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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition periods from __________ to _____________
Commission file number 0-11053
COMMONWEALTH TELEPHONE ENTERPRISES, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2093008
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
100 CTE Drive
Dallas, Pennsylvania 18612-9774
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (570) 631-2700
(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
requirement for the past 90 days.
YES X NO
As of June 30, 2002 there were 21,416,247 shares of the registrant's common
stock, $1.00 par value per share, outstanding and 2,053,070 shares of the
registrant's Class B common stock, $1.00 par value per share, outstanding.
COMMONWEALTH TELEPHONE ENTERPRISES, INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of
Operations and Comprehensive Income
Three and Six Months ended
June 30, 2002 and 2001
Condensed Consolidated Balance Sheets
June 30, 2002 and December 31, 2001
Condensed Consolidated Statements of Cash Flows
Six Months Ended June 30, 2002 and 2001
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits and Reports on Form 8-K
Item 7(a). Quantitative and Qualitative Disclosures about Market Risk
SIGNATURES
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
COMMONWEALTH TELEPHONE ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Dollars in Thousands, Except Per Share Data)
(Unaudited)
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Sales $ 78,300 $ 76,467 $ 156,696 $ 153,413
Costs and expenses, excluding other
operating expenses itemized below 39,439 44,060 78,203 89,567
Management fees, related party 300 300 600 600
Depreciation and amortization 16,505 16,020 33,478 31,588
Restructuring charges (reversals) (2,057) (3,410) (2,057) (3,410)
Voluntary employee retirement program - - 2,333 -
---------- ---------- ---------- ----------
Operating income 24,113 19,497 44,139 35,068
Interest and dividend income 491 365 1,372 1,565
Interest expense (3,248) (4,752) (6,597) (10,358)
Other income, net 379 301 370 72
---------- ---------- ---------- ----------
Income before income taxes 21,735 15,411 39,284 26,347
Provision for income taxes 8,982 7,014 16,010 12,191
---------- ---------- ---------- ----------
Income before equity in unconsolidated
entities 12,753 8,397 23,274 14,156
Equity in income of unconsolidated entities 1,345 1,272 1,573 1,409
---------- ---------- ---------- ----------
Net income $ 14,098 $ 9,669 $ 24,847 $ 15,565
Cumulative effect of accounting change for
derivative instruments, net of tax - - - (182)
Unrealized gain (loss) on derivative
instruments, net of tax (970) 222 (128) (731)
---------- ---------- ---------- ----------
Comprehensive net income $ 13,128 $ 9,891 $ 24,719 $ 14,652
========== ========== ========== ==========
Basic earnings per share:
Net income $ 0.60 $ 0.42 $ 1.06 $ 0.68
========== ========== ========== ==========
Weighted average shares outstanding 23,374,395 23,049,794 23,363,307 22,989,850
Diluted earnings per share:
Net income $ 0.60 $ 0.41 $ 1.05 $ 0.66
========== ========== ========== ==========
Weighted average shares and common
stock equivalents outstanding 23,690,464 23,472,540 23,683,912 23,450,962
See accompanying notes to Condensed Consolidated Financial Statements.
3
COMMONWEALTH TELEPHONE ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
June 30, December 31,
2002 2001
---------- ------------
ASSETS
Current assets:
Cash and temporary cash investments $ 23,471 $ 27,298
Accounts receivable and unbilled revenues,
net of reserve for doubtful accounts of $5,075 at
June 30, 2002 and $3,047 at December 31, 2001 46,821 49,849
Other current assets 32,561 32,509
---------- ----------
Total current assets 102,853 109,656
Property, plant and equipment, net of accumulated
depreciation of $405,627 at June 30, 2002
and $381,888 at December 31, 2001 418,755 428,916
Investments 9,498 9,428
Deferred charges and other assets 17,364 15,676
Unamortized debt issuance costs 756 928
---------- ----------
Total assets $ 549,226 $ 564,604
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 9,010 $ 9,010
Notes payable 65,000 65,000
Accounts payable 33,491 41,961
Accrued restructuring expenses 4,060 7,381
Accrued expenses 44,918 51,993
Accrued income taxes 948 -
Other current liabilities 5,144 5,258
Deferred income taxes - current 1,347 2,156
---------- ----------
Total current liabilities 163,918 182,759
Long-term debt 116,805 151,309
Deferred income taxes 42,324 33,779
Other liabilities 34,977 31,241
Common shareholders' equity:
Common stock 27,291 27,265
Additional paid-in capital 256,308 255,570
Deferred compensation (4,103) (4,306)
Accumulated other comprehensive loss (3,007) (2,879)
Retained earnings 45,692 20,845
Treasury stock at cost, 3,821,883 shares at
June 30, 2002 and December 31, 2001 (130,979) (130,979)
---------- ----------
Total common shareholders' equity 191,202 165,516
---------- ----------
Total liabilities and shareholders' equity $ 549,226 $ 564,604
========== ==========
See accompanying notes to Condensed Consolidated Financial Statements.
4
COMMONWEALTH TELEPHONE ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
Six months ended
June 30,
-------------------
2002 2001
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 52,103 $ 39,440
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant & equipment (23,555) (29,297)
Other 1,745 2,215
-------- --------
Net cash used in investing activities (21,810) (27,082)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of short-term debt - 65,000
Redemption of long-term debt (34,505) (64,505)
Redemption of short-term debt - (30,000)
Proceeds from exercise of stock options 450 5,932
Capital lease obligation (65) 358
-------- --------
Net cash used in financing activities (34,120) (23,215)
-------- --------
Net decrease in cash and
temporary cash investments (3,827) (10,857)
-------- --------
Cash and temporary cash investments
at beginning of year 27,298 37,046
-------- --------
Cash and temporary cash investments at
June 30, $ 23,471 $ 26,189
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the periods for:
Interest $ 6,668 $ 10,031
======== ========
Income taxes $ 7,816 $ 3,243
======== ========
See accompanying notes to Condensed Consolidated Financial Statements.
5
COMMONWEALTH TELEPHONE ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Data)
The Condensed Consolidated Financial Statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
("GAAP") have been condensed or omitted pursuant to such rules and regulations.
However, in the opinion of our Management, the Condensed Consolidated Financial
Statements include all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial information. The
Condensed Consolidated Financial Statements should be read in conjunction with
the financial statements and notes thereto included in our Form 10-K for the
fiscal year ended December 31, 2001.
1. Background and Basis of Presentation - The consolidated financial statements
of Commonwealth Telephone Enterprises, Inc. ("CTE," "we," "us" or "our") include
the accounts of its wholly-owned subsidiaries, Commonwealth Telephone Company
("CT"), a rural incumbent local exchange carrier ("RLEC"); CTSI, LLC ("CTSI"),
our RLEC edge-out operation; and other operations ("Other"), which include
Commonwealth Communications ("CC"), a provider of telecommunications equipment
and facilities management services; the portion of epix(R) Internet Services
("epix"), that includes revenue from Internet customers within CT's operating
territory; the portion of Jack Flash(R) ("Jack Flash"), the digital subscriber
line ("DSL") product offering in CT's franchise area; and Commonwealth Long
Distance Company ("CLD"), a reseller of long-distance services. Other also
includes our corporate financing entity. All significant intercompany accounts
and transactions are eliminated.
2. Segment Information - CT provides local and long-distance telephone service
to residential and business customers in a 19-county service territory in rural
northeastern and central Pennsylvania. CT also provides network access and
billing/collection services to interexchange carriers and sells
telecommunications products and services.
CTSI, which operates in three edge-out regional Pennsylvania markets that border
CT's territory, is a competitive local exchange carrier, offering bundled local
and long-distance telephone, Internet, DSL and enhanced services.
The Other segment includes the results of CC and CLD, the portion of the results
of epix that includes dial-up Internet customers within CT's territory, DSL
customers within CT's territory and CTE's corporate financing entity.
We have expanded certain financial information of CTSI to distinguish between
the three ongoing edge-out markets and the five exited expansion markets which
are included in our restructuring.
We define adjusted EBITDA as earnings before interest, taxes, voluntary employee
retirement program, restructuring charges (reversals), depreciation and
amortization, other income (expense) and equity in income of unconsolidated
entities. We believe that adjusted EBITDA is an additional measure of operations
that (1) gauges the performance of our business and (2) may provide investors
and research analysts with a benchmark against certain other communications
companies. Adjusted EBITDA is not a measurement under U.S. Generally Accepted
Accounting Principles (GAAP) and may not be comparable to other similarly titled
measures of other companies.
6
Financial information by business segment is as follows:
Quarter ended June 30, 2002
- ---------------------------
CTSI CTSI Total
CT Edge-Out Expansion CTSI Other Consolidated
-------- -------- --------- --------- -------- ------------
Sales $ 51,072 $ 21,505 $ - $ 21,505 $ 9,660 $ 82,237
Elimination of intersegment sales 3,529 181 - 181 227 3,937
External sales 47,543 21,324 - 21,324 9,433 78,300
Adjusted EBITDA 30,180 7,878 - 7,878 503 38,561
Depreciation and amortization 11,262 4,630 - 4,630 613 16,505
Restructuring charges (reversals) - (2,057) - (2,057) - (2,057)
Operating income (loss) 18,918 5,305 - 5,305 (110) 24,113
Interest expense, net (932) - (1,825) (2,757)
Other income (expense), net (100) 501 (22) 379
Income (loss) before income taxes 17,886 5,806 (1,957) 21,735
Provision (benefit) for income
taxes 7,004 2,726 (748) 8,982
Equity in income of unconsolidated entities - 1,345 - 1,345
Net income (loss) 10,882 4,425 (1,209) 14,098
Quarter ended June 30, 2001
- ---------------------------
CTSI CTSI Total
CT Edge-Out Expansion CTSI Other Consolidated
-------- -------- --------- --------- -------- ------------
Sales $ 49,418 $ 18,266 $ 1,747 $ 20,013 $ 10,495 $ 79,926
Elimination of intersegment sales 3,166 172 7 179 114 3,459
External sales 46,252 18,094 1,740 19,834 10,381 76,467
Adjusted EBITDA 29,342 4,226 (1,468) 2,758 7 32,107
Depreciation and amortization 10,484 4,206 - 4,206 1,330 16,020
Restructuring charges (reversals) - - (3,410) (3,410) - (3,410)
Operating income (loss) 18,858 20 1,942 1,962 (1,323) 19,497
Interest expense, net (1,879) - (2,508) (4,387)
Other income (expense), net (365) 489 177 301
Income (loss) before income taxes 16,614 2,451 (3,654) 15,411
Provision (benefit) for income
taxes 7,017 1,303 (1,306) 7,014
Equity in income of unconsolidated entities - 1,272 - 1,272
Net income (loss) 9,597 2,420 (2,348) 9,669
Six months ended June 30, 2002
- ------------------------------
CTSI CTSI Total
CT Edge-Out Expansion CTSI Other Consolidated
-------- -------- --------- --------- -------- ------------
Sales $103,180 $ 42,538 $ - $ 42,538 $ 18,753 $ 164,471
Elimination of intersegment sales 7,021 333 - 333 421 7,775
External sales 96,159 42,205 - 42,205 18,332 156,696
Adjusted EBITDA 61,383 15,527 - 15,527 983 77,893
Depreciation and amortization 22,284 9,125 - 9,125 2,069 33,478
Restructuring charges (reversals) - (2,057) - (2,057) - (2,057)
Voluntary employee retirement program - - - - 2,333 2,333
Operating income (loss) 39,099 8,459 - 8,459 (3,419) 44,139
Interest expense, net (1,422) - (3,803) (5,225)
Other income (expense), net (95) 491 (26) 370
Income (loss) before income taxes 37,582 8,950 (7,248) 39,284
Provision (benefit) for income
taxes 14,570 3,965 (2,525) 16,010
Equity in income of unconsolidated entities - 1,573 - 1,573
Net income (loss) 23,012 6,558 (4,723) 24,847
7
Six months ended June 30, 2001
- ------------------------------
CTSI CTSI Total
CT Edge-Out Expansion CTSI Other Consolidated
-------- -------- --------- --------- -------- ------------
Sales $ 99,401 $ 35,204 $ 5,576 $ 40,780 $ 20,208 $ 160,389
Elimination of intersegment sales 6,471 275 13 288 217 6,976
External sales 92,930 34,929 5,563 40,492 19,991 153,413
Adjusted EBITDA 58,480 7,061 (2,650) 4,411 355 63,246
Depreciation and amortization 20,801 8,154 - 8,154 2,633 31,588
Restructuring charges (reversals) - - (3,410) (3,410) - (3,410)
Operating income (loss) 37,679 (1,093) 760 (333) (2,278) 35,068
Interest expense, net (2,838) (1) (5,954) (8,793)
Other income (expense), net (396) 513 (45) 72
Income (loss) before income taxes 34,445 179 (8,277) 26,347
Provision (benefit) for income taxes 14,545 555 (2,909) 12,191
Equity in income of unconsolidated entities - 1,409 - 1,409
Net income (loss) 19,900 1,033 (5,368) 15,565
3. Revenue Recognition - Local telephone service is recorded based on tariffed
or contracted rates. Telephone network access and long-distance revenues are
derived from access charges, toll rates and settlement arrangements. CT's
interstate access charges are subject to a pooling process with the National
Exchange Carrier Association ("NECA"). Final interstate revenues are based on
nationwide average costs applied to certain demand quantities. Increases to CT's
reserve for doubtful accounts are charged against revenue. Internet access
service revenues are based on contracted fees. Long-distance telephone service
revenues are recorded based on minutes of traffic processed and tariffed rates
or contracted fees. Revenue from local telephone, Internet access and
long-distance telephone services is earned and recorded when the services are
provided. Long-term contracts of CC are accounted for on the
percentage-of-completion method. We defer and amortize CT, CTSI and epix
installation revenue as well as direct incremental service installation costs
over their respective estimated customer life. We carry in the Consolidated
Balance Sheets a deferred credit of $5,820 as of June 30, 2002 in other
liabilities representing the unamortized portion of installation revenue.
Additionally, we have a deferred charge of $5,820 as of June 30, 2002 in other
assets representing the unamortized portion of installation costs.
4. Income Taxes - The provision for income taxes is different than the amount
computed by applying the United States statutory federal tax rate primarily due
to state income taxes net of federal benefit. In the third quarter of 2001, we
implemented certain tax strategies to reduce our effective tax rate. These
strategies included a reorganization of our legal entity structure that will
allow the state of Pennsylvania tax losses of CTSI to be offset against taxable
income of CT. Recently, the state of Pennsylvania passed legislation that
increased the time frame for the utilization of Pennsylvania tax losses that may
result in an additional benefit. Also, CT has taken advantage of certain tax
incentives offered by the state of Pennsylvania aimed at attracting business
into certain areas of qualifying cities in the state. We will have continued
savings as a result of these tax strategies.
5. CTE Stock Options and Restricted Stock - At June 30, 2002, we have
approximately 1,632,000 options outstanding at exercise prices ranging from
$9.378 to $54.3125. During the first six months of 2002, 253,500 options were
granted, 8,437 options were canceled and 23,071 options were exercised, yielding
cash proceeds of $450. As provided for in the CTE Equity Incentive Plan, we
granted 155,000 shares of restricted stock in 2000, of which 25,000 have been
canceled. As of June 30, 2002, 65,000 shares were vested. The compensation cost
recognized in 2002 was $769, in accordance with Accounting Principles Board
(APB) Opinion No. 25 "Accounting for Stock Issued to Employees," as clarified by
Interpretation No. 44 "Accounting for Certain Transactions Involving Stock
Compensation" as issued by the FASB.
6. Earnings per Share - Basic earnings per share amounts are based on net income
divided by the weighted average number of shares of Common Stock and Class B
Common Stock outstanding during the period.
Diluted earnings per share amounts are based on net income divided by the
weighted average number of shares of Common Stock and Class B Common Stock
8
outstanding during each period after giving effect to dilutive common stock
equivalents.
The following table is a reconciliation of the numerators and denominators of
the basic and diluted per share computations for net income:
Three months ended Six months ended
June 30, June 30,
------------------------ -----------------------
2002 2001 2002 2001
----------- ----------- ----------- ----------
Net income $ 14,098 $ 9,669 $ 24,847 $ 15,565
=========== =========== =========== ==========
Basic earnings per share:
Weighted average shares outstanding 23,374,395 23,049,794 23,363,307 22,989,850
=========== =========== =========== ==========
Net income per share $ 0.60 $ 0.42 $ 1.06 $ 0.68
=========== =========== =========== ==========
Diluted earnings per share:
Weighted average shares outstanding 23,374,395 23,049,794 23,363,307 22,989,850
Dilutive shares resulting from common
stock equivalents 316,069 422,746 320,605 461,112
----------- ----------- ----------- ----------
Weighted average shares and common
stock equivalents outstanding 23,690,464 23,472,540 23,683,912 23,450,962
=========== =========== =========== ==========
Net income per share $ 0.60 $ 0.41 $ 1.05 $ 0.66
=========== =========== =========== ==========
7. Derivative Instruments - We utilize interest rate swap agreements to reduce
the impact of changes in interest rates on our floating rate debt. The swap
agreements are contracts to exchange floating rate for fixed interest payments
periodically over the life of the agreements without exchange of the underlying
notional amounts. The notional amounts of interest rate swap agreements are used
to measure interest to be paid or received and do not represent the amount of
exposure to credit loss.
Effective January 1, 2001, we adopted the provisions of SFAS 138: "Accounting
for Certain Derivative Instruments and Certain Hedging Activities--an Amendment
of FAS 133," in accounting for our interest rate swaps. The interest rate swaps
meet the eligibility requirements for hedge accounting and are considered to be
cash flow hedges. The fair value of the interest rate swaps is recorded in other
liabilities on our Consolidated Balance Sheets. The effective portion of
interest rate swap gains or losses is initially reported as a component of other
comprehensive income and subsequently reclassified into earnings as an
adjustment to interest expense. The ineffective portion, if any, is reported as
other income (expense). The fair value of the interest rate swaps at January 1,
2001 was ($280). The transaction adjustment of $182, net of taxes of $98, is
reported as a cumulative effect-type adjustment of accumulated other
comprehensive loss. In the six months ended June 30, 2002, we recorded an
adjustment of ($196) (($128) net of tax) to adjust the fair value of the swaps
to ($4,626). In the six months ended June 30, 2001, we recorded an adjustment of
$1,176 to adjust the fair value of the swaps, of which $52 was ineffective and
recognized in current earnings, and $1,124 ($731 net of tax), which was recorded
in other comprehensive income.
The interest rate swaps are highly effective in achieving the offset of changes
in cash flows of the underlying debt. We calculate the excess in the present
value of the cumulative change in cash flows relating to the floating leg of the
swaps as compared to the present value of the cumulative changes in interest
cash outflows on the debt to measure ineffectiveness.
8. Restructuring Charges (Reversals) - In December 2000, we initiated an exit
strategy for CTSI to reduce its network expansion plan from a total of eight
9
markets to three markets. This strategy was aimed at focusing on the three
"edge-out" markets adjacent to CT's rural footprint. These edge-out markets
encompass the Wilkes-Barre/Scranton/Hazleton, Harrisburg and
Lancaster/Reading/York, PA markets. Related to this strategy, CTE recorded an
estimated restructuring charge of $99,713 (pre-tax) and $64,813 (after-tax).
CTSI had completed its withdrawal from the five non-"edge-out" expansion markets
(suburban Philadelphia, PA; Binghamton, NY; Syracuse, NY; Charleston/Huntington,
WV; and Youngstown, OH) by June 30, 2001.
During December 2000, we reduced our workforce by approximately 220 employees
and as of December 31, 2001 we reduced our workforce by an additional 33
employees who had remained to facilitate the transition of customers to other
service providers. No further workforce reductions as a result of this
restructuring will occur.
Employee termination benefits associated with this workforce reduction and
included in the restructuring charge was $2,628. Of this liability, $2,534 was
paid and the remaining $94 was reversed in the fourth quarter of 2001.
Also included in accrued restructuring expenses were estimated incremental costs
associated with financial advisory, legal and other fees of $3,500. In 2000 and
2001, $1,328 was paid with $1,600 reversed in the second quarter of 2001 as a
result of favorable negotiation of commitments. In the six months ended June 30,
2002, $41 of this liability was paid and the remaining $531 was reversed in the
second quarter of 2002 due to lower than anticipated legal expenses.
Additionally, other exit costs associated with terminating customer contracts,
committed purchases of equipment, building and circuit lease terminations, asset
removal and site restorations were estimated to be $17,580. During 2001, $6,213
was paid. In the second quarter 2001, $1,810 associated with a canceled
committed equipment purchase that was favorably negotiated was reversed. In the
third quarter 2001, as a result of the sale of certain assets and the assignment
of certain leases to a CLEC, we reversed $2,233 of these charges. In the fourth
quarter 2001, $515 was reversed due to a favorable building lease settlement. In
the six months ended June 30, 2002, $1,223 of this liability was paid. In the
second quarter of 2002, $1,526 was reversed due to the elimination of
liabilities associated with certain customer contracts.
We expect the majority of the remaining liabilities to be utilized in 2002. Any
funding associated with the reduction of the outstanding liabilities at June 30,
2002 of $4,060 will come from cash flow from operations or existing credit
facilities.
The restructuring charge as of December 31, 2000 included $73,994, net of
estimated salvage value, for the write-down of assets included in property,
plant and equipment. Estimated salvage values were based on estimates of
proceeds from the sale of the affected assets, offset by costs of removal. These
assets primarily relate to switching, central office equipment and outside
communications plant physically located in the exited markets. In July 2001, a
CLEC purchased a portion of our assets in the New York expansion markets at
amounts higher than estimated, resulting in a gain of $3,035.
No depreciation expense was recorded for the expansion markets in 2001 or 2002.
No further depreciation expense will be incurred for these expansion market
assets.
The restructuring charge also included $2,011 related to the write-down, net of
estimated salvage value, of assets included in inventory to be sold or disposed
of in connection with the restructuring.
The write-down of the assets to be disposed of was a direct result of our
unwillingness to incur the capital requirements necessary to grow these markets
and make them profitable; and accordingly, no future cash flows from these
assets could be anticipated. Excluding the expansion market assets, we are not
aware of any events or circumstances that would suggest the carrying amount of
our remaining assets would not be recoverable.
10
The key elements of the restructuring charge recorded in December 2000 were:
Assets,
Employee Disposal
Termination Contract and Removal
Benefits Terminations Costs Other Total
----------- ------------ ----- ----- -----
Employee termination benefits $2,628 $ 2,628
Contract terminations and settlements $15,294 15,294
Removal and restoration costs $ 2,286 2,286
Write-down of assets 76,005 76,005
Investment advisory and other fees $3,500 3,500
------ ------- ------- ------ -------
Total restructuring charges $2,628 $15,294 $78,291 $3,500 $99,713
====== ======= ======= ====== =======
Accrued restructuring expense comprises the following:
Balance Reversal Balance Reversal Balance
December 31, of December 31, of June 30,
Provision Payments 2000 Payments Provision 2001 Payments Provision 2002
--------- -------- ------------ -------- --------- ------------ -------- --------- ---------
Employee termination benefits $ 2,628 $(1,572) $ 1,056 $ (962) $ (94) $ - $ - $ - $ -
Contract terminations and
settlements 15,294 - 15,294 (5,150) (3,788) 6,356 (1,223) (1,526) 3,607
Removal and restoration costs 2,286 - 2,286 (1,063) (770) 453 - - 453
Investment advisory and other
fees 3,500 (311) 3,189 (1,017) (1,600) 572 (41) (531) -
------- ------- ------- ------- ------- ------- -------- -------- ---------
Total accrued restructuring
expenses $23,708 $(1,883) $21,825 $(8,192) $(6,252) $ 7,381 $ (1,264) $ (2,057) $ 4,060
======= ======= ======= ======= ======= ======= ======== ======== =========
We have not realized and do not anticipate any significant change to
non-expansion market revenues or costs as a result of this event.
9. Voluntary Retirement Program - On December 12, 2001, we initiated a
Voluntary Retirement Program ("VRP"). The program was offered to certain
eligible employees across all of our operations. The VRP is largely being funded
from pension assets and, therefore, nearly 80% of the cost is non-cash to the
Company. Since the deadline related to this program extended into 2002, and
because only a portion of the eligible employees had made a decision to accept
this program prior to year-end 2001, $2,333 ($1,423 after-tax) was recorded in
the first quarter of 2002. The VRP costs of $2,333 represent $1,805 of non-cash
charges related to pension enhancement, social security supplements and vacation
benefits. Other VRP program costs of $528 relate to medical insurance and other
program expenses.
10. Debt - On April 6, 2001, we amended our September 15, 2000, 364-day
revolving line of credit agreement with CoBank to provide for an additional
$35,000 of borrowing capacity and to change other terms and conditions of the
loan. In April 2002, the maturity was extended to June 2002. The amended
revolving line of credit agreement with CoBank was entered into on June 4, 2002
that extended the availability of credit to June 2003.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
(Dollars in Thousands, Except Per Share Data)
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act and we
intend that such forward-looking statements be subject to these safe harbors.
These statements are generally accompanied by words such as "intend,"
"anticipate," "believe," "estimate," "expect" or similar statements. Our
forward-looking statements involve risks and uncertainties that could
significantly affect expected results in the future differently than expressed
in any forward-looking statements we have made. These risks and uncertainties
include, but are not limited to:
11
.. uncertainties relating to our ability to further penetrate our markets and
the related cost of that effort;
.. economic conditions, acquisitions and divestitures;
.. government and regulatory policies;
.. the pricing and availability of equipment, materials and inventories;
.. technological developments; and
.. changes in the competitive environment in which we operate.
Although we believe that the assumptions underlying our forward-looking
statements are reasonable, any of the assumptions could prove inaccurate and,
therefore, we cannot provide any assurance that the results contemplated in such
forward-looking statements will be realized. The inclusion of this
forward-looking information should not be regarded as a representation by us or
any other person that the future events, plans or expectations that we
contemplate will be achieved. Furthermore, past performance in operations and
share price is not necessarily predictive of future performance. The following
discussion should be read in conjunction with the attached Condensed
Consolidated Financial Statements and notes thereto and with the Company's
audited financial statements and notes thereto included in the Company's Form
10-K for the fiscal year ended December 31, 2001.
Overview and Segments
Our two primary operations are Commonwealth Telephone Company, or CT, which is a
rural incumbent local exchange carrier ("RLEC"), and CTSI, LLC, our RLEC edge-
out operation. We also have another business segment labeled "Other" which is
comprised of telecommunications-related businesses that all operate in the
deregulated segments of the telecommunications industry and support the
operations of our two primary operating companies. These support businesses are
epix(R) Internet Services, a rural Internet service provider; Jack Flash(R), a
broadband data service that uses DSL technology to offer high-speed Internet
access and digital connectivity solutions; Commonwealth Communications, a
provider of telecommunications equipment and facilities management services; and
Commonwealth Long Distance Company, a facilities-based long-distance reseller.
Both epix and Jack Flash results included in Other represent the portion of
these businesses in our RLEC's territory. Other also includes our corporate
financing entity.
Our RLEC has been operating in various rural Pennsylvania markets since 1897. As
of June 30, 2002, our RLEC served over 335,000 switched access lines. In 1997,
we formally launched our facilities-based RLEC edge-out operation. CTSI operates
in three "edge-out" regional Pennsylvania markets that border our RLEC's markets
and that we believe offer attractive market demographics such as higher
population density and a higher concentration of businesses. CTSI served over
119,000 switched access lines as of June 30, 2002, which were mainly business
customers. Beginning in 1998, CTSI expanded beyond its original three "edge-out"
markets into five additional expansion markets in Pennsylvania, New York, Ohio
and West Virginia. At the end of 2000, we developed an exit strategy for these
"expansion" markets in order to refocus our attention on our three original
"edge-out" markets. This strategy has allowed us to grow our adjusted EBITDA and
significantly reduced our capital needs. We had completed our withdrawal from
these markets by June 30, 2001.
Revenue
Our RLEC revenue is derived primarily from access, local service, enhanced
services and intraLATA toll. IntraLATA toll revenue is derived from customers
who have chosen us to provide intrastate long-distance service. Access revenue
consists primarily of charges paid by long-distance companies for access to our
network in connection with the completion of long-distance telephone calls.
Local service revenue consists of charges for local exchange telephone services,
including monthly tariffs for basic local service. Enhanced services revenue is
derived from service for special calling features, such as Caller ID and Call
Waiting.
12
CTSI's revenue is derived primarily from access, local service, point-to-point
circuit, Internet access, DSL and long-distance service revenue. Access revenue
consists primarily of charges paid by long-distance companies and other carriers
for access to our network in connection with the completion of long-distance
telephone and local calls and the delivery of other services. Local service
revenue consists of charges for local exchange telephone services, including
monthly recurring charges for basic services and special calling features.
Competitive access revenue consists of charges for point-to-point connections.
Internet access revenue consists of charges for dial-up Internet access provided
to CTSI customers. DSL revenue consists of charges for high-speed Internet
access and digital connectivity solutions provided to CTSI customers.
Long-distance revenue consists of charges for long-distance service paid by CTSI
customers.
Our "Other" business segment includes a portion of the revenue from epix(R)
Internet Services and Jack Flash(R) and all of the revenues from Commonwealth
Communications and Commonwealth Long Distance Company. epix revenue for this
segment consists of Internet revenue from customers within the RLEC service
territory and non-CTSI customers outside the RLEC territory. Jack Flash revenue
for this segment consists of charges for DSL service from customers within the
RLEC service territory. Commonwealth Communications generates revenue primarily
from telecommunications projects including installation of PBX systems for
business customers, cabling projects and telecommunication systems design.
Commonwealth Long Distance primarily derives its revenue from long-distance
customers within the RLEC operating territory.
Operating Costs
Our operating costs and expenses for each of our segments primarily include
access charges and other direct costs of sales, payroll and related benefits,
selling and advertising, software and information system services and general
and administrative expenses. These costs have increased over time as we have
grown our operations and revenues. We expect these costs to continue to increase
as our revenue growth continues, but generally at a slower rate than revenue
growth. CTSI also incurs additional costs related to leased local loop charges
associated with providing last mile access, circuit rentals, engineering costs,
colocation expense, terminating access for local calls and long-distance
expense. Commonwealth Long Distance also incurs long-distance expense associated
with purchasing long-distance minutes on a wholesale basis from a third party
provider. Commonwealth Communications also incurs expenses primarily related to
equipment and materials used in the course of the installation and provision of
service.
Capital Expenditures
We incur line-related capital expenditures associated with access line growth,
maintenance expenditures for upgrading existing facilities and costs related to
the provisioning of DSL services in our RLEC and RLEC edge-out territories.
Capital expenditures associated with access line growth, comprising a
significant portion of our overall capital spending, are success-based and
therefore result in incremental revenue.
Results of Operations
Quarters ended June 30, 2002 vs June 30, 2001
Our consolidated sales were $78,300 and $76,467 for the quarters ended June 30,
2002 and 2001, respectively. Contributing to the sales increase of $1,833 or
2.4% were higher sales of CT of $1,291 and higher CTSI edge-out sales of $3,230,
partially offset by the loss of CTSI expansion sales of $1,740 and a decline of
$948 in Other sales. CT's revenue was reduced by a $2,000 charge related to
WorldCom receivables that was recorded as contra-revenue in June 2002.
Our consolidated operating income was $24,113 for the quarter ended June 30,
2002 as compared to $19,497 for the quarter ended June 30, 2001. The increase in
operating income of $4,616 was primarily the result of increased consolidated
sales and lower costs in providing these sales, partially offset by increased
13
consolidated depreciation expense and a smaller positive settlement in 2002
associated with our 2000 restructuring charge.
Consolidated net income was $14,098 or $0.60 per diluted share for the quarter
ended June 30, 2002 and $9,669 or $0.41 per diluted share for the quarter ended
June 30, 2001. Contributing to the increase of $4,429 is the increase in
operating income discussed above and a reduction in interest expense, partially
offset by an increase in the provision for income taxes.
Six months ended June 30, 2002 vs June 30, 2001
Consolidated sales were $156,696 and $153,413 for the six months ended June 30,
2002 and 2001, respectively. Contributing to the sales increase of $3,283 or
2.1% were higher sales of CT of $3,229 and higher CTSI edge-out sales of $7,276,
partially offset by the loss of CTSI expansion sales of $5,563 and a decline of
$1,659 in Other sales. CT's revenue was reduced by a $2,000 charge related to
WorldCom receivables that was recorded as contra-revenue in June 2002.
Our consolidated operating income was $44,139 for the six months ended June 30,
2002 as compared to $35,068 for the six months ended June 30, 2001. The increase
in operating income of $9,071 or 25.9% was primarily the result of increased
consolidated sales and lower costs in providing these sales, partially offset by
increased consolidated depreciation expense, a smaller positive settlement in
2002 associated with our 2000 restructuring charge and expenses recorded in
connection with the Voluntary Retirement Program that was initiated in December
2001.
Consolidated net income was $24,847 or $1.05 per diluted share for the six
months ended June 30, 2002 and $15,565 or $0.66 per diluted share for the six
months ended June 30, 2001. Contributing to the increase of $9,282 is the
increase in operating income discussed above and a reduction in interest
expense, partially offset by an increase in the provision for income taxes.
Selected Segment Data
Adjusted EBITDA
We provide as supplemental data our adjusted EBITDA on both a consolidated and
segment basis. We define adjusted EBITDA as earnings before interest, taxes,
voluntary employee retirement program, restructuring charges (reversals),
depreciation and amortization, other income (expense) and equity in income of
unconsolidated entities. We believe that adjusted EBITDA is an additional
measure of operations that (1) gauges the performance of our business; and (2)
may provide investors and research analysts with a benchmark against certain
other communications companies. Adjusted EBITDA is not a measurement under GAAP
and may not be comparable to other similarly titled measures of other companies.
Pro forma data
The pro forma data presented gives effect to CTSI's exit from five expansion
markets in 2001. The pro forma data is calculated by eliminating sales and
identifiable direct operating expenses related to our operations in the
expansion markets for the periods presented. However, the pro forma data is not
necessarily indicative of the results we would have achieved had we actually
completed the exit before January 2001, or of our results of future operations.
14
Sales: Quarters ended Six months ended
June 30, June 30,
-------------------------------- -----------------------------
Pro forma Pro forma
2002 2001 2001/*/ 2002 2001 2001/*/
------- ------- --------- -------- -------- --------
CT $47,543 $46,252 $ 46,252 $ 96,159 $ 92,930 $ 92,930
------- ------- --------- -------- -------- --------
CTSI - edge-out 21,324 18,094 18,094 42,205 34,929 34,929
CTSI - expansion - 1,740 - - 5,563 -
------- ------- --------- -------- -------- --------
Total CTSI 21,324 19,834 18,094 42,205 40,492 34,929
------- ------- --------- -------- -------- --------
Other 9,433 10,381 10,381 18,332 19,991 19,991
------- ------- --------- -------- -------- --------
Total $78,300 $76,467 $ 74,727 $156,696 $153,413 $147,850
======= ======= ========= ======== ======== ========
Operating income (loss): Quarters ended Six months ended
June 30, June 30,
-------------------------------- -----------------------------
Pro forma Pro forma
2002 2001 2001/*/ 2002 2001 2001/*/
------- ------- --------- -------- -------- ---------
CT $18,918 $18,858 $ 18,858 $ 39,099 $ 37,679 $ 37,679
------- ------- --------- -------- -------- --------
CTSI - edge-out 5,305 20 20 8,459 (1,093) (1,093)
CTSI - expansion - 1,942 - - 760 -
------- ------- --------- -------- -------- --------
Total CTSI 5,305 1,962 20 8,459 (333) (1,093)
------- ------- --------- -------- -------- --------
Other (110) (1,323) (1,323) (3,419) (2,278) (2,278)
------- ------- --------- -------- -------- --------
Total $24,113 $19,497 $ 17,555 $ 44,139 $ 35,068 $ 34,308
======= ======= ========= ======== ======== ========
Adjusted EBITDA: Quarters ended Six months ended
June 30, June 30,
------------------------------- -----------------------------
Pro forma Pro forma
2002 2001 2001/*/ 2002 2001 2001/*/
------- ------- --------- -------- -------- --------
CT $30,180 $29,342 $ 29,342 $ 61,383 $ 58,480 $ 58,480
------- ------- --------- -------- -------- --------
CTSI - edge-out 7,878 4,226 4,226 15,527 7,061 7,061
CTSI - expansion - (1,468) - - (2,650) -
------- ------- --------- -------- -------- --------
Total CTSI 7,878 2,758 4,226 15,527 4,411 7,061
------- ------- --------- -------- -------- --------
Other 503 7 7 983 355 355
------- ------- --------- -------- -------- --------
Total $38,561 $32,107 $ 33,575 $ 77,893 $ 63,246 $ 65,896
======= ======= ========= ======== ======== ========
15
Installed access lines: June 30,
-----------------------------------
Pro forma
2002 2001 2001/*/
------- ------- --------
CT 335,467 323,971 323,971
------- ------- -------
CTSI - edge-out 119,471 105,090 105,090
CTSI - expansion - - -
------- ------- -------
Total CTSI 119,471 105,090 105,090
------- ------- -------
Total 454,938 429,061 429,061
======= ======= =======
* The pro forma data is calculated by eliminating sales, identifiable direct
operating expenses and restructuring charges (reversals) related to our
operations in the expansion markets for the periods presented.
Commonwealth Telephone Company
Sales were $47,543 and $46,252 for the quarters ended June 30, 2002 and 2001,
respectively. The sales increase of $1,291 or 2.8% is primarily due to higher
access, enhanced services and local service revenues resulting from an increase
in installed access lines of 11,496 or 3.5%. CT's successful marketing of
residential additional lines and sales of business lines contributed to the
access line growth. Residential additional line penetration was approximately
40% at June 30, 2002 as compared to approximately 37% at June 30, 2001. The 2002
revenue was reduced by a $2,000 charge related to WorldCom receivables that was
recorded as contra-revenue.
CT's sales were $96,159 and $92,930 for the six months ended June 30, 2002 and
2001, respectively. The sales increase of $3,229 or 3.5% is primarily due to
higher access, enhanced services and local service revenues resulting from an
increase in installed access lines, partially offset by the $2,000 charge
related to WorldCom receivables.
Interstate access revenue increased $1,651 and $2,935 for the three and six
months ended June 30, 2002, versus the comparable period of 2001, resulting from
an increase in the NECA average schedule formulas in July 2001, growth in access
lines and an increase in minutes of use.
State access revenue increased $1,288 and $2,343 for the three and six months
ended June 30, 2002 as compared to the comparable period of 2001, primarily a
result of an increase in minutes and access line growth.
Local service revenue increased $270 and $561 for the three and six months ended
June 30, 2002, as compared to the same period last year, primarily as a result
of the increase in access lines and a rate increase in May 2002.
Enhanced services revenue increased $349 and $666 for the three and six months
ended June 30, 2002 in comparison to the same period last year primarily as a
result of increases in Caller ID and certain other custom calling sales.
IntraLATA toll revenue decreased $382 and $804 for the three and six months
ended June 30, 2002 as compared to the comparable period of 2001, primarily as a
result of lower market share due to customers selecting alternate lower cost
service providers and attractive calling packages offered by several
non-wireline providers in certain areas of CT's territory. We expect this trend
to continue.
Costs and expenses excluding depreciation, amortization, management fees,
voluntary employee retirement program and restructuring charges (reversals) for
the quarter ended June 30, 2002 were $17,063 as compared to $16,610 for the
quarter ended June 30, 2001. Contributing to the increase of $453 or 2.7% are
higher payroll costs resulting from annual salary increases and
performance-based incentives and higher expenses for additional advertising
partially offset by favorable reductions in Pennsylvania capital stock tax due
to certain tax incentives offered by the state of Pennsylvania aimed at
attracting business into certain areas of qualifying cities in the state.
16
For the six months ended June 30, 2002, costs and expenses excluding
depreciation, amortization, management fees, voluntary employee retirement
program and restructuring charges (reversals) were $34,176 as compared to
$33,850 for the six months ended June 30, 2001. Contributing to the increase of
$326 or 1.0% are higher payroll costs resulting from annual salary increases and
performance-based incentives. Also contributing to the increase are higher
expenses for additional advertising, partially offset by favorable reductions in
Pennsylvania capital stock tax due to certain tax incentives offered by the
state of Pennsylvania aimed at attracting business into certain areas of
qualifying cities in the state and lower expenses associated with fewer business
system sales.
CTSI
CTSI sales were $21,324 (edge-out $21,324; expansion $0) for the quarter ended
June 30, 2002 as compared to $19,834 (edge-out $18,094; expansion $1,740) for
the same period in 2001. The increase of $3,230 or 17.9% in the edge-out markets
primarily represents an increase in local service, access and customer
point-to-point circuit revenues. The increase in revenue is in part the result
of an increase in installed access lines. At June 30, 2002, CTSI edge-out
markets had 119,471 installed access lines versus 105,090 edge-out market
installed access lines at June 30, 2001, an increase of 14,381 or 13.7%. Also
contributing to the increase in revenue was an increase in Internet service
provider ("ISP")-related traffic. For the quarter ended June 30, 2002, CTSI
recorded approximately $2,881 or 13.5% of its edge-out market revenues from
revenue associated with ISP traffic, as compared to $2,459 or 13.6% for the same
period last year. Regulatory developments during 2001 are expected to adversely
affect CTSI's revenues in future periods. See "Legislative and Regulatory
Developments." The increase in point-to-point circuit revenue is due to Internet
and cellular providers using our circuits to allow their networks to tie into
the switched network system.
CTSI sales were $42,205 (edge-out $42,205; expansion $0) for the six months
ended June 30, 2002 as compared to $40,492 (edge-out $34,929; expansion $5,563)
for the same period in 2001. The increase of $7,276 or 20.8% in the edge-out
markets primarily represents an increase in local service, access and customer
point-to-point circuit revenues. The increase in revenue is in part the result
of an increase in installed access lines of 14,381 in the edge-out markets for
the period and increased ISP traffic. Internet and cellular providers using our
circuits to allow their networks to tie into the switched network system
contributed to an increase of $1,647 in point-to-point circuit revenue. For the
six months ended June 30, 2002, CTSI recorded approximately $5,974 or 14.2% of
its edge-out market revenues from revenue associated with ISP traffic, as
compared to $4,304 or 12.3% for the same period last year.
Costs and expenses, excluding depreciation, amortization, management fees,
voluntary employee retirement program and restructuring charges (reversals) were
$13,347 (edge-out $13,347; expansion $0) and $16,977 (edge-out $13,769;
expansion $3,208) for the quarters ended June 30, 2002 and 2001, respectively.
For the six months ended June 30, 2002, costs and expenses, excluding
depreciation, amortization, management fees, voluntary employee retirement
program and restructuring charges (reversals) were $26,480 (edge-out $26,480;
expansion $0) as compared to $35,883 (edge-out $27,670; expansion $8,213) for
the six months ended June 30, 2001. Contributing to the decrease in expenses for
the edge-out markets are a lower effective monthly rate for leased loops,
reduced bad debt expense due to improved collection efforts and a reduction in
terminating access charges from independent local exchange carriers. These lower
expenses were partially offset by additional circuit rental expense, higher
management information systems charges and increased payroll costs resulting
from annual salary increases and performance-based incentives. The decline in
the expenses of the expansion markets is due to our exit from those markets.
17
Other
Sales of our support businesses were $9,433 and $10,381 for the quarters ended
June 30, 2002 and 2001, respectively. The decline of $948 or 9.1% is due
primarily to a decline in CC and CLD sales, offset by an increase in Jack Flash
sales.
CC sales decreased $563 or 12.2% primarily due to a decrease in premises
distribution system (cabling projects) and business systems upgrades sales. CLD
sales declined $406 or 25.2% as a result of customers switching to alternate
long-distance providers due to CLD's above-average long-distance rates. epix
sales decreased $195 or 5.3% due to a decrease in dial-up subscribers. At June
30, 2002, Jack Flash had 8,511 installed DSL subscribers as compared to 5,616 at
June 30, 2001, contributing to its increase in revenue of $216.
For the six months ended June 30, 2002, sales of our support businesses were
$18,332 as compared to $19,991 for the six months ended June 30, 2001. The
decline of $1,659 or 8.3% is due primarily to a decline in CC sales of $1,002 or
11.8%, decreased CLD sales of $899 or 26.9% and decreased epix sales of $201 or
2.8%, offset by an increase in Jack Flash sales of $443.
Costs and expenses of our support businesses, excluding depreciation,
amortization, management fees, voluntary employee retirement program and
restructuring charges (reversals) were $9,029 and $10,473 for the three months
ended June 30, 2002 and 2001, respectively. For the six months ended June 30,
2002, costs and expenses of our support businesses, excluding depreciation,
amortization, management fees, voluntary employee retirement program and
restructuring charges (reversals) were $17,547 as compared to $19,834 for the
six months ended June 30, 2001.
CC costs and expenses decreased $565 and $890 for the three and six months ended
June 30, 2002, as compared to the same periods last year, due primarily to the
decrease in sales. CLD costs and expenses decreased $624 and $893 for the three
and six months ended June 30, 2002, as compared to the same periods last year,
due primarily to the decrease in sales. epix expenses decreased $292 and $725
for the three and six months ended June 30, 2002, in comparison to the same
periods last year due to lower transport costs and a reduction in headcount. DSL
costs decreased $306 and $784 for the three and six months ended June 30, 2002,
as compared to the same periods last year, due to lower advertising costs and a
reduction in the number of people focused on Jack Flash.
Adjusted EBITDA
Consolidated adjusted EBITDA was $38,561 and $32,107 for the quarters ended June
30, 2002 and 2001, respectively. The increase of $6,454 or 20.1% is primarily
due to increased consolidated sales and decreased consolidated costs and
expenses, as previously discussed. The adjusted EBITDA for the three months
ended June 2001 includes losses in the CTSI expansion markets of $1,468.
Consolidated adjusted EBITDA was $77,893 and $63,246 for the six months ended
June 30, 2002 and 2001, respectively. The increase of $14,647 or 23.2% is
primarily due to increased consolidated sales and decreased consolidated costs
and expenses, as previously discussed. The adjusted EBITDA for the six months
ended June 2001 includes losses in the CTSI expansion markets of $2,650.
Depreciation and amortization
Consolidated depreciation and amortization increased $485 or 3.0% for the
quarter ended June 30, 2002 as compared to the quarter ended June 30, 2001. For
the six months ended June 30, 2002, depreciation and amortization increased
$1,890 or 6.0%. The increase for the three and six month periods is primarily
due to a higher depreciable plant balance as a result of CT and CTSI capital
expenditures during 2001 and 2002.
Voluntary Employee Retirement Program
On December 12, 2001, we initiated a Voluntary Retirement Program ("VRP"). The
program was offered to certain eligible employees across all of our operations.
The VRP is largely being funded from pension assets and, therefore, nearly 80%
of the cost is non-cash to the Company. Since the deadline related to this
18
program extended into 2002, and because only a portion of the eligible employees
had made a decision to accept this program prior to year-end 2001, $2,333
($1,423 after-tax) was recorded in the first quarter of 2002. The VRP costs of
$2,333 represent $1,805 of non-cash charges related to pension enhancement,
social security supplements and vacation benefits. Other VRP program costs of
$528 relate to medical insurance and other program expenses. As a result of the
VRP, we reduced our headcount by 103 employees, or approximately 7% of our
overall workforce. The results of this program allowed us to achieve increased
efficiency and reduced costs.
Interest expense
Interest expense includes interest on CT's mortgage note payable to CoBank, ACB
("CoBank"), interest on CTE's revolving credit facility and amortization of debt
issuance costs. We used interest rate swaps on $105,000 of floating rate debt to
hedge against interest rate exposure. Consolidated interest expense was $3,248
and $4,752 for the quarters ended June 30, 2002 and 2001, respectively; this
represents a decrease of $1,504 or 31.6% from the comparable period of 2001.
Consolidated interest expense was $6,597 and $10,358 for the six months ended
June 30, 2002 and 2001, respectively; this represents a decrease of $3,761 or
36.3% from the comparable period of 2001. The decrease in interest expense is
primarily due to lower average debt outstanding and lower interest rates on
variable rate debt not subject to interest rate swaps. Interest expense on CT's
mortgage note payable to CoBank decreased as a result of scheduled principal
payments.
Income taxes
Our effective income tax rates were 38.9% and 42.0% for the quarters ended June
30, 2002 and 2001, respectively. For the six months ended June 30, 2002 and
2001, our effective income tax rates were 39.2% and 43.9%, respectively. In July
of 2001, we implemented certain tax strategies to reduce our effective tax rate.
These strategies included a reorganization of our legal entity structure that
will allow the state of Pennsylvania tax losses of CTSI to be offset against
taxable income of CT. Also, CT has taken advantage of certain tax incentives
offered by the state of Pennsylvania aimed at attracting business into certain
areas of qualifying cities in the state.
Liquidity and capital resources:
June 30, December 31,
2002 2001
-------- --------
Cash and temporary cash investments $ 23,471 $ 27,298
Working capital deficit $(61,065) $(73,103)
Long-term debt (including current maturities
and notes payable) $190,815 $225,319
Six months ended June 30,
2002 2001
-------- --------
Net cash provided by operating activities $ 52,103 $ 39,440
Investing activities:
Additions to property, plant and equipment $(23,555) $(29,297)
19
We have the following financing arrangements in place that provide liquidity
based on our current needs. Aggregate amounts available under existing
facilities were $175,000 at June 30, 2002 and $105,000 at June 30, 2001.
June 30, 2002 June 30, 2001
------------------- -------------------
Balance Available Balance Available
-------- --------- -------- ---------
Revolving credit facility $ 65,000 $ 175,000 $135,000 $ 105,000
Credit agreement - CoBank 60,815 - 69,824 -
Revolving line of credit - CoBank 65,000 - 65,000 -
-------- --------- -------- ---------
Total $190,815 $ 175,000 $269,824 $ 105,000
======== ========= ======== =========
Cash and temporary cash investments were $23,471 at June 30, 2002 as compared to
$27,298 at December 31, 2001. Our working capital ratio was 0.63 to 1 at June
30, 2002 as compared to 0.60 to 1 at December 31, 2001. The net increase is due
to increased liquidity provided by operations and reductions in capital
spending.
For the six months ended June 30, 2002, our net cash provided by operating
activities was $52,103 comprised of net income of $24,847, non-cash depreciation
and amortization of $33,478 and other non-cash items and working capital changes
resulting in a reduction of $6,222. Net cash used in investing activities of
$21,810 consisted primarily of additions to property, plant and equipment of
$23,555, partially offset by proceeds on retired assets. Net cash used in
financing activities of $34,120 consisted primarily of the net redemption of
debt of $34,505, partially offset by proceeds of stock option exercises of $450.
We expect to have adequate resources to meet our currently foreseeable
obligations and development plans for our CTSI edge-out markets and customer
demand for additional capacity and service. In addition to cash generated from
operations and existing credit facilities, sources of funding for any additional
capital requirements or acquisitions may include financing from public offerings
or private placements of equity and/or debt securities and bank loans. There can
be no assurance that additional financing will be available to us or, if
available, that it can be obtained on a timely basis and on acceptable terms.
Failure to obtain such financing could result in the delay or curtailment of our
development plans and expenditures.
We have a $65,000 revolving line of credit with CoBank. This agreement contains
restrictive covenants which, among other things, requires the maintenance of a
specific debt to cash flow ratio. As amended in June 2002, the revolving line of
credit agreement provides for the availability of credit to June 2003.
On April 2, 2002, we completed a 4,898,000 share secondary equity offering of
our common stock. All of these shares were offered by a subsidiary of Level 3
Communications, Inc. As such, we did not receive any proceeds from the sale of
shares in this offering. We may, from time to time, consider purchasing some or
all of our shares held by Level 3 Communications, Inc. and its affiliates in one
or more transactions and may finance these purchases through public or private
offerings of equity or debt, operating cash flows and/or bank loans.
Related and Like Parties
Level 3 Communications, Inc. ("Level 3") holds a significant portion of the
voting power in our equity securities. Four of our directors are also directors
of Level 3. Level 3 will continue to have significant influence over the
election of our directors and our corporate and management policies, including
potential mergers or acquisitions, asset sales and other significant corporate
transactions.
We have existing relationships with RCN Corporation ("RCN"), which is an
affiliate of Level 3. Our Chairman, David McCourt, is also the Chairman and CEO
of RCN Corporation, a facilities-based telecommunications company. Eight of our
directors also serve on the board of directors of RCN. We have entered into a
month-to-month long-distance resale agreement and a management service agreement
with RCN, the latter of which was not the result of arm's-length negotiations.
In addition, Level 3 owns approximately 26% of the outstanding equity securities
of RCN.
Level 3 maintains certain rights to register its shares for resale and has
stated publicly that it would consider monetizing certain of its non-core
assets, including its holdings in public companies such as our company.
20
Legislative and Regulatory Developments
Commonwealth Telephone Company
Our RLEC is subject to regulation by the Pennsylvania Public Utility Commission
for intrastate ratemaking purposes, which includes rates for basic local
services, intraLATA toll services and access services for the origination and
termination of in-state long-distance calls. In 1997, our RLEC entered into an
alternative regulatory framework with the Public Utility Commission for all of
its intrastate operations under which it agreed to meet certain broadband
service delivery parameters in exchange for a price cap formula, rather than
rate of return regulations. As a result of the alternative regulatory framework,
our RLEC's profits are not directly limited by the Commission as they were under
the former rate of return system of regulation. Instead, our RLEC received the
flexibility to increase local rates annually based on inflation less 2
percentage points, so that increased returns arising from improved productivity
and efficiency in excess of 2% per annum accrue to the equity owners of the
RLEC. Our RLEC can also seek to rebalance rates periodically between various
intrastate service categories, such as toll and access. Additionally, our RLEC
has the ability to request relief on a dollar-for-dollar basis for certain
events deemed outside of its control that result in reduced revenues or
increased expenses. This may include changes in revenues that may result from
portions of the interstate access charge reform.
The Public Utility Commission is currently considering intrastate access reform
for independent local exchange carriers in Pennsylvania. At this time, we are
unable to predict the outcome of these developments on our results of operations
or financial condition.
The Public Utility Commission must also approve any issuance of stock,
incurrence of long-term debt, or acquisition or sale of material utility assets
by our RLEC. In addition, the Public Utility Commission must approve any change
in control of either our RLEC or its holding company. The Public Utility
Commission defines a "change in control" as either an acquisition or disposition
of the largest single voting interest in a company, if that interest exceeds
20%. In addition, the FCC must also approve any sale or "transfer of control" of
our RLEC or of its holding company.
Our RLEC is subject to the jurisdiction of the Federal Communications
Commission, or FCC, with respect to interstate rates, services, access charges
and other matters, including the prescription of a uniform system of accounts.
Interstate services, for the purpose of determining FCC jurisdiction, are
communications that originate in one state and terminate in another state or
foreign country, including the provision of access to local telephone networks
for the origination or termination of such communications. Prices for our RLEC's
interstate services, consisting primarily of subscriber line charges and access
charges for interstate toll calls, which accounted for approximately 31.8% of
our RLEC's 2002 revenues, are regulated by the FCC based on "average schedule"
formulas that are designed to approximate the interstate jurisdictional costs of
telephone companies based on statistical data rather than actual costs. These
average schedule formulas are subject to periodic revision by the FCC and
changes in the formulas, or removal of our RLEC from them, could result in a
significant revenue loss. However, removal of our RLEC from these formulas is
specifically listed in its Pennsylvania alternative regulation plan as an event
outside of its control that would justify an offsetting rate adjustment.
On November 9, 2001, the FCC released an order changing its interstate access
charge rules and universal service support system for rate-of-return rural
incumbent local exchange carriers. The new rules change the sources of funding
under the average schedule formulas, but not the amounts paid to participants.
These modifications include a reduction in access charges to long-distance
companies, an increase in subscriber line charges to local service customers,
and the creation of a universal funding mechanism funded by all
telecommunications carriers. In addition to the above modifications, the FCC has
also released a Notice of Proposed Rulemaking under which it will investigate
the possibility of allowing telephone companies such as our RLEC to convert to a
form of incentive regulation similar in some respects to its existing
alternative regulation plan in Pennsylvania. We are unable to predict the
outcome of this proposed rulemaking at this time.
21
CTSI
The Pennsylvania Public Utility Commission exercises jurisdiction over
intrastate service, including basic local exchange service, intrastate access
services and intraLATA toll services. Under the Public Utility Commission's
current practices, CTSI's rates and services are generally subject to much less
regulatory scrutiny than those of the RLEC in its markets. Additionally,
municipalities and other local government agencies may oversee CTSI's access to
public rights-of-way.
Under the Telecommunications Act of 1996, the Pennsylvania Public Utility
Commission also has authority to arbitrate any disputes over the terms and
conditions of interconnection between CTSI and Verizon, and the prices of
various unbundled network elements CTSI purchases from Verizon. This Commission
has taken a number of actions over the past several years affecting the prices
for network elements, as well as the terms and conditions under which these
elements are provided. Further decisions by this Commission may have a material
effect on CTSI's costs and profitability.
At the federal level, the Federal Communications Commission has jurisdiction
over interstate services, including access charges as well as long-distance
services. CTSI's rates, terms and conditions of service are filed with the FCC
in tariffs and are subject to the FCC's complaint jurisdiction, and in the case
of switched access service are subject to rate caps prescribed by the FCC, as
described further below.
In April 2001, the FCC released an order adopting new rules limiting the right
of competitive local exchange carriers to collect reciprocal compensation on
local telephone calls that terminate to Internet service providers. Under the
new rules, which took effect on June 14, 2001, the amount of compensation
payable by other local telephone companies to our RLEC edge-out operation on
calls to Internet service providers will generally be limited to $0.0015 per
minute for the first six months after the rules took effect, $0.0010 per minute
for the next eighteen months and $0.0007 per minute thereafter. Any traffic
exchanged between carriers that exceeds a three-to-one ratio of terminating to
originating minutes is presumed to be traffic to Internet service providers,
although either CTSI or the other telephone company may attempt to rebut this
presumption and show a different level of Internet traffic. In addition, the
number of minutes on which compensation is payable is limited by a formula based
upon the number of compensable minutes exchanged in the first quarter of 2001.
The rates under the new rules are substantially lower than the compensation CTSI
was previously collecting in Pennsylvania, where the effective rates were as
high as $0.0028 per minute. For the six months ended June 30, 2002, CTSI
recorded approximately $5,974 or 14.2% of its edge-out revenues from revenue for
calls terminated to Internet service providers. This compares to $4,304 or 12.3%
for the corresponding period in the prior year.
On May 3, 2002, the U.S. Court of Appeals for the D.C. Circuit remanded the
FCC's order on reciprocal compensation for Internet traffic on the grounds that
the FCC did not provide proper statutory authority for its order. The Court did
not vacate the order and thus the current compensatory scheme will remain in
effect pending the remand. However, should the FCC fail to satisfy the Court's
demand for adequate statutory authority, the FCC's order would be vacated. The
effect of such a vacation on CTSI's operations is currently unknown.
Also in April 2001, the FCC released a separate order adopting new rules to
limit the access charges of non-dominant providers. Under these rules which took
effect on June 20, 2001, competitive carriers are required to reduce their
interstate access charges to rates no higher than 2.5 cents per minute (CTSI's
previous interstate access charges were as high as 4.5 cents per minute). After
one year, this rate ceiling will be reduced to 1.8 cents and after two years to
1.2 cents per minute. After three years, CTSI will be required to charge rates
no higher than the incumbent local exchange carrier (in our case, Verizon, which
we expect will charge rates of approximately 0.45 cents per minute by 2004 as a
result of an FCC plan requiring regional Bell operating companies to reduce
their rates to this level). For the six months ended June 30, 2002, interstate
access revenue accounted for approximately 5.7% of CTSI's "edge-out" market
22
revenue. This decision will result in substantial reductions in CTSI's billed
access charges.
On June 14, 2002 the U.S. Court of Appeals for the D.C. Circuit vacated the
FCC's October 2001 Declaratory Ruling finding that interexchange carriers
("IXCs") must complete calls to and from customers of competitive local exchange
carriers ("CLECs") that charge presumptively reasonable rates for interstate
switched access service. This decision has created uncertainty concerning when
IXCs may lawfully, if ever, decline to pay CLEC access charges while receiving
CLEC access services. CTSI currently has agreements with two of the three
largest IXCs for the termination of its calls. However, it has no such
agreements with other IXCs and therefore the Court of Appeals' decision raises
questions relating to these carriers' obligations to accept CTSI traffic. In
addition, the Court's decision may lead to an invalidation of the CLEC Benchmark
Access Charge Order by the D.C. Circuit on the same grounds (see above).
On May 24, 2002, the U.S. Court of Appeals for the D.C. Circuit issued a
decision remanding certain elements of the FCC's Local Competition Order
relating to the provisioning of unbundled network elements ("UNEs") provided by
incumbent local telephone companies to competitors such as CTSI. The FCC has
requested that the full D.C. Court of Appeals rehear the case in light of the
recent United States Supreme Court decision dealing with the FCC's UNE pricing
regulation. However, should this decision stand, it could affect CTSI's access
to unbundled network elements which are necessary to provide service to certain
of its customers. Further decisions by the FCC may have a material effect on
CTSI's costs and profitability.
The FCC has recently begun reviews of several of its local competition policies
that could result in changes to the interconnection arrangements on which our
RLEC edge-out operation relies, or in additional competition from the incumbent
local telephone companies. We cannot predict the outcome of these reviews, or of
future rule changes that the FCC may initiate.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders was held on May 8, 2002. Matters
submitted to our shareholders included:
1) The election of the following Class III Directors to serve for a
term of three (3) years:
Nominee For Withheld
------- ---------------------
James Q. Crowe 46,163,272 273,770
Michael A. Adams 46,163,272 273,770
Stuart E. Graham 46,163,272 273,770
Richard R. Jaros 46,163,272 273,770
Timothy J. Stoklosa 46,163,272 273,770
Additional Directors whose term of office as a Director continued
after the meeting included:
David C. McCourt
Daniel E. Knowles
Walter Scott, Jr.
David C. Mitchell
Michael J. Mahoney
Frank M. Henry
Eugene Roth, Esq.
John J. Whyte
23
2) The ratification of the selection of PricewaterhouseCoopers LLP as
our independent auditors for the year ending December 31, 2002.
For Against Abstain
---------------------------------------
45,757,041 663,157 16,844
3) The approval of amendments to our Equity Incentive Plan.
For Against Abstain
---------------------------------------
41,272,595 5,095,657 68,790
4) The approval of our updated Bonus Plan.
For Against Abstain
---------------------------------------
44,129,233 2,216,288 91,521
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(4) Instruments defining the rights of security holders,
including indentures
(a) Second amended and restated line of credit agreement
dated as of June 4, 2002 by and between Commonwealth
Telephone Company as borrower and CoBank, ACB.
(10) Material Contracts
(a) Amended CTE 1996 Equity Incentive Plan dated as of May
15, 2002.
(b) Commonwealth Telephone Enterprises, Inc. Bonus Plan.
(99) Additional Exhibits
(a) Registrant's certification of periodic report.
(b) Reports on Form 8-K
None
Item 7(a). Quantitative and Qualitative Disclosure
about Market Risk
Quantitative and Qualitative Disclosure about Market Risk - We are exposed to
interest rate risk primarily through our borrowing activities. There is inherent
rollover risk for borrowings as they mature and are renewed at current market
rates. The extent of this risk is not quantifiable or predictable because of the
variability of future interest rates and our future financing requirements.
24
The table that follows summarizes the fair values of our fixed and variable rate
debt. The table also provides a sensitivity analysis of the estimated fair
values of these financial instruments assuming 100-basis-point upward and
downward shifts in the weighted average interest rate.
Fair value Fair value
(thousands of dollars) assuming assuming
Carrying +100 basis -100 basis
As of June 30, 2002 amount Fair value point shift point shift
----------------------------------------------------------------------------------------------
Long-term debt and notes payable:
Fixed $ 30,794 $ 32,530 $ 32,446 $ 32,615
Variable $ 160,021 $ 160,021 $ 158,181 $ 161,899
We manage our interest rate risk through a combination of variable and fixed
rate debt instruments at varying maturities and by using interest rate swaps.
The table below provides information about our interest rate swaps. Notional
amounts are used to calculate the contractual payments to be exchanged under the
contract. The estimated fair value amounts have been provided to us by the
financial institutions with which we have swap contracts using appropriate and
consistent valuation methodologies.
(thousands of dollars)
Approximate
Maturity Notional fair value as of
date Fixed rate amount June 30, 2002
-------------------------------------------------------
Variable to fixed:
Hedge 3 2004/(a)/ 5.78% $20,000 $(1,072)
Hedge 4 2002/(b)/ 6.13% $15,000 $ (953)
Hedge 5 2002 6.36% $15,000 $ (171)
Hedge 6 2006 5.40% $35,000 $(1,898)
Hedge 7 2003 4.75% $20,000 $ (532)
/(a)/ With an option by the counterparty to terminate the contract in 2002.
/(b)/ Extendible to 2004 at the option of the counterparty.
Two of our interest rate swaps matured in the second quarter 2002, and were not
renewed. Additionally, two interest rate swaps are maturing in the third quarter
2002. One swap contains an option to extend, and we believe the counterparty
will invoke this option. We will analyze market conditions as the maturity date
approaches.
As of August 14, 2002, we had no other material exposure to market risk.
25
SIGNATURES
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.
Date: August 14, 2002 Commonwealth Telephone Enterprises, Inc.
/s/ Donald P. Cawley
--------------------
Donald P. Cawley
Senior Vice President and
Chief Accounting Officer
(Principal Financial Officer and
Principal Accounting Officer)
26