CITIZENS COMMUNICATIONS COMPANY
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2007
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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)
(203) 614-5600
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(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is 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 Exchange Act).
Yes No X
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The number of shares outstanding of the registrant's Common Stock as of April
27, 2007 was 342,417,357.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index
Page No.
--------
Part I. Financial Information (Unaudited)
Financial Statements
Consolidated Balance Sheets at March 31, 2007 and December 31, 2006 2
Consolidated Statements of Operations for the three months ended March 31, 2007 and 2006 3
Consolidated Statements of Shareholders' Equity for the year ended
December 31, 2006 and the three months ended March 31, 2007 4
Consolidated Statements of Comprehensive Income for the three
months ended March 31, 2007 and 2006 4
Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and 2006 5
Notes to Consolidated Financial Statements 6
Management's Discussion and Analysis of Financial Condition and Results of Operations 24
Quantitative and Qualitative Disclosures about Market Risk 35
Controls and Procedures 35
Part II. Other Information
Legal Proceedings 36
Risk Factors 36
Unregistered Sales of Equity Securities and Use of Proceeds 37
Exhibits 37
Signature 38
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)
(Unaudited)
March 31, 2007 December 31, 2006
------------------ -------------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 1,037,729 $ 1,041,106
Accounts receivable, less allowances of $22,648 and $108,537, respectively 218,174 187,737
Other current assets 61,322 44,150
------------------ -------------------
Total current assets 1,317,225 1,272,993
Property, plant and equipment, net 3,329,687 2,983,504
Goodwill, net 2,492,098 1,917,751
Other intangibles, net 896,820 432,353
Investments 20,609 16,474
Other assets 172,878 168,130
------------------ -------------------
Total assets $ 8,229,317 $ 6,791,205
================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Long-term debt due within one year $ 569,848 $ 39,271
Accounts payable and other current liabilities 423,656 386,372
------------------ -------------------
Total current liabilities 993,504 425,643
Deferred income taxes 761,083 514,130
Other liabilities 403,140 332,645
Long-term debt 4,755,148 4,460,755
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares; 343,129,000
and 322,265,000 outstanding, respectively, 349,456,000 issued at
March 31, 2007 and 343,956,000 issued at December 31, 2006) 87,364 85,989
Additional paid-in capital 1,287,404 1,207,399
Retained earnings 116,910 134,705
Accumulated other comprehensive loss, net of tax (81,919) (81,899)
Treasury stock (93,317) (288,162)
------------------ -------------------
Total shareholders' equity 1,316,442 1,058,032
------------------ -------------------
Total liabilities and shareholders' equity $ 8,229,317 $ 6,791,205
================== ===================
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
2
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
($ in thousands, except for per-share amounts)
(Unaudited)
2007 2006
--------------- --------------
Revenue $ 556,147 $ 506,861
Operating expenses:
Network access expenses 50,793 40,218
Other operating expenses 189,871 187,301
Depreciation and amortization 122,181 122,004
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Total operating expenses 362,845 349,523
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Operating income 193,302 157,338
Investment and other income (loss), net 10,017 (1,351)
Interest expense 93,964 85,393
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Income from continuing operations before income taxes 109,355 70,594
Income tax expense 41,688 26,607
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Income from continuing operations 67,667 43,987
Discontinued operations (see Note 6):
Income from discontinued operations - 10,458
Income tax expense - 3,962
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Income from discontinued operations - 6,496
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Net income available for common shareholders $ 67,667 $ 50,483
=============== ==============
Basic income per common share:
Income from continuing operations $ 0.21 $ 0.13
Income from discontinued operations - 0.02
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Net income per common share $ 0.21 $ 0.15
=============== ==============
Diluted income per common share:
Income from continuing operations $ 0.21 $ 0.13
Income from discontinued operations - 0.02
--------------- --------------
Net income per common share $ 0.21 $ 0.15
=============== ==============
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
3
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2006 AND THE THREE MONTHS ENDED MARCH 31, 2007
($ in thousands)
(Unaudited)
Accumulated
Common Stock Additional Other Treasury Stock Total
------------------ Paid-In Retained Comprehensive ------------------- Shareholders'
Shares Amount Capital Earnings Loss Shares Amount Equity
-------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balance January 1, 2006 343,956 $85,989 $1,374,610 $ (85,344) $(123,242) (15,788) $(210,204) $1,041,809
Cumulative effect adjustment - - - 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 No.
158, net of taxes - - - - (83,634) - - (83,634)
Other comprehensive loss, 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
Stock plans - - 610 - - 1,055 4,648 5,258
Acquisition of Commonwealth 5,500 1,375 78,047 - - 12,552 166,803 246,225
Conversion of EPPICS - - (513) - - 280 3,718 3,205
Conversion of Commonwealth Notes - - 1,861 - - 2,300 31,692 33,553
Dividends on common stock of
$0.25 per share - - - (85,462) - - - (85,462)
Shares repurchased - - - - - (823) (12,016) (12,016)
Net income - - - 67,667 - - - 67,667
Other comprehensive income,
net of tax and
reclassifications adjustments - - - - (20) - - (20)
-------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balance March 31, 2007 349,456 $87,364 $1,287,404 $ 116,910 $ (81,919) (6,327) $ (93,317) $1,316,442
======== ========= =========== ============ ============ ======== =========== ===========
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
($ in thousands)
(Unaudited)
For the three months ended March 31,
---------------------------------------
2007 2006
------------------ -------------------
Net income $ 67,667 $ 50,483
Other comprehensive income(loss), net
of tax and reclassifications
adjustments* (20) 8
------------------ -------------------
Total comprehensive income $ 67,647 $ 50,491
================== ===================
* Consists of unrealized holding (losses)/gains of marketable securities.
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
4
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
($ in thousands)
(Unaudited)
2007 2006
---------------- ---------------
Cash flows provided by (used in) operating activities:
Net income $ 67,667 $ 50,483
Deduct: Income from discontinued operations, net of tax - (6,496)
Adjustments to reconcile income to net cash provided by
operating activities:
Depreciation and amortization expense 122,181 122,004
Stock based compensation expense 3,407 2,677
Other non-cash adjustments 2,982 4,362
Deferred income taxes 23,614 24,163
Change in accounts receivable 10,366 23,166
Change in accounts payable and other liabilities (57,242) (52,606)
Change in other current assets (1,714) (3,140)
---------------- ---------------
Net cash provided by continuing operating activities 171,261 164,613
Cash flows from investing activities:
Capital expenditures (45,111) (43,765)
Cash paid for Commonwealth (net of acquired) (649,507) -
Other assets (purchased) distributions received, net 571 324
---------------- ---------------
Net cash used by investing activities (694,047) (43,441)
Cash flows from financing activities:
Repayment of customer advances for
construction and contributions in aid of construction, net (602) (473)
Long-term debt borrowings 950,000 -
Long-term debt payments (327,815) (240)
Financing costs paid (9,815) -
Issuance of common stock 5,119 9,452
Common stock repurchased (12,016) (37,916)
Dividends paid (85,462) (82,633)
---------------- ---------------
Net cash provided (used by) financing activities 519,409 (111,810)
Cash flows of discontinued operations:
Operating cash flows - 8,580
Investing cash flows - (2,422)
Financing cash flows - -
---------------- ---------------
- 6,158
Increase (decrease) in cash and cash equivalents (3,377) 15,520
Cash and cash equivalents at January 1, 1,041,106 268,917
---------------- ---------------
Cash and cash equivalents at March 31, $ 1,037,729 $ 284,437
================ ===============
Cash paid during the period for:
Interest $ 97,416 $ 95,079
Income taxes (refunds) $ 6,786 $ (133)
Non-cash investing and financing activities:
Change in fair value of interest rate swaps $ 2,349 $ (8,811)
Conversion of EPPICS $ 3,205 $ 13,130
Conversion of Commonwealth Notes $ 33,553 $ -
Debt-for-debt exchange, net $ - $ (70)
Shares issued for Commonwealth acquisition $ 246,225 $ -
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
5
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
(1) Summary of Significant Accounting Policies:
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(a) Basis of Presentation and Use of Estimates:
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Citizens Communications Company and its subsidiaries are referred to
as "we," "us," "our," or the "Company" in this report. Our unaudited
consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (GAAP) and should be read in conjunction with the consolidated
financial statements and notes included in our Annual Report on Form
10-K for the year ended December 31, 2006. Certain reclassifications
of balances previously reported have been made to conform to the
current presentation. All significant intercompany balances and
transactions have been eliminated in consolidation. These unaudited
consolidated financial statements include all adjustments (consisting
of normal recurring accruals) considered necessary to present fairly
the results for the interim periods shown.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions which affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results may differ from those estimates.
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. Certain information and footnote disclosures have been
excluded and/or condensed pursuant to Securities and Exchange
Commission rules and regulations. The results of the interim periods
are not necessarily indicative of the results for the full year.
(b) Cash Equivalents:
-----------------
We consider all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
(c) Revenue Recognition:
--------------------
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.
The Company collects various taxes from its customers and subsequently
remits such funds to governmental authorities. Substantially all of
these taxes are recorded through the balance sheet and presented on a
net basis in our statement of operations. We also collect Universal
Service Fund ("USF") surcharges from customers (primarily federal USF)
which have been recorded on a gross basis in our statement of
operations and have been included in revenues and other operating
expenses at $7,102,000 and $10,167,000 for the three months ended
March 31, 2007 and 2006, respectively.
(d) Property, Plant and Equipment:
------------------------------
Property, plant and equipment are stated at original cost or fair
market value for our acquired properties, including capitalized
interest. Maintenance and repairs are charged to operating expenses as
incurred. The gross book value of routine property, plant and
equipment retired is charged against accumulated depreciation.
(e) Goodwill and Other Intangibles:
-------------------------------
Intangibles represent the excess of purchase price over the fair value
of identifiable tangible assets acquired. We undertake studies to
determine the fair values of assets and liabilities acquired and
allocate purchase prices to assets and liabilities, including
property, plant and equipment, goodwill and other identifiable
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.
6
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill
and Other Intangible Assets," 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) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
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of:
---
We review long-lived assets to be held and used and long-lived assets
to be disposed of, including intangible assets with estimated useful
lives, for impairment whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be
recoverable. Recoverability of assets to be held and used is measured
by comparing the carrying amount of the asset to the future
undiscounted net cash flows expected to be generated by the asset.
Recoverability of assets held for sale is measured by comparing the
carrying amount of the assets to their estimated fair market value. If
any assets are considered to be impaired, the impairment is measured
by the amount by which the carrying amount of the assets exceeds the
estimated fair value.
(g) Derivative Instruments and Hedging Activities:
----------------------------------------------
We account for derivative instruments and hedging activities in
accordance with SFAS No. 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.
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.
(h) 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 three month period ended March 31, 2007 was $3,407,000 ($2,147,000
after tax, or $0.01 per basic and diluted share of common stock) and
$2,677,000 ($1,673,000 after tax, or $0.01 per basic and diluted share
of common stock) for the three month period ended March 31, 2006. 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.
7
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), the 1996 Equity Incentive Plan (EIP) or the Amended and
Restated 2000 EIP stock plan.
(i) Net Income Per Common Share Available for Common Shareholders:
--------------------------------------------------------------
Basic net income per common share is computed using the weighted
average number of common shares outstanding during the period being
reported on. Except when the effect would be antidilutive, diluted net
income per common share reflects the dilutive effect of the assumed
exercise of stock options using the treasury stock method at the
beginning of the period being reported on as well as common shares
that would result from the conversion of convertible preferred stock
(EPPICS) and convertible notes. 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:
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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 either taken or expected to be
taken in the Company's income tax returns. We have adopted the provisions
of FIN No. 48 in the first quarter of 2007. The total amount of our FIN No.
48 tax liability for tax positions that may not be sustained under a "more
likely than not" threshold is reflected on the Company's balance sheet as
of the date of adoption at $44,708,000. This amount includes an accrual for
interest in the amount of $4,621,000. These balances include amounts of
$8,977,000 and $1,439,000 for total FIN No. 48 tax liabilities and accrued
interest, respectively, pursuant to the Company's acquisition of
Commonwealth Telephone Enterprises, Inc. The amount of our total FIN No. 48
tax liabilities reflected above that would positively impact the
calculation of our effective income tax rate, if our tax positions are
sustained, is $20,901,000.
The Company's policy regarding the classification of interest and penalties
is to include these amounts as a component of income tax expense. This
treatment of interest and penalties is consistent with prior periods. We
have recognized in our year to date statement of operations additional
interest in the amount of $239,000. We do not expect that our balances with
respect to our uncertain tax positions will significantly increase or
decrease within the next 12 months. We are subject to income tax
examinations generally for the years 2003 forward for both our federal and
state filing jurisdictions.
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," 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 adopted the disclosure requirements of EITF No. 06-3
commencing January 1, 2007.
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 adoption of the
accounting requirements of EITF No. 06-5 in the first quarter of 2007 had
no impact on our financial position, results of operation or cash flows.
8
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 SFAS 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.
Fair Value Measurements
-----------------------
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements",
which defines fair value, establishes a framework for measuring fair value,
and expands disclosures about fair value measurements. The provisions of
SFAS No. 157 are effective as of the beginning of our 2008 fiscal year. The
Company is currently evaluating the impact that the adoption of the
standard will have on the Company's results of operations or financial
condition.
Fair Value Option for Financial Assets and Financial Liabilities
----------------------------------------------------------------
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities Including an amendment of FASB
Statement No. 115," which permits entities to choose to measure many
financial instruments and certain other items at fair value. The provisions
of SFAS No. 159 are effective as of the beginning of our 2008 fiscal year.
The Company is currently evaluating the impact that the adoption of the
standard will have on the Company's results of operations or financial
condition.
Accounting for Collateral Assignment Split-Dollar Life Insurance
---------------------------------------------------------------------------
Arrangements
------------
In March 2007, the FASB ratified the consensus reached by the EITF on Issue
No. 06-10, "Accounting for Collateral Assignment Split-Dollar Life
Insurance Arrangements." EITF No. 06-10 provides guidance on an employers'
recognition of a liability and related compensation costs for collateral
assignment split-dollar life insurance arrangements that provide a benefit
to an employee that extends into postretirement periods and the asset in
collateral assignment split-dollar life insurance arrangements. The
effective date of EITF No. 06-10 is for fiscal years beginning after
December 15, 2007. The Company is currently evaluating the impact that the
adoption of the standard will have on the Company's results of operations
or financial condition.
(3) Acquisition of Commonwealth Telephone:
--------------------------------------
On March 8, 2007, we acquired Commonwealth Telephone Enterprises, Inc.
("Commonwealth" or "CTE") in a cash-and-stock taxable transaction, for a
total consideration of approximately $1.1 billion. At closing we paid
$790.0 million in cash ($649.5 million net, after cash acquired), issued
common stock with a value of $246.2 million and accrued $19.7 million of
closing costs.
In connection with the acquisition of Commonwealth, we assumed $35 million
of debt under a revolving credit facility and $192 million face amount of
Commonwealth convertible notes (fair value of $210 million). During March
2007, we paid down the $35 million credit facility and retired $115 million
face amount (for which we paid $92.2 million in cash and $22.4 million in
common stock) of the convertible notes (premium paid of $11.2 million and
recorded as purchase price). We have received conversion notices and will
retire an additional $68.7 million of Commonwealth notes during the second
quarter of 2007, resulting in a remaining outstanding balance of $8.5
million.
We are accounting for the acquisition of Commonwealth as a purchase under
U.S. generally accepted accounting principles. Under the purchase method of
accounting, the assets and liabilities of Commonwealth are recorded as of
the acquisition date, at their respective fair values, and consolidated
with those of Citizens. The reported consolidated financial condition of
Citizens as of March 31, 2007 reflects a preliminary estimate of these fair
values.
9
The following schedule provides a summary of the purchase price paid by
Citizens in the acquisition of Commonwealth ($ in thousands):
Cash paid at closing $ 789,982
Value of Citizens common stock issued 246,225
Accrued closing costs 19,664
--------------
Total Purchase Price $ 1,055,871
==============
The allocation of the purchase price to assets and liabilities is
preliminary. The estimated purchase price has been allocated to the net
tangible and intangible assets and liabilities acquired as follows ($ in
thousands):
Allocation of estimated purchase price:
Current assets (1) $ 190,361
Property, plant and equipment 387,720
Goodwill 574,347
Other intangibles - customer list 500,000
Other assets 11,234
Current portion of debt (35,000)
Accounts payable and other current liabilities (77,224)
Deferred income taxes (251,394)
Convertible Notes (210,749)
Other liabilities (33,424)
---------------
Total Purchase Price $ 1,055,871
===============
(1) Includes $140.5 million of acquired cash.
The final allocation of the purchase price will be based on the fair values
of the assets acquired and liabilities assumed as determined by third-party
valuation. The actual allocation may differ significantly from the
preliminary allocation.
The following unaudited pro forma financial information presents the
combined results of operations of Citizens and Commonwealth as if the
acquisition had occurred at the beginning of each period presented. The
historical results of the Company include the results of Commonwealth from
the date of acquisition on March 8, 2007. The pro forma information is not
necessarily indicative of what the financial position or results of
operations actually would have been had the acquisition been completed at
the date indicated. In addition, the unaudited pro forma financial
information does not purport to project the future financial position or
operating results of Citizens after completion of the acquisition.
10
For the three months ended
March 31,
-------------------------------
2007 2006
-------------- ---------------
($ in thousands, except per share amounts)
----------------------------------------
Revenue $ 618,411 $ 589,052
Operating income $ 204,832 $ 172,359
Income from continuing operations $ 75,664 $ 45,315
Income from discontinued operations $ - $ 6,496
Net income available for common shareholders $ 75,664 $ 51,811
Basic income per common share:
Income from continuing operations $ 0.22 $ 0.13
Income from discontinued operations - 0.02
-------------- ---------------
Net income per common share $ 0.22 $ 0.15
============== ===============
Diluted income per common share:
Income from continuing operations $ 0.22 $ 0.13
Income from discontinued operations - 0.02
-------------- ---------------
Net income per common share $ 0.22 $ 0.15
============== ===============
(4) Accounts Receivable:
--------------------
The components of accounts receivable, net at March 31, 2007 and December
31, 2006 are as follows:
($ in thousands) March 31, 2007 December 31, 2006
-------------- --------------------- --------------------
End user $ 224,036 $ 273,828
Other 16,786 22,446
Less: Allowance for doubtful accounts (22,648) (108,537)
--------------------- --------------------
Accounts receivable, net $ 218,174 $ 187,737
===================== ====================
The Company maintains an allowance for estimated bad debts based on its
estimate of collectibility of its accounts receivable. Bad debt expense,
which is recorded as a reduction of revenue, was $4,904,000 and $4,373,000
for the three months ended March 31, 2007 and 2006, respectively.
Our allowance for doubtful accounts (and "end user" receivables) declined
from December 31, 2006 primarily as a result of the resolution of a carrier
dispute. On March 12, 2007, we entered into a settlement agreement with a
carrier pursuant to which we were paid $37.5 million, resulting in a
favorable impact on our revenue for the three months ended March 31, 2007
of $38.7 million.
(5) Property, Plant and Equipment, Net:
-----------------------------------
Property, plant and equipment at March 31, 2007 and December 31, 2006 are
as follows:
($ in thousands) March 31, 2007 December 31, 2006
-------------- --------------------- ---------------------
Property, plant and equipment $ 7,109,325 $ 6,685,466
Less: accumulated depreciation (3,779,638) (3,701,962)
--------------------- ---------------------
Property, plant and equipment, net $ 3,329,687 $ 2,983,504
===================== =====================
Depreciation expense is principally based on the composite group method.
Depreciation expense was $86,647,000 and $90,409,000 for the three months
ended March 31, 2007 and 2006, respectively.
11
(6) Discontinued Operations:
------------------------
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 $5.0 million due to the utilization of
existing tax net operating losses on both the federal and state level.
In accordance with SFAS No. 144, any component of our business that we
dispose of or classify as held for sale that has operations and cash flows
clearly distinguishable from continuing operations for financial reporting
purposes, and that will be eliminated from the ongoing operations, should
be classified as discontinued operations. Accordingly, we have classified
the results of operations of ELI as discontinued operations in our
consolidated statement of operations.
Summarized financial information for ELI is set forth below:
For the three months ended
($ in thousands) March 31, 2006
-------------- ----------------
Revenue $ 42,494
Operating income $ 10,458
Income taxes $ 3,962
Net income $ 6,496
(7) Other Intangibles:
------------------
Other intangibles at March 31, 2007 and December 31, 2006 are as follows:
($ in thousands) March 31, 2007 December 31, 2006
-------------- ------------------------ ---------------------
Customer base - amortizable over 96 months $ 1,494,744 $ 994,605
Trade name - non-amortizable 121,919 122,058
------------------------ ---------------------
Other intangibles 1,616,663 1,116,663
Less: Accumulated amortization (719,843) (684,310)
------------------------ ---------------------
Total other intangibles, net $ 896,820 $ 432,353
======================== =====================
Amortization expense was $35,534,000 and $31,595,000 for the three months
ended March 31, 2007 and 2006, respectively. Amortization expense for the
three months ended March 31, 2007 is comprised of $31,595,000 for our "base
business" and $3,939,000 for the 23 days of March during which we owned
Commonwealth. On a preliminary basis, $500,000,000 has been allocated to
the customer base acquired in the Commonwealth acquisition, with
amortization to be based on an eight-year life ($62,500,000 annually).
12
(8) Long-Term Debt:
---------------
The activity in our long-term debt from December 31, 2006 to March 31, 2007
is as follows:
Three months ended March 31, 2007
----------------------------------------------------------
Assumed Interest
From Rate* at
December 31, New Commonwealth Interest Reclassification/ March 31, March 31,
($ in thousands) 2006 Payments Borrowings Acquisition Rate Swap Other 2007 2007
---------------- ----- -------- ---------- ----------- --------- ----- ----- ----
FIXED RATE
Rural Utilities Service
Loan Contracts $ 21,886 $ (243) $ - $ - $ - $ - $ 21,643 6.01%
Senior Unsecured Debt 4,435,018 (327,572) 950,000 226,779 2,349 (22,356) 5,264,218 7.99%
EPPICS 17,860 - - - - (3,205) 14,655 5.00%
Industrial Development
Revenue Bonds 58,140 - - - - - 58,140 5.56%
----------- ---------- --------- ---------- -------- ---------- -----------
TOTAL LONG-TERM DEBT $4,532,904 $(327,815) $ 950,000 $ 226,779 $ 2,349 $(25,561) $5,358,656 7.95%
----------- ========== ========= ========== ======== ========== -----------
Less: Debt Discount (32,878) (33,660)
Less: Current Portion (39,271) (569,848)
----------- -----------
$4,460,755 $4,755,148
=========== ===========
* Interest rate includes amortization of debt issuance costs, debt premiums or
discounts. The interest rates for Rural Utilities Service Loan Contracts, Senior
Unsecured Debt, and Industrial Development Revenue Bonds represent a weighted
average of multiple issuances.
For the three months ended March 31, 2007, we retired an aggregate
principal amount of $353,376,000 of debt, including $3,205,000 of 5%
Company Obligated Mandatorily Redeemable Convertible Preferred Securities
due 2036 (EPPICS) and $22,356,000 of 3.25% Commonwealth convertible notes
that were converted into our common stock. Additionally, as further
described below, we temporarily borrowed and repaid $200 million during the
month of March 2007, utilized to temporarily fund our acquisition of
Commonwealth. Although this borrowing does not appear in our December 31,
2006 or March 31, 2007 balance sheet, the borrowing and repayment are shown
gross in the above table.
During the first quarter of 2006, we entered into two debt-for-debt
exchanges of our debt securities. As a result, $47,500,000 of our 7.625%
notes due 2008 were exchanged for approximately $47,430,000 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 that were exchanged. No cash was exchanged
in these transactions. However, 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 for the three months ended March 31,
2006.
In connection with the acquisition of Commonwealth, we assumed $35 million
of debt under a revolving credit facility and approximately $192 million
face amount of Commonwealth convertible notes (fair value of approximately
$210 million). During March we paid down the $35 million credit facility
and retired approximately $115 million face amount (for which we paid $92.2
million in cash and $22.4 million in common stock) of the convertible notes
(premium paid of $11.2 million and recorded as purchase price). We have
received conversion notices and will retire an additional $68.7 million of
Commonwealth notes during the second quarter of 2007, resulting in a
remaining outstanding balance of $8.5 million.
13
On March 23, 2007, we issued in a private placement an aggregate $300.0
million principal amount of 6.625% Senior Notes due 2015 and $450.0 million
principal amount of 7.125% Senior Notes due 2019. Proceeds from the sale
were used to pay down $200.0 million principal amount of indebtedness
borrowed on March 8, 2007 under a bridge loan facility. The bridge loan was
established to help fund our acquisition of Commonwealth, and with the pay
down the facility was terminated. During the three months ended March 31,
2007, we incurred and expensed approximately $4.0 million of fees
associated with the bridge loan facility. We have filed with the SEC a
registration statement for the purpose of exchanging the $750.0 million in
private placement notes described above, in addition to the $400 million
principal amount of 7.875% Senior Notes issued in a private placement on
December 22, 2006, for registered notes, and commenced the exchange offer.
On April 26, 2007, we redeemed $495.2 million principal amount of our
7.625% Senior Notes due 2008 at a price of 103.041% plus accrued and unpaid
interest, and have classified that debt as a current obligation in our
balance sheet as of March 31, 2007.
As of March 31, 2007, EPPICS representing a total principal amount of
$197.1 million have been converted into 15.9 million shares of our common
stock. Approximately $4.2 million of EPPICS, which are convertible into
361,904 shares of our common stock, were outstanding at March 31, 2007. Our
long-term debt footnote indicates $14,655,000 of EPPICS outstanding at
March 31, 2007, of which $10,500,000 is debt of related parties for which
the company has an offsetting receivable.
The total outstanding principal amount of industrial development revenue
bonds, that are included in long-term debt, was $58,140,000 at March 31,
2007 and December 31, 2006. 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 approximately
$33,440,000. The first call dates for these bonds 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 March 31, 2007, we had available lines of credit with financial
institutions in the aggregate amount of $249.6 million. Outstanding standby
letters of credit issued under the facility were $0.4 million. Associated
facility fees vary, depending on our leverage ratio, and were 0.375% per
annum as of March 31, 2007. The expiration date for the facility is October
29, 2009. During the term of the credit facility we may borrow, repay and
reborrow funds. The credit facility is available for general corporate
purposes but may not be used to fund dividend payments.
We are in compliance with all of our debt and credit facility covenants.
14
(9) Net Income Per Common Share:
----------------------------
The reconciliation of the net income per common share calculation for the
three months ended March 31, 2007 and 2006, respectively, is as follows:
($ in thousands, except per-share amounts) For the three months ended March 31,
---------------------------------------- ----------------------------------
2007 2006
---------------- ----------------
Net income used for basic and diluted earnings
----------------------------------------------
per common share:
-----------------
Income from continuing operations $ 67,667 $ 43,987
Income from discontinued operations - 6,496
---------------- ----------------
Total basic net income available for common shareholders $ 67,667 $ 50,483
================ ================
Effect of conversion of preferred securities - EPPICS 58 182
---------------- ----------------
Total diluted net income available for common shareholders $ 67,725 $ 50,665
================ ================
Basic earnings per common share:
--------------------------------
Weighted-average shares outstanding - basic 326,542 327,132
---------------- ----------------
Income from continuing operations $ 0.21 $ 0.13
Income from discontinued operations - 0.02
---------------- ----------------
Net income per share available for common shareholders $ 0.21 $ 0.15
================ ================
Diluted earnings per common share:
----------------------------------
Weighted-average shares outstanding 326,542 327,132
Effect of dilutive shares 832 960
Effect of conversion of preferred securities - EPPICS 503 1,458
---------------- ----------------
Weighted-average shares outstanding - diluted 327,877 329,550
================ ================
Income from continuing operations $ 0.21 $ 0.13
Income from discontinued operations - 0.02
---------------- ----------------
Net income per share available for common sharesholders $ 0.21 $ 0.15
================ ================
Stock Options
-------------
For the three months ended March 31, 2007 and 2006, options to purchase
1,803,000 and 1,960,000 shares, respectively, (at exercise prices ranging
from $12.82 to $18.46) issuable under employee compensation plans were
excluded from the computation of diluted EPS for those periods because the
exercise prices were greater than the average market price of common shares
and, therefore, the effect would be antidilutive. In calculating diluted
EPS we apply the treasury stock method and include future unearned
compensation as part of the assumed proceeds.
In addition, for the three months ended March 31, 2007 and 2006, restricted
stock awards of 1,409,000 and 1,488,000 shares, respectively, are excluded
from our basic weighted average shares outstanding and included in our
dilutive shares until the shares are no longer contingent upon the
satisfaction of all specified conditions.
EPPICS
------
As a result of our July 2004 dividend announcement with respect to our
common stock, our EPPICS began to convert into shares of our common stock.
As of March 31, 2007, approximately 98% of the EPPICS outstanding, or about
$197,101,000 aggregate principal amount of EPPICS, have converted into
15,906,539 shares of our common stock, including shares issued from
treasury.
At March 31, 2007, we had 82,977 shares of potentially dilutive EPPICS,
which were convertible into our common stock at a 4.3615 to 1 ratio at an
exercise price of $11.46 per share. If all remaining EPPICS are converted,
we would issue approximately 361,904 shares of our common stock. These
securities have been included in the diluted income per common share
calculation for the period ended March 31, 2007.
15
At March 31, 2006, we had 202,991 shares of potentially dilutive EPPICS,
which were convertible into our common stock at a 4.3615 to 1 ratio at an
exercise price of $11.46 per share. If all remaining EPPICS are converted
we would issue approximately 885,345 shares of our common stock. These
securities have been included in the diluted income per common share
calculation for the three months ended March 31, 2006.
Stock Units
-----------
At March 31, 2007 and 2006, we had 385,178 and 259,320 stock units,
respectively, issued under our Non-Employee Directors' Deferred Fee Equity
Plan (Deferred Fee Plan), Non-employee Directors' Equity Incentive Plan
(Directors' Equity Plan) and Non-Employee Directors' Retirement Plan. These
securities have not been included in the diluted income per share of common
stock calculation because their inclusion would have had an antidilutive
effect.
Share Repurchase Programs
-------------------------
In February 2007, our Board of Directors authorized us to repurchase up to
$250,000,000 of our common stock in public or private transactions over the
following twelve-month period. This share repurchase program commenced on
March 19, 2007. As of March 31, 2007, we had repurchased 823,000 shares of
our common stock at an aggregate cost of approximately $12,016,000.
(10) Stock Plans:
------------
At March 31, 2007, we had five stock-based compensation plans, which are
described below. 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
the cost of stock options, restricted shares and stock units issued
pursuant to the Management Equity Incentive Plan (MEIP), the 1996 Equity
Incentive Plan (1996 EIP), the Amended and Restated 2000 Equity Incentive
Plan (2000 EIP), the Deferred Fee Plan and the Directors' Equity Plan. Our
general policy is to issue shares upon the grant of restricted shares and
exercise of options from treasury. At March 31, 2007, there were 16,058,182
shares authorized for grant under these plans and 5,233,978 shares
available for grant. No further awards may be granted under the MEIP, the
1996 EIP or the Deferred Fee Plan.
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 4 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, SARs, restricted stock or other stock-based
awards. As discussed under the Non-Employee Directors' Compensation Plans
below, prior to May 25, 2006 non-employee directors received an award of
stock options under the 2000 EIP upon commencement of service.
At March 31, 2007, there were 13,517,421 shares authorized for grant under
the 2000 EIP and 2,813,787 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. 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 4 years).
16
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.
The following summary presents information regarding outstanding stock
options as of March 31, 2007 and changes during the three months then ended
with regard to options under the MEIP and the EIPs:
Aggregate
Weighted Weighted Intrinsic
Shares Average Average Value at
Subject to Option Price Remaining March 31,
Option Per Share Life in Years 2007
--------------------------------------------- -------------- --------------- -------------- -----------------
Balance at January 1, 2007 5,242,000 $12.41
Options granted - -
Options exercised (488,000) $ 9.83 $ 2,311,000
Options canceled, forfeited or lapsed (9,000) $12.56
--------------------------------------------- --------------
Balance at March 31, 2007 4,745,000 $12.68 4.17 $13,962,000
============================================= ==============
Exercisable at March 31, 2007 4,303,000 $12.89 3.95 $12,031,000
============================================= ==============
There were no options granted during the first three months of 2007. Cash
received upon the exercise of options during the first three months of 2007
totaled $5,119,000. Total remaining unrecognized compensation cost
associated with unvested stock options at March 31, 2007 was $340,000 and
the weighted average period over which this cost is expected to be
recognized is approximately one year.
The total intrinsic value of stock options exercised during the first three
months of 2006 was $3,146,000. The total intrinsic value of stock options
outstanding and exercisable at March 31, 2006 was $16,683,000 and
$11,783,000, respectively. There were no option grants made during the
first three months of 2006. Cash received upon the exercise of options
during the first three months of 2006 totaled $9,452,000.
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.
The following table presents the weighted average assumptions used for
grants in fiscal 2006:
2006
---------------------------- --------------
Dividend yield 7.55%
Expected volatility 44%
Risk-free interest rate 4.89%
Expected life 5 years
---------------------------- --------------
17
The following summary presents information regarding unvested restricted
stock as of March 31, 2007 and changes during the three months then ended
with regard to restricted stock under the MEIP and the EIPs:
Weighted Aggregate
Average Fair Value at
Number of Grant Date March 31,
Shares Fair Value 2007
------------------------------------ ------------- ----------------- ----------------
Balance at January 1, 2007 1,174,000 $12.89
Restricted stock granted 691,000 $15.08 $10,325,000
Restricted stock vested (456,000) $12.74 $ 6,801,000
Restricted stock forfeited - -
------------------------------------ -------------
Balance at March 31, 2007 1,409,000 $14.02 $21,069,000
==================================== =============
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 March 31, 2007 was $18,527,000 and the weighted
average period over which this cost is expected to be recognized is
approximately three years.
The total fair value of shares granted and vested during the three months
ended March 31, 2006 was approximately $9,027,000 and $6,923,000,
respectively. The total fair value of unvested restricted stock at March
31, 2006 was $19,752,000. The weighted average grant-date fair value of
restricted shares granted during the three months ended March 31, 2006 was
$12.83. Shares granted during the first three months of 2006 totaled
680,000.
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. Options granted under the 2000 EIP
expire on the tenth anniversary of the grant date.
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 Directors' 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.
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 2007, 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 and to receive meeting fees and lead
director and committee chair stipends in the form of cash or stock units.
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 March 31, 2007,
there were 2,420,191 shares available for grant. There were 13 directors
participating in the directors' plans during the first quarter of 2007. In
the first three months of 2007, total plan units earned were 65,754. At
March 31, 2007, 205,925 options were exercisable at a weighted average
exercise price of $12.22.
18
We account for the Deferred Fee Plan and the Directors' Equity Plan in
accordance with SFAS No. 123R. To the extent directors elect to receive the
distribution of their stock unit accounts 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 March 31, 2007, the
liability for such payments was approximately $700,000, all of which will
be payable in stock (based on the July 15, 1999 stock price).
(11) Segment Information:
--------------------
As of January 1, 2007, 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
materially impact the economic characteristics or operating results of a
particular property.
(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 March 31, 2007 and December 31, 2006
were $550,000,000. Such contracts require us to pay variable rates of
interest (average pay rates of approximately 8.96% as of March 31, 2007 and
approximately 9.02% as of December 31, 2006) and receive fixed rates of
interest (average receive rates of 8.26% as of March 31, 2007 and December
31, 2006). The fair value of these derivatives is reflected in other
liabilities as of March 31, 2007 and December 31, 2006, in the amount of
($7,940,000) and ($10,289,000), respectively. The related underlying debt
has been decreased by a like amount. For the three months ended March 31,
2007, the interest expense resulting from these interest rate swaps totaled
$1,266,000.
19
We do not anticipate any nonperformance by counter-parties to our
derivative contracts as all counter-parties have investment grade credit
ratings.
(13) Investment and Other Income (Loss), Net:
----------------------------------------
The components of investment and other income (loss), net are as follows:
For the three months ended March 31,
---------------------------------
($ in thousands) 2007 2006
-------------- --------------- ----------------
Interest and dividend income $ 14,526 $ 3,806
Bridge loan fee (4,026) -
Loss on exchange of debt - (2,392)
Other, net (483) (2,765)
--------------- ----------------
Total investment and other income
(loss), net $ 10,017 $ (1,351)
=============== ================
(14) Company Obligated Mandatorily Redeemable Convertible Preferred Securities:
--------------------------------------------------------------------------
In 1996, our consolidated wholly owned subsidiary, Citizens Utilities Trust
(the Trust), issued, in an underwritten public offering, 4,025,000 shares
of 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 first quarter of 2007 and the four quarters of 2006. Cash
was paid (net of investment returns) to the Partnership in payment of the
interest on the Convertible Subordinated Debentures. The cash was then
distributed by the Partnership to the Trust and then by the Trust to the
holders of the EPPICS.
As of March 31, 2007, EPPICS representing a total principal amount of
$197,101,000 have been converted into 15,906,633 shares of our common
stock. A total of approximately $4,149,000 of EPPICS is outstanding as of
March 31, 2007 and if all outstanding EPPICS were converted, 361,904 shares
of our common stock would be issued upon such conversion. Our long-term
debt footnote indicates $14,655,000 of EPPICS outstanding at March 31,
2007, of which $10,500,000 is debt of related parties for which the company
has an offsetting receivable.
20
(15) Retirement Plans:
-----------------
The following tables provide the components of net periodic benefit cost:
Pension Benefits
---------------------------
For the three months ended
March 31,
---------------------------
2007 2006
------------- ------------
($ in thousands)
--------------
Components of net periodic benefit cost
---------------------------------------
Service cost $ 2,009 $ 1,759
Interest cost on projected benefit obligation 11,930 11,504
Expected return on plan assets (15,676) (15,126)
Amortization of prior service cost and unrecognized
net obligation (27) (61)
Amortization of unrecognized loss 2,900 3,085
------------- ------------
Net periodic benefit cost $ 1,136 $ 1,161
============= ============
Other Postretirement Benefits
---------------------------
For the three months ended
March 31,
---------------------------
2007 2006
------------- ------------
($ in thousands)
--------------
Components of net periodic benefit cost
---------------------------------------
Service cost $ 175 $ 174
Interest cost on projected benefit obligation 2,208 2,211
Expected return on plan assets (254) (245)
Amortization of prior service cost and unrecognized
net obligation (1,447) (1,026)
Amortization of unrecognized loss 1,190 1,513
------------- ------------
Net periodic benefit cost $ 1,872 $ 2,627
============= ============
We expect that our pension and other postretirement benefit expenses,
including the costs associated with our recently acquired Commonwealth
plans, for 2007 will be between $14,000,000 and $17,000,000, and that no
contribution will be required to be made by us to the pension plan in 2007.
(16) Commitments and Contingencies:
------------------------------
We anticipate capital expenditures of approximately $315,000,000 -
$325,000,000 for 2007. Although we from time to time make short-term
purchasing commitments to vendors with respect to these expenditures, we
generally do not enter into firm, written contracts for such activities.
The 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.
21
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 findings, 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 approved the settlement terms,
and a settlement agreement was executed by the City and Citizens. We have
also executed a Consent Decree with the City and the State that was
submitted to the Court on April 11, 2007 with a request that it be entered
following a 30-day period of public review and comment. Completion of this
settlement remains contingent upon final approval of this Consent Decree by
the Court. 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.
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. During 2007, we received letters 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 will continue to investigate whether we are utilizing Katz Technology's
patented technology, and discuss Katz Technology's license offer with new
Katz counsel as 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. In 2005, Citibank moved to dismiss the underlying
complaint against it. That motion is currently pending. 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.
22
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.
(17) Subsequent Events:
------------------
As the result of our call of all of our 7.625% Senior Notes due 2008, we
terminated three interest rate swaps involving an aggregate $150,000,000
notional amount of indebtedness. Payments on the swap terminations of
approximately $1.0 million will be made in the second quarter of 2007.
23
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
Forward-Looking Statements
--------------------------
This quarterly report on Form 10-Q 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 Private Securities 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 successfully integrate Commonwealth's operations and to
realize the synergies from the acquisition;
* 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 voice over internet protocol (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;
24
* 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;
* 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 the future) and our liquidity;
* The effects of utilizing our Federal and state net operating loss
carry forwards and AMT tax credit carry forwards which will
significantly increase our cash taxes in 2007 and beyond;
* 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," in our Annual Report on Form 10-K for the year
ended December 31, 2006, in evaluating any statement in this report on Form 10-Q
or otherwise made by us or on our behalf. The following information is unaudited
and should be read in conjunction with the consolidated financial statements and
related notes included in this report. 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. On March 8, 2007, we completed the acquisition of Commonwealth
Telephone Enterprises, Inc. This acquisition expands our presence in
Pennsylvania and strengthens our position as a market-leading full-service
communications provider to rural markets.
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.
25
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.
a) Liquidity and Capital Resources
-------------------------------
Cash Flow from Operating Activities
-----------------------------------
As of March 31, 2007, we had cash and cash equivalents aggregating $1.04
billion. Our primary source of funds continues to be cash generated from
operations. For the three months ended March 31, 2007, we used cash flow from
continuing operations and cash and cash equivalents to fund a significant
portion of the acquisition of Commonwealth, capital expenditures, dividends,
interest payments, debt repayments and stock repurchases.
We believe our operating cash flows, existing cash balances, and credit facility
will be adequate to finance our working capital requirements, fund capital
expenditures, make required debt payments through 2008, pay taxes, pay dividends
to our shareholders in accordance with our dividend policy and support our
short-term and long-term operating strategies. We have approximately $569.2
million and $2.5 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 and beyond our
cash taxes will increase substantially as our Federal and state net operating
loss carry forwards and AMT tax credit carry forwards are estimated to be fully
utilized during 2007 and 2008.
Cash Flow from Investing Activities
-----------------------------------
Acquisition
-----------
On March 8, 2007, we acquired Commonwealth in a cash-and-stock taxable
transaction, for a total consideration of approximately $1.1 billion. At closing
we paid $790.0 million in cash ($649.5 million net, after cash acquired), issued
common stock with a value of $246.2 million and accrued $19.7 million of closing
costs.
In connection with the acquisition of Commonwealth, we assumed $35 million of
debt under a revolving credit facility and $192 million face amount of
Commonwealth convertible notes (fair value of $210 million). During March 2007,
we paid down the $35 million credit facility and retired $115 million face
amount (for which we paid $92.2 million in cash and $22.4 million in common
stock) of the convertible notes (premium paid of $11.2 million and recorded as
purchase price). We have received conversion notices and will retire an
additional $68.7 million of Commonwealth notes during the second quarter of
2007, resulting in a remaining outstanding balance of $8.5 million.
Capital Expenditures
--------------------
For the three months ended March 31, 2007, our capital expenditures were $45.1
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 $315.0
million - $325.0 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.
26
Cash Flow from Financing Activities
-----------------------------------
Debt Reduction and Debt Exchanges
---------------------------------
For the three months ended March 31, 2007, we retired an aggregate principal
amount of $353.4 million of debt, including $3.2 million of 5% Company Obligated
Mandatorily Redeemable Convertible Preferred Securities (EPPICS). Our debt
repayments relate primarily to our acquisition of Commonwealth. During the first
quarter of 2007, we borrowed and repaid $200 million utilized to temporarily
fund the acquisition, we paid down the $35 million Commonwealth credit facility
and retired $115 million face amount of Commonwealth convertible notes for which
we paid $92.2 million in cash and $22.4 million in 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 March 23, 2007, we issued in a private placement an aggregate $300.0 million
principal amount of 6.625% Senior Notes due 2015 and $450.0 million principal
amount of 7.125% Senior Notes due 2019. Proceeds from the sale were used to
refinance $200.0 million principal amount of indebtedness incurred on March 8,
2007 under a bridge loan facility in connection with the acquisition of
Commonwealth. We have filed with the SEC a registration statement for the
purpose of exchanging the $750 million in private placement notes described
above, in addition to the $400 million principal amount of 7.875% Senior Notes
issued in a private placement on December 22, 2006, for registered notes, and
commenced the exchange offer. On April 26, 2007, we redeemed $495.2 million
principal amount of our 7.625% Senior Notes due 2008 at a price of 103.041% plus
accrued and unpaid interest.
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 related to the issuances of
such securities, taken together, constitute a full and unconditional guarantee
by us of the Trust's obligations relating to the Trust Convertible Preferred
Securities and the Partnership's obligations relating to the Partnership
Convertible Preferred Securities.
In accordance with the terms of the issuances, we paid the annual 5% interest in
quarterly installments on the Convertible Subordinated Debentures in the first
quarter of 2007 and the four quarters of 2006. Cash was paid (net of investment
returns) to the Partnership in payment of the interest on the Convertible
Subordinated Debentures. The cash was then distributed by the Partnership to the
Trust and then by the Trust to the holders of the EPPICS.
As of March 31, 2007, EPPICS representing a total principal amount of $197.1
million have been converted into 15.9 million shares of our common stock, and a
total of $4.2 million remains outstanding to third parties. Our long-term debt
footnote indicates $14.7 million of EPPICS outstanding at March 31, 2007, of
which $10.5 million is debt of related parties for which we have an offsetting
receivable.
27
Interest Rate Management
------------------------
In order to manage our interest expense, we have entered into interest swap
agreements. Under the terms of these agreements, we make semi-annual, floating
rate interest payments based on six month LIBOR and receive a fixed rate on the
notional amount. The underlying variable rate on these swaps is set either in
advance or in arrears.
The notional amounts of fixed-rate indebtedness hedged as of March 31, 2007 and
December 31, 2006 were $550.0 million. Such contracts require us to pay variable
rates of interest (estimated average pay rates of approximately 8.96% as of
March 31, 2007 and approximately 9.02% as of December 31, 2006) and receive
fixed rates of interest (average receive rate of 8.26% as of March 31, 2007 and
December 31, 2006). All swaps are accounted for under SFAS No. 133 (as amended)
as fair value hedges. For the three months ended March 31, 2007, the interest
expense resulting from these interest rate swaps totaled approximately $1.3
million.
Credit Facilities
-----------------
As of March 31, 2007, 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 March 31, 2007. 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 March 31, 2007 and 2006,
we received approximately $5.1 million and $9.5 million, respectively, upon the
exercise of outstanding stock options.
Share Repurchase Programs
-------------------------
In February 2007, our Board of Directors authorized us to repurchase up to
$250.0 million of our common stock in public or private transactions over the
following twelve month period. This share repurchase program commenced on March
19, 2007. As of March 31, 2007 we had repurchased 823,000 shares of our common
stock at an aggregate cost of approximately $12.0 million.
28
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.
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 relationships with unconsolidated entities that would be expected to
have a material current or future effect upon our financial statements.
Critical Accounting Policies and Estimates
------------------------------------------
We review all significant estimates affecting our consolidated financial
statements on a recurring basis and record the effect of any necessary
adjustment prior to their publication. Uncertainties with respect to such
estimates and assumptions are inherent in the preparation of financial
statements; accordingly, it is possible that actual results could differ from
those estimates and changes to estimates could occur in the near term. The
preparation of our financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of the contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Estimates and judgments are used when accounting for allowance for
doubtful accounts, impairment of long-lived assets, intangible assets,
depreciation and amortization, employee benefit plans, income taxes,
contingencies, and pension and postretirement benefits expenses among others.
Management has discussed the development and selection of these critical
accounting estimates with the Audit Committee of our Board of Directors and our
Audit Committee has reviewed our disclosures relating to them.
There have been no material changes to our critical accounting policies and
estimates from the information provided in "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in our
Annual Report on Form 10-K for the year ended December 31, 2006.
New Accounting Pronouncements
-----------------------------
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 either taken or expected to be
taken in the Company's income tax returns. We have adopted the provisions
of FIN No. 48 in the first quarter of 2007. The total amount of our FIN No.
48 tax liability for tax positions that may not be sustained under a "more
likely than not" threshold is reflected on the Company's balance sheet as
of the date of adoption at $44,708,000. This amount includes an accrual for
interest in the amount of $4,621,000. These balances include amounts of
$8,977,000 and $1,439,000 for total FIN No. 48 tax liabilities and accrued
interest, respectively, pursuant to the Company's acquisition of
Commonwealth Telephone Enterprises, Inc. The amount of our total FIN No. 48
tax liabilities reflected above that would positively impact the
calculation of our effective income tax rate, if our tax positions are
sustained, is $20,901,000.
The Company's policy regarding the classification of interest and penalties
is to include these amounts as a component of income tax expense. This
treatment of interest and penalties is consistent with prior periods. We
have recognized in our year to date statement of operations additional
interest in the amount of $239,000. We do not expect that our balances with
respect to our uncertain tax positions will significantly increase or
decrease within the next 12 months. We are subject to income tax
examinations generally for the years 2003 forward for both our federal and
state filing jurisdictions.
29
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," 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 adopted the disclosure requirements of EITF No. 06-3
commencing January 1, 2007.
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 adoption of the
accounting requirements of EITF No. 06-5 in the first quarter of 2007 had
no material impact on our financial position, results of operation or cash
flows.
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 SFAS 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.
Fair Value Measurements
-----------------------
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements",
which defines fair value, establishes a framework for measuring fair value,
and expands disclosures about fair value measurements. The provisions of
SFAS No. 157 are effective as of the beginning of our 2008 fiscal year. The
Company is currently evaluating the impact that the adoption of the
standard will have on the Company's results of operations or financial
condition.
Fair Value Option for Financial Assets and Financial Liabilities
-----------------------------------------------------------------------
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities Including an amendment of FASB
Statement No. 115," which permits entities to choose to measure many
financial instruments and certain other items at fair value. The provisions
of SFAS No. 159 are effective as of the beginning of our 2008 fiscal year.
The Company is currently evaluating the impact that the adoption of the
standard will have on the Company's results of operations or financial
condition.
Accounting for Collateral Assignment Split-Dollar Life Insurance
---------------------------------------------------------------------------
Arrangements
------------
In March 2007, the FASB ratified the consensus reached by the EITF on Issue
No. 06-10, "Accounting for Collateral Assignment Split-Dollar Life
Insurance Arrangements." EITF No. 06-10 provides guidance on an employers'
recognition of a liability and related compensation costs for collateral
assignment split-dollar life insurance arrangements that provide a benefit
to an employee that extends into postretirement periods and the asset in
collateral assignment split-dollar life insurance arrangements. The
effective date of EITF No. 06-10 is for fiscal years beginning after
December 15, 2007. The Company is currently evaluating the impact that the
adoption of the standard will have on the Company's results of operations
or financial condition.
30
(b) Results of Operations
---------------------
REVENUE
Revenue is generated primarily through the provision of local, network access,
long distance, and data and internet 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 for the three months ended March 31, 2007 increased $49.3
million, or 9.7%, as compared with the prior year period. Excluding the
additional revenue due to the CTE acquisition, revenue increased $28.6 million,
or 5.6%, as compared with the prior year period. During the first quarter of
2007, we had a significant favorable settlement of a dispute with a carrier that
resulted in a favorable one-time impact to our revenues of $38.7 million.
Excluding the impact of the CTE acquisition and the one-time favorable
settlement, our first quarter revenues would have been $496.8 million, a
decrease of $10.1 million, or 2%, as compared to the first quarter of 2006.
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. Excluding the impact of the CTE acquisition, we lost
approximately 22,700 access lines during the three months ended March 31, 2007,
but added approximately 20,300 high-speed internet subscribers during this same
period. The loss of lines during the first three months of 2007 was primarily
among residential customers. The non-residential line losses were principally in
our central region and 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
herein may cause our revenues, profitability and cash flows to decrease in 2007.
Our historical results include the results of operations of Commonwealth from
the date of its acquisition on March 8, 2007. The financial tables below include
a comparative analysis of our results of operations on a historical basis for
the three months ended March 31, 2007 and 2006. We have also presented an
analysis of each category for the three months ended March 31, 2007 for the
results of Citizens (excluding CTE) and the results of CTE for the last 23 days
of March, as included in the consolidated results of operations. All variance
explanations in the succeeding paragraphs are based on analysis of the three
months ended March 31, 2007 financial data for Citizens (excluding CTE) in
comparison to the three months ended March 31, 2006, as presented below.
TELECOMMUNICATIONS REVENUE
For the three months ended March 31, 2007
--------------------------------------- For the three
($ in thousands) As CTE Citizens months ended
-------------- Reported (for 23 days)(excluding CTE) March 31, 2006 $ Change % Change
---------- ----------- --------------- -------------- ---------- ---------
Local services $ 206,043 $ 8,674 $ 197,369 $ 203,566 $ (6,197) -3%
Data and internet services 116,425 2,556 113,869 100,089 13,780 14%
Access services 139,024 5,695 133,329 111,237 22,092 20%
Long distance services 40,428 2,047 38,381 39,158 (777) -2%
Directory services 28,670 68 28,602 28,797 (195) -1%
Other 25,557 1,626 23,931 24,014 (83) 0%
---------- ----------- --------------- ----------- ----------
$ 556,147 $ 20,666 $ 535,481 $ 506,861 $ 28,620 6%
========== =========== =============== =========== ==========
Local Services
Local services revenue for the three months ended March 31, 2007 decreased $6.2
million, or 3%, as compared with the prior year period. The loss of access lines
accounted for $7.3 million of the decline in local revenue. Enhanced services
revenue increased $1.1 million, as compared with the prior year period,
primarily due to sales of additional feature packages. Economic conditions or
increasing competition could make it more difficult to sell our packages and
bundles and cause us to lower our prices for those products and services, which
would adversely affect our revenues, profitability and cash flow.
31
Data and Internet Services
Data and internet services revenue for the three months ended March 31, 2007
increased $13.8 million, or 14%, as compared with the prior year period
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 72,000,
or 21%, since March 31, 2006. Data and 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 $2.1 million, or 4%, as
compared with the prior year period, primarily due to growth in those circuits.
Access Services
Access services revenue for the three months ended March 31, 2007 increased
$22.1 million, or 20%, as compared with the prior year period. Switched access
revenue of $100.5 million increased $32.7 million, as compared with the prior
year period, primarily due to the settlement of a dispute with a carrier
resulting in a favorable impact on our revenue of $38.7 million (a one-time
event), partially offset by the impact of a decline in minutes of use related to
access line losses. Access service revenue includes subsidy payments we receive
from federal and state agencies. Subsidy revenue of $32.8 million decreased
$10.6 million primarily due to lower receipts under the Federal High Cost Fund
program resulting from our lower cost structure and an increase in the program's
national average cost per local loop (NACPL).
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 federal 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 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 during the remainder of 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 three months ended March 31, 2007
decreased $0.8 million, or 2%, as compared with the prior year period. We have
actively marketed packages of long distance minutes particularly with our
bundled service offerings. The sale of packaged minutes has resulted in an
increase in minutes used by our long distance customers and has had the effect
of lowering our overall average rate per minute billed. Our long distance
minutes of use increased by 9% during the first quarter of 2007 compared to the
first quarter of 2006 and, as noted below, has increased our cost of services
provided. Our long distance revenues may continue to decrease in the future due
to lower rates and/or minutes of use. Competing services such as wireless, VOIP,
and cable telephony are resulting in a loss of customers, minutes of use and
further declines in the rates we charge our customers. We expect these factors
will continue to adversely affect our long distance revenues during the
remainder of 2007.
Directory Services
Directory services revenue for the three months ended March 31, 2007 was
relatively unchanged as compared with the prior year period due to slightly
lower yellow pages advertising, mainly in Rochester, New York.
Other
Other revenue for the three months ended March 31, 2007 was relatively unchanged
as compared with the prior year period.
32
NETWORK ACCESS EXPENSES
For the three months ended March 31, 2007
--------------------------------------- For the three
($ in thousands) As CTE Citizens months ended
-------------- Reported (for 23 days) (excluding CTE) March 31, 2006 $ Change % Change
---------- ----------- --------------- --------------- ---------- ---------
Network access $ 50,793 $ 3,849 $ 46,944 $ 40,218 $ 6,726 17%
Network access expenses for the three months ended March 31, 2007 increased $6.7
million, or 17%, as compared with the prior year period due to increasing rates
and usage. As we continue to increase our sales of data products such as
high-speed internet and expand the availability of our unlimited long distance
calling plans, our network access expense is likely to continue to increase.
Expenses associated with access lines lost have offset some of the increase.
OTHER OPERATING EXPENSES
For the three months ended March 31, 2007
--------------------------------------- For the three
($ in thousands) As CTE Citizens months ended
-------------- Reported (for 23 days)(excluding CTE) March 31, 2006 $ Change % Change
---------- ----------- --------------- -------------- ------------ ---------
Operating expenses $ 138,976 $ 6,926 $ 132,050 $ 138,246 $ (6,196) -4%
Taxes other than income taxes 26,200 1,289 24,911 25,835 (924) -4%
Sales and marketing 24,695 1,789 22,906 23,220 (314) -1%
---------- ----------- --------------- -------------- ------------
$ 189,871 $ 10,004 $ 179,867 $ 187,301 $ (7,434) -4%
========== =========== =============== ============== ============
Operating expenses for the three months ended March 31, 2007 decreased $6.2
million, or 4%, as compared with the prior year period primarily due to
headcount reductions and associated decreases in salaries and benefits which
included $3.7 million of severance payments associated with a voluntary early
retirement program offered to certain employees during the first quarter of
2006. The program resulted in a reduction of 62 employees. The USF contribution
rate and PUC fees decreased from the prior year period, resulting in a reduction
in costs of $4.1 million. While we expect to achieve operating efficiencies with
the acquisition of Commonwealth, in the short term our operating expenses will
increase.
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 $3.4 million and $2.7 million for the three months ended March 31,
2007 and 2006, 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, including the costs
associated with our recently acquired Commonwealth plans, will be approximately
$14.0 million to $17.0 million in 2007 and that no contribution will be required
to be made by us to the pension plan in 2007. In future periods, if the value of
our pension assets decline and/or projected pension and/or postretirement
benefit costs increase, we may have increased pension and/or postretirement
expenses.
Taxes other than income taxes for the three months ended March 31, 2007
decreased $0.9 million, or 4%, as compared with the prior year period primarily
due to reduced payroll taxes.
Sales and marketing expenses for the three months ended March 31, 2007 were
relatively unchanged as compared with the prior year period. As our markets
become more competitive and we launch new products, we expect that our marketing
costs may increase.
33
DEPRECIATION AND AMORTIZATION EXPENSE
For the three months ended March 31, 2007
--------------------------------------- For the three
($ in thousands) As CTE Citizens months ended
-------------- Reported (for 23 days)(excluding CTE) March 31, 2006 $ Change % Change
---------- ----------- --------------- ------------- ------------ ---------
Depreciation expense $ 86,647 $ 2,960 $ 83,687 $ 90,409 $ (6,722) -7%
Amortization expense 35,534 3,939 * 31,595 31,595 - 0%
---------- ----------- --------------- ------------- ------------
$122,181 $ 6,899 $115,282 $122,004 $ (6,722) -6%
========== =========== =============== ============= ============
* Represents amortization expense for the 23 days of March related to the
customer base acquired in the Commonwealth acquisition.
Depreciation expense for the three months ended March 31, 2007 decreased $6.7
million, or 7%, as compared with the prior year period due to a declining net
asset base.
INVESTMENT AND OTHER INCOME (LOSS), NET / INTEREST EXPENSE / INCOME TAX EXPENSE
For the three months ended March 31, 2007
--------------------------------------- For the three
($ in thousands) As CTE Citizens months ended
-------------- Reported (for 23 days)(excluding CTE) March 31, 2006 $ Change % Change
---------- ----------- --------------- -------------- ----------- ---------
Investment and
other income (loss), net $ 10,017 $ 784 $ 9,233 $ (1,351) $ 10,584 783%
Interest expense $ 93,964 $ 225 $ 93,739 $ 85,393 $ 8,346 10%
Income tax expense $ 41,688 $ 2,281 $ 39,407 $ 26,607 $ 12,800 48%
Investment and other income (loss), net for the three months ended March 31,
2007 increased $10.6 million, or 783%, as compared with the prior year period
primarily due to an increase of $11.1 million in income from short-term
investments of cash. We borrowed $550 million in December, 2006 in anticipation
of the Commonwealth acquisition in 2007. Our average cash balance was $1,039.4
million and $276.7 million for the three months ended March 31, 2007 and 2006,
respectively. Other income (loss) included a $4.0 million expense of a bridge
loan fee during the first quarter of 2007 and a $2.4 million loss incurred on
the exchange of debt during the first quarter of 2006.
Interest expense for the three months ended March 31, 2007 increased $8.3
million, or 10%, as compared with the prior year period primarily due to a
higher average debt balance resulting from financing the Commonwealth
acquisition. Our average debt outstanding was $4,945.8 million and $4,224.4
million for the three months ended March 31, 2007 and 2006, respectively. Our
composite average borrowing rate (including the effect of our swap agreements)
for the three months ended March 31, 2007 as compared with the prior year period
was 3 basis points higher, increasing from 8.07% to 8.10%.
Income taxes for the three months ended March 31, 2007 increased $12.8 million,
or 48%, as compared with the prior year period primarily due to changes in
taxable income. The effective tax rate on a fully consolidated basis for the
first three months of 2007 was 38.1% as compared with 37.7% for the first three
months of 2006. We expect that in 2007 our cash paid for income taxes will
increase significantly.
DISCONTINUED OPERATIONS
($ in thousands) For the three months ended March 31,
-------------- ----------------------------------------------------
2007 2006 $ Change % Change
---------- ----------- --------------- -----------
Revenue $ - $ 42,494 $ (42,494) -100%
Operating income $ - $ 10,458 $ (10,458) -100%
Income taxes $ - $ 3,962 $ (3,962) -100%
Net income $ - $ 6,496 $ (6,496) -100%
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.
34
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities. Market risk refers to the
potential change in fair value of a financial instrument as a result of
fluctuations in interest rates and equity prices. We do not hold or issue
derivative instruments, derivative commodity instruments or other financial
instruments for trading purposes. As a result, we do not undertake any specific
actions to cover our exposure to market risks, and we are not party to any
market risk management agreements other than in the normal course of business or
to hedge long-term interest rate risk. Our primary market risk exposures are
interest rate risk and equity price risk as follows:
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest-bearing portion of our investment portfolio and interest on our
long-term debt. The long-term debt include various instruments with various
maturities and weighted average interest rates.
Our objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, a majority of our borrowings have
fixed interest rates. Consequently, we have limited material future earnings or
cash flow exposures from changes in interest rates on our long-term debt. An
adverse change in interest rates would increase the amount that we pay on our
variable obligations and could result in fluctuations in the fair value of our
fixed rate obligations. Based upon our overall interest rate exposure at March
31, 2007, a near-term change in interest rates would not materially affect our
consolidated financial position, results of operations or cash flows.
In order to manage our interest rate risk exposure, we have entered into
interest rate swap agreements. Under the terms of the agreements, we make
semi-annual, floating interest rate interest payments based on six month LIBOR
and receive a fixed rate on the notional amount.
Sensitivity analysis of interest rate exposure
At March 31, 2007, the fair value of our long-term debt was estimated to be
approximately $4.9 billion, based on our overall weighted average interest rate
of 7.95% and our overall weighted average maturity of approximately 13 years.
There has been no material change in the weighted average maturity applicable to
our obligations since December 31, 2006.
The overall weighted average interest rate decreased approximately 24 basis
points during the first quarter of 2007. A hypothetical increase of 80 basis
points (10% of our overall weighted average borrowing rate) would result in an
approximate $267.5 million decrease in the fair value of our fixed rate
obligations.
Equity Price Exposure
Our exposure to market risks for changes in equity prices as of March 31, 2007
is limited to our pension assets. We have no other equity investments of any
material amount.
Item 4. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures
We carried out an evaluation, under the supervision and with the participation
of our management, 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, March 31, 2007, that our disclosure
controls and procedures are effective.
(b) Changes in internal control over financial reporting
As a result of our Commonwealth acquisition we have begun to integrate certain
business processes and systems of the acquired entity. Accordingly, certain
changes have been made and will continue to be made to our internal controls
over financial reporting until such time as this integration is complete. There
have been no other changes in our internal control over financial reporting
identified in an evaluation thereof that occurred during the first fiscal
quarter of 2007 that materially affected or is reasonably likely to materially
affect our internal control over financial reporting.
35
PART II. OTHER INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Item 1. Legal Proceedings
-----------------
The City of Bangor, Maine, filed suit against us on November 22, 2002, in the
U.S. District Court for the District of Maine (City of Bangor v. Citizens
Communications Company, Civ. Action No. 02-183-B-S). The City 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 findings, 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 approved the settlement terms, and a
settlement agreement was executed by the City and Citizens. We have also
executed a Consent Decree with the City and the State that was submitted to the
Court on April 11, 2007 with a request that it be entered following a 30-day
period of public review and comment. Completion of this settlement remains
contingent upon final approval of this Consent Decree by the Court. 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.
Item 1A. Risk Factors
------------
There have been no material changes to our risk factors from the information
provided in Item 1A. "Risk Factors" included in our Annual Report on Form 10-K
for the year ended December 31, 2006.
36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
There were no unregistered sales of equity securities during the quarter ended
March 31, 2007.
--------------------------------------------------------------------------------------------------------
(d) Maximum
Approximate
Dollar Value of
(c) Total Number of Shares that May
(a) Total Shares Purchased as Yet Be
Number of (b) Average Part of Publicly Purchased
Shares Price Paid Announced Plans or Under the Plans
Period Purchased per Share Programs or Programs
--------------------------------------------------------------------------------------------------------
January 1, 2007 to January 31, 2007
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 1,867 $ 14.34 N/A N/A
February 1, 2007 to February 28, 2007
Share Repurchase Program (1) - $ - - $ 250,000,000
Employee Transactions (2) 52,118 $ 15.06 N/A N/A
March 1, 2007 to March 31, 2007
Share Repurchase Program (1) 823,000 $ 14.60 823,000 $ 238,000,000
Employee Transactions (2) 89,410 $ 14.53 N/A N/A
Totals January 1, 2007 to March 31, 2007
Share Repurchase Program (1) 823,000 $ 14.60 823,000 $ 238,000,000
Employee Transactions (2) 143,395 $ 14.72 N/A N/A
(1) In February 2007, our Board of Directors authorized us to repurchase up to
$250.0 million of our common stock, in public or private transactions over
the following twelve-month period. This share repurchase program commenced
on March 19, 2007.
(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.
Item 6. Exhibits
--------
a) Exhibits:
31.1 Certification of Principal Executive Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934.
31.2 Certification of Principal Financial Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
37
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Robert J. Larson
--------------------------
Robert J. Larson
Senior Vice President and
Chief Accounting Officer
Date: May 4, 2007
38