CITIZENS COMMUNICATIONS COMPANY
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
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OF THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE YEAR ENDED DECEMBER 31, 2006
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2006
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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
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CITIZENS COMMUNICATIONS COMPANY
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(Exact name of registrant as specified in its charter)
Delaware 06-0619596
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 614-5600
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Common Stock, par value $.25 per share New York Stock Exchange
Guarantee of Convertible Preferred Securities of Citizens Utilities Trust New York Stock Exchange
Series A Participating Preferred Stock Purchase Rights New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes X No __
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Act. Yes No X
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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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer [X] Accelerated Filer [ ] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes No X
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The aggregate market value of common stock held by non-affiliates of the
registrant on June 30, 2006 was approximately $4,166,069,000 based on the
closing price of $13.05 per share.
The number of shares outstanding of the registrant's Common Stock as of January
31, 2007 was 322,538,000.
DOCUMENT INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Company's 2007 Annual Meeting of
Stockholders to be held on May 18, 2007 are incorporated by reference into Part
III of this Form 10-K.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
TABLE OF CONTENTS
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Page
PART I ----
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Item 1. Business 2
Item 1A. Risk Factors 8
Item 1B. Unresolved Staff Comments 12
Item 2. Properties 12
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 13
Executive Officers 14
PART II
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Item 5. Market for Registrant's Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities 16
Item 6. Selected Financial Data 19
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 37
Item 8. Financial Statements and Supplementary Data 38
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 38
Item 9A. Controls and Procedures 38
Item 9B. Other Information 38
PART III
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Item 10. Directors and Executive Officers of the Registrant 38
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 39
Item 13. Certain Relationships and Related Transactions 39
Item 14. Principal Accountant Fees and Services 39
PART IV
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Item 15. Exhibits and Financial Statement Schedules 39
Index to Consolidated Financial Statements F-1
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
PART I
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Item 1. Business
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Citizens Communications Company (Citizens) and its subsidiaries will be referred
to as the "Company," "we," "us" or "our" throughout this report. Citizens was
incorporated in the State of Delaware in 1935 as Citizens Utilities Company.
We are a communications company providing services to rural areas and small and
medium-sized towns and cities. We offer our services under the "Frontier" name.
Revenue from our Frontier operations was $2.025 billion in 2006. Among the
highlights for 2006:
* Proposed Acquisition
On September 17, 2006, we entered into a definitive agreement to
acquire Commonwealth Telephone Enterprises, Inc. (Commonwealth). Total
consideration (cash and stock) to be paid is approximately $1.2
billion. We expect to close this transaction in the first half of
2007.
* Cash Generation
We continued to grow free cash flow through further growth of
broadband and value added services, productivity improvements, and a
disciplined capital expenditure program that emphasizes return on
investment. In 2006, we sold our competitive local exchange carrier
(CLEC), Electric Lightwave, LLC, or ELI (including the sale of
associated real estate), for approximately $255 million in cash. We
also received approximately $65 million from the dissolution of the
Rural Telephone Bank.
* Stockholder Value
During 2006, we repurchased $135.2 million of our common stock and we
continued to pay an annual dividend of $1.00 per common share.
* Growth
During 2006, we added approximately 75,100 new high-speed internet
customers and almost 88,200 customers began buying a bundle or package
of our services. At December 31, 2006, we had approximately 393,200
high-speed data customers and almost 517,700 customers buying a bundle
or package of services. During 2005, we also began offering a
television product in partnership with Echostar's DISH Network, and at
the end of 2006 we had approximately 62,900 customers.
Our objective is to be the leading provider of communications services to homes
and businesses in our service areas. We are committed to delivering innovative
and reliable products and solutions with an emphasis on convenience, service and
customer satisfaction. We offer a variety of voice, television and internet
services that are available as bundled or package solutions or, for some
products, a la carte. We believe that superior customer service and innovative
product positioning will continue to differentiate us from our competitors in
the marketplace.
Telecommunications Services
As of December 31, 2006, we operated as an incumbent local exchange carrier in
23 states.
Frontier is typically the dominant incumbent carrier in the markets we serve and
provides the "last mile" of telecommunications services to residential and
business customers in these markets.
The telecommunications industry is undergoing significant changes and
difficulties and our financial results reflect the impact of this challenging
environment. As discussed in more detail in Management's Discussion and Analysis
of Financial Condition and Results of Operations (MD&A), we operate in an
increasingly challenging environment and, accordingly, our Frontier revenues
have been growing only slightly.
Our business, under the Frontier name, is primarily with residential customers
and, to a lesser extent, non-residential customers. Our Frontier services
include:
* access services,
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* local services,
* long distance services,
* data and internet,
* directory services, and
* television services.
Access services. Switched access services allow other carriers the use of our
facilities to originate and terminate their long distance voice and data
traffic. These services are generally offered on a month-to-month basis and the
service is billed on a minutes-of-use basis. Access charges are based on access
rates filed with the Federal Communications Commission (FCC) for interstate
services and with the respective state regulatory agency for intrastate
services. In addition, subsidies received from state and federal universal
service funds based on the high cost of providing telephone service to certain
rural areas are a part of our access services revenue.
Revenue is recognized when services are provided to customers or when products
are delivered to customers. Monthly recurring network access service revenue is
billed in advance. The unearned portion of this revenue is initially deferred on
our balance sheet and recognized in revenue over the period that the services
are provided.
Local services. We provide basic telephone wireline services to residential and
non-residential customers in our service areas. Our service areas are largely
residential and are generally less densely populated than the primary service
areas of the largest incumbent local exchange carriers. We also provide enhanced
services to our customers by offering a number of calling features including
call forwarding, conference calling, caller identification, voicemail and call
waiting. All of these local services are billed monthly in advance. The unearned
portion of this revenue is initially deferred on our balance sheet and
recognized in revenue over the period that the services are provided. We also
offer packages of communications services. These packages permit customers to
bundle their basic telephone line with their choice of enhanced, long distance,
television and internet services for a monthly fee and/or usage fee depending on
the plan.
We intend to continue to increase the penetration of enhanced services. We
believe that increased sales of such services will produce revenue with higher
operating margins due to the relatively low marginal operating costs necessary
to offer such services. We believe that our ability to integrate these services
with other services will provide us with the opportunity to capture an increased
percentage of our customers' communications expenditures.
Long distance services. We offer long distance services in our territories to
our customers. We believe that many customers prefer the convenience of
obtaining their long distance service through their local telephone company and
receiving a single bill. Long distance network service to and from points
outside of our operating territories is provided by interconnection with the
facilities of interexchange carriers, or IXCs. Our long distance services are
billed either as unlimited/fixed number of minutes in advance or on a per minute
of use basis, in which case it is billed in arrears.
Data and internet services. We offer data services including internet access
(via dial up or high-speed internet access), frame relay, ethernet and
asynchronous transfer mode (ATM) switching services. We offer other data
transmission services to other carriers and high-volume commercial customers
with dedicated high-capacity circuits like DS-1's and DS-3's. Such services are
generally offered on a contract basis and the service is billed on a fixed
monthly recurring charge basis. Data and internet services are typically billed
monthly in advance.
Directory services. Directory services involves the provision of white and
yellow page directories of residential and business listings. We provide this
service through a third-party contractor and are paid a percentage of revenues
from the sale of advertising in these directories. Our directory service also
includes "Frontier Pages," an internet-based directory service which generates
advertising revenue. We recognize the revenue from these services over the life
of the related white or yellow pages book.
Television services. We offer a television product in partnership with
Echostar's DISH Network (DISH). We provide access to all-digital television
channels featuring movies, sports, news, music, and high-definition TV
programming. We offer packages that include 100, 200 or 250 channels,
high-definition channels, family channels and ethnic channels. We are in an
"agency" relationship with DISH. We bill the customer for the monthly services
and remit those billings to DISH without recognizing any revenue. We in-turn
receive from DISH and recognize as revenue activation fees and a nominal billing
and collection fee.
3
Wireless services. During 2006, we began offering wireless data services in
certain markets. Our wireless data services utilize technologies that are
relatively new, and we depend to some degree on the representations of equipment
vendors, lab testing and the experiences of others who have been successful at
deploying these new technologies. During 2007, we expect to begin offering
differentiated wireless voice and data packages in certain markets. Our success
in offering wireless voice services will, to a great extent, be determined by
the relationships we are developing with both wireless carriers and switching
equipment vendors, and is also dependent on their capabilities.
In the fourth quarter of 2006, the Company revised its reporting of certain
operating metrics to be consistent with those used by management to run the
business. The data reported below is consistent with that used by management
internally on a daily basis.
The following table sets forth certain information with respect to our revenue
generating units (RGUs), which consists of access lines plus high-speed internet
subscribers, as of December 31, 2006 and 2005.
Frontier RGUs at December 31,
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State 2006 2005
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New York............ 952,500 1,001,500
Minnesota........... 296,900 296,400
Arizona............. 198,700 196,000
California.......... 190,200 188,400
West Virginia....... 178,100 171,000
Illinois............ 129,100 130,800
Tennessee........... 111,000 110,300
Wisconsin........... 77,600 77,100
Iowa................ 57,600 59,200
Nebraska............ 54,100 55,700
All other states (13)... 274,000 269,200
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Total 2,519,800 2,555,600
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Change in the number of our access lines is important to our revenue and
profitability. We have lost access lines primarily because of competition,
changing consumer behavior, economic conditions, changing technology and because
some customers disconnect second lines when they add high-speed internet or
cable modem service. We lost approximately 111,000 access lines during the year
ended December 31, 2006, but added over 75,100 high-speed internet subscribers
during this same period. We lost 98,800 residential customer lines and 12,200
non-residential customer lines in 2006. 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 2007. A continued loss of access lines,
combined with increased competition and the other factors discussed in MD&A, may
cause our profitability and cash flows to decrease during 2007.
Regulatory Environment
General
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The majority of our operations are regulated by various state regulatory
agencies, often called public service or utility commissions, and the FCC.
Our revenue is subject to regulation by the FCC and various state regulatory
agencies. We expect federal and state lawmakers to continue to review the
statutes governing the level and type of regulation for telecommunications
services.
4
The Telecommunications Act of 1996, or the 1996 Act, dramatically changed the
telecommunications industry. The main purpose of the 1996 Act was to open local
telecommunications marketplaces to competition. The 1996 Act preempts state and
local laws to the extent that they prevent competition with respect to
communications services. Under the 1996 Act, however, states retain authority to
impose requirements on carriers necessary to preserve universal service, protect
public safety and welfare, ensure quality of service and protect consumers.
States are also responsible for mediating and arbitrating interconnection
agreements between CLECs and ILECs if voluntary negotiations fail. In order to
create an environment in which local competition is a practical possibility, the
1996 Act imposes a number of requirements for access to network facilities and
interconnection on all local communications providers. All incumbent local
carriers must interconnect with other carriers, unbundle some of their services
at wholesale rates, permit resale of some of their services, enable collocation
of equipment, provide local telephone number portability and dialing parity,
provide access to poles, ducts, conduits and rights-of-way, and complete calls
originated by competing carriers under termination arrangements.
At the federal level and in a number of the states in which we operate, we are
subject to price cap or incentive regulation plans under which prices for
regulated services are capped in return for the elimination or relaxation of
earnings oversight. The goal of these plans is to provide incentives to improve
efficiencies and increased pricing flexibility for competitive services while
ensuring that customers receive reasonable rates for basic services. Some of
these plans have limited terms and, as they expire, we may need to renegotiate
with various states. These negotiations could impact rates, service quality
and/or infrastructure requirements which could impact our earnings and capital
expenditures. In other states in which we operate, we are subject to rate of
return regulation that limits levels of earnings and returns on investments. In
some states, we have been required to refund customers as a result of exceeding
earnings limitations. In a small number of states (California, Alabama, Iowa,
Indiana, Michigan, Nebraska), we have been successful in reducing or eliminating
price regulation on services under state commission jurisdiction. We continue to
advocate our position of less regulation with various regulatory agencies.
For interstate services regulated by the FCC, we have elected a form of
incentive regulation known as "price caps" for most of our operations. In May
2000, the FCC adopted a methodology for regulating the interstate access rates
of price cap companies through May 2005. The program, known as the Coalition for
Affordable Local and Long Distance Services, or CALLS plan, reduced prices for
interstate-switched access services and phased out many of the implicit
subsidies in interstate access rates. The CALLS program expired in 2005. The FCC
may address future changes in interstate access charges during 2007 and such
changes may adversely affect our revenues and profitability.
Another goal of the 1996 Act was to remove implicit subsidies from the rates
charged by local telecommunications companies. The CALLS plan addressed this
requirement for interstate services. State legislatures and regulatory agencies
are beginning to reduce the implicit subsidies in intrastate rates. The most
common subsidies are in access rates that historically have been priced above
their costs to allow basic local rates to be priced below cost. Legislation has
been considered in several states to require regulators to eliminate these
subsidies and implement state universal service programs where necessary to
maintain reasonable basic local rates. However, not all the reductions in access
charges would be fully offset. We anticipate additional state legislative and
regulatory pressure to lower intrastate access rates.
Some state legislatures and regulators are also examining the provision of
telecommunications services to previously unserved areas. Since many unserved
areas are located in rural markets, we could be required to expand our service
territory into some of these areas.
5
Recent and Potential Regulatory Developments
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Wireline and wireless carriers are required to provide local number portability
(LNP). LNP is the ability of customers to switch from a wireline or wireless
carrier to another wireline or wireless carrier without changing telephone
numbers. We are 100% LNP capable in our largest markets and over 99% of our
exchanges are LNP capable. We will upgrade the remaining exchanges in response
to bona fide requests as required by FCC regulations.
In 1994, Congress passed the Communications Assistance for Law Enforcement Act
(CALEA) to ensure that telecommunication networks can meet law enforcement
wiretapping needs. Our company was fully compliant, for all TDM voice services,
by June 2006. In June 2006, the FCC issued an order addressing the assistance
capabilities required, pursuant to section 103 of the CALEA law, for
facilities-based broadband Internet access providers and providers of
interconnected VOIP. Frontier expects to be fully compliant in 2007 as required
by the order.
The FCC and Congress may address issues involving inter-carrier compensation,
the universal service fund and internet telephony in 2007. The FCC adopted a
Further Notice of Proposed Rulemaking (FNPRM) addressing inter-carrier
compensation on February 10, 2005. Some of the proposals being discussed with
respect to inter-carrier compensation, such as "bill and keep" (under which
switched access charges would be reduced or eliminated), could reduce our access
revenues and our profitability. The FCC requested additional comments on
intercarrier compensation proposals in late 2006. The universal service fund is
under pressure as local exchange companies lose access lines and more entities,
such as wireless companies, seek to receive monies from the fund. The rules
surrounding the eligibility of Competitive Eligible Telecommunication Carriers,
such as wireless companies, to receive universal service funds are expected to
be clarified by the Federal-State Joint Board on Universal Service and the
clarification of the rules may heighten the pressures on the fund. In addition
the Joint Board requested comments, on August 8, 2006, on the merits of using
reverse auctions to determine the distribution of high-cost Universal Service
support. Changes in the funding or payout rules of the universal service fund
could further reduce our subsidy revenues and our profitability. As discussed in
MD&A, our access and subsidy revenues are important to our cash flows and our
access revenues declined in 2006 compared to 2005. Our access and subsidy
revenues are both likely to decline in 2007.
The development and growth of internet telephony (also known as VOIP) by cable
and other companies have increased the importance of regulators at both the
federal and state levels addressing whether such services are subject to the
same or different regulatory and financial models as traditional telephony. The
FCC has concluded that certain VOIP services are jurisdictionally interstate in
nature and are thereby exempt from state telecommunications regulations. The FCC
has not addressed other related issues, such as: whether or under what terms
VOIP traffic may be subject to intercarrier compensation; and whether VOIP
services are subject to general state requirements relating to taxation and
general commercial business requirements. The FCC has stated its intent to
address these open questions in subsequent orders in its ongoing "IP-Enabled
Services Proceeding," which opened in February 2004. Internet telephony may have
an advantage over our traditional services if it remains less regulated. We are
actively participating in the FCC's consideration of all these issues. On June
3, 2005, the FCC issued an order requiring VOIP services interconnected to the
public switched telephone network to include E-911 calling capabilities by
November 28, 2005. Subsequently, the FCC issued a number of public notices
detailing the steps that could be considered sufficient interim compliance. The
FCC stated in a public notice that providers not in full compliance would not be
required to disconnect existing subscribers but would be expected not to connect
new subscribers in areas where they are not transmitting 911 calls in full
compliance with the rules. On September 23, 2005, the FCC issued an order
stating that both interconnected VOIP services and broadband internet access
services will be required to comply with CALEA by May 12, 2007. On June 27,
2006, the FCC issued an order stating that revenues from certain VOIP services
are subject to contributing to the universal service fund. Both the VOIP E-911
order and the CALEA order have been fully litigated in the FCC's reconsideration
petition and appealed before federal courts; the result is that VOIP will be
required to comply with both of these regulatory mandates.
Some state regulators (including New York and Illinois) have in the past
considered imposing on regulated companies (including us) cash management
practices that could limit the ability of a company to transfer cash between its
subsidiaries or to its parent company. None of the existing state requirements
materially affect our cash management but future changes by state regulators
could affect our ability to freely transfer cash within our consolidated
companies.
Competition
Competition in the telecommunications industry is intense and increasing. We
experience competition from many communications service providers including
cable operators, wireless carriers, VOIP providers, long distance providers,
competitive local exchange carriers, internet providers and other wireline
carriers. We believe that competition will continue to intensify in 2007 across
all products and in all of our markets. Our Frontier business experienced
erosion in access lines and switched access minutes of use in 2006 as a result
of competition. Competition in our markets may result in reduced revenues in
2007.
6
We are responding to this competitive environment with new product offers and by
bundling products and services together with an end user contract term
commitment. Revenues from data services and packages continue to increase as a
percentage of our total revenues. There will continue to be price and margin
pressures in our business that may result in less revenues and profitability.
The telecommunications industry is undergoing significant changes. The market is
extremely competitive, resulting in lower prices, and consumers are changing
behavior, such as using wireless in place of wireline services and using e-mail
instead of making calls. 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 bankrupt carriers.
Divestiture of Public Utilities Services
In the past we provided public utilities services including natural gas
transmission and distribution, electric transmission and distribution, water
distribution and wastewater treatment services to primarily rural and suburban
customers throughout the United States. In 1999, we announced a plan of
divestiture for our public utilities services properties. Since then, we have
divested all of our public utility operations for an aggregate of $1.9 billion.
Our last public utility operation (Vermont Electric) was sold in April of 2004.
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 which state that if any VJO member defaults on its purchase
obligation under the contract to purchase power from Hydro-Quebec, then 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, 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 No. 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 credit ratings
that are equal to or superior to ours, 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, 2008 and remained in default for the duration of the contract
(another 7 years), we estimate that our undiscounted purchase obligation for
2008 through 2015 would be approximately $1.1 billion. In such a scenario we
would then own the power and could seek to recover our 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.
Divestiture of Electric Lightwave LLC
In 2006, we sold our CLEC business, Electric Lightwave LLC (ELI) for $255.3
million (including the sale of associated real estate) in cash plus the
assumption of approximately $4.0 million in capital lease obligations. We
recognized a pre-tax gain on the sale of ELI of approximately $116.7 million.
Our after-tax gain on the sale was $71.6 million. Our cash liability for taxes
as a result of the sale is expected to be approximately $5.0 million due to the
utilization of existing tax net operating losses on both the federal and state
level.
7
Segment Information
With the 2006 sale of our CLEC (ELI), we currently operate in only one
reportable segment.
Financial Information about Foreign and Domestic Operations and Export Sales
We have no foreign operations.
General
Order backlog is not a significant consideration in our businesses. We have no
material contracts or subcontracts that may be subject to renegotiation of
profits or termination at the election of the Federal government. We hold no
patents, licenses or concessions that are material.
Employees
As of December 31, 2006, we had 5,446 employees. 2,996 of our employees are
affiliated with a union. The number of union employees covered by agreements set
to expire during 2007 is 1,526. We consider our relations with our employees to
be good.
Available Information
We are subject to the informational requirements of the Securities Exchange Act
of 1934. Accordingly, we file periodic reports, proxy statements and other
information with the Securities and Exchange Commission (SEC). Such reports,
proxy statements and other information may be obtained by visiting the Public
Reference Room of the SEC at 100 F Street, NE, Washington, D.C. 20549 or by
calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet
site (www.sec.gov) that contains reports, proxy and information statements and
other information regarding the Company and other issuers that file
electronically. Material filed by us can also be inspected at the offices of the
New York Stock Exchange, Inc. (NYSE), 20 Broad Street, New York, NY 10005, on
which our common stock is listed. On June 26, 2006, our Chief Executive Officer
submitted the annual certification required by Section 303A.12(a) of the NYSE
Listed Company Manual. In addition, the certifications of our Chief Executive
Officer and Chief Financial Officer required under Section 302 of the
Sarbanes-Oxley Act of 2002 are included as exhibits to this Form 10-K.
We also make available on our website, or in printed form upon request, free of
charge, our Corporate Governance Guidelines, Code of Business Conduct and
Ethics, and the charters for the Audit, Compensation, and Nominating and
Corporate Governance committees of the Board of Directors. Stockholders may
request printed copies of these materials by writing to: 3 High Ridge Park,
Stamford, Connecticut 06905 Attention: Corporate Secretary. Our website address
is www.czn.net.
Item 1A. Risk Factors
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Before you make an investment decision with respect to our securities, you
should carefully consider all the information we have included or incorporated
by reference in this Form 10-K and our subsequent periodic filings with the SEC.
In particular, you should carefully consider the risk factors described below
and read the risks and uncertainties related to "forward-looking statements" as
set forth in the "Management's Discussion and Analysis of Financial Condition
and Results of Operations" section of this Form 10-K. The risks and
uncertainties described below are not the only ones facing our company.
Additional risks and uncertainties that are not presently known to us or that we
currently deem immaterial or that are not specific to us, such as general
economic conditions, may also adversely affect our business and operations.
Risks Related to Competition and Our Industry
---------------------------------------------
We face intense competition, which could adversely affect us.
The telecommunications industry is extremely competitive and
competition is increasing. The traditional dividing lines between long distance,
local, wireless, cable and internet services are becoming increasingly blurred.
Through mergers and various service expansion strategies, services providers are
striving to provide integrated solutions both within and across geographic
markets. Our competitors include CLECs and other providers (or potential
providers) of services, such as internet service providers, or ISPs, wireless
companies, neighboring incumbents, VOIP providers such as Vonage and cable
companies that may provide services competitive with ours or services that we
intend to introduce. Competition is intense and increasing and we cannot assure
you that we will be able to compete effectively. For example, at December 31,
2006 we had 111,000 fewer access lines than we had at December 31, 2005 and we
believe wireless and cable telephony providers have increased their market share
in our markets. We expect to continue to lose access lines and that competition
with respect to all our products and services will increase.
8
We expect competition to intensify as a result of the entrance of new
competitors and the development of new technologies, products and services. We
cannot predict which of the many possible future technologies, products or
services will be important to maintain our competitive position or what
expenditures will be required to develop and provide these technologies,
products or services. Our ability to compete successfully will depend on
marketing and on our ability to anticipate and respond to various competitive
factors affecting the industry, including a changing regulatory environment that
may affect our competitors and us differently, new services that may be
introduced, changes in consumer preferences, demographic trends, economic
conditions and pricing strategies by competitors. Increasing competition may
reduce our revenues and increase our costs as well as require us to increase our
capital expenditures and thereby decrease our cash flow.
Some of our competitors have superior resources, which may place us
at a cost and price disadvantage.
Some of our current and potential competitors have market presence,
engineering, technical and marketing capabilities, and financial, personnel and
other resources substantially greater than ours. In addition, some of our
competitors can raise capital at a lower cost than we can. Consequently, some
competitors may be able to develop and expand their communications and network
infrastructures more quickly, adapt more swiftly to new or emerging technologies
and changes in customer requirements, take advantage of acquisition and other
opportunities more readily and devote greater resources to the marketing and
sale of their products and services than we can. Additionally, the greater brand
name recognition of some competitors may require us to price our services at
lower levels in order to retain or obtain customers. Finally, the cost
advantages of some competitors may give them the ability to reduce their prices
for an extended period of time if they so choose.
Risks Related to Our Business
-----------------------------
Decreases in certain types of our revenues will impact our
profitability.
Our Frontier business has been experiencing declining access lines,
switched access minutes of use, long distance prices and related revenues
because of economic conditions, increasing competition, changing consumer
behavior (such as wireless displacement of wireline use, email use, instant
messaging and increasing use of VOIP), technology changes and regulatory
constraints. These factors are likely to cause our local network service,
switched network access, long distance and subsidy revenues to continue to
decline, and these factors, together with our increasing employee costs, and the
potential need to increase our capital spending, may cause our cash generated by
operations to decrease.
We may be unable to grow our revenue and cash flow despite the
initiatives we have implemented.
We must produce adequate cash flow that, when combined with funds
available under our revolving credit facility, will be sufficient to service our
debt, fund our capital expenditures, pay our taxes and maintain our current
dividend policy. We expect that our cash taxes will increase substantially in
2007 as we begin to have lower amounts of tax operating losses. We have
implemented several growth initiatives, including increasing our marketing
promotion/expenditures and launching new products and services with a focus on
areas that are growing or demonstrate meaningful demand such as wireline and
wireless high-speed internet. There is no assurance that these initiatives will
result in an improvement in our financial position or our results of operations.
We may complete a significant business combination or other transaction
that could increase our shares outstanding, affect our debt, result in a change
in control, or all of the above.
From time to time we evaluate potential acquisitions and other
arrangements, such as the Commonwealth acquisition, that would extend our
geographic markets, expand our services, enlarge the capacity of our networks or
increase the types of services provided through our networks. If we complete any
acquisition or other arrangement, we may require additional financing that could
result in an increase in our shares outstanding and/or debt, result in a change
in control, or all of the above. There can be no assurance that we will enter
into any transaction.
9
Our business is sensitive to the creditworthiness of our wholesale
customers.
We have substantial business relationships with other
telecommunications carriers for whom we provide service. During the past few
years, several of our customers have filed for bankruptcy. While these
bankruptcies have not had a material adverse effect on our business to date,
future bankruptcies in our industry could result in our loss of significant
customers, more price competition and uncollectible accounts receivable. As a
result, our revenues and results of operations could be materially and adversely
affected.
Risks Related to Liquidity, Financial Resources, and Capitalization
-------------------------------------------------------------------
Substantial debt and debt service obligations may adversely affect us.
We have a significant amount of indebtedness. We may also obtain
additional long-term debt and working capital lines of credit to meet future
financing needs, subject to certain restrictions under our existing
indebtedness, which would increase our total debt.
The significant negative consequences on our financial condition and
results of operations that could result from our substantial debt include:
* limitations on our ability to obtain additional debt or equity
financing;
* instances in which we are unable to meet the financial covenants
contained in our debt agreements or to generate cash sufficient
to make required debt payments, which circumstances have the
potential of accelerating the maturity of some or all of our
outstanding indebtedness;
* the allocation of a substantial portion of our cash flow from
operations to service our debt, thus reducing the amount of our
cash flow available for other purposes, including operating
costs, capital expenditures and dividends that could improve our
competitive position or results of operations;
* requiring us to sell debt or equity securities or to sell some of
our core assets, possibly on unfavorable terms, to meet payment
obligations;
* compromising our flexibility to plan for, or react to,
competitive challenges in our business and the communications
industry; and
* the possibility of our being put at a competitive disadvantage
with competitors who do not have as much debt as us, and
competitors who may be in a more favorable position to access
additional capital resources.
We will require substantial capital to upgrade and enhance our
operations.
Replacing or upgrading our infrastructure will result in significant
capital expenditures. If this capital is not available when needed, our business
will be adversely affected. 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. In addition, our
ongoing annual dividend of $1.00 per share under our current policy utilizes a
significant portion of our cash generated by operations and therefore limits our
operating and financial flexibility and our ability to significantly increase
capital expenditures. While we believe that the amount of our dividend will
allow for adequate amounts of cash flow for capital spending and other purposes,
any material 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, the effects of
increased competition, lower subsidy and access revenues and the other factors
described above may reduce our cash generated by operations and may require us
to increase capital expenditures. In addition, we expect our cash paid for taxes
to increase significantly over the next several years.
10
Risks Related to Regulation
---------------------------
The access charge revenues we receive may be reduced at any time.
A significant portion of our revenues ($263.0 million or 13% in 2006)
is derived from access charges paid by IXCs for services we provide in
originating and terminating intrastate and interstate traffic. The amount of
access charge revenues we receive for these services is regulated by the FCC and
state regulatory agencies. Recent rulings regarding access charges have lowered
the amount of revenue we receive from this source. The FCC has an open
proceeding to address reform to access charges and other intercarrier
compensation. A material reduction in the access revenues we receive would
adversely affect our financial results.
We are reliant on support funds provided under federal and state laws.
We receive a portion of our revenue ($165.0 million or 8% in 2006) from
federal and state subsidies, including the federal high cost fund, federal local
switching support fund, federal USF surcharge and various state funds. 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 revenue.
The federal high cost fund is our largest source of subsidy revenue
(approximately $59.0 million in 2006). We currently expect that as a result of
both an increase in the national average cost per loop and a decrease in our
cost structure, there is likely to be a decrease in the subsidy revenue earned
in 2007 through the federal high cost support fund and such decrease may be
significant in relation to the total amount of our subsidy revenue.
In addition, approximately $37.1 million or 2% of our revenue
represents a surcharge to customers (local, long distance and IXC) which is
remitted to the FCC and recorded as an expense in "other operating expenses".
The FCC revised the calculation for this surcharge by eliminating high speed
internet connections from the calculation effective August 15, 2006. As a
result, we expect this surcharge revenue (and its associated expense) to
decrease in 2007 and such decrease may be significant in relation to the total
amount of our subsidy revenue.
Our company and industry are highly regulated, imposing substantial
compliance costs and restricting our ability to compete in our target markets.
As an incumbent, we are subject to significant regulation from federal,
state and local authorities. This regulation restricts our ability to change our
rates, especially on our basic services, and imposes substantial compliance
costs on us. Regulation restricts our ability to compete and, in some
jurisdictions, it may restrict how we are able to expand our service offerings.
In addition, changes to the regulations that govern us may have an adverse
effect upon our business by reducing the allowable fees that we may charge,
imposing additional compliance costs, or otherwise changing the nature of our
operations and the competition in our industry.
Customers are now permitted to retain their wireline number when
switching to another service provider. This is likely to increase the number of
our customers who decide to disconnect their service from us. Other pending
rulemakings, including those relating to intercarrier compensation, universal
service and VOIP regulations, could have a substantial adverse impact on our
operations.
Risks Related to the Acquisition of Commonwealth
------------------------------------------------
There is no assurance that the acquisition of Commonwealth will occur.
While we have received the requisite Hart-Scott Rodino and FCC
approvals, the acquisition of Commonwealth is still subject to a number of
conditions, including the approval of the Pennsylvania Public Utilities
Commission, or Pennsylvania PUC.
The integration of Commonwealth following the acquisition may present
significant challenges.
11
We may face significant challenges in combining Commonwealth's
operations into our operations in a timely and efficient manner and in retaining
key Commonwealth personnel. The failure to integrate successfully and to manage
successfully the challenges presented by the integration process may result in
us not achieving the anticipated benefits of the acquisition. In addition, we
and Commonwealth expect to incur costs associated with transaction fees and
other costs related to the acquisition. We will also incur integration and
restructuring costs following the completion of the acquisition as we integrate
the businesses of Commonwealth with those of ours. Although we expect that the
realization of efficiencies related to the integration of the business will
offset incremental transaction, integration and restructuring costs over time,
we cannot give any assurance that this net benefit will be achieved.
Risks Related to Technology
---------------------------
In the future as competition intensifies within our markets, we may be
unable to meet the technological needs or expectations of our customers, and
may lose customers as a result.
The telecommunications industry is subject to significant changes in
technology. If we do not replace or upgrade technology and equipment, we will be
unable to compete effectively because we will not be able to meet the needs or
expectations of our customers. Replacing or upgrading our infrastructure could
result in significant capital expenditures.
In addition, rapidly changing technology in the telecommunications
industry may influence our customers to consider other service providers. For
example, we may be unable to retain customers who decide to replace their
wireline telephone service with wireless telephone service. In addition, VOIP
technology, which operates on broadband technology, now provides our competitors
with a low-cost alternative to provide voice services to our customers.
Item 1B. Unresolved Staff Comments
-------------------------
None.
Item 2. Properties
----------
Our principal corporate offices are located in leased premises at 3 High Ridge
Park, Stamford, Connecticut 06905.
An operations support office is currently located in leased premises at 180
South Clinton Avenue, Rochester, New York 14646. In addition, we lease and own
space in our operating markets throughout the United States.
Our telephone properties include: connecting lines between customers' premises
and the central offices; central office switching equipment; fiber-optic and
microwave radio facilities; buildings and land; and customer premise equipment.
The connecting lines, including aerial and underground cable, conduit, poles,
wires and microwave equipment, are located on public streets and highways or on
privately owned land. We have permission to use these lands pursuant to local
governmental consent or lease, permit, franchise, easement or other agreement.
Item 3. Legal Proceedings
-----------------
The City of Bangor, Maine, filed suit against us on November 22, 2002, in the
U.S. District Court for the District of Maine (City of Bangor v. Citizens
Communications Company, Civ. Action No. 02-183-B-S). The City 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 owned by Bangor Gas Company from 1852-1948 and by us from 1948-1963. In
acquiring the operation in 1948 we acquired the stock of Bangor Gas Company and
merged it into us. The City alleged the existence of extensive contamination of
the Penobscot River and initially 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 filed an answer denying liability to
the City, and asserted a number of counterclaims against the City. In addition,
we identified a number of other potentially responsible parties that may be
liable for the damages alleged by the City and joined them as parties to the
lawsuit. These additional parties include UGI Utilities, Inc. and Centerpoint
Energy Resources Corporation. The Court dismissed all but two of the City's
claims, including its claims for joint and several liability under the
Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA)
and the claim against us for punitive damages.
On June 27, 2006, the court issued Findings of Fact and Conclusions of Law in
the first phase of the case. The court found contamination in only a small
section of the River and determined that Citizens and the City should share
cleanup costs 60% and 40%, respectively. The precise nature of the remedy in
this case remains to be determined by subsequent proceedings. However, based
upon the Court's ruling, we believed that we would be responsible for only a
portion of the cost to clean up and the final resolution of this matter would
not be material to the operating results nor the financial condition of the
Company.
12
Subsequent to the June 27, 2006 judgment, we began settlement discussions with
the City, with participation from the State of Maine. In January 2007, we
reached an agreement in principle to settle the matter for a payment by us of
$7,625,000. The Bangor City Council has approved the settlement terms, and a
settlement agreement has been executed by the City and Citizens. Completion of
settlement remains contingent upon entry of a Consent Decree with the State that
is reasonably acceptable to us. We are in negotiations with the State over the
terms of the Consent Decree. If the settlement of this matter does not become
effective, we intend to (i) seek relief from the Court in connection with the
adverse aspects of the Court's opinion and (ii) continue pursuing our right to
obtain contribution from the third parties against whom we have commenced
litigation in connection with this case. In addition, 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 and 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. We cannot at this time determine what amount we may recover
from third parties or insurance carriers.
We are party to other legal proceedings arising in the normal course of our
business. The outcome of individual matters is not predictable. However, we
believe that the ultimate resolution of all such matters, after considering
insurance coverage, will not have a material adverse effect on our financial
position, results of operations, or our cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None in fourth quarter 2006.
13
Executive Officers of the Registrant
Our Executive Officers as of February 1, 2007 were:
Name Age Current Position and Officer
---- --- ----------------------------
Mary Agnes Wilderotter 52 Chairman of the Board and Chief Executive Officer
Donald R. Shassian 51 Chief Financial Officer
John H. Casey, III 50 Executive Vice President
Hilary E. Glassman 44 Senior Vice President, General Counsel and Secretary
Peter B. Hayes 49 Executive Vice President Sales, Marketing and Business Development
Robert J. Larson 47 Senior Vice President and Chief Accounting Officer
Daniel J. McCarthy 42 Executive Vice President and Chief Operating Officer
Cecilia K. McKenney 44 Senior Vice President, Human Resources
There is no family relationship between directors or executive officers. The
term of office of each of the foregoing officers of Citizens will continue until
the next annual meeting of the Board of Directors and until a successor has been
elected and qualified.
MARY AGNES WILDEROTTER has been with Citizens since November 2004. She was
elected Chairman of the Board and Chief Executive Officer in December 2005.
Previously, Mrs. Wilderotter was President and Chief Executive Officer from
November 2004 to December 2005. Prior to joining Citizens, she was Senior Vice
President - Worldwide Public Sector in 2004, Microsoft Corp. and Senior Vice
President - Worldwide Business Strategy, Microsoft Corp., 2002 to 2004. Before
that she was President and Chief Executive Officer, Wink Communications, 1997 to
2002.
DONALD R. SHASSIAN has been with Citizens since April 2006. Prior to joining
Citizens, Mr. Shassian had been an independent consultant since 2001 primarily
providing M&A advisory services to several organizations in the communications
industry. In his role as independent consultant, Mr. Shassian also served as
Interim Chief Financial Officer of the Northeast region of Health Net, Inc. for
a short period of time, and assisted in the evaluation of acquisition,
disposition and capital raising opportunities for several companies in the
communications industry including ATT, Consolidated Communications and smaller
companies in the rural local exchange business. Mr. Shassian is a certified
public accountant, and served for 5 years as the Senior Vice President and Chief
Financial Officer of Southern New England Telecommunications Corporation and for
more than 16 years at Arthur Andersen.
JOHN H. CASEY, III has been with Citizens since November 1999. He is currently
Executive Vice President. Previously, he was Executive Vice President and
President and Chief Operating Officer of our ILEC Sector from July 2002 to
December 2004. He was Vice President of Citizens, President and Chief Operating
Officer, ILEC Sector from January 2002 to July 2002, Vice President and Chief
Operating Officer, ILEC Sector from February 2000 to January 2002, and Vice
President, ILEC Sector from December 1999 to February 2000.
HILARY E. GLASSMAN has been with Citizens since July 2005. Prior to joining
Citizens, from February 2003, she was associated with Sandler O'Neill &
Partners, L.P., an investment bank with a specialized financial institutions
practice, first as Managing Director, Associate General Counsel and then as
Managing Director, Deputy General Counsel. From February 2000 through February
2003, Ms. Glassman was Vice President and General Counsel of Newview
Technologies, Inc. (formerly e-Steel Corporation), a privately-held software
company.
PETER B. HAYES has been with Citizens since February 2005. He is currently
Executive Vice President, Sales, Marketing and Business Development. Previously,
he was Senior Vice President, Sales, Marketing and Business Development from
February 2005 to December 2005. Prior to joining Citizens, he was associated
with Microsoft Corp. and served as Vice President, Public Sector, Europe, Middle
East, Africa from 2003 to 2005 and Vice President and General Manager, Microsoft
U.S. Government from 1997 to 2003.
ROBERT J. LARSON has been with Citizens since July 2000. He was elected Senior
Vice President and Chief Accounting Officer of Citizens in December 2002.
Previously, he was Vice President and Chief Accounting Officer from July 2000 to
December 2002. Prior to joining Citizens, he was Vice President and Controller
of Century Communications Corp.
14
DANIEL J. McCARTHY has been with Citizens since December 1990. He is currently
Executive Vice President and Chief Operating Officer. Previously, he was Senior
Vice President, Field Operations from December 2004 to December 2005. He was
Senior Vice President Broadband Operations from January 2004 to December 2004,
President and Chief Operating Officer of Electric Lightwave from January 2002 to
December 2004, President and Chief Operating Officer, Public Services Sector
from November 2001 to January 2002, Vice President and Chief Operating Officer,
Public Services Sector from March 2001 to November 2001 and Vice President,
Citizens Arizona Energy from April 1998 to March 2001.
CECILIA K. McKENNEY has been with Citizens since February 2006. Prior to joining
Citizens, she was the Group Vice President, of Headquarters of Human Resources
of The Pepsi Bottling Group (PBG) from 2004 to 2005. Previously at PBG, Ms.
McKenney was the Vice President, Headquarters Human Resources from 2000 to 2004.
15
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
PART II
-------
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
----------------------------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
PRICE RANGE OF COMMON STOCK
Our common stock is traded on the New York Stock Exchange under the symbol CZN.
The following table indicates the high and low prices per share during the
periods indicated.
2006 2005
------------------- -------------------
High Low High Low
------- ------- ------- -------
First Quarter $13.72 $11.97 $14.05 $12.25
Second Quarter $13.76 $12.25 $13.74 $12.16
Third Quarter $14.31 $12.38 $13.98 $13.05
Fourth Quarter $14.95 $13.68 $13.57 $12.08
As of January 31, 2007, the approximate number of security holders of record of
our common stock was 25,053. This information was obtained from our transfer
agent, Illinois Stock Transfer Company.
DIVIDENDS
The amount and timing of dividends payable on our common stock are within the
sole discretion of our Board of Directors. In 2004, we paid a special,
non-recurring dividend of $2.00 per share of common stock, and instituted a
regular annual dividend of $1.00 per share of common stock to be paid quarterly.
Cash dividends paid to shareholders were approximately $323.7 million, $338.4
million and $832.8 million in 2006, 2005 and 2004, respectively. There are no
material restrictions on our ability to pay dividends. The table below sets
forth dividends paid during the periods indicated.
2006 2005 2004
----------- ----------- -----------
First Quarter $ 0.25 $ 0.25 $ -
Second Quarter $ 0.25 $ 0.25 $ -
Third Quarter $ 0.25 $ 0.25 $ 2.25
Fourth Quarter $ 0.25 $ 0.25 $ 0.25
16
STOCKHOLDER RETURN PERFORMANCE GRAPH
The following performance graph compares the cumulative total return of our
common stock to the S&P 500 Stock Index and to the S&P Telecommunications
Services Index for the five-year period commencing December 31, 2001. The graph
assumes $100 was invested in our common stock as of December 31, 2001. It also
assumes reinvestment of dividends, if applicable.
Cumulative Total Return
-----------------------------------------------------------------------------------------------------
12/01 12/02 12/03 12/04 12/05 12/06
-----------------------------------------------------------------------------------------------------
Citizens Communications Company $100.00 $98.97 $116.51 $155.79 $149.07 $188.67
S & P 500 100.00 77.90 100.24 111.15 116.61 135.03
S & P Telecommunication Services 100.00 65.89 70.56 84.57 79.81 109.18
RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM
REGISTERED SECURITIES
None.
17
ISSUER PURCHASES OF EQUITY SECURITIES
------------------------------------------------------------------------------------------------------
(d) Maximum
Approximate
(c) Total Number Dollar Value of
of Shares Shares that
(a) Total Purchased as Part May Yet Be
Number of (b)Average of Publicly Purchased
Shares Price Paid per Announced Plans Under the Plans
Period Purchased Share or Programs or Programs
------------------------------------------------------------------------------------------------------
October 1, 2006 to October 31, 2006
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 722 $ 14.36 N/A N/A
November 1, 2006 to November 30, 2006
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 12,435 $ 14.66 N/A N/A
December 1, 2006 to December 31, 2006
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
Totals October 1, 2006 to December 31, 2006
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 13,157 $ 14.64 N/A N/A
(1) In February 2006, our Board of Directors authorized the Company to
repurchase up to $300.0 million of the Company's common stock, in public or
private transactions, over the following twelve month period. This share
repurchase program commenced on March 6, 2006. No shares were repurchased
during the fourth quarter of 2006.
(2) Includes restricted shares withheld (under the terms of grants under
employee stock compensation plans) to offset minimum tax withholding
obligations that occur upon the vesting of restricted shares. The Company's
stock compensation plans provide that the value of shares withheld shall be
the average of the high and low price of the Company's common stock on the
date the relevant transaction occurs.
18
Item 6. Selected Financial Data
-----------------------
($ in thousands, except per share amounts) Year Ended December 31,
------------------------------------------ --------------------------------------------------------------
2006 2005 2004 2003 2002
------------ ----------- ------------ ------------ -----------
Revenue (4) $2,025,367 $2,017,041 $2,022,378 $2,268,561 $2,482,440
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle(1) $ 254,008 $ 187,942 $ 57,064 $ 71,879 $ (313,257)
Net income (loss) $ 344,555 $ 202,375 $ 72,150 $ 187,852 $ (682,897)
Basic income (loss) per share of common stock
from continuing operations before cumulative
effect of change in accounting principle (1) $ 0.79 $ 0.56 $ 0.19 $ 0.26 $ (1.12)
Earnings (loss) available for common shareholders
per basic share $ 1.07 $ 0.60 $ 0.24 $ 0.67 $ (2.43)
Earnings (loss) available for common shareholders
per diluted share $ 1.06 $ 0.60 $ 0.23 $ 0.64 $ (2.43)
Cash dividends declared (and paid) per common
share $ 1.00 $ 1.00 $ 2.50 $ - $ -
As of December 31,
--------------------------------------------------------------
2006 2005 2004 2003 2002
------------ ----------- ------------ ------------ -----------
Total assets $6,791,205 $6,427,567 $6,679,899 $7,457,939 $8,153,078
Long-term debt $4,460,755 $3,995,130 $4,262,658 $4,179,590 $4,816,163
Equity units (2) $ - $ - $ - $ 460,000 $ 460,000
Company Obligated Mandatorily Redeemable
Convertible Preferred Securities (3) $ - $ - $ - $ 201,250 $ 201,250
Shareholders' equity $1,058,032 $1,041,809 $1,362,240 $1,415,183 $1,172,139
(1) The cumulative effect of change in accounting principles represents the
$65.8 million after tax non-cash gain resulting from the adoption of
Statement of Financial Accounting Standards No. 143 in 2003.
(2) On August 17, 2004, we issued common stock to equity unit holders in
settlement of the equity purchase contract.
(3) The consolidation of this item changed effective January 1, 2004 as a
result of the adoption of FIN No. 46R, "Consolidation of Variable Interest
Entities."
(4) Operating results include activities from our Vermont Electric segment for
three months of 2004 and the years ended 2003 and 2002.
19
Item 7. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
Forward-Looking Statements
--------------------------
This annual report on Form 10-K contains forward-looking statements that are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed or implied in the statements. Statements that
are not historical facts are forward-looking statements made pursuant to the
Safe Harbor Provisions of the Litigation Reform Act of 1995. Words such as
"believes," "anticipates," "expects" and similar expressions are intended to
identify forward-looking statements. Forward-looking statements (including oral
representations) are only predictions or statements of current plans, which we
review continuously. Forward-looking statements may differ from actual future
results due to, but not limited to, and our future results may be materially
affected by, any of the following possibilities:
* Our ability to complete the acquisition of Commonwealth, to
successfully integrate their operations and to realize the synergies
from the acquisition;
* Our ability to refinance the bridge loan that will be used to finance
any remaining cash portion of the merger consideration with long-term
debt;
* 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 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 general and local economic and employment conditions on
our revenues;
* Our ability to effectively manage 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;
* Our ability to sell enhanced and data services in order to offset
ongoing declines in revenue from local services, switched access
services and subsidies;
* Changes in accounting policies or practices adopted voluntarily or as
required by generally accepted accounting principles or regulators;
* The effects of changes in regulation in the communications industry as
a result of federal and state legislation and regulation, including
potential changes in access charges and subsidy payments, and
regulatory network upgrade and reliability requirements;
* Our ability to comply with federal and state regulation (including
state rate of return limitations on our earnings) and our ability to
successfully renegotiate state regulatory plans as they expire or come
up for renewal from time to time;
* Our ability to manage our operations, operating expenses and capital
expenditures, to pay dividends and to reduce or refinance our debt;
* Adverse changes in the ratings given to our debt securities by
nationally accredited ratings organizations, which could limit or
restrict the availability and/or increase the cost of financing;
* The effects of bankruptcies in the telecommunications industry, which
could result in potential bad debts;
20
* The effects of technological changes and competition 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;
* Changes in income tax rates, tax laws, regulations or rulings, and/or
federal or state tax assessments;
* The effects of state regulatory cash management policies on our
ability to transfer cash among our subsidiaries and to the parent
company;
* Our ability to successfully renegotiate expiring union contracts
covering approximately 1,526 employees that are scheduled to expire
during 2007;
* 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
(which will increase in 2007) and our liquidity;
* The effects of any future liabilities or compliance costs in
connection with 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,
business and industry conditions.
Any of the foregoing events, or other events, could cause financial information
to vary from management's forward-looking statements included in this report.
You should consider these important factors, as well as the risks set forth
under Item 1A. "Risk Factors" above, in evaluating any statement in this Form
10-K or otherwise made by us or on our behalf. The following information is
unaudited and should be read in conjunction with the consolidated financial
statements and related notes included in this report. We have no obligation to
update or revise these forward-looking statements.
Overview
--------
We are a full-service communications provider and one of the largest exchange
telephone carriers in the country. We offer our incumbent local exchange carrier
(ILEC) services under the "Frontier" name. On July 31, 2006 we sold our
competitive local exchange carrier (CLEC), Electric Lightwave, LLC (ELI). We are
accounting for ELI as a discontinued operation in our consolidated statements of
operations. In September 2006, we entered into a definitive agreement to acquire
Commonwealth. This acquisition, if successfully completed, will expand our
presence in Pennsylvania and strengthen our position as a market-leading
full-service communications provider to rural markets. The acquisition is
subject to approval by the Pennsylvania PUC. All other regulatory approvals have
been received.
Competition in the telecommunications industry is intense and increasing. We
experience competition from many telecommunications service providers including
cable operators, wireless carriers, voice over internet protocol (VOIP)
providers, long distance providers, competitive local exchange carriers,
internet providers and other wireline carriers. We believe that competition will
continue to intensify in 2007 across all of our products and in all of our
markets. Our Frontier business experienced erosion in access lines and switched
access minutes in 2006 as a result of competition. Competition in our markets
may result in reduced revenues in 2007.
The communications industry is undergoing significant changes. The market is
extremely competitive, resulting in lower prices. 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.
Revenues from data and internet services such as high-speed internet continue to
increase as a percentage of our total revenues and revenues from services such
as local line and access charges and subsidies are decreasing as a percentage of
our revenues. These factors, along with the potential for increasing operating
costs, could cause our profitability and our cash generated by operations to
decrease.
21
(a) Liquidity and Capital Resources
-------------------------------
Cash Flow from Operating Activities
-----------------------------------
As of December 31, 2006, we had cash and cash equivalents aggregating $1.04
billion. Our primary source of funds continued to be cash generated from
operations. Our cash balance increased significantly in December 2006 when we
borrowed $550.0 million. For the year ended December 31, 2006, we used cash flow
from continuing operations, proceeds from the Rural Telephone Bank (RTB),
proceeds from the sale of ELI and cash and cash equivalents to fund capital
expenditures, dividends, interest payments, debt repayments and stock
repurchases.
We believe our operating cash flows, existing cash balances, and credit
facilities 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 $39.3
million and $497.7 million of debt maturing in 2007 and 2008, respectively.
A number of factors, including but not limited to, losses of access lines,
increases in competition and lower subsidy and access revenues are expected to
reduce our cash generated by operations and may require us to increase capital
expenditures. Our below investment grade credit ratings 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 in 2007 our cash taxes
will increase substantially.
Cash Flow from Investing Activities
-----------------------------------
Commonwealth Acquisition
------------------------
On September 17, 2006, we entered into a definitive agreement to acquire
Commonwealth for $41.72 per share, in a cash-and-stock taxable transaction, for
a total consideration of $1.16 billion, based on the closing price of Citizens'
common stock on September 15, 2006. Each Commonwealth share will receive $31.31
in cash and 0.768 shares of Citizens' common stock.
The acquisition has been approved by the Boards of Directors of both Citizens
and Commonwealth and by Commonwealth's shareholders. The transaction has
received the requisite Hart-Scott Rodino and FCC approvals, but is still subject
to Pennsylvania PUC regulatory approval. We expect the transaction to be
consummated in the first half of 2007.
We intend to finance the cash portion of the transaction with a combination of
cash on hand and debt. We obtained a commitment letter for a $990.0 million
senior unsecured term loan, the proceeds of which may be used to pay the cash
portion of the acquisition consideration (including cash payable upon the
assumed conversion of $300.0 million of the Commonwealth convertible notes in
connection with the acquisition), to cash out restricted shares, options and
other equity awards of Commonwealth, to repay all of Commonwealth's outstanding
indebtedness (which was $35.0 million as of December 31, 2006) and to pay fees
and expenses related to the acquisition. We expect to refinance this term loan,
which matures within one year, with long-tem debt prior to the maturity thereof.
On December 22, 2006 this commitment was reduced by $400.0 million as the result
of our issuance of 7.875% senior notes due 2027 in the amount of $400.0 million
(see "Cash Flow from Financing Activities - Issuance of Debt Securities" below).
In December 2006, we also borrowed $150.0 million from CoBank under a 6-year
unsecured term loan. These proceeds can be used to repurchase existing
indebtedness or to essentially reduce the amount of additional borrowings needed
in connection with the Commonwealth transaction. We expect the need to borrow
$200.0 million - $300.0 million under the remaining commitment to close the
Commonwealth transaction, pay all closing transaction costs and implementation
costs.
Rural Telephone Bank Proceeds
-----------------------------
In August 2005, the Board of Directors of the RTB voted to dissolve the bank. In
November 2005, the liquidation and dissolution of the RTB was initiated with the
signing of the 2006 Agricultural Appropriation bill by President Bush. We
received approximately $64.6 million in cash from the dissolution of the RTB in
April 2006, which resulted in the recognition of a pre-tax gain of approximately
$61.4 million during the second quarter of 2006. Our cash liability for taxes as
a result of the cash distribution is expected to be approximately $2.0 million
due to the utilization of existing tax net operating losses on both the federal
and state level.
22
Sale of Non-Core Operations and Investments
-------------------------------------------
During 2006, we sold ELI, our CLEC business (including its associated real
estate), for $255.3 million in cash plus the assumption of approximately $4.0
million in capital lease obligations.
During 2005, we executed a strategy of divesting non-core assets, which resulted
in the following transactions:
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 Conference Call USA, LLC for $43.6
million.
In June 2005, we sold for cash our interests in certain key man life insurance
policies on the lives of Leonard Tow, our former Chairman and Chief Executive
Officer, and his wife, a former director. The cash surrender value of the
policies purchased by Dr. Tow totaled approximately $24.2 million, and we
recognized a gain of approximately $457,000 that is included in investment and
other income.
During 2005, we sold 79,828 shares of Global Crossing Limited for $1.1 million
in cash.
Capital Expenditures
--------------------
For the year ended December 31, 2006, our capital expenditures were $268.8
million. 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. We anticipate capital expenditures of approximately $270.0
million - $280.0 million for 2007.
Increasing competition and improving the capabilities or reducing the
maintenance costs of our plant may cause our capital expenditures to increase in
the future. Our capital expenditures planned for new services such as wireless
and VOIP in 2007 are not material. However, based on the success of our planned
roll-out of these products that began in late 2006, our capital expenditures for
these products may increase in the future.
Cash Flow from Financing Activities
-----------------------------------
Debt Reduction and Debt Exchanges
---------------------------------
For the year ended December 31, 2006, we retired an aggregate principal amount
of $251.0 million of debt, including $15.9 million of 5% Company Obligated
Mandatorily Redeemable Convertible Preferred Securities (EPPICS) that were
converted into our common stock.
During the first quarter of 2006, we entered into two debt-for-debt exchanges of
our debt securities. As a result, $47.5 million of our 7.625% notes due 2008
were exchanged for approximately $47.4 million of our 9.00% notes due 2031.
During the fourth quarter of 2006, we entered into four debt-for-debt exchanges
and exchanged $157.3 million of our 7.625% notes due 2008 for $149.9 million of
our 9.00% notes due 2031. The 9.00% notes are callable on the same general terms
and conditions as the 7.625% notes exchanged. No cash was exchanged in these
transactions. However, with respect to the first quarter debt exchanges, a
non-cash pre-tax loss of approximately $2.4 million was recognized in accordance
with EITF No. 96-19, "Debtor's Accounting for a Modification or Exchange of Debt
Instruments," which is included in other income (loss), net.
On June 1, 2006, we retired at par our entire $175.0 million principal amount of
7.60% Debentures due June 1, 2006.
On June 14, 2006, we repurchased $22.7 million of our 6.75% Senior Notes due
August 17, 2006 at a price of 100.181% of par.
On August 17, 2006, we retired at par the $29.1 million remaining balance of the
6.75% Senior Notes.
In February 2006, our Board of Directors authorized us to repurchase up to
$150.0 million of our outstanding debt over the following twelve-month period.
Through December 31, 2006, we had not made any purchases pursuant to this
authorization.
23
For the year ended December 31, 2005, we retired an aggregate principal amount
of $36.4 million of debt, including $30.0 million of EPPICS that were converted
into our common stock. During the second quarter of 2005, we entered into two
debt-for-debt exchanges of our debt securities. As a result, $50.0 million of
our 7.625% notes due 2008 were exchanged for approximately $52.2 million of our
9.00% notes due 2031. The 9.00% notes are callable on the same general terms and
conditions as the 7.625% notes exchanged. No cash was exchanged in these
transactions, however a non-cash pre-tax loss of approximately $3.2 million was
recognized in accordance with EITF No. 96-19, "Debtor's Accounting for a
Modification or Exchange of Debt Instruments," which is included in other income
(loss), net.
During August and September 2004, we repurchased an additional $108.2 million of
our 6.75% notes which, in addition to the $300.0 million we purchased in July,
resulted in a pre-tax charge of approximately $20.1 million during the third
quarter of 2004, but resulted in an annual reduction in interest expense of
about $27.6 million per year. See the discussion below concerning EPPICS
conversions for further information regarding the issuance of common stock.
We may from time to time repurchase our debt in the open market, through tender
offers, exchanges of debt securities, by exercising rights to call or privately
negotiated transactions. We may also exchange existing debt for newly issued
debt obligations.
Issuance of Debt Securities
---------------------------
On December 22, 2006, we issued in a private placement, $400.0 million principal
amount of 7.875% Senior Notes due January 15, 2027. Proceeds from the sale are
expected to be used to partially finance our acquisition of Commonwealth or if
the acquisition is not completed, to purchase, redeem or otherwise retire a
portion of our outstanding debt. We have agreed to file with the SEC a
registration statement for the purpose of exchanging these notes for registered
notes.
In December 2006, we borrowed $150.0 million under a senior unsecured term loan
agreement. The loan matures in 2012 and bears interest based on an average prime
rate or London Interbank Offered Rate or LIBOR, at our election plus a margin
which varies depending on our debt leverage ratio. We intend to use the proceeds
to repurchase a portion of our outstanding debt or to partially finance our
acquisition of Commonwealth.
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 share of our common
stock. 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 of common stock 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 relating 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 2006, 2005
and 2004. 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 December 31, 2006, EPPICS representing a total principal amount of $193.9
million have been converted into 15.6 million shares of our common stock, and a
total of $7.4 million remains outstanding to third parties. Our long-term debt
footnote indicates $17.9 million of EPPICS outstanding at December 31, 2006, of
which $10.5 million is debt of related parties for which we have an offsetting
receivable.
24
Interest Rate Management
------------------------
In order to manage our interest expense, we have entered into interest rate 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 or in arrears.
The notional amounts of fixed-rate indebtedness hedged as of December 31, 2006
and December 31, 2005 were $550.0 million and $500.0 million, respectively. Such
contracts require us to pay variable rates of interest (estimated average pay
rates of approximately 9.02% as of December 31, 2006 and approximately 8.60% as
of December 31, 2005) and receive fixed rates of interest (average receive rate
of 8.26% as of December 31, 2006 and 8.46% as of December 31, 2005). All swaps
are accounted for under SFAS No. 133 (as amended) as fair value hedges. For the
year ended December 31, 2006, the interest expense resulting from these interest
rate swaps totaled approximately $4.2 million. For the years ended December 31,
2005, and 2004 our interest expense was reduced by $2.5 million and $9.4
million, respectively, as a result of our swaps.
Credit Facilities
-----------------
As of December 31, 2006, we had an available line of credit with financial
institutions in the aggregate amount of $249.6 million. Outstanding standby
letters of credit issued under the facility were $0.4 million. Associated
facility fees vary, depending on our debt leverage ratio, and are 0.375% per
annum as of December 31, 2006. 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.
Covenants
---------
The terms and conditions contained in our indentures and credit facilities
agreements include the timely 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.
Our $250.0 million credit facility and our $150.0 million senior unsecured term
loan contain a maximum leverage ratio covenant. Under the leverage ratio
covenant, we are required to maintain a ratio of (i) total indebtedness minus
cash and cash equivalents in excess of $50.0 million to (ii) consolidated
adjusted EBITDA (as defined in the agreements) over the last four quarters no
greater than 4.50 to 1. Although both facilities are unsecured, they 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.
Certain indentures for our senior unsecured debt obligations limit our ability
to create liens or merge or consolidate with other companies and our
subsidiaries' ability to borrow funds, subject to important exceptions and
qualifications.
We are in compliance with all of our debt and credit facility covenants.
Proceeds from the Sale of Equity Securities
-------------------------------------------
We receive proceeds from the issuance of our common stock pursuant to our
stock-based compensation plans. For the periods ended December 31, 2006 and
2005, we received approximately $27.2 million and $47.6 million, respectively,
upon the exercise of outstanding stock options.
On August 17, 2004, we issued 32,074,000 shares of common stock, including
3,591,000 treasury shares, to our equity unit holders in settlement of the
equity purchase contract component of the equity units. With respect to the
$460.0 million senior note component of the equity units, we repurchased $300.0
million principal amount of these notes in July 2004. The remaining $160.0
million of the senior notes were repriced and a portion was remarketed on August
12, 2004 as our 6.75% notes due August 17, 2006.
25
Share Repurchase Programs
-------------------------
In February 2007, our Board of Directors authorized us to repurchase up to $250
million of our common stock in public or private transactions over the following
twelve month period.
In February 2006, our Board of Directors authorized us to repurchase up to
$300.0 million of our common stock in public or private transactions over the
following twelve-month period. This share repurchase program commenced on March
6, 2006. As of December 31, 2006, we had repurchased 10,199,900 shares of our
common stock at an aggregate cost of approximately $135.2 million. No more
shares can be repurchased under this authorization.
On May 25, 2005, our Board of Directors authorized us to repurchase up to $250.0
million of our common stock. This share repurchase program commenced on June 13,
2005. As of December 31, 2005, we completed the repurchase program and had
repurchased a total of 18,775,156 shares of our common stock at an aggregate
cost of $250.0 million.
Dividends
---------
Our ongoing annual dividends of $1.00 per share of common stock under our
current policy utilize a significant portion of our cash generated by operations
and therefore could limit our operating and financial flexibility. While we
believe that the amount of our dividends will allow for adequate amounts of cash
flow for other purposes, any reduction in cash generated by operations and any
increases in capital expenditures, interest expense or cash taxes would reduce
the amount of cash generated in excess of dividends.
Off-Balance Sheet Arrangements
------------------------------
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationship with unconsolidated entities that would be expected to
have a material current or future effect upon our financial statements.
Future Commitments
------------------
A summary of our future contractual obligations and commercial commitments as of
December 31, 2006 is as follows:
Contractual Obligations: Payment due by period
------------------------ ---------------------------------------------------------------
Less than More than
($ in thousands) Total 1 year 1-3 years 3-5 years 5 years
---------------- ------ ------ --------- --------- --------
Long-term debt obligations,
excluding interest (see Note 11) (1) $4,532,904 $39,271 $500,195 $1,258,403 $2,735,035
Operating lease
obligations (see Note 25) 69,393 15,794 19,510 15,904 18,185
Purchase obligations (see Note 25) 70,165 26,449 35,509 7,547 660
---------- ------- -------- ---------- ----------
Total $4,672,462 $81,514 $555,214 $1,281,854 $2,753,880
========== ======= ======== ========== ==========
(1) Includes interest rate swaps (($10.3) million).
At December 31, 2006, we have outstanding performance letters of credit totaling
$22.8 million.
Management Succession and Strategic Alternatives Expenses
---------------------------------------------------------
On July 11, 2004, our Board of Directors announced that it completed its review
of our financial and strategic alternatives. In 2004, we expensed $90.6 million
of costs related to management succession and our exploration of financial and
strategic alternatives. Included are $36.6 million of non-cash expenses for the
acceleration of stock benefits, cash expenses of $19.2 million for advisory
fees, $19.3 million for severance and retention arrangements and $15.5 million
primarily for tax reimbursements.
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.
26
Discontinued Operations
-----------------------
On July 31, 2006, we sold our CLEC business Electric Lightwave LLC (ELI) for
$255.3 million (including a later sale of associated real estate) in cash plus
the assumption of approximately $4.0 million in capital lease obligations. We
recognized a pre-tax gain on the sale of ELI of approximately $116.7 million.
Our after-tax gain on the sale was $71.6 million. Our cash liability for taxes
as a result of the sale is expected to be approximately $5.0 million due to the
utilization of existing tax net operating losses on both the federal and state
level.
On March 15, 2005, we completed the sale of Conference Call USA, LLC (CCUSA) for
$43.6 million in cash. 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.
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.
Telecommunications Bankruptcies
Our estimate of anticipated losses related to telecommunications bankruptcies is
a "critical accounting estimate." We have significant on-going normal course
business relationships with many telecom providers, some of which have filed for
bankruptcy. We generally reserve approximately 95% of the net outstanding
pre-bankruptcy balances owed to us and believe that our estimate of the net
realizable value of the amounts owed to us by bankrupt entities is appropriate.
In 2006 and 2005, we had no "critical estimates" related to telecommunications
bankruptcies.
Asset Impairment
In 2006 and 2005, we had no "critical estimates" related to asset impairments.
Depreciation and Amortization
The calculation of depreciation and amortization expense is based on the
estimated economic useful lives of the underlying property, plant and equipment
and identifiable intangible assets. An independent study of the estimated useful
lives of our plant assets was completed in 2005 and updated in 2006. We adopted
the lives proposed in the study effective October 1, 2005 and as revised on
October 1, 2006.
Intangibles
Our indefinite lived intangibles consist of goodwill and trade name, which
resulted from the purchase of ILEC properties. We test for impairment of these
assets annually, or more frequently, as circumstances warrant. All of our ILEC
properties share similar economic characteristics and as a result, we aggregate
our reporting units into one ILEC segment. In determining fair value of goodwill
during 2006 we compared the net book value of the reporting units to current
trading multiples of ILEC properties as well as trading values of our publicly
traded common stock. Additionally, we utilized a range of prices to gauge
sensitivity. Our test determined that fair value exceeded book value of
goodwill. An independent third party appraiser analyzed trade name.
27
Pension and Other Postretirement Benefits
Our estimates of pension expense, other post retirement benefits including
retiree medical benefits and related liabilities are "critical accounting
estimates." We sponsor a noncontributory defined benefit pension plan covering a
significant number of current and former employees and other post retirement
benefit plans that provide medical, dental, life insurance benefits and other
benefits for covered retired employees and their beneficiaries and covered
dependents. The pension plan for the majority of our current employees is
frozen. The accounting results for pension and post retirement benefit costs and
obligations are dependent upon various actuarial assumptions applied in the
determination of such amounts. These actuarial assumptions include the
following: discount rates, expected long-term rate of return on plan assets,
future compensation increases, employee turnover, healthcare cost trend rates,
expected retirement age, optional form of benefit and mortality. We review these
assumptions for changes annually with our independent actuaries. We consider our
discount rate and expected long-term rate of return on plan assets to be our
most critical assumptions.
The discount rate is used to value, on a present basis, our pension and post
retirement benefit obligation as of the balance sheet date. The same rate is
also used in the interest cost component of the pension and post retirement
benefit cost determination for the following year. The measurement date used in
the selection of our discount rate is the balance sheet date. Our discount rate
assumption is determined annually with assistance from our actuaries based on
the pattern of expected future benefit payments and the prevailing rates
available on long-term, high quality corporate bonds that approximate the
benefit obligation. In making this determination we consider, among other
things, the yields on the Citigroup Pension Discount Curve and Bloomberg Finance
and the changes in those rates from one period to the next. This rate can change
from year-to-year based on market conditions that impact corporate bond yields.
Our discount rate increased from 5.625% at year-end 2005 to 6.00% at year-end
2006.
The expected long-term rate of return on plan assets is applied in the
determination of periodic pension and post retirement benefit cost as a
reduction in the computation of the expense. In developing the expected
long-term rate of return assumption, we considered published surveys of expected
market returns, 10 and 20 year actual returns of various major indices, and our
own historical 5-year and 10-year investment returns. The expected long-term
rate of return on plan assets is based on an asset allocation assumption of 35%
to 55% in fixed income securities, 35% to 55% in equity securities and 5% to 15%
in alternative investments. We review our asset allocation at least annually and
make changes when considered appropriate. In 2006, we did not change our
expected long-term rate of return from the 8.25% used in 2005. Our pension plan
assets are valued at actual market value as of the measurement date.
Accounting standards in effect prior to December 31, 2006 required that we
record an additional minimum pension liability when the plan's "accumulated
benefit obligation" exceeded the fair market value of plan assets at the pension
plan measurement (balance sheet) date. In the fourth quarter of 2004, mainly due
to a decrease in the year-end discount rate, we recorded an additional minimum
pension liability in the amount of $17.4 million with a corresponding charge to
shareholders' equity of $10.7 million, net of taxes of $6.7 million. In the
fourth quarter of 2005, primarily due to another decrease in the year-end
discount rate, we recorded an additional minimum pension liability in the amount
of $36.4 million with a corresponding charge to shareholders' equity of $22.5
million, net of taxes of $13.9 million. These adjustments did not impact our net
income or cash flows.
We expect that our pension and other postretirement benefit expenses for 2007
will be $11.0 million to $14.0 million (they were $11.3 million in 2006) and
that no contribution will be required to be made by us to the pension plan in
2007. No contribution was made to our pension plan during 2006.
Income Taxes
Our effective tax rates in 2005 and 2004 were below statutory rate levels (2006
was close to statutory) as a result of the completion of audits with federal and
state taxing authorities and changes in the structure of certain of our
subsidiaries.
New Accounting Pronouncements
-----------------------------
Accounting for Defined Benefit Pension and Other Postretirement Plans
---------------------------------------------------------------------
In October 2006, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 158, "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans," which completes the first phase of a FASB project that
will comprehensively reconsider accounting for pensions and other postretirement
benefit plans and amends the following FASB Statements:
* SFAS No. 87, "Employers' Accounting for Pensions;"
28
* SFAS No. 88, "Employers' Accounting for Settlements and Curtailments
of Defined Benefit Pension Plans and for Termination Benefits;"
* SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions;" and
* SFAS No. 132(R), "Employers' Disclosures about Pensions and Other
Postretirement Benefits."
SFAS No. 158 requires (1) recognition of the funded status of a benefit plan in
the balance sheet, (2) recognition in other comprehensive income of gains or
losses and prior service costs or credits arising during the period but which
are not included as components of periodic benefit cost, (3) measurement of
defined benefit plan assets and obligations as of the balance sheet date, and
(4) disclosure of additional information about the effects on periodic benefit
cost for the following fiscal year arising from delayed recognition in the
current period. In addition, SFAS No. 158 amends SFAS No. 87 and SFAS No. 106 to
include guidance regarding selection of assumed discount rates for use in
measuring the benefit obligation.
For public companies, the requirements to recognize the funded status of a plan
and to comply with the disclosure provisions of SFAS No. 158 are effective as of
the end of the fiscal year that ends after December 15, 2006. The requirement to
measure plan assets and benefit obligations as of the balance sheet date is
effective for fiscal years ending after December 15, 2008. Adoption of SFAS No.
158 on December 31, 2006 did not have a material impact on the Company's
financial position at December 31, 2006. See Note 24.
Consideration of Prior Years' Errors in Quantifying Current Year Misstatements
------------------------------------------------------------------------------
In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108,
"Consideration of Prior Years' Errors in Quantifying Current Year
Misstatements." SAB No. 108 provides guidance concerning the process to be
applied in considering the impact of prior years' errors in quantifying
misstatements in the current year. SAB No. 108 is effective for periods ending
after November 15, 2006. We adopted SAB No. 108 in the fourth quarter of 2006.
See Note 5.
Accounting for Uncertainty in Income Taxes
------------------------------------------
In July 2006, the FASB issued FASB Interpretation No. (FIN) 48, "Accounting for
Uncertainty in Income Taxes." Among other things, FIN No. 48 requires applying a
"more likely than not" threshold to the recognition and derecognition of
uncertain tax positions. FIN No. 48 is effective for fiscal years beginning
after December 15, 2006. We do not expect the adoption of FIN No. 48 to have a
material impact on our financial position, results of operations or cash flows.
How Taxes Collected from Customers and Remitted to Governmental Authorities
---------------------------------------------------------------------------
Should be Presented in the Income Statement
-------------------------------------------
In June 2006, the FASB issued EITF Issue No. 06-3, "How Taxes Collected from
Customers and Remitted to Governmental Authorities Should be Presented in the
Income Statement" (EITF No. 06-3), which requires disclosure of the accounting
policy for any tax assessed by a governmental authority that is directly imposed
on a revenue-producing transaction, that is Gross versus Net presentation. EITF
No. 06-3 is effective for periods beginning after December 15, 2006. We will
adopt the disclosure requirements of EITF No. 06-3 commencing January 1, 2007.
Exchanges of Productive Assets
------------------------------
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets," an amendment of Accounting Principles Board (APB) Opinion No. 29. SFAS
No. 153 addresses the measurement of exchanges of certain non-monetary assets
(except for certain exchanges of products or property held for sale in the
ordinary course of business). The Statement requires that non-monetary exchanges
be accounted for at the fair value of the assets exchanged, with gains or losses
being recognized, if the fair value is determinable within reasonable limits and
the transaction has commercial substance. SFAS No. 153 is effective for
nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005.
We have not had any "exchanges of nonmonetary" assets.
Accounting for Conditional Asset Retirement Obligations
-------------------------------------------------------
In March 2005, the FASB issued FIN No. 47, "Accounting for Conditional Asset
Retirement Obligations," an interpretation of FASB No. 143. FIN No. 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 No. 47 also clarifies when an
entity would have sufficient information to reasonably estimate the fair value
of an asset retirement obligation. Although a liability exists for the removal
of asbestos, sufficient information is not available currently to estimate the
amount of our liability, as the range of time over which we may settle theses
obligations is unknown or cannot be reasonably estimated. The adoption of FIN
No. 47 during the fourth quarter of 2005 had no impact on our financial position
or results of operations.
29
Accounting Changes and Error Corrections
----------------------------------------
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections," a replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS
No. 154 changes the accounting for, and reporting of, a change in accounting
principle. SFAS No. 154 requires retrospective application to prior period's
financial statements of voluntary changes in accounting principle, and changes
required by new accounting standards when the standard does not include specific
transition provisions, unless it is impracticable to do so. The adoption of SFAS
No. 154 during the first quarter of 2006 had no impact on our financial position
or results of operations.
Partnerships
------------
In June 2005, the FASB issued EITF No. 04-5, "Determining Whether a General
Partner, or the General Partners as a Group, Controls a Limited Partnership or
Similar Entity When the Limited Partners Have Certain Rights," which provides
new guidance on how general partners in a limited partnership should determine
whether they control a limited partnership. EITF No. 04-5 is effective for
fiscal periods beginning after December 15, 2005. We are the managing partner
and have a 33% ownership position in a wireless voice business, Mohave Cellular
Limited Partnership (Mohave).
The Company has applied the provisions of EITF No. 04-5 retrospectively and
consolidated Mohave for all periods presented.
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 SEC
required adoption of SFAS No. 123R for annual periods beginning after June 15,
2005. Accordingly, we have adopted SFAS No. 123R commencing January 1, 2006
using a modified prospective application, as permitted by SFAS No. 123R.
Accordingly, prior period amounts have not been restated. Under this
application, we are required to record compensation expense for all awards
granted after the date of adoption and for the unvested portion of previously
granted awards that remain outstanding at the date of adoption.
Prior to the adoption of SFAS No. 123R, we applied APB No. 25 and related
interpretations to account for our stock plans resulting in the use of the
intrinsic value to value the stock. Under APB No. 25, we were not required to
recognize compensation expense for the cost of stock options. In accordance with
the adoption of SFAS No. 123R, we recorded stock-based compensation expense for
the cost of stock options, restricted shares and stock units issued under our
stock plans (together, Stock-Based Awards). Stock-based compensation expense for
the year ended December 31, 2006 was $10.3 million ($6.7 million after tax or
$0.02 per basic and diluted share of common stock).
Accounting for Endorsement Split-Dollar Life Insurance Arrangements
-------------------------------------------------------------------
In September 2006, the FASB reached consensus on the guidance provided by EITF
No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit
Aspects of Endorsement Split-Dollar Life Insurance Arrangements. The guidance is
applicable to endorsement split-dollar life insurance arrangements, whereby the
employer owns and controls the insurance policy, that are associated with a
postretirement benefit. EITF No. 06-4 requires that for a split-dollar life
insurance arrangement within the scope of the issue, an employer should
recognize a liability for future benefits in accordance with FAS No. 106 (if, in
substance, a postretirement benefit plan exists) or Accounting Principles Board
Opinion No. 12 (if the arrangement is, in substance, an individual deferred
compensation contract) based on the substantive agreement with the employee.
EITF No. 06-4 is effective for fiscal years beginning after December 15, 2007.
The Company is currently evaluating the impact the adoption of the standard will
have on the Company's results of operations or financial condition.
Accounting for Purchases of Life Insurance
------------------------------------------
In September 2006, the FASB reached consensus on the guidance provided by EITF
No. 06-5, Accounting for Purchases of Life Insurance-Determining the Amount
That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4,
Accounting for Purchases of Life Insurance. EITF No. 06-5 states that a
policyholder should consider any additional amounts included in the contractual
terms of the insurance policy other than the cash surrender value in determining
the amount that could be realized under the insurance contract. EITF No. 06-5
also states that a policyholder should determine the amount that could be
realized under the life insurance contract assuming the surrender of an
individual-life by individual-life policy (or certificate by certificate in a
30
group policy). EITF No. 06-5 is effective for fiscal years beginning after
December 15, 2006. The Company is currently evaluating the impact the adoption
of the standard will have on the Company's results of operations or financial
condition.
31
(b) Results of Operations
---------------------
REVENUE
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.
Consolidated revenue increased $8.3 million, from $2.017 billion in 2005 to
$2.025 billion in 2006.
Consolidated revenue decreased $5.3 million in 2005. The decrease in 2005 is
primarily due to the sale in 2004 of our electric utility property, partially
offset by an increase of $4.4 million in telecommunications revenue. Our
electric utility contributed $9.7 million of revenue in 2004.
In July 2006, we sold our CLEC segment (ELI) to Integra. As a result, we have
reclassified ELI's results of operations as discontinued operations in our
consolidated statements of operations and restated prior periods.
In June 2005, the FASB issued EITF No. 04-5, "Determining Whether a General
Partner, or the General Partners as a Group, Controls a Limited Partnership or
Similar Entity When the Limited Partners Have Certain Rights," which provides
new guidance on how general partners in a limited partnership should determine
whether they control a limited partnership. The Company has applied the
provisions of EITF No. 04-5 retrospectively and consolidated Mohave for all
periods presented.
On March 15, 2005, we completed the sale of our conferencing service business,
CCUSA. As a result of the sale, we have classified CCUSA's 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 important to our revenue and
profitability. We have lost access lines primarily because of 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 111,000 access lines during 2006, but
added approximately 75,100 high-speed internet subscribers during this same
period. We lost 98,800 residential customer lines and 12,200 non-residential
customer lines in 2006. 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 2007. A continued loss of access lines, combined with
increased competition and the other factors discussed in MD&A, may cause our
revenues, profitability and cash flows to decrease in 2007.
TELECOMMUNICATIONS REVENUE
($ in thousands) 2006 2005 2004
---------------- ----------------------------- ------------------------------ ----------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------ ----------- ------------------ ----------
Local services $ 809,584 $ (20,101) -2% $ 829,685 $ (21,392) -3% $ 851,077
Access services 427,959 (3,380) -1% 431,339 (25,589) -6% 456,928
Long distance services 153,272 (16,224) -10% 169,496 (14,127) -8% 183,623
Data and internet services 424,209 58,596 16% 365,613 51,835 17% 313,778
Directory services 114,138 1,046 1% 113,092 2,469 2% 110,623
Other 96,205 (11,611) -11% 107,816 11,202 12% 96,614
---------- --------- ----------- ---------- ----------
ILEC revenue $2,025,367 $ 8,326 0% $2,017,041 $ 4,398 0% $2,012,643
========== ========= =========== ========== ==========
Local Services
Local services revenue for the year ended December 31, 2006 decreased $20.1
million or 2%, as compared with the prior year. Local revenue decreased $25.9
million primarily due to continued losses of access lines partially offset by a
local rate increase on some of our Rochester residential access lines effective
August 2006. 2005 reflected a reserve of $4.0 million associated with a state
rate of return limitation on earnings. Enhanced services revenue increased $5.8
million, primarily due to sales of additional feature packages. Economic
conditions and/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 and profitability and cash
flow.
32
Local services revenue for the year ended December 31, 2005 decreased $21.4
million or 3%, as compared with the prior year. This decline is comprised of
$18.8 million related to the continued loss of access lines and $4.0 million
related to a reserve associated with state rate of return limitations on
earnings. Enhanced services revenue increased $5.9 million, as compared with the
prior year, primarily due to sales of additional product packages.
Access Services
Access services revenue for the year ended December 31, 2006 decreased $3.4
million or 1%, as compared with the prior year. Access services includes both
switched revenue and subsidy payments. Switched access revenue decreased $13.9
million to $263.4 million. Approximately $24.0 million of the switched access
decline was attributable to a decline in minutes of use related to access line
losses. This decline was offset by approximately $9.3 million of disputed
carrier activity resolved in the Company's favor during the fourth quarter of
2006. Subsidies revenue increased $10.5 million to $164.6 million primarily due
to increased receipts from the federal high cost fund due to higher costs in the
base year, as well as increased receipts from state high cost funds.
Access services revenue for the year ended December 31, 2005 decreased $25.6
million or 6%, as compared with the prior year. Switched access revenue
decreased $9.7 million, as compared with the prior year period, primarily due to
a decline in minutes of use. Access service revenue includes subsidy payments we
receive from federal and state agencies. Subsidy revenue decreased $15.9 million
primarily due to decreased Universal Service Fund (USF) support of $19.2 million
because of increases in the national average cost per loop (NACPL) and a
decrease of $2.0 million related to changes in measured factors, partially
offset by an increase of $6.4 million in USF surcharge rates.
Increases in the number of Competitive Eligible Telecommunications Companies
(including wireless companies) receiving federal subsidies, among other factors,
may lead to further increases in the NACPL, thereby resulting in 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.
Additionally, the FCC has an open proceeding to address reform to access charges
and other intercarrier compensation. We cannot predict when or how these matters
will be decided nor the effect on our subsidy or access 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 and cash flows. We currently
expect that as a result of an increase in the national average cost per loop, a
decrease in our cost structure and the elimination of high speed internet from
the calculation of the FCC's USF surcharge (which has a corresponding decrease
in operating expenses) there is likely to be a decrease in the total subsidy
revenue earned in 2007 and such decrease may be significant in relation to the
total amount of our subsidy revenue.
Long Distance Services
Long distance services revenue for the years ended December 31, 2006 and 2005
decreased $16.2 million or 10% in 2006 and $14.1 million or 8% in 2005,
primarily due to a decline in the average rate per minute. Our long distance
minutes of use increased during 2006. We have actively marketed bundles or
unlimited use of long distance minutes particularly with our packages of
multiple services. The sale of bundled and unlimited minutes has resulted in an
increase in minutes used by our long distance customers and has had the effect
of lowering our overall average rate per minute billed. Our long distance
revenues may continue to decrease in the future due to lower rates and/or
minutes of use. Competing services such as wireless, VOIP and cable telephony
are resulting in a loss of customers, minutes of use and further declines in the
rates we charge our customers. We expect these factors will continue to
adversely affect our long distance revenues during 2007.
Data and Internet Services
Data and internet services revenue for the years ended December 31, 2006 and
2005 increased $58.6 million, or 16%, and $51.8 million, or 17%, respectively,
as compared with the prior year primarily due to growth in data and high-speed
internet services. The number of the Company's high-speed internet subscribers
has increased by more than 75,000 or 24% since December 31, 2005. Data &
Internet services also includes revenue from data transmission services to other
carriers and high-volume commercial customers with dedicated high-capacity
circuits like DS-1's and DS-3's. Revenue from these dedicated high-capacity
circuits increased $9.1 million in 2006 and $15.0 million in 2005, primarily due
to growth in those circuits.
33
Directory Services
Directory revenue for the years ended December 31, 2006 and 2005 increased $1.0
million, or 1%, and $2.5 million, or 2%, respectively, as compared with the
prior year due to growth in yellow pages advertising.
Other
Other revenue for the year ended December 31, 2006 decreased $11.6 million or
11%, as compared with the prior year primarily due to an increase in bad debt
expense of $7.5 million and decreases of $2.3 million for promotional credits,
$1.8 million in sales of customer premise equipment (CPE) and $1.6 million in
"bill and collect" fee revenue. The decreases were partially offset by an
increase of $2.5 million for cellular roaming revenue of the Mohave Cellular
Limited Partnership.
Other revenue for the year ended December 31, 2005 increased $11.2 million, or
12%, compared with the prior year primarily due to a $4.8 million decrease in
bad debt expense, a $4.1 million increase in cellular revenue and a $1.8 million
increase related to sales of television service.
ELECTRIC REVENUE
We sold our Vermont electric division on April 1, 2004. Electric revenue for the
year ended December 31, 2004 was $9.7 million. We have sold all of our electric
operations and as a result will have no operating results in future periods for
these businesses.
COST OF SERVICES
($ in thousands) 2006 2005 2004
---------------- ----------------------------- ------------------------------ ----------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------ ----------- ------------------ ----------
Network access $ 171,247 $ 14,425 9% $ 156,822 $ 1,431 1% $ 155,391
Electric energy and fuel
oil purchased - - - (5,523) -100% 5,523
--------- --------- ----------- ---------- ----------
$ 171,247 $ 14,425 9% $ 156,822 $ (4,092) -3% $ 160,914
========= ========= =========== ========== ==========
Network access
Network access expenses for the years ended December 31, 2006 and 2005 increased
$14.4 million and $1.4 million, or 9%, and 1%, respectively, as compared with
the prior year period. In the fourth quarter of 2006, we expensed $9.7 million
of promotional costs associated with a fourth quarter high speed internet
promotion that subsidized the cost of a new personal computer for the customer
in return for a multi-year contract. The remaining increases in network costs
for 2006 and 2005 are primarily due to increasing rates and usage. As we
continue to increase our sales of data products such as high-speed internet and
expand the availability of our unlimited long distance calling plans, our
network access expense is likely to increase. Access line losses have offset
some of the increase.
Electric energy and fuel oil purchased
We sold our Vermont electric division on April 1, 2004. Electric energy and fuel
oil purchased for the year ended December 31, 2004 was $5.5 million. We have
sold all of our electric operations and as a result will have no operating
results in future periods for these businesses.
OTHER OPERATING EXPENSES
($ in thousands) 2006 2005 2004
---------------- ----------------------------- ------------------------------ ----------
Amount $ Change % Change Amount $ Change % Change Amount
--------- ------------------ ----------- ------------------ ----------
Operating expenses $551,620 $ (21,505) -4% $ 573,125 $ (11,586) -2% $ 584,711
Taxes other than income taxes 86,568 (5,219) -6% 91,787 181 0% 91,606
Sales and marketing 94,955 8,820 10% 86,135 1,302 2% 84,833
--------- --------- ----------- ---------- ----------
$733,143 $ (17,904) -2% $ 751,047 $ (10,103) -1% $ 761,150
========= ========= =========== ========== ==========
Operating Expenses
Operating expenses for the year ended December 31, 2006 decreased $21.5 million,
or 4%, as compared with the prior year primarily due to headcount reductions and
associated decreases in salaries and benefits and improved expense control in
benefit costs.
34
Operating expenses for the year ended December 31, 2005 decreased $11.6 million,
or 2%, as compared with the prior year primarily due to lower billing expenses
as a result of the conversion of one of our billing systems in 2004 partially
offset by rate increases for federal USF mandated contributions and annual fees
to regulatory agencies.
We routinely review our operations, personnel and facilities to achieve greater
efficiencies. We are in the process of consolidating our call center operations.
As we work through the consolidation, including the opening of a new call center
in Deland, FL in August 2006, and the closing of call centers in 2007, we expect
that our operating expenses will temporarily increase. As noted elsewhere, the
introduction of new service offerings may also negatively impact our cost
structure.
Included in operating expenses is stock compensation expense. Stock compensation
expense was $10.3 million and $8.4 million for the years ended December 31, 2006
and 2005, respectively. In 2006, we began expensing the cost of the unvested
portion of outstanding stock options pursuant to SFAS No. 123R.
Included in operating expenses is pension and other postretirement benefit
expenses. Based on current assumptions and plan asset values, we estimate that
our pension and other postretirement benefit expenses which was $11.3 million in
2006 will be approximately $11.0 million to $14.0 million in 2007 and that no
contribution will be required to be made by us to the pension plan in 2007. No
contribution was made to our pension plan during 2006. In future periods, if the
value of our pension assets decline and/or projected benefit costs increase, we
may have increased pension expenses.
Taxes Other than Income Taxes
Taxes other than income taxes for the year ended December 31, 2006 decreased
$5.2 million, or 6%, as compared with the prior year primarily due to refunds
received and changes in revenue subject to gross receipts taxes.
Sales and Marketing
Sales and marketing expenses for the year ended December 31, 2006 increased $8.8
million, or 10%, as compared with the prior year and increased $1.3 million, or
2% for the year ended 2005 as compared to 2004. Sales and marketing expenses are
increasing due to a competitive environment and the launch of new products. As
our markets become more competitive and we launch new products, we expect that
our marketing costs may increase.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) 2006 2005 2004
---------------- ------------------------------ ------------------------------ ----------
Amount $ Change % Change Amount $ Change % Change Amount
---------- -------------------------------- ------------------ ----------
Depreciation expense $ 350,107 $ (43,719) -11% $ 393,826 $ (29,035) -7% $ 422,861
Amortization expense 126,380 2 0% 126,378 (142) 0% 126,520
---------- ---------- ----------- ---------- ----------
$ 476,487 $ (43,717) -8% $ 520,204 $ (29,177) -5% $ 549,381
========== ========== =========== ========== ==========
Depreciation expense for the years ended December 31, 2006 and 2005 decreased
$43.7 million, or 11%, and $29.0 million, or 7%, respectively, as compared with
the prior years due to a declining net asset base and changes in the remaining
useful lives of certain assets. Effective with the completion of an independent
study of the estimated useful lives of our plant assets we adopted new lives
beginning October 1, 2005. The study concluded that remaining life estimates
should be increased for copper facilities and decreased for switching assets
(among other less minor changes). This study was updated as of September 30,
2006. Based on the study and our planned capital expenditures, we expect that
our depreciation expense will continue to decline in 2007 by approximately 5% as
compared to 2006.
MANAGEMENT SUCCESSION AND STRATEGIC ALTERNATIVES EXPENSES
On July 11, 2004, our Board of Directors announced that it completed its review
of our financial and strategic alternatives. In 2004, we expensed $90.6 million
of costs related to management succession and our exploration of financial and
strategic alternatives. Included are $36.6 million of non-cash expenses for the
acceleration of stock benefits, cash expenses of $19.2 million for advisory
fees, $19.3 million for severance and retention arrangements and $15.5 million
primarily for tax reimbursements.
35
INVESTMENT AND OTHER INCOME (LOSS), NET / INTEREST EXPENSE /
INCOME TAX EXPENSE (BENEFIT)
($ in thousands) 2006 2005 2004
---------------- ------------------------------ ------------------------------ ----------
Amount $ Change % Change Amount $ Change % Change Amount
---------- ------------------- ----------- ------------------ ----------
Investment income $ 83,570 $ 69,230 483% $ 14,340 $ (18,426) -56% $ 32,766
Other income (loss), net $ (1,127) $ 234 17% $ (1,361) $ 52,104 97% $(53,465)
Interest expense $336,446 $ (2,289) -1% $338,735 $ (39,556) -10% $378,291
Income tax expense $136,479 $ 61,209 81% $ 75,270 $ 71,023 1672% $ 4,247
Investment Income
Investment income for the year ended December 31, 2006 increased $69.2 million
as compared with the prior year primarily due to higher cash balances during the
year arising from the $65.0 million of cash received from the liquidation and
dissolution of the RTB (and gain recognized of $61.4 million), the $255.3
million in cash received from the sale of ELI and the postponement of our stock
repurchase and debt repurchase programs during the second half of 2006 in
connection with our acquisition of Commonwealth.
Investment income for the year ended December 31, 2005 decreased $18.4 million,
or 56%, as compared with the prior year primarily due to the sale in 2004 of our
investments in D & E Communications, Inc. (D & E) and Hungarian Telephone and
Cable Corp. (HTCC), partially offset by higher income in 2005 from short-term
investments.
Other Income (Loss), net
Other income (loss), net for the year ended December 31, 2006 increased $0.2
million as compared to the prior year. Other income (loss) in 2006 consists
primarily of the $4.2 million minority share of income in the Mohave Limited
Partnership, insurance proceeds of $4.2 million, a loss of $2.4 million on the
exchange of debt and gains recognized on the extinguishment of approximately
$3.5 million of retained liabilities of our disposed water properties.
Other income, net for the year ended December 31, 2005 increased $52.1 million,
or 97%, as compared to prior year. The increase is primarily due to a pre-tax
loss from the early extinguishment of debt of $66.5 million in 2004 and a net
loss on sales of assets of $1.9 million, which is primarily attributable to the
loss on the sale of our corporate aircraft, partially offset by $25.3 million in
income 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. In addition, during 2005 $7.0 million was reserved in
the fourth quarter in connection with a lawsuit, and during the second quarter
we incurred a $3.2 million loss on the exchange of debt, partially offset by
gains on our forward rate agreements.
Interest Expense
Interest expense for the year ended December 31, 2006 decreased $2.3 million, or
1%, as compared with the prior year primarily due to lower average debt levels
partially offset by higher short term interest rates that we pay on our swap
agreements ($550.0 million in principal amount is swapped to floating rate at
December 31, 2006). Our composite average borrowing rate for the year ended
December 31, 2006 as compared with the prior year was 18 basis points higher,
increasing from 7.94% to 8.12%. With the expected acquisition of Commonwealth
and the related incurrence of indebtness we expect our interest expense to
increase in 2007. In December we borrowed $400.0 million in advance of the
acquisition and another $150.0 million to be used for debt retirements. We
expect the need to borrow another $200.0 - $300.0 million to close the
Commonwealth transaction, pay all closing transaction costs and implementation
costs.
Interest expense for the year ended December 31, 2005 decreased $39.6 million,
or 10%, as compared with the prior year primarily due to the retirement and
refinancing of debt. Our composite average borrowing rate for the year ended
December 31, 2005 as compared with the prior year was 2 basis points lower,
decreasing from 7.96% to 7.94%.
Income Taxes
Income taxes for the year ended December 31, 2006 increased $61.2 million, or
81%, as compared with the prior year primarily due to changes in taxable income.
The effective tax rate for 2006 was 35% as compared with an effective tax rate
of 29% for 2005. We expect to utilize a substantial amount of tax net operating
losses as a result of the sale of ELI and receipt of the RTB proceeds. We expect
that in 2007 our cash paid for income taxes will increase significantly.
36
Income taxes for the year ended December 31, 2005 increased $71.0 million, as
compared with the prior year primarily due to changes in taxable income and the
effective tax rate. The effective tax rate for 2005 was 28.6% as compared with
6.9% for 2004. Our effective tax rate was below statutory rates in both years as
a result of the completion of audits with federal and state taxing authorities
and changes in the structure of certain of our subsidiaries.
DISCONTINUED OPERATIONS
($ in thousands) 2006 2005 2004
---------------- --------- --------- ----------
Amount Amount Amount
--------- --------- ----------
Revenue $ 100,612 $ 163,768 $180,588
Operating income $ 27,882 $ 22,969 $ 24,809
Income taxes $ 11,583 $ 9,519 $ 9,132
Net income $ 18,912 $ 13,266 $ 15,086
Gain on disposal of ELI and CCUSA,
net of tax $ 71,635 $ 1,167 $ -
On July 31, 2006, we sold our CLEC business, Electric Lightwave LLC (ELI) for
$255.3 million (including the sale of associated real estate) in cash plus the
assumption of approximately $4.0 million in capital lease obligations. We
recognized a pre-tax gain on the sale of ELI of approximately $116.7 million.
Our after-tax gain on the sale was $71.6 million. Our cash liability for taxes
as a result of the sale is expected to be approximately $5.0 million due to the
utilization of existing tax net operating losses on both the federal and state
level.
On March 15, 2005, we completed the sale of CCUSA for $43.6 million in cash. 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.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities, including those associated with
our pension assets. 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.
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. The long-term debt includes 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, all but $150.0 million 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. A hypothetical 10% adverse change in interest rates would
increase the amount that we pay on our variable obligations and could result in
fluctuations in the fair value of our fixed rate obligations. Based upon our
overall interest rate exposure at December 31, 2006, 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 expense, we have entered into interest rate swap
agreements. Under the terms of the agreements, which qualify for hedge
accounting, 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 for these interest rate swaps is set in arrears. For the years
ended December 31, 2006 and 2005, the net cash interest payment or (savings)
resulting from these interest rate swaps totaled approximately $4.2 million and
$(2.5) million, respectively.
37
Sensitivity analysis of interest rate exposure
At December 31, 2006, the fair value of our long-term debt was estimated to be
approximately $4.6 billion, based on our overall weighted average borrowing rate
of 8.19% and our overall weighted maturity of 13 years. There has been no
material change in the weighted average maturity since December 31, 2005.
The overall weighted average interest rate on our long-term debt increased in
2006 by approximately 11 basis points. A hypothetical increase of 82 basis
points in our weighted average interest rate (10% of our overall weighted
average borrowing rate) would result in an approximate $238.0 million decrease
in the fair value of our fixed rate obligations or an increase in our annual
interest expense of approximately $5.75 million.
Equity Price Exposure
Our exposure to market risks for changes in equity prices as of December 31,
2006 is limited to our pension assets of $770.2 million. We have no other equity
investments of any material amount.
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
The following documents are filed as part of this Report:
1. Financial Statements, See Index on page F-1.
2. Supplementary Data, Quarterly Financial Data is included in the
Financial Statements (see 1. above).
Item 9. Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
--------------------
None.
Item 9A. Controls and Procedures
-----------------------
(i) Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the
participation of our management, including our principal executive officer
and principal financial officer, regarding the effectiveness of the design
and operation of our disclosure controls and procedures. Based upon this
evaluation, our principal executive officer and principal financial officer
concluded, as of the end of the period covered by this report, December 31,
2006, that our disclosure controls and procedures are effective.
(ii) Internal Control Over Financial Reporting
(a) Management's annual report on internal control over financial reporting
Our management report on internal control over financial reporting appears
on page F-4.
(b) Attestation report of registered public accounting firm
The attestation report of KPMG LLP, our independent registered public
accounting firm, on management's assessment of the effectiveness of our
internal control over financial reporting appears on page F-3.
(c) Changes in internal control over financial reporting.
We reviewed our internal control over financial reporting at December 31,
2006. There has been no change in our internal control over financial
reporting during the last fiscal quarter of 2006 that materially affected
or is reasonably likely to materially affect our internal control over
financial reporting.
Item 9B. Other Information
-----------------
None.
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
--------------------------------------------------
38
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2007 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2006. See "Executive Officers of the Registrant" in Part I of this Report
following Item 4 for information relating to executive officers.
Item 11. Executive Compensation
----------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2007 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2006.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
------------------------------------------------------------------
Related Stockholder Matters
---------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2007 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2006.
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2007 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2006.
Item 14. Principal Accountant Fees and Services
--------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2007 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2006.
PART IV
-------
Item 15. Exhibits and Financial Statement Schedules
------------------------------------------
List of Documents Filed as a Part of This Report:
(1) Index to Consolidated Financial Statements:
Report of Independent Registered Public Accounting Firm
Consolidated balance sheets as of December 31, 2006 and 2005
Consolidated statements of operations for the years ended
December 31, 2006, 2005 and 2004
Consolidated statements of shareholders' equity for the years ended
December 31, 2006, 2005 and 2004
Consolidated statements of comprehensive income (loss) for the years ended
December 31, 2006, 2005 and 2004
Consolidated statements of cash flows for the years ended
December 31, 2006, 2005 and 2004
Notes to consolidated financial statements
All other schedules have been omitted because the required information is
included in the consolidated financial statements or the notes thereto, or is
not applicable or required.
39
(2) Index to Exhibits:
Exhibit
No. Description
------- -----------
3.1 Restated Certificate of Incorporation of Citizens Communications
Company, (filed as Exhibit 3.200.1 to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended June 30, 2000).*
3.2 By-laws of Citizens Communications Company, as amended (filed
as Exhibit 99.2 to the Company's Current Report on Form 8-K filed
on May 31, 2006).*
4.1 Rights Agreement, dated as of March 6, 2002, between Citizens
Communications Company and Mellon Investor Services, LLC, as
Rights Agent (filed as Exhibit 1 to the Company's Registration
Statement on Form 8-A filed on March 22, 2002).*
4.2 Certificate of Trust of Citizens Communications Trust dated as
of April 27, 2001 (filed as Exhibit 4.5 to Amendment No.1 to the
Company's Form S-3 filed on May 7, 2001 (Registration No.
333-58044)). *
4.3 Trust Agreement of Citizens Capital Trust I, dated as of April
27, 2001 (filed as Exhibit 4.6 to Amendment No.1 to the Company's
Form S-3 filed on May 7, 2001 (Registration No. 333-58044)). *
4.4 Form of Senior Note due 2011 (filed as Exhibit 4.4 to the
Company's Current Report on Form 8-K filed on May 24, 2001 (the
"May 24, 2001 8-K")). *
4.5 Form of Senior Note due 2008 and due 2031 (filed as Exhibit 4.1
to the Company's Current Report on Form 8-K filed on August 22,
2001). *
4.6 Form of Senior Note due 2013 (filed as Exhibit 4.2 to the
Company's Current Report on Form 8-K filed on November 12, 2004
(the "November 12, 2004 8-K")). *
4.7 5% Convertible Subordinated Debenture due 2036 (filed as
Exhibit A to Exhibit 4.200.2 to the Company's Form 8-K Current
Report filed on May 28, 1996 (the "May 28, 1996 8-K")). *
4.8 Amended and Restated Declaration of Trust dated as of January
15, 1996, of Citizens Utilities Trust (filed as Exhibit 4.200.4
to the May 28, 1996 8-K). *
4.9 Convertible Preferred Security Certificate (filed as Exhibit
A-1 to Exhibit 4.200.4 to the May 28, 1996 8-K). *
4.10 Amended and Restated Limited Partnership Agreement dated as
of January 15, 1996 of Citizens Utilities Capital L.P. (filed as
Exhibit 4.200.6 to the May 28, 1996 8-K). *
4.11 Partnership Preferred Security Certificate (filed as Annex A to
Exhibit 4.200.6 to the May 28, 1996 8-K).*
4.12 Convertible Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Communications Company (f/k/a
Citizens Utilities Company) and JPMorgan Chase Bank, N.A. (as
successor to Chemical Bank), as guarantee trustee (filed as
Exhibit 4.200.8 to the May 28, 1996 8-K). *
4.13 Partnership Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Communications Company (f/k/a
Citizens Utilities Company) and JPMorgan Chase Bank, N.A. (as
successor to Chemical Bank), as guarantee trustee (filed as
Exhibit 4.200.9 to the May 28, 1996 8-K). *
4.14 Letter of Representations dated January 18, 1996, from Citizens
Communications Company (f/k/a Citizens Utilities Company) and
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), as
trustee, to DTC, for deposit of Convertible Preferred Securities
with DTC (filed as Exhibit 4.200.10 to the May 28, 1996 8-K). *
4.15 Indenture of Securities, dated as of August 15, 1991, and
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), as
Trustee (filed as Exhibit 4.100.1 to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended September 30,
1991). *
4.16 Indenture, dated as of January 15, 1996, between Citizens
Communications Company (f/k/a Citizens Utilities Company) and
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), as
indenture trustee (filed as Exhibit 4.200.1 to the May 28, 1996
8-K). *
4.17 First Supplemental Indenture, dated as of January 15, 1996,
between Citizens Communications Company (f/k/a Citizens Utilities
Company) and JPMorgan Chase Bank, N.A. (as successor to Chemical
Bank), as indenture trustee (filed as Exhibit 4.200.2 to the May
28, 1996 8-K). *
4.18 Fourth Supplemental Indenture, dated October 1, 1994, to
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), as
Trustee (filed as Exhibit 4.100.7 to the Company Current Report
on Form 8-K filed on January 3, 1995). *
4.19 Fifth Supplemental Indenture, dated as of June 15, 1995, to
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), as
Trustee (filed as Exhibit 4.100.8 to the Company Current Report
on Form 8-K filed on March 29, 1996 (the "March 29, 1996 8-K")).*
* Incorporated by reference.
40
4.20 Sixth Supplemental Indenture, dated as of October 15, 1995, to
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), as
Trustee (filed as Exhibit 4.100.9 to the March 29, 1996 8-K). *
4.21 Seventh Supplemental Indenture, dated as of June 1, 1996 to
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank),(filed
as Exhibit 4.100.11 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1996 (the "1996 10-K")). *
4.22 Eighth Supplemental Indenture, dated as of December 1, 1996 to
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), (filed
as Exhibit 4.100.12 to the 1996 10-K). *
4.23 Senior Indenture, dated as of May 23, 2001, between Citizens
Communications Company and JPMorgan Chase Bank, N.A.(as successor
to The Chase Manhattan Bank), as trustee (filed as Exhibit 4.1
to the May 24, 2001 8-K). *
4.24 First Supplemental Indenture, dated as of May 23, 2001, to Senior
Indenture, (filed as Exhibit 4.2 of the May 24, 2001 8-K). *
4.25 Third Supplemental Indenture, dated as of November 12, 2004, to
Senior Indenture, dated as of May 23, 2001 (filed as Exhibit 4.1
to the November 12, 2004 8-K). *
4.26 Indenture, dated as of August 16, 2001, between Citizens
Communications Company and JPMorgan Chase Bank, N.A.(as successor
to The Chase Manhattan Bank), as Trustee (filed as Exhibit 4.1 of
the Company's Current Report on Form 8-K filed on August 22,
2001). *
4.27 Indenture, dated as of December 22, 2006, between Citizens
Communications Company and The Bank of New York, as Trustee
(filed as Exhibit 4.1 to the Company's Current Report on Form
8-K filed on December 29, 2006 (the "December 29, 2006 8-K")). *
4.28 Registration Rights Agreement, dated December 22, 2006, between
Citizens Communications Company and Citigroup Global Markets
Inc., Credit Suisse Securities (USA) LLC and J.P. Morgan
Securities Inc. (filed as Exhibit 4.2 to the December 29, 2006
8-K). *
10.1 Competitive Advance and Revolving Credit Facility Agreement
for $250,000,000 dated October 29, 2004(filed as Exhibit 10.19
to the Company's Quarterly Report on Form 10-Q for the fiscal
quarter ended September 30, 2004 (the "3rd Quarter 2004 10-Q")).*
10.2 Credit Agreement, dated as of December 6, 2006, among Citizens
Communications Company, as the Borrower, and CoBank, ACB, as
the Administrative Agent, the Lead Arranger and a Lender, and
the other Lenders referred to therein (filed as Exhibit 10.1 to
the Company's Current Report on Form 8-K filed on December 6,
2006). *
10.3 Amended and Restated Non-Employee Directors' Deferred Fee Equity
Plan dated as of May 18, 2004 (filed as Exhibit 10.1.2 to the
Company's Quarterly Report on Form 10-Q for the fiscal quarter
ended June 30, 2004 (the "2nd Quarter 2004 10-Q")). *
10.4 Amendment No. 1 to the Amended and Restated Non-Employee
Directors' Deferred Fee Equity Plan (filed as Exhibit 10.2 to the
Company's Current Report on Form 8-K filed on December 20,
2005). *
10.5 Non-Employee Directors' Equity Incentive Plan (filed as Appendix
B to the Company's Proxy Statement dated April 17, 2006). *
10.6 Separation Agreement between Citizens Communications Company
and Leonard Tow effective July 10, 2004 (filed as Exhibit 10.2.4
of the 2nd Quarter 2004 10-Q). *
10.7 Citizens Executive Deferred Savings Plan dated January 1, 1996
(filed as Exhibit 10.19 to the Company's Annual Report on Form
10-K for the year ended December 31, 1999 (the "1999 10-K")). *
10.8 Citizens Incentive Plan restated as of March 21, 2000 (filed as
Exhibit 10.19 to the 1999 10-K). *
10.9 1996 Equity Incentive Plan (filed as Appendix A to the Company's
Proxy Statement dated March 29, 1996). *
10.10 2000 Equity Incentive Plan, as amended (filed as Appendix A to
the Company's Proxy Statement dated April 20, 2005). *
10.11 Amendment to 1996 Equity Incentive Plan (filed as Exhibit B to
the Company's Proxy Statement dated March 28, 1997). *
10.12 Amendment to 1996 Equity Incentive Plan (effective March 4,
2005) (filed as Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the fiscal quarter ended March 31, 2005). *
10.13 Citizens 401(K) Savings Plan effective as of January 1, 1997,
as amended (filed as Exhibit 10.37 to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended June 30, 2001).*
10.14 Loan Agreement between Citizens Communications Company and
Rural Telephone Finance Cooperative for $200,000,000 dated
October 24, 2001 (filed as Exhibit 10.39 to the Company's
Quarterly Report on Form 10-Q for the fiscal quarter ended
September 30, 2001). *
10.15 Amendment No. 1, dated as of March 31, 2003, to Loan Agreement
between Citizens Communications Company and Rural Telephone
Finance Cooperative (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the fiscal quarter ended March
31, 2003). *
41
10.16 Employment Agreement between Citizens Communications Company
and Mary Agnes Wilderotter, effective November 1, 2004 (filed
as Exhibit 10.16 to the 3rd Quarter 2004 10-Q). *
10.17 Employment Agreement between Citizens Communications Company
and Robert Larson, effective September 1, 2004 (filed as Exhibit
10.18 to the 3rd Quarter 2004 10-Q). *
10.18 Employment Agreement between Citizens Communications Company
and John H. Casey, III, effective February 15, 2005 (filed as
Exhibit 10.20 to the Company's Annual Report on Form 10-K for
the year ended December 31, 2004 (the "2004 10-K")). *
10.19 Offer of Employment Letter between Citizens Communications
Company and Peter B. Hayes, effective February 1, 2005 (filed as
Exhibit 10.23 to the 2004 10-K). *
10.20 Offer of Employment Letter between Citizens Communications
Company and Donald R. Shassian, effective March 8, 2006 (filed
as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended March 31, 2006). *
10.21 Separation Agreement between Citizens Communications Company
and L. Russell Mitten dated July 13, 2005 (filed as Exhibit 10.24
to the Company's Quarterly Report on Form 10-Q for the fiscal
quarter ended September 30, 2005 (the "3rd Quarter 2005 10-Q")).*
10.22 Amendment to the Separation Agreement between Citizens
Communications Company and L. Russell Mitten dated August 31,
2005 (filed as Exhibit 10.24.1 to the 3rd Quarter 2005 10-Q). *
10.23 Summary of Compensation Arrangements for Named Executive Officers
Outside of Employment Agreements (filed as Exhibit 10.1 to the
Company's Current Report on Form 8-K filed February 26, 2007). *
10.24 Summary of Non-Employee Directors' Compensation Arrangements
Outside of Formal Plans, (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the fiscal quarter ended June
30, 2006). *
10.25 Membership Interest Purchase Agreement between Citizens
Communications Company and Integra Telecom Holdings, Inc. dated
February 6, 2006 (filed as Exhibit 10.1 to the Company's Current
Report on Form 8-K filed on February 9, 2006). *
10.26 Stock Redemption Agreement between Citizens Utilities Rural
Company, Inc. and The Rural Telephone Bank effective November 10,
2005 (including schedule of substantially identical agreements
with other Subsidiaries of the Registrant) (filed as Exhibit
10.24 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2005). *
10.27 Agreement and Plan of Merger dated as of September 17, 2006
among Commonwealth Telephone Enterprises, Inc., Citizens
Communications Company and CF Merger Corp. (filed as Exhibit 2.1
to the Company's Current Report on Form 8-K filed on September
18, 2006). *
12.1 Computation of ratio of earnings to fixed charges (this item is
included herein for the sole purpose of incorporation by
reference).
21.1 Subsidiaries of the Registrant
23.1 Auditors' Consent
31.1 Certification of Principal Executive Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934 (the "1934
Act").
31.2 Certification of Principal Financial Officer pursuant to Rule
13a-14(a) under the 1934 Act.
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 ("SOXA").
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of SOXA .
Exhibits 10.3, 10.4, 10.5, 10.6, 10.7, 10.8, 10.9, 10.10, 10.11, 10.12, 10.15,
10.16, 10.17, 10.18, 10.19, 10.20, 10.21, 10.22 and 10.23 are management
contracts or compensatory plans or arrangements.
42
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Mary Agnes Wilderotter
---------------------------
Mary Agnes Wilderotter
Chairman of the Board, President and Chief Executive Officer
February 28, 2007
43
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 28th day of February 2007.
Signature Title
--------- -----
/s/ Kathleen Q. Abernathy Director
--------------------------------------------
(Kathleen Q. Abernathy)
/s/ Leroy T. Barnes, Jr. Director
--------------------------------------------
(Leroy T. Barnes, Jr.)
/s/ Michael T. Dugan Director
--------------------------------------------
(Michael T. Dugan)
/s/ Jeri B. Finard Director
--------------------------------------------
(Jeri B. Finard)
/s/ Lawton Fitt Director
--------------------------------------------
(Lawton Fitt)
/s/ Stanley Harfenist Director
--------------------------------------------
(Stanley Harfenist)
/s/ William Kraus Director
--------------------------------------------
(William Kraus)
/s/ Robert J. Larson Senior Vice President and
-------------------------------------------- Chief Accounting Officer
(Robert J. Larson)
/s/ Howard L. Schrott Director
--------------------------------------------
(Howard L. Schrott)
/s/ Larraine D. Segil Director
--------------------------------------------
(Larraine D. Segil)
/s/ Donald R. Shassian Chief Financial Officer
--------------------------------------------
(Donald R. Shassian)
/s/ Bradley E. Singer Director
--------------------------------------------
(Bradley E. Singer)
/s/ Edwin Tornberg Director
--------------------------------------------
(Edwin Tornberg)
/s/ David H. Ward Director
--------------------------------------------
(David H. Ward)
/s/ Myron A. Wick III Director
--------------------------------------------
(Myron A. Wick III)
/s/ Mary Agnes Wilderotter Chairman of the Board,
-------------------------------------------- President and Chief Executive
(Mary Agnes Wilderotter) Officer
44
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index to Consolidated Financial Statements
Item Page
---- -----
Reports of Independent Registered Public Accounting Firm F-2 and F-3
Management's Report on Internal Control Over Financial Reporting F-4
Consolidated balance sheets as of December 31, 2006 and 2005 F-5
Consolidated statements of operations for the years ended
December 31, 2006, 2005 and 2004 F-6
Consolidated statements of shareholders' equity for the years ended
December 31, 2006, 2005 and 2004 F-7
Consolidated statements of comprehensive income (loss) for the years ended
December 31, 2006, 2005 and 2004 F-7
Consolidated statements of cash flows for the years ended
December 31, 2006, 2005 and 2004 F-8
Notes to consolidated financial statements F-9
F-1
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited the accompanying consolidated balance sheets of Citizens
Communications Company and subsidiaries as of December 31, 2006 and 2005, and
the related consolidated statements of operations, shareholders' equity,
comprehensive income and cash flows for each of the years in the three-year
period ended December 31, 2006. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Citizens
Communications Company and subsidiaries as of December 31, 2006 and 2005 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2006, in conformity with U.S. generally
accepted accounting principles.
As discussed in Notes 1 and 2 to the accompanying consolidated financial
statements, effective January 1, 2006, the Company adopted the fair value method
of accounting for stock-based compensation as required by Statement of Financial
Accounting Standards No. 123(R), "Share-Based Payment" and Staff Accounting
Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements." Also, as
discussed in Note 2 to the accompanying consolidated financial statements, the
Company adopted the recognition and disclosure provisions of Statement of
Financial Accounting Standards No. 158, "Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans" as of December 31, 2006.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Citizens
Communications Company and subsidiaries internal control over financial
reporting as of December 31, 2006, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO), and our report dated February 28, 2007
expressed an unqualified opinion on management's assessment of, and the
effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Stamford, Connecticut
February 28, 2007
F-2
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Citizens
Communications Company and subsidiaries maintained effective internal control
over financial reporting as of December 31, 2006, based on criteria established
in Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Citizens Communications
Company's management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Citizens Communications Company and
subsidiaries maintained effective internal control over financial reporting as
of December 31, 2006, is fairly stated, in all material respects, based on
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also,
in our opinion, Citizens Communications Company and subsidiaries maintained, in
all material respects, effective internal control over financial reporting as of
December 31, 2006, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Citizens Communications Company and subsidiaries as of December 31, 2006 and
2005, and the related consolidated statements of operations, shareholders'
equity and comprehensive income and cash flows for each of the years in the
three-year period ended December 31, 2006, and our report dated February 28,
2007 expressed an unqualified opinion on those consolidated financial
statements.
/s/ KPMG LLP
Stamford, Connecticut
February 28, 2007
F-3
Management's Report on Internal Control Over Financial Reporting
----------------------------------------------------------------
The Board of Directors and Shareholders
Citizens Communications Company:
The management of Citizens Communications Company and subsidiaries is
responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and
15d-15(f).
Under the supervision and with the participation of our management, we conducted
an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal Control--Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on our evaluation our management concluded that our internal control over
financial reporting was effective as of December 31, 2006 and for the period
then ended.
Our management's assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2006 has been audited by KPMG LLP, an
independent registered public accounting firm, as stated in their report which
is included herein.
Stamford, Connecticut
February 28, 2007
F-4
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
($ in thousands)
2006 2005
-------------- --------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 1,041,106 $ 263,749
Accounts receivable, less allowances of $108,537
and $31,385, respectively 187,737 203,070
Prepaid expenses 30,377 27,753
Other current assets 13,773 12,447
Assets of discontinued operations - 162,716
-------------- --------------
Total current assets 1,272,993 669,735
Property, plant and equipment, net 2,983,504 3,058,312
Goodwill, net 1,917,751 1,921,465
Other intangibles, net 432,353 558,733
Investments 16,474 15,999
Other assets 168,130 203,323
-------------- --------------
Total assets $ 6,791,205 $ 6,427,567
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Long-term debt due within one year $ 39,271 $ 227,693
Accounts payable 153,890 140,494
Advanced billings 39,417 29,245
Income taxes accrued 9,897 5,776
Other taxes accrued 21,434 20,501
Interest accrued 103,342 101,021
Other current liabilities 58,392 70,763
Liabilities of discontinued operations - 46,266
-------------- --------------
Total current liabilities 425,643 641,759
Deferred income taxes 514,130 325,084
Other liabilities 332,645 423,785
Long-term debt 4,460,755 3,995,130
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized
shares; 322,265,000 and 328,168,000 outstanding,
respectively, and 343,956,000 issued at December 31,
2006 and 2005) 85,989 85,989
Additional paid-in capital 1,207,399 1,374,610
Retained earnings/(deficit) 134,705 (85,344)
Accumulated other comprehensive loss, net of tax (81,899) (123,242)
Treasury stock (288,162) (210,204)
-------------- --------------
Total shareholders' equity 1,058,032 1,041,809
-------------- --------------
Total liabilities and shareholders' equity $ 6,791,205 $ 6,427,567
============== ==============
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
F-5
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
($ in thousands, except for per-share amounts)
2006 2005 2004
--------------- -------------- --------------
Revenue $ 2,025,367 $ 2,017,041 $ 2,022,378
Operating expenses:
Cost of services (exclusive of depreciation and amortization) 171,247 156,822 160,914
Other operating expenses 733,143 751,047 761,150
Depreciation and amortization 476,487 520,204 549,381
Management succession and strategic alternatives expenses - - 90,632
--------------- -------------- --------------
Total operating expenses 1,380,877 1,428,073 1,562,077
--------------- -------------- --------------
Operating income 644,490 588,968 460,301
Investment income 83,570 14,340 32,766
Other income (loss), net (1,127) (1,361) (53,465)
Interest expense 336,446 338,735 378,291
--------------- -------------- --------------
Income from continuing operations before income taxes 390,487 263,212 61,311
Income tax expense 136,479 75,270 4,247
--------------- -------------- --------------
Income from continuing operations 254,008 187,942 57,064
Discontinued operations (see Note 8):
Income from discontinued operations 147,136 36,844 24,218
Income tax expense 56,589 22,411 9,132
--------------- -------------- --------------
Income from discontinued operations 90,547 14,433 15,086
--------------- -------------- --------------
Net income available for common shareholders $ 344,555 $ 202,375 $ 72,150
=============== ============== ==============
Basic income per common share:
Income from continuing operations $ 0.79 $ 0.56 $ 0.19
Income from discontinued operations 0.28 0.04 0.05
--------------- -------------- --------------
Net income per common share $ 1.07 $ 0.60 $ 0.24
=============== ============== ==============
Diluted income per common share:
Income from continuing operations $ 0.78 $ 0.56 $ 0.18
Income from discontinued operations 0.28 0.04 0.05
--------------- -------------- --------------
Net income per common share $ 1.06 $ 0.60 $ 0.23
=============== ============== ==============
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
F-6
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
(dollars and shares in thousands, except for per-share amounts)
Accumulated
Common Stock Additional Other Treasury Stock Total
------------------ Paid-In Retained Comprehensive ----------------- Shareholders'
Shares Amount Capital Earnings (Defict) Income (Loss) Shares Amount Equity
--------- -------- ----------- ------------------ ------------- ------ ---------- -------------
--------- -------- ----------- ------------------ ------------- ------ ---------- -------------
Balance December 31, 2003 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
contracts - - - 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 2,096 524 24,039 - - 2,598 34,689 59,252
Conversion of EPPICS 2,225 556 24,308 - - 391 5,115 29,979
Dividends on common stock of
$1.00 per share - - (338,364) - - - - (338,364)
Shares repurchased - - - - - (18,775) (250,000) (250,000)
Net income - - - 202,375 - - - 202,375
Other comprehensive loss, net
of tax and reclassifications
adjustments - - - - (23,673) - - (23,673)
--------- -------- ------------ -------------- -------------- -------- ---------- -------------
Balance December 31, 2005 343,956 85,989 1,374,610 (85,344) (123,242) (15,788) (210,204) 1,041,809
Cumulative Effect Adjustment
(see Note 5) - - - 36,392 - - - 36,392
Stock plans - - (1,875) - - 2,908 38,793 36,918
Conversion of EPPICS - - (2,563) - - 1,389 18,488 15,925
Dividends on common stock of
$1.00 per share - - (162,773) (160,898) - - - (323,671)
Shares repurchased - - - - - (10,200) (135,239) (135,239)
Net income - - - 344,555 - - - 344,555
Pension Liability Adjustment,
after adoption of SFAS 158,
net of taxes - - - - (83,634) - - (83,634)
Other comprehensive income, net
of tax and reclassifications
adjustments - - - - 124,977 - - 124,977
--------- -------- ------------ -------------- -------------- -------- ---------- -------------
Balance December 31, 2006 343,956 $ 85,989 $1,207,399 $ 134,705 $ (81,899) (21,691) $(288,162) $ 1,058,032
========= ======== ============ ============== ============== ======== ========== =============
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
($ in thousands, except for per-share amounts)
2006 2005 2004
-------------- -------------- -------------
Net income $ 344,555 $ 202,375 $ 72,150
Other comprehensive income (loss), net of tax
and reclassifications adjustments* 124,977 (23,673) (27,893)
-------------- -------------- -------------
Total comprehensive income $ 469,532 $ 178,702 $ 44,257
============== ============== =============
* Consists of unrealized holding (losses)/gains of marketable securities,
realized gains taken to income as a result of the sale of securities and
minimum pension and other post-retirement liabilities (see Note 21).
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
F-7
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
($ in thousands)
2006 2005 2004
--------------- --------------- ----------------
Cash flows provided by (used in) operating activities:
Net income $ 344,555 $ 202,375 $ 72,150
Deduct: Gain on sale of discontinued operations - (net) (71,635) (1,167) -
Income from discontinued operations - (net) (18,912) (13,266) (15,086)
Adjustments to reconcile income to net cash provided by
operating activities:
Depreciation and amortization expense 476,487 520,204 549,381
Gain on expiration/settlement of customer advance (3,539) (681) (25,345)
Stock based compensation expense 10,340 8,427 47,581
Loss on debt exchange 2,420 3,175 -
Loss on extinguishment of debt - - 66,480
Investment gains (61,428) (492) (12,066)
Gain on sales of assets - - 1,945
Other non-cash adjustments 8,743 23,119 31,262
Deferred taxes 132,031 100,636 24,016
Change in accounts receivable 15,333 8,782 6,804
Change in accounts payable and other liabilities (3,064) (37,257) (62,234)
Change in other current assets (2,148) 5,313 (3,639)
--------------- --------------- ----------------
Net cash provided by operating activities 829,183 819,168 681,249
Cash flows provided from (used by) investing activities:
Proceeds from sales of assets, net of selling expenses - 24,195 30,959
Proceeds from sale of discontinued operations 255,305 43,565 -
Capital expenditures (268,806) (259,448) (263,949)
Securities sold - 1,112 26,514
Other asset (purchased) distributions received 67,050 (139) (28,234)
--------------- --------------- ----------------
Net cash provided from (used by) investing activities 53,549 (190,715) (234,710)
Cash flows provided from (used by) financing activities:
Repayment of customer advances for construction
and contributions in aid of construction (264) (1,662) (2,089)
Long-term debt borrowings 550,000 - 700,000
Debt issuance costs (6,948) - (15,502)
Long-term debt payments (227,693) (6,299) (1,202,403)
Premium to retire debt - - (66,480)
Issuance of common stock 27,200 47,550 544,562
Shares repurchased (135,239) (250,000) -
Dividends paid (323,671) (338,364) (832,768)
--------------- --------------- ----------------
Net cash used by financing activities (116,615) (548,775) (874,680)
Cash flows of discontinued operations:
Operating cash flows 17,833 27,500 32,294
Investing cash flows (6,593) (11,388) (14,820)
Financing cash flows - (134) (11,618)
--------------- --------------- ----------------
11,240 15,978 5,856
Increase (decrease) in cash and cash equivalents 777,357 95,656 (422,285)
Cash and cash equivalents at January 1, 263,749 168,093 590,378
--------------- --------------- ----------------
Cash and cash equivalents at December 31, $ 1,041,106 $ 263,749 $ 168,093
=============== =============== ================
Cash paid during the period for:
Interest $ 332,204 $ 318,638 $ 370,128
Income taxes (refunds) $ 5,365 $ 4,711 $ (4,901)
Non-cash investing and financing activities:
Change in fair value of interest rate swaps $ (1,562) $ (13,193) $ (6,135)
Conversion of EPPICS $ 15,925 $ 29,980 $ 147,991
Debt-for-debt exchange $ 2,433 $ 2,171 $ -
Investment write-downs $ - $ - $ 5,286
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
F-8
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Description of Business and Summary of Significant Accounting Policies:
-----------------------------------------------------------------------
(a) Description of Business:
------------------------
Citizens Communications Company and its subsidiaries are referred to
as "we," "us," the "Company," or "our" in this report. We are a
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.
(b) Principles of Consolidation and Use of Estimates:
-------------------------------------------------
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (GAAP). Certain reclassifications of balances previously
reported have been made to conform to the current presentation. All
significant intercompany balances and transactions have been
eliminated in consolidation.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions which affect the
amounts of assets, liabilities, revenue and expenses we have reported
and our disclosure of contingent assets and liabilities at the date of
the financial statements. Actual results may differ from those
estimates. We believe that our critical estimates are depreciation
rates, pension assumptions, calculations of impairment amounts,
reserves established for receivables, income taxes and contingencies.
(c) Cash Equivalents:
-----------------
We consider all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
(d) Revenue Recognition:
--------------------
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.
(e) 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 gross book value of routine property, plant and
equipment retired is charged against accumulated depreciation.
(f) 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
intangibles. We annually (during the fourth quarter) examine the
carrying value of our goodwill and trade name to determine whether
there are any impairment losses and have determined for the year ended
December 31, 2006 that there was no impairment.
Statement of Financial Accounting Standards (SFAS) No. 142 also
requires that intangible assets with estimated useful lives be
amortized over those lives and be reviewed for impairment in
accordance with SFAS No. 144, "Accounting for Impairment or Disposal
of Long-Lived Assets" to determine whether any changes to these lives
are required. We periodically reassess the useful life of our
intangible assets to determine whether any changes to those lives are
required.
F-9
(g) 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.
(h) Derivative Instruments and Hedging Activities:
----------------------------------------------
We account for derivative instruments and hedging activities in
accordance with SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended. SFAS No. 133, as amended,
requires that all derivative instruments, such as interest rate swaps,
be recognized in the financial statements and measured at fair value
regardless of the purpose or intent of holding them.
On the date we enter into a derivative contract that qualifies for
hedge accounting, we designate the derivative as either a fair value
or cash flow hedge. A hedge of the fair value of a recognized asset or
liability or of an unrecognized firm commitment is a fair value hedge.
A hedge of a forecasted transaction or the variability of cash flows
to be received or paid related to a recognized asset or liability is a
cash flow hedge. We formally document all relationships between
hedging instruments and hedged items, as well as our risk-management
objective and strategy for undertaking the hedge transaction. This
process includes linking all derivatives that are designated as fair
value or cash flow hedges to specific assets and liabilities on the
balance sheet or to specific firm commitments or forecasted
transactions.
We also formally assess, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. If it is determined that a derivative
is not highly effective as a hedge or that it has ceased to be a
highly effective hedge, we would discontinue hedge accounting
prospectively.
All derivatives are recognized on the balance sheet at their fair
value. Changes in the fair value of derivative financial instruments
are either recognized in income or shareholders' equity (as a
component of other comprehensive income), depending on whether the
derivative is being used to hedge changes in fair value or cash flows.
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. 133, as amended. As a result, the fair value
of the swaps is carried on the balance sheet in other liabilities and
the related hedged liabilities are also adjusted to fair value by the
same amount.
(i) Investments:
------------
Marketable Securities
We classify our cost method investments at purchase as
available-for-sale. We do not maintain a trading portfolio or
held-to-maturity securities. Our marketable securities are
insignificant (see Note 9).
Investments in Other Entities
Investments in entities that we do not control, but where we have the
ability to exercise significant influence over operating and financial
policies, are accounted for using the equity method of accounting (see
Note 9).
(j) Income Taxes and Deferred Income Taxes:
---------------------------------------
We file a consolidated federal income tax return. We utilize the asset
and liability method of accounting for income taxes. Under the asset
and liability method, deferred income taxes are recorded for the tax
effect of temporary differences between the financial statement basis
and the tax basis of assets and liabilities using tax rates expected
to be in effect when the temporary differences are expected to
reverse.
F-10
(k) Stock Plans:
------------
We have various employee stock-based compensation plans. Awards under
these plans are granted to eligible officers, management employees,
non-management employees and non-employee directors. 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. We have no awards with market or performance
conditions. Our general policy is to issue shares upon the grant of
restricted shares and exercise of options from treasury.
On January 1, 2006, we adopted the provisions of SFAS No. 123 (revised
2004), "Share-Based Payment" (SFAS No. 123R) and elected to use the
modified prospective transition method. The modified prospective
transition method requires that compensation cost be recognized in the
financial statements for all awards granted after the date of adoption
as well as for existing awards for which the requisite service had not
been rendered as of the date of adoption. Estimated compensation cost
for awards that are outstanding at the effective date will be
recognized over the remaining service period using the compensation
cost calculated for pro forma disclosure purposes. Prior periods have
not been restated.
On November 10, 2005, the Financial Accounting Standards Board (FASB)
issued FASB Staff Position SFAS No. 123R-3, "Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards."
We elected to adopt the alternative transition method provided for
calculating the tax effects of share-based compensation pursuant to
SFAS No. 123R. The alternative transition method includes a simplified
method to establish the beginning balance of the additional paid-in
capital pool (APIC pool) related to the tax effects of employee
share-based compensation, which is available to absorb tax
deficiencies recognized subsequent to the adoption of SFAS No. 123R.
In accordance with the adoption of SFAS No. 123R, we recorded
stock-based compensation expense for the cost of stock options,
restricted shares and stock units issued under our stock plans
(together, Stock-Based Awards). Stock-based compensation expense for
the year ended December 31, 2006 was $10.3 million ($6.7 million after
tax, or $0.02 per basic and diluted share of common stock). The
compensation cost recognized is based on awards ultimately expected to
vest. SFAS No. 123R requires forfeitures to be estimated and revised,
if necessary, in subsequent periods if actual forfeitures differ from
those estimates.
Prior to the adoption of SFAS No. 123R, we applied Accounting
Principles Board Opinion (APB) No. 25 and related interpretations to
account for our stock plans resulting in the use of the
intrinsic-value based method to value the stock. Under APB No. 25, we
were not required to recognize compensation expense for the cost of
stock options issued under the Management Equity Incentive Plan
(MEIP), 1996 Equity Incentive Plan (EIP) and the Amended and Restated
2000 EIP stock plans.
Prior to 2006, we provided pro forma net income and pro forma net
income per common share disclosures for employee and non-employee
director stock option grants based on the fair value of the options at
the date of grant (see Note 17). For purposes of presenting pro forma
information, the fair value of options granted is computed using the
Black Scholes option-pricing model.
F-11
Had we determined compensation cost based on the fair value at the
grant date for the Management Equity Incentive Plan (MEIP), Equity
Incentive Plan (EIP), Employee Stock Purchase Plan (ESPP) and
Non-Employee Directors' Deferred Fee Equity Plan, our pro forma net
income and net income per common share available for common
shareholders would have been as follows:
2006 2005 2004
---------------- ----------------- ----------------
($ in thousands) (No Change)
----------------
Net income available for common
shareholders As reported $202,375 $ 72,150
Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects 5,267 29,381
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (8,165) (38,312)
-------- --------
Pro forma $199,477 $ 63,219
======== ========
Net income per common share As reported:
available for common shareholders Basic $ 0.60 $ 0.24
Diluted 0.60 0.23
Pro forma:
Basic $ 0.59 $ 0.21
Diluted 0.59 0.20
In connection with the payment of the special, non-recurring dividend
of $2.00 per common share on September 2, 2004, the exercise price and
number of all outstanding options was 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 No.
44), "Accounting for Certain Transactions Involving Stock
Compensation" and EITF No. 00-23, "Issues Related to the Accounting
for Stock Compensation under APB No. 25 and FIN No. 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.
(l) 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 debt (net of tax) is
added back to income since it would not be paid if the debt was
converted to common stock.
(2) Recent Accounting Literature and Changes in Accounting Principles:
------------------------------------------------------------------
Accounting for Defined Benefit Pension and Other Postretirement Plans
---------------------------------------------------------------------
In October 2006, the FASB issued SFAS No. 158, "Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans" (OPEB),
which completes the first phase of a FASB project that will
comprehensively reconsider accounting for pensions and other
postretirement benefit plans and amends the following FASB Statements:
F-12
* SFAS No. 87, "Employers' Accounting for Pensions;"
* SFAS No. 88, "Employers' Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination
Benefits;"
* SFAS No. 106, "Employers' Accounting for Postretirement Benefits
Other Than Pensions;" and
* SFAS No. 132(R), "Employers' Disclosures about Pensions and Other
Postretirement Benefits."
SFAS No. 158 requires (1) recognition of the funded status of a
benefit plan in the balance sheet, (2) recognition in other
comprehensive income of gains or losses and prior service costs or
credits arising during the period but which are not included as
components of periodic benefit cost, (3) measurement of defined
benefit plan assets and obligations as of the balance sheet date, and
(4) disclosure of additional information about the effects on periodic
benefit cost for the following fiscal year arising from delayed
recognition in the current period.
For public companies, the requirements to recognize the funded status
of a plan and to comply with the disclosure provisions of SFAS No. 158
are effective as of the end of the fiscal year that ends after
December 15, 2006. The requirement to measure plan assets and benefit
obligations as of the balance sheet date is effective for fiscal years
ending after December 15, 2008. See Note 24.
Consideration of Prior Years' Errors in Quantifying Current Year
----------------------------------------------------------------------
Misstatements
-------------
In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No.
108, "Consideration of Prior Years' Errors in Quantifying Current Year
Misstatements." SAB No. 108 provides guidance concerning the process
to be applied in considering the impact of prior years' errors in
quantifying misstatements in the current year. SAB No. 108 is
effective for periods ending after November 15, 2006. The Company
adopted SAB No. 108 in the fourth quarter of 2006. See Note 5.
Accounting for Uncertainty in Income Taxes
------------------------------------------
In July 2006, the FASB issued FASB Interpretation No. (FIN) 48,
"Accounting for Uncertainty in Income Taxes." Among other things, FIN
No. 48 requires applying a "more likely than not" threshold to the
recognition and derecognition of uncertain tax positions. FIN No. 48
is effective for fiscal years beginning after December 15, 2006. We do
not expect the adoption of FIN No. 48 to have a material impact on our
financial position, results of operations or cash flows.
How Taxes Collected from Customers and Remitted to Governmental
----------------------------------------------------------------------
Authorities should be presented in the Income Statement
-------------------------------------------------------
In June 2006, the FASB issued EITF Issue No. 06-3, "How Taxes
Collected from Customers and Remitted to Governmental Authorities
Should be Presented in the Income Statement" (EITF No. 06-3), which
requires disclosure of the accounting policy for any tax assessed by a
governmental authority that is directly imposed on a revenue-producing
transaction, that is Gross versus Net presentation. EITF No. 06-3 is
effective for periods beginning after December 15, 2006. We will adopt
the disclosure requirements of EITF No. 06-3 commencing January 1,
2007.
Exchanges of Productive Assets
------------------------------
In December 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets," an amendment of APB Opinion No. 29. SFAS No. 153
addresses the measurement of exchanges of certain non-monetary assets
(except for certain exchanges of products or property held for sale in
the ordinary course of business). The Statement requires that
non-monetary exchanges be accounted for at the fair value of the
assets exchanged, with gains or losses being recognized, if the fair
value is determinable within reasonable limits and the transaction has
commercial substance. SFAS No. 153 is effective for nonmonetary
exchanges occurring in fiscal periods beginning after June 15, 2005.
We have not had any "exchanges of nonmonetary" assets.
F-13
Accounting for Conditional Asset Retirement Obligations
-------------------------------------------------------
In March 2005, the FASB issued FIN No. 47, "Accounting for Conditional
Asset Retirement Obligations," an interpretation of FASB No. 143. FIN
No. 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 No. 47 also clarifies when an entity would
have sufficient information to reasonably estimate the fair value of
an asset retirement obligation. Although a liability exists for the
removal of asbestos, sufficient information is not available currently
to estimate our liability, as the range of time over which we may
settle these obligations is unknown or cannot be reasonably estimated.
The adoption of FIN No. 47 during the fourth quarter of 2005 had no
impact on our financial position or results of operations.
Accounting Changes and Error Corrections
----------------------------------------
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections," a replacement of APB Opinion No. 20 and FASB
Statement No. 3. SFAS No. 154 changes the accounting for, and
reporting of, a change in accounting principle. SFAS No. 154 requires
retrospective application to prior period's financial statements of
voluntary changes in accounting principle, and changes required by new
accounting standards when the standard does not include specific
transition provisions, unless it is impracticable to do so. The
adoption of SFAS No. 154 during the first quarter of 2006 had no
impact on our financial position or results of operations.
Partnerships
------------
In June 2005, the FASB issued EITF No. 04-5, "Determining Whether a
General Partner, or the General Partners as a Group, Controls a
Limited Partnership or Similar Entity When the Limited Partners Have
Certain Rights," which provides new guidance on how general partners
in a limited partnership should determine whether they control a
limited partnership. EITF No. 04-5 is effective for fiscal periods
beginning after December 15, 2005. We are the managing partner and
have a 33% ownership position in a wireless voice business, Mohave
Cellular Limited Partnership (Mohave).
The Company has applied the provisions of EITF No. 04-5
retrospectively and consolidated Mohave for all periods presented.
Selected data for the Mohave partnership is as follows:
($ in thousands) Year Ended December 31,
-------------- -----------------------
2006 2005 2004
------ ------ ------
Revenues $18,458 $16,151 $12,084
Depreciation Expense $ 2,022 $ 2,053 $ 1,864
Operating Income $ 6,035 $ 3,599 $ 817
Accounting for Endorsement Split-Dollar Life Insurance Arrangements
-------------------------------------------------------------------
In September 2006, the FASB reached consensus on the guidance provided
by EITF No. 06-4, Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life
Insurance Arrangements. The guidance is applicable to endorsement
split-dollar life insurance arrangements, whereby the employer owns
and controls the insurance policy, that are associated with a
postretirement benefit. EITF No. 06-4 requires that for a split-dollar
life insurance arrangement within the scope of the issue, an employer
should recognize a liability for future benefits in accordance with
FAS No. 106 (if, in substance, a postretirement benefit plan exists)
or Accounting Principles Board Opinion No. 12 (if the arrangement is,
in substance, an individual deferred compensation contract) based on
the substantive agreement with the employee. EITF No. 06-4 is
effective for fiscal years beginning after December 15, 2007. The
Company is currently evaluating the impact the adoption of the
standard will have on the Company's results of operations or financial
condition.
F-14
Accounting for Purchases of Life Insurance
------------------------------------------
In September 2006, the FASB reached consensus on the guidance provided
by EITF No. 06-5, Accounting for Purchases of Life
Insurance--Determining the Amount That Could Be Realized in Accordance
with FASB Technical Bulletin No. 85-4, Accounting for Purchases of
Life Insurance. EITF No. 06-5 states that a policyholder should
consider any additional amounts included in the contractual terms of
the insurance policy other than the cash surrender value in
determining the amount that could be realized under the insurance
contract. EITF No. 06-5 also states that a policyholder should
determine the amount that could be realized under the life insurance
contract assuming the surrender of an individual-life by
individual-life policy (or certificate by certificate in a group
policy). EITF No. 06-5 is effective for fiscal years beginning after
December 15, 2006. The Company is currently evaluating the impact the
adoption of the standard will have on the Company's results of
operations or financial condition.
(3) Proposed Acquisition of Commonwealth Telephone:
-----------------------------------------------
On September 17, 2006, we entered into a definitive agreement to acquire
Commonwealth Telephone for $41.72 per share, in a cash-and-stock taxable
transaction, for a total purchase price of $1.2 billion. Each Commonwealth
share will receive $31.31 in cash and 0.768 shares of Citizens' common
stock. We expect to issue approximately 21 million shares in the merger.
The acquisition has been approved by the Boards of Directors of both
Citizens and Commonwealth and by Commonwealth's shareholders. The
acquisition has received the requisite Hart-Scott Rodino and FCC approvals,
but is still subject to Pennsylvania PUC approval. We expect the
transaction to be consummated in the first half of 2007.
We intend to finance the cash portion of the transaction with a combination
of cash on hand and debt. We obtained a commitment letter for a $990.0
million senior unsecured term loan, the proceeds of which may be used to
pay the cash portion of the acquisition consideration (including cash
payable upon the assumed conversion of $300.0 million of the Commonwealth
convertible notes in connection with the acquisition), to cash out
restricted shares, options and other equity awards of Commonwealth, to
repay all of Commonwealth's outstanding indebtedness (which was $35.0
million as of December 31, 2006) and to pay fees and expenses related to
the acquisition. We expect to refinance this term loan, which matures
within one year, with long-term debt prior to the maturity thereof. On
December 22, 2006, this commitment was reduced by $400.0 million as the
result of our issuance of 7.875% senior notes due 2027 in the amount of
$400.0 million. In December 2006, we borrowed $150.0 million from CoBank
under a 6 year unsecured term loan. These proceeds can be used to
repurchase existing indebtedness or to essentially reduce the amount of
additional borrowings needed in connection with the Commonwealth
transaction. We expect the need to borrow $200.0 million - $300.0 million
under the remaining commitment to close the Commonwealth transaction, pay
all closing transaction costs and implementation costs.
F-15
(4) Property, Plant and Equipment:
------------------------------
The components of property, plant and equipment at December 31, 2006 and
2005 are as follows:
Estimated
($ in thousands) Useful Lives 2006 2005
---------------- ------------------- ----------------- ------------------
Land N/A $ 17,944 $ 17,921
Buildings and leasehold improvements 41 years 324,230 320,789
General support 5 to 17 years 425,952 411,191
Central office/electronic circuit equipment 5 to 11 years 2,602,168 2,509,769
Cable and wire 15 to 60 years 3,171,421 3,052,560
Other 20 to 30 years 11,800 22,307
Construction work in progress 131,951 98,582
----------------- ------------------
6,685,466 6,433,119
Less: accumulated depreciation (3,701,962) (3,374,807)
----------------- ------------------
Property, plant and equipment, net $ 2,983,504 $ 3,058,312
================= ==================
Depreciation expense is principally based on the composite group method.
Depreciation expense was $350,107,000, $393,826,000 and $422,861,000 for
the years ended December 31, 2006, 2005 and 2004, respectively. Effective
with the completion of an independent study of the estimated useful lives
of our plant assets we adopted new lives beginning October 1, 2006.
(5) Retained Earnings - Cumulative Effect Adjustment:
-------------------------------------------------
In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB)
Topic 1N (SAB No. 108), "Financial Statements - Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements". SAB No. 108 provides guidance on how prior year
misstatements should be taken into consideration when quantifying
misstatements in current year financial statements for purposes of
determining whether the financial statements are materially misstated.
Under this guidance, companies should take into account both the effect of
a misstatement on the current year balance sheet as well as the impact upon
the current year income statement in assessing the materiality of a current
year misstatement. Once a current year misstatement has been quantified,
the guidance in SAB Topic 1M, "Financial Statements Materiality," (SAB No.
99) will be applied to determine whether the misstatement is material.
SAB No. 108 allows for a one-time transitional cumulative effect adjustment
to beginning retained earnings as of January 1, 2006 for errors that were
not previously deemed material as they were being evaluated under a single
method but are material when evaluated under the dual approach proscribed
by SAB No. 108. The Company adopted SAB No. 108 in connection with the
preparation of its financial statements for the year ended December 31,
2006. The adoption did not have any impact on the Company's cash flow or
prior year financial statements. As a result of adopting SAB No. 108 in the
fourth quarter of 2006 and electing to use the one-time transitional
cumulative effect adjustment, the Company made adjustments to the beginning
balance of retained earnings as of January 1, 2006 in the fourth quarter of
2006 for the following errors (all of which were determined to be
immaterial under the Company's previous methodology):
F-16
Summary SAB No. 108 entry recorded January 1, 2006:
($ in thousands) Increase/(Decrease)
---------------- -------------------
Property, Plant & Equipment $ 1,990
Goodwill (3,716)
Other Assets (20,081)
-----------
$ (21,807)
===========
Current Liabilities $ (2,922)
Deferred Taxes (17,339)
Other Long-Term Liabilities (13,037)
Long-term Debt (24,901)
Retained Earnings 36,392
-----------
$ (21,807)
===========
Deferred Tax Accounting. As a result of adopting SAB No. 108 in the fourth
quarter of 2006 we recorded a decrease in deferred income tax liabilities
in the amount of approximately $23.5 million and an increase in retained
earnings of approximately $23.5 million as of January 1, 2006. The change
in deferred tax and retained earnings is a result of excess deferred tax
liabilities that built up in periods prior to 2003 (approximately $4
million in 2003, $5.4 million in 2002 and $14.1 million in 2001 and prior)
resulting primarily from differences between actual state income tax rates
and the effective composite state rate utilized for estimating the
Company's book state tax provisions.
Goodwill. During 2002 we estimated and booked impairment charges (pre-tax)
of $1.07 billion. We subsequently discovered that the impairment charge
recorded was overstated as it exceeded the underlying book value by
approximately $8.1 million. The result was an understatement of goodwill.
We corrected this error by reversing the negative goodwill balance of $8.1
million with an offset to increase retained earnings.
Unrecorded Liabilities. Citizens has changed its accounting policies
associated with the accrual of utilities and vacation expense.
Historically, the Company's practice was to expense utility and vacation
costs in the period these items were paid, which generally resulted in a
full year of utilities and vacation expense in the consolidated statements
of income. The utility costs will now be accrued in the period used and
vacation costs will be accrued in the period earned. The cumulative amount
of these changes as of the beginning of fiscal 2006 was approximately $3.0
million and, as provided in SAB No. 108, the impact was recorded as a
reduction of retained earnings as of the beginning of fiscal 2006.
We established an accrual of $4.5 million for advance billings associated
with certain revenue at two telephone properties that the Company has
operated since the 1930's. For these two properties, the Company's records
have not reflected the liability. This had no impact on the revenue
reported for any of the five years reported in this 10-K.
We recorded a liability of $2.5 million to recognize a post retirement
annuity payment obligation for two former executives of the Company. The
liability should have been established in 1999 at the time the two
employees elected to exchange their death benefit rights for an annuity
payout in accordance with the terms of their respective split dollar life
insurance agreements. We established the liability effective January 1,
2006 in accordance with SAB No. 108 by reducing retained earnings by a like
amount.
Long-Term Debt. We recorded a reclassification of $20.1 million from other
assets to long-term debt. The balance represents debt discounts which the
company historically accounted for as a deferred asset. For certain debt
issuances the Company amortized the debt discount using the straight line
method instead of the effective interest method. We corrected this error by
increasing the debt discount by $4.8 million and increasing retained
earnings by a like amount.
F-17
Customer Advances for Construction. Amounts associated with "construction
advances" remaining on the Company's balance sheet ($92.4 million at
December 31, 2005) included approximately $7.3 million of such contract
advances that were transferred to the purchaser of our water and wastewater
operations on January 15, 2002 and accordingly should have been included in
the gain recognized upon sale during that period. Upon the adoption of SAB
No. 108 in the fourth quarter of 2006, this error was corrected as of
January 1, 2006 through a decrease in other long-term liabilities and an
increase in retained earnings.
Purchase Accounting. During the period 1991 to 2001 Citizens acquired a
number of telecommunications businesses, growing its asset base from
approximately $400 million in 1991 to approximately $6 billion by the end
of 2001. As a result of these acquisitions, we recorded in accordance with
purchase accounting standards, all of the assets and liabilities associated
with these properties. We have determined that approximately $18.8 million
(net) of liabilities were established in error. Approximately $18.0 million
of the liabilities should have been recorded as a decrease to goodwill,
$4.2 million should have been an increase to property, plant and equipment
($1.99 million after amortization of $2.21 million). In addition, $4.964
million of liabilities should have been reversed in 2001. We corrected this
error by reversing the liability to retained earnings.
As permitted by the adoption of SAB No. 108 we have adjusted our previously
recorded acquisition entries as follows:
($ in thousands, increase/(decrease))
-------------------------------------
Property, Plant & Equipment $ 1,990
Goodwill (18,049)
----------
Assets $ (16,059)
==========
Current Liabilities $ (10,468)
Other Long-Term Liabilities (8,345)
Retained Earnings 2,754
----------
$ (16,059)
==========
Tax Effect. The net effect on taxes (excluding the $23.5 million entry
described above) resulting from the adoption of SAB No. 108 was an increase
to deferred tax liabilities of $6.2 million and an increase to goodwill of
$6.2 million.
(6) Accounts Receivable:
--------------------
The components of accounts receivable at December 31, 2006 and 2005 are as
follows:
($ in thousands) 2006 2005
---------------- -------------- ---------------
End user $ 278,891 $ 210,224
Other 17,383 24,231
Less: Allowance for doubtful accounts (108,537) (31,385)
-------------- ---------------
Accounts receivable, net $ 187,737 $ 203,070
============== ===============
Additions
-------------------------------
Balance at Charged to Charged to other Balance at
beginning of bad debt accounts- end of
Accounts period expense * revenue Deductions period
------------------------------ -----------------------------------------------------------------------
Allowance for doubtful accounts
2004 $ 35,916 $ 17,657 $ 2,215 $ 20,708 $ 35,080
2005 35,080 12,797 1,080 17,572 31,385
2006 31,385 20,257 80,003 23,108 108,537
-------------------------------------------------------------------------------------------------------
* Such amounts are included in bad debt expense and for financial reporting
purposes are classified as contra-revenue.
F-18
We maintain an allowance for estimated bad debts based on our estimate of
collectibility of our accounts receivable. Bad debt expense is recorded as
a reduction to revenue. Our reserve has increased by approximately
$78,250,000 as a result of carrier activity that is in dispute.
Our principal carrier dispute concerns the "origination" of certain calls
carried by AT&T Corp. and AT&T Communications, Inc. (collectively, "AT&T")
and terminated on our networks. In January 2006, we filed a complaint
against AT&T in the United States District Court for the District of New
Jersey with respect to this dispute (which case was consolidated with that
of other plaintiffs in February 2006). During the pendency of the dispute
we became better able to estimate the true "origination" of the calls and
minutes in dispute and back billed AT&T for the difference in rates,
including interest. We have reserved substantially all of these amounts.
The FCC has denied AT&T's petition regarding its treatment on the
"origination" of the specific class of calls but left any resolution of
retroactive payments to the parties. In November 2006, AT&T filed
counterclaims against us. We have been engaged in settlement negotiations
with AT&T. If a settlement is not reached, we will continue to vigorously
pursue our case and defend the counterclaims in the federal court.
(7) Other Intangibles:
------------------
Other intangibles at December 31, 2006 and 2005 are as follows:
($ in thousands) 2006 2005
---------------- --------------- ----------------
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 (684,310) (557,930)
--------------- ----------------
Total other intangibles, net $ 432,353 $ 558,733
=============== ================
Amortization expense was $126,380,000, $126,378,000 and $126,520,000 for
the years ended December 31, 2006, 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 $57,535,000 in 2009, at which
point the customer base will have been fully amortized.
(8) Discontinued Operations:
------------------------
(a) Electric Lightwave
------------------
On July 31, 2006, we sold our CLEC business, Electric Lightwave LLC
(ELI), for $255.3 million in cash plus the assumption of approximately
$4.0 million in capital lease obligations. We recognized a pre-tax
gain on the sale of ELI of approximately $116.7 million. Our after-tax
gain on the sale was $71.6 million. Our cash liability for taxes as a
result of the sale is expected to be approximately $5.0 million due to
the utilization of existing tax net operating losses on both the
federal and state level.
In accordance with SFAS No. 144, any component of our business that we
dispose of or classify as held for sale that has operations and cash
flows clearly distinguishable from operations, and for financial
reporting purposes, and that will be eliminated from the ongoing
operations, should be classified as discontinued operations.
Accordingly, we have classified the results of operations of ELI as
discontinued operations in our consolidated statements of operations
and have restated prior periods.
We ceased to record depreciation expense effective February 2006.
F-19
Summarized financial information for ELI (discontinued operations) is
set forth below:
($ in thousands) For the years ended December 31,
---------------- -----------------------------------------------------
2006 2005 2004
----------------- ----------------- -----------------
Revenue $ 100,612 $ 159,161 $ 156,030
Operating income $ 27,882 $ 21,480 $ 16,621
Income taxes $ 11,583 $ 9,070 $ 6,175
Net income $ 18,912 $ 12,226 $ 9,855
Gain on disposal, net of tax $ 71,635 $ - $ -
December 31, December 31,
($ in thousands) 2006 2005
---------------- ----------------- -----------------
(Sold)
Current assets $ 24,986
Net property, plant and equipment 137,730
-----------------
Total assets of discontinued operations $ 162,716
=================
Current liabilities $ 21,605
Long term liabilities 24,661
-----------------
Total liabilities of discontinued operations $ 46,266
=================
(b) 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. The
pre-tax gain on the sale of CCUSA was $14,061,000. Our after-tax gain
was approximately $1,167,000. The book income taxes recorded upon sale
are primarily attributable to a low tax basis in the assets sold.
In accordance with SFAS No. 144, any component of our business that we
dispose of or classify as held for sale that has operations and cash
flows clearly distinguishable from operations, and for financial
reporting purposes, and that will be eliminated from the ongoing
operations, should be classified as discontinued operations.
Accordingly, we have classified the results of operations of CCUSA as
discontinued operations in our consolidated statements of operations
and have restated prior periods.
The company had no outstanding debt specifically identified with CCUSA
and therefore no interest expense was allocated to discontinued
operations. In addition, we ceased to record depreciation expense
effective February 16, 2005.
Summarized financial information for CCUSA (discontinued operations)
is set forth below:
($ in thousands) For the years ended December 31,
---------------- -----------------------------------------------------
2006 2005 2004
----------------- ----------------- -----------------
Revenue (Sold) $ 4,607 $ 24,558
Operating income $ 1,489 $ 8,188
Income taxes $ 449 $ 2,957
Net income $ 1,040 $ 5,231
Gain on disposal of CCUSA, net of tax $ 1,167 $ -
There was no balance sheet data to report for CCUSA as of December 31,
2006 or 2005.
(c) Public Utilities
----------------
On April 1, 2004, we completed the sale of our Vermont electric
distribution operations for approximately $13,992,000 in cash, net of
selling expenses. With that transaction, we completed the divestiture
of our public utilities services business pursuant to plans announced
in 1999.
F-20
(9) Investments:
------------
The components of investments at December 31, 2006 and 2005 are as follows:
($ in thousands) 2006 2005
---------------- ---------------- ----------------
Marketable equity securities $ 30 $ 122
Equity method investments 16,444 15,877
---------------- ----------------
$ 16,474 $ 15,999
================ ================
Marketable Securities
As of December 31, 2006 and 2005, we owned 3,059,000 shares of Adelphia
Communications Corp. (Adelphia) common stock. As a result of write downs
recorded in 2002 and 2001, our "book cost basis" was reduced to zero and
subsequent increases and decreases, except for those deemed other than
temporary, are included in accumulated other comprehensive income (loss).
Unrealized holding gains at December 31, 2006 and 2005 were $30,000 and
$122,000 respectively which approximates the fair market value.
During 2004, we sold our investments in D & E Communications, Inc. (D & E)
and Hungarian Telephone and Cable Corp. (HTCC) for approximately
$13,300,000 and $13,200,000 in cash, respectively. We recorded net realized
gains of $12,066,000 in our statement of operations for the sale of these
marketable securities.
At December 31, 2006 and 2005, we did not have any investments that have
been in a continuous unrealized loss position deemed to be temporary for
more than 12 months. We determined that market fluctuations during the
period are not other than temporary because the severity and duration of
the unrealized losses were not significant.
Equity Method Investments
Our investments in entities that are accounted for under the equity method
of accounting consist of the following: (1) a 16.8% interest in the
Fairmount Cellular Limited Partnership which is engaged in cellular mobile
telephone service in the Rural Service Area (RSA) designated by the FCC as
Georgia RSA No. 3; and (2) our investments in CU Capital and CU Trust with
relation to our convertible preferred securities. The investments in these
entities amounted to $16,444,000 and $15,877,000 at December 31, 2006 and
2005, respectively.
(10) Fair Value of Financial Instruments:
------------------------------------
The following table summarizes the carrying amounts and estimated fair
values for certain of our financial instruments at December 31, 2006 and
2005. For the other financial instruments, representing cash, accounts
receivables, long-term debt due within one year, accounts payable and other
accrued liabilities, the carrying amounts approximate fair value due to the
relatively short maturities of those instruments.
The fair value of our marketable securities and long-term debt is estimated
based on quoted market prices at the reporting date for those financial
instruments. Other securities and investments for which market values are
not readily available are carried at cost.
($ in thousands) 2006 2005
---------------- ----------------------------------- ---------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------------- ------------------ ---------------- ----------------
Investments $ 16,474 $ 16,474 $ 15,999 $ 15,999
Long-term debt (1) $ 4,460,755 $ 4,620,921 $ 3,995,130 $ 4,022,960
(1) 2006 and 2005 includes interest rate swaps of ($10,289,000) and
($8,727,000), respectively. 2006 and 2005 includes EPPICS of $17,860,000
and $33,785,000, respectively.
F-21
(11) Long-term Debt:
---------------
The activity in our long-term debt from December 31, 2005 to December 31,
2006 is summarized as follows:
Twelve Months Ended
--------------------------------------------
Interest Rate* at
December 31, New Rate December 31, December 31,
($ in thousands) 2005 Payments Borrowings Swap Other 2006 2006
----------------
Rural Utilities Service Loan
Contracts $ 22,809 $ (923) $ - $ - $ - $ 21,886 6.080%
Senior Unsecured Debt 4,120,781 (226,770) 550,000 (1,562) (7,431) 4,435,018 8.296%
EPPICS (see Note 15) 33,785 - - - (15,925) 17,860 5.000%
Industrial Development Revenue
Bonds 58,140 - - - - 58,140 5.559%
------------ ---------- ---------- --------- --------- -----------
TOTAL LONG TERM DEBT $4,235,515 $(227,693) $550,000 $ (1,562) $(23,356) $4,532,904
------------ ========== ========== ========= ========= -----------
Less: Debt Discount (12,692) (32,878)
Less: Current Portion (227,693) (39,271)
------------ -----------
$3,995,130 $4,460,755
============ ===========
* Interest rate includes amortization of debt issuance expenses, debt
premiums or discounts. The interest rate for Rural Utilities Service Loan
Contracts, Senior Unsecured Debt, and Industrial Development Revenue Bonds
represent a weighted average of multiple issuances.
Additional information regarding our Senior Unsecured Debt at December 31:
2006 2005
--------------------------------- ---------------------------------
Principal Interest Principal Interest
($ in thousands) Outstanding Rate Outstanding Rate
---------------- ----------------- ------------ ----------------- ------------
Senior Notes:
Due 8/17/2006 $ - - $ 51,770 6.758%
Due 8/15/2008 495,240 7.625% 699,990 7.625%
Due 5/15/2011 1,050,000 9.250% 1,050,000 9.250%
Due 10/24/2011 200,000 6.270% 200,000 6.270%
Due 12/31/2012 150,000 6.75% (variable) - -
Due 1/15/2013 700,000 6.250% 700,000 6.250%
Due 1/15/2027 400,000 7.875% - -
Due 8/15/2031 945,325 9.000% 748,006 9.000%
----------------- -----------------
3,940,565 3,449,766
Debentures due 2025 - 2046 468,742 7.136% 643,742 7.263%
Subsidiary Senior
Notes due 12/1/2012 36,000 8.050% 36,000 8.050%
Fair value of interest rate
swaps (10,289) (8,727)
----------------- -----------------
Total $ 4,435,018 $ 4,120,781
================= =================
For the year ended December 31, 2006, we retired an aggregate principal
amount of $251.0 million of debt, including $15.9 million of 5% Company
Obligated Mandatorily Redeemable Convertible Preferred Securities due 2006
(EPPICS) that were converted into our common stock.
During the first quarter of 2006, we entered into two debt-for-debt
exchanges of our debt securities. As a result, $47.5 million of our 7.625%
notes due 2008 were exchanged for approximately $47.4 million of our 9.00%
notes due 2031. During the fourth quarter of 2006, we entered into four
debt-for-debt exchanges and exchanged $157.3 million of our 7.625% notes
due 2008 for $149.9 million of our 9.00% notes due 2031. The 9.00% notes
are callable on the same general terms and conditions as the 7.625% notes
exchanged. No cash was exchanged in these transactions. However, with
respect to the first quarter debt exchanges, a non-cash pre-tax loss of
approximately $2.4 million was recognized in accordance with EITF No.
96-19, "Debtor's Accounting for a Modification or Exchange of Debt
Instruments," which is included in other income (loss), net.
F-22
On June 1, 2006, we retired at par our entire $175.0 million principal
amount of 7.60% Debentures due June 1, 2006.
On June 14, 2006, we repurchased $22.7 million of our 6.75% Senior Notes
due August 17, 2006 at a price of 100.181% of par.
On August 17, 2006, we retired at par the $29.1 million remaining balance
of the 6.75% Senior Notes.
In February 2006, our Board of Directors authorized us to repurchase up to
$150.0 million of our outstanding debt over the following twelve-month
period. These repurchases may require us to pay premiums, which would
result in pre-tax losses to be recorded in investment and other income
(loss). Through December 31, 2006, we have not made any purchases pursuant
to this authorization.
On December 22, 2006, we issued in a private placement, an aggregate $400.0
million principal amount of 7.875% Senior Notes due January 15, 2027.
Proceeds from the sale are expected to be used to partially finance our
acquisition of Commonwealth Telephone or if the acquisition is not
completed, to purchase, redeem or otherwise retire a portion of our
outstanding debt. We have agreed to file with the SEC a registration
statement for the purpose of exchanging these notes for registered notes.
In December 2006, we borrowed $150.0 million under a senior unsecured term
loan agreement. The loan matures in 2012 and bears interest based on an
average prime rate or London Interbank Offered Rate or LIBOR plus 1 3/8%,
at our election. We intend to use the proceeds to repurchase a portion of
our outstanding debt or to partially finance the Commonwealth acquisition.
As of December 31, 2006, EPPICS representing a total principal amount of
$193.9 million had been converted into 15.6 million shares of our common
stock, and a total of $7.4 million remains outstanding to third parties.
Our long term debt footnote indicates $17.9 million of EPPICS outstanding
at December 31, 2006, of which $10.5 million is debt of related parties for
which the Company has an offsetting receivable.
We had a total outstanding principal amount of industrial development
revenue bonds of $58,140,000 at December 31, 2006 and 2005. The earliest
maturity date for these bonds is in August 2015. Under the terms of our
agreements to sell our former gas and electric operations in Arizona,
completed in 2003, we are obligated to call for redemption, at their first
available call dates, three Arizona industrial development revenue bond
series aggregating to approximately $33,440,000. These bonds' first call
dates are in 2007. We expect to retire all called bonds with cash. In
addition, holders of $11,150,000 principal amount of industrial development
bonds may tender such bonds to us at par and we have the simultaneous
option to call such bonds at par on August 7, 2007. We expect to call the
bonds and retire them with cash.
As of December 31, 2006 we had available lines of credit with financial
institutions in the aggregate amount of $249,600,000 with a maturity date
of October 29, 2009. Outstanding standby letters of credit issued under the
facility were $0.4 million. Associated facility fees vary depending on our
leverage ratio and were 0.375% as of December 31, 2006. During the term of
the credit facility we may borrow, repay and re-borrow funds. The credit
facility is available for general corporate purposes but may not be used to
fund dividend payments.
For the year ended December 31, 2005, we retired an aggregate principal
amount of $36.4 million of debt, including $30.0 million of 5% Company
Obligated Mandatorily Redeemable Convertible Preferred Securities due 2036
(EPPICS) that were converted into our common stock. During the second
quarter of 2005, we entered into two debt-for-debt exchanges of our debt
securities. As a result, $50.0 million of our 7.625% notes due 2008 were
exchanged for approximately $52.2 million of our 9.00% notes due 2031. The
9.00% notes are callable on the same general terms and conditions as the
7.625% notes exchanged. No cash was exchanged in these transactions,
however a non-cash pre-tax loss of approximately $3.2 million was
recognized in accordance with EITF No. 96-19, "Debtor's Accounting for a
Modification or Exchange of Debt Instruments," which is included in other
income (loss), net.
F-23
For the year ended December 31, 2004, we retired an aggregate
$1,350,397,000 of debt (including $147,991,000 of EPPICS conversions),
representing approximately 28% of total debt outstanding at December 31,
2003. The retirements generated a pre-tax loss on the early extinguishment
of debt at a premium of approximately $66,480,000 recorded in other income
(loss), net.
We are in compliance with all of our debt and credit facility covenants.
Our principal payments for the next five years are as follows:
($ in thousands)
---------------- Principal
Payments
---------
2007 39,271
2008 497,688
2009 2,507
2010 5,886
2011 1,252,517
(12) 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 sheets and the related portion of fixed-rate debt
being hedged is reflected at an amount equal to the sum of its book value
and an amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. Changes in the fair
value of interest rate swap contracts, and the offsetting changes in the
adjusted carrying value of the related portion of the fixed-rate debt being
hedged, are recognized in the consolidated statements of operations in
interest expense. The notional amounts of interest rate swap contracts
hedging fixed-rate indebtedness as of December 31, 2006 and December 31,
2005 were $550,000,000 and $500,000,000, respectively. Such contracts
require us to pay variable rates of interest (average pay rates of
approximately 9.02% and 8.60% as of December 31, 2006 and 2005,
respectively) and receive fixed rates of interest (average receive rates of
8.26% and 8.46% as of December 31, 2006 and 2005, respectively). The fair
value of these derivatives is reflected in other liabilities as of December
31, 2006 and 2005, in the amount of ($10,289,000) and ($8,727,000),
respectively. The related underlying debt has been decreased in 2006 and
2005 by a like amount. For the year ended December 31, 2006 , the interest
expense resulting from these interest rate swaps totaled approximately $4.2
million. For the years ended December 31, 2005 and 2004 our interest
expense was reduced by $2.5 million and $9.4 million, respectively.
We do not anticipate any nonperformance by counter-parties to our
derivative contracts as all counter-parties have investment grade credit
ratings.
(13) Management Succession and Strategic Alternatives Expenses:
----------------------------------------------------------
On July 11, 2004, our Board of Directors announced that it had completed
its review of our financial and strategic alternatives, and on September 2,
2004, we paid a special, non-recurring dividend of $2.00 per common share
and a quarterly dividend of $0.25 per common share to shareholders of
record on August 18, 2004. Concurrently, Leonard Tow decided to step down
from his position as chief executive officer, effective immediately, and
resigned his position as Chairman of the Board on September 27, 2004. The
Board of Directors named Mary Agnes Wilderotter president and chief
executive officer in November 2004.
F-24
In 2004, we expensed approximately $90,632,000 of costs related to
management succession and our exploration of financial and strategic
alternatives. Included are $36,618,000 of non-cash expenses for the
acceleration of stock benefits, cash expenses of $19,229,000 for advisory
fees, $19,339,000 for severance and retention arrangements and $15,446,000
primarily for tax reimbursements.
(14) Investment Income and Other Income (Loss), net:
-----------------------------------------------
During 2006 we recognized a gain of $61.4 million (recorded in investment
income) arising from the liquidation and dissolution of the RTB.
The components of other income (loss), net for the years ended December 31,
2006, 2005 and 2004 are as follows:
($ in thousands) 2006 2005 2004
---------------- ----------------- ----------------- -----------------
Legal contingencies $ (1,000) $ (7,000) $ -
Gain on expiration/settlement of customer advances 3,539 681 25,345
Loss on exchange of debt (2,433) (3,175) -
Premium on debt repurchases - - (66,480)
Minority share of Mohave Cellular net income (4,164) (3,599) (817)
Gain on forward rate agreements 430 1,851 -
Loss on sale of assets - - (1,945)
Other, net 2,501 9,881 (9,568)
----------------- ----------------- -----------------
Total other income (loss), net $ (1,127) $ (1,361) $ (53,465)
================= ================= =================
During 2006 and 2005, we recorded expense in connection with the Bangor,
Maine legal matter. In connection with our exchange of debt during the
first quarter of 2006 and second quarter of 2005, we recognized a non-cash,
pre-tax loss. 2006 and 2005 also include a gain for the changes in fair
value of our forward rate agreements.
During 2006, 2005 and 2004, we recognized income in connection with certain
retained liabilities, that have terminated, associated with customer
advances for construction from our disposed water properties.
Pre-tax gains (losses) in connection with the following transactions were
recorded in other income (loss), net:
2005
----
On February 1, 2005, we sold shares of Prudential Financial, Inc. for
approximately $1,112,000 in cash, and we recognized a pre-tax gain of
approximately $493,000.
In June 2005, we sold for cash our interests in certain key man life
insurance policies on the lives of Leonard Tow, our former Chairman and
Chief Executive Officer, and his wife, a former director. The cash
surrender value of the policies purchased by Dr. Tow totaled approximately
$24,195,000, and we recognized a pre-tax gain of approximately $457,000.
During 2005, we sold shares of Global Crossing Limited for approximately
$1,084,000 in cash, and we recognized a pre-tax gain for the same amount.
2004
----
In October 2004, we sold cable assets in California, Arizona, Indiana, and
Wisconsin for approximately $2,263,000 in cash. The pre-tax gain on the
sale was $40,000.
During the third quarter of 2004, we sold our corporate aircraft for
approximately $15,298,000 in cash. The pre-tax loss on the sale was
$1,087,000.
F-25
(15) 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 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 convert into our
common stock at an adjusted conversion price of $11.46 per share of our
common stock. 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 of common
stock 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 four quarters of 2006, 2005 and 2004. 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 December 31, 2006, EPPICS representing a total principal amount of
$193,896,000 had been converted into 15,626,965 shares of our common stock.
A total of $7,354,000 of EPPICS is outstanding as of December 31, 2006 and
if all outstanding EPPICS were converted, 641,485 shares of our common
stock would be issued upon such conversion. Our long-term debt footnote
indicates $17,860,000 of EPPICS outstanding at December 31, 2006, of which
$10,500,000 is debt of related parties for which the company has an
offsetting receivable.
We adopted the provisions of FIN No. 46R (revised December 2003) (FIN No.
46R), "Consolidation of Variable Interest Entities," effective January 1,
2004. Accordingly, the Trust holding the EPPICS and the related Citizens
Utilities Capital L.P. are deconsolidated.
(16) Capital Stock:
--------------
We are authorized to issue up to 600,000,000 shares of common stock. The
amount and timing of dividends payable on common stock are, subject to
applicable law, within the sole discretion of our Board of Directors.
(17) Stock Plans:
------------
At December 31, 2006, we had five stock-based compensation plans under
which grants have been made and awards remained outstanding. These plans,
which are described below are the Management Equity Incentive Plan (MEIP),
the 1996 Equity Incentive Plan (1996 EIP), the Amended and Restated 2000
Equity Incentive Plan (2000 EIP), the Non-Employee Directors' Deferred Fee
Plan (Deferred Fee Plan) and the Non-Employee Directors' Equity Incentive
Plan (Director's Equity Plan, and together with the Deferred Fee plan, the
Director Plans).
Prior to the adoption of SFAS No. 123R, we applied APB No. 25 and related
interpretations to account for our stock plans resulting in the use of the
intrinsic value to value the stock and determine compensation expense.
Under APB No. 25, we were not required to recognize compensation expense
for the cost of stock options. In accordance with the adoption of SFAS No.
123R, we recorded stock-based compensation expense for 2006 in the amount
of $2,230,000 for the cost of stock options. Our general policy is to issue
shares upon the grant of restricted shares and exercise of options from
treasury. At December 31, 2006, there were 29,930,472 shares authorized for
grant under these plans and 5,871,730 shares available for grant. No
further awards may be granted under the MEIP, the 1996 EIP and the Deferred
Fee plan.
F-26
In connection with the Director Plans, compensation costs associated with
the issuance of stock units was $2,017,000, $1,069,000 and $2,222,000 in
2006, 2005 and 2004, respectively. Cash compensation associated with this
plan was $502,000, $434,000 and $642,000 in 2006, 2005 and 2004,
respectively. These costs are recognized in other operating expenses.
We have granted restricted stock awards to key employees in the form of our
common stock. The number of shares issued as restricted stock awards during
2006, 2005 and 2004 were 732,000, 352,000 and 2,172,000, respectively. None
of the restricted stock awards may be sold, assigned, pledged or otherwise
transferred, voluntarily or involuntarily, by the employees until the
restrictions lapse, subject to limited exceptions. The restrictions are
time based. At December 31, 2006, 1,174,000 shares of restricted stock were
outstanding. Compensation expense, recognized in operating expense, of
$6,034,000, $7,358,000 and $45,313,000, for the years ended December 31,
2006, 2005 and 2004, respectively, has been recorded in connection with
these grants.
Management Equity Incentive Plan
--------------------------------
Prior to its expiration on June 21, 2000, awards of our common stock could
have been granted under the MEIP to eligible officers, management employees
and non-management employees in the form of incentive stock options,
non-qualified stock options, stock appreciation rights (SARs), restricted
stock or other stock-based awards.
Since the expiration of the MEIP, no awards have been or may be granted
under the MEIP. The exercise price of stock options issued was equal to or
greater than the fair market value of the underlying common stock on the
date of grant. Stock options were not ordinarily exercisable on the date of
grant but vest over a period of time (generally four years). Under the
terms of the MEIP, subsequent stock dividends and stock splits have the
effect of increasing the option shares outstanding, which correspondingly
decreases the average exercise price of outstanding options.
1996 and 2000 Equity Incentive Plans
------------------------------------
Since the expiration date of the 1996 EIP on May 22, 2006, no awards have
been or may be granted under the 1996 EIP. Under the 2000 EIP, awards of
our common stock may be granted to eligible officers, management employees
and non-management employees in the form of incentive stock options,
non-qualified stock options, SAR's, restricted stock or other stock-based
awards. As discussed under the Non-Employee Directors' Compensation Plans
below, prior to May 25, 2006 directors received an award of stock options
under the 2000 EIP upon commencement of service.
At December 31, 2006, there were 27,389,711 shares authorized for grant
under the 2000 EIP and 3,385,785 shares available for grant, as adjusted to
reflect stock dividends. No awards will be granted more than 10 years after
the effective date (May 18, 2000) of the 2000 EIP plan. The exercise price
of stock options and SARs under the 2000 and 1996 EIP generally shall be
equal to or greater than the fair market value of the underlying common
stock on the date of grant. Stock options are not ordinarily exercisable on
the date of grant but vest over a period of time (generally four years).
Under the terms of the EIPs, subsequent stock dividends and stock splits
have the effect of increasing the option shares outstanding, which
correspondingly decrease the average exercise price of outstanding options.
In connection with the payment of the special, non-recurring dividend of
$2.00 per common share on September 2, 2004, the exercise price and number
of all outstanding options was 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 No. 44), "Accounting for
Certain Transactions Involving Stock Compensation" and EITF No. 00-23,
"Issues Related to the Accounting for Stock Compensation under APB No. 25
and FIN No. 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.
F-27
The following summary presents information regarding outstanding stock
options and changes with regard to options under the MEIP and EIP plans:
Weighted Weighted Aggregate
Shares Average Average Intrinsic
Subject to Option Price Remaining Value at
Option Per Share Life in Years December 31
---------------------------------------------- --------------------- --------------- ------------------ ------------------
Balance at January 1, 2004 17,965,000 $11.94
Options granted - -
Options exercised (7,411,000) 9.69 $29,002,000
Options canceled, forfeited or lapsed (355,000) 12.14
Effect of special, non-recurring dividend 2,212,000 -
---------------------------------------------- ---------------------
Balance at December 31, 2004 12,411,000 11.15 6.11 $38,162,000
Options granted 183,000 11.58
Options exercised (4,317,000) 10.52 $12,730,000
Options canceled, forfeited or lapsed (292,000) 10.48
---------------------------------------------- ---------------------
Balance at December 31, 2005 7,985,000 11.52 5.32 $13,980,000
Options granted 22,000 12.55
Options exercised (2,695,000) 9.85 $ 9,606,000
Options canceled, forfeited or lapsed (70,000) 10.13
---------------------------------------------- ---------------------
Balance at December 31, 2006 5,242,000 $12.41 4.36 $14,490,000
============================================== =====================
The following table summarizes information about shares subject to options
under the MEIP and EIP plans at December 31, 2006:
Options Outstanding Options Exercisable
--------------------------------------------------------------------------------- ---------------------------------
Weighted Average Weighted
Number Range of Weighted Average Remaining Number Average
Outstanding Exercise Prices Exercise Price Life in Years Exercisable Exercise Price
------------------ -------------------- -------------------- -------------------- -- ----------------- ---------------
327,000 $ 6.45 - 6.67 $ 6.51 1.94 327,000 $ 6.51
149,000 7.33 - 7.98 7.37 0.75 149,000 7.37
581,000 8.19 - 8.19 8.19 5.38 581,000 8.19
29,000 8.53 - 9.68 8.96 1.53 29,000 8.96
900,000 10.44 - 10.44 10.44 6.41 483,000 10.44
379,000 11.15 - 11.15 11.15 3.80 379,000 11.15
740,000 11.79 - 11.79 11.79 4.38 740,000 11.79
2,137,000 11.90 - 18.46 16.13 3.99 2,103,000 16.18
------------------ -----------------
5,242,000 $ 6.45 - 18.46 $12.41 4.36 4,791,000 $12.58
================== =================
The number of options exercisable at December 31, 2005 and 2004 were
6,548,000 and 9,235,000, with a weighted average exercise price of $11.92
and $11.57, respectively.
Cash received upon the exercise of options during 2006, 2005 and 2004 was
$27,200,000, $47,550,000 and $84,522,000 respectively. Total remaining
unrecognized compensation cost associated with unvested stock options at
December 31, 2006 was $771,000 and the weighted average period over which
this cost is expected to be recognized is approximately one year.
For purposes of determining compensation expense, the fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model which requires the use of various assumptions
including expected life of the option, expected dividend rate, expected
volatility, and risk-free interest rate. The expected life (estimated
period of time outstanding) of stock options granted was estimated using
the historical exercise behavior of employees. The risk free interest rate
is based on the U.S. Treasury yield curve in effect at the time of the
grant. Expected volatility is based on historical volatility for a period
equal to the stock option's expected life, calculated on a monthly basis.
F-28
The following table presents the weighted average assumptions used for
grants in 2006 and 2005. There were no option grants during 2004.
2006 2005
--------------------------- --------------- --------------
Dividend yield 7.55% 7.72%
Expected volatility 44% 46%
Risk-free interest rate 4.89% 4.16%
Expected life 5 years 6 years
--------------------------- --------------- --------------
The following summary presents information regarding unvested restricted
stock and changes with regard to restricted stock under the MEIP and the
EIPs:
Weighted Aggregate
Average Fair Value at
Number of Grant Date December 31,
Shares Fair Value 2006
---------------------------------------------- --------------------- --------------- ------------------
Balance at January 1, 2004 1,159,000 $10.18
Restricted stock granted 2,172,000 12.68 $29,953,000
Restricted stock vested (1,638,000) 11.32 $22,592,000
Restricted stock forfeited (7,000) 12.59
---------------------------------------------- ---------------------
Balance at December 31, 2004 1,686,000 12.29 $23,253,000
Restricted stock granted 352,000 13.11 $ 4,305,000
Restricted stock vested (491,000) 12.27 $ 6,000,000
Restricted stock forfeited (91,000) 12.58
---------------------------------------------- ---------------------
Balance at December 31, 2005 1,456,000 12.47 $17,808,000
Restricted stock granted 732,000 12.87 $10,494,000
Restricted stock vested (642,000) 12.08 $ 9,226,000
Restricted stock forfeited (372,000) 12.60
---------------------------------------------- ---------------------
Balance at December 31, 2006 1,174,000 $12.89 $16,864,000
============================================== =====================
For purposes of determining compensation expense, the fair value of each
restricted stock grant is estimated based on the average of the high and
low market price of a share of our common stock on the date of grant. Total
remaining unrecognized compensation cost associated with unvested
restricted stock awards at December 31, 2006 was $9,934,000 and the
weighted average period over which this cost is expected to be recognized
is approximately two years.
Non-Employee Directors' Compensation Plans
------------------------------------------
Upon commencement of his or her service on the Board of Directors, each
non-employee director receives a grant of 10,000 stock options. These
options are currently awarded under the Directors' Equity Plan. Prior to
effectiveness of the Directors' Equity Plan on May 25, 2006, these options
were awarded under the 2000 EIP. The exercise price of these options, which
become exercisable six months after the grant date, is the fair market
value (as defined in the relevant plan) of our common stock on the date of
grant. Options granted under the Directors' Equity Plan expire on the
earlier of the tenth anniversary of the grant date or the first anniversary
of termination of service as a director.
Each non-employee director also receives an annual grant of 3,500 stock
units. These units are currently awarded under the Directors' Equity Plan
and prior to effectiveness of that plan, were awarded under the Deferred
Fee plan. Since the effectiveness of the Director's Equity Plan, no further
grants have been made under the Deferred Fee Plan. Prior to April 20, 2004,
each non-employee director received an award of 5,000 stock options. The
exercise price of such options was set at 100% of the fair market value on
the date the options were granted. The options are exercisable six months
after the grant date and remain exercisable for ten years after the grant
date.
F-29
In addition, each year, each non-employee director is also entitled to
receive a retainer, meeting fees, and, when applicable, fees for serving as
a committee chair or as Lead Director, which are awarded under the
Directors' Equity Plan. For 2006, each non-employee director had to elect,
by December 31 of the preceding year, to receive $40,000 cash or 5,760
stock units as an annual retainer. Directors making a stock unit election
must also elect to convert the units to either common stock (convertible on
a one-to-one basis) or cash upon retirement or death. Prior to June 30,
2003, a director could elect to receive 20,000 stock options as an annual
retainer in lieu of cash or stock units. The exercise price of the stock
options was set at the average of the high and low market prices of our
common stock on the date of grant. The options were exercisable six months
after the date of grant and had a 10-year term.
The number of shares of common stock authorized for issuance under the
Directors' Equity Plan is 2,540,761, which includes 540,761 shares that
were available for grant under the Deferred Fee Plan on the effective date
of the Directors' Equity Plan. In addition, if and to the extent that any
"plan units" outstanding on May 25, 2006 under the Deferred Fee Plan are
forfeited or if any option granted under the Deferred Fee Plan terminates,
expires, or is cancelled or forfeited, without having been fully exercised,
shares of common stock subject to such "plan units" or options cancelled
shall become available under the Directors' Equity Plan. At December 31,
2006, there were 2,485,945 shares available for grant. There were 13
directors participating in the Directors' Plans during all or part of 2006.
In 2006, the total options, plan units, and stock earned were 20,000,
81,000 and 0, respectively. In 2005, the total options, plan units, and
stock earned were 70,000, 64,000 and 0, respectively. In 2004, the total
options, plan units, and stock earned were 50,000, 57,226 and 0,
respectively. Options granted prior to the adoption of the Director's
Equity Plan were granted under the 2000 EIP. At December 31, 2006, 157,908
options were exercisable at a weighted average exercise price of $11.97.
For 2006, each non-employee director received fees of $2,000 for each
in-person Board of Directors and committee meeting attended and $1,000 for
each telephone Board and committee meeting attended. The chairs of the
Audit, Compensation, Nominating and Corporate Governance and Retirement
Plan Committees were paid an additional annual fee of $25,000, $15,000,
$7,500 and $5,000, respectively. In addition, the Lead Director, who heads
the ad hoc committee of non-employee directors, received an additional
annual fee of $15,000. A director must elect, by December 31 of the
preceding year, to receive meeting and other fees in cash, stock units, or
a combination of both. All fees paid to the non-employee directors in 2006
were paid quarterly. If the director elects stock units, the number of
units credited to the director's account is determined as follows: the
total cash value of the fees payable to the director are divided by 85% of
the closing prices of our common stock on the last business day of the
calendar quarter in which the fees or stipends were earned. Units are
credited to the director's account quarterly.
We account for the Deferred Fee Plan and Directors' Equity Plan in
accordance with SFAS No. 123R. To the extent directors elect to receive the
distribution of their stock unit account in cash, they are considered
liability-based awards. To the extent directors elect to receive the
distribution of their stock unit accounts in common stock, they are
considered equity-based awards. Compensation expense for stock units that
are considered equity-based awards is based on the market value of our
common stock at the date of grant. Compensation expense for stock units
that are considered liability-based awards is based on the market value of
our common stock at the end of each period. For awards granted prior to
1999, a director could elect to be paid in stock options. Generally,
compensation cost was not recorded because the options were granted at the
fair market value of our common stock on the grant date under APB No. 25
and related interpretations.
We had also maintained a Non-Employee Directors' Retirement Plan providing
for the payment of specified sums annually to our non-employee directors,
or their designated beneficiaries, starting at the director's retirement,
death or termination of directorship. In 1999, we terminated this Plan. The
vested benefit of each non-employee director, as of May 31, 1999, was
credited to the director's account in the form of stock units. Such benefit
will be payable to each director upon retirement, death or termination of
directorship. Each participant had until July 15, 1999 to elect whether the
value of the stock units awarded would be payable in our common stock
(convertible on a one-for-one basis) or in cash. As of December 31, 2006,
the liability for such payments was $686,000 all of which will be payable
in stock (based on the July 15, 1999 stock price).
(18) Restructuring and Other Expenses:
---------------------------------
2006, 2005 and 2004
-------------------
During 2006, 2005 and 2004, we did not recognize any restructuring and
other expenses. We continue to review our operations, personnel and
facilities to achieve greater efficiency.
F-30
(19) Income Taxes:
-------------
The following is a reconciliation of the provision for income taxes for
continuing operations computed at federal statutory rates to the effective
rates for the years ended December 31, 2006, 2005 and 2004:
2006 2005 2004
------------ ----------- -----------
Consolidated tax provision at federal statutory rate 35.0 % 35.0 % 35.0 %
State income tax provisions, net of federal income tax benefit 2.1 % 1.6 % 1.4 %
Tax reserve adjustment 0.2 % (8.2)% (22.5)%
All other, net (2.4)% 0.2 % (7.0)%
------------ ----------- -----------
34.9 % 28.6 % 6.9 %
============ =========== ===========
The components of the net deferred income tax liability (asset) at December
31 are as follows:
($ in thousands) 2006 2005
---------------- ------------ -----------
Deferred income tax liabilities:
--------------------------------
Property, plant and equipment basis differences $ 547,726 $ 571,956
Intangibles 175,991 168,703
Other, net 9,675 3,207
------------ -----------
733,392 743,866
------------ -----------
Deferred income tax assets:
---------------------------
Minimum pension liability - 76,368
FASB 158 pension/OPEB liability 51,660 -
Tax operating loss carryforward 81,515 260,053
Alternate minimum tax credit carryforward 54,834 43,678
Employee benefits 70,013 66,853
Other, net 24,039 21,279
------------ -----------
282,061 468,231
Less: Valuation allowance (49,679) (38,131)
------------ -----------
Net deferred income tax asset 232,382 430,100
------------ -----------
Net deferred income tax liability $ 501,010 $ 313,766
============ ===========
Deferred tax assets and liabilities are reflected in
----------------------------------------------------
the following captions on the balance sheet:
--------------------------------------------
Deferred income taxes $ 514,130 $ 325,084
Other current assets (13,120) (11,318)
------------ -----------
Net deferred income tax liability $ 501,010 $ 313,766
============ ===========
Our federal and state tax operating loss carryforwards as of December 31,
2006 are estimated at $56,636,000 and $1,186,873,000, respectively. Our
federal loss carryforward will expire in the year 2025. A portion of our
state loss carryforward will begin to expire in 2007. Our alternative
minimum tax credit as of December 31, 2006 can be carried forward
indefinitely to reduce future regular tax liability.
F-31
The provision (benefit) for federal and state income taxes, as well as the
taxes charged or credited to shareholders' equity, includes amounts both
payable currently and deferred for payment in future periods as indicated
below:
($ in thousands) 2006 2005 2004
---------------- ------------ ----------- -----------
Income taxes charged (credited) to the income statement for
continuing operations:
Current:
Federal $ 772 $ 16,708 $ (9,951)
State 3,676 (33,006) (3,643)
------------ ----------- -----------
Total current 4,448 (16,298) (13,594)
Deferred:
Federal 128,534 89,446 21,183
Federal tax credits - (18) (40)
State 3,497 2,140 (3,302)
------------ ----------- -----------
Total deferred 132,031 91,568 17,841
------------ ----------- -----------
Subtotal income taxes for continuing operations 136,479 75,270 4,247
Income taxes charged to the income statement for
discontinued operations:
Current:
Federal 3,018 - -
State 2,004 2 3
------------ ----------- -----------
Total current 5,022 2 3
Deferred:
Federal 47,732 18,871 8,219
State 3,835 3,538 910
------------ ----------- -----------
Total deferred 51,567 22,409 9,129
------------ ----------- -----------
Subtotal income taxes for discontinued operations 56,589 22,411 9,132
------------ ----------- -----------
Total income taxes charged to the income statement (a) 193,068 97,681 13,379
Income taxes charged (credited) to shareholders' equity:
Deferred income taxes (benefits) on unrealized/realized
gains or losses on securities classified as
available-for-sale (35) (411) (10,982)
Current benefit arising from stock options exercised and
restricted stock (3,777) (5,976) (13,765)
Deferred income taxes (benefits) arising from the recognition
of additional pension/OPEB liability 24,707 (13,933) (6,645)
Deferred tax benefit from recording adjustments from the
adoption of SAB 108 (17,339) - -
------------ ----------- -----------
Income taxes charged (credited) to shareholders'
equity (b) 3,556 (20,320) (31,392)
------------ ----------- -----------
Total income taxes: (a) plus (b) $ 196,624 $ 77,361 $(18,013)
============ =========== ===========
F-32
(20) Net Income Per Common Share:
----------------------------
The reconciliation of the net income per common share calculation for the
years ended December 31, 2006, 2005 and 2004 is as follows:
($ in thousands, except per-share amounts)
------------------------------------------ 2006 2005 2004
------------------ ------------------ ------------------
Net income used for basic and diluted
earnings per common share:
Income from continuing operations $ 254,008 $ 187,942 $ 57,064
Income from discontinued operations 90,547 14,433 15,086
------------------ ------------------ ------------------
Total basic net income available for common shareholders $ 344,555 $ 202,375 $ 72,150
------------------ ------------------ ------------------
Effect of conversion of preferred securities 401 1,255 -
------------------ ------------------ ------------------
Total diluted net income available for common shareholders $ 344,956 $ 203,630 $ 72,150
================== ================== ==================
Basic earnings per common share:
Weighted-average shares outstanding - basic 322,641 337,065 303,989
================== ================== ==================
Income from continuing operations $ 0.79 $ 0.56 $ 0.19
Income from discontinued operations 0.28 0.04 0.05
------------------ ------------------ ------------------
Net income per share available for common shareholders $ 1.07 $ 0.60 $ 0.24
================== ================== ==================
Diluted earnings per common share:
Weighted-average shares outstanding 322,641 337,065 303,989
Effect of dilutive shares 931 1,417 5,194
Effect of conversion of preferred securities 973 3,193 -
------------------ ------------------ ------------------
Weighted-average shares outstanding - diluted 324,545 341,675 309,183
================== ================== ==================
Income from continuing operations $ 0.78 $ 0.56 $ 0.18
Income from discontinued operations 0.28 0.04 0.05
------------------ ------------------ ------------------
Net income per share available for common shareholders $ 1.06 $ 0.60 $ 0.23
================== ================== ==================
Stock Options
-------------
For the years ended December 31, 2006, 2005 and 2004 options of 1,917,000
(at exercise prices ranging from $13.45 to $18.46), 1,930,000 and 2,495,000
(at exercise prices ranging from $13.09 to $18.46), respectively, issuable
under employee compensation plans were excluded from the computation of
diluted earnings per share (EPS) for those periods as the effect would be
antidilutive. In calculating diluted EPS we apply the treasury stock method
and include future unearned compensation as part of the assumed proceeds.
In connection with the payment of the special, non-recurring dividend of
$2.00 per common share on September 2, 2004, the exercise price and number
of all outstanding options was 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 No. 44), "Accounting for
Certain Transactions involving Stock Compensation" and EITF No. 00-23,
"Issues Related to the Accounting for Stock Compensation under APB No. 25
and FIN No. 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 years ended December 31, 2006, 2005 and 2004,
restricted stock awards of 1,174,000, 1,456,000 and 1,686,000 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.
F-33
Equity Units and EPPICS
-----------------------
On August 17, 2004 we issued 32,073,633 shares of common stock, including
3,591,000 treasury shares, to our equity unit holders in settlement of the
equity purchase contract component of the equity units. With respect to the
$460,000,000 Senior Note component of the equity units, we repurchased
$300,000,000 principal amount of these Notes in July 2004. The remaining
$160,000,000 of the Senior Notes were repriced and a portion was remarketed
on August 12, 2004 as the 6.75% Notes due August 17, 2006. During 2004, we
repurchased an additional $108,230,000 of the 6.75% Notes which, in
addition to the $300,000,000 purchased in July, resulted in a pre-tax
charge of approximately $20,080,000 during the third quarter of 2004.
At December 31, 2006 and 2005, we had 147,079 and 465,588 shares,
respectively, of potentially dilutive EPPICS, which were convertible into
common stock at an exercise price of $11.46 per share. If all EPPICS that
remain outstanding are converted, we would issue approximately 641,485
shares of our common stock. 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 $11.46. These securities have been
included in the diluted income per common share calculation for the period
ended December 31, 2006 and 2005. However, 1,065,171 shares for 2004 have
not been included in the diluted income per share calculation for the
period ended December 31, 2004 because their inclusion would have had an
antidilutive effect.
Stock Units
-----------
At December 31, 2006, 2005 and 2004, we had 319,423, 206,630, and 464,879
stock units, respectively, issued under our Directors' Deferred Fee Equity
Plan and Non-Employee Directors' Retirement Plan. These securities have not
been included in the diluted income per share calculation because their
inclusion would have had an antidilutive effect.
(21) Comprehensive Income (Loss):
----------------------------
Comprehensive income consists of net income (loss) and other gains and
losses affecting shareholder's investment and FAS No. 158 pension/OPEB
liabilities that, under GAAP, are excluded from net income (loss).
F-34
Our other comprehensive income (loss) for the years ended December 31,
2006, 2005 and 2004 is as follows:
2006
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- -------------- --------------- -------------
Net unrealized holding losses on securities
arising during period $ (92) $ (35) $ (57)
FAS No. 158 pension/OPEB liability 199,653 74,619 125,034
-------------- --------------- -------------
Other comprehensive income $ 199,561 $ 74,584 $ 124,977
============== =============== =============
2005
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- -------------- --------------- -------------
Net unrealized holding losses on securities
arising during period $ (1,055) $ (395) $ (660)
Minimum pension liability (36,416) (13,933) (22,483)
Less: Reclassification adjustments for net gains
on securities realized in net income (537) (7) (530)
-------------- --------------- -------------
Other comprehensive (loss) $ (38,008) $ (14,335) $ (23,673)
============== =============== =============
2004
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- -------------- --------------- -------------
Net unrealized holding losses on securities
arising during period $ (1,901) $ (742) $ (1,159)
Minimum pension liability (17,372) (6,645) (10,727)
Less: Reclassification adjustments for net gains
on securities realized in net income (26,247) (10,240) (16,007)
-------------- --------------- -------------
Other comprehensive (loss) $ (45,520) $ (17,627) $ (27,893)
============== =============== =============
(22) Segment Information:
--------------------
We operate in one reportable segment, Frontier. Frontier provides both
regulated and unregulated communications services to residential, business
and wholesale customers and is typically the incumbent provider in its
service areas. As permitted by SFAS No. 131, we have utilized the
aggregation criteria in combining our markets because all of our Frontier
properties share similar economic characteristics, in that they provide the
same products and services to similar customers using comparable
technologies in all of the states in which we operate. The regulatory
structure is generally similar. Differences in the regulatory regime of a
particular state do not impact the economic characteristics or operating
results of a particular property.
Information for 2004 relates to our electric utility segment that was sold
during 2004 and did not meet the criteria for classification as a
discontinued operation.
F-35
($ in thousands) For the year ended December 31, 2004
---------------- ------------------------------------------------------
Total
Frontier Electric Segments
--------------- ----------------- -----------------
Revenue $ 2,012,643 $ 9,735 $ 2,022,378
Depreciation and Amortization 549,381 - 549,381
Management Succession and
Strategic Alternatives Expenses 90,632 - 90,632
Operating Income (Loss) 463,435 (3,134) 460,301
Capital Expenditures 263,949 - 263,949
Assets 6,679,899 - 6,679,899
(23) Quarterly Financial Data (Unaudited):
-------------------------------------
($ in thousands, except per share amounts)
------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
2006
---- --------- --------- --------- ----------
Revenue $506,861 $ 506,912 $ 507,198 $ 504,396
Operating income 157,338 169,458 160,720 156,974
Net income 50,483 101,702 128,459 63,911
Net income available for common shareholders per basic share $ 0.15 $ 0.32 $ 0.40 $ 0.20
Net income available for common shareholders per diluted share $ 0.15 $ 0.31 $ 0.40 $ 0.20
2005
----
Revenue $502,334 $ 496,133 $ 501,211 $ 517,363
Operating income 144,481 142,281 136,920 165,286
Net income 42,634 44,584 38,376 76,781
Net income available for common shareholders per basic share $ 0.13 $ 0.13 $ 0.11 $ 0.23
Net income available for common shareholders per diluted share $ 0.13 $ 0.13 $ 0.11 $ 0.23
The quarterly net income per common share amounts are rounded to the
nearest cent. Annual net income per common share may vary depending on the
effect of such rounding. During the second quarter of 2006 we recorded a
gain in investment income of $61.4 million resulting from the dissolution
and liquidation of the Rural Telephone Bank. In the third quarter of 2006
we sold ELI (see Note 8). See Note 14 for a description of other
miscellaneous transactions impacting our quarterly results.
(24) Retirement Plans:
-----------------
We sponsor a noncontributory defined benefit pension plan covering a
significant number of our employees and other postretirement benefit plans
that provide medical, dental, life insurance and other benefits for covered
retired employees and their beneficiaries and covered dependents. The
benefits are based on years of service and final average pay or career
average pay. Contributions are made in amounts sufficient to meet ERISA
funding requirements while considering tax deductibility. Plan assets are
invested in a diversified portfolio of equity and fixed-income securities
and alternative investments.
The accounting results for pension and postretirement benefit costs and
obligations are dependent upon various actuarial assumptions applied in the
determination of such amounts. These actuarial assumptions include the
following: discount rates, expected long-term rate of return on plan
assets, future compensation increases, employee turnover, healthcare cost
trend rates, expected retirement age, optional form of benefit and
mortality. We review these assumptions for changes annually with our
independent actuaries. We consider our discount rate and expected long-term
rate of return on plan assets to be our most critical assumptions.
F-36
The discount rate is used to value, on a present value basis, our pension
and postretirement benefit obligation as of the balance sheet date. The
same rate is also used in the interest cost component of the pension and
postretirement benefit cost determination for the following year. The
measurement date used in the selection of our discount rate is the balance
sheet date. Our discount rate assumption is determined annually with
assistance from our actuaries based on the pattern of expected future
benefit payments and the prevailing rates available on long-term, high
quality corporate bonds that approximate the benefit obligation. In making
this determination we consider, among other things, the yields on the
Citigroup Pension Discount Curve and Bloomberg Finance and the changes in
those rates from one period to the next. This rate can change from
year-to-year based on market conditions that impact corporate bond yields.
Our discount rate increased from 5.625% at year end 2005 to 6.00% at year
end 2006.
The expected long-term rate of return on plan assets is applied in the
determination of periodic pension and postretirement benefit cost as a
reduction in the computation of the expense. In developing the expected
long-term rate of return assumption, we considered published surveys of
expected market returns, 10 and 20 year actual returns of various major
indices, and our own historical 5-year and 10-year investment returns. The
expected long-term rate of return on plan assets is based on an asset
allocation assumption of 35% to 55% in fixed income securities, 35% to 55%
in equity securities and 5% to 15% in alternative investments. We review
our asset allocation at least annually and make changes when considered
appropriate. In 2006, we did not change our expected long-term rate of
return from the 8.25% used in 2005. Our pension plan assets are valued at
actual market value as of the measurement date. The measurement date used
to determine pension and other postretirement benefit measures for the
pension plan and the postretirement benefit plan is December 31.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans" (SFAS No. 158). We
adopted SFAS No. 158 prospectively on December 31, 2006. SFAS No. 158
requires that we recognize all obligations related to defined benefit
pensions and other postretirement benefits. This statement requires that we
quantify the plans' funded status as an asset or a liability on our
consolidated balance sheets. In accordance with SFAS No. 158, our 2005
accounting and related disclosures were not affected by the adoption of the
new standard. The table below summarizes the incremental effects of SFAS
No. 158 adoption on the individual line items in our consolidated balance
sheet at December 31, 2006:
Pre SFAS SFAS Post SFAS
No. 158 No. 158 No. 158
($ in thousands) Adoption Adjustment Adoption
---------------- -------- ---------- --------
Liabilities:
Deferred income taxes $ 564,041 $ (49,911) $ 514,130
Other liabilities 199,100 133,545 332,645
Stockholder's Equity:
Accumulated other comprehensive loss 1,735 (83,634) (81,899)
SFAS No. 158 requires that we measure the plan's assets and obligations
that determine our funded status as of the end of the fiscal year. We are
also required to recognize as a component of Other Comprehensive Income
"OCI" the changes in funded status that occurred during the year that are
not recognized as part of net periodic benefit cost as explained in SFAS
No. 87, "Employers' Accounting for Pensions," or SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions."
Based on the funded status of our defined benefit pension and
postretirement benefit plans as of December 31, 2006, we reported a gain
(net of tax) to our AOCI of $41.4 million, a decrease of $66.1 million to
accrued pension obligations and an increase of $24.7 million to accumulated
deferred income taxes. Our adoption of SFAS No. 158 on December 31, 2006,
had no impact on our earnings. The following tables present details about
our pension plans.
F-37
Pension Plan
------------
The following tables set forth the plan's projected benefit obligations and
fair values of plan assets as of December 31, 2006 and 2005 and net
periodic benefit cost for the years ended December 31, 2006, 2005 and 2004:
($ in thousands) 2006 2005
---------------- ------------- --------------
Change in projected benefit obligation
--------------------------------------
Projected benefit obligation at beginning of year $ 842,602 $ 799,458
Service cost 6,811 6,117
Interest cost 45,215 46,416
Actuarial (gain) loss (46,597) 48,750
Benefits paid (69,005) (58,139)
Special termination benefits and other of (116) 1,693 -
------------- --------------
Projected benefit obligation at end of year $ 780,719 $ 842,602
============= ==============
Change in plan assets
---------------------
Fair value of plan assets at beginning of year $ 762,225 $ 761,168
Actual return on plan assets 76,962 59,196
Employer contribution - -
Benefits paid (69,005) (58,139)
------------- --------------
Fair value of plan assets at end of year $ 770,182 $ 762,225
============= ==============
(Accrued)/Prepaid benefit cost
------------------------------
Funded status $ (10,537) $ (80,377)
=============
Unrecognized prior service cost (1,745)
Unrecognized net actuarial loss 223,525
--------------
Prepaid benefit cost $ 141,403
==============
Amounts recognized in the consolidated balance sheet
----------------------------------------------------
Other long-term liabilities $ (10,537) $ (58,250)
============= ==============
Accumulated other comprehensive income $ 147,248 $ 199,653
============= ==============
Expected
($ in thousands) 2007 2006 2005 2004
---------------- ------------- ------------- ------------- --------------
Components of net periodic benefit cost
---------------------------------------
Service cost $ 6,811 $ 6,117 $ 5,748
Interest cost on projected benefit obligation 45,215 46,416 46,468
Expected return on plan assets (60,759) (60,371) (57,203)
Amortization of prior service cost and unrecognized
net obligation $ (255) (255) (244) (244)
Amortization of unrecognized loss 6,585 11,871 9,882 8,806
------------- ------------- --------------
Net periodic benefit cost 2,883 1,800 3,575
Special termination charge 1,809 - -
------------- ------------- --------------
Total periodic benefit cost $ 4,692 $ 1,800 $ 3,575
============= ============= ==============
F-38
The plan's weighted average asset allocations at December 31, 2006 and 2005
by asset category are as follows:
2006 2005
---- ----
Asset category:
---------------
Equity securities 53% 50%
Debt securities 34% 34%
Alternative investments 12% 13%
Cash and other 1% 3%
----- ------
Total 100% 100%
===== ======
The plan's expected benefit payments by year are as follows:
($ in thousands)
----------------
Year Amount
--------------- --------------
2007 $ 52,441
2008 53,863
2009 57,319
2010 58,418
2011 59,892
2012 - 2016 320,383
--------------
Total $ 602,316
==============
Our required contribution to the plan in 2007 is $0.
The accumulated benefit obligation for the plan was $762,085,000 and
$820,475,000 at December 31, 2006 and 2005, respectively.
Assumptions used in the computation of annual pension costs and valuation
of the year-end obligations were as follows:
2006 2005
------ ------
Discount rate - used at year end to value obligation 6.00% 5.625%
Discount rate - used to compute annual cost 5.625% 6.00%
Expected long-term rate of return on plan assets 8.25% 8.25%
Rate of increase in compensation levels 4.00% 4.00%
Postretirement Benefits Other Than Pensions - "OPEB"
----------------------------------------------------
The following table sets forth the plan's benefit obligations, fair values
of plan assets and the postretirement benefit liability recognized on our
balance sheets at December 31, 2006 and 2005 and net periodic
postretirement benefit costs for the years ended December 31, 2006, 2005
and 2004.
In 2005, we approved changes to certain retiree medical plans. The plan
changes (reflected as amendments in the table below) and the related impact
are included in the accumulated postretirement benefit obligation (APBO) as
of December 31, 2005. The plan changes resulted in a reduction in the APBO
of $59,798,000 which will be amortized as a reduction of retiree medical
expense over the average remaining service life.
Assumptions used in the computation of annual OPEB costs and valuation of
the year-end OPEB obligations were as follows:
2006 2005
------ ------
Discount rate - used at year end to value obligation 6.00% 5.625%
Discount rate - used to compute annual cost 5.625% 6.00%
Expected long-term rate of return on plan assets 8.25% 8.25%
F-39
($ in thousands) 2006 2005
---------------- ------------- --------------
Change in benefit obligation
----------------------------
Benefit obligation at beginning of year $ 160,922 $ 217,380
Service cost 664 1,046
Interest cost 8,974 12,055
Plan participants' contributions 1,558 3,461
Actuarial loss 1,778 3,770
Amendments - (59,798)
Benefits paid (13,965) (16,992)
------------- --------------
Benefit obligation at end of year $ 159,931 $ 160,922
============= ==============
Change in plan assets
---------------------
Fair value of plan assets at beginning of year $ 11,424 $ 15,126
Actual return on plan assets 445 397
Benefits paid (12,407) (13,530)
Employer contribution 12,407 9,431
------------- --------------
Fair value of plan assets at end of year $ 11,869 $ 11,424
============= ==============
Accrued benefit cost
--------------------
Funded status $(148,062) $(149,498)
=============
Unrecognized prior service cost (61,161)
Unrecognized loss 42,325
--------------
Accrued benefit cost $(168,334)
==============
Amounts recognized in the consolidated balance sheet
----------------------------------------------------
Current liabilities $ (7,238) $ -
============= ==============
Other long-term liabilities $(140,824) $(168,334)
============= ==============
Accumulated other comprehensive income $ (13,703) $ -
============= ==============
Expected
($ in thousands) 2007 2006 2005 2004
--------------- ------------- ------------- ------------- --------------
Components of net periodic postretirement benefit cost
------------------------------------------------------
Service cost $ 664 $ 1,046 $ 1,128
Interest cost on projected benefit obligation 8,974 12,055 12,698
Return on plan assets (889) (1,248) (2,268)
Amortization of prior service cost and transition obligation $ (7,586) (7,589) (1,255) (204)
Amortization of unrecognized loss 4,064 4,678 6,615 5,238
------------- ------------- --------------
Net periodic postretirement benefit cost $ 5,838 $ 17,213 $ 16,592
============= ============= ==============
F-40
The plan's weighted average asset allocations at December 31, 2006 and 2005
by asset category are as follows:
2006 2005
---- ----
Asset category:
---------------
Equity securities 0% 0%
Debt securities 100% 100%
Cash and other 0% 0%
------ ------
Total 100% 100%
====== ======
The plan's expected benefit payments by year are as follows:
($ in thousands)
----------------
Gross Medicare D
Year Benefits Subsidy Total
--------------- -------------- ------------- --------------
2007 $ 10,069 $ 346 $ 9,723
2008 10,386 395 9,991
2009 10,757 455 10,302
2010 11,129 510 10,619
2011 11,648 - 11,648
2012 - 2016 59,857 - 59,857
-------------- ------------- --------------
Total $ 113,846 $ 1,706 $ 112,140
============== ============= ==============
Our expected contribution to the plan in 2007 is $9,723,000.
For purposes of measuring year-end benefit obligations, we used, depending
on medical plan coverage for different retiree groups, a 9.0% annual rate
of increase in the per-capita cost of covered medical benefits, gradually
decreasing to 5% in the year 2015 and remaining at that level thereafter.
The effect of a 1% increase in the assumed medical cost trend rates for
each future year on the aggregate of the service and interest cost
components of the total postretirement benefit cost would be $620,000 and
the effect on the accumulated postretirement benefit obligation for health
benefits would be $8,816,000. The effect of a 1% decrease in the assumed
medical cost trend rates for each future year on the aggregate of the
service and interest cost components of the total postretirement benefit
cost would be $(517,000) and the effect on the accumulated postretirement
benefit obligation for health benefits would be $(7,844,000).
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. It includes a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that
is at least actuarially equivalent to the Medicare Part D benefit. The
amount of the federal subsidy is based on 28% of an individual
beneficiary's annual eligible prescription drug costs ranging between $250
and $5,000. We have determined that the Company-sponsored postretirement
healthcare plans that provide prescription drug benefits are actuarially
equivalent to the Medicare Prescription Drug benefit. The impact of the
federal subsidy has been incorporated into the calculation.
The amounts in accumulated other comprehensive income that have not yet
been recognized as components of net periodic benefit cost at December 31,
2006 are as follows:
($ in thousands) Pension Plan OPEB
---------------- ------------ ------
Net actuarial loss $ 148,854 $ 39,869
Prior service cost (1,606) (53,572)
--------- ----------
Total $ 147,248 $ (13,703)
========= ==========
F-41
The amounts recognized as a component of accumulated comprehensive income
for the year ended December 31, 2006 are as follows:
($ in thousands) Pension Plan OPEB
---------------- ------------ -----------
Net actuarial loss recognized during year $ (11,871) $ (4,678)
Prior service cost recognized during year 255 7,589
Net actuarial loss (gain) occurring during year (62,800) 2,222
Prior service cost (credit) occurring during year (116) -
Other adjustments 22,128 (18,836)
------------ -----------
Net amount recognized in comprehensive income
for the year $ (52,404) $ (13,703)
============ ===========
401(k) Savings Plans
--------------------
We sponsor an employee retirement savings plan under section 401(k) of the
Internal Revenue Code. The plan covers substantially all full-time
employees. Under the plan, we provide matching and certain profit-sharing
contributions. Employer contributions were $4,705,000, $6,665,000 and
$7,931,000 for 2006, 2005 and 2004, respectively.
(25) 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). The City
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 owned by Bangor Gas Company from
1852-1948 and by us from 1948-1963. In acquiring the operation in 1948 we
acquired the stock of Bangor Gas Company and merged it into us. The City
alleged the existence of extensive contamination of the Penobscot River and
initially 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 filed an answer denying liability to the
City, and asserted a number of counterclaims against the City. In addition,
we identified a number of other potentially responsible parties that may be
liable for the damages alleged by the City and joined them as parties to
the lawsuit. These additional parties include UGI Utilities, Inc. and
Centerpoint Energy Resources Corporation. The Court dismissed all but two
of the City's claims, including its claims for joint and several liability
under the Comprehensive Environmental Response, Compensation, and Liability
Act (CERCLA) and the claim against us for punitive damages.
On June 27, 2006, the court issued Findings of Fact and Conclusions of Law
in the first phase of the case. The court found contamination in only a
small section of the River and determined that Citizens and the City should
share cleanup costs 60% and 40%, respectively. The precise nature of the
remedy in this case remains to be determined by subsequent proceedings.
However, based upon the Court's ruling, we believed that we would be
responsible for only a portion of the cost to clean up and the final
resolution of this matter would not be material to the operating results
nor the financial condition of the Company.
Subsequent to the June 27, 2006 judgment, we began settlement discussions
with the City, with participation from the State of Maine. In January 2007,
we reached an agreement in principle to settle the matter for a payment by
us of $7,625,000. The Bangor City Council has approved the settlement
terms, and a settlement agreement has been executed by the City and
Citizens. Completion of settlement remains contingent upon entry of a
Consent Decree with the State that is reasonably acceptable to us. We are
in negotiations with the State over the terms of the Consent Decree. If the
settlement of this matter does not become effective, we intend to (i) seek
relief from the Court in connection with the adverse aspects of the Court's
opinion and (ii) continue pursuing our right to obtain contribution from
the third parties against whom we have commenced litigation in connection
with this case. In addition, 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 and 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. We cannot at this time determine what
amount we may recover from third parties or insurance carriers.
F-42
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 were cooperating with the patent holder
to determine if we are using or have used any of the processes that are
protected by its patents but received no correspondence in this regard from
late 2004 through January 2007. In January 2007, we received a letter from
counsel to Katz Technology asking to meet with us to discuss Katz
Technology's continuing offer of a license under Katz Technology's patents.
We are continuing to investigate whether we are utilizing Katz Technology's
patented technology, and will discuss Katz Technology's license offer with
them, as and when appropriate.
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 $1,000,000,000. In August 2004, we notified Citibank by letter that
we believe its claims for indemnification are invalid and are not supported
by applicable law. We have received no further communications from Citibank
since our August 2004 letter.
We are party to other legal proceedings arising in the normal course of our
business. The outcome of individual matters is not predictable. However, we
believe that the ultimate resolution of all such matters, after considering
insurance coverage, will not have a material adverse effect on our
financial position, results of operations, or our cash flows.
Although we from time to time make short-term purchasing commitments to
vendors with respect to these expenditures, we generally do not enter into
firm, written contracts for such activities.
We conduct certain of our operations in leased premises and also lease
certain equipment and other assets pursuant to operating leases. The lease
arrangements have terms ranging from 1 to 99 years and several contain rent
escalation clauses providing for increases in monthly rent at specific
intervals. When rent escalation clauses exist, we record total expected
rent payments on a straight-line basis over the lease term. Certain leases
also have renewal options. Renewal options that are reasonably assured are
included in determining the lease term. Future minimum rental commitments
for all long-term noncancelable operating leases and future minimum capital
lease payments for continuing operations as of December 31, 2006 are as
follows:
($ in thousands)
---------------- Operating
Leases
----------
Year ending December 31:
2007 $ 15,794
2008 9,817
2009 9,693
2010 8,593
2011 7,311
Thereafter 18,185
---------
Total minimum lease payments $ 69,393
=========
F-43
Total rental expense included in our results of operations for the years
ended December 31, 2006, 2005 and 2004 was $16,281,000, $16,859,000 and
$17,410,000, respectively.
We are a party to contracts with several unrelated long distance carriers.
The contracts provide fees based on traffic they carry for us subject to
minimum monthly fees.
At December 31, 2006, the estimated future payments for obligations under
our noncancelable long distance contracts and service agreements are as
follows:
($ in thousands)
----------------
Year
--------------- ---------------
2007 $ 26,449
2008 18,899
2009 16,610
2010 7,382
2011 165
thereafter 660
---------------
Total $ 70,165
===============
We sold all of our 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 No. 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 credit
ratings equal to or superior to ours, 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, 2008 and remained in default for
the duration of the contract (another 8 years), we estimate that our
undiscounted purchase obligation for 2008 through 2015 would be
approximately $1.1 billion. In such a scenario the Company would then own
the power and could seek to recover its costs. We would do this by seeking
to recover our costs from the defaulting members and/or reselling the power
to other utility providers or the northeast power grid. There is an active
market for the sale of power. We could potentially lose money if we were
unable to sell the power at cost. We caution that we cannot predict with
any degree of certainty any potential outcome.
At December 31, 2006, we have outstanding performance letters of credit as
follows:
($ in thousands)
----------------
Cellco (Verizon Wireless) $ 375
CNA 19,404
State of New York 2,993
ELI projects 50
--------
Total $ 22,822
========
F-44
CNA serves as our agent with respect to general liability claims (auto,
workers compensation and other insured perils of the Company). As our
agent, they administer all claims and make payments for claims on our
behalf. We reimburse CNA for such services upon presentation of their
invoice. To serve as our agent and make payments on our behalf, CNA
requires that we establish a letter of credit in their favor. CNA could
potentially draw against this letter of credit if we failed to reimburse
CNA in accordance with the terms of our agreement. The value of the letter
of credit is reviewed annually and adjusted based on claims history.
None of the above letters of credit restrict our cash balances.
F-45