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CITIZENS COMMUNICATIONS COMPANY
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2005
--------------
or
--
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________to__________
Commission file number: 001-11001
---------
CITIZENS COMMUNICATIONS COMPANY
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-0619596
------------------------------ ----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
-------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
(203) 614-5600
----------------------------------------------------------------
(Registrant's telephone number, including area code)
N/A
---------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---- ----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
---- ----
The number of shares outstanding of the registrant's Common Stock as of April
29, 2005 was 340,594,090.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index
Page No.
--------
Part I. Financial Information (Unaudited)
Financial Statements
Consolidated Balance Sheets at March 31, 2005 and December 31, 2004 2
Consolidated Statements of Operations for the three months ended March 31, 2005 and 2004 3
Consolidated Statements of Shareholders' Equity for the year ended
December 31, 2004 and the three months ended March 31, 2005 4
Consolidated Statements of Comprehensive Income for the three months ended March
31, 2005 and 2004 4
Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004 5
Notes to Consolidated Financial Statements 6
Management's Discussion and Analysis of Financial Condition and Results of Operations 18
Quantitative and Qualitative Disclosures about Market Risk 27
Controls and Procedures 28
Part II. Other Information
Legal Proceedings 29
Exhibits 29
Signature 30
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)
(Unaudited)
March 31, 2005 December 31, 2004
----------------- ------------------
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 284,220 $ 167,463
Accounts receivable, less allowances of $30,831 and $35,996, respectively 204,714 233,690
Other current assets 41,108 45,605
Assets of discontinued operations - 24,122
----------------- ------------------
Total current assets 530,042 470,880
Property, plant and equipment, net 3,279,957 3,335,850
Goodwill, net 1,921,465 1,921,465
Other intangibles, net 653,516 685,111
Investments 20,305 23,062
Other assets 216,737 232,051
----------------- ------------------
Total assets $ 6,622,022 $ 6,668,419
================= ==================
LIABILITIES AND EQUITY
- ----------------------
Current liabilities:
Long-term debt due within one year $ 6,362 $ 6,380
Accounts payable and other current liabilities 382,969 410,405
Liabilities of discontinued operations - 735
----------------- ------------------
Total current liabilities 389,331 417,520
Deferred income taxes 270,615 232,766
Customer advances for construction and contributions in aid of construction 93,284 94,601
Other liabilities 288,873 294,294
Long-term debt 4,253,034 4,266,998
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares; 340,559,000
and 339,633,000 outstanding and 340,458,000 and 339,635,000 issued at
March 31, 2005 and December 31, 2004, respectively ) 85,140 84,909
Additional paid-in capital 1,588,483 1,664,627
Accumulated deficit (245,085) (287,719)
Accumulated other comprehensive loss, net of tax (100,376) (99,569)
Treasury stock (1,277) (8)
----------------- ------------------
Total shareholders' equity 1,326,885 1,362,240
----------------- ------------------
Total liabilities and equity $ 6,622,022 $ 6,668,419
================= ==================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
2
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
($ in thousands, except per-share amounts)
(Unaudited)
2005 2004
--------------- --------------
Revenue $ 537,223 $ 552,311
Operating expenses:
Cost of services (exclusive of depreciation and amortization) 51,018 55,550
Other operating expenses 201,448 211,418
Management succession and strategic alternatives expenses (see Note 12) - 4,382
Depreciation and amortization 139,645 143,363
--------------- --------------
Total operating expenses 392,111 414,713
--------------- --------------
Operating income 145,112 137,598
Investment and other income, net 4,773 25,295
Interest expense 83,785 97,781
--------------- --------------
Income from continuing operations before income taxes 66,100 65,112
Income tax expense 25,673 23,705
--------------- --------------
Income from continuing operations 40,427 41,407
Discontinued operations (see Note 5):
Income from operations of discontinued conferencing business
(including gain on disposal of $14,061) 15,550 2,206
Income tax expense 13,343 745
--------------- --------------
Income from discontinued operations 2,207 1,461
--------------- --------------
Net income available to common shareholders $ 42,634 $ 42,868
=============== ==============
Basic income per common share:
Income from continuing operations $ 0.12 $ 0.15
Income from discontinued operations 0.01 -
--------------- --------------
Net income available to common shareholders $ 0.13 $ 0.15
=============== ==============
Diluted income per common share:
Income from continuing operations $ 0.11 $ 0.15
Income from discontinued operations 0.01 -
--------------- --------------
Net income available to common shareholders $ 0.12 $ 0.15
=============== ==============
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
3
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2004 AND THE THREE MONTHS ENDED MARCH 31, 2005
($ in thousands)
(Unaudited)
Accumulated
Additional Other Total
Common Stock Paid-In Accumulated Comprehensive Treasury Stock Shareholders'
------------------ --------------------
Shares Amount Capital Deficit Loss Shares Amount Equity
-------- --------- ----------- ------------ ----------- -------- ----------- -----------
Balance January 1, 2004 295,434 $73,858 $ 1,953,317 $ (365,181) $ (71,676) (10,725) $ (175,135) $1,415,183
Stock plans 4,821 1,206 14,236 - - 6,407 106,823 122,265
Conversion of EPPICS 10,897 2,724 133,621 - - 725 11,646 147,991
Conversion of Equity Units 28,483 7,121 396,221 - - 3,591 56,658 460,000
Dividends on common stock of
$2.50 per share - - (832,768) - - - - (832,768)
Net income - - - 72,150 - - - 72,150
Tax benefit on equity forward
contract - - - 5,312 - - - 5,312
Other comprehensive loss, net of
tax and reclassifications
adjustments - - - - (27,893) - - (27,893)
-------- --------- ----------- ------------ ---------- -------- ----------- -----------
Balance December 31, 2004 339,635 84,909 1,664,627 (287,719) (99,569) (2) (8) 1,362,240
Stock plans 789 197 7,428 - - (99) (1,269) 6,356
Conversion of EPPICS 135 34 1,509 - - - - 1,543
Dividends on common stock of
$0.25 per share - - (85,081) - - - - (85,081)
Net income - - - 42,634 - - - 42,634
Other comprehensive loss, net of
tax and reclassifications
adjustments - - - - (807) - - (807)
-------- --------- ----------- ------------ ----------- -------- ----------- -----------
Balance March 31, 2005 340,559 $85,140 $ 1,588,483 $ (245,085) $(100,376) (101) $ (1,277) $1,326,885
======== ========= =========== ============= =========== ======== =========== ===========
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
($ in thousands)
(Unaudited)
For the three months ended March 31,
---------------------------------------
2005 2004
------------------- ------------------
Net income $ 42,634 $ 42,868
Other comprehensive loss, net of tax
and reclassifications adjustments* (807) (758)
------------------- ------------------
Total comprehensive income $ 41,827 $ 42,110
=================== ==================
* Consists of unrealized holding (losses)/gains of marketable securities
and realized gains taken to income as a result of the sale of securities.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
4
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
($ in thousands)
(Unaudited)
2005 2004
---------------- ----------------
Income from continuing operations $ 40,427 $ 41,407
Adjustments to reconcile income from continuing operations
to net cash provided by operating activities:
Depreciation and amortization expense 139,645 143,363
Gain on expiration/settlement of customer advances (80) (24,182)
Stock based compensation expense 2,265 3,189
Investment gain (493) -
Other non-cash adjustments 163 3,857
Deferred income taxes 25,109 20,991
Change in accounts receivable 28,976 21,549
Change in accounts payable and other liabilities (32,167) (7,270)
Change in other current assets 1,058 2,522
-------------- -------------
Net cash provided by continuing operating activities 204,903 205,426
Cash flows from investing activities:
Secuities sold 1,112 -
Capital expenditures (52,183) (54,539)
Other assets (purchased) distributions received, net 247 -
-------------- --------------
Net cash used by investing activities (50,824) (54,539)
Cash flows from financing activities:
Repayment of customer advances for
construction and contributions in aid of construction (1,237) (1,775)
Long-term debt payments (307) (93,557)
Debt issuance costs (385) -
Issuance of common stock 5,552 7,682
Dividends paid (85,081) -
-------------- --------------
Net cash used by financing activities (81,458) (87,650)
Cash provided by discontinued operations
Proceeds from sale of discontinued operations 43,565 -
Net cash provided by discontinued operations 571 1,104
-------------- --------------
44,136 1,104
Increase in cash and cash equivalents 116,757 64,341
Cash and cash equivalents at January 1, 167,463 583,671
-------------- --------------
Cash and cash equivalents at March 31, $284,220 $ 648,012
============== ==============
Cash paid (refunded) during the period for:
Interest $ 71,336 $ 97,515
Income taxes $ (1,859) $ 227
Non-cash investing and financing activities:
Change in fair value of interest rate swaps $(11,992) $ 7,363
Conversion of EPPICS $ 1,543 $ -
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
5
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
(1) Summary of Significant Accounting Policies:
------------------------------------------
(a) Basis of Presentation and Use of Estimates:
------------------------------------------
Citizens Communications Company and its subsidiaries are referred to
as "we," "us," "our" or the "Company" in this report. Our unaudited
consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (GAAP) and should be read in conjunction with the consolidated
financial statements and notes included in our 2004 Annual Report on
Form 10-K. 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. These unaudited consolidated financial statements
include all adjustments, which consist of normal recurring accruals
necessary to present fairly the results for the interim periods shown.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions which affect the
amounts of assets, liabilities, revenue and expenses we have reported
and our disclosure of contingent assets and liabilities at the date of
the financial statements. Actual results may differ from those
estimates. We believe that our critical estimates are accounting for
allowance for doubtful accounts, impairment of long-lived assets,
intangible assets, depreciation and amortization, employee benefit
plans, income taxes, contingencies, and pension and postretirement
benefits expenses among others.
Certain information and footnote disclosures have been excluded and/or
condensed pursuant to Securities and Exchange Commission rules and
regulations. The results of the interim periods are not necessarily
indicative of the results for the full year.
(b) Cash Equivalents:
----------------
We consider all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
(c) Revenue Recognition:
-------------------
Incumbent Local Exchange Carrier (ILEC) - Revenue is recognized when
services are provided or when products are delivered to customers.
Revenue that is billed in advance includes: monthly recurring network
access services, special access services and monthly recurring local
line charges. The unearned portion of this revenue is initially
deferred as a component of other 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.
Electric Lightwave, LLC (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.
(d) Property, Plant and Equipment:
-----------------------------
Property, plant and equipment are stated at original cost or fair
market value for our acquired properties, including capitalized
interest. Maintenance and repairs are charged to operating expenses as
incurred. The book value, net of salvage, of routine property, plant
and equipment retired is charged against accumulated depreciation.
(e) Goodwill and Other Intangibles:
------------------------------
Intangibles represent the excess of purchase price over the fair value
of identifiable tangible assets acquired. We undertake studies to
determine the fair values of assets and liabilities acquired and
allocate purchase prices to assets and liabilities, including
property, plant and equipment, goodwill and other identifiable
6
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 (primarily
trade name) 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 (during the fourth quarter)
examine the carrying value of our goodwill and trade name to determine
whether there are any impairment losses.
SFAS No. 142 also requires that intangible assets (primarily customer
base) 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) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
----------------------------------------------------------------------
of:
--
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.
(g) Derivative Instruments and Hedging Activities:
---------------------------------------------
We account for derivative instruments and hedging activities in
accordance with SFAS No. 149, "Amendment of Statement 133 on
Accounting for Derivative Instruments and Hedging." SFAS No. 149
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.
We have 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. 149. As a result, the fair value of the
hedges is carried on the balance sheet in other assets and the related
underlying liabilities are also adjusted to fair value by the same
amount.
(h) Employee Stock Plans:
--------------------
We have various employee stock-based compensation plans. Awards under
these plans are granted to eligible officers, management employees and
non-management employees. Awards may be made in the form of incentive
stock options, non-qualified stock options, stock appreciation rights,
restricted stock or other stock based awards. As permitted by current
accounting rules, we 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.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment," ("SFAS No. 123R"). SFAS 123R requires that
stock-based employee compensation be recorded as a charge to earnings.
In April 2005, the Securities and Exchange Commission required the
adoption of SFAS No. 123R for annual periods beginning after June 15,
2005. Accordingly, we will adopt SFAS 123R commencing January 1, 2006
and expect to recognize approximately $2,700,000 of expense for the
year ended December 31, 2006.
7
We provide pro forma net income and pro forma net income per common
share disclosures for employee stock option grants based on the fair
value of the options at the date of grant. For purposes of presenting
pro forma information, the fair value of options granted is computed
using the Black Scholes option-pricing model.
Had we determined compensation cost based on the fair value at the
grant date for the Management Equity Incentive Plan (MEIP), Equity
Incentive Plan (EIP), Employee Stock Purchase Plan (ESPP) and
Directors' Deferred Fee Equity Plan, our pro forma net income and net
income per common share available for common shareholders would have
been as follows:
Three Months Ended March 31,
----------------------------
2005 2004
----------- -----------
($ in thousands)
Net income available
for common shareholders As reported $ 42,634 $ 42,868
Add: Stock-based employee
compensation expense included
in reported net income, net of
related tax effects 1,416 2,031
Deduct: Total stock-based
employee compensation expense
determined under fair
value based method for all
awards, net of related tax
effects (2,361) (3,999)
---------- -----------
Pro forma $ 41,689 $ 40,900
========== ===========
Net income per common share
available for common
shareholders As reported:
Basic $ 0.13 $ 0.15
Diluted 0.12 0.15
Pro forma:
Basic $ 0.12 $ 0.14
Diluted 0.12 0.14
(i) Net Income Per Common Share Available for Common Shareholders:
-------------------------------------------------------------
Basic net income 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
(EPPICS). 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:
-----------------------------------------------------------------
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 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
reviewed all of our investments and determined that the EPPICS, issued by
our consolidated wholly-owned subsidiary, Citizens Utilities Trust and the
related Citizens Utilities Capital L.P., were our only VIEs. The adoption
of FIN 46R on January 1, 2004 did not have any material impact on our
financial position or results of operations (see Note 14).
8
Accounting for Conditional Asset Retirement Obligations
--------------------------------------------------------
In March 2005, the FASB issued FIN 47, "Accounting for Conditional Asset
Retirement Obligations," an interpretation of FASB No. 143. FIN 47
clarifies that the term conditional asset retirement obligation as used in
FASB No. 143 refers to a legal obligation to perform an asset retirement
activity in which the timing or method of settlement are conditional on a
future event that may or may not be within the control of the entity. FIN
47 also clarifies when an entity would have sufficient information to
reasonably estimate the fair value of an asset retirement obligation. FIN
47 is effective for the year ended December 31, 2005. The Company is
currently evaluating the effect that implementation of the new standard
will have on the Company's financial position, results of operations and
cash flows.
(3) Accounts Receivable:
-------------------
The components of accounts receivable, net at March 31, 2005 and December
31, 2004 are as follows:
($ in thousands) March 31, 2005 December 31, 2004
----------------- --------------------
Customers $ 205,103 $ 227,385
Other 30,442 42,301
Less: Allowance for doubtful accounts (30,831) (35,996)
--------------- ---------------
Accounts receivable, net $ 204,714 $ 233,690
=============== ===============
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 $3,609,000 and $2,192,000
for the three months ended March 31, 2005 and 2004, respectively. In
addition, additional reserves are provided for known or impending
telecommunications bankruptcies, disputes or other significant collection
issues.
(4) Property, Plant and Equipment, Net:
----------------------------------
Property, plant and equipment at March 31, 2005 and December 31, 2004 is as
follows:
($ in thousands) March 31, 2005 December 31, 2004
------------------- -------------------
Property, plant and equipment $ 6,472,889 $ 6,428,364
Less: accumulated depreciation (3,192,932) (3,092,514)
---------------- -----------------
Property, plant and equipment, net $ 3,279,957 $ 3,335,850
================ =================
Depreciation expense is principally based on the composite group method.
Depreciation expense was $108,050,000 and $111,733,000 for the three months
ended March 31, 2005 and 2004, respectively.
(5) Discontinued Operations and Net Assets Held for Sale:
----------------------------------------------------
Conference Call USA
-------------------
In February 2005, we entered into a definitive agreement to sell
Conference-Call USA, LLC (CCUSA), our conferencing services business. On
March 15, 2005, we completed the sale for $43,565,000 in cash, subject to
adjustments under the terms of the agreement. The pre-tax gain on the sale
of CCUSA was $14,061,000. Our after-tax gain was approximately $1,167,000.
The book income taxes recorded upon sale are primarily attributable to a
low tax basis in the assets sold.
In accordance with SFAS No. 144, any component of our business that we
dispose of or classify as held for sale that has operations and cash flows
clearly distinguishable from operations, and for financial reporting
purposes, and that will be eliminated from the ongoing operations, should
be classified as discontinued operations. Accordingly, we have classified
the results of operations of CCUSA as discontinued operations in our
consolidated statement of operations and have restated prior periods.
9
CCUSA had revenues of approximately $24,600,000 and operating income of
approximately $8,000,000 for the year ended December 31, 2004. At December
31, 2004, CCUSA'S net assets totaled approximately $23,400,000. The company
had no outstanding debt specifically identified with CCUSA and therefore no
interest expense was allocated to discontinued operations. In addition, we
ceased to record depreciation expense effective February 16, 2005.
Summarized financial information for CCUSA (discontinued operations) is set
forth below:
December 31,
($ in thousands) 2004
--------------
Current assets $ 2,819
Net property, plant and equipment 2,450
Goodwill 18,853
--------------
Total assets held for sale $ 24,122
==============
Current liabilities $ 735
--------------
Total liabilities related to assets held for sale $ 735
==============
For the three months ended March 31,
--------------------------------------
($ in thousands) 2005 2004
------------------ ------------------
Revenue $ 4,607 $ 6,157
Operating income 1,489 2,206
Income taxes 449 745
Net income 1,040 1,461
Gain on disposal of CCUSA, net of tax 1,167 -
Public Utilities
----------------
On April 1, 2004, we completed the sale of our Vermont electric
distribution operations for approximately $13,992,000 in cash, net of
selling expenses. With that transaction, we completed the divestiture of
our public utilities services business pursuant to plans announced in 1999.
Losses on the sales of our Vermont properties were included in the
impairment charges recorded in 2003.
(6) Intangibles:
-----------
Intangibles at March 31, 2005 and December 31, 2004 are as follows:
($ in thousands) March 31, 2005 December 31, 2004
--------------- -----------------
Customer base - amortizable over 96 months $ 994,605 $ 994,605
Trade name - non-amortizable 122,058 122,058
----------- ------------
Other intangibles 1,116,663 1,116,663
Accumulated amortization (463,147) (431,552)
----------- ------------
Total other intangibles, net $ 653,516 $ 685,111
=========== ============
Amortization expense was $31,595,000 and $31,630,000 for the three months
ended March 31, 2005 and 2004, respectively. Amortization expense, based on
our estimate of useful lives, is estimated to be $126,380,000 per year
through 2008 and $57,533,000 in 2009, at which point these assets will have
been fully amortized.
10
(7) Long-Term Debt:
--------------
The activity in our long-term debt from December 31, 2004 to March 31, 2005
is as follows:
Three Months Ended March 31, 2004
--------------------------------------------------
Interest Rate*
at
December 31, Interest March 31, March 31,
($ in thousands) 2004 Payments Rate Swap Reclassification 2005 2005
----- -------- --------- ---------------- ----- ----
FIXED RATE
Rural Utilities Service Loan $ 29,108 $ (259) $ - $ - $ 28,849 6.120%
Contracts
Senior Unsecured Debt 4,131,803 - (11,992) - 4,119,811 7.929%
EPPICS** (reclassified as a
result of adopting FIN 46R) 63,765 - - (1,543) 62,222 5.000%
ELI Capital Leases 4,421 (48) - - 4,373 10.360%
Industrial Development Revenue
Bonds 58,140 - - - 58,140 5.559%
----------- ---------- --------- -------- ----------
TOTAL LONG TERM DEBT $ 4,287,237 $ (307) $(11,992) $ (1,543) 4,273,395
----------- ========== ========= ======== ----------
Less: Debt Discount (13,859) (13,999)
Less: Current Portion (6,380) (6,362)
----------- ----------
$ 4,266,998 $4,253,034
=========== ==========
* Interest rate includes amortization of debt issuance costs, 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.
** In accordance with FIN 46R, the Trust holding the EPPICS and the related
Citizens Utilities Capital L.P. are now deconsolidated (see Note 14).
Total future minimum cash payment commitments under ELI's long-term capital
leases amounted to $9,651,000 as of March 31, 2005.
As of March 31, 2005, we have available lines of credit with financial
institutions in the aggregate amount of $250.0 million. Associated facility
fees vary, depending on our debt leverage ratio, and are 0.375% per annum
as of March 31, 2005. The expiration date for the facility is October 29,
2009. During the term of the facility we may borrow, repay and reborrow
funds. The credit facility is available for general corporate purposes but
may not be used to fund dividend payments. There have never been any
borrowings under the facility.
For the quarter ended March 31, 2005, we retired an aggregate principal
amount of $1,850,000 of debt, including $1,543,000 of EPPICS that were
converted to our common stock.
11
(8) Net Income Per Common Share:
---------------------------
The reconciliation of the income per common share calculation for the three
months ended March 31, 2005 and 2004, respectively, is as follows:
($ in thousands, except per-share amounts) For the three months ended March 31,
----------------------------------------
2005 2004
------------------- -------------------
Net income used for basic and diluted earnings
- ----------------------------------------------
per common share:
----------------
Income from continuing operations $ 40,427 $ 41,407
Income from discontinued operations 2,207 1,461
------------------- -------------------
Net income available to common shareholders $ 42,634 $ 42,868
=================== ===================
Effect of conversion of preferred securities - EPPICS 418 1,585
------------------- -------------------
Diluted net income available to common shareholders $ 43,052 $ 44,453
=================== ===================
Basic earnings per common share:
- -------------------------------
Weighted-average shares outstanding - basic 338,450 283,990
------------------- -------------------
Income from continuing operations $ 0.12 $ 0.15
Income from discontinued operations 0.01 -
------------------- -------------------
Net income available to common shareholders $ 0.13 $ 0.15
=================== ===================
Diluted earnings per common share:
- ---------------------------------
Weighted-average shares outstanding 338,450 283,990
Effect of dilutive shares 3,910 5,578
Effect of conversion of preferred securities - EPPICS 4,510 15,134
------------------- -------------------
Weighted-average shares outstanding - diluted 346,870 304,702
=================== ===================
Income from continuing operations $ 0.11 $ 0.15
Income from discontinued operations 0.01 -
------------------- -------------------
Net income available to common shareholders $ 0.12 $ 0.15
=================== ===================
Stock Options
-------------
For the three months ended March 31, 2005 and 2004, options of 2,481,000
and 7,414,000, respectively, at exercise prices ranging from $13.30 to
$18.46 issuable under employee compensation plans were excluded from the
computation of diluted EPS for those periods because the exercise prices
were greater than the average market price of common shares and, therefore,
the effect would be antidilutive.
In connection with the payment of the special, non-recurring dividend of $2
per common share on September 2, 2004, the exercise price and number of all
outstanding options were adjusted such that each option had the same value
to the holder after the dividend as it had before the dividend. In
accordance with FASB Interpretation No. 44 ("FIN 44"), "Accounting for
Certain Transactions involving Stock Compensation" and EITF 00-23, "Issues
Related to the Accounting for Stock Compensation under APB No. 25 and FIN
44", there is no accounting consequence for changes made to the exercise
price and the number of shares of a fixed stock option or award as a direct
result of the special, non-recurring dividend.
In addition, for the three months ended March 31, 2005 and 2004, restricted
stock awards of 1,489,000 and 2,639,000 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.
EPPICS
------
As a result of our July 2004 dividend announcement with respect to our
common shares, our 5% Company Obligated Mandatorily Redeemable Convertible
Preferred Securities due 2036 (EPPICS) began to convert to Citizens common
shares. As of March 31, 2005, approximately 74% of the EPPICS outstanding,
or about $149,534,000 aggregate principal amount of units, have converted
to 11,757,305 Citizens common shares, including 725,000 shares issued from
treasury.
12
At March 31, 2005, we had 1,034,318 shares of potentially dilutive EPPICS,
which were convertible into common stock at a 4.36 to 1 ratio at an
exercise price of $11.46 per share. As a result of the September 2004
special, non-recurring dividend, the EPPICS exercise price for conversion
into common stock was reduced from $13.30 to $11.46. These securities have
been included in the diluted income per share calculation for the period
ended March 31, 2005.
At March 31, 2004, we had 4,025,000 shares of potentially dilutive EPPICS,
which were convertible into common stock at a 3.76 to 1 ratio at an
exercise price of $13.30 per share. These securities have been included in
the diluted income per common share calculation for the period ended March
31, 2004.
Stock Units
-----------
At March 31, 2005 and 2004, we had 211,759 and 416,365 stock units,
respectively, issuable under our Directors' Deferred Fee Equity Plan and
Non-Employee Directors' Retirement Plan. These securities have not been
included in the diluted income per share calculation because their
inclusion would have had an antidilutive effect.
(10) Segment Information:
-------------------
As of April 1, 2004, we operate in two segments, ILEC and ELI (a
competitive local exchange carrier (CLEC)). 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 was sold on April 1, 2004
and is classified as "assets held for sale" and "liabilities related to
assets held for sale" for the quarter ended March 31, 2004.
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.
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
materially impact the economic characteristics or operating results of a
particular property.
($ in thousands) For the three months ended March 31, 2005
----------------------------------------------
Total
ILEC ELI Segments
-------------- -------------- ---------------
Revenue $ 499,243 $ 37,980 $ 537,223
Depreciation and amortization 133,366 6,279 139,645
Operating income 144,440 672 145,112
Capital expenditures 47,325 4,801 52,126
($ in thousands) For the three months ended March 31, 2004
------------------------------------------------------------
Total
ILEC ELI Electric Segments
-------------- -------------- --------------- -------------
Revenue $ 502,811 $ 39,765 $ 9,735 $ 552,311
Depreciation and amortization 137,528 5,835 - 143,363
Management succession and
strategic alternatives expenses 4,220 162 - 4,382
Operating income (loss) 136,510 2,390 (1,302) 137,598
Capital expenditures 52,777 1,762 - 54,539
13
The following table reconciles sector capital expenditures to total
consolidated capital expenditures.
($ in thousands) For the three months ended
March 31,
------------------------------
2005 2004
-------------- --------------
Total segment capital expenditures $ 52,126 $ 54,539
General capital expenditures 57 -
-------------- --------------
Consolidated reported capital
expenditures $ 52,183 $ 54,539
============== ==============
(11) Derivative Instruments and Hedging Activities:
---------------------------------------------
Interest rate swap agreements are used to hedge a portion of our debt that
is subject to fixed interest rates. Under our interest rate swap
agreements, we agree to pay an amount equal to a specified variable rate of
interest times a notional principal amount, and to receive in return an
amount equal to a specified fixed rate of interest times the same notional
principal amount. The notional amounts of the contracts are not exchanged.
No other cash payments are made unless the agreement is terminated prior to
maturity, in which case the amount paid or received in settlement is
established by agreement at the time of termination and represents the
market value, at the then current rate of interest, of the remaining
obligations to exchange payments under the terms of the contracts.
The interest rate swap contracts are reflected at fair value in our
consolidated balance sheet and the related portion of fixed-rate debt being
hedged is reflected at an amount equal to the sum of its book value and an
amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. The notional amounts
of fixed-rate indebtedness hedged as of March 31, 2005 and December 31,
2004 was $500,000,000 and $300,000,000, respectively. Such contracts
require us to pay variable rates of interest (estimated average pay rates
of approximately 7.30% as of March 31, 2005 and approximately 6.12% as of
December 31, 2004) and receive fixed rates of interest (average receive
rates of 8.46% as of March 31, 2005 and 8.44% as of December 31, 2004,
respectively). The fair value of these derivatives is reflected in other
assets as of March 31, 2005, in the amount of $(7,526,000) and the related
underlying debt has been decreased by a like amount. The amounts received
during the three months ended March 31, 2005 as a result of these contracts
amounted to $1,068,000 and are included as a reduction of interest expense.
We do not anticipate any nonperformance by counterparties to our derivative
contracts as all counterparties have investment grade credit ratings.
(12) Management Succession and Strategic Alternatives Expenses:
---------------------------------------------------------
On July 11, 2004, our Board of Directors announced that it had completed
its review of the Company's financial and strategic alternatives. Through
the first three months of 2004, we expensed approximately $4,382,000
related to our exploration of financial and strategic alternatives and
management succession costs.
(13) Investment and Other Income, Net:
--------------------------------
The components of investment and other income, net are as follows:
For the three months ended March 31,
-----------------------------------------
($ in thousands) 2005 2004
------------------ -------------------
Investment income $ 2,179 $ 3,035
Gain on expiration/settlement of customer advances 80 24,182
Investment gain 493 -
Gain/(loss) on sale of assets - (1,370)
Other, net 2,021 (552)
------------------ -------------------
Total investment and other income, net $ 4,773 $ 25,295
================== ===================
14
During 2005 and 2004, we recognized income in connection with certain
retained liabilities associated with customer advances for construction
from our disposed water properties, as a result of some of these
liabilities terminating. Gain/(loss) on sale of assets represents the
gain/(loss) recognized on the sale of fixed assets during 2004.
(14) 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 (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). These securities have an
adjusted conversion price of $11.46 per Citizens common share. The
conversion price was reduced from $13.30 to $11.46 during the third quarter
of 2004 as a result of the $2.00 per share special, non-recurring dividend.
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 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 annual 5%
interest in quarterly installments on the Convertible Subordinated
Debentures in the first quarter of 2005 and the four quarters of 2004. Only
cash was paid (net of investment returns) 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.
As of March 31, 2005, EPPICS representing a total principal amount of
$149,534,000 had been converted into 11,757,305 shares of Citizens common
stock, and a total of $51,715,000 remains outstanding to third parties. Our
long-term debt footnote indicates $62,221,000 of EPPICS outstanding at
March 31, 2005 of which $10,506,000 is intercompany debt of related parties
of a wholly-owned consolidated subsidiary. Our accounting treatment of the
EPPICS debt is in accordance with FIN 46R (see Note 2 and 14).
We adopted the provisions of FIN 46R (revised December 2003) ("FIN 46R"),
"Consolidation of Variable Interest Entities," effective January 1, 2004.
(15) Retirement Plans:
----------------
The following table provides the components of net periodic benefit cost:
For three months ended March 31,
--------------------------------------------------------------
2005 2004 2005 2004
------------- ------------- -------------- ---------------
Pension Benefits Other Postretirement Benefits
---------------------------- -------------------------------
($ in thousands)
Components of net periodic benefit cost
- ---------------------------------------
Service cost $ 1,495 $ 1,589 $ 282 $ 399
Interest cost on projected benefit obligation 11,764 11,496 3,177 3,157
Return on plan assets (14,390) (14,308) (565) (530)
Amortization of prior service cost and unrecognized
net obligation (61) (61) (51) 6
Amortization of unrecognized loss 2,527 1,854 1,311 1,559
------------- ------------- -------------- ---------------
Net periodic benefit cost $ 1,335 $ 570 $ 4,154 $ 4,591
============= ============= ============== ===============
15
We expect that our pension expense for 2005 will be $5,000,000 - $7,000,000
(it was $3,600,000 in 2004) and no contribution will be required to be made
by us to the pension plan in 2005. We expect that our retiree medical cost
for 2005 will be approximately $17,000,000 (it was $16,600,000 in 2004).
In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) became law. 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. The amount of
the federal subsidy will be based on 28 percent of an individual
beneficiary's annual eligible prescription drug costs ranging between $250
and $5,000. Currently, the Company has not yet been able to conclude
whether the benefits provided by its postretirement medical plan are
actuarially equivalent to Medicare Part D under the Act. Therefore, the
Company cannot quantify the effects, if any, that the Act will have on its
future benefit costs or accumulated postretirement benefit obligation and
accordingly, the effects of the Act have not been reflected in the
accompanying consolidated financial statements.
(16) 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 has asserted that money damages and other relief
at issue in the lawsuit could exceed $50,000,000. 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. 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. The Court
has dismissed all but two of the City's claims including its CERCLA claims
and the claim against us for punitive damages. We are currently pursuing
settlement discussions with the other parties, but if those efforts fail a
trial of the City's remaining claims could begin as early as September
2005. We have demanded that various of our insurance carriers defend and
indemnify us with respect to the City's lawsuit, and on 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.
On June 7, 2004, representatives of Robert A. Katz Technology Licensing,
LP, contacted us regarding possible infringement of several patents held by
that firm. The patents cover a wide range of operations in which telephony
is supported by computers, including obtaining information from databases
via telephone, interactive telephone transactions, and customer and
technical support applications. We are cooperating with the patent holder
to determine if we are currently using any of the processes that are
protected by its patents. If we determine that we are utilizing the patent
holder's intellectual property, we expect to commence negotiations on a
license agreement.
On June 24, 2004, one of our subsidiaries, Frontier Subsidiary Telco Inc.,
received a "Notice of Indemnity Claim" from Citibank, N.A., that is related
to a complaint pending against Citibank and others in the U.S. Bankruptcy
Court for the Southern District of New York as part of the Global Crossing
bankruptcy proceeding. Citibank bases its claim for indemnity on the
provisions of a credit agreement that was entered into in October 2000
between Citibank and our subsidiary. We purchased Frontier Subsidiary
Telco, Inc., in June 2001 as part of our acquisition of the Frontier
telephone companies. The complaint against Citibank, for which it seeks
indemnification, alleges that the seller improperly used a portion of the
proceeds from the Frontier transaction to pay off the Citibank credit
agreement, thereby defrauding certain debt holders of Global Crossing North
America Inc. Although the credit agreement was paid off at the closing of
the Frontier transaction, Citibank claims the indemnification obligation
survives. Damages sought against Citibank and its co-defendants could
exceed $1,000,000,000. In August 2004 we notified Citibank by letter that
we believe its claims for indemnification are invalid and are not supported
by applicable law. We have received no further communications from Citibank
since our August letter.
16
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 2005 of approximately
$270,000,000, including $255,000,000 for ILEC and $15,000,000 for ELI.
Although we from time to time make short-term purchasing commitments to
vendors with respect to these expenditures, we generally do not enter into
firm, written contracts for such activities.
The Company sold all of its utility businesses as of April 1, 2004.
However, we have retained a potential payment obligation associated with
our previous electric utility activities in the state of Vermont. The
Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities, including
us, entered into a purchase power agreement with Hydro-Quebec in 1987. 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. Our pro-rata share of the
purchase power obligation is 10%. If any member of the VJO defaults on its
obligations under the Hydro-Quebec agreement, then 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 (which runs through 2015). Paragraph 13 of FIN 45 requires that
we disclose, "the maximum potential amount of future payments
(undiscounted) the guarantor could be required to make under the
guarantee." Paragraph 13 also states that we must make such disclosure "...
even if the likelihood of the guarantor's having to make any payments under
the guarantee is remote..." As noted above, our obligation only arises as a
result of default by another VJO member such as upon bankruptcy. Therefore,
to satisfy the "maximum potential amount" disclosure requirement we must
assume that all members of the VJO simultaneously default, a highly
unlikely scenario given that the two members of the VJO that have the
largest potential payment obligations are publicly traded with investment
grade credit ratings, and that all VJO members are regulated utility
providers with regulated cost recovery. Regardless, despite the remote
chance that such an event could occur, or that the State of Vermont could
or would allow such an event, assuming that all the members of the VJO
defaulted on January 1, 2006 and remained in default for the duration of
the contract (another 10 years), we estimate that our undiscounted purchase
obligation for 2006 through 2015 would be approximately $1,400,000,000. In
such a scenario the Company would then own the power and could seek to
recover its costs. We would do this by seeking to recover our costs from
the defaulting members and/or reselling the power to other utility
providers or the northeast power grid. There is an active market for the
sale of power. We could potentially lose money if we were unable to sell
the power at cost. We caution that we cannot predict with any degree of
certainty any potential outcome.
17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
This quarterly report on Form 10-Q contains forward-looking statements that are
subject to risks and uncertainties which could cause actual results to differ
materially from those expressed or implied in the statements. Forward-looking
statements (including oral representations) are only predictions or statements
of current plans, which we review continuously. Forward-looking statements may
differ from actual future results due to, but not limited to, and our future
results may be materially affected by, any of the following possibilities:
* Changes in the number of our revenue generating units, which consists
of access lines plus high-speed internet subscribers;
* The effects of competition from wireless, other wireline carriers
(through 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 in order to offset ongoing declines in
highly profitable revenue from local services, access services and
subsidies;
* Our ability to comply with Section 404 of the Sarbanes-Oxley Act of
2002, which requires management to assess its internal control systems
and disclose whether the internal control systems are effective, and
the identification of any material weaknesses in our internal control
over financial reporting;
* The effects of changes in regulation in the telecommunications
industry as a result of federal and state legislation and regulation,
including potential changes in access charges and subsidy payments,
regulatory network upgrade and reliability requirements, and
portability requirements;
* Our ability to successfully renegotiate certain ILEC state regulatory
plans as they expire or come up for renewal from time to time;
* Our ability to manage our operating expenses, capital expenditures,
pay dividends and reduce or refinance 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 more price competition and potential bad debts;
* The effects of technological changes on our capital expenditures and
product and service offerings, including the lack of assurance that
our ongoing network improvements will be sufficient to meet or exceed
the capabilities and quality of competing networks;
* The effects of increased medical, retiree and pension expenses and
related funding requirements;
* The effect of changes in the telecommunications market, including the
likelihood of significantly increased price and service competition;
* The effects of state regulatory cash management policies on our
ability to transfer cash among our subsidiaries and to the parent
company;
18
* Our ability to successfully renegotiate expiring union contracts
covering approximately 58 employees that are scheduled to expire
during 2005;
* Our ability to pay a $1.00 per common share dividend annually may be
affected by our cash flow from operations, amount of capital
expenditures, debt service requirements, cash paid for income taxes
and our liquidity;
* The effects of any future liabilities or compliance costs in
connection with environmental and worker health and safety matters;
* The effects of any unfavorable outcome with respect to any of our
current or future legal, governmental, or regulatory proceedings,
audits or disputes; 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-Q or otherwise made by us or on our behalf. The following information is
unaudited and should be read in conjunction with the consolidated financial
statements and related notes included in this report and as presented in our
2004 Annual Report on Form 10-K. We have no obligation to update or revise these
forward-looking statements.
Overview
- --------
We are a communications company providing 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.
Competition in the telecommunications industry is increasing. We experience
competition from other wireline local carriers, VOIP providers such as Vonage,
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. Competition from cable
companies and other high-speed internet service providers with respect to
internet access is intense and increasing in many of our markets. We expect
cable telephony competition to increase during 2005. 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 is extremely competitive, resulting in lower prices.
Demand and pricing for certain CLEC services have decreased substantially,
particularly for long-haul services. 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.
Revenues from data services such as high-speed internet 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
will cause our cash generated by operations to decrease.
19
(a) Liquidity and Capital Resources
-------------------------------
For the three months ended March 31, 2005, we used cash flow from continuing
operations, proceeds from the sale of non-strategic assets, and cash and cash
equivalents to fund capital expenditures, dividends, interest payments and debt
repayments. As of March 31, 2005, we had cash and cash equivalents aggregating
$284.2 million.
For the three months ended March 31, 2005, our capital expenditures were $52.2
million, including $47.3 million for the ILEC segment, $4.8 million for the ELI
segment and $0.1 million of general capital expenditures. 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
2005 we will allocate significant capital to services such as high-speed
internet in areas that are growing or demonstrate meaningful demand. We will
continue to focus on managing our costs while increasing our investment in
certain product areas such as high-speed internet. Increasing competition,
offering new services, improving the capabilities or reducing the maintenance
costs of our plant may cause our capital expenditures to increase in the future.
We have budgeted approximately $270.0 million for our 2005 capital projects,
including $255.0 million for the ILEC segment and $15.0 million for the ELI
segment. Included in these budgeted capital amounts are approximately $6.9
million of capital expenditures associated with the Communications Assistance
for Law Enforcement Act (CALEA).
As of March 31, 2005, we have available lines of credit with financial
institutions in the aggregate amount of $250.0 million. Associated facility fees
vary, depending on our debt leverage ratio, and are 0.375% per annum as of March
31, 2005. The expiration date for the facility is October 29, 2009. During the
term of the facility we may borrow, repay and reborrow funds. The credit
facility is available for general corporate purposes but may not be used to fund
dividend payments. There have never been any borrowings under the facility.
Our ongoing annual dividends of approximately $341.0 million under our current
policy will reduce our operating and financial flexibility and our ability to
significantly increase capital expenditures. While we believe that the amount of
our dividends will allow for adequate amounts of cash flow for other purposes,
any reduction in cash generated by operations and any increases in capital
expenditures, interest expense or cash taxes would reduce the amount of cash
generated in excess of dividends. Losses of access lines, increases in
competition, lower subsidy and access revenues and the other factors described
above is expected to reduce our cash generated by operations and may require us
to increase capital expenditures. The downgrades in our credit ratings in July
2004 to below investment grade may make it more difficult and expensive to
refinance our maturing debt. We have in recent years paid relatively low amounts
of cash taxes. We expect that over time our cash taxes will increase.
We believe our operating cash flows, existing cash balances, and credit facility
will be adequate to finance our working capital requirements, fund capital
expenditures, make required debt payments through 2007, pay taxes, pay dividends
to our stockholders in accordance with our dividend policy and support our
short-term and long-term operating strategies. We have approximately $6.4
million, $227.8 million and $37.9 million of debt maturing in 2005, 2006 and
2007, respectively.
Debt Reduction
- --------------
For the quarter ended March 31, 2005, we retired an aggregate principal amount
of $1.9 million of debt, including $1.5 million of EPPICS that were converted to
our common stock.
We may from time to time repurchase our debt in the open market, through tender
offers, exchanges of debt securities or privately negotiated transactions.
Interest Rate Management
- ------------------------
In order to manage our interest expense, we have entered into interest swap
agreements. Under the terms of these 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 March 31, 2005 and
December 31, 2004 were $500.0 and $300.0 million, respectively. Such contracts
require us to pay variable rates of interest (estimated average pay rates of
approximately 7.30% as of March 31, 2005 and approximately 6.12% as of December
31, 2004) and receive fixed rates of interest (average receive rate of 8.46% as
of March 31, 2005 and 8.44% as of December 31, 2004). All swaps are accounted
for under SFAS No. 133 as fair value hedges. For the three months ended March
31, 2005, the interest savings resulting from these interest rate swaps totaled
approximately $1.1 million.
20
Sale of Non-Strategic Investments
- ---------------------------------
On February 1, 2005, we sold 20,672 shares of Prudential Financial, Inc. for
approximately $1.1 million in cash.
On March 15, 2005, we completed the sale of our conferencing business for
approximately $43.6 million in cash.
Off-Balance Sheet Arrangements
- ------------------------------
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationships with unconsolidated entities that would be expected to
have a material current or future effect upon our financial statements.
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). These
securities have an adjusted conversion price of $11.46 per Citizens common
share. The conversion price was reduced from $13.30 to $11.46 during the third
quarter of 2004 as a result of the $2.00 per share special, non-recurring
dividend. 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.
In accordance with the terms of the issuances, we paid the annual 5% interest in
quarterly installments on the Convertible Subordinated Debentures in the first
quarter of 2005 and the four quarters of 2004. Only cash was paid (net of
investment returns) 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.
As of March 31, 2005, EPPICS representing a total principal amount of $149.5
million had been converted into 11,757,305 shares of Citizens common stock, and
a total of $51.7 million remains outstanding to third parties. Our long-term
debt footnote indicates $62.2 million of EPPICS outstanding at March 31, 2005 of
which $10.5 million is intercompany debt of related parties of a wholly owned
consolidated subsidiary. Our accounting treatment of the EPPICS debt is in
accordance with FIN 46R (see Note 2 and 14).
We adopted the provisions of FASB Interpretation No. 46R (revised December 2003)
("FIN 46R"), "Consolidation of Variable Interest Entities," effective January 1,
2004.
Covenants
- ---------
The terms and conditions contained in our indentures and credit facilities
agreements include the timely and punctual payment of principal and interest
when due, the maintenance of our corporate existence, keeping proper books and
records in accordance with GAAP, restrictions on the allowance of liens on our
assets, and restrictions on asset sales and transfers, mergers and other changes
in corporate control. We currently have no restrictions on the payment of
dividends either by contract, rule or regulation.
Our $200.0 million term loan facility with the Rural Telephone Finance
Cooperative (RTFC) contains 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 agreement) over the last four
quarters no greater than 4.00 to 1.
21
Our $250 million credit facility contains 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 agreement) over the last
four quarters no greater than 4.50 to 1. Although the credit facility is
unsecured, it will be equally and ratably secured by certain liens and equally
and ratably guaranteed by certain of our subsidiaries if we issue debt that is
secured or guaranteed. We are in compliance with all of our debt and credit
facility covenants.
Divestitures
- ------------
On August 24, 1999, our Board of Directors approved a plan of divestiture for
our public utilities services businesses, which included gas, electric and water
and wastewater businesses. We have sold all of these properties. 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 April 1, 2004, we completed the sale of our electric distribution facilities
in Vermont for $14.0 million in cash, net of selling expenses.
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,
contingencies, and pension and postretirement benefits expenses among others.
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.
There have been no material changes to our critical accounting policies and
estimates from the information provided in "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in our 2004
Annual Report on Form 10-K.
New Accounting Pronouncements
- -----------------------------
Stock-Based Compensation
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment," ("SFAS No. 123R"). SFAS No. 123R requires that stock-based employee
compensation be recorded as a charge to earnings. In April 2005, the Securities
and Exchange Commission required adoption of SFAS No. 123R for annual periods
beginning after June 15, 2005. Accordingly, we will adopt SFAS 123R commencing
January 1, 2006 and expect to recognize approximately $2.7 million of expense
for the year ended December 31, 2006.
Accounting for Conditional Asset Retirement Obligations
In March 2005, the FASB issued FIN 47, "Accounting for Conditional Asset
Retirement Obligations," an interpretation of FASB No. 143. FIN 47 clarifies
that the term conditional asset retirement obligation as used in FASB No. 143
refers to a legal obligation to perform an asset retirement activity in which
the timing or method of settlement are conditional on a future event that may or
may not be within the control of the entity. FIN 47 also clarifies when an
entity would have sufficient information to reasonably estimate the fair value
of an asset retirement obligation. FIN 47 is effective for the year ended
December 31, 2005. The Company is currently evaluating the effect that
implementation of the new standard will have on the Company's financial
position, results of operations and cash flows.
22
(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 disputed portions of such revenue
until realizability is assured. Revenue earned from long-haul contracts is
recognized over the term of the related agreement.
Consolidated revenue for the three months ended March 31, 2005 decreased $15.1
million, or 3%, as compared with the prior year period. The decrease is due to a
$3.6 million decrease in ILEC revenue, a $1.8 million decrease in ELI revenue
and a $9.7 million decrease in electric revenue.
On March 15, 2005, we completed the sale of our conferencing service business,
CCUSA. As a result of the sale, we have classified the results of operations as
discontinued operations in our consolidated statement of operations and restated
prior periods.
Change in the number of our access lines is a critical determinant of our
revenue. We have been losing access lines primarily because of increased
competition, changing consumer behavior, economic conditions, changing
technology and by some customers disconnecting second lines when they add
high-speed internet or cable modem service. We lost approximately 22,300 access
lines during the three months ended March 31, 2005 but added approximately
30,500 high-speed internet subscribers during this period on a net basis. The
loss of lines during the first three months of 2005 was primarily among
residential customers. The non-residential line losses were principally in
Rochester, New York, while the residential losses were throughout our markets.
We expect to continue to lose access lines but to increase high-speed internet
subscribers during 2005. A continued loss of access lines, combined with
increased competition and the other factors discussed in MD&A, will cause our
revenues to decrease in 2005.
TELECOMMUNICATIONS REVENUE
($ in thousands) For the three months ended March 31,
-------------------------------------------------------
2005 2004 $ Change % Change
-------------- ------------- --------------- ----------
Access services $ 157,322 $ 161,483 $ (4,161) -3%
Local services 209,986 212,742 (2,756) -1%
Long distance and data services 82,359 79,005 3,354 4%
Directory services 27,963 27,474 489 2%
Other 21,613 22,107 (494) -2%
-------------- ------------- ---------------
ILEC revenue 499,243 502,811 (3,568) -1%
ELI 37,980 39,765 (1,785) -4%
-------------- ------------- ---------------
$ 537,223 $ 542,576 $ (5,353) -1%
============== ============= ===============
Access Services
Access services revenue for the three months ended March 31, 2005 decreased $4.2
million or 3%, as compared with the prior year period. Switched access revenue
decreased $3.3 million, as compared with the prior year period, primarily due to
a decline in minutes of use. Special access revenue increased $2.6 million
primarily due to growth in high-capacity circuits. Access service revenue
includes subsidy payments we receive from federal and state agencies. Subsidy
revenue decreased $3.5 million primarily due to decreased Universal Service Fund
(USF) support of $5.7 million because of increases in the national average cost
per loop (NACPL), partially offset by an increase of $2.8 million in USF
surcharge rates.
23
We currently expect our subsidy revenue in 2005 will be at least $20.0 million
lower than 2004 because of improvement in prior years in the profitability of
our operations and because of increases in the NACPL. Increases in the number of
competitive communications companies (including wireless companies) receiving
federal subsidies may lead to further increases in the NACPL, thereby resulting
in further decreases in our subsidy revenue in the future. The FCC and state
regulators are currently considering a number of proposals for changing the
manner in which eligibility for federal subsidies is determined as well as the
amounts of such subsidies. The FCC is also reviewing the mechanism by which
subsidies are funded. We cannot predict when or how these matters will be
decided nor the effect on our subsidy revenues. Future reductions in our subsidy
and access revenues are not expected to be accompanied by proportional decreases
in our costs, so any further reductions in those revenues will directly affect
our profitability.
Local Services
Local services revenue for the three months ended March 31, 2005 decreased $2.8
million or 1% as compared with the prior year period. Local revenue decreased
$4.8 million primarily due to continued losses of access lines. Enhanced
services revenue increased $2.0 million, as compared with the prior year period,
primarily due to sales of additional feature packages. 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.
Long Distance and Data Services
Long distance and data services revenue for the three months ended March 31,
2005 increased $3.4 million or 4%, as compared with the prior period primarily
due to growth of $7.0 million related to data services (data includes high-speed
internet) partially offset by decreased long distance revenue of $3.6 million as
a result of a 14% decline in the average rate per long distance minute. Our long
distance minutes of use increased approximately 9.0% during the first quarter of
2005. Our long distance revenues could decrease in the future due to lower long
distance minutes of use because consumers are increasingly using their wireless
phones or calling cards to make long distance calls. Our long distance revenues
could also decline because of lower average rates per minute as a result of
unlimited and packages of minutes for long distance plans. We expect these
factors will continue to adversely affect our long distance revenues during the
remainder of 2005.
ELI
ELI revenue for the three months ended March 31, 2005 decreased $1.8 million, or
4%, as compared to the prior year period primarily due to lower demand and
prices for long-haul services and lower reciprocal compensation revenues.
ELECTRIC REVENUE
($ in thousands) For the three months ended March 31,
-------------------------------------------------------
2005 2004 $ Change % Change
-------------- ------------- --------------- ----------
Electric revenue $ - $ 9,735 $ (9,735) -100%
Electric revenue for the three months ended March 31, 2005 decreased $9.7
million, as compared with the prior year period due to the sale of our Vermont
electric division on April 1, 2004. We have sold all of our electric operations
and as a result will have no operating results in future periods for these
businesses.
COST OF SERVICES
($ in thousands) For the three months ended March 31,
-------------------------------------------------------
2005 2004 $ Change % Change
-------------- ------------- --------------- ----------
Network access $ 51,018 $ 50,027 $ 991 2%
Electric energy and
fuel oil purchased - 5,523 (5,523) -100%
-------------- ------------- ---------------
$ 51,018 $ 55,550 $ (4,532) -8%
============== ============= ===============
24
Network access expenses for the three months ended March 31, 2005 increased $1.0
million, or 2%, as compared with the prior year period. Our network access
expense could increase as we continue to increase our sales of data products
such as high-speed internet and continue to increase the number of long distance
minutes we sell.
Electric energy and fuel oil purchased for the three months ended March 31, 2005
decreased $5.5 million, as compared with the prior year period due to the sale
of our Vermont electric division on April 1, 2004. We have sold all of our
electric operations and as a result will have no operating results in future
periods for these businesses.
OTHER OPERATING EXPENSES
($ in thousands) For the three months ended March 31,
-------------------------------------------------------
2005 2004 $ Change % Change
-------------- ------------- --------------- ----------
Operating expenses $ 146,483 $ 158,030 $ (11,547) -7%
Taxes other than income taxes 26,957 26,188 769 3%
Sales and marketing 28,008 27,200 808 3%
-------------- ------------- ---------------
$ 201,448 $ 211,418 $ (9,970) -5%
============== ============= ===============
Operating expenses for the three months ended March 31, 2005 decreased $11.5
million, or 7%, as compared with the prior year period primarily due to lower
billing expenses as a result of the conversion of our billing system in 2004,
increased operating efficiencies and a reduction of personnel in our
communications business and decreased operating expenses in the public services
sector due to the sale of our Vermont electric division. We routinely review our
operations, personnel and facilities to achieve greater efficiencies. These
reviews may result in reductions in personnel and an increase in severance
costs.
Included in operating expenses is stock compensation expense. Stock compensation
expense was $2.3 million and $3.2 million for the first three months of 2005 and
2004, respectively. In 2006, we will begin expensing the cost of the unvested
portion of outstanding stock options pursuant to SFAS No. 123R. We expect to
recognize approximately $2.7 million of stock option expense for the year ended
December 31, 2006.
Included in operating expenses is pension expense. In future periods, if the
value of our pension assets decline and/or projected benefit costs increase, we
may have increased pension expenses. Based on current assumptions and plan asset
values, we estimate that our pension expense will increase from $3.6 million in
2004 to approximately $5.0 million to $7.0 million in 2005. In addition, as
medical costs increase the costs of our postretirement benefit costs also
increase. Our retiree medical costs for 2004 were $16.6 million and our current
estimate for 2005 is approximately $17.0 million.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) For the three months ended March 31,
-------------------------------------------------------
2005 2004 $ Change % Change
-------------- ------------- --------------- ----------
Depreciation expense $ 108,050 $ 111,733 $ (3,683) -3%
Amortization expense 31,595 31,630 (35) 0%
-------------- ------------- ---------------
$ 139,645 $ 143,363 $ (3,718) -3%
============== ============= ===============
Depreciation expense for the three months ended March 31, 2005 decreased $3.7
million, or 3%, as compared with the prior year period due to declining asset
base.
MANAGEMENT SUCCESSION AND STRATEGIC ALTERNATIVES EXPENSES
($ in thousands) For the three months ended March 31,
-------------------------------------------------------
2005 2004 $ Change % Change
-------------- ------------- --------------- ----------
Management succession
and strategic alternatives
expenses $ - $ 4,382 $ (4,382) -100%
25
Management succession and strategic alternatives expenses in 2004 include a mix
of cash retention payments, equity awards and severance agreements.
INVESTMENT AND OTHER INCOME, NET / INTEREST EXPENSE /
INCOME TAX EXPENSE
($ in thousands) For the three months ended March 31,
-------------------------------------------------------
2005 2004 $ Change % Change
-------------- ------------- --------------- -------------
Investment and
other income, net $ 4,773 $ 25,295 $ (20,522) -81%
Interest expense $ 83,785 $ 97,781 $ (13,996) -14%
Income tax expense $ 25,673 $ 23,705 $ 1,968 8%
Investment and other income, net for the three months ended March 31, 2005
decreased $20.5 million, or 81%, as compared with the prior year period
primarily due to $24.2 million of income in 2004 from the expiration of certain
retained liabilities at less than face value, which are associated with customer
advances for construction from our disposed water properties.
Interest expense for the three months ended March 31, 2005 decreased $14.0
million, or 14%, as compared with the prior year period primarily due to
conversions and refinancing of debt. Our composite average borrowing rate for
the three months ended March 31, 2005 as compared with the prior year period was
20 basis points lower, decreasing from 8.04% to 7.84%.
Income taxes for the three months ended March 31, 2005 increased $2.0 million,
or 8%, as compared with the prior year period primarily due to changes in
taxable income. The effective tax rate for the first quarter of 2005 was 38.8%
as compared with 36.3% for the first quarter of 2004.
DISCONTINUED OPERATIONS
($ in thousands) For the three months ended March 31,
-------------------------------------------------------
2005 2004 $ Change % Change
-------------- ------------- --------------- ----------
Revenue $ 4,607 $ 6,157 $ (1,550) -25%
Operating income $ 1,489 $ 2,206 $ (717) -33%
Income from discontinued
operations, net of tax $ 1,040 $ 1,461 $ (421) -29%
Gain on disposal of CCUSA,
net of tax $ 1,167 $ - $ 1,167 100%
On March 15, 2005, we completed the sale of CCUSA for $43.6 million in cash,
subject to adjustments under the terms of the agreement. The pre-tax gain on the
sale of CCUSA was $14.1 million. Our after-tax gain was $1.2 million. The book
income taxes recorded upon sale are primarily attributable to a low tax basis in
the assets sold.
26
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities. Market risk refers to the
potential change in fair value of a financial instrument as a result of
fluctuations in interest rates and equity and commodity prices. We do not hold
or issue derivative instruments, derivative commodity instruments or other
financial instruments for trading purposes. As a result, we do not undertake any
specific actions to cover our exposure to market risks and we are not party to
any market risk management agreements other than in the normal course of
business or to hedge long-term interest rate risk. Our primary market risk
exposures are interest rate risk and equity and commodity price risk as follows:
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest-bearing portion of our investment portfolio and interest on our
long-term debt and capital lease obligations. The long term debt and capital
lease obligations include various instruments with various maturities and
weighted average interest rates.
Our objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, a majority of our borrowings have
fixed interest rates. 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 March 31, 2005, a near-term change in
interest rates would not materially affect our consolidated financial position,
results of operations or cash flows.
In order to manage our interest rate risk exposure, we have entered into
interest 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 March 31, 2005, the fair value of our long-term debt and capital lease
obligations was estimated to be approximately $4.3 billion, based on our overall
weighted average rate of 7.84% and our overall weighted maturity of 12 years.
There has been no material change in the weighted average maturity applicable to
our obligations since December 31, 2004.
The overall weighted average interest rate increased approximately 1 basis point
during the first quarter of 2005. A hypothetical increase of 78 basis points
(10% of our overall weighted average borrowing rate) would result in an
approximate $222.0 million decrease in the fair value of our fixed rate
obligations.
Equity Price Exposure
Our exposure to market risks for changes in equity prices as of March 31, 2005
is limited and relates to our investment in Adelphia, and our pension assets.
As of March 31, 2005 and December 31, 2004, we owned 3,059,000 shares of
Adelphia common stock. The stock price of Adelphia was $0.24 and $0.39 at March
31, 2005 and December 31, 2004, respectively.
Sensitivity analysis of equity price exposure
At March 31, 2005, the fair value of the equity portion of our investment
portfolio was estimated to be $0.7 million. A hypothetical 10% decrease in
quoted market prices would result in an approximate $73,000 decrease in the fair
value of the equity portion of our investment portfolio.
27
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 March 31, 2005. It does not consider those exposures or
positions, which could arise after that date. As a result, our ultimate exposure
with respect to our market risks will depend on the exposures that arise during
the period and the fluctuation of interest rates and quoted market prices.
Item 4. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures
We carried out an evaluation, under the supervision and with the participation
of our management, 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, March 31, 2005, 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 March 31, 2005.
There have been no changes in our internal control over financial reporting
identified in an evaluation thereof that occurred during the first fiscal
quarter of 2005, that materially affected or is reasonably likely to materially
affect our internal control over financial reporting.
28
PART II. OTHER INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Item 1. Legal Proceedings
-----------------
There have been no material changes to our legal proceedings from the
information provided in Item 3. Legal Proceedings included in our Annual Report
on Form 10-K for the year ended December 31, 2004.
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 6. Exhibits
--------
a) Exhibits:
10.1 Amendment to 1996 Equity Incentive Plan (effective March 4, 2005).
10.2 Amendment No. 3 to 2000 Equity Incentive Plan (effective March 4,
2005).
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.
29
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Robert J. Larson
----------------------------------
Robert J. Larson
Senior Vice President and
Chief Accounting Officer
Date: May 4, 2005
30