CITIZENS COMMUNICATIONS COMPANY
-------------------------------
FORM 10-K
---------
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
---------------------------------------------
OF THE SECURITIES EXCHANGE ACT OF 1934
--------------------------------------
FOR THE YEAR ENDED DECEMBER 31, 2003
------------------------------------
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 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)
Registrant's telephone number, including area code: (203) 614-5600
---------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
- -------------------------------------------------------------------------------- -----------------------------------------
Common Stock, par value $.25 per share New York Stock Exchange
Guarantee of Convertible Preferred Securities of Citizens Utilities Trust New York Stock Exchange
Equity Units New York Stock Exchange
Citizens Convertible Debentures N/A
Guarantee of Partnership Preferred Securities of Citizens Utilities Capital L.P. N/A
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
--- ---
The aggregate market value of common stock held by non-affiliates of the
registrant on June 30, 2003 was approximately $3,543,684,938, based on the
closing price of $12.89 per share.
The number of shares outstanding of the registrant's Common Stock as of February
27, 2004 was 285,804,460.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the registrant's 2004 Annual Meeting of
Stockholders to be held on May 18, 2004 are incorporated by reference into Part
III of this Form 10-K.
TABLE OF CONTENTS
-----------------
Page
----
PART I
- ------
Item 1. Business 2
Item 2. Properties 9
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
Executive Officers 10
PART II
- -------
Item 5. Market for Registrant's Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities 13
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 34
Item 8. Financial Statements and Supplementary Data 35
Item 9. Changes in and Disagreements with Accountants on Accounting 35
and Financial Disclosure
Item 9A. Controls and Procedures 36
PART III
- --------
Item 10. Directors and Executive Officers of the Registrant 36
Item 11. Executive Compensation 36
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholders Matters 36
Item 13. Certain Relationships and Related Transactions 37
Item 14. Principal Accountant Fees and Services 37
PART IV
- -------
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 37
Signatures 42
Index to Consolidated Financial Statements F-1
PART I
------
Item 1. Business Overview
-----------------
Citizens Communications Company and its subsidiaries (Citizens) will be referred
to as the "Company," "we," "us" or "our" throughout this report.
We are a telecommunications company providing wireline communications services
to rural areas and small and medium-sized towns and cities as an incumbent local
exchange carrier, or ILEC. We offer our ILEC services under the "Frontier" name.
In addition, we provide competitive local exchange carrier, or CLEC, services to
business customers and to other communications carriers in certain metropolitan
areas in the western United States through Electric Lightwave, LLC, or ELI, our
wholly-owned subsidiary. We also provide electric distribution and generation
services to primarily rural customers in Vermont. We have a contract to sell
those electric distribution and generation operations.
In December 2003, we announced that our Board of Directors decided to explore
strategic alternatives and we have retained financial advisors to assist in this
process. In February 2004, we engaged J.P. Morgan Securities and Morgan Stanley
as financial advisors and Simpson Thacher & Bartlett LLP, as legal counsel to
assist in our exploration of alternatives. The advisors will assist the Company
in evaluating a range of possible financial and strategic alternatives designed
to enhance shareholder value, although there can be no assurance that the
Company will undertake any particular action as a result of this review.
Revenue from our ILEC, CLEC and public utility operations was $2,040.9 million,
$165.4 million, and $238.6 million, respectively, in 2003. Approximately $205.0
million of the revenue from our public utility operations relates to businesses
that were sold during 2003.
We have grown from approximately 1.0 million access lines in 1999 to
approximately 2.4 million access lines as of December 31, 2003 through
acquisitions. During 2001, we purchased 1.1 million access lines for
approximately $3,373.0 million in cash. During 2000, we acquired approximately
334,500 access lines for approximately $986.2 million in cash.
In 1999, we announced plans to divest our public utilities services segments. As
a result, in 2001 we sold two of our four natural gas transmission and
distribution businesses, during 2002 we sold our entire water distribution and
wastewater treatment business and one of our three electric businesses, and in
2003 we completed the sales of The Gas Company in Hawaii, our Arizona gas and
electric divisions and our electric transmission operations in Vermont. We
expect to close the sale of our remaining Vermont operations in mid - 2004. As
of December 31, 2003, we had sold all of our gas operations and, as a result,
will have no operating results in future periods for these businesses.
Telecommunications Services
Our telecommunications services are principally ILEC services and also include
CLEC services delivered through ELI. As of December 31, 2003, we operated ILECs
in 23 states, serving approximately 2.4 million access lines and 120,500 digital
subscriber line (DSL) customers. Our CLEC services consist of a variety of
integrated telecommunications products.
As an ILEC, we are typically the dominant incumbent carrier in the markets we
serve and provide the "last mile" of telecommunications services to residential
and business customers in these markets. As an ILEC, we compete with CLECs that
may operate in our markets. As a CLEC, we provide telecommunications services to
businesses and other carriers in competition with the ILEC. As a CLEC, we
frequently obtain the "last mile" access to customers through arrangements with
the applicable ILEC. ILECs and CLECs are subject to different regulatory
frameworks of the Federal Communications Commission (FCC). ELI does not compete
with our ILEC business.
As discussed in more detail in Management's Discussion & Analysis of Financial
Condition and Results of Operations (MD&A), we are in a challenging environment
with respect to revenues. The telecommunications industry in general, and the
CLEC sector in particular, are undergoing significant changes and difficulties.
Our ILEC revenues have been decreasing, and demand and pricing for CLEC services
have decreased substantially, particularly for long-haul services, and economic,
regulatory and competitive pressures are likely to cause these trends to
continue.
2
ILEC Services
- -------------
Our ILEC services segment accounted for $2,040.9 million, or 83%, of our total
revenues in 2003. Approximately 24% of our ILEC services segment revenues came
from federal and state subsidies and regulated access charges.
Our ILEC services business is primarily with residential customers and, to a
lesser extent, non-residential customers. Our ILEC services segment provides:
* local network services,
* enhanced services,
* network access services,
* long distance and data services, and
* directory services.
Local network services. We provide telephone wireline access services to
residential and non-residential customers in our service areas. Our service
areas are largely residential and are generally less densely populated than what
we believe to be the primary service areas of the five largest ILECs.
Enhanced services. We provide our ILEC customers a number of calling features
including call forwarding, conference calling, caller identification, voicemail
and call waiting. We offer packages of telecommunications services. These
packages permit customers to bundle their basic telephone line with their choice
of enhanced, long distance and data services for a monthly fee and/or usage
depending on the plan.
We intend to increase the penetration of enhanced services. We believe that
increased sales of such services in our ILEC markets will produce revenue with
higher operating margins due to the relatively low marginal operating costs
necessary to offer such services. We believe that our ability to integrate these
services with other ILEC services will provide us with the opportunity to
capture an increased percentage of our customers' telecommunications
expenditures.
Network access services. We provide network access services to long distance
carriers and other carriers in connection with the use of our facilities to
originate and terminate interstate and intrastate telephone calls. Such services
are generally offered on a month-to-month basis and the service is billed on a
minutes-of-use basis. Access charges to long distance carriers and other
customers are based on access rates filed with the FCC for interstate services
and with the respective state regulatory agency for intrastate services.
Revenue is recognized when services are provided to customers or when products
are delivered to customers. Monthly recurring network access service revenue is
billed in advance. The unearned portion of this revenue is initially deferred on
our balance sheet and recognized in revenue over the period that the services
are provided. Non-recurring network access service revenue is billed in arrears.
The earned but unbilled portion of this revenue is recognized in revenue in the
period that the services are provided.
Long distance and data services. Long distance network service to and from
points outside of a telephone company's operating territories is provided by
interconnection with the facilities of interexchange carriers, or IXCs. We offer
long distance services in our territories to our ILEC customers. We believe that
many customers prefer the convenience of obtaining their long distance service
through their local telephone company and receiving a single bill.
We also offer data services including internet access via dial up or DSL access,
frame relay, ethernet and asynchronous transfer mode (ATM) switching in portions
of our system.
Directory services. Directory services involves the provision of white and
yellow page listings of residential and business directories. We provide this
service through a third party contractor who pays us a percentage of revenues
realized from the sale of advertising in these directories. Our directory
service also includes "Frontier Pages," an internet-based directory service
which generates advertising revenue. We recognize the revenue from these
services over the life of the related white or yellow pages book.
3
The following table sets forth certain information with respect to our telephone
access lines as of December 31, 2003 and 2002.
ILEC Access Lines at December 31,
---------------------------------
State 2003 2002
----- --------- ---------
New York............ 985,000 1,009,700
Minnesota........... 268,100 272,800
Arizona............. 165,500 167,100
West Virginia....... 157,100 158,600
California.......... 154,500 153,400
Illinois............ 126,700 131,600
Tennessee........... 96,000 97,600
Wisconsin........... 73,400 73,800
Iowa................ 60,900 62,800
Nebraska............ 53,500 55,600
All other states (13)(1)... 245,800 261,400
--------- ---------
Total 2,386,500 2,444,400
========= =========
(1) On April 1, 2003 and October 31, 2002, we sold approximately 11,000 and
4,000 telephone access lines, respectively, in the state of North Dakota. These
sales affect the comparability of data presented.
CLEC Services
- -------------
ELI provides a broad range of wireline communications products and services to
businesses and other carriers in the western United States. ELI accounted for
$165.4 million, or 7%, of our total revenues in 2003. Our CLEC service revenues
have declined from a peak of $240.8 million in fiscal year 2000.
ELI's facilities-based network consists of optical fiber and voice and data
switches. ELI has a national internet and data network with switches and routers
in key cities, linked by leased transport facilities. In addition, ELI has a
long-haul, fiber-optic network connecting the cities it serves in the western
United States which utilizes an optically self-healing Synchronous Optical
Network (SONET) architecture. ELI currently provides the full range of its
services in the following cities and their surrounding areas: Boise, Idaho;
Portland, Oregon; Salt Lake City, Utah; Seattle, Washington; Spokane,
Washington; Phoenix, Arizona; and Sacramento, California.
Regulatory Environment
ILEC Services Regulation
- ------------------------
The majority of our operations are regulated extensively by various state
regulatory agencies, often called public service commissions, and the FCC.
The Telecommunications Act of 1996, or the 1996 Act, dramatically changed the
telecommunications industry. The main purpose of the 1996 Act was to open local
telecommunications marketplaces to competition. The 1996 Act preempts state and
local laws to the extent that they prevent competitive entry into the provision
of any switched communications service. Under the 1996 Act, however, states
retain authority to impose requirements on carriers necessary to preserve
universal service, protect public safety and welfare, ensure quality of service
and protect consumers. States are also responsible for mediating and arbitrating
interconnection agreements between CLECs and ILECs if voluntary negotiations
fail. In order to create an environment in which local competition is a
practical possibility, the 1996 Act imposes a number of requirements for access
to network facilities and interconnection on all local communications providers.
All local carriers must interconnect with other carriers, unbundle their
services at wholesale rates, permit resale of their services, enable collocation
of equipment, provide local telephone number portability and dialing parity,
provide access to poles, ducts, conduits, and rights-of-way, and complete calls
originated by competing carriers under termination arrangements.
At the federal level and in states covering approximately half of our access
lines we are subject to incentive regulation plans under which prices for
regulated services are capped in return for the elimination or relaxation of
earnings oversight. The goal of these plans is to provide incentives to improve
efficiencies and increased pricing flexibility for competitive services while
ensuring that customers receive reasonable rates for basic services that
continue to be deemed part of a monopoly. Some of these plans have limited terms
and as they expire, the Company may need to renegotiate with the states. These
negotiations could impact rates, service quality and/or infrastructure
requirements which could impact our earnings. In the other states in which we
operate, we are subject to rate of return regulation that limits levels of
earnings and returns on investments.
4
Our ILEC services segment revenue is subject to regulation by the FCC and
various state regulatory agencies. We expect federal and state lawmakers to
continue to review the statutes governing the level and type of regulation for
telecommunications services.
For interstate services regulated by the FCC, we have elected a form of
incentive regulation known as price caps for most of our operations. Under price
caps, interstate access rates are capped and adjusted annually by the difference
between the level of inflation and a productivity factor. Given the relatively
low inflation rate in recent years, interstate access rates have been adjusted
downward annually. In May 2000, the FCC adopted a revised methodology for
regulating the interstate access rates of price cap companies through May 2005.
The program, known as the Coalition for Affordable Local and Long Distance
Services, or CALLS plan, establishes a price floor for interstate-switched
access services and phases out many of the subsidies in interstate access rates.
We have been able to offset some of the reduction in interstate access rates
through end-user charges. We believe the net effect of reductions in interstate
access rates and increases in end-user charges will reduce our revenues by
approximately $10.0 million in 2004 compared to 2003. Annual reductions in
interstate switched access rates will continue through 2005 until the price
floor is reached.
Another goal of the 1996 Act was to remove implicit subsidies from the rates
charged by local telecommunications companies. The CALLS plan addressed this
requirement for interstate services. State legislatures and regulatory agencies
are beginning to reduce the implicit subsidies in intrastate rates. The most
common subsidies are in access rates that historically have been priced above
their costs to allow basic local rates to be priced below cost. Legislation has
been considered in several states to require regulators to eliminate these
subsidies and implement state universal service programs where necessary to
maintain reasonable basic local rates. However, not all the reductions in access
charges would be fully offset. We anticipate additional state legislative and
regulatory pressure to lower intrastate access rates in the near future. Many
states are embracing the need for state universal service funds to ensure
protection for customers while ensuring that local telecommunications companies
continue to have the incentive to recover in rates their investment in their
networks and new services.
State legislatures and regulators are also examining the provision of
telecommunications services to previously unserved areas. Since many unserved
areas are located in rural markets, we may be required to expand our service
territory into some of these areas.
Recent and Potential Regulatory Developments
- --------------------------------------------
Effective November 24, 2003, the FCC issued an order requiring wireline and
wireless carriers to provide local number portability (LNP). LNP is the ability
of customers to switch from a wireline carrier to a wireless carrier, or from
one wireless carrier to another wireless carrier, without changing telephone
numbers. Wireline carriers operating in the 100 largest Metropolitan Statistical
Areas (MSAs) (which includes our Rochester, New York market) must support
wireline-to-wireless number porting. Wireline carriers operating outside the 100
largest MSAs are required to comply with the order on May 24, 2004.
LNP will most likely promote further competition between wireline and wireless
carriers in an environment where the displacement of traditional wireline
services has been increasing because of technological substitutions such as cell
phones, e-mail and Internet phone calling.
The Company expects to incur approximately $9.0 million of capital expenditures
and $2.0 million of expenses during 2004 associated with LNP. If the number of
requests for LNP exceeds our expectations, these amounts could increase. Costs
to implement LNP will, however, be mitigated by charges to end-users for
enabling our systems to be capable of LNP.
In 1994, Congress passed the Communications Assistance for Law Enforcement Act
(CALEA) to ensure that telecommunication networks can meet law enforcement
wiretapping needs. The Company has received extensions of time to make our
entire network CALEA compliant. However, failure to be granted further
extensions could increase capital expenditures by up to $7.0 million in 2004.
5
The FCC in 2003 issued an order as a result of its triennial review of the 1996
Act. The order essentially kept in place the existing regulatory regime with
respect to Unbundled Network Elements Platform (UNEP) competition, provided
significant authority to state regulators to implement UNEP competition and
pricing, and eliminated a previous requirement of ILECs to share their DSL lines
with competitors. Because we do not currently have UNEP competition or
competitors providing DSL service, the FCC's order is not expected to have a
material effect on us in the near term. The Federal appeals court in the
District of Columbia overturned many aspects of the FCC's order, in particular
the broad delegation to state authorities to implement UNEP competition and
pricing. The appeals court did, however, uphold the line sharing provisions of
the order. This case may be further appealed and we will continue to evaluate
the effect on us as the challenges with respect to the order are decided.
The FCC is expected to address issues involving inter-carrier compensation, the
universal service fund and internet telephony in 2004 and 2005. Some of the
proposals being discussed with respect to inter-carrier compensation, such as
"bill and keep" (under which switched access charges and reciprocal compensation
would be reduced or eliminated), could reduce our access revenues. The universal
service fund is under pressure as local exchange companies lose access lines and
more entities, such as wireless companies, seek to receive monies from the fund.
The rules surrounding the eligibility of Competitive Eligible Telecommunication
Carriers (CETC's) such as wireless companies to receive universal service funds
are expected to be clarified by the Federal State Joint Board on Universal
Service during 2004 or 2005 and the outcome may heighten the pressures on the
fund. Changes in the funding or payout rules of the universal service fund could
further reduce our subsidy revenues. As discussed in MD&A, our subsidy revenues
are expected to decline in 2004 compared to 2003. The development and growth of
internet telephony (also known as VOIP) by cable and other companies has
increased the importance of regulators at both the federal and state levels
addressing whether such services are subject to the same or different regulatory
and financial schemes as traditional telephony. Issues to be determined include
whether internet telephony will be responsible for the payment of access charges
and contributions to the universal service fund, as well as CALEA and 911
regulation. Internet telephony may have an advantage over our traditional
services if it is less regulated. We are actively participating in the FCC's
consideration of all these issues.
Some state regulators (including New York and Illinois) have recently considered
imposing on regulated companies (including us) cash management practices that
could limit the ability of companies to transfer cash between subsidiaries or to
the parent company. None of the existing state requirements materially affect
our cash management but future changes by state regulators could affect our
ability to freely transfer cash within our consolidated companies.
CLEC Services Regulation
- ------------------------
As a CLEC, ELI is subject to federal, state and local regulation. However, the
level of regulation is typically less than that experienced by an ILEC. Local
governments may require ELI to obtain licenses or franchises regulating the use
of public rights-of-way necessary to install and operate its networks.
ELI has various interconnection agreements in the states in which it operates.
These agreements govern reciprocal compensation relating to the transport and
termination of traffic between the ILEC's and ELI's networks. The FCC is
significantly reducing intercarrier compensation for ISP traffic, also known as
"reciprocal compensation."
Most state public service commissions require competitive communications
providers, such as ELI, to obtain operating authority prior to initiating
intrastate services. Most states also require the filing of tariffs or price
lists and/or customer-specific contracts. ELI is not currently subject to
rate-of-return or price regulation. However, ELI is subject to state-specific
quality of service, universal service, periodic reporting and other regulatory
requirements, although the extent of these requirements is generally less than
those applicable to ILECs.
Competition
ILEC Services Competition
- -------------------------
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 carriers through
Unbundled Network Elements (UNE), Voice Over Internet Protocol (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 other internet service providers with respect to
internet access and cable telephony, and from wireless carriers. Most of the
wireline competition we face is in our Rochester, New York market, with
competition also present in a few other areas. Competition from cable companies
with respect to high-speed internet access is intense in many of our markets. We
expect the cable company in Rochester to begin offering a VOIP product during
2004. Competition from wireless companies, other long distance companies and
internet service providers is increasing in all of our markets.
6
Our ILEC business has been experiencing declining access lines, switched access
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, technology changes
and regulatory constraints. These factors are likely to cause our local service,
network access, long distance and subsidy revenues to continue to decline during
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
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 distance, long-haul and related services in the United States is
extremely competitive, with substantial overcapacity in the market, resulting in
lower prices. 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. 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 IXCs have filed for bankruptcy protection, which will allow
them to substantially reduce their cost structure and debt. This could enable
such companies to further reduce prices and increase competition.
The 1996 Act and subsequent FCC interconnection decisions have established the
relationships between ILECs and CLECs and the mechanisms for competitive market
entry. Though carriers like us, who serve rural markets, did receive a qualified
exemption from some of the technical requirements imposed upon all ILECs for
interconnection arrangements, we did not receive an exemption from
interconnection or local exchange competition in general. The exemption, known
as the rural telephone company exemption, applies to approximately 19% of our
access lines and continues until a bona fide request for interconnection is
received from a CLEC and a state public services commission with jurisdiction
determines that discontinuance of the exemption is warranted. The state
commission must determine that discontinuing the exemption will not adversely
impact the availability of universal service in the state nor impose an undue
economic hardship on us and that the requested interconnection is technically
feasible.
CLEC Services Competition
- -------------------------
ELI faces significant competition from ILECs in each of its markets. Principal
ILEC competitors include Qwest, SBC and Verizon. ELI also competes with all of
the major IXCs, internet access providers and other CLECs. CLEC service
providers have generally encountered intense competitive pressures, the result
of which is the failure of a number of CLECs and substantial financial pressures
on others.
Competitors in ELI's markets include, in addition to the incumbent providers:
AT&T, Sprint, Time Warner Telecom, MCI, Integra and XO Communications. In each
of the markets in which ELI operates, at least one other CLEC, and in some cases
several other CLECs, offer many of the same services that ELI provides,
generally at similar prices.
Competition is based on price, quality, network reliability, customer service,
service features and responsiveness to the customer's needs.
Many of these competitors have greater market presence and greater financial,
technical, marketing and human resources, more extensive infrastructure and
stronger customer and strategic relationships than are available to us.
7
Public Utilities Services
We have historically provided public utilities services including natural gas
transmission and distribution, electric transmission and distribution, water
distribution and wastewater treatment services to primarily rural and suburban
customers throughout the United States. In 1999, we announced a plan of
divestiture for our public utilities services properties. Since then, we have
divested or entered into contracts to divest all of our public utility
operations for an aggregate of $1.9 billion. In 1999, we initially accounted for
the planned divestiture of our public utilities services segments as
discontinued operations. Because we had not yet entered into agreements to sell
our entire gas and electric segments, we reclassified all our gas and electric
assets and their related liabilities in the second half of 2000 as "net assets
held for sale." As a result, our discontinued operations only reflected the
assets and related liabilities of the water and wastewater businesses.
In 2001, we sold our Louisiana gas operations for $363.4 million in cash and our
Colorado gas division for $8.9 million in cash. In 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, and our Kauai electric division for $215.0
million in cash. In 2003, we completed the sales of The Gas Company in Hawaii
division for $119.3 million in cash and assumed liabilities, our Arizona gas and
electric divisions for $224.1 million in cash and our electric transmission
operations in Vermont for $7.3 million in cash. These transactions are subject
to routine purchase price adjustments.
We have entered into definitive agreements to sell the remaining assets of our
Vermont electric division to Great Bay Hydro Corporation and Vermont Electric
Cooperative, Inc. for an aggregate of approximately $12.7 million in cash,
subject to adjustments under the terms of the agreements. The transactions,
which are subject to regulatory and other customary approvals, are expected to
close by mid-2004.
Natural Gas
- -----------
Our natural gas segment accounted for $137.7 million, or 6%, of our total
revenues in 2003.
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 division for $139.6
million in cash.
At December 31, 2003, we had sold all of our gas operations and, as a result,
will have no operating results in future periods for these businesses.
Electric
- --------
Our remaining electric operation provides electric distribution services in
Vermont to primarily residential customers. Our electric segment accounted for
$100.9 million, or 4%, of our total revenues in 2003. Approximately $67.4
million of the revenue from our electric segment relates to operations sold
during 2003. At December 31, 2003, the number of customers in the state of
Vermont totaled approximately 21,000.
Electric services and/or rates charged are subject to the jurisdiction of
federal and state regulatory agencies. We purchased approximately 96% of the
electric energy needed to provide service to our customers in Vermont. We
believe our supply is adequate to meet current demands and to provide for
additional sales to new customers. We have generating facilities in Vermont,
which are used mainly for back-up power supply.
Our Vermont Electric Division is a member of the Vermont Joint Owners, a
consortium of 14 Vermont utilities that has entered into a purchase power
agreement with a Canadian power generation facility. The agreement provides for
up to 395 MW of power per annum and associated energy to be delivered to
Vermont, in varying amounts, between 1990 and 2020. If any member of the
consortium defaults on its share of power under the agreement, the remaining
members of the consortium are required by "step-up" provisions of the agreement
to assume responsibility for a defaulting member's share on a pro-rata basis.
Our liability under this agreement continues after we have completed the sale of
our Vermont electric division and may be subject to the provisions of FASB
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, including the Indebtedness of Others," which, if applicable, would
require us to recognize a liability for the fair value of the obligation under
the guarantee, as well as provide additional disclosures about the obligations
associated with the guarantee.
In July 2002, the Vermont Public Service Board approved a rate increase of
17.45% for services rendered on or after July 15, 2002.
On November 1, 2002, we completed the sale of our Kauai electric division for
$215.0 million in cash.
8
On August 11, 2003, we completed the sale of our Arizona electric division for
$84.5 million in cash.
On December 2, 2003, we completed the sale of our transmission facilities in
Vermont for $7.3 million in cash.
Segment Information
Note 23 to Consolidated Financial Statements provides financial information
about our industry segments for the last three fiscal years.
Financial Information about Foreign and Domestic Operations and Export Sales
We have no foreign operations, although we have a 19% interest in Hungarian
Telephone and Cable Company (See Note 10 to Consolidated Financial Statements),
a company that provides wireline telephone service in Hungary.
General
Order backlog is not a significant consideration in our businesses. We have no
contracts or subcontracts that may be subject to renegotiations of profits or
termination at the election of the Federal government. We hold no patents,
licenses or concessions that are material. As of December 31, 2003, we had 6,708
employees, of whom 5,944 were associated with ILEC operations, 517 were
associated with ELI and 71 were associated with public utilities services
operations. At December 31, 2003, the total number of our employees affiliated
with a union was 3,855, of which 1,064 are covered by agreements set to expire
during 2004 (as of March 2004). We consider our relations with our employees to
be good.
Available Information
We make available on our website, free of charge, the periodic reports that we
file with or furnish to the Securities and Exchange Commission (the "SEC"), as
well as all amendments to these reports, as soon as reasonably practicable after
such reports are filed with or furnished to the SEC. We also make available on
our website, or in printed form upon request, free of charge, our Corporate
Governance Guidelines, Code of Business Conduct and Ethics, and the charters for
the Audit, Compensation, and Nominating and Corporate Governance committees of
the Board of Directors. Stockholders may request printed copies of these
materials by writing to: 3 High Ridge Park, Stamford, Connecticut 06905
Attention: Corporate Secretary. Our website address is http://www.czn.com.
Item 2. Properties
----------
Our principal corporate offices are located in leased premises at 3 High Ridge
Park, Stamford, Connecticut.
An operations support office is currently located in leased premises at 180
South Clinton Avenue, Rochester, New York. In conjunction with the acquisition
of Frontier in 2001, we evaluated our facilities to take advantage of
operational and functional synergies between the two companies with the
objective of concentrating our resources in the areas where we have the most
customers, to better serve those customers. As a result, we closed our
operations support center in Plano, Texas in April 2002 and sold the building in
2003. In addition, our ILEC segment leases and owns office space in various
markets throughout the United States.
An operations support office for ELI is located in a building we own at 4400 NE
77th Avenue, Vancouver, Washington. In addition, our CLEC segment leases local
office space in various markets throughout the United States, and also maintains
a warehouse facility in Portland, Oregon. Our CLEC segment also leases network
hub and network equipment installation sites in various locations throughout the
areas in which it provides services.
Our ILEC and CLEC services segments own telephone properties which include:
connecting lines between customers' premises and the central offices; central
office switching equipment; fiber-optic and microwave radio facilities;
buildings and land; and customer premise equipment. The connecting lines,
including aerial and underground cable, conduit, poles, wires and microwave
equipment, are located on public streets and highways or on privately owned
land. We have permission to use these lands pursuant to local governmental
consent or lease, permit, franchise, easement or other agreement.
Our remaining electric operation is administered locally in Vermont. Pending the
sale of this business, we own electric distribution and generating facilities in
Vermont.
9
Item 3. Legal Proceedings
-----------------
The City of Bangor, Maine, filed suit against us on November 22, 2002, in the
U.S. District Court for the District of Maine (City of Bangor v. Citizens
Communications Company, Civ. Action No. 02-183-B-S). We intend to defend
ourselves vigorously against the City's lawsuit. The City has alleged, among
other things, that we are responsible for the costs of cleaning up environmental
contamination alleged to have resulted from the operation of a manufactured gas
plant by Bangor Gas Company, which we owned from 1948-1963. The City alleged the
existence of extensive contamination of the Penobscot River and 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 counterclaims against the City. On October
24, 2003, we filed a motion for partial summary judgment with respect to the
City's claims under CERCLA. We anticipate a decision on that motion sometime in
the first or second quarter of 2004. In addition, we have identified a number of
other potentially responsible parties that may be liable for the damages alleged
by the City and have joined them as parties to the lawsuit. These additional
parties include Honeywell Corporation, the Army Corps of Engineers, Guilford
Transportation (formerly Maine Central Railroad), UGI Utilities, Inc., and
Centerpoint Energy Resources Corporation. We 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 this lawsuit to obtain from our
insurance carriers indemnification for any damages that may be assessed against
us in the City's lawsuit as well as to recover the costs of our defense of that
lawsuit.
In connection with an informal inquiry initiated on November 15, 2002, that we
believe was the result of allegations made to federal authorities during their
investigation of an embezzlement by two of our former officers, we have
cooperated fully 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.
We are party to other legal proceedings arising in the normal course of our
business. The outcome of individual matters is not predictable. However, we
believe that the ultimate resolution of all such matters, after considering
insurance coverage, will not have a material adverse effect on our financial
position, results of operations, or our cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None in fourth quarter 2003.
Executive Officers of the Registrant
- ------------------------------------
Information as to Executive Officers of the Company as of March 1, 2004 follows:
Name Age Current Position and Office
---- --- ---------------------------
Leonard Tow 75 Chairman of the Board and Chief Executive Officer
Scott N. Schneider 46 Vice Chairman of the Board, President and Chief Operating Officer
Donald B. Armour 56 Senior Vice President, Finance and Treasurer
John H. Casey, III 47 President and Chief Operating Officer of the ILEC Sector and Executive Vice
President
Jean M. DiSturco 40 Senior Vice President, Human Resources
Jerry Elliott 44 Senior Vice President and Chief Financial Officer
Michael G. Harris 57 Senior Vice President, Engineering and New Technology
Dean Jackson 37 Senior Vice President, Business Support Services
Robert J. Larson 44 Senior Vice President and Chief Accounting Officer
Daniel J. McCarthy 39 Senior Vice President Broadband Operations, President and COO
Electric Lightwave and President and COO Public Services Sector
L. Russell Mitten 52 Senior Vice President, General Counsel and Secretary
Dean Jackson, Senior Vice President, Business Support Services is the son-in-law
of Leonard Tow, the Chairman of the Board and Chief Executive Officer of
Citizens. There is no other family relationship between directors or executive
officers. The term of office of each of the foregoing officers of Citizens will
continue until the next annual meeting of the Board of Directors and until a
successor has been elected and qualified.
10
LEONARD TOW has been associated with Citizens since April 1989 as a Director. In
June 1990, he was elected Chairman of the Board and Chief Executive Officer. He
was also Chief Financial Officer from October 1991 through November 1997.
Previously he was Chief Executive Officer and Director of Century Communications
Corp., a cable telecom company, since its organization in 1973 to October 1999
and Chairman of the Board from 1989 to 1999. He is a Director of Hungarian
Telephone and Cable Corp., and is a Director of the United States Telephone
Association.
SCOTT N. SCHNEIDER has been associated with Citizens since November 1999. In
January 2001, he was elected Vice Chairman of the Board. In July 2000, he was
elected a Director of Citizens. He has served as Vice Chairman of the Board,
President and Chief Operating Officer of Citizens since July 2002. Previously he
was Vice Chairman - Executive Vice President from May 2001 to July 2002 and
Executive Vice President Strategic Planning and Development from May 2000 to May
2001 and Executive Vice President of Electric Lightwave, LLC from October 1999
to May 2000. Prior to joining Citizens, he was Director from October 1994 to
October 1999, Chief Financial Officer from December 1996 to October 1999, and
Senior Vice President and Treasurer from June 1991 to October 1999 of Century
Communications Corp. He also served as Director, Chief Financial Officer, Senior
Vice President and Treasurer of Centennial Cellular from August 1991 to October
1999.
DONALD B. ARMOUR has been associated with Citizens since October 2000. He was
elected Senior Vice President, Finance and Treasurer in December 2002.
Previously, he was Vice President, Finance and Treasurer from October 2000 to
December 2002. Prior to joining Citizens, he was the Treasurer of the cable
television division of Time Warner Inc. from January 1994 to September 2000.
JOHN H. CASEY, III has been associated with Citizens since November 1999. He is
currently Executive Vice President of Citizens and President and Chief Operating
Officer of our ILEC Sector. Previously he was Vice President of Citizens,
President and Chief Operating Officer, ILEC Sector from January 2002 to July
2002, Vice President and Chief Operating Officer, ILEC Sector from February 2000
to January 2002 and Vice President, ILEC Sector from December 1999 to February
2000. Prior to joining Citizens, he was Vice President, Operations from January
1995 to January 1997 and then Senior Vice President, Administration of
Centennial Cellular until November 1999.
JEAN M. DISTURCO has been associated with Citizens since 1987. She was elected
Senior Vice President, Human Resources in December 2002. Previously, she was
Vice President, Human Resources since October 2001, Vice President, Compensation
and Benefits since March 2001 and Director of Compensation from 1996 to March
2001.
JERRY ELLIOTT has been associated with Citizens since March 2002. He was elected
Senior Vice President and Chief Financial Officer in December 2002. Previously,
he was Vice President and Chief Financial Officer from March 2002 to December
2002. Prior to joining Citizens, he was Managing Director of Morgan Stanley's
Communications Investment Banking Group from July 1998 to March 2002. Prior to
joining Morgan Stanley, he was a partner with the law firm of Shearman &
Sterling.
MICHAEL G. HARRIS has been associated with Citizens since December 1999. He was
elected Senior Vice President, Engineering and New Technology in December 2002.
Previously, he was Vice President, Engineering and New Technology from December
1999 to December 2002. Prior to joining Citizens, he was Senior Vice President,
Engineering of Centennial Cellular from August 1991 to December 1999. He was
also Senior Vice President, Engineering of Century Communications Corp. from
June 1991 to October 1999.
DEAN JACKSON has been associated with Citizens since December 1999. He was
elected Senior Vice President, Business Support Services in February 2004.
Previously he was Vice President, Business Support Services from October 2002 to
February 2004, Assistant Vice President, Integration from August 2001 to October
2002 and Director, Integration from December 1999 to July 2001. Prior to joining
Citizens, he was Director, Programming and Business Development at Century
Communications Corp. from October 1998 to October 1999.
ROBERT J. LARSON has been associated with Citizens since July 2000. He was
elected Senior Vice President and Chief Accounting Officer of Citizens in
December 2002. Previously, he was Vice President and Chief Accounting Officer
from July 2000 to December 2002. Prior to joining Citizens, he was Vice
President and Controller of Century Communications Corp. from October 1994 to
October 1999. He was also Vice President, Accounting and Administration of
Centennial Cellular from March 1995 to October 1999.
11
DANIEL J. McCARTHY has been associated with Citizens since December 1990. He is
currently Senior Vice President Broadband Operations, President and COO Electric
Lightwave LLC., and President and COO Public Services. He was elected Senior
Vice President Broadband Operations in January 2004. He was elected President
and Chief Operating Officer, Electric Lightwave LLC. in January 2002.
Previously, he was President and Chief Operating Officer, Public Services Sector
from November 2001 to January 2002, Vice President and Chief Operating Officer,
Public Services Sector from March 2001 to November 2001, and Vice President,
Citizens Arizona Energy from April 1998 to March 2001.
L. RUSSELL MITTEN has been associated with Citizens since June 1990. He was
elected Senior Vice President, General Counsel and Secretary in December 2002.
Previously, he was Vice President, General Counsel and Secretary from September
2000 to December 2002. He was also Vice President, General Counsel and Assistant
Secretary from June 1991 to September 2000.
12
PART II
-------
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
----------------------------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
PRICE RANGE OF COMMON STOCK
Our Common Stock is traded on the New York Stock Exchange under the symbol CZN.
The following table indicates the high and low prices per share during the
periods indicated.
2003 2002
------------------- ------------------
High Low High Low
------- -------- ------- ------
First Quarter $11.55 $8.81 $11.30 $8.91
Second Quarter $13.40 $9.99 $11.52 $8.22
Third Quarter $13.39 $10.93 $8.80 $2.51
Fourth Quarter $12.80 $10.23 $10.99 $5.44
As of February 27, 2004, the approximate number of security holders of record of
our Common Stock was 29,698. This information was obtained from our transfer
agent.
DIVIDENDS
The amount and timing of dividends payable on our Common Stock are within the
sole discretion of our Board of Directors. We are currently exploring financial
and strategic alternatives, which may include a review of our future dividend
policy. There are no material restrictions on our ability to pay dividends.
RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM
REGISTERED SECURITIES
None
13
Item 6. Selected Financial Data
-----------------------
($ in thousands, except per share amounts) Year Ended December 31,
---------------------------------------- -----------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ----------- ------------ ------------ -----------
Revenue (1) $ 2,444,938 $ 2,669,332 $ 2,456,993 $ 1,802,358 $ 1,598,236
Income (loss) from continuing operations before
extraordinary expense and cumulative effect of
changes in accounting principle (2) $ 122,083 $ (822,976) $ (63,926) $ (40,071) $ 136,599
Net income (loss) $ 187,852 $ (682,897) $ (89,682) $ (28,394) $ 144,486
Basic income (loss) per share of Common Stock
from continuing operations before extraordinary
expense and cumulative effect of changes in
accounting principle (2) $ 0.44 $ (2.93) $ (0.28) $ (0.15) $ 0.53
Available for common shareholders per basic share $ 0.67 $ (2.43) $ (0.38) $ (0.11) $ 0.56
Available for common shareholders per diluted share $ 0.64 $ (2.43) $ (0.38) $ (0.11) $ 0.55
As of December 31,
--------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ----------- ------------ ------------ -----------
Total assets $ 7,689,110 $ 8,222,705 $10,646,169 $ 7,058,713 $ 5,926,824
Long-term debt $ 4,195,629 $ 4,957,361 $ 5,534,906 $ 3,062,289 $ 2,107,460
Equity units $ 460,000 $ 460,000 $ 460,000 $ - $ -
Company Obligated Mandatorily Redeemable
Convertible Preferred Securities $ 201,250 $ 201,250 $ 201,250 $ 201,250 $ 201,250
Shareholders' equity $ 1,415,183 $ 1,172,139 $ 1,946,142 $ 1,720,001 $ 1,919,935
(1) Represents revenue from continuing operations. Revenue from acquisitions
contributed $569.8 million and $49.5 million for the years ended December
31, 2001 and 2000, respectively. Revenue from gas operations sold
represented $137.7 million, $218.8 million, $232.3 million and $175.4
million in 2003, 2001, 2000 and 1999, respectively. Revenue from electric
operations sold represented $67.4 million, $76.6 million, $94.3 million,
$95.1 million and $78.7 million in 2003, 2002, 2001, 2000 and 1999,
respectively.
(2) Extraordinary expense represents an extraordinary after tax expense of
$43.6 million related to the discontinuance of the application of Statement
of Financial Accounting Standards No. 71 to our local exchange telephone
operations in 2001. The cumulative effect of changes in accounting
principles represents the $65.8 million after tax non-cash gain resulting
from the adoption of Statement of Financial Accounting Standards No. 143 in
2003, and the write-off of ELI's goodwill of $39.8 million resulting from
the adoption of Statement of Financial Accounting Standards No. 142 in
2002.
14
Item 7. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
This annual report on Form 10-K contains forward-looking statements that are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed or implied in the statements. Statements that
are not historical facts are forward-looking statements made pursuant to the
Safe Harbor Provisions of the Litigation Reform Act of 1995. In addition, words
such as "believes", "anticipates", "expects" and similar expressions are
intended to identify forward-looking statements. Forward-looking statements
(including oral representations) are only predictions or statements of current
plans, which we review continuously. Forward-looking statements may differ from
actual future results due to, but not limited to, any of the following
possibilities:
* Changes in the number of our access lines;
* The effects of competition from wireless, other wireline carriers
(through Unbundled Network Elements (UNE), Unbundled Network Elements
Platform (UNEP), voice over internet protocol (VOIP) or otherwise),
high speed cable modems and cable telephony;
* The effects of general and local economic and employment conditions on
our revenues;
* Our ability to effectively manage and otherwise monitor our
operations, costs, regulatory compliance and service quality;
* Our ability to successfully introduce new product offerings including
our ability to offer bundled service packages on terms that are both
profitable to us and attractive to our customers, and our ability to
sell enhanced and data services;
* The effects of changes in regulation in the telecommunications
industry as a result of the Telecommunications Act of 1996 and other
federal and state legislation and regulation, including changes in
access charges and subsidy payments;
* 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 medical expenses and related funding
requirements;
* The effect of changes in the telecommunications market, including the
likelihood of significantly increased price and service competition;
* Our ability to successfully convert the billing system for
approximately 775,000 of our access lines on a timely basis and within
our expected 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 from the
conversion;
* The effects of 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 1,100 employees that are scheduled to expire
during 2004;
15
* Possible changes to our capital structure (including the amount of our
debt), liquidity and strategy that could result from our ongoing
review of strategic and financial alternatives; and
* The effects of more general factors, including changes in economic
conditions; changes in the capital markets; changes in industry
conditions; changes in our credit ratings; and changes in accounting
policies or practices adopted voluntarily or as required by generally
accepted accounting principles or regulators.
You should consider these important factors in evaluating any statement in this
Form 10-K 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. We have no obligation to
update or revise these forward-looking statements.
Overview
- --------
We are a telecommunications company providing wireline communications services
to rural areas and small and medium-sized towns and cities as an incumbent local
exchange carrier, or ILEC. We offer our ILEC services under the "Frontier" name.
In addition, we provide competitive local exchange carrier, or CLEC, services to
business customers and to other communications carriers in certain metropolitan
areas in the western United States through Electric Lightwave, LLC, or ELI, our
wholly-owned subsidiary. We also provide electric distribution services to
primarily rural customers in Vermont.
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 cable telephony,
and from wireless carriers. Most of the wireline competition we face is in our
Rochester, New York market, with competition also present in a few other areas.
Time Warner Cable is expected to begin selling VOIP service in our Rochester
market during 2004. Competition from cable companies and other internet service
providers with respect to internet access is intense. Competition from wireless
companies and other long distance companies is increasing in all of our markets.
The telecommunications industry is undergoing significant changes and
difficulties. The market for internet access, long distance, long-haul and
related services in the United States is extremely competitive, with substantial
overcapacity in the market. Demand and pricing for certain CLEC services (such
as long-haul services) have decreased substantially. There is also increasing
price pressure on certain of our ILEC services such as long distance and
internet access. These trends are likely to continue and result in a challenging
revenue environment. These factors could also result in more bankruptcies in the
sector and therefore affect our ability to collect money owed to us by carriers.
Several long distance and Interexchange Carriers (IXCs) have filed for
bankruptcy protection, which will allow them to substantially reduce their cost
structure and debt. This could enable such companies to further reduce prices
and increase competition.
Our ILEC business has been experiencing declining access lines, switched minutes
of use and revenues because of economic conditions, high unemployment levels,
increasing competition (as described above), changing consumer behavior (such as
wireless displacement of wireline use and email use) and regulatory constraints.
During 2003, our access lines declined 1.9%, our switched minutes of use
declined 1.8% and our ILEC revenues declined 0.7%, in each case as compared to
2002. These factors are likely to cause our local network service, switched
network access, long distance and subsidy revenues to continue to decline during
2004. During 2003, our switched network access revenue declined 6.0%, our long
distance revenue declined 4.7% and our subsidy revenue declined 4.5%, in each
case as compared to 2002. One of the ways we are responding to competition is by
bundling services and products and offering them for a single price, which
results in lower pricing than purchasing the services separately. During 2003,
we added approximately 76,200 customers who are buying one of our bundled
packages and increased our revenue from enhanced services by 7.8%. In addition,
we added approximately 49,800 DSL subscribers during 2003 and increased our data
revenue by 19.8%. Our average revenue per month per average number of customers
during 2003 was $70.51 compared to $69.83 during 2002. The above discussion
excludes the sale of approximately 11,000 and 4,000 access lines in North Dakota
on April 1, 2003 and October 31, 2002, respectively.
Revenues from data services such as DSL continue to increase as a percentage of
our total revenues and revenues from high margin services such as local line and
access charges and subsidies are decreasing as a percentage of our revenues.
These factors, along with increasing operating and employee costs may cause our
profitability to decrease. In addition, costs we will incur during 2004 to
convert the billing system for some of our access lines, to enable our systems
to be capable of LNP and to retain certain employees will affect our
profitability and capital expenditures during 2004.
16
(a) Liquidity and Capital Resources
-------------------------------
For the year ended December 31, 2003, we used cash flows from continuing
operations, the proceeds from the sale of utility properties, cash and cash
equivalents to fund capital expenditures, interest payments and debt repayments.
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, and on December 1, 2003 we completed the sale of our electric
transmission facility in Vermont for $7.3 million in cash. The proceeds were
used for general corporate purposes, including the repayment of outstanding
indebtedness. As of December 31, 2003, we had cash and cash equivalents
aggregating $583.7 million.
For the year ended December 31, 2003, our capital expenditures were $278.0
million, including $244.0 million for the ILEC segment, $9.5 million for the ELI
segment, $23.9 million for the public utilities services segments ($22.1 million
of which related to businesses that have been sold) and $0.6 million of general
capital expenditures. Our capital spending has been trending lower as we
continue to closely scrutinize all of our capital projects, emphasize return on
investment and focus our capital expenditures on areas and services that have
the greatest opportunities with respect to revenue growth and cost reduction.
For example, in 2004 we will allocate significant capital to services such as
DSL in areas that are growing or demonstrate meaningful demand for DSL, and for
cost reduction opportunities such as our billing system conversion. In the past,
large capital outlays were made in newly acquired properties to be able to offer
all of our services across all of our areas and in order to improve network
capability and service quality. After those investments were made, the total
amount of capital spending has been further reduced because of declining
revenues and lower costs from vendors. We will continue to focus on managing our
costs while increasing our investment in certain new product areas such as DSL,
VPN and VOIP.
We have budgeted approximately $276.0 million for our 2004 capital projects
including $265.0 million for the ILEC segment (approximately $12.0 million of
which relates to our billing system conversion) and $11.0 million for the ELI
segment. Included in these budgeted capital amounts are approximately $9.0
million of capital expenditures associated with LNP. If the number of requests
for LNP exceeds our expectations, this amount could increase. Costs to implement
LNP will, however, be mitigated by charges to end-users for enabling our systems
to be capable of LNP. Furthermore, the Company has received extensions of time
to make our entire network CALEA compliant. However, failure to be granted
further extensions could increase capital expenditures by up to $7.0 million in
2004.
We have an available shelf registration of $825.6 million and we have available
lines of credit with financial institutions in the aggregate amount of $805.0
million. Associated facility fees vary, depending on our credit ratings, and are
0.25% per annum as of December 31, 2003. The expiration date for the facilities
is October 24, 2006. During the term of the facilities we may borrow, repay and
reborrow funds. As of December 31, 2003, there were no outstanding advances
under these facilities.
We believe operating cash flows, existing cash balances, and current credit
facilities will be adequate to finance our working capital requirements, make
required debt repayments through 2005 and support our short-term and long-term
operating strategies. Our credit facilities expire, and we have approximately
$1,335.0 million of debt that matures, in 2006 (assuming the $460 million of
debt that is part of our Equity Units remains outstanding until then). We are
likely to need to refinance a significant amount of this debt prior to maturity
and to extend the term of our credit facilities prior to expiration. In
addition, our ongoing review of financial and strategic alternatives could
result in an increase in the amount of our debt and as a result our debt service
requirements.
Debt Reduction
- --------------
For the year ended December 31, 2003, we retired an aggregate principal amount
of $726.6 million of debt.
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 its obligations under
another capital lease by reducing the number of optical fibers leased, which
resulted in a non-cash pre-tax gain of $25.0 million included in investment and
other income (loss), net.
17
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. During July and August 2003, we redeemed for
cash two additional Industrial Development Revenue Bond series aggregating $13.5
million.
During the twelve months ended December 31, 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. We subsequently
repurchased $1.0 million of these debentures in the open market. Accordingly,
the $11.6 million of remaining have been reclassified as long-term debt on the
balance sheet, with a final maturity of August 15, 2026.
In connection with the sale of our gas property in Hawaii during August 2003,
the buyer assumed, and the State of Hawaii released us from, all of our
obligations in connection with approximately $17.6 million of outstanding Hawaii
special purpose revenue bonds.
In connection with the sale of our Arizona utility businesses in August 2003, we
called for redemption approximately $31.2 million of the Company's Arizona
industrial development revenue bonds. These bonds were redeemed with cash during
November 2003. 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. 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 $100.0 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 the debt, 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.
On November 15, 2003, we redeemed with cash at par approximately $8.9 million of
the Company's Illinois environmental facilities revenue bonds.
On December 1, 2003, ELI settled all of its outstanding liabilities under a
capital lease with a cash payment of $19.0 million, representing a premium from
the carrying value of the capital lease obligation of approximately $1.3
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.
The notional amounts of fixed-rate indebtedness hedged as of December 31, 2003
and December 31, 2002 were $400.0 million and $250.0 million, respectively. Such
contracts require us to pay variable rates of interest (average pay rate of
approximately 5.46% as of December 31, 2003) and receive fixed rates of interest
(average receive rate of 8.38% as of December 31, 2003). All swaps are accounted
for under SFAS No. 133 as fair value hedges. For the year ended December 31,
2003, the interest savings resulting from these interest rate swaps totaled
approximately $8.9 million.
Off-Balance Sheet Arrangements
- ------------------------------
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationship with unconsolidated entities that would be expected to
have a material current or future effect upon our financial statements.
18
Future Commitments
- ------------------
A summary of our future contractual obligations and commercial commitments as of
December 31, 2003 is as follows:
Contractual Obligations:
- ------------------------ Less than More than
($ in thousands) Total 1 year 1-3 years 3-5 years 5 years
- --------------- ------ --------- --------- --------- ---------
Long-term debt
obligations (See Note 12) (1) $4,733,570 $ 87,851 $1,342,224 $ 755,269 $2,548,226
Capital lease
obligations (See Note 27) 10,061 151 329 419 9,162
Operating lease
obligations (See Note 27) 107,128 23,601 28,809 19,905 34,813
Purchase obligations (See Note 27) 86,631 57,881 28,750 - -
Other long-term liabilities (See
Note16) (2) 201,250 - - - 201,250
---------- --------- ---------- --------- ----------
Total $5,138,640 $ 169,484 $1,400,112 $ 775,593 $2,793,451
========== ========= ========== ========= ==========
(1) Includes the debt portion of the equity units ($460.0 million) and interest
rate swaps ($10.6 million).
(2) Consists of our Equity Providing Preferred Income Convertible Securities
(EPPICS) reflected on our balance sheet.
At December 31, 2003, we have outstanding performance letters of credit totaling
$19.5 million.
Our Board of Directors has approved retention and "change of control"
arrangements to incent certain executives and employees to continue their
employment with Citizens while we explore and consider our financial and
strategic alternatives. These arrangements include a mix of cash retention
payments, equity awards and enhanced severance and are contingent upon the
occurrence of certain events and tenure. If (i) the covered employees remain
with the Company for specified time periods, (ii) a change of control (as
defined) occurs and (iii) all employees covered by the arrangements are
terminated, additional compensation currently estimated to be approximately
$54.0 million in the aggregate is payable to the employees. If (i) the covered
employees remain for the specified time periods and (ii) a "change of control"
occurs but none of the employees are terminated, the amount payable to the
employees would be reduced to approximately $45.0 million. If no "change of
control" occurs, but the covered employees remain with the Company for the
specified periods, we expect to recognize (assuming all the employees remain for
the specified periods), approximately $9.8 million of additional compensation
expense in 2004, $3.4 million in 2005 and $3.0 million in 2006, pursuant to the
arrangements.
In addition to the arrangements and amounts described in the preceding
paragraph, restrictions on stock that has been previously awarded to employees
as part of their regular compensation would lapse in the event of a change of
control. We expense such grants over their vesting life (typically three to four
years). We will expense approximately $8.5 million of such restricted stock
awards in 2004, which is consistent with our prior years' expense. The
unamortized cost with respect to such restricted stock at the end of 2004 that
would be accelerated and immediately expensed upon a change in control is
currently estimated to be approximately $23.0 million.
EPPICS
- ------
In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust (the
Trust), issued, in an underwritten public offering, 4,025,000 shares of 5%
Company Obligated Mandatorily Redeemable Convertible Preferred Securities due
2036 (Trust Convertible Preferred Securities or EPPICS), representing preferred
undivided interests in the assets of the Trust, with a liquidation preference of
$50 per security (for a total liquidation amount of $201.3 million). The
proceeds from the issuance of the Trust Convertible Preferred Securities and a
Company capital contribution were used to purchase $207.5 million aggregate
liquidation amount of 5% Partnership Convertible Preferred Securities due 2036
from another wholly owned consolidated subsidiary, Citizens Utilities Capital
L.P. (the Partnership). The proceeds from the issuance of the Partnership
Convertible Preferred Securities and a Company capital contribution were used to
purchase from us $211.8 million aggregate principal amount of 5% Convertible
Subordinated Debentures due 2036. The sole assets of the Trust are the
Partnership Convertible Preferred Securities and our Convertible Subordinated
Debentures are substantially all the assets of the Partnership. Our obligations
under the agreements related to the issuances of such securities, taken
together, constitute a full and unconditional guarantee by us of the Trust's
obligations relating to the Trust Convertible Preferred Securities and the
Partnership's obligations relating to the Partnership Convertible Preferred
Securities.
19
In accordance with the terms of the issuances, we paid the 5% interest on the
Convertible Subordinated Debentures in 2003, 2002 and 2001. Only cash was paid
to the Partnership in payment of the interest on the Convertible Subordinated
Debentures. The cash was then distributed by the Partnership to the Trust and
then by the Trust to the holders of the EPPICS.
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 material restrictions on the payment of dividends by our
subsidiaries to us, or by us to our shareholders, either by contract, rule or
regulation.
Our $805.0 million credit facilities and our $200.0 million term loan facility
with the Rural Telephone Finance Cooperative (RTFC) contain a maximum leverage
ratio covenant. Under the leverage ratio covenant, we are required to maintain a
ratio of (i) total indebtedness minus cash and cash equivalents in excess of
$50.0 million to (ii) consolidated adjusted EBITDA (as defined in the
agreements) over the last four quarters of 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 and credit facility
covenants.
Acquisitions
- ------------
On June 29, 2001, we purchased Frontier for approximately $3,373.0 million in
cash.
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 these properties except for one
electric distribution and generation business in Vermont (see Note 9 to
Consolidated Financial Statements). All of the agreements relating to the sales
provide that we will indemnify the buyer against certain liabilities (typically
liabilities relating to events that occurred prior to sale), including
environmental liabilities, for claims made by specified dates and that exceed
threshold amounts specified in each agreement.
On January 15, 2002, we sold our water and wastewater services operations for
$859.1 million in cash and $122.5 million in assumed debt and other liabilities.
On October 31, 2002, we completed the sale of approximately 4,000 access lines
in North Dakota for approximately $9.7 million in cash.
On November 1, 2002, we completed the sale of our Kauai electric division for
$215.0 million in cash.
On April 1, 2003, we completed the sale of approximately 11,000 access lines in
North Dakota for approximately $25.7 million in cash.
On April 4, 2003, we completed the sale of our wireless partnership interest in
Wisconsin for approximately $7.5 million in cash.
On August 8, 2003, we completed the sale of The Gas Company in Hawaii division
for $119.3 million in cash and assumed liabilities.
On August 11, 2003, we completed the sale of our Arizona gas and electric
divisions for $224.1 million in cash.
On December 2, 2003, we completed the sale of our electric transmission
facilities in Vermont for $7.3 million in cash.
All of the remaining 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.
20
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.
Discontinuation of SFAS No. 71
- ------------------------------
Prior to 2001, our incumbent local exchange telephone properties had been
predominantly regulated following a cost of service/rate of return approach.
Accordingly, we applied the provisions of Statement of Financial Accounting
Standards (SFAS) No. 71 in the preparation of our consolidated financial
statements.
In the third quarter of 2001, we concluded that the provisions of SFAS No. 71
were no longer applicable to our local exchange telephone properties. Our
conclusion was based on the fact that pricing for a majority of our revenues in
our incumbent local exchange telephone properties is based upon price cap plans
that limit prices to changes in general inflation and estimates of productivity
for the industry at large or upon market pricing rather than on the specific
costs of operating our business, a requirement for the application of SFAS
No.71. We expect these trends in the deregulation of pricing and the
introduction of competition to continue. We intend to operate all of our
properties as competitive enterprises, to meet competitive entry and maximize
revenue by providing a broad range of products and services, such as data
services. Many of these future services will not be regulated, further
increasing the percentage of our revenue provided by our networks that is not
based upon historical cost/rate of return regulation.
As discussed further in Note 24 to Consolidated Financial Statements, in 2001 we
recorded a non-cash extraordinary charge of $43.6 million net of tax in our
statement of operations, to write-off regulatory assets and liabilities that
were recorded on our balance sheet. Based upon our evaluation of the pace of
technological change that is estimated to occur in certain components of our
rural telephone networks, we concluded that minor modifications in our asset
lives were required for the major network technology assets. In accordance with
the provisions of SFAS No. 101 and SFAS No. 121, we performed a test of the
impairment of the property, plant and equipment accounts for our properties
discontinuing SFAS No. 71 and based upon our expectations of future changes in
sales volumes and prices and the anticipated rate of entry of additional
competition into our markets, we concluded that an asset impairment was not
warranted.
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.
Telecommunications Bankruptcies
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.
Asset Impairment
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.
21
Depreciation and Amortization
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 and the
associated discharge of obligations.
Intangibles
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 of goodwill during 2003 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 value exceeded book value of goodwill. An
independent third party appraiser analyzed trade name.
Pension and Other Postretirement Benefits
Our estimates of pension expense, other post retirement benefits including
retiree medical benefits and related liabilities are "critical accounting
estimates." We sponsor a noncontributory defined benefit pension plan covering a
significant number of our employees and other post retirement benefit plans that
provide medical, dental, life insurance benefits and other benefits for covered
retired employees and their beneficiaries and covered dependents. The accounting
results for pension and post retirement benefit costs and obligations are
dependent upon various actuarial assumptions applied in the determination of
such amounts. These actuarial assumptions include the following: discount rates,
expected long-term rate of return on plan assets, future compensation increases,
employee turnover, healthcare cost trend rates, expected retirement age,
optional form of benefit and mortality. The Company reviews these assumptions
for changes annually with its outside actuaries. We consider our discount rate
and expected long-term rate of return on plan assets to be our most critical
assumptions.
The discount rate is used to value, on a present basis, our pension and post
retirement benefit obligation as of the balance sheet date. The same rate is
also used in the interest cost component of the pension and post retirement
benefit cost determination for the following year. The measurement date used in
the selection of our discount rate is the balance sheet date. Our discount rate
assumption is determined annually with assistance from our actuaries based on
the interest rates for long-term high quality corporate bonds. This rate can
change from year-to-year based on market conditions that impact corporate bond
yields.
The expected long-term rate of return on plan assets is applied in the
determination of periodic pension and post retirement benefit cost as a
reduction in the computation of the expense. In developing the expected
long-term rate of return assumption, we considered published surveys of expected
market returns, 10 and 20 year actual returns of various major indices, and our
own historical 5-year and 10-year investment returns.
The expected long-term rate of return on plan assets is based on an asset
allocation assumption of 30% to 45% in fixed income securities and 55% to 70% in
equity securities. We review our asset allocation at least annually and make
changes when considered appropriate. We continue to evaluate our own actuarial
assumptions, including the expected rate of return, at least annually. Our
pension plan assets are valued at actual market value as of the measurement
date.
Accounting standards require that we record an additional minimum pension
liability when the plan's "accumulated benefit obligation" exceeds the fair
market value of plan assets at the pension plan measurement (balance sheet)
date. In the fourth quarter of 2002, due to weak performance in the equity
markets during 2002 as well as a decrease in the year-end discount rate, we
recorded an additional minimum pension liability in the amount of $181.0 million
with a corresponding charge to shareholders' equity of $112.0 million, net of
taxes of $69.0 million. In the fourth quarter of 2003, due to strong performance
in the equity markets during 2003, partially offset by a decrease in the
year-end discount rate, the Company recorded a reduction to its minimum pension
liability in the amount of $35.0 million with a corresponding credit to
shareholders' equity of $22.0 million, net of taxes of $13.0 million. These
adjustments did not impact our earnings or cash flows. If discount rates and the
equity markets performance decline, the Company could be required to increase
its minimum pension liabilities and record additional charges to shareholder's
equity in the future.
22
Actual results that differ from our assumptions are added or subtracted to our
balance of unrecognized actuarial gains and losses. For example, if the year-end
discount rate used to value the plan's projected benefit obligation decreases
from the prior year-end then the plan's actuarial loss will increase. If the
discount rate increases from the prior year-end then the plan's actuarial loss
will decrease. Similarly, the difference generated from the plan's actual asset
performance as compared to expected performance would be included in the balance
of unrecognized gains and losses.
The impact of the balance of accumulated actuarial gains and losses are
recognized in the computation of pension cost only to the extent this balance
exceeds 10% of the greater of the plan's projected benefit obligation or market
value of plan assets. If this occurs, that portion of gain or loss that is in
excess of 10% is amortized over the estimated future service period of plan
participants as a component of pension cost. The level of amortization is
affected each year by the change in actuarial gains and losses and could
potentially be eliminated if the gain/loss activity reduces the net accumulated
gain/loss balance to a level below the 10% threshold.
We expect that our pension expense for 2004 will be $2 million - $4 million (it
was $12.4 million in 2003) and no contribution will be required to be made by us
to the pension plan in 2004. No contribution was made, or required, in 2003.
Income Taxes
We expect to reach conclusion on various state and federal income tax audits in
2004. Our 2004 effective income tax rate may vary from that of prior periods as
a result.
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
- -----------------------------
Goodwill and Other Intangibles
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets." This statement requires that goodwill and other intangibles with
indefinite useful lives no longer be amortized to earnings, but instead be
reviewed for impairment. We have no intangibles with indefinite useful lives
other than goodwill and trade name. The amortization of goodwill and trade name
ceased upon adoption of the statement on January 1, 2002. We were required to
test for impairment of goodwill and other intangibles with indefinite useful
lives as of January 1, 2002 and at least annually thereafter. Any transitional
impairment loss at January 1, 2002 was recognized as the cumulative effect of a
change in accounting principle in our statement of operations. As a result of
our adoption of SFAS No. 142, we recognized a transitional impairment loss
related to ELI of $39.8 million as a cumulative effect of a change in accounting
principle in our statement of operations in 2002. We annually examine the
carrying value of our goodwill and other intangibles with estimated useful lives
to determine whether there are any impairment losses and have determined for the
year ended December 31, 2003 that there was no impairment.
SFAS No. 142 also requires that intangible assets with estimated useful lives be
amortized over those lives and be reviewed for impairment in accordance with
SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets." We
reassess the useful life of our intangible assets with estimated useful lives
annually. The impact of the adoption of SFAS No. 142 is discussed in Note 2 to
Consolidated Financial Statements.
Accounting for Asset Retirement Obligations
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.
23
Depreciation expense for the Company's wireline operations had 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 2003.
Long-Lived Assets
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement establishes a single accounting
model, based on the framework established in SFAS No. 121, for impairment of
long-lived assets held and used and for long-lived assets to be disposed of by
sale, whether previously held and used or newly acquired, and broadens the
presentation of discontinued operations to include more disposal transactions.
We adopted this statement on January 1, 2002.
Debt Retirement
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
This statement eliminates the requirement that gains and losses from
extinguishment of debt be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. The statement requires
gains and losses from extinguishment of debt to be classified as extraordinary
items only if they meet the criteria in Accounting Principles Board Opinion No.
30, "Reporting the Results of Operations - Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" which provides guidance for distinguishing transactions
that are part of an entity's recurring operations from those that are unusual or
infrequent or that meet the criteria for classification as an extraordinary
item. We adopted SFAS No. 145 in the second quarter of 2002. During the years
ended December 31, 2003 and 2002, we recognized $64.8 million and $29.3 million
of gains from early debt retirement as other income, respectively. In addition,
for the year ended December 31, 2002, we recognized a $12.8 million loss due to
a tender offer related to certain debt securities. There were no similar types
of retirements in 2001.
Exit or Disposal Activities
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which nullified Emerging Issues Task Force
(EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity." SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred, rather than on the date of commitment to an exit
plan. This Statement is effective for exit or disposal activities that are
initiated after December 31, 2002. We adopted SFAS No. 146 on January 1, 2003.
The adoption of SFAS No. 146 did not have any material impact on our financial
position or results of operations.
Guarantees
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Guarantees of Indebtedness of Others." FIN 45 requires that a guarantor be
required to recognize, at the inception of a guarantee, a liability for the fair
value of the obligation assumed under the guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with the guarantee. The provisions
of FIN 45 are effective for guarantees issued or modified after December 31,
2002, and the disclosure requirements were effective for financial statements
for periods ending after December 15, 2002. We adopted FIN 45 on January 1,
2003. The adoption of FIN 45 did not have any material impact on our financial
position or results of operations.
Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No 123,
"Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based compensation and amends the disclosure requirements
of SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements. This statement is effective for fiscal years ending after
December 15, 2002. We have adopted the expanded disclosure requirements of SFAS
No. 148.
24
Variable Interest Entities
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003) ("FIN 46R"), "Consolidation of Variable Interest Entities," which
addresses how a business enterprise should evaluate whether it has a controlling
financial interest in an entity through means other than voting rights and
accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation
No. 46, "Consolidation of Variable Interest Entities," which was issued in
January 2003. We are required to apply FIN 46R to variable interests in variable
interest entities or VIEs created after December 31, 2003. For variable
interests in VIEs created before January 1, 2004, the Interpretation will be
applied beginning on January 1, 2005. For any VIEs that must be consolidated
under FIN 46R that were created before January 1, 2004, the assets, liabilities
and noncontrolling interests of the VIE initially would be measured at their
carrying amounts with any difference between the net amount added to the balance
sheet and any previously recognized interest being recognized as the cumulative
effect of an accounting change. If determining the carrying amounts is not
practicable, fair value at the date FIN 46R first applies may be used to measure
the assets, liabilities and noncontrolling interest of the VIE. We are currently
evaluating our investments and other arrangements to determine whether any of
our investee companies are VIEs. It is not practicable to reasonably estimate
the impact of adopting this Statement on our financial statements at the date of
this report.
Derivative Instruments and Hedging
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging," which clarifies financial accounting and
reporting for derivative instruments including derivative instruments embedded
in other contracts. This Statement is effective for contracts entered into or
modified after June 30, 2003. We adopted SFAS No. 149 on July 1, 2003. The
adoption of SFAS No. 149 did not have any material impact on our financial
position or results of operations.
Financial Instruments with Characteristics of Both Liabilities and Equity
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." The Statement
establishes standards for the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity.
Generally, the Statement is effective for financial instruments entered into or
modified after May 31, 2003 and is otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. We adopted the provisions of
the Statement on July 1, 2003. The adoption of SFAS No. 150 did not have any
material impact on our financial position or results of operations.
Pension and Other Postretirement Benefits
In December 2003, the FASB issued SFAS No. 132 (revised), "Employers'
Disclosures about Pensions and Other Postretirement Benefits." This statement
retains and revises the disclosure requirements contained in the original
statement. It requires additional disclosures including information describing
the types of plan assets, investment strategy, measurement date(s), plan
obligations, cash flows, and components of net periodic benefit cost recognized
in interim periods. This statement is effective for fiscal years ending after
December 15, 2003. We adopted the expanded disclosure requirements of SFAS No.
132 (revised).
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.
(b) Results of Operations
---------------------
REVENUE
ILEC revenue is generated primarily through the provision of local, network
access, long distance and data services. Such services are provided under either
a monthly recurring fee or based on usage at a tariffed rate and is not
dependent upon significant judgments by management, with the exception of a
determination of a provision for uncollectible amounts.
CLEC revenue is generated through local, long distance, data and long-haul
services. These services are primarily provided under a monthly recurring fee or
based on usage at agreed upon rates and are not dependent upon significant
judgments by management with the exception of the determination of a provision
for uncollectible amounts and realizability of reciprocal compensation. CLEC
usage based revenue includes amounts determined under reciprocal compensation
agreements. While this revenue is governed by specific contracts with the
counterparty, management defers recognition of portions of such revenue until
realizability is assured. Revenue earned from long-haul contracts is recognized
over the term of the related agreement.
25
Revenue from the provision of public utility services are recognized based on
usage without significant judgments made by management with the exception of a
provision for uncollectible accounts.
Consolidated revenue decreased $224.4 million, or 8% in 2003. The decrease in
2003 was primarily due to $192.7 million of decreased gas and electric revenue
primarily due to the disposition of our Arizona gas and electric operations and
The Gas Company in Hawaii division and $31.7 million of decreased
telecommunications revenue. Consolidated revenue increased $212.3 million, or
9%, in 2002. The increase in 2002 was primarily due to $420.5 million of
increased telecommunications revenue, largely due to the impact of the Frontier
acquisition on June 29, 2001, partially offset by $195.0 million of decreased
gas revenue largely due to the disposition of the Louisiana and Colorado gas
operations and the disposition of the Kauai electric division. The increase in
2001 was primarily due to the impact of acquisitions in the ILEC sector as well
as the pass-through to customers of the increased cost of gas offset by the
disposition of the Louisiana and Colorado gas operations.
On October 31, 2002 and April 1, 2003, we sold approximately 4,000 and 11,000
telephone access lines, respectively, in North Dakota. The revenues related to
these access lines totaled $1.9 million; $10.2 million and $11.1 million for the
years ended December 31, 2003, 2002 and 2001, respectively.
TELECOMMUNICATIONS REVENUE
($ in thousands) 2003 2002 2001
-------------- ------------------------------ ------------------------------ ---------
Amount $ Change % Change Amount $ Change % Change Amount
---------- ------------------ --------- ------------------- ---------
Access services $ 667,042 $ (24,852) -4% $ 691,894 $ 111,126 19% $ 580,768
Local services 859,002 8,683 1% 850,319 191,036 29% 659,283
Long distance and data
services 306,834 7,508 3% 299,326 102,229 52% 197,097
Directory services 106,934 2,551 2% 104,383 32,008 44% 72,375
Other 101,123 (15,860) -14% 116,983 32,453 38% 84,530
--------- --------- ---------- ---------- ----------
ILEC revenue 2,040,935 (21,970) -1% 2,062,905 468,852 29% 1,594,053
ELI 165,389 (9,690) -6% 175,079 (48,312) -22% 223,391
--------- --------- ---------- ---------- ----------
$2,206,324 $ (31,660) -1% $2,237,984 $420,540 23% $1,817,444
========= ========= ========== ========== ==========
Change in the number of our access lines is the most fundamental driver of
changes in our telecommunications revenue. Historically, rural local telephone
companies experienced steady growth in access lines because of positive
demographic trends, steady rural local economies and little competition. Many
rural local telephone companies (including us) have recently experienced a loss
of access lines primarily because of difficult economic conditions, increased
competition from competitive wireline providers, from wireless providers and
from cable companies (currently with respect to broadband but which may in the
future expand to cable telephony), and by some customers disconnecting second
lines when they add DSL or cable modem service. Excluding the North Dakota sale,
we lost approximately 47,100 access lines during 2003 but added approximately
49,800 DSL subscribers during this period. The loss of lines during 2003 was
equally weighted between residential and non-residential customers. The
non-residential line losses were principally in Rochester, while the residential
losses were throughout our markets. We expect to continue to lose access lines
during 2004. A continued decrease in access lines, combined with increased
competition and the other factors discussed in this MD&A, may cause our revenues
to decrease in 2004.
Access Services
Access services revenue for the year ended December 31, 2003 decreased $24.9
million or 4% as compared with the prior year period. Switched access revenue
decreased $20.7 million primarily due to the $18.1 million effect of access rate
reductions effective July 1, 2003, $2.6 million in increased disputes and $1.2
million related to the sale of our North Dakota exchanges. Special access
revenue increased $4.6 million primarily due to growth in special circuits of
$8.4 million partially offset by a decrease of $1.7 million attributable to the
sale of our North Dakota exchanges and $1.2 million in increased disputes.
Access services revenue includes our subsidy revenue, which decreased $8.7
million primarily due to decreased National Exchange Carrier Association (NECA)
support of $11.8 million partially offset by an increase of $4.9 million in
Universal Service Fund (USF) surcharge rates.
26
We expect our subsidy revenue to be approximately $9.0 million lower in 2004
than in 2003 primarily because of increases implemented during 2003 and 2004 in
national average loop costs that are compared to our costs (which have been
decreasing) to determine the amount of subsidy payments we receive. Our switched
access revenues are impacted by the program, known as the Coalition for
Affordable Local and Long Distance Services, or CALLS plan, which establishes a
price floor for interstate-switched access services and phases out many of the
subsidies in interstate access rates. We have been able to offset some of the
reduction in interstate access rates through end-user charges. There are no
material increases in end-user charges scheduled to take effect during 2004 or
2005. We believe the net effect of reductions in interstate access rates and
increases in end-user charges will reduce our revenues by approximately $10.0
million in 2004 compared to 2003. Annual reductions in interstate switched
access rates will continue through 2005 until the price floor is reached. Our
switched access revenues have also been adversely affected by declining switched
access minutes of use, which we expect to continue. Our subsidy and switched
access revenues are very profitable so any reductions in those revenues may
reduce our profitability.
Access services revenue for the year ended December 31, 2002 increased $111.1
million, or 19%, as compared with the prior year period primarily due to the
full year impact of Frontier of $92.4 million. Increases in subsidies of $20.3
million and non-switched access revenue of $12.5 million due to higher circuit
sales were partially offset by a decrease in switched access revenue of $16.5
million primarily from the effect of tariff rate reductions effective as of July
1, 2002.
Local Services
Local services revenue for the year ended December 31, 2003 increased $8.7
million, or 1% as compared with the prior year period. Local revenue decreased
$1.1 million primarily due to a $7.6 million decrease from continued losses of
access lines and the $4.0 million impact of the sale of our North Dakota
exchanges in 2003, partially offset by an $10.4 million increase in subscriber
line charges due to rate changes. Local services revenue includes our enhanced
services revenue, which increased $9.8 million primarily due to the sale of
additional feature packages. Continued difficult economic conditions or
increasing competition could make it more difficult to sell our packages and
bundles and cause us to lower our prices for those products and services, which
would adversely affect our revenues.
Local services revenue for the year ended December 31, 2002 increased $191.0
million, or 29%, as compared with the prior year period primarily due to the
full year impact of Frontier of $184.8 million. Increases of $8.0 million in
enhanced services for feature packages and $12.5 million from SLC were partially
offset by an $8.6 million decrease resulting from rate changes and line losses.
Long Distance and Data Services
Long distance and data services revenue for the year ended December 31, 2003
increased $7.5 million or 3% as compared with the prior year period primarily
due to growth of $17.6 million related to data services, partially offset by a
decrease of $10.0 million in long distance revenue. Our long distance revenues
decreased during 2003 due to lower average rates per minute related to the
introduction of new products including unlimited long distance and lower long
distance minutes of use because consumers are increasingly using their wireless
phones or calling cards to make long distance calls. We expect these factors
will continue to affect our long distance revenues during 2004.
Long distance and data services revenue for the year ended December 31, 2002
increased $102.2 million, or 52%, as compared with the prior year period
primarily due to the full year impact of Frontier of $72.4 million, $13.7
million growth related to data and dedicated circuits and growth in long
distance services of $11.0 million.
Directory Services
Directory revenue for the year ended December 31, 2003 increased $2.6 million or
2%, as compared with the prior year periods primarily due to growth in yellow
pages advertising.
Directory services revenue for the year ended December 31, 2002 increased $32.0
million, or 44%, as compared with the prior year period primarily due to the
full year impact of Frontier of $30.0 million and growth in yellow pages
advertising revenue of $2.0 million.
Other
Other revenue for the year ended December 31, 2003 decreased $15.9 million, or
14% compared with the prior year period primarily due to $7.8 million in
increased dispute reserves, the termination in 2002 of $2.5 million in contract
services provided to Global Crossing and a decrease of $2.0 million in Customer
Premise Equipment (CPE) sales. In addition, revenue from collocation/rents
declined $1.1 million and conferencing revenue decreased $1.0 million.
27
Other revenue for the year ended December 31, 2002 increased $32.5 million, or
38%, as compared with the prior year period primarily due to the full year
impact of Frontier of $32.8 million.
ELI revenue for the years ended December 31, 2003 and 2002 decreased $9.7
million, or 6%, and $48.3 million, or 22%, respectively, primarily due to lower
demand and prices for long-haul services, a decline in Integrated Service
Digital Network (ISDN) services due to less demand from internet service
providers and lower reciprocal compensation revenues.
GAS AND ELECTRIC REVENUE
($ in thousands) 2003 2002 2001
-------------- ------------------------------- ----------------------------- ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- -------------------- --------- ------------------- ---------
Gas revenue $ 137,686 $ (78,831) -36% $ 216,517 $ (195,017) -47% $ 411,534
Electric revenue $ 100,928 $ (113,903) -53% $ 214,831 $ (13,184) -6% $ 228,015
Gas revenue for the year ended December 31, 2003 decreased $78.8 million, or
36%, as compared with the prior year period 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.
Gas revenue for the year ended December 31, 2002 decreased $195.0 million, or
47%, as compared with the prior year period primarily due to the sale of our
Louisiana and Colorado gas operations partially offset by higher purchased gas
costs passed on to consumers.
Electric revenue for the year ended December 31, 2003 decreased $113.9 million,
or 53%, as compared with the prior year period primarily due to the sales of our
Arizona electric division and Kauai Electric. Included in electric revenue for
the year ended December 31, 2002 is approximately $183.5 million 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 December 31, 2003. We expect to sell this property by mid
- - 2004.
Electric revenue for the year ended December 31, 2002 decreased $13.2 million,
or 6%, as compared with the prior year period primarily due to the sale of our
Kauai electric division partially offset by increased unit sales and the effect
of a rate increase approved in Vermont on July 15, 2002.
COST OF SERVICES
($ in thousands) 2003 2002 2001
-------------- ----------------------------- ----------------------------- ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------- ---------- ------------------ ---------
Network access $ 223,547 $ (11,915) -5% $ 235,462 $ 41,368 21% $ 194,094
Gas purchased 82,311 (40,604) -33% 122,915 (159,146) -56% 282,061
Electric energy and fuel
oil purchased 63,831 (54,712) -46% 118,543 (4,680) -4% 123,223
--------- --------- --------- ---------- ---------
$ 369,689 $(107,231) -22% $ 476,920 $(122,458) -20% $ 599,378
========= ========= ========= ========== =========
Network access expenses for the year ended December 31, 2003 decreased $11.9
million, or 5%, as compared with the prior year period primarily due to
decreased costs in long distance access expense related to rate changes
partially offset by increased circuit expense associated with additional data
product sales in the ILEC sector. ELI costs have declined due to a drop in
demand coupled with improved network cost efficiencies. If we continue to
increase our sales of data products such as DSL or expand the availability of
our unlimited calling plans, our network access expense could increase.
Network access expenses for the year ended December 31, 2002 increased $41.4
million, or 21%, as compared with the prior year period primarily due to the
full year impact of Frontier of $41.3 million and increased costs of $16.6
million in the ILEC sector, partially offset by decreased costs of $16.5 million
in ELI as a result of decreases in demand and a reduction in the number of
cities in which ELI operates.
28
Gas purchased for the year ended December 31, 2003 decreased $40.6 million, or
33%, as compared with the prior year period primarily due to the sales of The
Gas Company in Hawaii and our Arizona gas division. We no longer have any gas
operations.
Gas purchased for the year ended December 31, 2002 decreased $159.1 million, or
56%, as compared with the prior year period primarily due to the sale of our
Louisiana and Colorado gas operations partially offset by an increase in the
cost of gas due to higher commodity pricing.
Electric energy and fuel oil purchased for the year ended December 31, 2003
decreased $54.7 million, or 46%, as compared with the prior year period
primarily due to the sales of our Arizona electric division and Kauai Electric.
Electric energy and fuel oil purchased for the year ended December 31, 2002
decreased $4.7 million, or 4%, as compared with the prior year period primarily
due to the sale on November 1, 2002 of Kauai electric partially offset by
increased purchased power costs. Included in electric energy and fuel oil
purchased for 2002 and 2001 is approximately $27.5 million and $37.9 million,
respectively, of electricity purchased by our Kauai electric operation that
ceased upon its sale on November 1, 2002.
OTHER OPERATING EXPENSES
($ in thousands) 2003 2002 2001
-------------- ----------------------------- ------------------------------ ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------- ---------- ------------------- ---------
Operating expenses $ 692,249 $ (70,624) -9% $ 762,873 $ 23,751 3% $ 739,122
Taxes other than income taxes 97,119 (34,139) -26% 131,258 15,448 13% 115,810
Sales and marketing 112,383 4,159 4% 108,224 11,446 12% 96,778
--------- ---------- ---------- --------- ---------
$ 901,751 $(100,604) -10% $1,002,355 $ 50,645 5% $ 951,710
========= ========== ========== ========= =========
Operating expenses for the year ended December 31, 2003 decreased $70.6 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
(310 fewer employees than 2002) and decreased operating expenses in the gas and
electric sectors due to the sales of The Gas Company in Hawaii ($11.3 million),
our Arizona gas and electric divisions ($16.4 million) and Kauai Electric ($21.5
million). Expenses were negatively impacted by increased compensation expense of
$1.5 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.
Operating expenses for the year ended December 31, 2002 increased $23.8 million,
or 3%, as compared with prior year period primarily due to increased operating
expenses related to the full year impact of Frontier of $149.9 million partially
offset by increased operating efficiencies and a reduction of personnel in the
ILEC and ELI sectors, and decreased operating expenses in the gas sector due to
the sale of our Louisiana and Colorado gas operations on July 2, 2001 and
November 30, 2001, respectively. The increase was also offset by the fact that
there were no acquisition assimilation costs in 2002 compared to $21.4 million
of such costs in 2001.
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 our assumptions for 2004 (return
on plan assets of 8.25% per year and a discount rate of 6.25%) and plan asset
values, we estimate that our pension expense, which increased from $4.3 million
in 2002 to $12.4 million in 2003, will decrease to approximately $2 - $4 million
in 2004 and that no contribution will be required to be made by us to the
pension plan in 2004. No contribution was made, or required, in 2003. In
addition, as medical costs increase the costs of our post retirement benefit
costs also increase. Our postretirement benefit costs for 2003 were $16.9
million and our current estimate for 2004 is approximately $19 - $20 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 2004.
In future periods, compensation expense related to variable stock plans may be
materially affected by our stock price. A $1.00 change in our stock price
impacts compensation expense by approximately $1.0 million.
Taxes other than income taxes for the year ended December 31, 2003 decreased
$34.1 million, or 26%, 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.
29
Taxes other than income taxes for the year ended December 31, 2002 increased
$15.4 million, or 13%, as compared to prior year period primarily due to the
full year impact of Frontier of $25.6 million partially offset by decreased
payroll taxes in the ILEC sector related to workforce reductions and decreased
taxes in the gas sector due to the sale of our Louisiana and Colorado gas
operations on July 2, 2001 and November 30, 2001, respectively.
Sales and marketing expenses for the year ended December 31, 2003 increased $4.2
million, or 4%, as compared to the prior year period due to increased marketing
costs in the ILEC sector primarily related to enhanced services and DSL.
Sales and marketing expenses for the year ended December 31, 2002 increased
$11.4 million, or 12%, as compared to prior year period primarily due to the
full year impact of Frontier of $22.2 million, partially offset by decreased
sales and marketing in the ELI sector of $10.0 million, primarily due to a
reduction in personnel and related costs.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) 2003 2002 2001
-------------- ------------------------------ ------------------------------ ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------- ---------- ------------------- ---------
Depreciation expense $ 468,438 $ (161,675) -26% $ 630,113 $ 141,156 29% $ 488,957
Amortization expense 126,838 1,429 1% 125,409 (17,970) -13% 143,379
--------- ---------- ---------- ---------- ---------
$ 595,276 $ (160,246) -21% $ 755,522 $ 123,186 19% $ 632,336
========= ========== ========== ========== =========
Depreciation expense for the year ended December 31, 2003 decreased $161.7
million, or 26%, 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 $23.4 million relating to the closing of our Plano, Texas facility also
contributed to the decrease.
Depreciation expense for the year ended December 31, 2002 increased $141.2
million, or 29%, as compared to prior year period primarily due to the full year
impact of Frontier of $82.6 million and increased depreciation of $35.6 million
at ELI. The increase at ELI was primarily due to the purchase of $110.0 million
of previously leased facilities in April 2002 and changes in our estimates of
the depreciable lives as of June 2002. The Company assessed the estimated life
of those facilities as well as the useful lives of similar depreciable assets
already held by ELI. The reassessment of the useful lives of ELI's long lived
assets was performed to ensure that those lives reflected the expected life of
the assets given the nature of ELI's industry and included a comparison to
others in the CLEC industry. These increases were offset by a decrease related
to the ELI impairment charge recognized during the third quarter of 2002. As a
result of ELI's continued losses and continued revenue declines in excess of
previously projected results, ELI's assets including those subject to the change
in estimated lives in June 2002, were the subject of the impairment charge
reflected as of September 30, 2002.
Amortization expense for the year ended December 31, 2003 increased $1.4
million, or 1% as compared with the prior year period primarily due to the
receipt of the final valuation report of our Frontier acquisition during the
second quarter of 2002, which resulted in an increase in our customer base.
Amortization expense for the year ended December 31, 2002 decreased $18.0
million, or 13%, as compared to the prior year period primarily due to the fact
that we ceased amortization of goodwill and trade name related to our previous
acquisitions as of January 1, 2002 in accordance with SFAS No. 142, "Goodwill
and Other Intangible Assets." This decrease was offset by full year amortization
of Frontier acquired customer base. As a result of ELI's adoption of SFAS No.
142, we recognized a transitional impairment loss of $39.8 million as a
cumulative effect of a change in accounting principle in our statement of
operations in the first quarter of 2002.
RESERVE FOR TELECOMMUNICATIONS BANKRUPTCIES / RESTRUCTURING AND OTHER EXPENSES
($ in thousands) 2003 2002 2001
-------------- ------------------------------- ----------------------------- ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- -------------------- --------- ------------------- ---------
Reserve for (recovery of)
telecommunications bankruptcies $ (4,377) $ (15,257) -140% $ 10,880 $ (10,320) -49% $ 21,200
Restructuring and other expenses $ 9,687 $ (27,499) -74% $ 37,186 $ 17,859 92% $ 19,327
30
During the fourth quarter of 2003, an agreement with WorldCom/MCI settling all
pre-bankruptcy petition obligations and receivables was approved by the
bankruptcy court. This settlement resulted in reduction to our reserve of
approximately $6.6 million in the fourth quarter of 2003. 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.
Concurrent with the acquisition of Frontier, we entered into several operating
agreements with Global Crossing. We have ongoing commercial relationships with
Global Crossing affiliates. We reserved a total of $29.0 million of Global
Crossing receivables during 2001 and 2002 as a result of Global Crossing'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 Crossing, 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 severance
expenses related to reductions in personnel at our telecommunications operations
and the write-off of software no longer used.
Restructuring and other expenses for the year ended December 31, 2002 primarily
consist of $33.0 million of severance related to reductions in personnel at our
telecommunications operations, costs that were spent at both our Plano, Texas
facility and at other locations as a result of transitioning functions and jobs,
and $6.8 million related to our tender offer in June 2002 for all of the ELI
common shares that we did not already own. These costs were partially offset by
a $2.8 million reversal of a 2001 ELI accrual discussed below.
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 $14.6 million in the second
half of 2001, $0.8 million in the first quarter of 2002 and we adjusted our
accrual down by $0.1 million and $0.6 million in the second and third
quarter of 2002, respectively. Our objective is to concentrate our
resources in areas where we have the most customers, to better serve those
customers. We sold our Plano office building in 2003. The restructuring
resulted in the termination of 750 employees. We communicated with all
affected employees during July 2001. Certain employees were relocated
whereas others were offered severance, job training and/or outplacement
counseling. As of December 31, 2002, approximately $14.7 million had been
paid and all affected employees had been terminated. The restructuring
expenses primarily consist of severance benefits, retention payments earned
through December 31, 2002, and other planning and communication costs.
Sacramento Call Center Restructuring
In April 2002, we closed our Sacramento Customer Care Center. In connection
with this closing, we recorded a pre-tax charge of $0.7 million in the
fourth quarter of 2001, and $0.1 million and $9,000 in the first and second
quarters of 2002, respectively. We redirected the call traffic and other
work activities to our Kingman, Arizona call center. This restructuring
resulted in the elimination of 98 employees. We communicated with all
affected employees during November 2001. As of December 31, 2002,
approximately $0.8 million was paid, all affected employees were terminated
and no accrual remained.
ELI Restructuring
In the first half of 2002, ELI redeployed the internet routers, frame relay
switches and ATM switches from the Atlanta, Cleveland, Denver, Philadelphia
and New York markets to other locations in ELI's network. ELI ceased
leasing the collocation facilities and off-net circuits for the backbone
and local loops supporting the service delivery in these markets. It was
anticipated that this would lead to $4.2 million of termination fees, which
were accrued for but not paid at December 31, 2001. During 2002, ELI
adjusted its original accrual down by $2.8 million due to the favorable
settlements of termination charges for off-net circuit agreements. As of
December 31, 2002, $1.4 million has been paid and no accrual remained.
31
LOSS ON IMPAIRMENT
($ in thousands) 2003 2002 2001
-------------- ------------------------------- --------------------------------- ---------
Amount $ Change % Change Amount $ Change % Change Amount
--------- -------------------- ----------- --------------------- ----------
Loss on impairment $ 15,300 $ (1,058,758) -99% $ 1,074,058 $ 1,074,058 100% $ -
During the third and fourth quarters of 2003, we recognized additional pre-tax
impairment losses of $4.0 million and $11.3 million related to our Vermont
property to write down assets to be sold to our best estimate of their net
realizable value upon sale.
In the third quarter 2002, we recognized non-cash pre-tax impairment losses of
$656.7 million related to property, plant and equipment in the ELI sector and
$417.4 million related to the gas and electric sector assets held for sale. Our
assessment of impairment for ELI was a result of continued losses at ELI and
continued actual revenue declines in excess of projected revenue declines. The
gas and electric sector impairments were associated with the sale of our Arizona
and Hawaiian gas and electric properties at prices that were less than the
previous carrying values and the write-down of our remaining utility to our best
estimate of net realizable sales price. Previously, we believed that the net
realizable value of these properties was equal to or above their carrying
values. However, as a result of market conditions, and the desire to complete
the divestiture process quickly in order to focus on our core telecommunications
operations and raise money to further reduce debt, in the third quarter of 2002
we made a strategic decision to accept proceeds less than carrying values rather
than continue to market these properties for higher prices (See Critical
Accounting Policies and Estimates above).
INVESTMENT AND OTHER INCOME (LOSS), NET / GAIN (LOSS) ON SALE OF ASSETS /
INTEREST EXPENSE / INCOME TAX EXPENSE (BENEFIT)
($ in thousands) 2003 2002 2001
-------------- ------------------------------- ------------------------------ --------
Amount $ Change % Change Amount $ Change % Change Amount
--------- -------------------- --------- -------------------- --------
Investment income (loss), net $ 10,432 $ 108,791 111% $ (98,359) $ (35,951) 58% $ (62,408)
Other income (loss), net $ 64,481 $ 51,742 406% $ 12,739 $ 17,557 364% $ (4,818)
Gain (loss) on sale of assets $ (20,492) $ (30,290) -309% $ 9,798 $ (129,506) -93% $ 139,304
Interest expense $ 416,524 $ (51,705) -11% $ 468,229 $ 90,588 24% $ 377,641
Income tax expense (benefit) $ 67,216 $ 482,090 116% $(414,874) $ (400,069) 2702% $ (14,805)
Investment income for the year ended December 31, 2003 increased $108.8 million
as compared to prior year period primarily due to the recognition in 2002 of
non-cash pre-tax losses of $95.3 million resulting from an other than temporary
decline in the value of our investment in Adelphia and $16.4 million resulting
from an other than temporary decline in the value of our investment in D & E
Communications, Inc. (see Note 10 to Consolidated Financial Statements),
partially offset by lower income in 2003 from money market balances and
short-term investments.
Investment loss for the year ended December 31, 2002 increased $36.0 million, or
58%, as compared to prior year period primarily due to the recognition of a
$95.3 million loss, resulting from an other than temporary decline in the value
of our investment in Adelphia Communications Corp. (Adelphia), an increase of
$16.3 million compared to the loss of $79.0 million recorded on our Adelphia
investment in 2001. We also recognized during 2002 a loss of $16.4 million
resulting from an other than temporary decline in the value of our investment in
D & E Communications, Inc. (D & E).
Other income, net for the year ended December 31, 2003 increased $51.7 million
as compared to prior year period primarily due to $69.4 million in non-cash
pre-tax gains in 2003 related to capital lease restructurings at ELI, $6.2
million of income in 2003 from the settlement of certain retained liabilities at
less than face value, which are associated with customer advances for
construction from our disposed water properties, a decrease of $20.1 million
compared to income of $26.3 million in 2002. During 2003, we executed a series
of purchases in the open market of our outstanding notes and debentures that
generated a pre-tax loss from the early extinguishment of debt of approximately
$3.1 million.
Other income, net for the year ended December 31, 2002 increased $17.6 million
as compared to prior year period primarily due to $26.3 million of income from
the settlement of certain retained liabilities. During 2002, we executed a
series of purchases in the open market of our outstanding notes and debentures
that generated a pre-tax gain from the early extinguishment of debt of
approximately $6.0 million, which also contributed to the increase. The increase
was partially offset by a $12.8 million loss related to a tender offer completed
in December 2002 with respect to our 6.80% Debentures due 2026 (puttable at par
in 2003) and ELI's 6.05% Guaranteed Notes due 2004.
32
Loss on sale of assets of $20.5 million, net for the year ended December 31,
2003 decreased $30.3 million as compared with the prior year's gain of $9.8
million 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.
Gain on sale of assets of $9.8 million for the year ended December 31, 2002
decreased $129.5 million as compared with prior year's gain of $139.3 million
due to the sale of our Kauai electric division on November 1, 2002 as well as an
adjustment of the gain on the 2001 sale of our Louisiana gas operation. Gain on
sale of assets for the year ended December 31, 2001 represents the initial gain
on the sale of the Louisiana gas operation on July 2, 2001. The gain recognized
on our water sale is classified in discontinued operations.
Interest expense for the year ended December 31, 2003 decreased $51.7 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 year ended
December 31, 2003, we had average long-term debt (excluding equity units and
convertible preferred stock) outstanding of $4.6 billion compared to $5.2
billion during the year ended December 31, 2002. Our weighted average borrowing
rate for the year ended December 31, 2003 as compared with the prior year period
was 20 basis points higher, increasing from 7.87% to 8.07%, due to the repayment
of debt with interest rates below our average rate.
Interest expense for the year ended December 31, 2002 increased $90.6 million or
24% as compared with the prior year primarily because of the full year impact of
$3.5 billion of notes, $460.0 million of equity units and $200.0 million of
Rural Telephone Finance Cooperative notes issued during 2001 to refinance debt
incurred in connection with our acquisitions, and higher amortization of debt
issuance costs. These increases were partially offset by the repayment of bank
debt and repurchases of debt described under "Liquidity and Capital Resources -
Debt Reduction." During the year ended December 31, 2002, we had average
long-term debt outstanding excluding our equity units of $5.2 billion compared
to $4.3 billion during the year ended December 31, 2001. Our composite average
borrowing rate for the year ended December 31, 2002 as compared with the year
ended December 31, 2001 was 53 basis points higher, increasing from 7.34% to
7.87% due to the impact of higher interest rates as a result of our refinancing
our variable rate debt with fixed rate long-term debt.
Income taxes for the year ended December 31, 2003 increased $482.3 million as
compared with the prior year period primarily due to changes in taxable income
(loss). Income tax benefit for the year ended December 31, 2002 increased $400.1
million as compared with prior year period primarily due to changes in taxable
income (loss). The effective tax rate for 2003 is 34.4% as compared with an
effective tax rate of 33.7% for 2002.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
($ in thousands) 2003 2002
-------------- --------- ---------
Amount Amount
--------- ---------
Cumulative effect of change in accounting
principle $ 65,769 $ (39,812)
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 $39.8 million for
goodwill related to ELI (see Note 2 to Consolidated Financial Statements).
33
EXTRAORDINARY EXPENSE
($ in thousands) 2001
-------------- ---------
Amount
---------
Extraordinary expense - discontinuation of
Statement of Financial Accounting Standards
No. 71, net of tax $ 43,631
Extraordinary expense - discontinuation of Statement of Financial Accounting
Standards No. 71, net of tax, of $43.6 million for the year ended December 31,
2001, relates to the write-off of regulatory assets and liabilities previously
recognized under SFAS No. 71. Deregulation of most of our local exchange
telephone properties required us to cease application of SFAS No. 71 in the
third quarter, resulting in a non-cash extraordinary charge of $43.6 million,
net of tax, in our statement of operations. See discussion in Note 24 of
Consolidated Financial Statements.
DISCONTINUED OPERATIONS
($ in thousands) 2002 2001
-------------- ----------------------
Amount Amount
----------------------
Revenue $ 4,650 $ 116,868
Operating income (loss) $ (415) $ 37,211
Income (loss) from discontinued operations,
net of tax $ (1,478) $ 17,875
Gain on disposal of water segment, net of tax $ 181,369 $ -
Revenue, operating income (loss) and income (loss) from discontinued operations,
net of tax, for the year ended December 31, 2002 decreased as compared with the
prior year period due to the sale of our water and wastewater businesses in
January 2002. On January 15, 2002, we completed the sale of our water and
wastewater operations for $859.1 million in cash and $122.5 million of assumed
debt and other liabilities. The gain on the disposal of the water segment, net
of tax, was $181.4 million.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities. Market risk refers to the
potential change in fair value of a financial instrument as a result of
fluctuations in interest rates and equity and commodity prices. We do not hold
or issue derivative instruments, derivative commodity instruments or other
financial instruments for trading purposes. As a result, we do not undertake any
specific actions to cover our exposure to market risks and we are not party to
any market risk management agreements other than in the normal course of
business or to hedge long-term interest rate risk. Our primary market risk
exposures are interest rate risk and equity and commodity price risk as follows:
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest-bearing portion of our investment portfolio and interest on our
long term debt and capital lease obligations. The long term debt and capital
lease obligations include various instruments with various maturities and
weighted average interest rates.
Our objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, a majority of our borrowings have
fixed interest rates. 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 December 31, 2003, a near-term change
in interest rates would not materially affect our consolidated financial
position, results of operations or cash flows.
34
In order to manage our interest rate risk exposure, we have entered into
interest rate swap agreements. Under the terms of the agreements, we make
semi-annual, floating interest rate interest payments based on six month LIBOR
and receive a fixed rate on the notional amount.
Sensitivity analysis of interest rate exposure
At December 31, 2003, the fair value of our long-term debt and capital lease
obligations excluding our equity units was estimated to be approximately $4.6
billion, based on our overall weighted average borrowing rate of 8.09% and our
overall weighted maturity of 13 years. There has been no material change in the
weighted average maturity since December 31, 2002. The overall weighted average
interest rate increased in 2003 by approximately 4 basis points. A hypothetical
increase of 81 basis points in our weighted average interest rate (10% of our
overall weighted average borrowing rate) would result in an approximate $220.3
million decrease in the fair value of our fixed rate obligations.
Equity Price Exposure
Our exposure to market risks for changes in equity prices is minimal and relates
primarily to the equity portion of our investment portfolio. The equity portion
of our investment portfolio consists of equity securities (principally common
stock) of D & E and Hungarian Telephone and Cable Corp. (HTTC).
As of December 31, 2003, we owned 3,059,000 shares of Adelphia common stock.
As of December 31, 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. The stock price of
HTCC was $9.86 and $7.87 at December 31, 2003 and 2002, respectively.
As of December 31, 2003 and 2002, we owned 1,333,500 shares of D & E common
stock. The stock price of D & E was $14.51 and $8.36 at December 31, 2003 and
2002, respectively.
Sensitivity analysis of equity price exposure
At December 31, 2003, the fair value of the equity portion of our investment
portfolio was estimated to be $44.3 million. A hypothetical 10% decrease in
quoted market prices would result in an approximate $4.4 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 December 31, 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 8. Financial Statements and Supplementary Data
-------------------------------------------
The following documents are filed as part of this Report:
1. Financial Statements, See Index on page F-1.
2. Supplementary Data, Quarterly Financial Data is included in
the Financial Statements (see 1. above).
Item 9. Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
--------------------
None
35
Item 9A. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures
We carried out an evaluation, under the supervision and with the participation
of our management, regarding the effectiveness of the design and operation of
our disclosure controls and procedures. Based upon this evaluation, our
principal executive officer and principal financial officer concluded, as of the
end of the period covered by this report, December 31, 2003, that our disclosure
controls and procedures are effective.
(b) Changes in internal control over financial reporting
We reviewed our internal control over financial reporting at December 31, 2003.
There have been no changes in our internal control over financial reporting
identified in an evaluation thereof that occurred during the last fiscal quarter
of 2003, that materially affected or is reasonably likely to materially affect
our internal control over financial reporting.
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
--------------------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2004 Annual Meeting of Stockholders to be
held May 18, 2004 to be filed with the Commission pursuant to Regulation 14A
within 120 days after December 31, 2003. See "Executive Officers of the
Registrant" in Part I of this Report following Item 4 for information relating
to executive officers.
Item 11. Executive Compensation
----------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2004 Annual Meeting of Stockholders to be
held May 18, 2004.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
------------------------------------------------------------------
Related Stockholder Matters
---------------------------
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table provides information as of December 31, 2003 regarding
compensation plans (including individual compensation arrangements) under which
equity securities of Citizens Communications Company are authorized for
issuance.
(a) (b) (c)
Number of securities remaining
Number of securities to Weighted-average available for future issuance
be issued upon exercise exercise price of under equity compensation plans
of outstanding options, outstanding options, (excluding securities reflected in
Plan category warrants and rights warrants and rights column (a))
- ------------------------- -------------------------- ----------------------- -------------------------------------
Equity compensation
plans approved by
security holders 21,450,223 $ 12.08 5,240,484
Equity compensation
plans not approved
by security holders - - -
-------------------------- ----------------------- -------------------------------------
Total 21,450,223 $ 12.08 5,240,484
========================== ======================= =====================================
See Note 18 to Consolidated Financial Statements for information regarding the
material features of the above plans.
36
The other information required by this Item is incorporated by reference from
our definitive proxy statement for the 2004 Annual Meeting of Stockholders to be
held May 18, 2004.
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2004 Annual Meeting of Stockholders to be
held May 18, 2004.
Item 14. Principal Accountant Fees and Services
--------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2004 Annual Meeting of Stockholders to be
held May 18, 2004.
PART IV
-------
Item 15. Exhibits, Financial Statement Schedule and Reports on Form 8-K
--------------------------------------------------------------
(a) List of Documents Filed as a Part of This Report:
(1) Index to Consolidated Financial Statements:
Independent Auditors' Report
Consolidated balance sheets as of December 31, 2003 and 2002
Consolidated statements of operations for the years ended
December 31, 2003, 2002 and 2001
Consolidated statements of shareholders' equity for the years ended
December 31, 2003, 2002 and 2001
Consolidated statements of comprehensive income (loss) for the years ended
December 31, 2003, 2002 and 2001
Consolidated statements of cash flows for the years ended
December 31, 2003, 2002 and 2001
Notes to consolidated financial statements
(2) Index to Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts
All other schedules have been omitted because the required information is
included in the consolidated financial statements or the notes thereto, or is
not applicable or required.
(3) Index to Exhibits:
Exhibit
No. Description
- ------- -----------
3.200.1 Restated Certificate of Incorporation of Citizens Communications
Company, as restated May 19, 2000 (incorporated by reference to
Exhibit 3.200.1 to the Registrant's Quarterly Report on Form 10-Q
for the six months ended June 30, 2000, File No. 001-11001).
3.200.2 By-laws of Citizens Communications Company, with all amendments
to March 22, 2002 (incorporated by reference to Exhibits 3.1 and
3.2 to the Registrants' Form 8-K filed March 22, 2002, File No.
001-11001).
3.200.3 Amendment to By-laws of Citizens Communications Company
(effective April 1, 2003).
3.200.4 Amendment to By-laws of Citizens Communications Company
(effective July 30, 2002) (incorporated by reference to Exhibit
3.200.3 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 2002, File No. 001-11001).
37
4.100.1 Certificate of Trust of Citizens Communications Trust dated as of
April 27, 2001 (incorporated by reference to Exhibit 4.5 of the
Registrant's Amendment No.1 to Form S-3 filed May 7, 2001
(Registration No. 333-58044).
4.100.2 Trust Agreement of Citizens Capital Trust I, dated as of April
27, 2001 (incorporated by reference to Exhibit 4.6 of the
Registrant's Amendment No.1 to Form S-3 filed May 7, 2001
(Registration No. 333-58044).
4.100.3 Form of 2006 Note (incorporated by reference to Exhibit 4.3 of
the Registrant's Current Report on Form 8-K filed on May 24,
2001, File No. 001-11001).
4.100.4 Form of 2011 Note (incorporated by reference to Exhibit 4.4 of
the Registrant's Current Report on Form 8-K filed on May 24,
2001, File No. 001-11001).
4.100.5 Warrant Agreement, dated as of June 19, 2001, between Citizens
Communications Company and The Chase Manhattan Bank, as Warrant
Agent (incorporated by reference to Exhibit 4.1 of the
Registrant's Current Report on Form 8-K filed on May 24, 2001,
File No. 001-11001).
4.100.6 Form of Senior Note due 2006 (incorporated by reference to
Exhibit 4.5 of the Registrant's Current Report on Form 8-K filed
on June 21, 2001, File No. 001-11001).
4.100.7 Form of Equity Unit (included in the Warrant Agreement
incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on June 21, 2001, File No.
001-11001).
4.100.8 Form of Treasury Equity Unit (included in the Warrant Agreement
incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on June 21, 2001, File No.
001-11001).
4.100.9 Form of Senior Notes due 2008 and due 2031 (incorporated by
reference to Exhibit 4.1 of the Registrant's Current Report on
Form 8-K filed on August 22, 2001, File No. 001-11001).
4.200.1 First Supplemental Indenture dated as of January 15, 1996,
between Citizens Utilities Company and Chemical Bank, as
indenture trustee (incorporated by reference to Exhibit 4.200.2
to the Registrant's Form 8-K Current Report filed May 28, 1996,
File No. 001-11001).
4.200.2 5% Convertible Subordinated Debenture due 2036 (contained as
Exhibit A to Exhibit 4.200.2), (incorporated by reference to
Exhibit 4.200.2 to the Registrant's Form 8-K Current Report filed
May 28, 1996, File No. 001-11001).
4.200.3 Amended and Restated Declaration of Trust dated as of January 15,
1996, of Citizens Utilities Trust (incorporated by reference to
Exhibit 4.200.4 to the Registrant's Form 8-K Current Report filed
May 28, 1996, File No. 001-11001).
4.200.4 Convertible Preferred Security Certificate (contained as Exhibit
A-1 to Exhibit 4.200.4), (incorporated by reference to Exhibit
4.200.4 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.5 Amended and Restated Limited Partnership Agreement dated as of
January 15, 1996 of Citizens Utilities Capital L.P. (incorporated
by reference to Exhibit 4.200.6 to the Registrant's Form 8-K
Current Report filed May 28, 1996, File No. 001-11001).
4.200.6 Partnership Preferred Security Certificate (contained as Annex A
to Exhibit 4.200.6), (incorporated by reference to Exhibit
4.200.6 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.7 Convertible Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Utilities Company and Chemical
Bank, as guarantee trustee (incorporated by reference to Exhibit
4.200.8 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.8 Partnership Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Utilities Company and Chemical
Bank, as guarantee trustee (incorporated by reference to Exhibit
4.200.9 to the Registrant's Form 8-K Current Report filed May 28,
1996, File No. 001-11001).
4.200.9 Letter of Representations dated January 18, 1996, from Citizens
Utilities Company and Chemical Bank, as trustee, to DTC, for
deposit of Convertible Preferred Securities with DTC
(incorporated by reference to Exhibit 4.200.10 to the
Registrant's Form 8-K Current Report filed May 28, 1996, File No.
001-11001).
4.300 Indenture of Securities, dated as of August 15, 1991, to
Chemical Bank, as Trustee (incorporated by reference to Exhibit
4.100.1 to the Registrant's Quarterly Report on Form 10-Q for
the nine months ended September 30, 1991, File No. 001-11001).
4.300.1 Second Supplemental Indenture, dated January 15, 1992, to
Chemical Bank, as Trustee (incorporated by reference to Exhibit
4.100.4 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1991, File No. 001-11001).
4.300.2 Third Supplemental Indenture, dated April 15, 1994, to Chemical
Bank, as Trustee (incorporated by reference to Exhibit 4.100.6 to
the Registrant's Form 8-K Current Report filed July 5, 1994, File
No. 001-11001).
38
4.300.3 Fourth Supplemental Indenture, dated October 1, 1994, to Chemical
Bank, as Trustee (incorporated by reference to Exhibit 4.100.7 to
Registrant's Form 8-K Current Report filed January 3, 1995, File
No. 001-11001).
4.300.4 Fifth Supplemental Indenture, dated as of June 15, 1995, to
Chemical Bank, as Trustee (incorporated by reference to Exhibit
4.100.8 to Registrant's Form 8-K Current Report filed March 29,
1996, File No. 001-11001).
4.300.5 Sixth Supplemental Indenture, dated as of October 15, 1995, to
Chemical Bank, as Trustee (incorporated by reference to Exhibit
4.100.9 to Registrant's Form 8-K Current Report filed March 29,
1996, File No. 001-11001).
4.300.6 Seventh Supplemental Indenture, dated as of June 1, 1996
(incorporated by reference to Exhibit 4.100.11 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996, File No. 001-11001).
4.300.7 Eighth Supplemental Indenture, dated as of December 1, 1996
(incorporated by reference to Exhibit 4.100.12 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996, File No. 001-11001).
4.400 Senior Indenture, dated as of May 23, 2001, between Citizens
Communications Company and The Chase Manhattan Bank, as trustee
(incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on May 24, 2001, File No.
001-11001).
4.400.1 First Supplemental Indenture to Senior Indenture, dated as of May
23, 2001 ( incorporated by reference to Exhibit 4.2 of the
Registrant's Current Report on Form 8-K filed on May 24, 2001,
File No. 001-11001).
4.400.2 Second Supplemental Indenture, dated as of June 19, 2001, to
Senior Indenture, dated as of May 23, 2001 (incorporated by
reference to Exhibit 4.3 of the Registrant's Current Report on
Form 8-K filed on June 21, 2001, File No. 001-11001).
4.400.3 Pledge Agreement, dated as of June 19, 2001, among Citizens
Communications Company and The Bank of New York, as Collateral
Agent, Securities Intermediary and Custodial Agent and The Chase
Manhattan Bank, as Warrant Agent (incorporated by reference to
Exhibit 4.2 of the Registrant's Current Report on Form 8-K filed
on June 21, 2001, File No. 001-11001).
4.400.4 Remarketing Agreement dated June 19, 2001, among Citizens
Communications Company, Morgan Stanley & Co. Incorporated, as
Remarketing Agent, and The Chase Manhattan Bank, as Warrant Agent
and attorney-in-fact for the Holders of the Equity Units
(incorporated by reference to Exhibit 4.4 of the Registrant's
Current Report on Form 8-K filed on June 21, 2001, File No.
001-11001).
4.400.5 Indenture, dated as of August 16, 2001, between Citizens
Communications Company and The Chase Manhattan Bank, as Trustee
(incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on August 22, 2001, File No.
001-11001).
10.1 Non-Employee Directors' Deferred Fee Equity Plan dated as of June
28, 1994, with all amendments to May 5, 1997 (incorporated by
reference to Exhibit A to the Registrant's Proxy Statement dated
April 4, 1995 and Exhibit A to the Registrant's Proxy Statement
dated March 28, 1997, respectively, File No. 001-11001).
10.1.1 Amendment No. 2 to Non-Employee Directors' Deferred Fee Equity
Plan (effective June 30, 2003).
10.2 Employment Agreement between Citizens Utilities Company and
Leonard Tow, effective July 11, 1996 (incorporated by reference
to Exhibit 10.16.1 to the Registrant's Quarterly Report on Form
10-Q for the nine months ended September 30, 1996, File No.
001-11001).
10.2.1 Employment Agreement between Citizens Communications Company and
Leonard Tow, effective October 1, 2000 (incorporated by reference
to Exhibit 10.16.2 of the Registrants' Annual Report on Form 10-K
for the year ended December 31, 2000, File No. 001-11001).
10.2.2 Letter agreement, dated as of April 10, 2001, amending the
employment agreement, effective October 1, 2000, between Citizens
Communications Company and Leonard Tow (incorporated by reference
to Exhibit 10 of the Registrants' Forms S-4/A filed February 4,
2002, Registration No. 333-69740).
10.2.3 Letter agreement, dated as of May 16, 2002, amending the
employment agreement, effective October 1, 2000, between Citizens
Communications Company and Leonard Tow (incorporated by reference
to Exhibit 10.16.4 of the Registrants' Quarterly Report on Form
10-Q for the nine months ended September 30, 2002, File No.
001-11001).
10.3 Incentive Award Agreement between Citizens Communications Company
and Scott N. Schneider, effective March 11, 2004.
10.4 Citizens Executive Deferred Savings Plan dated January 1, 1996
(incorporated by reference to Exhibit 10.19 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999,
File No. 001-11001).
10.5 Citizens Incentive Plan restated as of March 21, 2000
(incorporated by reference to Exhibit 10.19 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999,
File No. 001-11001).
39
10.6 Indenture from ELI to Citibank, N.A., dated April 15, 1999, with
respect to ELI's 6.05% Senior Unsecured Notes due 2004
(incorporated by reference to Exhibit 10.24.1 of ELI's Annual
Report on Form 10-K for the year ended December 31, 1999, File
No. 0-23393).
10.6.1 First Supplemental Indenture from ELI, Citizens Utilities Company
and Citizens Newco Company to Citibank, N.A. dated April 15,
1999, with respect to the 6.05% Senior Unsecured Notes due 2004
(incorporated by reference to Exhibit 10.24.2 of ELI's Annual
Report on Form 10-K for the year ended December 31, 1999, File
No. 0-23393).
10.6.2 Form of ELI's 6.05% Senior Unsecured Notes due 2004 (incorporated
by reference to Exhibit 10.24.3 of ELI's Annual Report on Form
10-K for the year ended December 31, 1999, File No. 0-23393).
10.7 2000 Equity Incentive Plan dated May 18, 2000 (incorporated by
reference to Exhibit 10.33 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2000, File No.
001-11001).
10.7.1 Amendment No. 2 to 2000 Equity Incentive Plan (effective June 30,
2003).
10.8 Citizens 401(K) Savings Plan effective as of January 1, 1997
reflecting amendments made through April 2001 (incorporated by
reference to Exhibit 10.37 to the Registrant's Quarterly Report
on Form 10-Q for the six months ended June 30, 2001, File No.
001-11001).
10.9 Competitive Advance and Revolving Credit Facility Agreement for
$705,000,000 dated October 24, 2001 (incorporated by reference to
Exhibit 10.38 to the Registrant's Quarterly Report on Form 10-Q
for the nine months ended September 30, 2001, File No.
001-11001).
10.9.1 First Amendment, dated as of March 31, 2003, to Competitive
Advance and Revolving Credit Facility Agreement for $705,000,000
(incorporated by reference to Exhibit 10.1 to the Registrant's
Quarterly Report on Form 10-Q for the three months ended March
31, 2003, File No. 001-11001).
10.10 Loan Agreement between Citizens Communications Company and Rural
Telephone Finance Cooperative for $200,000,000 dated October 24,
2001 (incorporated by reference to Exhibit 10.39 to the
Registrant's Quarterly Report on Form 10-Q for the nine months
ended September 30, 2001, File No. 001-11001).
10.10.1 Amendment No. 1, dated as of March 31, 2003, to Loan Agreement
between Citizens Communications Company and Rural Telephone
Finance Cooperative (incorporated by reference to Exhibit 10.1 to
the Registrant's Quarterly Report on Form 10-Q for the three
months ended March 31, 2003, File No. 001-11001).
10.11 Asset Purchase Agreement between Citizens Communications Company
and Kauai Island Utility CO-OP dated March 5, 2002 (incorporated
by reference to Exhibit 10.11 to the Registrant's Annual Report
on Form 10-K for the yea ended December 31, 2002, File No.
001-11001).
10.12 Asset Purchase Agreement between Citizens Communications Company
and K-1 USA Ventures, Inc., dated December 19, 2002 (incorporated
by reference to Exhibit 10.12 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 2002, File No.
001-11001).
10.13 Asset Purchase Agreement between Citizens Communications Company
and UniSource Energy Corporation dated October 29, 2002, relating
to the sale of a gas utility business (incorporated by reference
to Exhibit 10-13 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 2002, File No. 001-11001).
10.14 Asset Purchase Agreement between Citizens Communications Company
and UniSource Energy Corporation dated October 29, 2002, relating
to the sale of an electric utility business (incorporated by
reference to Exhibit 10-14 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2002, File No.
001-11001).
10.15 Sale agreement between Citizens Telecom Services Company LLC
and Pepsico, Inc., dated January 31, 2003 (incorporated by
reference to Exhibit 10-15 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2002, File No.
001-11001).
12 Computation of ratio of earnings to fixed charges (this item is
included herein for the sole purpose of incorporation by
reference).
21 Subsidiaries of the Registrant
23 Auditors' Consent
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.
40
Exhibits 10.1, 10.2, 10.2.1, 10.2.2, 10.2.3, 10.4, 10.5, 10.7 and 10.8 are
management contracts or compensatory plans or arrangements.
We agree to furnish to the Commission upon request copies of the Realty and
Chattel Mortgage, dated as of March 1, 1965, made by Citizens Utilities Rural
Company, Inc., to the United States of America (the Rural Utilities Services and
Rural Telephone Bank) and the Mortgage Notes which that mortgage secures; and
the several subsequent supplemental Mortgages and Mortgage Notes; copies of
separate loan agreements and indentures governing various Industrial Development
Revenue Bonds; copies of documents relating to indebtedness of subsidiaries
acquired during 1996, 1997 and 1998. We agree to furnish to the Commission upon
request copies of schedules and exhibits to items 10.11, 10.12, 10.13, 10.14 and
10.15.
(b) Reports on Form 8-K:
We furnished on Form 8-K on November 6, 2003 under Item 12 "Disclosure of
Results of Operations and Financial Condition," a press release announcing
our earnings for the quarter and nine months ended September 30, 2003.
We filed on Form 8-K on December 11, 2003 under Item 5 "Other Events," a
press release announcing that our Board of Directors has determined to
explore strategic alternatives and to retain a financial advisor to assist
in this process.
41
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
--------------------------------
(Registrant)
By: /s/ Leonard Tow
---------------
Leonard Tow
Chairman of the Board; Chief Executive Officer;
Chairman of Executive Committee and Director
March 12, 2004
42
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 12th day of March 2004.
Signature Title
--------- -----
/s/ Robert J. Larson Senior Vice President and Chief Accounting Officer
- -------------------------------------------
(Robert J. Larson)
/s/ Jerry Elliott Senior Vice President and Chief Financial Officer
- -------------------------------------------
(Jerry Elliott)
/s/ Aaron I. Fleischman Member, Executive Committee and Director
- -------------------------------------------
(Aaron I. Fleischman)
/s/ Rudy J. Graf Member, Executive Committee and Director
- -------------------------------------------
(Rudy J. Graf)
/s/ Stanley Harfenist Member, Executive Committee and Director
- -------------------------------------------
(Stanley Harfenist)
/s/ Andrew N. Heine Director
- -------------------------------------------
(Andrew N. Heine)
/s/ William Kraus Director
- ------------------------------------------
(William Kraus)
/s/ Scott N. Schneider Vice Chairman of the Board, President and Chief
- ------------------------------------------- Operating Officer, and Director
(Scott N. Schneider)
/s/ John L. Schroeder Director
- -------------------------------------------
(John L. Schroeder)
/s/ Robert A. Stanger Member, Executive Committee and Director
- -------------------------------------------
(Robert A. Stanger)
/s/ Edwin Tornberg Director
- -------------------------------------------
(Edwin Tornberg)
/s/ Claire L. Tow Director
- -------------------------------------------
(Claire L. Tow)
/s/ David H. Ward Director
- -------------------------------------------
(David H. Ward)
43
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index to Consolidated Financial Statements
Item Page
- ---- ----
Independent Auditors' Report F-2
Consolidated balance sheets as of December 31, 2003 and 2002 F-3
Consolidated statements of operations for the years ended
December 31, 2003, 2002 and 2001 F-4
Consolidated statements of shareholders' equity for the years ended
December 31, 2003, 2002 and 2001 F-5
Consolidated statements of comprehensive income (loss) for the years ended
December 31, 2003, 2002 and 2001 F-5
Consolidated statements of cash flows for the years ended
December 31, 2003, 2002 and 2001 F-6
Notes to consolidated financial statements F-7
F-1
Independent Auditors' Report
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited the accompanying consolidated balance sheets of Citizens
Communications Company and subsidiaries as of December 31, 2003 and 2002 and the
related consolidated statements of operations, shareholders' equity,
comprehensive income (loss) and cash flows for each of the years in the
three-year period ended December 31, 2003. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Citizens
Communications Company and subsidiaries as of December 31, 2003 and 2002 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America. As discussed in
Note 2 to the consolidated financial statements, the Company adopted Statement
of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets" as of January 1, 2002. As discussed in Note 2 to the consolidated
financial statements, the Company adopted SFAS No. 143, "Accounting for Asset
Retirement Obligations" as of January 1, 2003.
/s/ KPMG LLP
New York, New York
March 4, 2004
F-2
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
($ in thousands)
2003 2002
-------------- --------------
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 583,671 $ 393,177
Accounts receivable, less allowances of $47,332 and $38,946, respectively 248,473 310,929
Other current assets 40,984 49,114
Assets held for sale 23,130 447,764
-------------- --------------
Total current assets 896,258 1,200,984
Property, plant and equipment, net 3,525,640 3,690,056
Goodwill, net 1,940,318 1,869,348
Other intangibles, net 812,407 942,970
Investments 44,316 29,846
Other assets 470,171 489,501
-------------- --------------
Total assets $7,689,110 $8,222,705
============== ==============
LIABILITIES AND EQUITY
- ----------------------
Current liabilities:
Long-term debt due within one year $ 88,002 $ 58,911
Accounts payable 126,705 195,278
Income taxes accrued 77,159 95,859
Other taxes accrued 32,039 41,068
Interest accrued 81,244 105,668
Customer deposits 2,105 2,632
Other current liabilities 112,973 134,191
Liabilities related to assets held for sale 16,128 145,969
-------------- --------------
Total current liabilities 536,355 779,576
Deferred income taxes 447,056 204,369
Customer advances for construction and contributions in aid of construction 122,035 146,661
Other liabilities 311,602 301,349
Equity units 460,000 460,000
Long-term debt 4,195,629 4,957,361
Company Obligated Mandatorily Redeemable Convertible Preferred Securities* 201,250 201,250
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares; 284,709,000 and 282,482,000
outstanding and 295,434,000 and 294,080,000 issued at December 31, 2003 and 2002,
respectively) 73,858 73,520
Additional paid-in capital 1,953,317 1,943,406
Accumulated deficit (365,181) (553,033)
Accumulated other comprehensive loss (71,676) (102,169)
Treasury stock (175,135) (189,585)
-------------- --------------
Total shareholders' equity 1,415,183 1,172,139
-------------- --------------
Total liabilities and equity $ 7,689,110 $ 8,222,705
============== ==============
* Represents securities of a subsidiary trust, the sole assets of which are
securities of a subsidiary partnership, substantially all the assets of which
are convertible debentures of the Company.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-3
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 and 2001
($ in thousands, except for per-share amounts)
2003 2002 2001
--------------- -------------- --------------
Revenue $ 2,444,938 $ 2,669,332 $ 2,456,993
Operating expenses:
Cost of services (exclusive of depreciation and amortization) 369,689 476,920 599,378
Other operating expenses 901,751 1,002,355 951,710
Depreciation and amortization 595,276 755,522 632,336
Reserve for (recovery of) telecommunications bankruptcies (4,377) 10,880 21,200
Restructuring and other expenses 9,687 37,186 19,327
Loss on impairment 15,300 1,074,058 -
--------------- -------------- --------------
Total operating expenses 1,887,326 3,356,921 2,223,951
--------------- -------------- --------------
Operating income (loss) 557,612 (687,589) 233,042
Investment income (loss), net 10,432 (98,359) (62,408)
Gain (loss) on sale of assets (20,492) 9,798 139,304
Other income (loss), net 64,481 12,739 (4,818)
Interest expense 416,524 468,229 377,641
--------------- -------------- --------------
Income (loss) from continuing operations before income taxes,
dividends on convertible preferred securities, extraordinary
expense and cumulative effect of change in accounting principle 195,509 (1,231,640) (72,521)
Income tax expense (benefit) 67,216 (414,874) (14,805)
--------------- -------------- --------------
Income (loss) from continuing operations before dividends on
convertible preferred securities, extraordinary expense and
cumulative effect of change in accounting principle 128,293 (816,766) (57,716)
Dividends on convertible preferred securities, net of income tax benefit of $(3,853) 6,210 6,210 6,210
--------------- -------------- --------------
Income (loss) from continuing operations before extraordinary
expense and cumulative effect of change in accounting principle 122,083 (822,976) (63,926)
Income (loss) from discontinued operations, net of income tax
(benefit) of $0, $(554) and $8,947, respectively - (1,478) 17,875
Gain on disposal of water segment, net of income taxes of $135,303 - 181,369 -
--------------- -------------- --------------
Total income from discontinued operations, net of income taxes
of $0, $134,749 and $8,947, respectively - 179,891 17,875
--------------- -------------- --------------
Income (loss) before extraordinary expense and cumulative
effect of change in accounting principle 122,083 (643,085) (46,051)
Extraordinary expense - discontinuation of Statement of Financial
Accounting Standards No. 71, net of tax - - 43,631
Cumulative effect of change in accounting principle, net of tax of
$41,591, $0 and $0, respectively 65,769 (39,812) -
--------------- -------------- --------------
Net income (loss) $ 187,852 $ (682,897) $ (89,682)
=============== ============== ==============
Carrying cost of equity forward contracts - - 13,650
--------------- -------------- --------------
Net income (loss) available for common shareholders $ 187,852 $ (682,897) $ (103,332)
=============== ============== ==============
Basic income (loss) per common share:
Income (loss) from continuing operations before extraordinary
expense and cumulative effect of change in accounting principle $ 0.44 $ (2.93) $ (0.28)
Income from discontinued operations - 0.64 0.06
--------------- -------------- --------------
Income (loss) before extraordinary expense and cumulative
effect of change in accounting principle 0.44 (2.29) (0.22)
Extraordinary expense - - (0.16)
Income (loss) from cumulative effect of change in accounting principle 0.23 (0.14) -
--------------- -------------- --------------
Net income (loss) per common share available for common shareholders $ 0.67 $ (2.43) $ (0.38)
=============== ============== ==============
Diluted income (loss) per common share:
Income (loss) from continuing operations before extraordinary
expense and cumulative effect of change in accounting principle $ 0.42 $ (2.93) $ (0.28)
Income from discontinued operations - 0.64 0.06
--------------- -------------- --------------
Income (loss) before extraordinary expense and cumulative
effect of change in accounting principle 0.42 (2.29) (0.22)
Extraordinary expense - - (0.16)
Income (loss) from cumulative effect of change in accounting principle 0.22 (0.14) -
--------------- -------------- --------------
Net income (loss) per common share available for common shareholders $ 0.64 $ (2.43) $ (0.38)
=============== ============== ==============
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-4
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 and 2001
($ in thousands, except for per-share amounts)
Accumulated
Common Stock Additional Retained Other Treasury Stock Total
----------------- Paid-In Earnings Comprehensive -------------- Shareholders'
Shares Amount Capital (Deficit) Income (Loss) Shares Amount Equity
-------- -------- ----------- ----------- --------------- ------------------ ------------
Balance January 1, 2001 265,768 $ 66,442 $1,471,816 $ 233,196 $ 418 (3,107) $ (51,871) $1,720,001
Stock plans 1,916 479 17,449 - - 696 12,527 30,455
Common stock offering 25,156 6,289 283,272 - - - - 289,561
Equity units offering - - 4,968 - - - - 4,968
Settlement of equity forward contracts - - 150,013 (13,650) - (9,140) (150,013) (13,650)
Net loss - - - (89,682) - - - (89,682)
Other comprehensive income, net of tax
and reclassifications adjustments - - - - 4,489 - - 4,489
-------- -------- ----------- ----------- ----------- -------- ----------------------
Balance December 31, 2001 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 loss, net of tax
and reclassifications adjustments - - - - (107,076) - - (107,076)
-------- -------- ----------- ----------- ----------- -------- ----------------------
Balance 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 9,911 - - 873 14,450 24,699
Net income - - - 187,852 - - - 187,852
Other comprehensive income, net of tax
and reclassifications adjustments - - - - 30,493 - - 30,493
-------- -------- ----------- ----------- ----------- -------- ----------------------
Balance December 31, 2003 295,434 $ 73,858 $1,953,317 $(365,181) $ (71,676) (10,725) $(175,135) $1,415,183
======== ======== =========== =========== =========== ======== ======================
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 and 2001
($ in thousands, except for per-share amounts)
2003 2002 2001
-------------- ------------- -------------
Net income (loss) $ 187,852 $(682,897) $ (89,682)
Other comprehensive income (loss), net of tax
and reclassifications adjustments* 30,493 (107,076) 4,489
-------------- ------------- -------------
Total comprehensive income (loss) $ 218,345 $(789,973) $ (85,193)
============== ============= =============
* Consists of unrealized holding (losses)/gains of marketable securities and
minimum pension liability (see Note 22).
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-5
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 and 2001
($ in thousands)
2003 2002 2001
-------------- -------------- ---------------
Income (loss) from continuing operations before extraordinary
expense and cumulative effect of change in accounting
principal $ 122,083 $ (822,976) $ (63,926)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization expense 595,276 755,522 632,336
Investment write-downs - 117,455 79,114
Gain on extinguishment of debt (75,569) (26,330) -
Investment (gains)/losses - (3,363) 660
(Gain)/loss on sales of assets, net 20,492 (9,798) (139,304)
Loss on impairment 15,300 1,074,058 -
Allowance for equity funds used during construction (128) (1,346) (2,811)
Deferred income taxes 76,948 (252,468) 17,030
Change in accounts receivable 70,077 1,373 57,145
Change in accounts payable and other liabilities (33,313) (343,620) (145,804)
Change in accrued taxes and interest (61,840) 46,984 113,771
Change in other current assets 999 101,376 (71,275)
-------------- -------------- ---------------
Net cash provided by continuing operating activities 732,325 636,867 476,936
Cash flows from investing activities:
Proceeds from sales of assets, net of selling
expenses 388,079 224,678 372,335
Capital expenditures (278,015) (468,742) (487,271)
Acquisitions - - (3,373,214)
Securities purchased (1,680) (1,175) (1,391)
Securities sold - 8,212 1,434
Securities matured - 2,014 -
ELI share purchases - (6,800) -
Other 68 727 639
-------------- -------------- --------------
Net cash provided from (used by) investing activities 108,452 (241,086) (3,487,468)
Cash flows from financing activities:
Long-term debt payments (653,462) (1,062,169) (1,077,931)
Issuance of common stock for employee plans 13,209 14,943 25,411
Long-term debt borrowings - - 3,703,483
Issuance of equity units - - 460,000
Debt issuance costs - - (67,657)
Common stock offering - - 289,561
Settlement of equity forward contracts - - (163,662)
Customer advances for construction
and contributions in aid of construction (10,030) (4,895) (27,816)
-------------- -------------- ---------------
Net cash used by financing activities (650,283) (1,052,121) 3,141,389
Cash provided by (used by) discontinued operations
Proceeds from sale of discontinued operations - 859,064 -
Net cash provided from (used by) discontinued
operations - (25,416) 14,926
-------------- -------------- ---------------
Increase in cash and cash equivalents 190,494 177,308 145,783
Cash and cash equivalents at January 1, 393,177 215,869 70,086
-------------- -------------- ---------------
Cash and cash equivalents at December 31, $ 583,671 $ 393,177 $ 215,869
============== ============== ===============
Cash paid during the period for:
Interest $ 418,561 $ 473,029 $ 303,660
Income taxes (refunds) $ (2,532) $ (17,621) $ (41,126)
Non-cash investing and financing activities:
Assets acquired under capital lease $ - $ 38,000 $ 33,985
Change in fair value of interest rate swaps $ (6,057) $ 16,229 $ 430
Investment write-downs $ - $ 117,455 $ 79,114
Debt assumed from acquisitions $ - $ - $ 117,630
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-6
(1) Description of Business and Summary of Significant Accounting Policies:
-----------------------------------------------------------------------
(a) Description of Business:
-----------------------
Citizens Communications Company and its subsidiaries are referred to
as "we", "us", the "Company" or "our" in this report. We are a
telecommunications company providing wireline communications services
to rural areas and small and medium-sized towns and cities as an
incumbent local exchange carrier, or ILEC. We offer our ILEC services
under the "Frontier" name. In addition, we provide competitive local
exchange carrier, or CLEC, services to business customers and to other
communications carriers in certain metropolitan areas in the western
United States through Electric Lightwave, LLC, or ELI, our
wholly-owned subsidiary. We also provide electric distribution
services to primarily rural customers in Vermont. We have a contract
to sell our remaining electric operation in Vermont.
In December 2003, we announced that our Board of Directors decided to
explore strategic alternatives and we have retained financial advisors
to assist in this process. In February 2004, we engaged J.P. Morgan
Securities and Morgan Stanley as financial advisors and Simpson
Thacher & Bartlett LLP, as legal counsel to assist in our exploration
of alternatives. The advisors will assist the Company in evaluating a
range of possible financial and strategic alternatives designed to
enhance shareholder value, although there can be no assurance that the
Company will undertake any particular action as a result of this
review.
During 2001, we purchased 1.1 million access lines for approximately
$3.4 billion in cash (see Note 6). During 2000, we acquired
approximately 334,500 telephone access lines for approximately
$986,200,000 in cash. Of our 2.4 million access lines as of December
31, 2003, approximately 41% are located in New York State, including
the greater Rochester metropolitan area; another 11% are located in
Minnesota.
In June 2002, we acquired all the common stock of ELI that we did not
previously own and as a result ELI became our wholly-owned subsidiary.
In 1999 we announced plans to divest our public utilities services
segments. As a result, in 2001 we sold two of our four natural gas
transmission and distribution businesses, during 2002 we sold our
entire water distribution and wastewater treatment business and one of
our three electric businesses and in 2003, we completed the sales of
The Gas Company in Hawaii and our Arizona gas and electric divisions
and our electric transmission operations in Vermont. We have a
contract to sell our remaining property in Vermont, which distributes
electricity to approximately 21,000 customers. Pending this
divestiture, we continue to provide electric utility services (see
Note 9).
(b) Principles of Consolidation and Use of Estimates:
-------------------------------------------------
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (GAAP). Certain reclassifications of balances previously
reported have been made to conform to the current presentation. All
significant intercompany balances and transactions have been
eliminated in consolidation.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions which affect the
amounts of assets, liabilities, revenue and expenses we have reported
and our disclosure of contingent assets and liabilities at the date of
the financial statements. Actual results may differ from those
estimates. We believe that our critical estimates are depreciation
rates, pension assumptions, calculations of impairment amounts,
reserves established for telecommunication bankruptcies, income taxes
and contingencies.
(c) Cash Equivalents:
-----------------
We consider all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
F-7
(d) Revenue Recognition:
--------------------
Incumbent Local Exchange Carrier (ILEC) - Revenue is recognized when
services are provided or when products are delivered to customers.
Revenue that is billed in advance includes: monthly recurring network
access services, special access services and monthly recurring local
line charges. The unearned portion of this revenue is initially
deferred as a component of other current liabilities on our
consolidated balance sheet and recognized in revenue over the period
that the services are provided. Revenue that is billed in arrears
includes: non-recurring network access services, switched access
services, non-recurring local services and long-distance services. The
earned but unbilled portion of this revenue is recognized in revenue
in our statement of operations and accrued in accounts receivable in
the period that the services are provided. Excise taxes are recognized
as a liability when billed. Installation fees and their related direct
and incremental costs are initially deferred and recognized as revenue
and expense over the average term of a customer relationship. We
recognize as current period expense the portion of installation costs
that exceeds installation fee revenue.
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.
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.
(e) Construction Costs and Maintenance Expense:
-------------------------------------------
Property, plant and equipment are stated at original cost or fair
market value for our acquired properties, including capitalized
interest for unregulated telecommunications businesses. Maintenance
and repairs are charged to operating expenses as incurred. The book
value, net of salvage, of routine property, plant and equipment
dispositions is charged against accumulated depreciation for regulated
operations.
Capitalized interest for unregulated construction activities amounted
to $2,993,000, $7,390,000 and $5,675,000 for 2003, 2002 and 2001,
respectively.
(f) Intangibles:
------------
Intangibles represent the excess of purchase price over the fair value
of identifiable tangible assets acquired. We undertake studies to
determine the fair values of assets and liabilities acquired and
allocate purchase prices to assets and liabilities, including
property, plant and equipment, goodwill and other identifiable
intangibles. On January 1, 2002, we adopted Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets," which applies to all goodwill and other intangible assets
recognized in the statement of financial position at that date,
regardless of when the assets were initially recognized. This
statement requires that goodwill and other intangibles with indefinite
useful lives no longer be amortized to earnings, but instead be tested
for impairment, at least annually. In performing this test, the
Company first compares the carrying amount of its reporting units to
their respective fair values. If the carrying amount of any reporting
unit exceeds its fair value, the Company is required to perform step
two of the impairment test by comparing the implied fair value of the
reporting unit's goodwill with its carrying amount. The amortization
of goodwill and other intangibles with indefinite useful lives ceased
upon adoption of the statement on January 1, 2002. We annually examine
the carrying value of our goodwill and trade name to determine whether
there are any impairment losses and have determined for the year ended
December 31, 2003 that there was no impairment (see Notes 2 and 8).
All remaining intangibles at December 31, 2003 are associated with the
ILEC segment, which is the reporting unit. The Company's remaining
reporting units are Electric and CLEC.
SFAS No. 142 also requires that intangible assets with estimated
useful lives be amortized over those lives and be reviewed for
impairment in accordance with SFAS No. 144, "Accounting for Impairment
or Disposal of Long-Lived Assets" to determine whether any changes to
these lives are required. We periodically reassess the useful life of
our intangible assets with estimated useful lives to determine whether
any changes to those lives are required.
F-8
(g) 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 (see Note 5).
We ceased to record depreciation expense on the gas assets held for
sale effective October 1, 2000 and on the electric assets held for
sale effective January 1, 2001 (see Note 9).
(h) Derivative Instruments and Hedging Activities:
----------------------------------------------
We account for derivative instruments and hedging activities in
accordance with SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities", as amended. SFAS No. 133, as amended,
requires that all derivative instruments, such as interest rate swaps,
be recognized in the financial statements and measured at fair value
regardless of the purpose or intent of holding them.
On the date the derivative contract is entered into, we designate the
derivative as either a fair value or cash flow hedge. A hedge of the
fair value of a recognized asset or liability or of an unrecognized
firm commitment is a fair value hedge. A hedge of a forecasted
transaction or the variability of cash flows to be received or paid
related to a recognized asset or liability is a cash flow hedge. We
formally document all relationships between hedging instruments and
hedged items, as well as its risk-management objective and strategy
for undertaking the hedge transaction. This process includes linking
all derivatives that are designated as fair-value or cash flow 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 stockholders' equity (as a
component of other comprehensive income), depending on whether the
derivative is being used to hedge changes in fair value or cash flows.
We entered into interest rate swap arrangements 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 current assets and
the related underlying liabilities are also adjusted to fair value by
the same amount.
(i) Investments:
------------
We classify our investments at purchase as available-for-sale. We do
not maintain a trading portfolio or held to maturity securities.
Securities classified as available-for-sale are carried at estimated
fair market value. These securities are held for an indefinite period
of time, but might be sold in the future as changes in market
conditions or economic factors occur. Net aggregate unrealized gains
and losses related to such securities, net of taxes, are included as a
separate component of shareholders' equity. Interest, dividends and
gains and losses realized on sales of securities are reported in
Investment income.
F-9
We evaluate our investments periodically to determine whether any
decline in fair value, below the cost basis, is other than temporary.
To determine whether an impairment is other than temporary, we
consider whether we have the ability and intent to hold the investment
until a market price recovery and whether evidence indicating the cost
of the investment is recoverable outweighs evidence to the contrary.
Evidence considered in this assessment includes the reasons for the
impairment, the severity and duration of the impairment, changes in
value subsequent to year-end, and forecasted performance of the
investee. If we determine that a decline in fair value is other than
temporary, the cost basis of the individual investment is written down
to fair value, which becomes the new cost basis. The amount of the
write-down is transferred from other comprehensive income (loss) and
included in the statement of operations as a loss.
(j) Income Taxes, Deferred Income Taxes and Investment Tax Credits:
---------------------------------------------------------------
We file a consolidated federal income tax return. We utilize the asset
and liability method of accounting for income taxes. Under the asset
and liability method, deferred income taxes are recorded for the tax
effect of temporary differences between the financial statement basis
and the tax basis of assets and liabilities using tax rates expected
to be in effect when the temporary differences are expected to
reverse. The investment tax credits relating to regulated operations,
as defined by applicable regulatory authorities, have been deferred
and are being amortized to income over the lives of the related
properties.
(k) Employee Stock Plans:
---------------------
We have various employee stock-based compensation plans. Awards under
these plans are granted to eligible officers, management and
non-management employees. Awards may be made in the form of incentive
stock options, non-qualified stock options, stock appreciation rights,
restricted stock or other stock based awards. As permitted by current
accounting rules, we apply Accounting Principles Board Opinions (APB)
No. 25 and related interpretations in accounting for the employee
stock plans resulting in the use of the intrinsic value to value the
stock.
SFAS No. 123, "Accounting for Stock-Based Compensation" and SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of SFAS No. 123," established accounting and
disclosure requirements using a fair-value-based method of accounting
for stock-based employee compensation plans. As permitted by existing
accounting standards, the Company has elected to continue to apply the
intrinsic-valued-based method of accounting described above, and has
adopted only the disclosure requirements of SFAS No. 123, as amended.
We provide pro forma net income (loss) and pro forma net income (loss)
per common share disclosures for employee stock option grants made in
1995 and thereafter based on the fair value of the options at the date
of grant (see Note 18). For purposes of presenting pro forma
information, the fair value of options granted is computed using the
Black Scholes option-pricing model.
F-10
Had we determined compensation cost based on the fair value at the
grant date for the Management Equity Incentive Plan (MEIP), Equity
Incentive Plan (EIP), Employee Stock Purchase Plan (ESPP) and
Directors' Deferred Fee Equity Plan, our pro forma net loss and net
income (loss) per common share available for common shareholders would
have been as follows:
2003 2002 2001
----------------- --------------- --------------
($ in thousands)
--------------
Net income (loss) available for common As reported $ 187,852 $ (682,897) $ (103,332)
shareholders
Add: Stock-based employee compensation
expense included in reported net income
(loss), net of related tax effects 6,264 5,063 7,728
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (16,263) (17,154) (36,671)
---------------- ------------- ------------
Pro forma $ 177,853 $ (694,988) $ (132,275)
================ ============== ============
Net income (loss) per common share As reported:
available for common shareholders Basic $ 0.67 $ (2.43) $ (0.38)
Diluted 0.64 (2.43) (0.38)
Pro forma:
Basic $ 0.63 $ (2.48) $ (0.48)
Diluted 0.61 (2.48) (0.48)
(l) Net Income (Loss) Per Common Share Available for Common Shareholders:
---------------------------------------------------------------------
Basic net income (loss) per common share is computed using the
weighted average number of common shares outstanding during the period
being reported on. Except when the effect would be antidilutive,
diluted net income per common share reflects the dilutive effect of
the assumed exercise of stock options using the treasury stock method
at the beginning of the period being reported on as well as common
shares that would result from the conversion of convertible preferred
stock. In addition, the related interest on preferred stock dividends
(net of tax) is added back to income since it would not be paid if the
preferred stock was converted to common stock.
(2) Recent Accounting Literature and Changes in Accounting Principles:
------------------------------------------------------------------
Goodwill and Other Intangibles
------------------------------
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets." This statement requires that goodwill and other
intangibles with indefinite useful lives no longer be amortized to
earnings, but instead be reviewed for impairment. We have no intangibles
with indefinite useful lives other than goodwill and trade name. The
amortization of goodwill and trade name ceased upon adoption of the
statement on January 1, 2002. We were required to test for impairment of
goodwill and other intangibles with indefinite useful lives as of January
1, 2002 and at least annually thereafter. Any transitional impairment loss
at January 1, 2002 was recognized as the cumulative effect of a change in
accounting principle in our statement of operations. As a result of our
adoption of SFAS No. 142, we recognized a transitional impairment loss
related to ELI of $39.8 million as a cumulative effect of a change in
accounting principle in our statement of operations in 2002. We annually
examine the carrying value of our goodwill and other intangibles with
indefinite useful lives to determine whether there are any impairment
losses and have determined for the year ended December 31, 2003 that there
was no impairment.
F-11
SFAS No. 142 also requires that intangible assets with estimated useful
lives be amortized over those lives and be reviewed for impairment in
accordance with SFAS No. 144, "Accounting for Impairment or Disposal of
Long-Lived Assets." We reassess the useful life of our intangible assets
with estimated useful lives annually.
The following table presents a reconciliation between reported net loss and
adjusted net loss. Adjusted net loss excludes amortization expense
recognized in prior periods related to goodwill and trade name that are no
longer being amortized as required by SFAS No. 142.
(In thousands, except per-share amounts) 2001
-------------------------------------- ---------------
Reported available for common shareholders $ (103,332)
Add back: Goodwill and trade name amortization, net of tax 61,938
---------------
Adjusted available for common shareholders $ (41,394)
===============
Basic loss per share:
- ---------------------
Reported available for common shareholders per share $ (0.38)
Goodwill and trade name amortization, net of tax 0.23
---------------
Adjusted available for common shareholders per share $ (0.15)
===============
Diluted earnings loss per share:
- --------------------------------
Reported available for common shareholders per share $ (0.38)
Goodwill and trade name amortization, net of tax 0.22
---------------
Adjusted available for common shareholders per share $ (0.16)
===============
Accounting for Asset Retirement Obligations
-------------------------------------------
In June 2001, the 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 and is reflected as a cumulative effect of a change in
accounting principle in our statement of operations in 2003 as the Company
has no legal obligation to remove certain of its long-lived assets.
The following table presents pro forma amounts related to the adoption of
SFAS 143.
(In thousands, except per-share amounts) 2003 2002 2001
-------------------------------------- ------------------- ------------------- ------------------
Reported available for common shareholders $ 187,852 $ (682,897) $ (103,332)
Add back: Cost of removal in depreciation expense - 15,990 17,011
------------------- ------------------- ------------------
Adjusted available for common shareholders $ 187,852 $ (666,907) $ (86,321)
=================== =================== ==================
Basic income (loss) per share:
- -----------------------------
Reported available for common shareholders per share $ 0.67 $ (2.43) $ (0.38)
Cost of removal in depreciation expense - 0.06 0.06
------------------- ------------------- ------------------
Adjusted available for common shareholders per share $ 0.67 $ (2.37) $ (0.32)
=================== =================== ==================
Diluted income (loss) per share:
- -------------------------------
Reported available for common shareholders per share $ 0.64 $ (2.43) $ (0.38)
Cost of removal in depreciation expense - 0.06 0.06
------------------- ------------------- ------------------
Adjusted available for common shareholders per share $ 0.64 $ (2.37) $ (0.32)
=================== =================== ==================
Long-Lived Assets
-----------------
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement establishes a
single accounting model, based on the framework established in SFAS No.
121, for impairment of long-lived assets held and used and for long-lived
assets to be disposed of by sale, whether previously held and used or newly
acquired, and broadens the presentation of discontinued operations to
include more disposal transactions. We adopted this statement on January 1,
2002.
F-12
Debt Retirement
---------------
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the requirement to aggregate gains
and losses from extinguishment of debt and, if material, classified as an
extraordinary item, net of related income tax effect. The statement
requires gains and losses from extinguishment of debt to be classified as
extraordinary items only if they meet the criteria in Accounting Principles
Board Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions" which provides guidance
for distinguishing transactions that are part of an entity's recurring
operations from those that are unusual or infrequent or that meet the
criteria for classification as an extraordinary item. We adopted SFAS No.
145 in the second quarter of 2002. For the year ended December 31, 2003, we
recognized $64,823,000 of gains from early debt retirement. For the year
ended December 31, 2002, we recognized $29,296,000 of gains from early debt
retirement as well as a $12,800,000 loss due to a tender offer related to
certain debt securities. There were no similar types of retirements in
2001.
Exit or Disposal Activities
---------------------------
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which nullified Emerging
Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity." SFAS
No. 146 requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred, rather than
on the date of commitment to an exit plan. This Statement is effective for
exit or disposal activities that are initiated after December 31, 2002. We
adopted SFAS No. 146 on January 1, 2003.
Guarantees
----------
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Guarantees of Indebtedness of Others." FIN 45 requires that a
guarantor be required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation assumed under the guarantee.
FIN 45 also requires additional disclosures by a guarantor in its interim
and annual financial statements about the obligations associated with the
guarantee. The provisions of FIN 45 are effective for guarantees issued or
modified after December 31, 2002, whereas the disclosure requirements were
effective for financial statements for period ending after December 15,
2002. We adopted FIN No. 45 as of January 1, 2003. The adoption of FIN 45
did not have any material impact on our financial position or results of
operations.
Stock-Based Compensation
------------------------
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement
No. 123, "Accounting for Stock-Based Compensation." SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based compensation and amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements. This statement is effective
for fiscal years ending after December 15, 2002. We have adopted the
expanded disclosure requirements of SFAS No. 148.
Variable Interest Entities
--------------------------
In December 2003, the FASB issued FASB Interpretation No. 46 (revised
December 2003) ("FIN 46R"), "Consolidation of Variable Interest Entities,"
which addresses how a business enterprise should evaluate whether it has a
controlling financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. FIN 46R replaces FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities," which
was issued in January 2003. We are required to apply FIN 46R to variable
interests in variable interest entities or VIEs created after December 31,
2003. For variable interests in VIEs created before January 1, 2004, the
Interpretation will be applied beginning on January 1, 2005. For any VIEs
that must be consolidated under FIN 46R that were created before January 1,
2004, the assets, liabilities and noncontrolling interests of the VIE
initially would be measured at their carrying amounts with any difference
between the net amount added to the balance sheet and any previously
recognized interest being recognized as the cumulative effect of an
accounting change. If determining the carrying amounts is not practicable,
fair value at the date FIN 46R first applies may be used to measure the
assets, liabilities and noncontrolling interest of the VIE.
F-13
Derivative Instruments and Hedging
----------------------------------
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging," which clarifies financial accounting
and reporting for derivative instruments including derivative instruments
embedded in other contracts. This Statement is effective for contracts
entered into or modified after June 30, 2003. We adopted SFAS No. 149 on
July 1, 2003. The adoption of SFAS No. 149 did not have any material impact
on our financial position or results of operations.
Financial Instruments with Characteristics of Both Liabilities and Equity
---------------------------------------------------------------------------
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity."
The Statement establishes standards for the classification and measurement
of certain financial instruments with characteristics of both liabilities
and equity. Generally, the Statement is effective for financial instruments
entered into or modified after May 31, 2003 and is otherwise effective at
the beginning of the first interim period beginning after June 15, 2003. We
adopted the provisions of the Statement on July 1, 2003. The adoption of
SFAS No. 150 did not have any material impact on our financial position or
results of operations.
Pension and Other Postretirement Benefits
-----------------------------------------
In December 2003, the FASB issued SFAS No. 132 (revised), "Employers'
Disclosures about Pensions and Other Postretirement Benefits." This
statement retains and revises the disclosure requirements contained in the
original statement. It requires additional disclosures including
information describing the types of plan assets, investment strategy,
measurement date(s), plan obligations, cash flows, and components of net
periodic benefit cost recognized in interim periods. This statement is
effective for fiscal years ending after December 15, 2003. We have adopted
the expanded disclosure requirements of SFAS No. 132 (revised).
The FASB also recently indicated that it would require stock-based employee
compensation to be recorded as a charge to earnings beginning in 2005. We
will continue to monitor the progress on the issuance of this standard.
(3) Accounts Receivable:
--------------------
The components of accounts receivable, net at December 31, 2003 and 2002
are as follows:
($ in thousands) 2003 2002
-------------- -------------- ---------------
Customers $ 247,894 $ 291,266
Other 47,911 58,609
Less: Allowance for doubtful accounts (47,332) (38,946)
-------------- ---------------
Accounts receivable, net $ 248,473 $ 310,929
============== ===============
The Company maintains an allowance for estimated bad debts based on its
estimate of collectibility of its accounts receivables. Bad debt expense,
which is recorded, as a reduction of revenue, was $33,972,000, $52,805,000
and $51,234,000 for the years ended December 31, 2003, 2002, and 2001,
respectively. In addition, additional reserves are provided for known or
impending telecommunications bankruptcies, disputes or other significant
collection issues.
An agreement was reached with WorldCom/MCI settling all pre-petition
obligations and receivables. The bankruptcy court approved the agreement
and we reduced our reserves by approximately $6.6 million in the fourth
quarter 2003 as a result of the settlement. During the second quarter 2002,
we reserved approximately $21,600,000 of trade receivables with WorldCom as
a result of WorldCom's filing for bankruptcy. These receivables were
generated as a result of providing ordinary course telecommunications
services. We have ongoing commercial relationships with WorldCom.
Concurrent with the acquisition of Frontier, we entered into several
operating agreements with Global Crossing. We have ongoing commercial
relationships with Global Crossing affiliates. We reserved a total of
$29,000,000 of Global Crossing receivables during 2001 and 2002 as a result
of Global Crossing's filing for bankruptcy to reflect our best estimate of
the net realizable value of receivables resulting from these commercial
relationships. We recorded a write-down of such receivables in the amount
of $7,800,000 in 2002 and $21,200,000 in 2001. In 2002, as the result of a
settlement agreement with Global Crossing, we reversed $11,600,000 of our
previous write-down reserve of the net realizable value of these
receivables.
F-14
(4) Property, Plant and Equipment:
------------------------------
The components of property, plant and equipment at December 31, 2003 and
2002 are as follows:
Estimated
($ in thousands) Useful Lives 2003 2002
-------------- ------------------- ----------------- -----------------
Land N/A $ 21,650 $ 21,372
Buildings and leasehold improvements 30 to 41 years 354,855 349,781
General support 3 to 17 years 411,660 463,750
Central office/electronic circuit equipment 5 to 11 years 2,421,341 2,265,117
Cable and wire 15 to 55 years 2,843,510 2,731,302
Other 5 to 20 years 53,303 91,305
Construction work in progress 114,988 217,145
----------------- -----------------
6,221,307 6,139,772
Less: accumulated depreciation (2,695,667) (2,449,716)
----------------- -----------------
Property, plant and equipment, net $ 3,525,640 $ 3,690,056
================= =================
Depreciation expense is principally based on the composite group method.
Depreciation expense was $468,438,000, $630,113,000 and $488,957,000 for
the years ended December 31, 2003, 2002 and 2001, respectively. Effective
January 1, 2003, as a result of the adoption of SFAS No. 143, "Accounting
for Asset Retirement Obligations," we ceased recognition of the cost of
removal provision in depreciation expense and eliminated the cumulative
cost of removal included in accumulated depreciation. In addition, we
increased the average depreciable lives for certain of our equipment in our
ILEC segment. As part of the preparation and adoption of SFAS No. 143, we
analyzed depreciation rates for the ILEC segment and compared them to
industry averages and historical expense data. Based on this review, the
Company identified certain assets for which the Company's analysis of
historical/estimated lives indicated that the existing estimated
depreciable life was shorter than such revised estimates. This change in
estimate reduced depreciation expense by $38,882,000 or $0.09 per share for
the year ended December 31, 2003.
We ceased to record depreciation expense on the gas assets held for sale
effective October 1, 2000 and on the electric assets held for sale
effective January 1, 2001 (see Note 9). During 2002 and 2001, we recognized
accelerated depreciation of $23,379,000 and $22,000,000 related to the
change in useful lives of our accounting and human resource systems and our
Plano, Texas office building, furniture and fixtures as a result of a
restructuring (see Note 19).
(5) Losses on Impairment:
---------------------
In the third and fourth quarters of 2003, we recognized non-cash pre-tax
impairment losses of $4,000,000 and $11,300,000, respectively, related to
our Vermont electric division assets held for sale in accordance with the
provisions of SFAS No. 144.
In the third quarter 2002, we recognized non-cash pre-tax impairment losses
of $656,658,000 related to property, plant and equipment in the ELI sector
and $417,400,000 related to the gas and electric sector assets held for
sale, in each case in accordance with the provisions of SFAS No. 144.
F-15
ELI
---
Prior to the third quarter of 2002, we tested for impairment of ELI and
determined that, based on our assumptions, the sum of the expected future
cash flows, undiscounted and without interest charges, exceeded the
carrying value of its long-lived assets and therefore we did not recognize
an impairment. Because sales for the nine months ended September 30, 2002
were lower than those in 2001 and were significantly below our original
2002 budget (which was used in the test for impairment at December 31,
2001), we evaluated the long-lived assets of ELI as of September 30, 2002.
At that date, we estimated that our undiscounted future cash flows were
less than the carrying value of our long-lived assets. As a result we
recognized a non-cash pre-tax impairment loss of $656,658,000, equal to the
difference between the estimated fair value of the assets (which we
determined by calculating the discounted value of the estimated future cash
flows weighting various possible scenarios for management's assessment of
probability of occurrence and discounting the probability-weighted cash
flows at an appropriate rate) and the carrying amount of the assets. Making
the determinations of impairment and the amount of impairment require
significant judgment by management and assumptions with respect to the
future cash flows of the ELI sector. The telecommunications industry in
general and the CLEC sector in particular is undergoing significant change
and disruption, which makes judgments and assumptions with respect to the
future cash flows highly subjective.
Electric Assets Held for Sale
-----------------------------
We have entered into definitive agreements to sell the remaining assets of
our Vermont electric division to Great Bay Hydro Corporation and Vermont
Electric Cooperative, Inc. for a net sales price of approximately
$12,700,000 in cash, subject to adjustments 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 of these assets
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
based upon the expected future sales price.
(6) Acquisitions:
-------------
On June 29, 2001, we purchased Frontier for approximately $3,373,000,000 in
cash. This acquisition has been accounted for using the purchase method of
accounting. The results of operations of Frontier have been included in our
financial statements from the date of acquisition.
The following summarizes the allocation of purchase price for our 2001
acquisition:
($ in thousands) June 29, 2001
-------------- Acquisition
of Frontier
---------------
Assets acquired:
Property, plant and
equipment $ 1,108,514
Current assets 119,016
Goodwill 1,506,647
Customer base 791,983
Trade name 122,058
Other assets 151,172
---------------
Total assets acquired 3,799,390
---------------
Liabilities assumed:
Debt 146,920
Other liabilities 279,536
---------------
Total liabilities assumed 426,456
---------------
Cash paid $ 3,372,934
===============
F-16
The following pro forma financial information for the year ended December
31, 2001 represents the combined results of our operations and acquisition
as if the acquisition had occurred at the beginning of the year of its
acquisition. The pro forma financial information does not necessarily
reflect the results of operations that would have occurred had we
constituted a single entity during such periods.
($ in thousands, except per share amounts)
---------------------------------------- 2001
---------------
Revenue $ 2,844,789
Net loss $ (161,619)
Net loss per share $ (0.64)
Included in revenue for the year ended December 31, 2001 is approximately
$313,070,000 of revenue from our Louisiana and Colorado gas operations sold
during 2001, and our Kauai electric division sold during 2002 (see Note 9).
(7) 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 $2,173,000.
(8) Intangibles:
------------
Intangibles at December 31, 2003 and 2002 are as follows:
($ in thousands) 2003 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 (305,504) (179,904)
--------------- ----------------
Total other intangibles, net $ 812,407 $ 942,970
=============== ================
Amortization expense was $126,838,000, $125,409,000 and $143,379,000 for
the years ended December 31, 2003, 2002 and 2001, respectively.
Amortization expense for each of the next five years, based on our estimate
of useful lives, is estimated to be $125,102,000 per year.
We have recorded assets and liabilities acquired at estimates of fair
market values as of the acquisition dates in accordance with SFAS No. 141,
"Business Combinations." Our allocations of purchase prices are based upon
independent appraisals of the respective properties acquired.
Our acquisitions were made in order for us to execute upon our business
strategy. Our strategy is to focus exclusively on providing
telecommunications services, primarily in rural, small and medium-sized
towns and cities where we believe we have a competitive advantage because
of our relatively larger size, greater resources, local focus and lower
levels of competition.
We paid more than the net book value (of the seller) for Frontier. We based
our purchase price on estimates of future earnings and future cash flows of
the business acquired. The "premium" to book value paid, including the
allocation to goodwill reflects the value created by all of the tangible
and intangible operating assets (existing and acquired) of our businesses
coming together to produce earnings, including without limitation, the fact
that we were able to immediately commence operations as the dominant local
exchange carrier in the applicable operating area. Additionally, the
premiums paid were impacted by the fact that our purchase price was
accepted by the sellers after a competitive bidding and negotiation
process.
F-17
We were willing to pay a premium (i.e., goodwill) over the fair value of
the tangible and identifiable intangible assets acquired less liabilities
assumed in order to obtain product cross-selling opportunities, economies
of scale (e.g., cost savings opportunities) and the potential benefit
resident in expected population/demographic trends.
(9) 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 disposal of the water
segment was $316,700,000.
Discontinued operations in the consolidated statements of operations
reflect the results of operations of the water/wastewater properties
sold in January 2002 including allocated interest expense for the
periods presented. Interest expense was allocated to the discontinued
operations based on the outstanding debt specifically identified with
these businesses.
Summarized financial information for the water/wastewater operations
(discontinued operations) is set forth below:
($ in thousands) For the years ended December 31,
-------------- -------------------------------
2002 2001
------------- ----------------
Revenue $ 4,650 $ 116,868
Operating income (loss) (415) 37,211
Income taxes (benefit) (554) 8,947
Net income (loss) (1,478) 17,875
Gain on disposal of water segment, net
of tax 181,369 -
Electric and Gas
----------------
On August 8, 2003, we completed the sale of The Gas Company in Hawaii
division for $119,290,000 in cash and assumed liabilities. The pre-tax
loss on the sale recognized in 2003 was $19,180,000 and is included in
gain (loss) on sale of assets.
On August 11, 2003, we completed the sale of our Arizona gas and
electric divisions for $224,100,000 in cash. The pre-tax loss on the
sale recognized in 2003 was $18,491,000 and is included in gain (loss)
on sale of assets.
On December 2, 2003, we completed the sale of substantially all of our
Vermont electric division's transmission assets for $7,344,000 million
in cash (less $1,837,000 in refunds to customers as ordered by the
Vermont Public Service Board).
On November 1, 2002, we completed the sale of our Kauai electric
division for $215,000,000 in cash.
On July 2, 2001, we completed the sale of our Louisiana Gas operations
for $363,436,000 in cash.
On November 30, 2001, we sold our Colorado Gas division for
approximately $8,900,000 in cash after purchase price adjustments.
F-18
All the remaining assets of our Vermont electric distribution operations
and their related liabilities are classified as "assets held for sale" and
"liabilities related to assets held for sale," respectively. Additional
impairment charges of $4,000,000 and $11,300,000 were recognized in the
third and fourth quarters of 2003, respectively, such that the net assets
have been written down to $ 7,002,000, our best estimate of the net
realizable value upon sale.
We initially accounted for the planned divestiture of all the public
utilities services properties as discontinued operations. Subsequently, we
reclassified all of our gas (on September 30, 2000) and electric (on
December 31, 2000) assets and their related liabilities to "assets held for
sale" and "liabilities related to assets held for sale," respectively. We
also reclassified the results of these operations from discontinued
operations to their original statement of operations captions as part of
continuing operations. Additionally, we ceased to record depreciation
expense on the gas assets effective October 1, 2000 and on the electric
assets effective January 1, 2001. Such depreciation expense would have been
an additional $19,223,000, $41,340,000 and $50,830,000 for the years ended
December 31, 2003, 2002 and 2001, respectively.
Summarized balance sheet information for the gas and electric operations
(assets held for sale) is set forth below:
($ in thousands) 2003 2002
-------------- -------------- ---------------
Current assets $ 4,688 $ 49,549
Net property, plant and equipment 7,225 358,135
Other assets 11,217 40,080
-------------- ---------------
Total assets held for sale $ 23,130 $ 447,764
============== ===============
Current liabilities $ 8,651 $ 79,194
Other liabilities 7,477 66,775
-------------- ---------------
Total liabilities related to assets held for sale $ 16,128 $ 145,969
============== ===============
(10) Investments:
------------
The components of investments at December 31, 2003 and 2002 are as follows:
($ in thousands) 2003 2002
-------------- ---------------- ----------------
Marketable equity securities $ 44,314 $ 29,844
Other fixed income securities 2 2
---------------- ----------------
$ 44,316 $ 29,846
================ ================
As of December 31, 2003 and 2002, we owned 3,059,000 shares of Adelphia
Communications Corp. (Adelphia) common stock. As a result of Adelphia's
price declines and filing for bankruptcy, we recognized losses of
$95,300,000 and $79,000,000 on our investment for the years ended December
31, 2002 and 2001, respectively, as the declines were determined to be
other than temporary.
As of December 31, 2003 and 2002, we owned 1,333,500 shares of D & E
Communications, Inc. (D & E) common stock. As the result of an other than
temporary decline in D & E's stock price, we recognized a loss of
$16,400,000 on our investment for the year ended December 31, 2002.
F-19
The following summarizes the adjusted cost, gross unrealized holding gains
and losses and fair market value for investments:
($ in thousands) Unrealized Holding
-------------- Adjusted --------------------------------- Aggregate Fair
Investment Classification Cost Gains (Losses) Market Value
------------------------- ---------------- ---------------- ---------------- ----------------
As of December 31, 2003
- -----------------------
Available-for-Sale $ 14,452 $ 29,864 $ - $ 44,316
As of December 31, 2002
- -----------------------
Available-for-Sale $ 14,452 $ 15,394 $ - $ 29,846
Marketable equity securities for 2003 and 2002 include 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 $70 per share and is convertible at our
option into 10 shares of common stock.
(11) Fair Value of Financial Instruments:
------------------------------------
The following table summarizes the carrying amounts and estimated fair
values for certain of our financial instruments at December 31, 2003 and
2002. For the other financial instruments, representing cash, accounts
receivables, long-term debt due within one year, accounts payable and other
accrued liabilities, the carrying amounts approximate fair value due to the
relatively short maturities of those instruments.
($ in thousands) 2003 2002
-------------- ----------------------------------- ---------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------------- ------------------ ---------------- ----------------
Investments $ 44,316 $ 44,316 $ 29,846 $ 29,846
Long-term debt (1) $ 4,195,629 $ 4,608,205 $ 4,957,361 $ 5,411,069
Equity Providing Preferred
Income Convertible Securities (EPPICS) $ 201,250 $ 205,275 $ 201,250 $ 191,188
The fair value of the above financial instruments is based on quoted prices
at the reporting date for those financial instruments.
(1) Excludes the $460,000,000 debt portion of the equity units. Includes
interest rate swaps of $10,601,000.
F-20
(12) Long-term Debt:
---------------
The activity in our long-term debt from December 31, 2002 to December 31,
2003 is summarized as follows:
Twelve Months Ended
----------------------------------------
Interest Rate*
at
December 31, Interest December 31, December 31,
($ in thousands) 2002 Payments** Rate Swap Other 2003 2003
-------------- ----- ---------- --------- ----- ----- ----
FIXED RATE
Rural Utilities Service Loan
Contracts $ 30,874 $ (864) $ - $ - $ 30,010 6.210%
Senior Unsecured Debt 4,508,880 (335,700) (6,057) - 4,167,123 8.198%
Equity Units 460,000 - - - 460,000 7.480%
ELI Notes 5,975 - - - 5,975 6.232%
ELI Capital Leases 135,200 (69,610) - (55,529) 10,061 9.746%
Industrial Development Revenue Bonds 186,390 (115,950) - - 70,440 5.590%
Other 40 (18) - - 22 12.987%
----------- --------- ----------- ---------- -------------
TOTAL FIXED RATE 5,327,359 (522,142) (6,057) (55,529) 4,743,631
----------- --------- ----------- ---------- -------------
VARIABLE RATE
Industrial Development Revenue Bonds 148,913 (131,320) - (17,593) -
----------- --------- ----------- ---------- -------------
TOTAL VARIABLE RATE 148,913 (131,320) - (17,593) -
----------- --------- ----------- ---------- -------------
TOTAL LONG TERM DEBT $5,476,272 $(653,462) $ (6,057) $(73,122) $4,743,631
----------- ========== =========== ========== -------------
Less: Current Portion (58,911) (88,002)
Less: Equity Units (460,000) (460,000)
----------- -------------
$4,957,361 $4,195,629
=========== =============
* 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 (see Note 2).
Total future minimum cash payment commitments over the next 25 years under
ELI's long-term capital leases amounted to $30,063,000 as of December 31,
2003.
The total outstanding principal amounts of industrial development revenue
bonds were $70,440,000 and $335,303,000 at December 31, 2003 and 2002,
respectively. The earliest maturity date for these bonds is in August 2015.
We have an available shelf registration of $825,600,000 and we have
available lines of credit with financial institutions in the aggregate
amount of $805,000,000. Associated facility fees vary, depending on our
credit ratings, and are 0.25% per annum as of December 31, 2003. The
expiration date for the facilities is October 24, 2006. During the term of
the facilities we may borrow, repay and reborrow funds. As of December 31,
2003, there were no outstanding advances under these facilities.
During the twelve months ended December 31, 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 $94,895,000 and
they generated a pre-tax loss on the early extinguishment of debt at a
premium of approximately $3,117,000 recorded in other income (loss), net.
During December 2002, we completed a tender offer with respect to our 6.80%
Debentures due 2026 (puttable at par in 2003) and ELI's 6.05% Guaranteed
Notes due 2004. As a result of the tender, $82,286,000 and $259,389,000,
respectively, of these securities were purchased and retired at a pre-tax
cost of $12,800,000 (recorded in other income (loss), net) in excess of the
principal amount of the securities purchased.
F-21
For the year ended December 31, 2003, we retired an aggregate $726,584,000
of debt, representing approximately 14% of total debt outstanding at
December 31, 2002.
Our principal payments and capital lease payments (principal only) for the
next five years are as follows:
($ in thousands)
-------------- Principal Capital
--------- -------
Payments Lease Payments
--------- --------------
2004 $87,851 $ 151
2005 6,302 154
2006 1,335,922 175
2007 4,331 197
2008 750,938 222
Holders of certain industrial development revenue bonds may tender at par
prior to maturity. The next tender date is August 1, 2007 for $30,350,000
principal amount of bonds. We expect to retire all such bonds that are
tendered. In connection with the sale of our Arizona utility businesses, we
agreed to call at their first call dates in 2007 another three Arizona
industrial development revenue bond series totaling approximately
$33,440,000.
(13) Derivative Instruments and Hedging Activities:
----------------------------------------------
Interest rate swap agreements are used to hedge a portion of our debt that
is subject to fixed interest rates. Under our interest rate swap
agreements, we agree to pay an amount equal to a specified variable rate of
interest times a notional principal amount, and to receive in return an
amount equal to a specified fixed rate of interest times the same notional
principal amount. The notional amounts of the contracts are not exchanged.
No other cash payments are made unless the agreement is terminated prior to
maturity, in which case the amount paid or received in settlement is
established by agreement at the time of termination and represents the
market value, at the then current rate of interest, of the remaining
obligations to exchange payments under the terms of the contracts.
The interest rate swap contracts are reflected at fair value in our
consolidated balance sheet and the related portion of fixed-rate debt being
hedged is reflected at an amount equal to the sum of its book value and an
amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. Changes in the fair
value of interest rate swap contracts, and the offsetting changes in the
adjusted carrying value of the related portion of the fixed-rate debt being
hedged, are recognized in the consolidated statements of operations in
interest expense. The notional amounts of fixed-rate indebtedness hedged as
of December 31, 2003 and December 31, 2002 was $400,000,000 and
$250,000,000, respectively. Such contracts require us to pay variable rates
of interest (average pay rate of approximately 5.46% as of December 31,
2003) and receive fixed rates of interest (average receive rate of 8.38% as
of December 31, 2003). The fair value of these derivatives is reflected in
other assets as of December 31, 2003, in the amount of $10,601,000 and the
related underlying debt has been increased by a like amount. The amounts
received during the year ended December 31, 2003 as a result of these
contracts amounted to $8,900,000 and are included as a reduction of
interest expense.
We do not anticipate any nonperformance by counter parties to our
derivative contracts as all counter parties have investment grade credit
ratings.
(14) Shareholder Rights Plan:
------------------------
On March 6, 2002, our Board of Directors adopted a Shareholder Rights Plan.
The purpose of the Shareholder Rights Plan is to deter coercive takeover
tactics and to encourage third parties interested in acquiring us to
negotiate with our Board of Directors. It is intended to strengthen the
ability of our Board of Directors to fulfill its fiduciary duties to take
actions, which are in the best interest of our shareholders. The rights
were distributed to shareholders as a dividend at the rate of one right for
each share of our common stock held by shareholders of record as of the
close of business on March 26, 2002. Initially, the rights generally were
exercisable only if a person or group acquired beneficial ownership of 15
percent or more of our common stock (the "Acquiror") without the consent of
our independent directors. On January 21, 2003, our Board of Directors
amended the terms of our Rights agreement increasing the level at which
these rights will become exercisable to 20 percent of our common stock.
Each right not owned by an Acquiror becomes the right to purchase our
common stock at a 50 percent discount.
F-22
(15) Settlement of Retained Liabilities:
-----------------------------------
We were 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 year ended
December 31, 2003 and 2002, we recognized gains of $6,165,000 and
$26,330,000 in other income (loss), net, as a result of these settlements.
(16) Company Obligated Mandatorily Redeemable Convertible Preferred Securities:
--------------------------------------------------------------------------
In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust
(the Trust), issued, in an underwritten public offering, 4,025,000 shares
of 5% Company Obligated Mandatorily Redeemable Convertible Preferred
Securities due 2036 (Trust Convertible Preferred Securities or EPPICS),
representing preferred undivided interests in the assets of the Trust, with
a liquidation preference of $50 per security (for a total liquidation
amount of $201,250,000). The proceeds from the issuance of the Trust
Convertible Preferred Securities and a Company capital contribution were
used to purchase $207,475,000 aggregate liquidation amount of 5%
Partnership Convertible Preferred Securities due 2036 from another
wholly-owned consolidated subsidiary, Citizens Utilities Capital L.P. (the
Partnership). The proceeds from the issuance of the Partnership Convertible
Preferred Securities and a Company capital contribution were used to
purchase from us $211,756,000 aggregate principal amount of 5% Convertible
Subordinated Debentures due 2036. The sole assets of the Trust are the
Partnership Convertible Preferred Securities and our Convertible
Subordinated Debentures are substantially all the assets of the
Partnership. Our obligations under the agreements related to the issuances
of such securities, taken together, constitute a full and unconditional
guarantee by us of the Trust's obligations relating to the Trust
Convertible Preferred Securities and the Partnership's obligations relating
to the Partnership Convertible Preferred Securities.
In accordance with the terms of the issuances, we paid the 5% interest on
the Convertible Subordinated Debentures in 2003, 2002 and 2001. Only cash
was paid to the Partnership in payment of the interest on the Convertible
Subordinated Debentures. The cash was then distributed by the Partnership
to the Trust and then by the Trust to the holders of the EPPICS.
(17) Capital Stock:
--------------
We are authorized to issue up to 600,000,000 shares of Common Stock. The
amount and timing of dividends payable on Common Stock are within the sole
discretion of our Board of Directors.
During 2000, we entered into a forward contract to purchase 9,140,000
shares of our common stock with Citibank, N.A. These purchases and others
made by us for cash during 2000 were made in open-market transactions. The
forward amount to be paid in the future included a carrying cost, based on
LIBOR plus a spread, and the dollar amount paid for the shares purchased.
Our equity forward contract was a temporary financing arrangement that gave
us the flexibility to purchase our stock and pay for those purchases in
future periods. Pursuant to transition accounting rules, commencing
December 31, 2000 through June 30, 2001 we were required to report our
equity forward contract as a reduction to shareholders' equity and as a
component of temporary equity for the gross settlement amount of the
contract ($150,013,000). On June 28, 2001, we entered into a master
confirmation agreement that amended the equity forward contract to no
longer permit share settlement of the contract. In 2001, we settled the
contract by paying the redemption amount of $150,012,000 plus $13,650,000
in associated carrying costs and took possession of our shares.
(18) Stock Plans:
------------
At December 31, 2003, we have four stock based compensation plans, which
are described below. We apply APB Opinion 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. Compensation cost has
not generally been recognized in the financial statements for options
issued pursuant to the Management Equity Incentive Plan (MEIP), or Equity
Incentive Plan (EIP), as the exercise price for such options was equal to
the market price of the stock at the time of grant. However, during 2002
the expiration date of approximately 79,000 options was extended and
compensation cost of approximately $220,000 was recognized. No compensation
cost has been recognized in the financial statements related to the
Employee Stock Purchase Plan (ESPP) because the purchase price is 85% of
the fair value. Compensation cost, recognized in operating expense, for our
Directors' Deferred Fee Equity Plan was $997,000, $607,000 and $741,000 in
2003, 2002 and 2001, respectively.
F-23
We have granted restricted stock awards to key employees in the form of our
Common Stock. The number of shares issued as restricted stock awards during
2003, 2002 and 2001 were 312,000, 538,000 and 100,000, respectively. None
of the restricted stock awards may be sold, assigned, pledged or otherwise
transferred, voluntarily or involuntarily, by the employees until the
restrictions lapse. The restrictions are both time and performance based.
At December 31, 2003, 3,166,000 shares of restricted stock were
outstanding. Compensation expense, recognized in operating expense, of
$8,552,000, $7,029,000 and $8,967,000 for the years ended December 31,
2003, 2002 and 2001, respectively, has been recorded in connection with
these grants.
Management Equity Incentive Plan
--------------------------------
Under the MEIP, awards of our Common Stock may be granted to eligible
officers, management employees and non-management employees in the form of
incentive stock options, non-qualified stock options, stock appreciation
rights (SARs), restricted stock or other stock-based awards. The
Compensation Committee of the Board of Directors administers the MEIP.
Since the expiration date of the MEIP plan on June 21, 2000, no awards can
be granted under the MEIP. The exercise price of stock options issued was
equal to or greater than the fair market value of the underlying common
stock on the date of grant. Stock options are generally not exercisable on
the date of grant but vest over a period of time. Under the terms of the
MEIP, subsequent stock dividends and stock splits have the effect of
increasing the option shares outstanding, which correspondingly decreases
the average exercise price of outstanding options.
Equity Incentive Plan
---------------------
In May 1996, our shareholders approved the 1996 EIP and in May 2001, our
shareholders approved the Amended and Restated 2000 EIP. Under the EIP
plans, awards of our Common Stock may be granted to eligible officers,
management employees and non-management employees in the form of incentive
stock options, non-qualified stock options, SARs, restricted stock or other
stock-based awards. The Compensation Committee of the Board of Directors
administers the EIP plans.
The maximum number of shares of common stock, which may be issued pursuant
to awards at any time for both plans, is 25,358,000 shares, which has been
adjusted for subsequent stock dividends. No awards will be granted more
than 10 years after the effective dates (May 23, 1996 and May 18, 2000) of
the EIP plans. The exercise price of stock options and SARs generally shall
be equal to or greater than the fair market value of the underlying common
stock on the date of grant. Stock options are generally not exercisable on
the date of grant but vest over a period of time.
Under the terms of the EIP plans, subsequent stock dividends and stock
splits have the effect of increasing the option shares outstanding, which
correspondingly decrease the average exercise price of outstanding options.
F-24
The following is a summary of share activity subject to option under the
MEIP and EIP plans.
Weighted
Shares Average
Subject to Option Price
Option Per Share
---------------------------------------------------------------------------------------------------------
Balance at January 1, 2001 17,621,000 $ 10.72
Options granted 3,969,000 13.62
Options exercised (1,728,000) 8.25
Options canceled, forfeited or lapsed (805,000) 11.45
---------------------------------------------------------------------------------------
Balance at December 31, 2001 19,057,000 11.87
Options granted 3,065,000 9.53
Options exercised (812,000) 7.90
Options canceled, forfeited or lapsed (2,178,000) 11.94
---------------------------------------------------------------------------------------
Balance at December 31, 2002 19,132,000 11.66
Options granted 2,017,000 12.14
Options exercised (1,612,000) 7.97
Options canceled, forfeited or lapsed (1,572,000) 12.92
---------------------------------------------------------------------------------------
Balance at December 31, 2003 17,965,000 $ 11.94
=======================================================================================
The following table summarizes information about shares subject to options
under the MEIP and EIP at December 31, 2003.
Options Outstanding Options Exercisable
--------------------------------------------------------------------------------- ---------------------------------
Weighted Average Weighted
Number Range of Weighted Average Remaining Number Average
Outstanding Exercise Prices Exercise Price Life in Years Exercisable Exercise Price
----------------------------------------------------------------------------------------------------------------------
6,000 $ 4.00 - 5.00 $ 4.29 0.73 6,000 $ 4.29
914,000 6.00 - 7.50 7.50 5.25 914,000 7.50
2,336,000 7.72 - 8.53 8.13 3.58 2,336,000 8.13
103,000 9.18 - 9.38 9.26 5.34 73,000 9.29
2,635,000 9.52 - 9.52 9.52 8.29 1,045,000 9.52
2,130,000 10.24 - 11.41 10.80 3.09 2,130,000 10.80
1,889,000 12.08 - 12.14 12.14 8.93 37,000 12.14
795,000 12.37 - 12.91 12.58 6.70 614,000 12.56
2,010,000 12.97 - 12.97 12.97 5.68 2,010,000 12.97
545,000 13.06 - 13.47 13.44 6.77 538,000 13.45
2,302,000 13.71 - 13.71 13.71 7.19 1,204,000 13.71
2,300,000 13.75 - 21.47 18.10 6.71 783,000 15.58
------------------ -----------------
17,965,000 $ 4.00 - 21.47 $ 11.94 5.57 11,690,000 $ 11.09
================== =================
The number of options exercisable at December 31, 2002 and 2001 were
12,198,000 and 10,676,342, respectively.
The weighted average fair value of options granted during 2003, 2002 and
2001 were $6.04, $4.98 and $6.00, respectively. For purposes of the pro
forma calculation, the fair value of each option grant is estimated on the
date of grant using the Black Scholes option-pricing model with the
following weighted average assumptions used for grants in 2003, 2002 and
2001:
2003 2002 2001
---------------------------------------------------------------------
Dividend yield - - -
Expected volatility 44% 44% 36%
Risk-free interest rate 2.94% 4.94% 5.10%
Expected life 7 years 7 years 6 years
---------------------------------------------------------------------
F-25
Employee Stock Purchase Plan
----------------------------
Our ESPP was approved by shareholders on June 12, 1992 and amended on May
22, 1997. Under the ESPP, eligible employees have the right to subscribe to
purchase shares of our Common Stock at 85% of the average of the high and
low market prices on the last day of the purchase period. An employee may
elect to have up to 50% of annual base pay withheld in equal installments
throughout the designated payroll-deduction period for the purchase of
shares. The value of an employee's subscription may not exceed $25,000 in
any one calendar year and the minimum contribution each purchase period is
$50.00. Active employees are required to hold their shares for three years
from the date of each purchase period. An employee may not participate in
the ESPP if such employee owns stock possessing 5% or more of the total
combined voting power or value of our capital stock. As of December 31,
2002, there were 6,407,000 shares of Common Stock reserved for issuance
under the ESPP. These shares may be adjusted for any future stock dividends
or stock splits. The ESPP will terminate when all shares reserved have been
subscribed for and purchased, unless terminated earlier or extended by the
Board of Directors. The Compensation Committee of the Board of Directors
administers the ESPP.
Effective November 30, 2002, the employee stock purchase plan was
temporarily suspended for future purchase periods. In 2002, 146,406 shares
were purchased under the ESPP and 4,072,647 shares were outstanding as of
date of suspension. For purposes of the pro forma calculation, compensation
cost is recognized for the fair value of the employees' purchase rights,
which was estimated using the Black Scholes option pricing model with the
following assumptions for subscription periods beginning in 2002 and 2001:
2002 2001
---------------------------
Dividend yield - -
Expected volatility 44% 36%
Risk-free interest rate 1.93% 2.71%
Expected life 6 months 6 months
The weighted average fair value of those purchase rights granted in 2002
and 2001 was $2.57 and $2.39, respectively.
Directors' Deferred Fee Equity Plan
-----------------------------------
The Company accounts for the Directors' Deferred Fee Equity Plan in
accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations. Compensation expense is recorded if
cash or stock units are elected. If stock units are elected, the
compensation expense is based on the market value of our common stock at
the date of grant. If the stock option election is chosen, compensation
expense is not recorded because the options are granted at the fair market
value of our common stock on the grant date.
Effective June 30, 2000, the annual cash retainer paid to non-employee
directors was eliminated. Instead, each non-employee director was required
to elect, by August 1, 2000, to receive as an annual retainer either 2,500
stock units or 10,000 stock options. Starting in July 2001, the Board of
Directors restored the ability of the non-employee directors to receive the
annual retainer in cash. Each non-employee director must now elect, by
December 1 of the prior year, to receive $30,000 cash, 5,000 stock units or
20,000 stock options as an annual retainer. Directors making a stock unit
election must also elect to receive payment in either stock or cash upon
retirement from the Board of Directors. Stock options have an exercise
price of the fair market value on the date of grant, are exercisable six
months after the date of grant and have a 10-year term. The Formula Plan
described below also remains in effect until its expiration in 2007.
For 2003, each non-employee director received fees of $2,000 for each Board
of Directors and committee meeting attended. In addition, committee chairs
(except the chairs of the Audit and Compensation Committees) receive an
additional fee of $5,000 per annum, paid quarterly. The chairs of the Audit
and Compensation Committees are each paid an additional fee of $15,000 per
annum. In addition, the Lead Director, who heads the ad hoc committee of
non-employee directors, receives an additional fee of $20,000 per annum.
From January 1, 2000 through June 30, 2001, the non-employee directors
could choose to receive their fees in either stock or stock units or a
combination of those two options. Effective July 2001, non-employee
directors have the choice to receive their fees paid in cash, stock, or
stock units or a combination of two of those three options. If stock was
elected, the stock was granted at the average of the high and low on the
first trading date of the year (Initial Market Value). If stock units were
elected, they were purchased at 85% of the Initial Market Value. Stock
units (except in an event of hardship) are held by us until retirement or
death. If the Final Market Value (the average of the high and low prices of
the stock on the last trading day of November) is less than Initial Market
Value, the number of shares of stock or stock units will be adjusted based
on Final Market Value.
F-26
The Formula Plan, which commenced in 1997 and continues through May 22,
2007, grants each Director options to purchase 5,000 shares of common stock
on the sixth trading day of the calendar year. The exercise price of the
options granted under the Formula Plan is 100% of the average of the fair
market values on the third, fourth, fifth, and sixth trading days of the
year in which the options are granted. The options are exercisable six
months after the grant date and remain exercisable for ten years after the
grant date. In addition, on September 1, 1996, each non-employee director
was granted options to purchase 2,500 shares of common stock.
As of any date, the maximum number of shares of common stock which the Plan
was obligated to deliver pursuant to the Directors' Plan shall not be more
than one percent (1%) of the total outstanding shares of our common stock
as of June 30, 2003, subject to adjustment in the event of changes in our
corporate structure affecting capital stock. There were 11 directors
participating in the Directors' Plan during all or part of 2003. In 2003,
the total options, plan units and stock earned were 80,208, 46,034 and 0,
respectively. In 2002, the total options, plan units and stock earned were
99,583, 43,031 and 1,514, respectively. In 2001, the total options, plan
units and stock earned were 90,000, 55,285 and 1,321, respectively. At
December 31, 2003, 1,346,550 options were exercisable at a weighted average
exercise price of $10.82.
We had also maintained a Non-Employee Directors' Retirement Plan providing
for the payment of specified sums annually to our non-employee directors,
or their designated beneficiaries, starting at the director's retirement,
death or termination of directorship. In 1999, we terminated this Plan. The
vested benefit of each non-employee director, as of May 31, 1999, was
credited in the form of stock units. Such benefit will be payable to each
director upon retirement, death or termination of directorship. Each
participant had until July 15, 1999 to elect whether the value of the stock
units awarded would be payable in our common stock (convertible on a one
for one basis) or in cash. As of December 31, 2003, the liability for such
payments was $2,066,000 of which $1,294,000 will be payable in stock (based
on the July 15, 1999 stock price) and $772,000 will be payable in cash.
While the number of shares of stock payable to those directors electing to
be paid in stock is fixed, the amount of cash payable to those directors
electing to be paid in cash will be based on the number of stock units
awarded multiplied by the stock price on the payment date.
(19) Restructuring 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, $32,985,000 related to 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 related to our tender offer in June 2002
for all of the publicly held ELI common shares that we did not already own.
These costs were partially offset by a $2,825,000 reversal of a 2001 ELI
accrual discussed below.
2001
----
During 2001, we examined all aspects of our business operations and our
facilities to take advantage of operational and functional synergies among
all of 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 $14,557,000
in the second half of 2001, $839,000 in the first quarter of 2002 and
we adjusted our accrual down by $92,000 and $561,000 in the second and
third quarter of 2002, respectively. Our objective is to concentrate
our resources in areas where we have the most customers, to better
serve those customers. We sold our Plano office building in 2003. The
restructuring resulted in the termination of 750 employees. We
communicated with all affected employees during July 2001. Certain
employees were relocated; others were offered severance, job training
and/or outplacement counseling. As of December 31, 2002, approximately
$14,730,000 was paid and all affected employees were terminated. The
restructuring expenses primarily consist of severance benefits,
retention earned through December 31, 2002, and other planning and
communication costs.
F-27
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 $731,000 in the fourth
quarter of 2001, $62,000 and $9,000 in the first and second quarter of
2002, respectively. We redirected the call traffic and other work
activities to our Kingman, Arizona call center. This restructuring
resulted in the elimination of 98 employees. We communicated with all
affected employees during November 2001. As of December 31, 2002,
approximately $802,000 was paid and all affected employees were
terminated and no accrual remained.
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. During 2002, ELI adjusted its original accrual down by
$2,825,000 due to the favorable settlements of termination charges for
off-net circuit agreements. As of December 31, 2002, $1,354,000 has
been 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. As a result, ELI became a
wholly-owned subsidiary, for total costs and expenses of approximately
$6,800,000. We accounted for this transaction as a purchase and
allocated the entire amount to goodwill. We evaluated the
recoverability of this goodwill in accordance with SFAS No. 142 and
determined that a write-off was necessary based on fair market value
as determined by discounted cash flows and other valuation
methodologies. This charge is included in restructuring and other
expenses.
F-28
The following tables display rollforwards of the accruals established for
restructuring expenses by plan:
($ in thousands)
- ---------------
2001 Severance Benefits Retention Other Total
----------------- ------------ ------------- ----------- -------------
2001 Plano Restructuring
Original accrued amount $ 9,353 $ 1,535 $ 1,178 $ 936 $ 13,002
Amount paid (1,386) (35) (80) (177) (1,678)
Additional accrual 551 - 1,793 27 2,371
Adjustments (325) (104) (64) (323) (816)
----------------- ------------ -------------- ---------- -------------
Accrued @ 12/31/2001 8,193 1,396 2,827 463 12,879
----------------- ------------ -------------- ---------- -------------
Amount paid (7,599) (1,355) (3,752) (346) (13,052)
Additional accrual 65 - 1,150 - 1,215
Adjustments (659) (28) (225) (117) (1,029)
----------------- ------------ -------------- ---------- -------------
Accrued @ 12/31/2002 - 13 - - 13
----------------- ------------ -------------- ---------- -------------
Amount paid - (13) - - (13)
Additional accrual - - - - -
Adjustments - - - - -
----------------- ------------ -------------- ---------- -------------
Accrued @ 12/31/2003 $ - $ - $ - $ - $ -
================= ============ ============== ========== =============
2001 Sacramento Call Center Restructuring
Accrued @ 12/31/2001 $ 552 $ 94 $ 85 $ - $ 731
Amount paid (529) (83) (190) - (802)
Additional accrual 45 - 116 - 161
Adjustments (68) (11) (11) - (90)
----------------- ------------ -------------- ---------- -------------
Accrued @ 12/31/2002 $ - $ - $ - $ - $ -
================= ============ ============== ========== =============
ELI 2001 Restructuring
Accrued @ 12/31/2001 $ - $ - $ - $ 4,179 $ 4,179
Amount paid - - - (1,354) (1,354)
Additional accrual - - - - -
Adjustments - - - (2,825) (2,825)
----------------- ------------ ------------------------ -------------
Accrued @ 12/31/2002 $ - $ - $ - $ - $ -
================= ============ ======================== =============
F-29
(20) Income Taxes:
-------------
The following is a reconciliation of the provision (benefit) for income
taxes for continuing operations computed at federal statutory rates to the
effective rates:
2003 2002 2001
------------ ------------ -------------
Consolidated tax provision (benefit) at federal statutory rate 35.0% -35.0% -35.0%
State income tax provisions (benefit), net of federal income
tax benefit 5.4% -1.3% 10.8%
Write-off of regulatory assets 0.0% 2.6% 11.7%
Tax reserve adjustment -7.0% 0.0% -1.0%
All other, net 1.0% 0.0% -6.9%
------------ ------------ -------------
34.4% -33.7% -20.4%
============ ============ =============
The components of the net deferred income tax liability (asset) at December
31 are as follows:
($ in thousands) 2003 2002
------------ ------------
Deferred income tax liabilities:
Property, plant and equipment basis differences $ 412,795 $ 229,132
Deferred energy commodity charges - 51,633
Intangibles 152,226 -
Unrealized securities gain 11,432 5,893
Other, net 15,042 41,038
------------ ------------
591,495 327,696
------------ ------------
Deferred income tax assets:
Minimum pension liability 55,837 69,209
Tax operating loss carryforward 253,215 214,943
Alternate minimum tax credit carryforward 49,864 49,864
Employee benefits 47,856 9,114
Other, net 40,745 45,004
------------ ------------
447,517 388,134
Less: Valuation allowance (44,236) (21,614)
------------ ------------
Net deferred income tax asset 403,281 366,520
------------ ------------
Net deferred income tax liability (asset) $ 188,214 $ (38,824)
============ ============
Deferred tax assets and liabilities are reflected in the following
captions on the balance sheet:
Deferred income taxes $ 447,056 $ 204,369
Other assets (258,842) (243,193)
------------ ------------
Net deferred income tax liability (asset) $ 188,214 $ (38,824)
============ ============
Our federal and state tax operating loss carryforwards as of December 31,
2003 are estimated at $515,802,000 and $943,783,000, respectively. Our
federal loss carryforward will begin to expire in the year 2020. A portion
of our state loss carryforward will begin to expire in 2005. Our
alternative minimum tax credit as of December 31, 2003 can be carried
forward indefinitely to reduce future regular tax liability.
F-30
The provision (benefit) for federal and state income taxes, as well as the
taxes charged or credited to shareholders' equity, includes amounts both
payable currently and deferred for payment in future periods as indicated
below:
($ in thousands) 2003 2002 2001
-------------- ------------ ------------ -------------
Income taxes charged (credited) to the income statement for
continuing operations:
Current:
Federal $ (12,632) $ (159,844) $ (37,003)
State 2,900 (2,562) 5,168
------------ ------------ -------------
Total current (9,732) (162,406) (31,835)
Deferred:
Federal 80,152 (230,388) 10,791
Federal tax credits (3,128) (352) (649)
State (76) (21,728) 6,888
------------ ------------ -------------
Total deferred 76,948 (252,468) 17,030
------------ ------------ -------------
Subtotal 67,216 (414,874) (14,805)
Income taxes charged (credited) to the income statement for
discontinued operations:
Current:
Federal - 169,246 5,093
State - 11,328 774
------------ ------------ -------------
Total current - 180,574 5,867
Deferred:
Federal - (39,904) 2,726
Investment tax credits - - (332)
State - (5,921) 686
------------ ------------ -------------
Total deferred - (45,825) 3,080
------------ ------------ -------------
Subtotal - 134,749 8,947
Income tax benefit on dividends on convertible preferred securities:
Current:
Federal (3,344) (3,344) (3,344)
State (508) (508) (508)
------------ ------------ -------------
Subtotal (3,852) (3,852) (3,852)
Income taxes charged to the income statement for
extraordinary expense - Discontinuation of Statement of Financial
Accounting Standards No. 71:
Deferred:
Federal - - 15,500
State - - 6,157
------------ ------------ -------------
Subtotal - - 21,657
------------ ------------ -------------
Income taxes charged to the income statement for
cumulative effect of change in accounting principle:
Deferred:
Federal 35,414 - -
State 6,177 - -
------------ ------------ -------------
Subtotal 41,591 - -
------------ ------------ -------------
Total income taxes charged (credited) to the income
statement (a) 104,955 (283,977) 11,947
F-31
Income taxes charged (credited) to shareholders' equity:
Deferred income taxes (benefits) on unrealized gains or losses on
securities classified as available-for-sale 5,539 2,726 2,908
Current benefit arising from stock options exercised (2,535) (720) (3,001)
Deferred income taxes (benefits) arising from recognition of
a minimum pension liability 13,373 (69,209) -
------------ ------------ -------------
Income taxes charged (credited) to shareholders'
equity (b) 16,377 (67,203) (93)
------------ ------------ -------------
Total income taxes: (a) plus (b) $ 121,332 $ (351,180) $ 11,854
============ ============ =============
F-32
(21) Net Income (Loss) Per Common Share:
----------------------------------
The reconciliation of the net income (loss) per common share calculation
for the years ended December 31, 2003, 2002 and 2001 is as follows:
($ in thousands, except per-share amounts)
---------------------------------------- 2003 2002 2001
------------------ ------------------ ------------------
Net income (loss) used for basic and diluted
earnings per common share:
Income (loss) from continuing operations before extraordinary
expense and cumulative effect of change in accounting principle $ 122,083 $ (822,976) $ (77,576)
Income from discontinued operations - 179,891 17,875
------------------ ------------------ ------------------
Income (loss) before extraordinary expense and cumulative effect
of change in accounting principle 122,083 (643,085) (59,701)
Extraordinary expense - - 43,631
Income (loss) from cumulative effect of change in accounting
principle 65,769 (39,812) -
------------------ ------------------ ------------------
Total basic net income (loss) available for common shareholders $ 187,852 $ (682,897) $ (103,332)
================== ================== ==================
Effect of conversion of preferred securities 6,210 - -
------------------ ------------------ ------------------
Total diluted net income (loss) available for common shareholders $ 194,062 $ (682,897) $ (103,332)
================== ================== ==================
Basic earnings (loss) per common share:
Weighted-average shares outstanding - basic 282,434 280,686 273,721
------------------ ------------------ ------------------
Income (loss) from continuing operations before extraordinary
expense and cumulative effect of change in accounting principle $ 0.44 $ (2.93) $ (0.28)
Income from discontinued operations - 0.64 0.06
------------------ ------------------ ------------------
Income (loss) before extraordinary expense and cumulative effect
of change in accounting principle 0.44 (2.29) (0.22)
Extraordinary expense - - (0.16)
Income (loss) from cumulative effect of change in accounting
principle 0.23 (0.14) -
------------------ ------------------ ------------------
Net income (loss) per share available for common shareholders $ 0.67 $ (2.43) $ (0.38)
================== ================== ==================
Diluted earnings (loss) per common share:
Weighted-average shares outstanding 282,434 280,686 273,721
Effect of dilutive shares 4,868 3,887 5,859
Effect of conversion of preferred securities 15,134 - -
------------------ ------------------ ------------------
Weighted-average shares outstanding - diluted 302,436 284,573 279,580
================== ================== ==================
Income (loss) from continuing operations before extraordinary
expense and cumulative effect of change in accounting principle $ 0.42 $ (2.93) $ (0.28)
Income from discontinued operations - 0.64 0.06
------------------ ------------------ ------------------
Income (loss) before extraordinary expense and cumulative effect
of change in accounting principle 0.42 (2.29) (0.22)
Extraordinary expense - - (0.16)
Income (loss) from cumulative effect of change in accounting
principle 0.22 (0.14) -
------------------ ------------------ ------------------
Net income (loss) per share available for common shareholders $ 0.64 $ (2.43) $ (0.38)
================== ================== ==================
For the years ended December 31, 2003, 2002 and 2001 options of 10,190,000,
14,391,000 and 10,447,000, 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.
F-33
In addition, for the years ended December 31, 2003, 2002 and 2001,
restricted stock awards of 1,249,000, 1,004,000 and 1,232,000 shares,
respectively, are excluded from our basic weighted average shares
outstanding and included in our dilutive shares until the shares are no
longer contingent upon the satisfaction of all specified conditions.
We also have 18,400,000 potentially dilutive equity units with each equity
unit consisting of a 6.75% senior note due 2006 and a purchase contract
(warrant) for our common stock. The purchase contract obligates the holder
to purchase from us, no later than August 17, 2004 for a purchase price of
$25, the following number of shares of our common stock:
* 1.7218 shares, if the average closing price of our common stock
over the 20-day trading period ending on the third trading day
prior to August 17, 2004 equals or exceeds $14.52;
* A number of shares having a value, based on the average closing
price over that period, equal to $25, if the average closing
price of our common stock over the same period is less than
$14.52 but greater than $12.10; and
* 2.0661 shares, if the average closing price of our common stock
over the same period is less than or equal to $12.10.
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 $13.30 per share
that have been included in the diluted income (loss) per common share
calculation for the period ended December 31, 2003.
As a result of our loss from continuing operations for the years ended
December 31, 2002 and 2001, dilutive securities of 3,373,846 and 3,559,936
issuable under employee compensation plans were excluded from the
computation of diluted EPS for those periods, respectively, because their
inclusion would have had an antidilutive effect.
(22) Comprehensive Income (Loss):
----------------------------
Comprehensive income consists of net income (loss) and other gains and
losses affecting shareowners' investment and minimum pension liability
that, under GAAP, are excluded from net income (loss).
F-34
Our other comprehensive income (loss) for the years ended December 31,
2003, 2002 and 2001 is as follows:
2003
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
-------------- ------------- -------------- -------------
Net unrealized gains on securities:
Net unrealized holding gains arising during period $ 14,470 $ 5,539 $ 8,931
Minimum pension liability 34,935 13,373 21,562
------------- -------------- -------------
Other comprehensive income $ 49,405 $ 18,912 $ 30,493
============= ============== =============
2002
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
-------------- ------------- -------------- -------------
Net unrealized losses on securities:
Net unrealized holding losses arising during period $(101,137) $(38,078) $ (63,059)
Add: Reclassification adjustments for net gain/
losses realized in net loss 108,376 40,804 67,572
Minimum pension liability (180,799) (69,210) (111,589)
------------- -------------- -------------
Other comprehensive loss $(173,560) $(66,484) $(107,076)
============= ============== =============
2001
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
-------------- ------------- -------------- -------------
Net unrealized losses on securities:
Net unrealized holding losses arising during period $ (70,771) $(27,015) $(43,756)
Add: Reclassification adjustments for net losses
realized in net loss 78,168 29,923 48,245
------------- -------------- -------------
Other comprehensive income $ 7,397 $ 2,908 $ 4,489
============= ============== =============
(23) Segment Information:
--------------------
We operate in three segments, ILEC, ELI (a 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 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 in any individual market.
As permitted by SFAS No. 131, we have utilized the aggregation criteria in
combining our markets because all of the Company's ILEC properties share
similar economic characteristics: they provide the same products and
services to similar customers using comparable technologies in all the
states we operate. The regulatory structure is generally similar.
Differences in the regulatory regime of a particular state do not impact
the economic characteristics or operating results of a particular property.
F-35
($ in thousands) For the year ended December 31, 2003
-------------- -------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
------------- -------------- ------------- ----------- -------------
Revenue $ 2,040,935 $ 165,389 $ 137,686 $ 100,928 $ 2,444,938
Depreciation and Amortization 571,766 23,510 - - 595,276
Reserve for Telecommunications
Bankruptcies (5,524) 1,147 - - (4,377)
Restructuring and Other Expenses 9,373 314 - - 9,687
Loss on Impairment - - - 15,300 15,300
Operating Income (Loss) 537,248 9,710 14,013 (3,359) 557,612
Capital Expenditures, net 244,089 9,496 9,877 13,984 277,446
Assets 6,420,204 184,559 - 23,130 6,627,893
($ in thousands) For the year ended December 31, 2002
-------------- -------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
------------- -------------- ------------- ----------- -------------
Revenue $ 2,062,905 $ 175,079 $ 216,517 $ 214,831 $ 2,669,332
Depreciation and Amortization 643,123 112,035 148 216 755,522
Reserve for Telecommunications
Bankruptcies 10,446 434 - - 10,880
Restructuring and Other Expenses 30,054 7,132 - - 37,186
Loss on Impairment - 656,658 152,300 265,100 1,074,058
Operating Income (Loss) 413,241 (759,161) (119,579) (222,090) (687,589)
Capital Expenditures, net 288,823 122,003 (1) 21,035 18,625 (3) 450,486
Assets 6,675,928 214,252 389,737 58,027 7,337,944
($ in thousands) For the year ended December 31, 2001
-------------- -------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Segments
------------- -------------- ------------- ----------- -------------
Revenue $ 1,594,053 $ 223,391 $ 411,534 $ 228,015 $ 2,456,993
Depreciation and Amortization 545,273 80,020 609 6,434 632,336
Reserve for Telecommunications
Bankruptcies 21,200 - - - 21,200
Restructuring and Other Expenses 15,148 4,179 - - 19,327
Operating Income (Loss) 220,956 (71,165) 47,916 35,335 233,042
Capital Expenditures, net 391,377 28,233 (2) 34,138 32,706 486,454
Assets 7,072,288 902,348 441,654 666,283 9,082,573
1) Includes $110,000,000 of previously leased facilities purchased by ELI in
April 2002.
2) Does not include approximately $33,985,000 of non-cash ELI capital lease
additions in 2001.
3) Does not include approximately $38,000,000 of non-cash capital lease
additions.
F-36
The following tables are reconciliations of certain sector items to the
total consolidated amount.
($ in thousands)
-------------- For the years ended December 31,
Capital Expenditures 2003 2002 2001
-------------- ------------- -----------
Total segment capital expenditures $ 277,446 $ 450,486 $ 486,454
General capital expenditures 569 18,256 817
-------------- ------------- -----------
Consolidated reported capital expenditures $ 278,015 $ 468,742 $ 487,271
============== ============= ===========
Assets 2003 2002
-------------- -------------
Total segment assets $ 6,627,893 $ 7,337,944
General assets 1,061,217 884,761
-------------- -------------
Consolidated reported assets $ 7,689,110 $ 8,222,705
============== =============
(24) Discontinuation of SFAS No. 71:
-------------------------------
We historically applied SFAS No. 71 in the preparation of our financial
statements because our incumbent local exchange telephone properties
(properties we owned prior to the 2000 and 2001 acquisitions of the
Verizon, Qwest and Frontier properties) were predominantly regulated in the
past following a cost of service/rate of return approach. Beginning in the
third quarter of 2001, these properties no longer met the criteria for
application of SFAS No. 71 due to the continuing process of deregulation
and the introduction of competition to our existing rural local exchange
telephone properties, and our expectation that these trends will continue
for all our properties.
Currently, pricing for a majority of our revenues is based upon price cap
plans that limit prices to changes in general inflation and estimates of
productivity for the industry at large, or upon market pricing, rather than
on the specific costs of operating our business, a requirement for the
application of SFAS No. 71. These trends in the deregulation of pricing and
the introduction of competition are expected to continue in the near future
as additional states adopt price cap forms of regulation.
Discontinued application of SFAS No. 71 required us to write off all of the
regulatory assets and liabilities of our incumbent local exchange telephone
operations. As a result we recognized a non-cash extraordinary charge in
our financial statements in the third quarter of 2001 as follows:
($ in thousands)
--------------
Assets:
Deferred income tax assets $31,480
Deferred cost of extraordinary plant retirements 25,348
Deferred charges 6,885
Liabilities:
Plant related
(10,259)
Deferred income tax liabilities
(2,531)
-----------
Pre-tax charge 50,923
Income tax benefit 7,292
-----------
Extraordinary expense $43,631
===========
F-37
Under SFAS No. 71, we depreciated our telephone plant for financial
reporting purposes over asset lives approved by the regulatory agencies
setting regulated rates. As part of the discontinuance of SFAS No. 71, we
revised the depreciation lives of our core technology assets to reflect
their estimated economic useful lives. Based upon our evaluation of the
pace of technology change that is estimated to occur in certain components
of our rural telephone networks, we concluded that minor modifications as
of the date of discontinuance were required in our asset lives for the
major network technology assets as follows:
Average Remaining Life in Years
-------------------------------
Regulated Economic
Life Life
---- ----
Switching Equipment 6.4 5.6
Circuit Equipment 4.3 4.9
Copper Cable 8.5 7.7
Upon discontinuation of SFAS No. 71, we tested the balances of property,
plant and equipment associated with the incumbent local exchange telephone
properties for impairment under SFAS No. 121 (as required by SFAS No. 101).
No impairment charge was required.
To reflect the expectation that competitive entry will occur over time for
certain of our properties acquired in prior purchase business combinations,
we have shortened the amortization life for previously acquired franchise
rights related to these properties to 20 years. This action was taken to
reflect the fact that our dominant position in the market related to the
existence of the prior monopoly in incumbent local exchange telephone
service may be reduced over time as competitors enter our markets.
(25) Quarterly Financial Data (Unaudited):
-------------------------------------
($ in thousands, except per share amounts) First Second Third Fourth
---------------------------------------- quarter quarter quarter quarter
---------- ---------- ---------- ----------
2003
Revenue $ 651,862 $ 643,954 $ 595,037 $ 554,085
Operating income 164,295 135,192 133,156 124,969
Income before cumulative effect of changes in accounting
principle 61,662 34,057 11,412 14,952
Net income 127,431 34,057 11,412 14,952
Income before cumulative effect of changes in accounting
principle available for common shareholders per basic share $ 0.22 $ 0.12 $ 0.04 $ 0.05
Income before cumulative effect of changes in accounting
principle available for common shareholders per diluted share $ 0.22 $ 0.12 $ 0.04 $ 0.05
Net income available for common shareholders per basic share $ 0.45 $ 0.12 $ 0.04 $ 0.05
Net income available for common shareholders per diluted share $ 0.45 $ 0.12 $ 0.04 $ 0.05
2002
Revenue $ 679,334 $ 662,439 $ 668,831 $ 658,728
Operating income (loss) 100,359 82,568 (969,038) 98,522
Income (loss) before cumulative effect of changes in accounting
principle 123,038 (41,559) (700,104) (24,460)
Net income (loss) 83,226 (41,559) (700,104) (24,460)
Income (loss) before cumulative effect of changes in accounting
principle available for common shareholders per basic share $ 0.44 $ (0.15) $ (2.49) $ (0.09)
Income (loss) before cumulative effect of changes in accounting
principle available for common shareholders per diluted share $ 0.43 $ (0.15) $ (2.49) $ (0.09)
Net income (loss) available for common shareholders per basic
share $ 0.30 $ (0.15) $ (2.49) $ (0.09)
Net income (loss) available for common shareholders per diluted
share $ 0.29 $ (0.15) $ (2.49) $ (0.09)
The quarterly net income (loss) per common share amounts are rounded to the
nearest cent. Annual net income (loss) per common share may vary depending
on the effect of such rounding.
F-38
2003 Transactions
-----------------
On April 1, 2003, we completed the sale of approximately 11,000 access
lines in North Dakota for approximately $25,700,000 in cash.
On April 4, 2003, we completed the sale of our wireless partnership
interest in Wisconsin for approximately $7,500,000 in cash.
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 initial
pre-tax loss on the sale was $18,480,000 recognized in the third quarter of
2003. We recognized an additional loss on the sale of $700,000 in the
fourth quarter of 2003 due to customary sale price adjustments.
On August 11, 2003, we completed the sale of our Arizona gas and electric
divisions for $224,100,000 in cash. The initial pre-tax loss on the sale
was $12,791,000 recognized in the third quarter of 2003. We recognized an
additional loss on the sale of $5,700,000 in the fourth quarter of 2003 due
to customary sale price adjustments.
In the third quarter 2003, we recognized a non-cash pre-tax impairment loss
of $4,000,000 related to the electric sector assets held for sale, in
accordance with the provisions of SFAS No. 144.
In the fourth quarter 2003, we recognized an additional non-cash pre-tax
impairment loss of $11,300,000 related to the electric sector assets held
for sale, in accordance with the provisions of SFAS No. 144.
On December 2, 2003, we completed the sale of substantially all of our
Vermont electric division's transmission assets for $7,344,000 in cash
(less $1,837,000 in refunds to customers per an order by the Vermont Public
Service Board).
In the fourth quarter 2003, we reduced our reserve for telecommunications
bankruptcies by approximately $6.6 million as a result of a settlement with
WorldCom/MCI.
Restructuring and other expenses in 2003 primarily consist of severance
expenses related to reductions in personnel at our telecommunications
operations and the write-off of software no longer useful.
2002 Transactions
-----------------
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.
In the third quarter 2002, we recognized non-cash pre-tax impairment losses
of $656,658,000 related to property, plant and equipment in the ELI sector
and $417,400,000 related to the gas and electric sector assets held for
sale, in each case in accordance with the provisions of SFAS No. 144.
On October 31, 2002, we completed the sale of approximately 4,000 access
lines in North Dakota for $9,700,000 in cash.
On November 1, 2002, we completed the sale of our Kauai electric division
to KIUC for $215,000,000 in cash.
Restructuring and other expenses in 2002 are primarily related to various
restructurings, $32,985,000 of severance expenses related to 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 pre-tax costs and
expenses related to our tender offer in the second quarter of 2002 for all
of the ELI common shares that we did not already own. These costs were
partially offset by a $2,825,000 pre-tax reversal of an ELI accrual.
As a result of Adelphia's price declines and filing for bankruptcy, during
the first and second quarters of 2002 we recognized other than temporary
pre-tax losses of $49,700,000 and $45,600,000, respectively, as the
declines were determined to be other than temporary.
F-39
As of December 31, 2002, we owned 1,333,500 shares of D & E common stock.
As the result of an other than temporary decline in D & E's stock price, we
recognized a pre-tax loss of $16,400,000 on our investment during the
quarter ended December 31, 2002.
Concurrent with the acquisition of Frontier, we entered into several
operating agreements with Global Crossing. We have ongoing commercial
relationships with Global Crossing affiliates. We reserved a total of
$29,000,000 of Global Crossing receivables during 2001 and 2002 as a result
of Global Crossing's filing for bankruptcy to reflect our best estimate of
the net realizable value of receivables incurred from these commercial
relationships. We recorded a pre-tax write-down of such receivables in the
amount of $7,800,000 in the first quarter 2002 and $21,200,000 in the
fourth quarter of 2001. In 2002, as the result of a settlement agreement
with Global Crossing, we reversed $11,600,000 of our previous reserve of
the net realizable value of these receivables.
(26) Retirement Plans:
-----------------
We sponsor a noncontributory defined benefit pension plan covering a
significant number of our employees and other postretirement benefit plans
that provide medical, dental, life insurance benefits and other benefits
for covered retired employees and their beneficiaries and covered
dependents. The benefits are based on years of service and final average
pay or career average pay. Contributions are made in amounts sufficient to
meet ERISA funding requirements while considering tax deductibility. Plan
assets are invested in a diversified portfolio of equity and fixed-income
securities.
The accounting results for pension and postretirement benefit costs and
obligations are dependent upon various actuarial assumptions applied in the
determination of such amounts. These actuarial assumptions include the
following: discount rates, expected long-term rate of return on plan
assets, future compensation increases, employee turnover, healthcare cost
trend rates, expected retirement age, optional form of benefit and
mortality. The Company reviews these assumptions for changes annually with
its outside actuaries. We consider our discount rate and expected long-term
rate of return on plan assets to be our most critical assumptions.
The discount rate is used to value, on a present basis, our pension and
postretirement benefit obligation as of the balance sheet date. The same
rate is also used in the interest cost component of the pension and
postretirement benefit cost determination for the following year. The
measurement date used in the selection of our discount rate is the balance
sheet date. Our discount rate assumption is determined annually with
assistance from our actuaries based on the interest rates for long-term
high quality corporate bonds. This rate can change from year-to-year based
on market conditions that impact corporate bond yields.
The expected long-term rate of return on plan assets is applied in the
determination of periodic pension and postretirement benefit cost as a
reduction in the computation of the expense. In developing the expected
long-term rate of return assumption, we considered published surveys of
expected market returns, 10 and 20 year actual returns of various major
indices, and our own historical 5-year and 10-year investment returns.
The expected long-term rate of return on plan assets is based on an asset
allocation assumption of 30% to 45% in fixed income securities and 55% to
70% in equity securities. We review our asset allocation at least annually
and make changes when considered appropriate. We continue to evaluate our
own actuarial assumptions, including the expected rate of return, at least
annually. Our pension plan assets are valued at actual market value as of
the measurement date. The measurement date used to determine pension and
other postretirement benefit measures for the pension plan and the
postretirement benefit plan is December 31.
Accounting standards require that Citizens record an additional minimum
pension liability when the plan's "accumulated benefit obligation" exceeds
the fair market value of plan assets at the pension plan measurement
(balance sheet) date. In the fourth quarter of 2002, due to weak
performance in the equity markets during 2002 as well as a decrease in the
year-end discount rate, the Company recorded an additional minimum pension
liability in the amount of $180,798,000 with a corresponding charge to
shareholders' equity of $111,589,000, net of taxes of $69,209,000. In the
fourth quarter of 2003, due to strong performance in the equity markets
during 2003, partially offset by a decrease in the year-end discount rate,
the Company recorded a reduction to its minimum pension liability in the
amount of $34,935,000 with a corresponding credit to shareholders' equity
of $21,562,000, net of taxes of $13,373,000. These adjustments did not
impact our earnings or cash flows for either year. If discount rates and
the equity markets performance decline, the Company would be required to
increase its minimum pension liabilities and record additional charges to
shareholder's equity in the future.
F-40
Actual results that differ from our assumptions are added or subtracted to
our balance of unrecognized actuarial gains and losses. For example, if the
year-end discount rate used to value the plan's projected benefit
obligation decreases from the prior year-end, then the plan's actuarial
loss will increase. If the discount rate increases from the prior year-end
then the plan's actuarial loss will decrease. Similarly, the difference
generated from the plan's actual asset performance as compared to expected
performance would be included in the balance of unrecognized gains and
losses.
The impact of the balance of accumulated actuarial gains and losses are
recognized in the computation of pension cost only to the extent this
balance exceeds 10% of the greater of the plan's projected benefit
obligation or market value of plan assets. If this occurs, that portion of
gain or loss that is in excess of 10% is amortized over the estimated
future service period of plan participants as a component of pension cost.
The level of amortization is affected each year by the change in actuarial
gains and losses and could potentially be eliminated if the gain/loss
activity reduces the net accumulated gain/loss balance to a level below the
10% threshold.
Effective February 1, 2003, the pension plan was frozen for all non-union
plan participants. The vested benefit earned through that date is protected
by law and will be available upon retirement. No additional benefit
accruals for service will occur after February 1, 2003 for those
participants.
F-41
Pension Plan
------------
The following tables set forth the plan's benefit obligations and fair
values of plan assets as of December 31, 2003 and 2002 and net periodic
benefit cost for the years ended December 31, 2003, 2002 and 2001.
($ in thousands) 2003 2002
-------------- ------------- --------------
Change in benefit obligation
- ----------------------------
Benefit obligation at beginning of year $ 780,237 $ 759,927
Service cost 6,479 12,159
Interest cost 49,103 53,320
Amendments (22,164) -
Actuarial loss 43,146 28,948
Acquisitions/Divestitures - (6,239)
Settlement due to transfer of plan (22,475) -
Plant closings/Reduction in force (1,198) (5,609)
Benefits paid (71,445) (62,269)
------------- --------------
Benefit obligation at end of year $ 761,683 $ 780,237
============= ==============
Change in plan assets
- ---------------------
Fair value of plan assets at beginning of year $ 692,361 $ 798,293
Actual return on plan assets 121,821 (60,026)
Settlement due to transfer of plan (23,115) -
Employer contribution - 16,363
Benefits paid (71,445) (62,269)
------------- --------------
Fair value of plan assets at end of year $ 719,622 $ 692,361
============= ==============
(Accrued)/Prepaid benefit cost
- ------------------------------
Funded status $ (42,061) $ (87,876)
Unrecognized net liability - 17
Unrecognized prior service cost (2,232) (1,450)
Unrecognized net actuarial loss 171,071 235,107
------------- --------------
Prepaid benefit cost $ 126,778 $ 145,798
============= ==============
Amounts recognized in the statement of financial position
- ---------------------------------------------------------
Prepaid benefit cost $ - $ 6,874
Accrued benefit liability (19,086) (41,874)
Other comprehensive income 145,864 180,798
------------- --------------
Net amount recognized $ 126,778 $ 145,798
============= ==============
F-42
($ in thousands) 2003 2002 2001
-------------- ------------- -------------- ---------------
Components of net periodic benefit cost
- ---------------------------------------
Service cost $ 6,479 $ 12,159 $ 14,065
Interest cost on projected benefit obligation 49,103 53,320 37,680
Return on plan assets (53,999) (63,258) (44,852)
Amortization of prior service cost and unrecognized
net obligation (172) (106) (242)
Amortization of unrecognized loss 11,026 2,137 -
------------- -------------- ---------------
Net periodic benefit cost 12,437 4,252 6,651
Curtailment/settlement charge 6,585 - -
------------- -------------- ---------------
Total periodic benefit cost $ 19,022 $ 4,252 $ 6,651
============= ============== ===============
The plan's weighted average asset allocations at December 31, 2003 and 2002
by asset category are as follows:
2003 2002
---- ----
Asset category:
--------------
Equity securities 62% 54%
Debt securities 36% 36%
Cash and other 2% 10%
------ ------
Total 100% 100%
====== ======
The Company's expected contribution to the plan in 2004 is $0.
The accumulated benefit obligation for the plan was $738,709,000 and
$711,870,000 at December 31, 2003 and 2002, respectively.
Assumptions used in the computation of pension and postretirement benefits
other than pension costs/year-end benefit obligations were as follows:
2003 2002
-------- -------
Discount rate 6.75/6.25% 7.25/6.75%
Expected long-term rate of return on plan assets 8.25%/N/A 8.25%/N/A
Rate of increase in compensation levels 4.0%/4.0% 4.0%/4.0%
In June 2001, we acquired Frontier, including substantially all their
pension assets and benefit obligations. This acquisition increased the
pension benefit obligation by $447,279,000 and the fair value of plan
assets by $583,190,000 as of June 29, 2001.
As part of the Frontier acquisition, Global Crossing and we agreed to the
transfer of pension liabilities and assets related to substantially all
Frontier employees. The liabilities associated with the Frontier employees
retained by Global Crossing were valued following the Pension Benefit
Guaranty Corporation's "safe harbor" rules. Prior to Global Crossing's
bankruptcy filing, Global Crossing and we reached an agreement on the value
of the pension assets and liabilities to be retained by Global Crossing as
well as the time frame and procedures by which the remainder of the assets
were to be transferred to a pension trust held by Citizens. Global Crossing
failed to execute and deliver an authorization letter to the Frontier plan
trustee directing the trustee to transfer to our pension plan record
ownership of the transferred assets. We initiated an adversary proceeding
with the Bankruptcy Court supervising Global Crossing's bankruptcy
proceeding, to determine and declare that Global Crossing's obligation was
not "executory", and to compel Global Crossing to execute and deliver such
authorization letter. On December 18, 2002 we entered into a stipulation
with Global Crossing and other parties, "so ordered" by the bankruptcy
court, fully and finally settling the adversary proceeding. Pursuant to the
stipulation and order, on February 3, 2003 Global Crossing instructed the
Frontier Plan Trustee to transfer record ownership of the transferred
assets with a market value of $447,800,000 to our pension plan, and the
transfer in fact took place on that date.
F-43
Postretirement Benefits Other Than Pensions
-------------------------------------------
The following tables set forth the plan's benefit obligations, fair values
of plan assets and the postretirement benefit liability recognized on our
balance sheets at December 31, 2003 and 2002 and net periodic
postretirement benefit costs for the years ended December 31, 2003, 2002
and 2001:
($ in thousands) 2003 2002
-------------- ------------- --------------
Change in benefit obligation
- ----------------------------
Benefit obligation at beginning of year $ 210,683 $ 190,342
Service cost 1,387 1,350
Interest cost 13,606 13,753
Plan participants' contributions 3,723 3,771
Actuarial loss 16,835 21,406
Acquisitions/Divestitures - (4,348)
Plant closings/Reduction in force - (1,950)
Benefits paid (22,897) (13,641)
------------- --------------
Benefit obligation at end of year $ 223,337 $ 210,683
============= ==============
Change in plan assets
- ---------------------
Fair value of plan assets at beginning of year $ 27,050 $ 29,090
Actual return on plan assets 1,624 (1,711)
Benefits paid (19,173) (9,870)
Employer contribution 19,568 9,541
Acquisitions/Divestitures (1,576) -
------------- --------------
Fair value of plan assets at end of year $ 27,493 $ 27,050
============= ==============
Accrued benefit cost
- --------------------
Funded status $(195,844) $(183,633)
Unrecognized transition obligation 211 234
Unrecognized prior service cost 13 16
Unrecognized loss 49,982 35,048
------------- --------------
Accrued benefit cost $(145,638) $(148,335)
============= ==============
($ in thousands) 2003 2002 2001
-------------- ------------- -------------- ---------------
Components of net periodic postretirement benefit cost
- ------------------------------------------------------
Service cost $ 1,387 $ 1,350 $ 937
Interest cost on projected benefit obligation 13,606 13,753 8,812
Return on plan assets (2,133) (2,438) (2,227)
Amortization of prior service cost and transition obligation 26 26 25
Amortization of unrecognized (gain)/loss 3,985 2,383 204
Settlement loss - - 491
------------- -------------- ---------------
Net periodic postretirement benefit cost $ 16,871 $ 15,074 $ 8,242
============= ============== ===============
F-44
The plan's weighted average asset allocations at December 31, 2003 and 2002
by asset category are as follows:
2003 2002
------- ------
Asset category:
--------------
Equity securities 16% 13%
Debt securities 63% 66%
Cash and other 21% 21%
-------- -------
Total 100% 100%
======== =======
The Company's expected contribution to the plan in 2004 is $14,200,000.
For purposes of measuring year-end benefit obligations, we used, depending
on medical plan coverage for different retiree groups, a 7 - 11% annual
rate of increase in the per-capita cost of covered medical benefits,
gradually decreasing to 5% in the year 2010 and remaining at that level
thereafter. The effect of a 1% increase in the assumed medical cost trend
rates for each future year on the aggregate of the service and interest
cost components of the total postretirement benefit cost would be
$1,566,000 and the effect on the accumulated postretirement benefit
obligation for health benefits would be $21,266,000. The effect of a 1%
decrease in the assumed medical cost trend rates for each future year on
the aggregate of the service and interest cost components of the total
postretirement benefit cost would be $(1,314,000) and the effect on the
accumulated postretirement benefit obligation for health benefits would be
$(18,094,000).
In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) became law in the United States. The
Act introduces a prescription drug benefit under Medicare as well as a
federal subsidy to sponsors of retiree health care benefit plans that
provide a benefit that is at least actuarially equivalent to the Medicare
benefit. In accordance with FASB Staff Position FAS 106-1, "Accounting and
Disclosure Requirements related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003," the Company has elected to
defer recognition of the effects of the Act in any measures of the benefit
obligation or cost. Specific authoritative guidance on the accounting for
the federal subsidy is pending and that guidance, when issued, could
require the Company to change previously reported information. Currently,
the Company does not believe it will need to amend its plan to benefit from
the Act.
In August 1999, our Board of Directors approved a plan of divestiture for
the public services properties. Any pension and/or postretirement gain or
loss associated with the divestiture of these properties will be recognized
when realized. During 2002, we sold our entire water distribution and
wastewater treatment business and one of our three electric businesses. The
pension plan has been frozen from the date of sale and we have retained
those liabilities. During 2003, we sold our remaining gas businesses in
Hawaii and Arizona as well as our electric business in Arizona. The pension
plan covering union employees for the Hawaiian gas property was transferred
in its entirety to the buyer. The pension plan liabilities covering the
remaining employees transferred have been retained by us. In all
transactions, the buyer assumed the retiree medical liabilities for those
properties.
In June 2001, we acquired Frontier Corp., including their postretirement
benefit plans. This acquisition increased the accumulated postretirement
benefit obligation by $118,819,000 and the fair value of plan assets by
$3,334,000 as of June 29, 2001.
401(k) Savings Plans
--------------------
We sponsor an employee retirement savings plan under section 401(k) of the
Internal Revenue Code. The Plan covers substantially all full-time
employees. Under the Plan, we provide matching and certain profit-sharing
contributions. Effective May 1, 2002, the Plan was amended to provide for
employer contributions to be made in cash rather than Company stock,
impacting all non-union employees and most union employees. Employer
contributions were $9,724,000, $10,331,000 and $6,878,000 for 2003, 2002
and 2001, respectively.
F-45
(27) Commitments and Contingencies:
------------------------------
The City of Bangor, Maine, filed suit against us on November 22, 2002, in
the U.S. District Court for the District of Maine (City of Bangor v.
Citizens Communications Company, Civ. Action No. 02-183-B-S). We intend to
defend ourselves vigorously against the City's lawsuit. The City has
alleged, among other things, that we are responsible for the costs of
cleaning up environmental contamination alleged to have resulted from the
operation of a manufactured gas plant by Bangor Gas Company, which we owned
from 1948-1963. The City alleged the existence of extensive contamination
of the Penobscot River and 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. On October 24, 2003,
we filed a motion for partial summary judgment with respect to the City's
claims under CERCLA. We anticipate a decision on that motion sometime in
the first or second quarter of 2004. In addition, we have identified a
number of other potentially responsible parties that may be liable for the
damages alleged by the City and have joined them as parties to the lawsuit.
These additional parties include Honeywell Corporation, the Army Corps of
Engineers, Guilford Transportation (formerly Maine Central Railroad), UGI
Utilities, Inc., and Centerpoint Energy Resources Corporation. We 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 this lawsuit to obtain from our insurance carriers
indemnification for any damages that may be assessed against us in the
City's lawsuit as well as to recover costs of our defense of that lawsuit.
In connection with an informal inquiry initiated on November 15, 2002, that
we believe was the result of allegations made to federal authorities during
their investigation of an embezzlement by two of our former officers, we
have been cooperating fully 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.
We are party to other legal proceedings arising in the normal course of our
business. The outcome of individual matters is not predictable. However, we
believe that the ultimate resolution of all such matters, after considering
insurance coverage, will not have a material adverse effect on our
financial position, results of operations, or our cash flows.
We have budgeted capital expenditures in 2004 of approximately
$276,000,000, including $265,000,000 for ILEC and $11,000,000 for ELI.
Certain commitments have been entered into in connection therewith. We
generally do not enter into firm, committed contracts for such activities.
F-46
We conduct certain of our operations in leased premises and also lease
certain equipment and other assets pursuant to operating leases. Future
minimum rental commitments for all long-term noncancelable operating leases
and future minimum capital lease payments for continuing operations as of
December 31, 2003 are as follows:
($ in thousands) Capital Operating
-------------- Leases Leases
----------- --------------
Year ending December 31:
2004 $ 1,189 $ 23,601
2005 1,178 15,328
2006 1,183 13,481
2007 1,189 10,445
2008 1,214 9,460
Thereafter 24,110 34,813
------------ --------------
Total minimum lease payments 30,063 $ 107,128
==============
Less amount representing interest (rates range from 9.25% to 10.65%) (20,002)
------------
Present value of net minimum capital lease payments 10,061
Less current installments of obligations under capital leases (151)
------------
Obligations under capital leases, excluding
current installments $ 9,910
============
Total rental expense included in our results of operations for the years
ended December 31, 2003, 2002 and 2001 was $33,008,000, $36,550,000 and
$38,829,000 respectively. We sublease, on a month-to-month basis, certain
office space in our corporate office to a charitable foundation formed by
our Chairman.
We are a party to contracts with several unrelated long distance carriers.
The contracts provide fees based on leased traffic subject to minimum
monthly fees. We also purchase capacity and associated energy from various
electric energy suppliers. Some of these contracts obligate us to pay
certain capacity costs whether or not energy purchases are made. These
contracts are intended to complement the other components in our power
supply to achieve the most economic mix reasonably available.
At December 31, 2003, the estimated future payments for long distance
contracts that we are obligated for are as follows:
($ in thousands) Year ILEC / ELI
-------------- -------------- --------------
2004 $ 57,881
2005 22,750
2006 6,000
2007 -
2008 -
thereafter -
--------------
Total $ 86,631
==============
The Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities,
including us, have entered into a purchase power agreement with
Hydro-Quebec. The agreement contains "step-up" provisions that state that
if any VJO member defaults on its purchase obligation under the contract to
purchase power from Hydro-Quebec the other VJO participants will assume
responsibility for the defaulting party's share on a pro-rata basis. As of
December 31, 2003, 2002 and 2001, our obligation under the agreement is
approximately 10% of the total contract. If any member of the VJO defaults
on its obligations under the Hydro-Quebec agreement, the remaining members
of the VJO, including us, may be required to pay for a substantially larger
share of the VJO's total power purchase obligation for the remainder of the
agreement. Such a result could have a materially adverse effect on our
financial results. Our liability under this agreement continues after we
have completed the sale of our Vermont electric division and may be subject
to the provisions of FIN 45, which, if applicable, would require us to
recognize a liability for the fair value of the obligation under the
guarantee, as well as provide additional disclosures about the obligations
associated with the guarantee.
F-47
At December 31, 2003, we have outstanding performance letters of credit as
follows:
($ in thousands)
--------------
CNA $ 19,404
ELI projects 50
--------
Total $ 19,454
========
During 2003, the Qwest, Pinnacle and Water projects letters of credit in
the amount of $64,280,000, $40,000,000 and $1,809,000, respectively, were
canceled.
CNA acts as our agent with respect to general liability claims (auto,
workers compensation and other insured perils of the Company). As our
agent, they administer all claims and make payments for claims on our
behalf. The Company reimburses CNA for such services upon presentation of
their invoice. To act as our agent and make payments on our behalf, CNA
requires that we establish a letter of credit in their favor. CNA could
potentially draw against this letter of credit if we failed to reimburse
CNA in accordance with the terms of our agreement. The value of the letter
of credit is reviewed annually and adjusted based on claims history.
None of the above letters of credit restrict our cash balances.
(28) Subsequent Events:
------------------
Our Board of Directors has approved retention and "change of control"
arrangements to incent certain executives and employees to continue their
employment with Citizens while we explore and consider our financial and
strategic alternatives. These arrangements include a mix of cash retention
payments, equity awards and enhanced severance and are contingent upon the
occurrence of certain events and tenure. If (i) the covered employees
remain with the Company for specified time periods, (ii) a change of
control (as defined) occurs and (iii) all employees covered by the
arrangements are terminated, additional compensation currently estimated to
be approximately $54,000,000 in the aggregate is payable to the employees.
If (i) the covered employees remain for the specified time periods and (ii)
a "change of control" occurs but none of the employees are terminated, the
amount payable to the employees would be reduced to approximately
$45,000,000. If no "change of control" occurs, but the covered employees
remain with the Company for the specified periods, we expect to recognize
(assuming all the employees remain for the specified periods),
approximately $9,800,000 of additional compensation expense in 2004,
$3,400,000 in 2005 and $3,000,000 in 2006, pursuant to the arrangements.
In addition to the arrangements and amounts described in the preceding
paragraph, restrictions on stock that has been previously awarded to
employees as part of their regular compensation would lapse in the event of
a change of control. We expense such grants over their vesting life
(typically three to four years). We will expense approximately $8,500,000
of such restricted stock awards in 2004, which is consistent with our prior
years' expense. The unamortized cost with respect to such restricted stock
at the end of 2004 that would be accelerated and immediately expensed upon
a change in control is currently estimated to be approximately $23,000,000.
F-48
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited and reported separately herein on the balance sheets of
Citizens Communications Company and subsidiaries as of December 31, 2003
and 2002 and the related consolidated statements of operations,
shareholders' equity, comprehensive income (loss) and cash flows for each
of the years in the three-year period ended December 31, 2003. Our report
refers to the adoption of Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangibles Assets" as of January 1,
2002 and to the adoption of SFAS No. 143, "Accounting for Asset Retirement
Obligations" as of January 1, 2003.
Our audits were made for the purpose of forming an opinion on the basic
financial statements of Citizens Communications Company and subsidiaries
taken as a whole. The supplementary information included in Schedule II is
presented for purposes of additional analysis and is not a required part of
the basic financial statements. Such information has been subjected to the
auditing procedures applied in the audit of the basic financial statements
and, in our opinion, is fairly stated in all material respects in relation
to the basic financial statements taken as a whole.
/s/ KPMG LLP
New York, New York
March 4, 2004
F-49
Schedule II
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Valuation and Qualifying Accounts
($ in thousands)
--------------
Balance at Charged to
Beginning of Revenue or Frontier Balance at
Accounts Period Expense Recoveries Acquisition Deductions End of Period
- --------------------------------------- --------------- -------------- ---------- ----------- ----------- --------------
Allowance for doubtful accounts
2001 23,913 51,234 (1) 5,966 10,709 (24,221) 67,601
2002 67,601 52,805 14,130 - (95,590) (2) 38,946
2003 38,946 33,972 22,411 - (47,997) 47,332
(1) Includes the reserve for Global receivables.
(2) Net of recoveries of amounts previously written off.
F-50