. At the settlement date, the entity will settle
the obligation for its recorded amount or recognize a gain or loss upon
settlement.
Depreciation expense for the Company's wireline operations has historically
included an additional provision for cost of removal. Effective with the
adoption of SFAS No. 143, on January 1, 2003, the Company ceased recognition of
the cost of removal provision in depreciation expense and eliminated the
cumulative cost of removal included in accumulated depreciation, as the Company
has no legal obligation to remove certain long-lived assets. The cumulative
effect of retroactively applying these changes to periods prior to January 1,
2003, resulted in an after tax non-cash gain of approximately $65.8 million
recognized in the first quarter of 2003.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which nullified Emerging Issues Task Force
(EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity." SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred, rather than on the date of commitment to an exit
plan. This Statement is effective for exit or disposal activities that are
initiated after December 31, 2002. We adopted SFAS No. 146 on January 1, 2003.
The adoption of SFAS No. 146 did not have any material impact on our financial
position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging," which clarifies financial accounting and
reporting for derivative instruments including derivative instruments embedded
in other contracts. This Statement is effective for contracts entered into or
modified after June 30, 2003. We adopted SFAS No. 149 on July 1, 2003. The
adoption of SFAS No. 149 did not have any material impact on our financial
position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." The Statement
requires issuers to classify as liabilities (or assets in some circumstances)
certain financial instruments that embody obligations of the issuer. Generally,
the Statement is effective for financial instruments entered into or modified
after May 31, 2003 and is otherwise effective at the beginning of the first
interim period beginning after June 15, 2003. We adopted the provisions of the
Statement on July 1, 2003. The adoption of SFAS No. 150 did not have any
material impact on our financial position or results of operations.
The FASB also recently indicated that it will require stock-based employee
compensation to be recorded as a charge to earnings beginning in 2004. We will
continue to monitor the progress on the issuance of this standard.
26
(b) Results of Operations
----------------------
REVENUE
Consolidated revenue for the three and nine months ended September 30, 2003
decreased $73.8 million, or 11% and $119.8 million, or 6%, as compared with the
prior year periods. The decrease for the three months ended September 30, 2003
is due to a $64.7 million decrease in gas and electric revenue largely due to
the dispositions of public utility businesses, a $8.2 million decrease in ILEC
revenue, and a decrease in ELI revenue of $0.9 million. The year-to-date
decrease is due to a $104.0 million decrease in gas and electric revenue largely
due to the dispositions of public utility businesses, a $7.2 million decrease in
ILEC revenue, and a decrease in ELI revenue of $8.6 million. On April 1, 2003,
we completed the sale of approximately 11,000 telephone access lines in North
Dakota. The North Dakota revenues related to these access lines totaled $1.9
million and $8.3 million for the nine months ended September 30, 2003 and 2002,
respectively.
TELECOMMUNICATIONS REVENUE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
-------------------------------------------- ----------------------------------------------
2003 2002 $ Change % Change 2003 2002 $ Change % Change
----------- ----------- ------------ -------- ----------- ----------- ------------ ---------
Access services $ 166,705 $ 170,069 $ (3,364) -2% $ 491,844 $ 507,065 $ (15,221) -3%
Local services 216,349 221,671 (5,322) -2% 658,155 656,109 2,046 0%
Long distance and data services 76,146 73,396 2,750 4% 227,410 214,711 12,699 6%
Directory services 26,817 26,443 374 1% 80,595 78,497 2,098 3%
Other 25,557 28,198 (2,641) -9% 77,332 86,112 (8,780) -10%
----------- ----------- ------------ ----------- ----------- ------------
ILEC revenue 511,574 519,777 (8,203) -2% 1,535,336 1,542,494 (7,158) 0%
ELI 40,416 41,311 (895) -2% 125,228 133,845 (8,617) -6%
----------- ----------- ------------ ----------- ----------- ------------
$ 551,990 $ 561,088 $ (9,098) -2% $ 1,660,564 $1,676,339 $ (15,775) -1%
=========== =========== ============ =========== =========== ============
Changes in the number of our access lines is the most fundamental driver of
changes in our telecommunications revenue. In recent quarters many rural local
telephone companies (including ours) have experienced a loss of access lines
because of difficult economic conditions, increased competition and
disconnecting second lines by some customers when they add DSL or other
high-speed internet service. Excluding the North Dakota sale, we lost
approximately 29,400 access lines during the nine months ended September 30,
2003 but added more than 35,000 DSL subscribers during this period. Residential
lines lost represented 67 percent of the total loss, excluding the North Dakota
sale. The non-residential line losses were principally in Rochester, New York
while the residential losses were throughout most of our markets other than
Arizona and California. We expect to continue to lose access lines during the
remainder of 2003 and into 2004. A continued decrease in access lines, combined
with continuing difficult economic conditions, lower minutes of use and access
rates and increased competition, may cause our revenues to decrease further
during the remainder of 2003 and into 2004.
Beginning in the first quarter 2003, the presentation of revenue categories
includes certain reclassifications to ensure consistency among reporting
properties.
Access services revenue for the three months ended September 30, 2003 decreased
$3.4 million or 2% as compared with the prior year period. Switched access
revenue decreased $8.3 million primarily due to the $4.4 million effect of
access rate reductions effective July 1, 2003. Special access revenue increased
$4.5 million primarily due to a $6.9 million reclassification of local private
line revenue from local services to special access offset by the discontinuation
of a $2.9 million reclassification from data services to special access.
Access services revenue for the nine months ended September 30, 2003 decreased
$15.2 million or 3% as compared with the prior year period. Switched access
revenue decreased $20.0 million due to the $15.2 million effect of access rate
reductions effective July 1, 2003. Special access revenue increased $3.7 million
primarily due to a $6.9 million reclassification of local private line revenue
from local services to special access and growth in special circuits of $3.1
million offset by the discontinuation of a $5.8 million reclassification from
data services to special access. Access services revenue includes our subsidy
revenue, which we expect to be slightly lower in 2003 than in 2002.
Local services revenue for the three months ended September 30, 2003 decreased
$5.3 million or 2% as compared with the prior year period. Local revenue
decreased $7.6 million primarily due to a $6.9 million reclassification of local
private line revenue from local services to special access, the $1.5 million
impact of the sale of our North Dakota exchanges in 2003 and a $0.5 million
decrease from continued losses of access lines, partially offset by a $1.3
million increase in subscriber line charges (SLC) due to rate changes. Enhanced
services revenue increased $2.3 million primarily due to the sale of additional
feature packages. Continued losses of access lines will result in lower local
service revenue.
27
Local services revenue for the nine months ended September 30, 2003 increased
$2.0 million as compared with the prior year period. Enhanced services revenue
increased $7.7 million primarily due to the sale of additional feature packages.
Local revenue decreased $5.6 million primarily due to a $6.9 million
reclassification of local private line revenue from local services to special
access, a $3.9 million decrease from continued losses of access lines and the
$3.5 million impact of the sale of our North Dakota exchanges in 2003, partially
offset by an $8.7 million increase in SLC due to rate changes.
Long distance and data services revenue for the three months ended September 30,
2003 increased $2.8 million or 4% as compared with the prior year period
primarily due to growth in data service revenue of $5.8 million and a $2.9
reclassification from special access to data services. The increase in data
services revenue was offset by a decrease of $4.7 million in long distance
revenue due to declining minutes of use.
Long distance and data services revenue for the nine months ended September 30,
2003 increased $12.7 million or 6% as compared with the prior year period
primarily due to growth of $13.2 million related to data services and a $5.8
million reclassification from special access to data services. The increase in
data services revenue was partially offset by a decrease of $6.0 million in long
distance revenue. Our long distance revenues decreased during 2003 due to
competition from wireless providers and declining minutes of use. We expect
these factors will continue to affect our long distance revenues during the
remainder of 2003 and into 2004.
Directory revenue for the three and nine months ended September 30, 2003
increased $0.4 million or 1%, and $2.1 million or 3%, respectively, as compared
with the prior year periods primarily due to growth in yellow pages advertising.
Other revenue for the three months ended September 30, 2003 decreased $2.6
million or 9% compared with the prior year period primarily due to decreases of
$1.4 million in customer premises equipment (CPE) sales, $1.0 million in service
activation revenue, $0.9 million in other revenue and a $0.5 million adjustment
related to contract services provided to Global Crossing Ltd. (Global) partially
offset by a $1.4 million decrease in uncollectible revenue.
Other revenue for the nine months ended September 30, 2003 decreased $8.8
million, or 10% compared with the prior year period primarily due to a decrease
of $3.3 million in service activation revenue, the termination in 2002 of $2.0
million (for the nine months) in contract services provided to Global and
decreases of $1.3 million in CPE sales and $1.0 million in conferencing revenue
partially offset by a $1.2 million decrease in uncollectible revenue.
ELI revenue for the three and nine months ended September 30, 2003 decreased
$0.9 million, or 2%, and $8.6 million, or 6%, respectively, as compared to the
prior year period primarily due to a decline in Integrated Service Digital
Network (ISDN) services due to less demand from Internet service providers and
lower demand for long haul services.
GAS AND ELECTRIC REVENUE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- -----------------------------------------------
2003 2002 $ Change % Change 2003 2002 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ ---------
Gas revenue $ 18,005 $ 40,584 $ (22,579) -56% $ 137,686 $ 159,805 $ (22,119) -14%
Electric revenue $ 25,042 $ 67,159 $ (42,117) -63% $ 92,603 $ 174,460 $ (81,857) -47%
Gas revenue for the three and nine months ended September 30, 2003 decreased
$22.6 million, or 56%, and $22.1 million, or 14%, respectively, as compared with
the prior year periods due to the sales of The Gas Company in Hawaii and our
Arizona gas division, which were sold on August 8, 2003 and August 11, 2003,
respectively. We have sold all of our gas operations and as a result will have
no operating results in future periods for these businesses.
Electric revenue for the three and nine months ended September 30, 2003
decreased $42.1 million, or 63%, and $81.9 million, or 47%, respectively, as
compared with the prior year periods primarily due to the sales of our Arizona
electric division and Kauai Electric. Included in electric revenue for the three
and nine months ended September 30, 2002 is approximately $59.2 million and
$151.5 million, respectively, of revenue from our Arizona electric division and
Kauai Electric which were sold on August 11, 2003 and November 1, 2002,
respectively. We have just one remaining electric utility property as of
September 30, 2003. We expect to sell this property by mid - 2004.
28
COST OF SERVICES
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2003 2002 $ Change % Change 2003 2002 $ Change % Change
----------- ----------- ------------ -------- ---------- ----------- ------------ ---------
Network access $ 57,133 $ 58,218 $ (1,085) -2% $ 171,816 $ 174,774 $ (2,958) -2%
Gas purchased 12,324 21,329 (9,005) -42% 82,311 91,130 (8,819) -10%
Electric energy and
fuel oil purchased 16,412 36,248 (19,836) -55% 58,498 91,915 (33,417) -36%
----------- ----------- ------------ ----------- ----------- ------------
$ 85,869 $115,795 $ (29,926) -26% $ 312,625 $ 357,819 $(45,194) -13%
=========== =========== ============ =========== =========== ============
Network access expenses for the three months ended September 30, 2003 decreased
$1.1 million, or 2%, as compared with the prior year period. ELI costs have
declined slightly due to a drop in demand while the ILEC sector decreased
primarily due to lower minutes of use.
Network access expenses for the nine months ended September 30, 2003 decreased
$3.0 million, or 2%, as compared with the prior year period. ELI costs have
declined due to a drop in demand while ILEC sector costs have risen slightly due
to increased circuit expense associated with additional data product sales and
increased long distance access expense. If we increase our sales of data
products such as DSL, our network access expense could increase.
Gas purchased for the three and nine months ended September 30, 2003 decreased
$9.0 million, or 42%, and $8.8 million, or 10%, respectively, as compared with
the prior year periods primarily due to the sales of The Gas Company in Hawaii
and our Arizona gas division. We no longer have any gas operations.
Electric energy and fuel oil purchased for the three and nine months ended
September 30, 2003 decreased $19.8 million, or 55%, and $33.4 million, or 36%,
respectively, as compared with the prior year periods primarily due to the sales
of our Arizona electric division and Kauai Electric.
OTHER OPERATING EXPENSES
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2003 2002 $ Change % Change 2003 2002 $ Change % Change
----------- ----------- ------------ -------- ---------- ---------- ------------ --------
Operating expenses $ 165,498 $ 189,410 $ (23,912) -13% $ 521,116 $ 570,904 $ (49,788) -9%
Taxes other than income taxes 26,095 33,550 (7,455) -22% 84,982 107,076 (22,094) -21%
Sales and marketing 28,683 25,718 2,965 12% 82,492 82,978 (486) -1%
----------- ----------- ------------ ----------- ---------- ------------
$ 220,276 $ 248,678 $ (28,402) -11% $ 688,590 $ 760,958 $ (72,368) -10%
=========== =========== ============ =========== ========== ============
Operating expenses for the three months ended September 30, 2003 decreased $23.9
million, or 13%, as compared with the prior year period primarily due to
increased operating efficiencies and a reduction of personnel in the ILEC and
ELI sectors and decreased operating expenses in the gas and electric sectors due
to the sales of The Gas Company in Hawaii, our Arizona gas and electric
divisions and Kauai Electric. Operating expenses were negatively impacted by
increased pension expenses as discussed below.
Operating expenses for the nine months ended September 30, 2003 decreased $49.8
million, or 9%, as compared with the prior year period primarily due to
increased operating efficiencies and a reduction of personnel in the ILEC and
ELI sectors and decreased operating expenses in the gas and electric sectors due
to the sales of The Gas Company in Hawaii, our Arizona gas and electric
divisions and Kauai Electric. Expenses were negatively impacted by increased
compensation expense of $2.7 million related to variable stock plans and
increased pension expenses as discussed below. We routinely review our
operations, personnel and facilities to achieve greater efficiencies. These
reviews may result in reductions in personnel and an increase in severance
costs.
Included in operating expenses is pension expense. In future periods, if the
value of our pension assets decline and/or projected benefit costs increase, we
may have increased pension expenses. Based on current assumptions and plan asset
values, we estimate that our pension expense will increase from $4.3 million in
2002 to approximately $12.0 - $13.0 million in 2003 but that no contribution to
our pension plans will be required in 2003. In addition, as medical costs
increase the costs of our retiree medical obligations also increase. Our retiree
medical costs for 2002 were $15.1 million and our current estimate for 2003 is
$16.0 - $17.0 million. Increases in medical costs also increase expenses for
providing health care benefits to our existing employees. We expect our total
benefit costs for existing employees to increase in 2003 compared to 2002.
29
Included in operating expenses is compensation expense. In future periods,
compensation expense related to variable stock plans may be materially affected
by our stock price.
Taxes other than income taxes for the three and nine months ended September 30,
2003 decreased $7.5 million, or 22%, and $22.1 million, or 21%, respectively, as
compared with the prior year periods primarily due to decreased property taxes
at ELI due to lower asset values and the sales of the Gas Company in Hawaii, our
Arizona gas and electric divisions and Kauai Electric.
Sales and marketing expenses for the three months ended September 30, 2003
increased $3.0 million, or 12%, as compared to the prior year period primarily
due to increased marketing costs in the ILEC sector. Sales and marketing
expenses for the nine months ended September 30, 2003 decreased $0.5 million, or
1%, as compared to the prior year period due to a reduction of personnel and
related costs in the ILEC sector.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- --------------------------------------------
2003 2002 $ Change % Change 2003 2002 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ ------
Depreciation expense $ 120,012 $ 167,772 $ (47,760) -28% $ 345,577 $ 471,642 $ (126,065) -27%
Amortization expense 31,866 31,839 27 0% 95,208 92,521 2,687 3%
----------- ----------- ------------ ----------- ----------- ------------
$ 151,878 $ 199,611 $ (47,733) -24% $ 440,785 $ 564,163 $ (123,378) -22%
=========== =========== ============ =========== =========== ============
Depreciation expense for the three months ended September 30, 2003 decreased
$47.8 million, or 28%, as compared with the prior year period primarily due to
the ELI impairment charge recognized during the third quarter of 2002, which
reduced ELI's asset base, the adoption of SFAS No. 143 and the increase in the
average depreciable lives for certain of our equipment.
Depreciation expense for the nine months ended September 30, 2003 decreased
$126.1 million, or 27%, as compared with the prior year period primarily due to
the ELI impairment charge recognized during the third quarter of 2002, which
reduced ELI's asset base, the adoption of SFAS No. 143 and the increase in the
average depreciable lives for certain of our equipment. Accelerated depreciation
in 2002 of $12.8 million relating to the closing of our Plano, Texas facility
also contributed to the decrease.
Amortization expense for the nine months ended September 30, 2003 increased $2.7
million, or 3%, as compared with the prior year period primarily due to
increased amortization of customer base, due to a final purchase price
allocation, resulting from the receipt of the final valuation report of our
Frontier acquisition during the second quarter of 2002.
RESERVE FOR TELECOMMUNICATIONS BANKRUPTCIES / RESTRUCTURING AND OTHER EXPENSES
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2003 2002 $ Change % Change 2003 2002 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ --------
Reserve for telecommunications
bankruptcies $ - $ - $ - - $ 2,260 $ 17,805 $ (15,545) -87%
Restructuring and other expenses $ (142) $ (273) $ 131 48% $ 9,950 $ 21,912 $ (11,962) -55%
An agreement has been reached with WorldCom/MCI settling all pre-petition
obligations and receivables. The bankruptcy court has approved the agreement and
we expect to recognize a gain of approximately $5.6 million in the fourth
quarter of 2003 as a result of the settlement.
During the second quarter 2003, we reserved approximately $2.3 million of trade
receivables with Touch America as a result of Touch America's filing for
bankruptcy. These receivables were generated as a result of providing ordinary
course telecommunication services. If other telecommunications companies file
for bankruptcy we may have additional significant reserves in future periods.
30
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. We have ongoing commercial relationships with
WorldCom. This charge was partially offset by 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 during
2001 and 2002 as a result of Global's filing for bankruptcy to reflect our best
estimate of the net realizable value of receivables incurred from these
commercial relationships. 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 reversed $11.6 million of our previous write-down of
the net realizable value of these receivables.
Restructuring and other expenses for 2003 primarily consist of expenses related
to reductions in personnel at our telecommunications operations and the write
off of software no longer used.
During 2002, restructuring and other expenses primarily consist of expenses
related to our various restructurings, including reductions in personnel at our
telecommunications operations, and costs that were spent at our Plano, Texas
facility and at other locations as a result of transitioning functions and jobs,
and $6.8 million of costs related to our tender offer in June 2002 of all the
ELI common shares that we did not already own.
INVESTMENT AND OTHER INCOME (LOSS), NET / GAIN (LOSS) ON SALE OF ASSETS /
INTEREST EXPENSE / INCOME TAX EXPENSE (BENEFIT)
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2003 2002 $ Change % Change 2003 2002 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ --------
Investment and
other income (loss), net $ (7,464) $ 13,111 $ (20,575) -157% $ 66,924 $ (65,028) $ 131,952 203%
Gain (loss) on sale of assets $ (16,813) $ 1,901 $ (18,714) -984% $ (11,792) $ 1,901 $ (13,693) -720%
Interest expense $ 103,124 $ 115,711 $ (12,587) -11% $ 318,836 $ 357,265 $ (38,429) -11%
Income tax expense (benefit) $ (7,210) $ (371,186) $ 363,976 98% $ 57,150 $ (424,688) $ 481,838 113%
Investment and other income (loss), net for the three months ended September 30,
2003 decreased $20.6 million as compared with the prior year period primarily
due to the write off of unamortized debt expense and net premium associated with
our early debt retirements. The 2002 activity included $10.8 million of income
from the settlement of certain retained liabilities at less than face value that
were associated with customer advances for construction from our disposed water
properties. The increase was partially offset by lower income from money market
balances and short-term investments.
Investment and other income (loss), net for the nine months ended September 30,
2003 increased $132.0 million as compared with the prior year period primarily
due to $65.7 million in non-cash pre-tax gains in 2003 related to capital lease
restructurings at ELI, $6.2 million of income in 2003 associated with the
retained liabilities settlements and the recognition in 2002 of a $95.3 million
non-cash pre-tax loss resulting from an other than temporary decline in the
value of our investment in Adelphia (see Note 10 to Consolidated Financial
Statements), partially offset by $20.8 million of income in 2002 from the
settlement of retained liabilities. The increase was partially offset by lower
income from money market balances and short-term investments.
Gain/(loss) on sales of assets, net decreased $18.7 million and $13.7 million as
compared with the prior year primarily due to the sales of The Gas Company in
Hawaii and our Arizona gas and electric divisions during the third quarter of
2003, the sale of access lines in North Dakota and our wireless partnership
interest in Wisconsin during the second quarter of 2003, and the sale of our
Plano office building in March 2003.
Interest expense for the three months ended September 30, 2003 decreased $12.6
million, or 11%, as compared with the prior year period primarily due to the
retirement of debt partially offset by higher average interest rates. During the
three months ended September 30, 2003, we had average long-term debt (excluding
equity units and convertible preferred stock) outstanding of $4.4 billion
compared to $5.3 billion during the three months ended September 30, 2002. Our
weighted average borrowing rate for the three months ended September 30, 2003 as
compared with the prior year period was 15 basis points higher, increasing from
7.93% to 8.08%, due to the repayment of debt with interest rates below our
average rate.
31
Interest expense for the nine months ended September 30, 2003 decreased $38.4
million, or 11%, as compared with the prior year period primarily due to the
retirement of debt partially offset by higher average interest rates. During the
nine months ended September 30, 2003, we had average long-term debt (excluding
equity units and convertible preferred stock) outstanding of $4.6 billion
compared to $5.4 billion during the nine months ended September 30, 2002. Our
weighted average borrowing rate for the nine months ended September 30, 2003 as
compared with the prior year period was 27 basis points higher, increasing from
7.82% to 8.09%, due to the repayment of debt with interest rates below our
average rate.
Income taxes for the three and nine months ended September 30, 2003 increased
$364.0 million and $482.0 million, respectively, as compared with the prior year
periods primarily due to changes in taxable income. The effective tax rate for
the first nine months of 2003 was 34% as compared with 35% for the first nine
months of 2002.
LOSS ON IMPAIRMENT
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
--------------------------------------------- ----------------------------------------------
2003 2002 $ Change % Change 2003 2002 $ Change % Change
----------- ----------- ------------ -------- ------------ ----------- ------------ --------
Loss on impairment $ 4,000 $1,074,058 $(1,070,058) -100% $ 4,000 $ 1,074,058 $(1,070,058) -100%
An additional non-cash pre-tax impairment loss of $4.0 million related to our
Vermont property has been recognized in the third quarter of 2003, such that the
net assets have been written down to our best estimate of the net realizable
value upon sale.
In the third quarter of 2002, we recognized non-cash pre-tax impairment losses
of $656.7 million related to property, plant and equipment in the ELI sector and
$417.4 million related to the gas and electric sector assets held for sale. Our
assessment of impairment for ELI was a result of continued losses at ELI and
continued actual revenue declines in excess of projected revenue declines. The
gas and electric sector impairments were associated with the sale of our Arizona
and Hawaiian gas and electric properties at prices that were less than the
previous carrying values and the write down of our remaining utility to our
estimate of net realizable sales price. Previously, we believed that the net
realizable value of these properties was equal to or above their carrying
values. However, as a result of market conditions, and the desire to complete
the divestiture process quickly in order to focus on our core telecommunications
operations and raise money to further reduce debt, in the third quarter of 2002
we made a strategic decision to accept proceeds less than carrying values rather
than continue to market these properties for higher prices.
DISCONTINUED OPERATIONS
($ in thousands) For the nine months
ended September 30,
2003 2002
----------- -----------
Revenue $ - $ 4,650
Operating income (loss) $ - $ (419)
Income (loss) from discontinued
operations, net of tax $ - $ (1,478)
Gain on disposal of water
segment, net of tax $ - $ 169,326
On January 15, 2002, we completed the sale of our water and wastewater
operations for $859.1 million in cash and $122.5 million of assumed debt and
other liabilities. The pre-tax gain on the sale recognized in 2002 was $316.7
million. The gain on the disposal of the water segment, net of tax was $169.3
million.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
During the first quarter of 2003, as a result of our adoption of SFAS No. 143,
"Accounting for Asset Retirement Obligations," we recognized an after tax
non-cash gain of approximately $65.8 million. During the first quarter of 2002,
as a result of our adoption of SFAS No. 142, "Goodwill and Other Intangible
Assets," we recognized a transitional impairment loss of $39.8 million for
goodwill related to ELI (see Note 14 to Consolidated Financial Statements).
32
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 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 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
interest rates.
Our objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, a majority of our borrowings have
fixed interest rates. Consequently, we have limited material future earnings or
cash flow exposures from changes in interest rates on our long-term debt and
capital lease obligations. A hypothetical 10% adverse change in interest rates
would increase the amount that we pay on our variable obligations and could
result in fluctuations in the fair value of our fixed rate obligations. Based
upon our overall interest rate exposure at September 30, 2003, a near-term
change in interest rates would not materially affect our consolidated financial
position, results of operations or cash flows.
In order to manage our interest rate risk exposure, we have entered into
interest swap agreements. Under the terms of the agreements, we make
semi-annual, floating interest rate interest payments based on six month LIBOR
and receive a fixed rate on the notional amount. The underlying variable rate on
the swaps is set either in advance, in arrears or based on each period's daily
average six-month LIBOR. In connection with these swaps, the Company entered
into a series of supplemental rate agreements which had the effect of setting
the floating rate portion of the swaps in advance of the contractually agreed
upon rate determination date.
Sensitivity analysis of interest rate exposure
At September 30, 2003, the fair value of our long-term debt and capital lease
obligations was estimated to be approximately $5.1 billion, based on our overall
weighted average rate of 8.1% 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, 2002. The overall weighted average interest
rate increased approximately 8 basis points during 2003. A hypothetical increase
of 81 basis points (10% of our overall weighted average borrowing rate) would
result in an approximate $244.1 million decrease in the fair value of our fixed
rate obligations.
Equity Price Exposure
Our exposure to market risk for changes in equity prices relate primarily to the
equity portion of our investment portfolio. The equity portion of our investment
portfolio includes equity securities of telecommunications companies.
As of September 30, 2003, we owned 3,059,000 shares of Adelphia common stock. As
of June 30, 2002, we had written this investment down to zero, and therefore we
have no additional exposure related to the market value of Adelphia stock.
As of September 30, 2003, we owned 2,305,908 common shares which represent an
ownership of 19% of the equity in Hungarian Telephone and Cable Corp., a company
of which our Chairman and Chief Executive Officer is a member of the Board of
Directors. In addition, we hold 30,000 shares of non-voting convertible
preferred stock, each share having a liquidation value of $70 per share and are
convertible at our option into 10 shares of common stock.
33
As of September 30, 2003, we owned 1,333,500 shares of D & E Communications (D &
E) common stock. The stock price of D & E was $14.18 and $8.36 at September 30,
2003 and December 31, 2002, respectively.
Sensitivity analysis of equity price exposure
At September 30, 2003, the fair value of the equity portion of our investment
portfolio was estimated to be $41.7 million. A hypothetical 10% decrease in
quoted market prices would result in an approximate $4.2 million decrease in the
fair value of the equity portion of our investment portfolio.
Disclosure of limitations of sensitivity analysis
Certain shortcomings are inherent in the method of analysis presented in the
computation of fair value of financial instruments. Actual values may differ
from those presented should market conditions vary from assumptions used in the
calculation of the fair value. This analysis incorporates only those exposures
that exist as of September 30, 2003. 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.
Item 4. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures.
We carried out an evaluation, under the supervision and with the participation
of our management, of the effectiveness of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the
end of the period covered by this report. Based on this evaluation, our
principal executive officer and principal financial officer concluded that our
disclosure controls and procedures were effective. It should be noted that the
design of any system of controls is based in part upon certain assumptions, and
there can be no assurance that any design will succeed in achieving its stated
goals.
(b) Changes in internal control over financial reporting.
There was no change in our internal control over financial reporting that
occurred during the fiscal quarter covered by this report that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
34
PART II. OTHER INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Item 1. Legal Proceedings
-----------------
The City of Bangor, Maine, filed suit against us on November 22, 2002, in the
U.S. District Court for the District of Maine (City of Bangor v. Citizens
Communications Company, Civ. Action No. 02-183-B-S). The City has alleged, among
other things, that we are responsible for the costs of cleaning up environmental
contamination alleged to have resulted from the operation of a manufactured gas
plant by Bangor Gas Company, which we owned from 1948-1963. The City alleged the
existence of extensive contamination of the Penobscot River and nearby land
areas and has asserted that money damages and other relief at issue in the
lawsuit could exceed $50.0 million. The City also requested that punitive
damages be assessed against us. We have filed an answer denying liability to the
City, and have asserted a number of counter claims against the City. We intend
to defend ourselves vigorously against the City's lawsuit. In addition, we have
identified a number of other potentially responsible parties that may be
responsible for the damages alleged by the City and joined them as parties to
the lawsuit. These additional parties include Honeywell Corporation, the Army
Corps of Engineers, Guilford Transportation (formerly Maine Central Railroad),
UGI Utilities, Inc., and Centerpoint Energy Resources Corporation. We also have
demanded that various of our insurance carriers defend and indemnify us with
respect to the City's lawsuit. On or about December 26, 2002, we filed a
declaratory judgment action against those insurance carriers in the Superior
Court of Penobscot County, Maine, for the purpose of establishing their
obligations to us with respect to the City's lawsuit. We intend to vigorously
pursue insurance coverage for the City's lawsuit.
On February 7, 2003, we received a letter from counsel representing Enron North
America Corporation (formerly known as Enron Gas Marketing, Inc.) demanding
payment of an "early termination liability" of approximately $12.5 million that
Enron claims it is owed under a gas supply agreement that we lawfully terminated
in November 2001. The demand was made in connection with Enron's ongoing
bankruptcy proceeding in the United States Bankruptcy Court for the Southern
District of New York. The parties have entered into a settlement agreement and
mutual release resolving, among other things, all issues raised by Enron in its
demand letter. The Bankruptcy Court approved the agreement by order dated
September 25, 2003. There was no material adverse impact on our financial
position or results of operations as a result of the settlement.
In connection with an inquiry that we believe has arisen as a result of
allegations made to federal authorities during their investigation of an
embezzlement by two of our former officers, our employees and we are cooperating
fully with the Office of the U.S. Attorney for the Southern District of New York
and with the New York office of the Securities and Exchange Commission. We have
provided requested documents to the SEC and we have agreed to comply with an SEC
request that, in connection with the informal inquiry that it has initiated, we
preserve financial, audit, and accounting records. On August 20, 2003, the U.S.
Attorney notified us that it had closed its investigation.
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.
35
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a) Exhibits:
31.1 Certification of Principal Executive Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934.
31.2 Certification of Principal Financial Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K:
We filed on Form 8-K on August 7, 2003 under Item 12 "Disclosure of Results
of Operations and Financial Condition," a press release announcing our
earnings for the quarter and six months ended June 30, 2003.
We filed on Form 8-K on August 12, 2003 under Item 5 "Other Events" and
Item 7 "Financial Statements, Pro forma Financial Information and
Exhibits," a press release announcing the completion of the sales of our
Arizona Gas and Electric divisions and the completion of the sale of The
Gas Company of Hawaii division.
36
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Robert J. Larson
-------------------------
Robert J. Larson
Senior Vice President and
Chief Accounting Officer
Date: November 12, 2003
37