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 JUNE 30, 2006
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 June 30, 2006
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or
--
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________to__________
Commission file number: 001-11001
---------
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-0619596
------------------------------ ----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
-------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
(203) 614-5600
--------------------------------------------------
(Registrant's telephone number, including area code)
N/A
---------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is 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
--- ---
The number of shares outstanding of the registrant's Common Stock as of July 31,
2006 was 320,833,416.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index
Page No.
--------
Part I. Financial Information (Unaudited)
Financial Statements
Consolidated Balance Sheets at June 30, 2006 and December 31, 2005 2
Consolidated Statements of Operations for the three months ended June 30, 2006 and 2005 3
Consolidated Statements of Operations for the six months ended June 30, 2006 and 2005 4
Consolidated Statements of Stockholders' Equity for the year ended
December 31, 2005 and the six months ended June 30, 2006 5
Consolidated Statements of Comprehensive Income for the three and six
months ended June 30, 2006 and 2005 5
Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005 6
Notes to Consolidated Financial Statements 7
Management's Discussion and Analysis of Financial Condition and Results of Operations 23
Quantitative and Qualitative Disclosures about Market Risk 33
Controls and Procedures 34
Part II. Other Information
Legal Proceedings 35
Risk Factors 35
Unregistered Sales of Equity Securities and Use of Proceeds, Issuer Purchases of Equity
Securities 36
Submission of Matters to a Vote of Security Holders 36
Other Information 37
Exhibits 37
Signature 39
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)
(Unaudited)
June 30, 2006 December 31, 2005
------------------ -------------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 141,316 $ 268,917
Accounts receivable, less allowances of $52,904 and $31,631, respectively 195,226 203,070
Other current assets 37,226 40,200
Assets of discontinued operations 162,915 162,716
------------------ -------------------
Total current assets 536,683 674,903
Property, plant and equipment, net 2,978,064 3,058,312
Goodwill, net 1,921,465 1,921,465
Other intangibles, net 495,543 558,733
Investments 16,599 15,999
Other assets 196,943 203,323
------------------ -------------------
Total assets $ 6,145,297 $ 6,432,735
================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Long-term debt due within one year $ 47,683 $ 227,693
Accounts payable and other current liabilities 334,052 372,968
Liabilities of discontinued operations 44,348 46,266
------------------ -------------------
Total current liabilities 426,083 646,927
Deferred income taxes 411,844 325,084
Other liabilities 432,416 423,785
Long-term debt 3,950,556 3,995,130
Stockholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares; 320,684,000
and 328,168,000 outstanding, respectively, and 343,956,000 issued at
June 30, 2006 and December 31, 2005) 85,989 85,989
Additional paid-in capital 1,203,951 1,374,610
Retained earnings (deficit) 66,841 (85,344)
Accumulated other comprehensive loss, net of tax (123,232) (123,242)
Treasury stock (309,151) (210,204)
------------------ -------------------
Total stockholders' equity 924,398 1,041,809
------------------ -------------------
Total liabilities and stockholders' equity $ 6,145,297 $ 6,432,735
================== ===================
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 JUNE 30, 2006 AND 2005
($ in thousands, except per-share amounts)
(Unaudited)
2006 2005
--------------- --------------
Revenue $ 506,912 $ 496,133
Operating expenses:
Cost of services (exclusive of depreciation and amortization) 38,402 35,595
Other operating expenses 179,500 185,783
Depreciation and amortization 119,552 132,474
--------------- --------------
Total operating expenses 337,454 353,852
--------------- --------------
Operating income 169,458 142,281
Investment and other income (loss), net 65,363 573
Interest expense 85,341 84,065
--------------- --------------
Income from continuing operations before income taxes 149,480 58,789
Income tax expense 54,734 17,326
--------------- --------------
Income from continuing operations 94,746 41,463
Discontinued operations (see Note 5):
Income from operations of discontinued CLEC business 11,482 5,231
Income tax expense 4,526 2,110
--------------- --------------
Income from discontinued operations 6,956 3,121
--------------- --------------
Net income available to common stockholders $ 101,702 $ 44,584
=============== ==============
Basic income per common share:
Income from continuing operations $ 0.30 $ 0.12
Income from discontinued operations 0.02 0.01
--------------- --------------
Net income available to common stockholders $ 0.32 $ 0.13
=============== ==============
Diluted income per common share:
Income from continuing operations $ 0.29 $ 0.12
Income from discontinued operations 0.02 0.01
--------------- --------------
Net income available to common stockholders $ 0.31 $ 0.13
=============== ==============
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 OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005
($ in thousands, except per-share amounts)
(Unaudited)
2006 2005
--------------- --------------
Revenue $ 1,013,773 $ 998,467
Operating expenses:
Cost of services (exclusive of depreciation and amortization) 78,620 75,317
Other operating expenses 366,801 369,820
Depreciation and amortization 241,556 266,568
--------------- --------------
Total operating expenses 686,977 711,705
--------------- --------------
Operating income 326,796 286,762
Investment and other income (loss), net 64,012 4,541
Interest expense 170,734 167,790
--------------- --------------
Income from continuing operations before income taxes 220,074 123,513
Income tax expense 81,341 42,542
--------------- --------------
Income from continuing operations 138,733 80,971
Discontinued operations (see Note 5):
Income from operations of discontinued CLEC business 21,940 6,607
Income from operations of discontinued conferencing business
(including gain on disposal of $14,061) - 15,550
Income tax expense 8,488 15,910
--------------- --------------
Income from discontinued operations 13,452 6,247
--------------- --------------
Net income available to common stockholders $ 152,185 $ 87,218
=============== ==============
Basic income per common share:
Income from continuing operations $ 0.43 $ 0.24
Income from discontinued operations 0.04 0.02
--------------- --------------
Net income available to common stockholders $ 0.47 $ 0.26
=============== ==============
Diluted income per common share:
Income from continuing operations $ 0.43 $ 0.24
Income from discontinued operations 0.04 0.02
--------------- --------------
Net income available to common stockholders $ 0.47 $ 0.26
=============== ==============
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 STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2005 AND THE SIX MONTHS ENDED JUNE 30, 2006
($ in thousands)
(Unaudited)
Accumulated
Common Stock Additional Retained Other Treasury Stock Total
------------------ Paid-In Earnings Comprehensive ------------------- Stockholders'
Shares Amount Capital (Deficit) Loss Shares Amount Equity
-------- --------- ----------- ------------ ------------ ------- ----------- -----------
Balance January 1, 2005 339,635 $84,909 $1,664,627 $(287,719) $ (99,569) (2) $ (8) $1,362,240
Stock plans 2,096 524 24,039 - - 2,598 34,689 59,252
Conversion of EPPICS 2,225 556 24,308 - - 391 5,115 29,979
Dividends on common stock of
$1.00 per share - - (338,364) - - - - (338,364)
Shares repurchased - - - - - (18,775) (250,000) (250,000)
Net income - - - 202,375 - - - 202,375
Other comprehensive loss, net
of tax and reclassifications
adjustments - - - - (23,673) - - (23,673)
-------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balance December 31, 2005 343,956 85,989 1,374,610 (85,344) (123,242) (15,788) (210,204) 1,041,809
Stock plans - - (5,590) - - 1,473 19,746 14,156
Conversion of EPPICS - - (2,296) - - 1,243 16,546 14,250
Dividends on common stock of
$0.50 per share - - (162,773) - - - - (162,773)
Shares repurchased - - - - - (10,200) (135,239) (135,239)
Net income - - - 152,185 - - - 152,185
Other comprehensive income, net
of tax and reclassifications
adjustments - - - - 10 - - 10
-------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balance June 30, 2006 343,956 $85,989 $1,203,951 $ 66,841 $(123,232) (23,272) $(309,151) $ 924,398
======== ========= =========== ============ ============ ======== =========== ===========
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
($ in thousands)
(Unaudited)
For the three months ended June 30, For the six months ended June 30,
--------------------------------------- ---------------------------------------
2006 2005 2006 2005
------------------- ------------------ ------------------ ------------------
Net income $ 101,702 $ 44,584 $ 152,185 $ 87,218
Other comprehensive income (loss), net
of tax and reclassifications adjustments* 2 (268) 10 (1,075)
------------------- ------------------ ------------------ ------------------
Total comprehensive income $ 101,704 $ 44,316 $ 152,195 $ 86,143
=================== ================== ================== ==================
* Consists of unrealized holding (losses)/gains of marketable securities
and for 2005 realized gains taken to income as a result of the sale of
securities.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
5
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005
($ in thousands)
(Unaudited)
2006 2005
--------------- ---------------
Cash flows provided by (used in) operating activities:
Net income $ 152,185 $ 87,218
Deduct: Gain on sale of discontinued operations - (1,167)
Income from discontinued operations (13,452) (5,080)
Adjustments to reconcile income to net cash provided by
operating activities:
Depreciation and amortization expense 241,556 266,568
Gain on expiration/settlement of customer advances - (668)
Stock based compensation expense 5,335 4,381
Loss on debt exchange - 3,175
Investment gain (61,428) (493)
Other non-cash adjustments 5,065 5,439
Deferred income taxes 78,153 44,859
Change in accounts receivable 7,844 25,107
Change in accounts payable and other liabilities (37,763) (29,603)
Change in other current assets 2,974 2,612
--------------- ---------------
Net cash provided by continuing operating activities 380,469 402,348
Cash flows from investing activities:
Proceeds from sales of assets, net of selling expenses - 24,195
Proceeds from sale of discontinued operations - 43,565
Securities sold - 1,112
Capital expenditures (98,284) (109,020)
Other assets (purchased) distributions received, net 62,244 (4,667)
--------------- ---------------
Net cash used by investing activities (36,040) (44,815)
Cash flows from financing activities:
Receipt (repayment) of customer advances for
construction and contributions in aid of construction, net 17 (1,645)
Long-term debt payments (198,126) (5,876)
Issuance of common stock 12,756 24,953
Common stock repurchased (135,239) (14,587)
Dividends paid (162,773) (171,022)
--------------- ---------------
Net cash used by financing activities (483,365) (168,177)
Cash flows of discontinued operations (revised - see Note 5):
Operating cash flows 16,880 17,095
Investing cash flows (5,545) (5,700)
Financing cash flows - (48)
--------------- ---------------
11,335 11,347
(Decrease) increase in cash and cash equivalents (127,601) 200,703
Cash and cash equivalents at January 1, 268,917 171,797
--------------- ---------------
Cash and cash equivalents at June 30, $ 141,316 $ 372,500
=============== ===============
Cash paid during the period for:
Interest $ 169,841 $ 143,436
Income taxes $ 2,871 $ 838
Non-cash investing and financing activities:
Change in fair value of interest rate swaps $ (15,100) $ (2,096)
Conversion of EPPICS $ 14,249 $ 25,512
Debt-for-debt exchange, net $ (70) $ 2,171
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
6
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
(1) Summary of Significant Accounting Policies:
------------------------------------------
(a) Basis of Presentation and Use of Estimates:
------------------------------------------
Citizens Communications Company and its subsidiaries are referred to
as "we," "us," "our," or the "Company" in this report. Our unaudited
consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (GAAP) and should be read in conjunction with the consolidated
financial statements and notes included in our Annual Report on Form
10-K for the year ended December 31, 2005. Certain reclassifications
of balances previously reported have been made to conform to the
current presentation. All significant intercompany balances and
transactions have been eliminated in consolidation. These unaudited
consolidated financial statements include all adjustments, which
consist of normal recurring accruals necessary to present fairly the
results for the interim periods shown.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions which affect the
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.
(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.
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill
and Other Intangible Assets," requires that intangible assets
(primarily customer base) with estimated useful lives be amortized
over those lives and be reviewed for impairment in accordance with
SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived
Assets" to determine whether any changes to these lives are required.
We periodically reassess the useful life of our intangible assets with
7
estimated useful lives to determine whether any changes to those lives
are required.
(f) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
----------------------------------------------------------------------
of:
--
We review long-lived assets to be held and used and long-lived assets
to be disposed of, including intangible assets with estimated useful
lives, for impairment whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be
recoverable. Recoverability of assets to be held and used is measured
by comparing the carrying amount of the asset to the future
undiscounted net cash flows expected to be generated by the asset.
Recoverability of assets held for sale is measured by comparing the
carrying amount of the assets to their estimated fair market value. If
any assets are considered to be impaired, the impairment is measured
by the amount by which the carrying amount of the assets exceeds the
estimated fair value.
(g) Derivative Instruments and Hedging Activities:
---------------------------------------------
We account for derivative instruments and hedging activities in
accordance with SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." 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 hedges is carried on the balance sheet in other liabilities and
the related underlying 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 has 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 No. SFAS 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 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 June 30, 2006 was $2,659,000 ($1,662,000
after tax, or $0.01 per basic and diluted share of common stock) and
$5,335,000 ($3,335,000 after tax, or $0.01 per basic and diluted share
of common stock) for the first six months of 2006. The compensation
cost recognized is based on awards ultimately expected to vest. SFAS
No. 123R requires forfeitures to be estimated and revised, if
necessary, in subsequent periods if actual forfeitures differ from
those estimates.
Prior to the adoption of SFAS No. 123R, we applied Accounting
Principles Board Opinion (APB) No. 25 and related interpretations to
account for our stock plans resulting in the use of the
intrinsic-value based method to value the stock. Under APB 25, we were
not required to recognize compensation expense for the cost of stock
options issued under the Management Equity Incentive Plan (MEIP), 1996
8
Equity Incentive Plan (EIP) and the Amended and Restated 2000 EIP
stock plans.
In the past, we provided pro forma net income and pro forma net income
per share of common stock disclosures for employee and non-employee
director stock option grants based on the fair value of the options at
the date of grant. For purposes of presenting pro forma information,
the fair value of options granted is computed using the Black-Scholes
option-pricing model.
Had we determined compensation cost based on the fair value at the
grant date for the MEIP, EIP, Employee Stock Purchase Plan (ESPP) and
Non-Employee Directors' Deferred Fee Equity Plan, our pro forma net
income and net income per share of common stock available for common
stockholders would have been as follows:
Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
--------------------- -----------------------
($ in thousands)
Net income available
for common stockholders As reported $ 44,584 $ 87,218
Add: Stock-based employee compensation
expense included in reported net
income, net of related tax effects
1,322 2,738
Deduct: Total stock-based employee
compensation expense determined under
fair
value based method for all awards, net
of related tax effects
(2,170) (4,531)
---------- ----------
Pro forma $ 43,736 $ 85,425
========== ==========
Net income per share of common stock
available for common stockholders
As
reported:
Basic $ 0.13 $ 0.26
Diluted $ 0.13 $ 0.26
Pro forma:
Basic $ 0.13 $ 0.25
Diluted $ 0.13 $ 0.25
(i) Net Income Per Share of Common Stock Available for Common
----------------------------------------------------------------------
Stockholders:
------------
Basic net income per share of common stock is computed using the
weighted average number of shares of common stock outstanding during
the period being reported on. Except when the effect would be
antidilutive, diluted net income per share of common stock 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 shares of common stock that would result from the
conversion of convertible preferred stock (EPPICS). In addition, the
related interest on debt (net of tax) is added back to income since it
would not be paid if the debt was converted into common stock.
(2) Recent Accounting Literature and Changes in Accounting Principles:
-----------------------------------------------------------------
Accounting for Conditional Asset Retirement Obligations
-------------------------------------------------------
In March 2005, the FASB issued FIN 47, "Accounting for Conditional Asset
Retirement Obligations," an interpretation of FASB No. 143. FIN 47
clarifies that the term conditional asset retirement obligation as used in
FASB No. 143 refers to a legal obligation to perform an asset retirement
activity in which the timing or method of settlement are conditional on a
future event that may or may not be within the control of the entity. FIN
47 also clarifies when an entity would have sufficient information to
reasonably estimate the fair value of an asset retirement obligation.
Although a liability exists for the removal of poles and asbestos,
sufficient information is not available currently to estimate our
liability, as the range of time over which we may settle these obligations
is unknown or cannot be reasonably estimated. The adoption of FIN 47 during
the fourth quarter of 2005 had no impact on our financial position, results
of operations or cash flows.
9
How Taxes Collected from Customers and Remitted to Governmental Authorities
---------------------------------------------------------------------------
Should be Presented in the Income Statement
-------------------------------------------
In June 2006, the FASB issued EITF Issue No. 06-3, "How Taxes Collected
from Customers and Remitted to Governmental Authorities Should be Presented
in the Income Statement" (EITF 06-3), which requires disclosure of the
accounting policy for any tax assessed by a governmental authority that is
directly imposed on a revenue-producing transaction, that is Gross versus
Net presentation. EITF 06-3 is effective for periods beginning after
December 15, 2006. We do not expect the adoption of EITF 06-3 to have a
material impact on our financial position, results of operations or cash
flows.
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 48 requires
applying a "more likely than not" threshold to the recognition and
derecognition of tax positions. FIN 48 is effective for fiscal years
beginning after December 15, 2006. We do not expect the adoption of FIN 48
to have a material impact on our financial position, results of operations
or cash flows.
Partnerships
------------
In June 2005, the FASB issued EITF No. 04-5, "Determining Whether a General
Partner, or the General Partners as a Group, Controls a Limited Partnership
or Similar Entity When the Limited Partners Have Certain Rights," which
provides new guidance on how general partners in a limited partnership
should determine whether they control a limited partnership. EITF No. 04-5
is effective for fiscal periods beginning after December 15, 2005.
The Company has applied the provisions of EITF No. 04-5 and consolidated
the Mohave Cellular Limited Partnership (Mohave) effective January 1, 2006.
As permitted, we elected to apply EITF No. 04-5 retrospectively from the
date of adoption. We are the managing partner and have a 33% ownership
position.
Selected data for the Mohave partnership is as follows:
For the three months For the six months ended
ended June 30, June 30,
--------------------------- ---------------------------
($ in thousands) 2006 2005 2006 2005
---- ---- ---- ----
Revenues $4,764 $3,969 $9,207 $7,667
Depreciation Expense 568 527 1,083 1,038
Operating Income 1,291 848 2,489 1,544
(3) Accounts Receivable:
-------------------
The components of accounts receivable, net at June 30, 2006 and December
31, 2005 are as follows:
($ in thousands) June 30, 2006 December 31, 2005
----------------- ---------------------
End user $ 228,116 $ 210,470
Other 20,014 24,231
Less: Allowance for doubtful accounts (52,904) (31,631)
----------------- ---------------------
Accounts receivable, net $ 195,226 $ 203,070
================= =====================
The Company maintains an allowance for estimated bad debts based on its
estimate of collectibility of its accounts receivables. Bad debt expense,
which is recorded as a reduction of revenue, was $2,806,000 and $3,943,000
for the three months ended June 30, 2006 and 2005, respectively, and
$7,181,000 and $6,863,000 for the six months ended June 30, 2006 and 2005,
respectively. Our reserve has increased by approximately $20,000,000 as a
result of carrier activity that is in dispute.
10
(4) Property, Plant and Equipment, Net:
----------------------------------
Property, plant and equipment at June 30, 2006 and December 31, 2005 is as
follows:
($ in thousands) June 30, 2006 December 31, 2005
-------------------- ---------------------
Property, plant and equipment $ 6,518,509 $ 6,433,119
Less: accumulated depreciation (3,540,445) (3,374,807)
-------------------- ---------------------
Property, plant and equipment, net $ 2,978,064 $ 3,058,312
==================== =====================
Depreciation expense is principally based on the composite group method.
Depreciation expense was $87,957,000 and $100,879,000 for the three months
ended June 30, 2006 and 2005, respectively, and $178,366,000 and
$203,378,000 for the six months ended June 30, 2006 and 2005, respectively.
(5) Discontinued Operations:
-----------------------
In accordance with SFAS No. 144, any component of our business that we
dispose of or classify as held for sale that has operations and cash flows
clearly distinguishable from operations and for financial reporting
purposes, and that will be eliminated from the ongoing operations, should
be classified as discontinued operations. Accordingly, we have classified
the results of operations of Electric Lightwave, LLC (ELI) and
Conference-Call USA, LLC (CCUSA) as discontinued operations in our
consolidated statement of operations. All prior periods have been restated.
In addition, our statement of cash flows for the six months ended June 30,
2005 has been revised to separately disclose the operating, investing and
financing portions of the cash flows attributable to our CCUSA discontinued
operations, which in prior periods were reported on a combined basis as a
single amount.
ELI
---
In February 2006, we entered into a definitive agreement to sell all of the
outstanding membership interests in ELI, our competitive local exchange
carrier business (CLEC), to Integra Telecom Holdings, Inc. (Integra), for
$247,000,000, including $243,000,000 in cash plus the assumption of
approximately $4,000,000 in capital lease obligations, subject to customary
adjustments under the terms of the agreement. This transaction closed on
July 31, 2006. We expect to recognize a pre-tax gain on the sale of ELI of
approximately $125,000,000. Our existing tax net operating losses will be
used to absorb the potential cash liability for taxes.
ELI had revenues of $159,200,000 and operating income of $21,300,000 for
the year ended December 31, 2005. At December 31, 2005, ELI's net assets
totaled $116,500,000. We had no outstanding debt specifically identified
with ELI and therefore no interest expense was allocated to discontinued
operations. We ceased to record depreciation expense effective February 1,
2006.
Summarized financial information for ELI is set forth below:
June 30, December 31,
($ in thousands) 2006 2005
---------------- ----------------
Current assets $ 21,710 $ 24,986
Net property, plant and equipment 141,205 137,730
---------------- ----------------
Total assets held for sale $ 162,915 $ 162,716
================ ================
Current liabilities $ 20,039 $ 21,605
Long-term debt 4,187 4,246
Other liabilities 20,122 20,415
---------------- ----------------
Total liabilities related to assets held for sale $ 44,348 $ 46,266
================ ================
11
For the three months ended June 30, For the six months ended June 30,
--------------------------------------- --------------------------------------
($ in thousands) 2006 2005 2006 2005
------------------ ------------------ ------------------ ------------------
Revenue $ 43,584 $ 39,027 $ 86,078 $ 77,007
Operating income 11,482 5,231 21,940 6,607
Income taxes 4,526 2,110 8,488 2,567
Net income 6,956 3,121 13,452 4,040
CCUSA
-----
In February 2005, we entered into a definitive agreement to sell CCUSA, our
conferencing services business. On March 15, 2005, we completed the sale
for $43,565,000 in cash, subject to adjustments under the terms of the
agreement. The pre-tax gain on the sale of CCUSA was $14,061,000. Our
after-tax gain was $1,167,000. The book income taxes recorded upon sale are
primarily attributable to a low tax basis in the assets sold.
We had no outstanding debt specifically identified with CCUSA and therefore
no interest expense was allocated to discontinued operations. In addition,
we ceased to record depreciation expense effective February 16, 2005.
Summarized financial information for CCUSA is set forth below:
For the six months ended June 30,
--------------------------------------
($ in thousands) 2006 2005
----------------- ------------------
Revenue $ - $ 4,607
Operating income - 1,489
Income taxes - 449
Net income - 1,040
Gain on disposal of CCUSA, net of tax - 1,167
(6) Other Intangibles:
-----------------
Other intangibles at June 30, 2006 and December 31, 2005 are as follows:
($ in thousands) June 30, 2006 December 31, 2005
------------------------ ---------------------
Customer base - amortizable over 96 months $ 994,605 $ 994,605
Trade name - non-amortizable 122,058 122,058
------------------------ ---------------------
Other intangibles 1,116,663 1,116,663
Accumulated amortization (621,120) (557,930)
------------------------ ---------------------
Total other intangibles, net $ 495,543 $ 558,733
======================== =====================
Amortization expense was $31,595,000 and $63,190,000 for the three and six
months ended June 30, 2006 and 2005, respectively. Amortization expense,
based on our estimate of useful lives, is estimated to be $126,380,000 per
year through 2008 and $57,533,000 in 2009, at which point these assets will
have been fully amortized.
12
(7) Long-Term Debt:
--------------
The activity in our long-term debt from December 31, 2005 to June 30, 2006
is as follows:
Six Months Ended June 30, 2006
------------------------------------------------------------
Interest
Rate* at
December 31, Interest June 30, June 30,
($ in thousands) 2005 Payments Rate Swap Reclassification 2006 2006
----- -------- --------- ---------------- ----- ----
FIXED RATE
Rural Utilities Service Loan
Contracts $ 22,809 $ (469) $ - $ - $ 22,340 6.08%
Senior Unsecured Debt 4,120,781 (197,657) (15,100) (70) 3,907,954 8.29%
EPPICS 33,785 - - (14,249) 19,536 5.00%
Industrial Development Revenue
Bonds 58,140 - - - 58,140 5.60%
------------- ----------- ---------- --------- -----------
TOTAL LONG TERM DEBT 4,235,515 $ (198,126) $ (15,100) $(14,319) 4,007,970 8.22%
------------- =========== ========== ========== -----------
Less: Debt Discount (12,692) (9,731)
Less: Current Portion (227,693) (47,683)
------------- -----------
$ 3,995,130 $3,950,556
============= ===========
* Interest rate includes amortization of debt issuance costs, debt premiums or
discounts. The interest rate for Rural Utilities Service Loan Contracts, Senior
Unsecured Debt, and Industrial Development Revenue Bonds represent a weighted
average of multiple issuances.
In February 2006, our Board of Directors authorized us to repurchase up to
$150,000,000 of our outstanding debt over the following twelve-month
period. These repurchases may require us to pay premiums, which would
result in pre-tax losses to be recorded in investment and other income
(loss).
For the six months ended June 30, 2006, we retired an aggregate principal
amount of $212,445,000 of debt, including $14,249,000 of 5% Company
Obligated Mandatorily Redeemable Convertible Preferred Securities due 2036
(EPPICS) that were converted into our common stock. During the first
quarter of 2006, we entered into two debt-for-debt exchanges of our debt
securities. As a result, $47,500,000 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 $2,392,000
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.
As of June 30, 2006, EPPICS representing a total principal amount of
$192,200,000 have been converted into 15,480,799 shares of our common
stock. Approximately $9,030,000 of EPPICS, which are convertible into
787,661 shares of our common stock, were outstanding at June 30, 2006.
The total outstanding principal amounts of industrial development revenue
bonds were $58,140,000 at June 30, 2006 and December 31, 2005. The earliest
maturity date for these bonds is in August 2015. Under the terms of our
agreements to sell our former gas and electric operations in Arizona,
completed in 2003, we are obligated to call for redemption, at their first
available call dates, three Arizona industrial development revenue bond
series aggregating to approximately $33,440,000. 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 1, 2007. We expect to call the
bonds and retire them with cash.
As of June 30, 2006, we have available lines of credit with financial
institutions in the aggregate amount of $250,000,000. Associated facility
fees vary, depending on our debt leverage ratio, and are 0.375% per annum
as of June 30, 2006. The expiration date for the facility is October 29,
2009. During the term of the facility we may borrow, repay and reborrow
funds. The credit facility is available for general corporate purposes but
may not be used to fund dividend payments. There have never been any
borrowings under the facility.
13
(8) Net Income Per Share of Common Stock:
------------------------------------
The reconciliation of the income per share of common stock calculation for
the three and six months ended June 30, 2006 and 2005, respectively, is as
follows:
For the three months For the six months
($ in thousands, except per-share amounts) ended June 30, ended June 30,
---------------------------- ----------------------------
2006 2005 2006 2005
------------- ------------- ------------- -------------
Net income used for basic and diluted earnings
----------------------------------------------
per share of common stock:
--------------------------
Income from continuing operations $ 94,746 $ 41,463 $ 138,733 $ 80,971
Income from discontinued operations 6,956 3,121 13,452 6,247
------------- ------------- ------------- -------------
Total basic net income available to common stockholders $ 101,702 $ 44,584 $ 152,185 $ 87,218
============= ============= ============= =============
Effect of conversion of preferred securities - EPPICS 79 - 261 -
------------- ------------- ------------- -------------
Total diluted net income available to common stockholders $ 101,781 $ 44,584 $ 152,446 $ 87,218
============= ============= ============= =============
Basic earnings per share of common stock:
-----------------------------------------
Weighted-average common stock outstanding - basic 322,337 340,389 324,501 339,484
------------- ------------- ------------- -------------
Income from continuing operations $ 0.30 $ 0.12 $ 0.43 $ 0.24
Income from discontinued operations 0.02 0.01 0.04 0.02
------------- ------------- ------------- -------------
Net income per share available to common stockholders $ 0.32 $ 0.13 $ 0.47 $ 0.26
============= ============= ============= =============
Diluted earnings per share of common stock:
-------------------------------------------
Weighted-average common stock outstanding 322,337 340,389 324,501 339,484
Effect of dilutive shares 698 3,252 992 3,402
Effect of conversion of preferred securities - EPPICS 847 - 1,191 -
------------- ------------- ------------- -------------
Weighted-average common stock outstanding - diluted 323,882 343,641 326,684 342,886
============= ============= ============= =============
Income from continuing operations $ 0.29 $ 0.12 $ 0.43 $ 0.24
Income from discontinued operations 0.02 0.01 0.04 0.02
------------- ------------- ------------- -------------
Net income per share available to common stockholders $ 0.31 $ 0.13 $ 0.47 $ 0.26
============= ============= ============= =============
Stock Options
-------------
For the three and six months ended June 30, 2006, options to purchase
1,960,000 shares at exercise prices ranging from $13.03 to $18.46 issuable
under employee compensation plans were excluded from the computation of
diluted earning per share of common stock for those periods because the
exercise prices were greater than the average market price of our common
stock and, therefore, the effect would be antidilutive.
For the three and six months ended June 30, 2005, options to purchase
2,521,000 and 2,501,000 shares, respectively, at exercise prices ranging
from $13.03 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 addition, for the three and six months ended June 30, 2006 and 2005,
restricted stock awards of 1,212,000 and 1,477,000 shares, respectively,
are excluded from our basic weighted average shares of common stock
outstanding and included in our dilutive shares of common stock using the
treasury stock method 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 June 30, 2006, approximately 96% of the EPPICS outstanding, or about
$192,200,000 aggregate principal amount of EPPICS, have converted into
15,480,799 shares of our common stock, including 2,358,549 shares issued
from treasury.
14
At June 30, 2006, we had 180,594 shares of potentially dilutive EPPICS,
which were convertible into our common stock at a 4.36 to 1 ratio at an
exercise price of $11.46 per share. If all remaining EPPICS are converted
we would issue approximately 787,661 shares of our common stock. These
securities have been included in the diluted income per share of common
stock calculation for the period ended June 30, 2006.
At June 30, 2005, we had 554,938 shares of potentially dilutive EPPICS,
which were convertible into our common stock at a 4.36 to 1 ratio at an
exercise price of $11.46 per share. These securities have not been included
in the diluted income per share of common stock calculation for the period
ended June 30, 2005 because their inclusion would have had an antidilutive
effect.
Stock Units
-----------
At June 30, 2006 and 2005, we had 282,000 and 201,000 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.
(9) Stock Plans:
-----------
At June 30, 2006, we have 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 25, we were not required to recognize
compensation expense for the cost of stock options. In accordance with the
adoption of SFAS 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 June 30, 2006, there were 29,841,523 shares authorized
for grant under these plans and 5,802,592 shares available for grant.
Management Equity Incentive Plan
--------------------------------
Under the MEIP, awards of our common stock were granted to eligible
officers, management employees and non-management employees in the form of
incentive stock options, non-qualified stock options, stock appreciation
rights (SARs), restricted stock or other stock-based awards.
Since the expiration date of the MEIP plan on June 21, 2000, no awards can
be granted under the MEIP. The exercise price of stock options issued was
equal to or greater than the fair market value of the underlying common
stock on the date of grant. Stock options are 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.
Equity Incentive Plans
----------------------
Since the expiration date of the 1996 EIP on May 22, 2006, no awards can 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 directors received an award of stock options
under the 2000 EIP upon commencement of service.
At June 30, 2006, there were 27,389,711 shares authorized for grant under
the 2000 EIP and 3,368,375 shares available for grant, as adjusted to
reflect stock dividends. No awards will be granted more than 10 years after
the effective date (May 18, 2000) of the 2000 EIP plan. The exercise price
of stock options and SARs under the 2000 and 1996 EIP generally shall be
equal to or greater than the fair market value of the underlying common
stock on the date of grant. Stock options are not ordinarily exercisable on
the date of grant but vest over a period of time (generally 4 years).
Under the terms of the EIP plans, subsequent stock dividends and stock
splits have the effect of increasing the option shares outstanding, which
correspondingly decrease the average exercise price of outstanding options.
15
The following summary presents information regarding outstanding stock
options as of June 30, 2006 and changes during the six months then ended
with regard to options under the MEIP and EIP plans:
Weighted Weighted Aggregate
Shares Average Average Intrinsic
Subject to Option Price Remaining Value at
Option Per Share Life in Years June 30, 2006
--------------------------------------------- -------------- --------------- -------------- -----------------
Balance at January 1, 2006 7,985,000 $11.52
Options granted 13,000 12.11
Options exercised (1,309,000) 9.67 $ 4,348,000
Options canceled, forfeited or lapsed (55,000) 9.88
--------------------------------------------- --------------
Balance at June 30, 2006 6,634,000 11.90 4.96 $14,327,000
============================================= ==============
Exercisable at June 30, 2006 6,162,000 $12.00 4.79 $13,195,000
============================================= ==============
Options granted during the first six months of 2006 totaled 13,000. The
weighted average grant-date fair value of options granted during the six
months ended June 30, 2006 was $3.08. Cash received upon the exercise of
options during the first six months of 2006 totaled $12,756,000. Total
remaining unrecognized compensation cost associated with unvested stock
options at June 30, 2006 was $1,632,000 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 six
months of 2005 was $6,996,000. The total intrinsic value of stock options
outstanding and exercisable at June 30, 2005 was $26,554,000 and
$21,095,000, respectively. The weighted average grant-date fair value of
options granted during the six months ended June 30, 2005 was $3.03.
Options granted during the first six months of 2005 totaled 50,000. Cash
received upon the exercise of options during the first six months of 2005
totaled $24,953,000.
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 the first six months of 2006:
2006
---------------------------- --------------
Dividend yield 7.55%
Expected volatility 44%
Risk-free interest rate 4.89%
Expected life 5 years
---------------------------- --------------
The following table presents the weighted average assumptions used for
grants in fiscal 2005:
2005
---------------------------- --------------
Dividend yield 7.72%
Expected volatility 46%
Risk-free interest rate 4.16%
Expected life 6 years
---------------------------- --------------
The following summary presents information regarding unvested restricted
stock as of June 30, 2006 and changes during the six months then ended with
regard to restricted stock under the MEIP and EIP plans:
16
Weighted
Average Aggregate
Number of Grant Date Fair Value at
Shares Fair Value June 30, 2006
---------------------------------- -------------- ------------------ ----------------
Unvested at January 1, 2006 1,456,000 $12.47
Granted 730,000 12.86 $9,530,000
Vested (602,000) 12.00 $7,581,000
Forfeited (372,000) 12.60
---------------------------------- --------------
Unvested at June 30, 2006 1,212,000 $12.90 $15,820,000
================================== ==============
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 June 30, 2006 was $13,179,000 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 six months
ended June 30, 2005 was approximately $4,240,000 and $6,119,000,
respectively. The total fair value of unvested restricted stock at June 30,
2005 was $19,856,000. The weighted average grant-date fair value of
restricted shares granted during the six months ended June 30, 2005 was
$13.10. Shares granted during the first six months of 2005 totaled 316,000.
Non-Employee Directors' Compensation Plans
------------------------------------------
Each non-employee director receives a grant of 10,000 stock options upon
commencement of his or her service on the Board of Directors. These options
are currently awarded under the Directors' Equity Plan. Prior to
effectiveness of the Directors' Equity Plan on May 25, 2006, these options
were awarded under the 2000 EIP. The exercise price of these options, which
become exercisable six months after the grant date, is the fair market
value (as defined in the relevant plan) of our common stock on the date of
grant. Options granted under the Directors' Equity Plan expire on the
earlier of the tenth anniversary of the grant date or the first anniversary
of termination of service as a director.
Each non-employee director also receives an annual grant of 3,500 stock
units. These units are currently awarded under the Directors' Equity Plan
and prior to effectiveness of that plan, were awarded under the Deferred
Fee Plan. Each non-employee director may also elect to receive meeting fees
and, when applicable, fees for serving as a committee chair and/or Lead
Director, in stock units. In addition, non-employee directors may also
elect to receive stock units in lieu of the annual cash retainer. Stock
units are payable upon termination of service as a director in either
common stock (convertible on a one-to-one basis) or cash, at the election
of the director.
Upon effectiveness of the Directors' Equity Plan, no further grants will be
made under the Deferred Fee Plan.
The number of shares of common stock authorized for issuance under the
Directors' Equity Plan is 2,451,812, which includes 451,812 shares
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 June 30, 2006,
there were 2,434,217 shares available for grant. There were 12 directors
participating in the non-employee plans during the second quarter of 2006.
In the first six months of 2006, total plan units earned were 75,493. At
June 30, 2006, 289,587 options were exercisable at a weighted average
exercise price of $10.40.
We account for the Deferred Fee Plan in accordance with SFAS No. 123R. If
cash is elected, it is considered a liability-based award. If stock units
are elected, they are considered equity-based awards. Compensation expense
for stock units is based on the market value of our common stock at the
date of grant. 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.
17
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 June 30, 2006, the
liability for such payments was approximately $654,000 all of which will be
payable in stock (based on the July 15, 1999 stock price).
(10) Segment Information:
-------------------
As of January 1, 2006, we operate in a single 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 the Company's Frontier properties
share similar economic characteristics: they provide the same products and
services to similar customers using comparable technologies in all the
states we operate. The regulatory structure is generally similar.
Differences in the regulatory regime of a particular state do not
materially impact the economic characteristics or operating results of a
particular property.
(11) Derivative Instruments and Hedging Activities:
---------------------------------------------
Interest rate swap agreements are used to hedge a portion of our debt that
is subject to fixed interest rates. Under our interest rate swap
agreements, we agree to pay an amount equal to a specified variable rate of
interest times a notional principal amount, and to receive in return an
amount equal to a specified fixed rate of interest times the same notional
principal amount. The notional amounts of the contracts are not exchanged.
No other cash payments are made unless the agreement is terminated prior to
maturity, in which case the amount paid or received in settlement is
established by agreement at the time of termination and represents the
market value, at the then current rate of interest, of the remaining
obligations to exchange payments under the terms of the contracts.
The interest rate swap contracts are reflected at fair value in our
consolidated balance sheet and the related portion of fixed-rate debt being
hedged is reflected at an amount equal to the sum of its book value and an
amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. The notional amounts
of fixed-rate indebtedness hedged as of June 30, 2006 and December 31, 2005
was $550,000,000 and $500,000,000, respectively. Such contracts require us
to pay variable rates of interest (estimated average pay rates of
approximately 9.17% as of June 30, 2006 and approximately 8.60% as of
December 31, 2005) and receive fixed rates of interest (average receive
rates of 8.26% as of June 30, 2006 and 8.46% as of December 31, 2005,
respectively). The fair value of these derivatives is reflected in other
liabilities as of June 30, 2006 and December 31, 2005, in the amount of
$23,827,000 and $8,727,000, respectively. The related underlying debt has
been decreased by a like amount. The amounts paid during the three and six
months ended June 30, 2006 as a result of these contracts amounted to
$1,134,000 and $1,668,000 and are included as interest expense.
During September 2005, we entered into a series of separate forward rate
agreements with our swap counter-parties that fixed the underlying variable
rate component of some of our swaps at the market rate as of the date of
execution for certain future rate-setting dates. These agreements have
expired. Fair value at December 31, 2005, was $1,129,000. A gain for the
changes in the fair value of these forward rate agreements of $46,000 and
$430,000, respectively, is included in other income (loss), net for the
three and six months ended June 30, 2006.
We do not anticipate any nonperformance by counterparties to our derivative
contracts as all counterparties have investment grade credit ratings.
18
(12) Investment and Other Income (Loss), Net:
---------------------------------------
The components of investment and other income (loss), net are as follows:
For the three months For the six months
ended June 30, ended June 30,
------------------------------- ------------------------------
($ in thousands) 2006 2005 2006 2005
-------------- -------------- ------------- --------------
Investment income $ 4,440 $ 3,925 $ 8,267 $ 6,021
Gain from Rural Telephone Bank dissolution 61,428 - 61,428 -
Loss on exchange of debt - (3,175) (2,392) (3,175)
Investment gain - 395 - 888
Other, net (505) (572) (3,291) 807
-------------- -------------- ------------- --------------
Total investment and other income (loss), net $ 65,363 $ 573 $ 64,012 $ 4,541
============== ============== ============= ==============
The gain of $61,428,000 resulted from the dissolution and liquidation of
the Rural Telephone Bank.
(13) 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 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
$207,475,000 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 and second quarters of 2006 and the four quarters
of 2005. Only cash was paid (net of investment returns) to the Partnership
in payment of the interest on the Convertible Subordinated Debentures. The
cash was then distributed by the Partnership to the Trust and then by the
Trust to the holders of the EPPICS.
As of June 30, 2006, EPPICS representing a total principal amount of
$192,200,000 have been converted into 15,480,799 shares of our common
stock. A total of $9,030,000 of EPPICS is outstanding as of June 30, 2006
and if all outstanding EPPICS were converted, 787,661 shares of our common
stock would be issued upon such conversion.
19
(14) Retirement Plans:
----------------
The following table provides the components of net periodic benefit cost:
Pension Benefits
-----------------------------------------------------------------
For the three months ended For the six months ended
June 30, June 30,
------------------------------- -------------------------------
2006 2005 2006 2005
-------------- --------------- -------------- ---------------
($ in thousands)
Components of net periodic benefit cost
---------------------------------------
Service cost $ 1,759 $ 1,584 $ 3,518 $ 3,079
Interest cost on projected benefit obligation 11,504 11,338 23,008 23,102
Return on plan assets (15,126) (15,795) (30,252) (30,185)
Amortization of prior service cost and unrecognized
net obligation (61) (61) (122) (122)
Amortization of unrecognized loss 3,085 2,136 6,170 4,663
-------------- --------------- -------------- ---------------
Net periodic benefit cost $ 1,161 $ (798) $ 2,322 $ 537
============== =============== ============== ===============
Other Postretirement Benefits
-----------------------------------------------------------------
For the three months ended For the six months ended
June 30, June 30,
------------------------------- -------------------------------
2006 2005 2006 2005
-------------- --------------- -------------- ---------------
($ in thousands)
Components of net periodic benefit cost
---------------------------------------
Service cost $ 174 $ 314 $ 348 $ 596
Interest cost on projected benefit obligation 2,211 3,128 4,422 6,305
Return on plan assets (245) (59) (490) (624)
Amortization of prior service cost and unrecognized
net obligation (1,026) (158) (2,052) (209)
Amortization of unrecognized loss 1,513 2,173 3,026 3,484
-------------- --------------- -------------- ---------------
Net periodic benefit cost $ 2,627 $ 5,398 $ 5,254 $ 9,552
============== =============== ============== ===============
We expect that our pension and other postretirement benefit expenses for
2006 will be $15,000,000 - $18,000,000 (down from $19,000,000 in 2005) and
no contribution will be required to be made by us to the pension plan in
2006.
(15) Related Party Transaction:
-------------------------
In June 2005, the Company sold for cash its interests in certain key man
life insurance policies on the lives of Leonard Tow, our former Chairman
and Chief Executive Officer, and his wife, a former director. The cash
surrender value of the policies purchased by Dr. Tow totaled approximately
$24,195,000, and we recognized a gain of approximately $457,000 that is
included in investment and other income.
(16) Commitments and Contingencies:
-----------------------------
We anticipate capital expenditures of approximately $270,000,000 -
$280,000,000 for 2006. 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.
20
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 believe that we will be
responsible for only a portion of the cost to clean up and the final
resolution of this matter will not be material to the operating results nor
the financial condition of the Company.
Prior to the next phase of the litigation, 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 currently using any of the processes that are
protected by its patents but we have not had any communication with them on
this issue since mid-2004. If we determine that we are utilizing the patent
holder's intellectual property, we expect to commence negotiations on a
license agreement.
On June 24, 2004, one of our subsidiaries, Frontier Subsidiary Telco, Inc.,
received a "Notice of Indemnity Claim" from Citibank, N.A., that is related
to a complaint pending against Citibank and others in the U.S. Bankruptcy
Court for the Southern District of New York as part of the Global Crossing
bankruptcy proceeding. Citibank bases its claim for indemnity on the
provisions of a credit agreement that was entered into in October 2000
between Citibank and our subsidiary. We purchased Frontier Subsidiary
Telco, Inc., in June 2001 as part of our acquisition of the Frontier
telephone companies. The complaint against Citibank, for which it seeks
indemnification, alleges that the seller improperly used a portion of the
proceeds from the Frontier transaction to pay off the Citibank credit
agreement, thereby defrauding certain debt holders of Global Crossing North
America Inc. Although the credit agreement was paid off at the closing of
the Frontier transaction, Citibank claims the indemnification obligation
survives. Damages sought against Citibank and its co-defendants could
exceed $1,000,000,000. In August 2004, we notified Citibank by letter that
we believe its claims for indemnification are invalid and are not supported
by applicable law. We have received no further communications from Citibank
since our August 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.
21
The Company sold all of its utility businesses as of April 1, 2004.
However, we have retained a potential payment obligation associated with
our previous electric utility activities in the state of Vermont. The
Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities, including
us, entered into a purchase power agreement with Hydro-Quebec in 1987. The
agreement contains "step-up" provisions that state that if any VJO member
defaults on its purchase obligation under the contract to purchase power
from Hydro-Quebec the other VJO participants will assume responsibility for
the defaulting party's share on a pro-rata basis. Our pro-rata share of the
purchase power obligation is 10%. If any member of the VJO defaults on its
obligations under the Hydro-Quebec agreement, then the remaining members of
the VJO, including us, may be required to pay for a substantially larger
share of the VJO's total power purchase obligation for the remainder of the
agreement (which runs through 2015). Paragraph 13 of FIN 45 requires that
we disclose, "the maximum potential amount of future payments
(undiscounted) the guarantor could be required to make under the
guarantee." Paragraph 13 also states that we must make such disclosure "...
even if the likelihood of the guarantor's having to make any payments under
the guarantee is remote...". As noted above, our obligation only arises as
a result of default by another VJO member such as upon bankruptcy.
Therefore, to satisfy the "maximum potential amount" disclosure requirement
we must assume that all members of the VJO simultaneously default, a highly
unlikely scenario given that the two members of the VJO that have the
largest potential payment obligations are publicly traded with credit
ratings equal 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, 2007 and remained in default for the duration
of the contract (another 10 years), we estimate that our undiscounted
purchase obligation for 2007 through 2015 would be approximately
$1,264,000,000. In such a scenario the Company would then own the power and
could seek to recover its costs. We would do this by seeking to recover our
costs from the defaulting members and/or reselling the power to other
utility providers or the northeast power grid. There is an active market
for the sale of power. We could potentially lose money if we were unable to
sell the power at cost. We caution that we cannot predict with any degree
of certainty any potential outcome.
22
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 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:
* 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 our operations, costs, capital
spending, regulatory compliance and service quality;
* Our ability to successfully introduce new product offerings including
our ability to offer bundled service packages on terms that are both
profitable to us and attractive to our customers;
* 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 operating expenses, capital expenditures,
pay dividends and 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 more price competition and potential bad debts;
* 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;
23
* The effects of increased medical, retiree and pension expenses and
related funding requirements;
* Changes in income tax rates, tax laws, regulations or rulings, and/or
federal or state tax assessments;
* The effects of state regulatory cash management policies on our
ability to transfer cash among our subsidiaries and to the parent
company;
* Our ability to successfully renegotiate expiring union contracts
covering approximately 1,045 employees that are scheduled to expire
during the remainder of 2006;
* 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 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 10-K in evaluating any statement in this
Form 10-Q or otherwise made by us or on our behalf. The following information is
unaudited and should be read in conjunction with the consolidated financial
statements and related notes included in this report. We have no obligation to
update or revise these forward-looking statements.
Overview
--------
We are a communications company providing services to rural areas and small and
medium-sized towns and cities as an incumbent local exchange carrier, or ILEC.
We offer our ILEC services under the "Frontier" name. In February 2006, we
entered into a definitive agreement to sell 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. ELI was
sold on July 31, 2006.
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 2006 across all products and in all of our markets. Our
Frontier business has experienced erosion in access lines and switched access
minutes in the first half of 2006 as a result of competition. Competition in our
markets could result in reduced revenues in 2006.
The communications industry is undergoing significant changes. The market is
extremely competitive, resulting in lower prices. These trends are likely to
continue and result in a challenging revenue environment. These factors could
also result in more bankruptcies in the sector and therefore affect our ability
to collect money owed to us by carriers.
Revenues from data and internet services such as high-speed internet continue to
increase as a percentage of our total revenues and revenues from high margin
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
-------------------------------
For the six months ended June 30, 2006, we used cash flow from continuing
operations, RTB proceeds and cash and cash equivalents to fund capital
expenditures, dividends, interest payments, debt repayments and stock
repurchases. As of June 30, 2006, we had cash and cash equivalents aggregating
$141.3 million.
24
For the six months ended June 30, 2006, our capital expenditures were $98.3
million. We continue to closely scrutinize all of our capital projects,
emphasize return on investment and focus our capital expenditures on areas and
services that have the greatest opportunities with respect to revenue growth and
cost reduction. We anticipate capital expenditures of approximately $270.0 -
280.0 million for 2006.
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 2006 are not material. However, based on the success of our planned
roll-out of these products in late 2006, our capital expenditures for these
products may increase in the future.
As of June 30, 2006, we had available lines of credit with financial
institutions in the aggregate amount of $250.0 million. Associated facility fees
vary, depending on our debt leverage ratio, and are 0.375% per annum as of June
30, 2006. The expiration date for the facility is October 29, 2009. During the
term of the facility we may borrow, repay and reborrow funds. The credit
facility is available for general corporate purposes but may not be used to fund
dividend payments. We have never borrowed any money under the facility.
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. Losses of access lines,
increases in competition, lower subsidy and access revenues and the other
factors described above are expected to reduce our cash generated by operations
and may require us to increase capital expenditures. The downgrades in our
credit ratings to below investment grade may make it more difficult and
expensive to refinance our maturing debt. We have in recent years paid
relatively low amounts of cash taxes. We expect that over the next several years
our cash taxes will increase substantially.
We believe our operating cash flows, existing cash balances, and credit facility
will be adequate to finance our working capital requirements, fund capital
expenditures, make required debt payments through 2007, pay taxes, pay dividends
to our stockholders in accordance with our dividend policy and support our
short-term and long-term operating strategies. We have approximately $29.6
million of debt maturing during the last six months of 2006 and $37.8 million
and $653.4 million of debt maturing in 2007 and 2008, respectively.
Share Repurchase Programs
-------------------------
On May 25, 2005, our Board of Directors authorized us to repurchase up to $250.0
million of our common stock. This share repurchase program commenced on June 13,
2005. As of December 31, 2005, we completed the repurchase program and had
repurchased a total of 18,775,156 shares of our common stock at an aggregate
cost of $250.0 million.
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 June 30, 2006, we had repurchased 10,199,900 shares of our common
stock at an aggregate cost of approximately $135.2 million.
Debt Reduction and Debt Exchanges
---------------------------------
For the quarter ended June 30, 2006, we retired an aggregate principal amount of
$212.4 million of debt, including $14.3 million of 5% Company Obligated
Mandatorily Redeemable Convertible Preferred Securities due 2006 (EPPICS) that
were converted into our common stock. During the first quarter of 2006, we
entered into two debt-for-debt exchanges of our debt securities. As a result,
$47.5 million of our 7.625% notes due 2008 were exchanged for approximately
$47.4 million of our 9.00% notes due 2031. The 9.00% notes are callable on the
same general terms and conditions as the 7.625% notes exchanged. No cash was
exchanged in these transactions, however a non-cash pre-tax loss of
approximately $2.4 million was recognized in accordance with EITF No. 96-19,
"Debtor's Accounting for a Modification or Exchange of Debt Instruments," which
is included in other income (loss), net.
On June 1, 2006, we retired at par our entire $175.0 million principal amount of
7.60% Debentures due June 1, 2006.
25
On June 14, 2006, we repurchased $22.7 million of our 6.75% Senior Notes due
August 17, 2006 at a price of 100.181% of par.
In February 2006, our Board of Directors authorized us to repurchase up to
$150.0 million of our outstanding debt over the following twelve-month period.
These repurchases may require us to pay premiums, which would result in pre-tax
losses to be recorded in investment and other income (loss). Through July 31,
2006, we have not made any purchases pursuant to this authorization.
We may from time to time repurchase our debt in the open market, through tender
offers, exchanges of debt securities or privately negotiated transactions. We
may also exchange existing debt for newly issued debt obligations.
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 June 30, 2006 and
December 31, 2005 were $550.0 million and $500.0 million, respectively. Such
contracts require us to pay variable rates of interest (estimated average pay
rates of approximately 9.17% as of June 30, 2006 and approximately 8.60% as of
December 31, 2005) and receive fixed rates of interest (average receive rate of
8.26% as of June 30, 2006 and 8.46% as of December 31, 2005). All swaps are
accounted for under SFAS No. 133 (as amended) as fair value hedges. For the
three and six months ended June 30, 2006, the interest expense resulting from
these interest rate swaps totaled approximately $1.1 million and $1.7 million,
respectively.
Sale of Non-Strategic Investments
---------------------------------
On February 1, 2005, we sold 20,672 shares of Prudential Financial, Inc. for
approximately $1.1 million in cash.
On March 15, 2005, we completed the sale of our conferencing business, CCUSA for
approximately $43.6 million in cash.
In June 2005, we sold for cash our interests in certain key man life insurance
policies on the lives of Leonard Tow, our former Chairman and Chief Executive
Officer, and his wife, a former director. The cash surrender value of the
policies purchased by Dr. Tow totaled approximately $24.2 million, and we
recognized a gain of approximately $457,000 that is included in investment and
other income.
Off-Balance Sheet Arrangements
------------------------------
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationships with unconsolidated entities that would be expected to
have a material current or future effect upon our financial statements.
EPPICS
------
In 1996, our consolidated wholly owned subsidiary, Citizens Utilities Trust (the
Trust), issued, in an underwritten public offering, 4,025,000 shares of 5%
Company Obligated Mandatorily Redeemable Convertible Preferred Securities due
2036 (Trust Convertible Preferred Securities or EPPICS), representing preferred
undivided interests in the assets of the Trust, with a liquidation preference of
$50 per security (for a total liquidation amount of $201.3 million). These
securities have an adjusted conversion price of $11.46 per 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.
26
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
and second quarters of 2006 and the four quarters of 2005. Only cash was paid
(net of investment returns) to the Partnership in payment of the interest on the
Convertible Subordinated Debentures. The cash was then distributed by the
Partnership to the Trust and then by the Trust to the holders of the EPPICS.
As of June 30, 2006, EPPICS representing a total principal amount of $192.2
million have been converted into 15,480,799 shares of our common stock, and a
total of $9.0 million remains outstanding to third parties. Our long-term debt
footnote indicates $19.5 million of EPPICS outstanding at June 30, 2006 of which
$10.5 million is intercompany debt of related parties.
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 contains a maximum leverage ratio covenant.
Under the leverage ratio covenant, we are required to maintain a ratio of (i)
total indebtedness minus cash and cash equivalents in excess of $50.0 million to
(ii) consolidated adjusted EBITDA (as defined in the agreement) over the last
four quarters no greater than 4.50 to 1. Although the credit facility is
unsecured, it will be equally and ratably secured by certain liens and equally
and ratably guaranteed by certain of our subsidiaries if we issue debt that is
secured or guaranteed.
We are in compliance with all of our debt and credit facility covenants.
Discontinued Operations
-----------------------
In February 2006, we entered into a definitive agreement to sell all of the
outstanding membership interests in ELI, our CLEC business, to Integra Telecom
Holdings, Inc. (Integra), for $247.0 million, including $243.0 million in cash
plus the assumption of approximately $4.0 million in capital lease obligations,
subject to customary adjustments under the terms of the agreement. This
transaction closed on July 31, 2006. We expect to recognize a pre-tax gain on
the sale of ELI of approximately $125.0 million. Our existing tax net operating
losses will be used to absorb the potential cash liability for taxes.
On March 15, 2005, we completed the sale of Conference Call USA, LLC (CCUSA) for
$43.6 million in cash, subject to adjustments under the terms of the agreement.
The pre-tax gain on the sale of CCUSA was $14.1 million. Our after-tax gain was
$1.2 million. The book income taxes recorded upon sale are primarily
attributable to a low tax basis in the assets sold.
Rural Telephone Bank
--------------------
In August 2005, the Board of Directors of the Rural Telephone Bank (RTB) voted
to dissolve the bank. In November 2005, the liquidation and dissolution of the
RTB was initiated with the signing of the 2006 Agricultural Appropriation bill
by President Bush. We received approximately $64.6 million in cash from the
dissolution of the RTB in April 2006, which resulted in the recognition of a
pre-tax gain of approximately $61.4 million during the second quarter of 2006.
Our existing tax net operating losses will be used to absorb the potential cash
liability for taxes.
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.
27
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, 2005.
New Accounting Pronouncements
-----------------------------
Accounting for Conditional Asset Retirement Obligations
-------------------------------------------------------
In March 2005, the FASB issued FIN 47, "Accounting for Conditional Asset
Retirement Obligations," an interpretation of FASB No. 143. FIN 47 clarifies
that the term conditional asset retirement obligation as used in FASB No. 143
refers to a legal obligation to perform an asset retirement activity in which
the timing or method of settlement are conditional on a future event that may or
may not be within the control of the entity. FIN 47 also clarifies when an
entity would have sufficient information to reasonably estimate the fair value
of an asset retirement obligation. Although a liability exists for the removal
of poles and asbestos, sufficient information is not available currently to
estimate our liability, as the range of time over which we may settle theses
obligations is unknown or cannot be reasonably estimated. The adoption of FIN 47
during the fourth quarter of 2005 had no impact on our financial position,
results of operations or cash flows.
How Taxes Collected from Customers and Remitted to Governmental Authorities
--------------------------------------------------------------------------------
Should be Presented in the Income Statement
-------------------------------------------
In June 2006, the FASB issued EITF Issue No. 06-3, "How Taxes Collected from
Customers and Remitted to Governmental Authorities Should be Presented in the
Income Statement" (EITF 06-3), which requires disclosure of the accounting
policy for any tax assessed by a governmental authority that is directly imposed
on a revenue-producing transaction, that is Gross versus Net presentation. EITF
06-3 is effective for periods beginning after December 15, 2006. We do not
expect the adoption of EITF 06-3 to have a material impact on our financial
position, results of operations or cash flows.
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 48 requires applying a
"more likely than not" threshold to the recognition and derecognition of tax
positions. FIN 48 is effective for fiscal years beginning after December 15,
2006. We do not expect the adoption of FIN 48 to have a material impact on our
financial position, results of operations or cash flows.
Partnerships
------------
In June 2005, the FASB issued EITF No. 04-5, "Determining Whether a General
Partner, or the General Partners as a Group, Controls a Limited Partnership or
Similar Entity When the Limited Partners Have Certain Rights," which provides
new guidance on how general partners in a limited partnership should determine
whether they control a limited partnership. EITF No. 04-5 is effective for
fiscal periods beginning after December 15, 2005.
The Company applied the provisions of EITF No. 04-5 and consolidated the Mohave
Cellular Limited Partnership (Mohave) effective January 1, 2006. As permitted,
we elected to apply EITF No. 04-5 retrospectively from the date of adoption.
Revenues, depreciation and operating income for Mohave were $4.8 million, $0.6
million and $1.3 million, respectively, for the three months ended June 30, 2006
and $9.2 million, $1.1 million and $2.5 million, respectively, for the six
months ended June 30, 2006.
Revenues, depreciation and operating income for Mohave were $4.0 million, $0.5
million and $0.8 million, respectively, for the three months ended June 30, 2005
and $7.7 million, $1.0 million and $1.5 million, respectively, for the six
months ended June 30, 2005.
28
Stock-Based Compensation
------------------------
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS No. 123R"). SFAS No. 123R requires that stock-based employee
compensation be recorded as a charge to earnings. In April 2005, the Securities
and Exchange Commission required adoption of SFAS No. 123R for annual periods
beginning after June 15, 2005. Accordingly, we have adopted SFAS 123R commencing
January 1, 2006 using a modified prospective application, as permitted by SFAS
No. 123R. Accordingly, prior period amounts have not been restated. Under this
application, we are required to record compensation expense for all awards
granted after the date of adoption and for the unvested portion of previously
granted awards that remain outstanding at the date of adoption.
Prior to the adoption of SFAS No. 123R, we applied Accounting Principles Board
Opinion (APB) No. 25 and related interpretations to account for our stock plans
resulting in the use of the intrinsic value to value the stock. Under APB 25, we
were not required to recognize compensation expense for the cost of stock
options. In accordance with the adoption of SFAS 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 months ended June 30, 2006 was $2.7 million
($1.7 million after tax or $0.01 per basic and diluted share of common stock).
Stock-based compensation expense for the first six months of 2006 was $5.3
million ($3.3 million after tax or $0.01 per basic and diluted share of common
stock).
(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 June 30, 2006 increased $10.8
million, or 2%, as compared with the prior year period.
Consolidated revenue for the six months ended June 30, 2006 increased $15.3
million, or 2%, as compared with the prior year period.
In February 2006, we entered into a definitive agreement to sell ELI to Integra.
As a result, we have classified ELI's results of operations as discontinued
operations in our consolidated statements of operations and restated prior
periods.
On March 15, 2005, we completed the sale of our conferencing service business,
CCUSA. As a result of the sale, we have classified CCUSA's results of operations
as discontinued operations in our consolidated statements of operations and
restated prior periods.
Change in the number of our access lines is important to our revenue and
profitability. We have lost access lines primarily because of competition,
changing consumer behavior, economic conditions, changing technology and by some
customers disconnecting second lines when they add high-speed internet or cable
modem service. We lost approximately 55,900 access lines during the six months
ended June 30, 2006 but added approximately 39,000 high-speed internet
subscribers during this same period. The loss of lines during the first six
months of 2006 was primarily among residential customers. The non-residential
line losses were principally in Rochester, New York, while the residential
losses were throughout our markets. We expect to continue to lose access lines
but to increase high-speed internet subscribers during 2006. A continued loss of
access lines, combined with increased competition and the other factors
discussed in MD&A, may cause our revenues, profitability and cash flows to
decrease in the second half of 2006.
29
($ in thousands) For the three months ended June 30, For the six months ended June 30,
------------------------------------------------ ----------------------------------------------------
2006 2005 $ Change % Change 2006 2005 $ Change % Change
------------ ----------- ------------- -------- ------------- ------------- ------------- ----------
Local services $ 203,254 $ 205,722 $ (2,468) -1% $ 406,820 $ 415,679 $ (8,859) -2%
Access services 153,582 151,654 1,928 1% 314,550 308,478 6,072 2%
Long distance services 38,692 42,337 (3,645) -9% 77,850 86,087 (8,237) -10%
Data and internet services 54,488 42,392 12,096 29% 104,846 81,001 23,845 29%
Directory services 28,547 28,541 6 0% 57,344 56,504 840 1%
Other 28,349 25,487 2,862 11% 52,363 50,718 1,645 3%
------------ ----------- ------------- ------------- ------------- -------------
$ 506,912 $ 496,133 $ 10,779 2% $ 1,013,773 $ 998,467 $ 15,306 2%
============ =========== ============= ============= ============= =============
Local Services
Local services revenue for the three months ended June 30, 2006 decreased $2.5
million, or 1% as compared with the prior year period. Local revenue decreased
$4.2 million primarily due to continued losses of access lines. Enhanced
services revenue increased $1.7 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.
Local services revenue for the six months ended June 30, 2006 decreased $8.9
million, or 2% as compared with the prior year period. Local revenue decreased
$12.1 million primarily due to continued losses of access lines. Enhanced
services revenue increased $3.2 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. Rate increases
for local access services are expected to increase revenues by approximately
$400,000 monthly beginning August of 2006.
Access Services
Access services revenue for the three months ended June 30, 2006 increased $1.9
million, or 1%, as compared with the prior year period. Special access revenue
increased $1.4 million primarily due to growth in high-capacity circuits. Access
service revenue includes subsidy payments we receive from federal and state
agencies. Subsidy revenue increased $9.0 million primarily due to significantly
higher recovery of costs. Switched access revenue decreased $8.5 million, as
compared with the prior year period, primarily due to a decline in minutes of
use.
Access services revenue for the six months ended June 30, 2006 increased $6.1
million, or 2%, as compared with the prior year period. Special access revenue
increased $5.1 million primarily due to growth in high-capacity circuits. Access
service revenue includes subsidy payments we receive from federal and state
agencies. Subsidy revenue increased $11.5 million primarily due to significantly
higher recovery of costs. Switched access revenue decreased $10.6 million, as
compared with the prior year period, primarily due to a decline in minutes of
use.
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 national average cost per loop (NACPL),
thereby resulting in decreases in our subsidy revenue in the future. The FCC and
state regulators are currently considering a number of proposals for changing
the manner in which eligibility for federal subsidies is determined as well as
the amounts of such subsidies. The FCC is also reviewing the mechanism by which
subsidies are funded. Additionally, the FCC has an open proceeding to address
reform to access charges and other intercarrier compensation. We cannot predict
when or how these matters will be decided nor the effect on our subsidy or
access revenues. Future reductions in our subsidy and access revenues are not
expected to be accompanied by proportional decreases in our costs, so any
further reductions in those revenues will directly affect our profitability and
cash flows.
Long Distance Services
Long distance services revenue for the three months ended June 30, 2006
decreased $3.6 million, or 9%, as compared with the prior period. Long distance
services revenue for the six months ended June 30, 2006 decreased $8.2 million,
or 10%, as compared with the prior 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 slightly during
the second quarter of 2006 compared to the second quarter of 2005. 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
2006.
30
Data and Internet Services
Data and internet services revenue for the three months ended June 30, 2006
increased $12.1 million, or 29%, as compared with the prior year primarily due
to growth in data and high-speed internet services. Data and internet services
revenue for the six months ended June 30, 2006 increased $23.8 million, or 29%,
as compared with the prior year primarily due to growth in data and high-speed
internet services. The number of the Company's high-speed internet subscribers
has increased by more than 83,000 or 31.1% since June 30, 2005.
Other
Other revenue for the three months ended June 30, 2006 increased $2.9 million,
or 11%, as compared with the prior year primarily due to a $1.1 million decrease
in bad debt expense due to improved agings, a $1.2 million increase in customer
premise equipment sales and an increase of $0.8 million in cellular roamer
revenue associated with the Mohave Cellular Limited Partnership which is being
consolidated in accordance with EITF 04-5 effective January 1, 2006.
Other revenue for the six months ended June 30, 2006 increased $1.6 million, or
3%, as compared with the prior year primarily due to an increase of $1.5 million
in cellular roamer revenue.
COST OF SERVICES
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------------- -------------------------------------------------
2006 2005 $ Change % Change 2006 2005 $ Change % Change
------------ ----------- ------------- ----------- ---------- ----------- ----------- --------
Network access $ 38,402 $ 35,595 $ 2,807 8% $ 78,620 $ 75,317 $ 3,303 4%
As we continue to increase our sales of data products such as high-speed
internet and expand the availability of our unlimited long distance calling
plans, our network access expense is likely to increase. Access line losses have
offset some of the increase.
OTHER OPERATING EXPENSES
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------------- ----------------------------------------------
2006 2005 $ Change % Change 2006 2005 $ Change % Change
------------- ------------- ------------- -------- ----------- ------------ ----------- --------
Operating expenses $ 135,827 $ 141,007 $ (5,180) -4% $ 274,073 $ 278,069 $ (3,996) -1%
Taxes other than income taxes 20,934 23,331 (2,397) -10% 46,769 49,763 (2,994) -6%
Sales and marketing 22,739 21,445 1,294 6% 45,959 41,988 3,971 9%
------------- ------------- ------------- ----------- ------------ -----------
$ 179,500 $ 185,783 $ (6,283) -3% $ 366,801 $ 369,820 $ (3,019) -1%
============= ============= ============= =========== ============ ===========
Operating expenses for the three months ended June 30, 2006 decreased $5.2
million, or 4%, as compared with the prior year period primarily due to
headcount reductions and associated decreases in salaries and benefits. We have
340 fewer employees as compared to June 30, 2005.
Operating expenses for the six months ended June 30, 2006 decreased $4.0
million, or 1%, as compared with the prior year period primarily due to
headcount reductions and associated decreases in salaries and benefits. We
routinely review our operations, personnel and facilities to achieve greater
efficiencies. We intend to consolidate our call center operations from 14
locations down to 2 or 3. As we work through the consolidation we expect that
our operating expenses will temporarily increase. Our expenses may also increase
marginally, as a result of absorbing the common operating costs of ELI and, as
noted elsewhere, the introduction of new service offerings may negatively impact
our cost structure.
Included in operating expenses is stock compensation expense. Stock compensation
expense was $5.3 million and $4.4 million for the first six months of 2006 and
2005, respectively and $2.7 million and $2.1 million for the three months ended
June 30, 2006 and 2005, respectively. In 2006, we began expensing the cost of
the unvested portion of outstanding stock options pursuant to SFAS No. 123R. We
expect to recognize approximately $2.2 million of incremental stock compensation
expense for the year ended December 31, 2006 assuming no modifications and that
actual forfeitures equal estimated forfeitures.
31
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 expenses will decrease from $19.0 million
in 2005 to approximately $15.0 million to $18.0 million in 2006 and that no
contribution will be required to be made by us to the pension plan in 2006. 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 June 30, 2006 decreased
$2.4 million, or 10% as compared with the prior year period primarily due to
refunds received for prior periods.
Taxes other than income taxes for the six months ended June 30, 2006 decreased
$3.0 million, or 6% as compared with the prior year period primarily due to
refunds received for prior periods.
Sales and marketing expenses for the three months ended June 30, 2006 increased
$1.3 million, or 6%, as compared with the prior year period primarily due to
increased marketing and advertising in an increasingly competitive environment
and the launch of new products.
Sales and marketing expenses for the six months ended June 30, 2006 increased
$4.0 million, or 9%, as compared with the prior year period primarily due to
increased marketing and advertising in an increasingly competitive environment
and the launch of new products. As our markets become more competitive and we
launch new products, we expect that our marketing costs will increase. We hope
to shift spending from other expense categories to compensate for sales and
marketing expense increases.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) For the three months ended June 30, For the six months ended June 30,
----------------------------------------------- -------------------------------------------------
2006 2005 $ Change % Change 2006 2005 $ Change % Change
------------ ----------- ------------- -------- ----------- ------------- ------------- ---------
Depreciation expense $ 87,957 $ 100,879 $ (12,922) -13% $ 178,366 $ 203,378 $ (25,012) -12%
Amortization expense 31,595 31,595 - 0% 63,190 63,190 - 0%
------------ ----------- ------------- ----------- ------------- -------------
$ 119,552 $ 132,474 $ (12,922) -10% $ 241,556 $ 266,568 $ (25,012) -9%
============ =========== ============= =========== ============= =============
Depreciation expense for the three months ended June 30, 2006 decreased $12.9
million, or 13%, as compared with the prior year period due to a declining asset
base and changes in the remaining useful lives of certain assets. Effective with
the completion of an independent study of the estimated useful lives of our
plant assets, we adopted new lives beginning October 1, 2005. Based on the study
and our planned capital expenditures, we expect that our depreciation expense
will decline in 2006 to approximately $350.0 million or by 11% compared to 2005.
The decrease is due to a declining asset base and the result of extending the
useful lives of our copper facilities. The decrease is expected to be partially
offset by the shortening of lives for our switching software assets all in
accordance with the independent study.
Depreciation expense for the six months ended June 30, 2006 decreased $25.0
million, or 12%, as compared with the prior year period due to a declining asset
base and changes in the remaining useful lives of certain assets.
INVESTMENT AND OTHER INCOME (LOSS), NET / INTEREST EXPENSE / INCOME TAX EXPENSE
($ in thousands) For the three months ended June 30, For the six months ended June 30,
-------------------------------------------------- -----------------------------------------------
2006 2005 $ Change % Change 2006 2005 $ Change % Change
------------ ----------- ------------ ------------ ----------- ------------ ---------- -----------
Investment and
other income (loss), net $ 65,363 $ 573 $ 64,790 11307% $ 64,012 $ 4,541 $ 59,471 1310%
Interest expense $ 85,341 $ 84,065 $ 1,276 2% $ 170,734 $ 167,790 $ 2,944 2%
Income tax expense $ 54,734 $ 17,326 $ 37,408 216% $ 81,341 $ 42,542 $ 38,799 91%
Investment and other income, net for the three months ended June 30, 2006
increased $64.8 million as compared with the prior year period primarily due to
proceeds received as a result of the liquidation and dissolution of the RTB.
Investment and other income, net for the six months ended June 30, 2006
increased $59.5 million as compared with the prior year period primarily due to
the net proceeds received as a result of the liquidation and dissolution of the
RTB partially offset by a $2.4 million loss we incurred on the exchange of debt
during the first quarter of 2006.
32
Interest expense for the three months ended June 30, 2006 increased $1.3
million, or 2%, as compared with the prior year period. The increase in interest
expense is due to higher short term interest rates that we pay under our swap
agreements ($550.0 million in principal amount is swapped to floating rate at
June 30, 2006). Our composite average borrowing rate (including the effect of
our swap agreements) for the three months ended June 30, 2006 as compared with
the prior year period was 36 basis points higher, increasing from 7.86% to
8.22%.
Interest expense for the six months ended June 30, 2006 increased $2.9 million,
or 2%, as compared with the prior year period. The increase in interest expense
is due to higher short term interest rates that we pay under our swap agreements
($550.0 million in principal amount is swapped to floating rate at June 30,
2006). Our composite average borrowing rate (including the effect of our swap
agreements) for the six months ended June 30, 2006 as compared with the prior
year period was 36 basis points higher, increasing from 7.86% to 8.22%.
Income taxes for the three and six months ended June 30, 2006 increased $37.4
million, or 216%, and $38.8 million, or 91%, respectively, as compared with the
prior year periods primarily due to changes in taxable income. The effective tax
rate for the first six months of 2006 was 37.0% as compared with 34.4% for the
first six months of 2005. We expect to utilize a substantial amount of tax net
operating losses as a result of the sale of ELI and RTB proceeds.
DISCONTINUED OPERATIONS
($ in thousands) For the three months ended June 30, For the six months ended June 30,
------------------------------------------------ -----------------------------------------------
2006 2005 $ Change % Change 2006 2005 $ Change % Change
------------ ----------- ------------- --------- ---------- ----------- ------------- -----------
Revenue $ 43,584 $ 39,027 $ 4,557 12% $ 86,078 $ 81,614 $ 4,464 5%
Operating income $ 11,482 $ 5,231 $ 6,251 119% $ 21,940 $ 8,096 $ 13,844 171%
Income taxes $ 4,526 $ 2,110 $ 2,416 115% $ 8,488 $ 3,016 $ 5,472 181%
Net income $ 6,956 $ 3,121 $ 3,835 123% $ 13,452 $ 5,080 $ 8,372 165%
In February 2006, we entered into a definitive agreement to sell ELI, our CLEC
business, to Integra Telecom Holdings, Inc. (Integra), for $247.0 million,
including $243.0 million in cash plus the assumption of approximately $4.0
million in capital lease obligations, subject to customary adjustments under the
terms of the agreement. This transaction closed on July 31, 2006. We expect to
recognize a pre-tax gain on the sale of ELI of approximately $125.0 million. Our
existing tax net operating losses will be used to absorb the potential cash
liability for taxes.
On March 15, 2005, we completed the sale of CCUSA for $43.6 million in cash,
subject to adjustments under the terms of the agreement. The pre-tax gain on the
sale of CCUSA was $14.1 million. Our after-tax gain was $1.2 million. The book
income taxes recorded upon sale are primarily attributable to a low tax basis in
the assets sold. Revenue, operating income, income taxes and net income of CCUSA
were $4.6 million, $1.5 million, $0.5 million and $1.0 million, for the six
months ended June 30, 2005, respectively.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities. Market risk refers to the
potential change in fair value of a financial instrument as a result of
fluctuations in interest rates and equity 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 and capital lease obligations. The long term debt and capital
lease obligations include various instruments with various maturities and
weighted average interest rates.
33
Our objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, a majority of our borrowings have
fixed interest rates. Consequently, we have limited material future earnings or
cash flow exposures from changes in interest rates on our long-term debt and
capital lease obligations. A hypothetical 10% adverse change in interest rates
would increase the amount that we pay on our variable obligations and could
result in fluctuations in the fair value of our fixed rate obligations. Based
upon our overall interest rate exposure at June 30, 2006, a near-term change in
interest rates would not materially affect our consolidated financial position,
results of operations or cash flows.
In order to manage our interest 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 June 30, 2006, the fair value of our long-term debt was estimated to be
approximately $4.0 billion, based on our overall weighted average interest rate
of 8.22% and our overall weighted maturity of 11 years. There has been no
material change in the weighted average maturity applicable to our obligations
since December 31, 2005.
The overall weighted average interest rate increased approximately 13 basis
points during the second quarter of 2006. A hypothetical increase of 82 basis
points (10% of our overall weighted average borrowing rate) would result in an
approximate $203.4 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 June 30, 2006 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, 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, June 30, 2006, that our disclosure
controls and procedures are effective.
(b) Changes in internal control over financial reporting
We reviewed our internal control over financial reporting at June 30, 2006.
There have been no changes in our internal control over financial reporting
identified in an evaluation thereof that occurred during the second fiscal
quarter of 2006, that materially affected or is reasonably likely to materially
affect our internal control over financial reporting.
34
PART II. OTHER INFORMATION
CITIZENS COMMUNICATIONS COMPANY SUBSIDIARIES
Item 1. Legal Proceedings
-----------------
There have been no material changes to our legal proceedings from the
information provided in Item 3. Legal Proceedings included in our Annual Report
on Form 10-K for the year ended December 31, 2005, except as set forth below:
As reported in our Annual Report on Form 10-K for the year ended December 31,
2005, 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.
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 believe that we will be responsible for only a
portion of the cost to clean up and the final resolution of this matter will not
be material to the operating results nor the financial condition of the Company.
Prior to the next phase of the litigation, 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, 2005.
35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds, Issuer
---------------------------------------------------------------------
Purchases of Equity Securities
------------------------------
There were no unregistered sales of equity securities during the quarter ended
June 30, 2006.
(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
-------------------------------------------------------------------------------------------------------
April 1, 2006 to April 30, 2006
Share Repurchase Program (1) 3,016,600 $ 13.39 3,016,600 $ 221,700,000
Employee Transactions (2) - $ - N/A N/A
May 1, 2006 to May 31, 2006
Share Repurchase Program (1) 3,512,200 $ 13.05 3,512,200 $ 175,900,000
Employee Transactions (2) 31,571 $ 13.00 N/A N/A
June 1, 2006 to June 30, 2006
Share Repurchase Program (1) 868,200 $ 12.81 868,200 $ 164,800,000
Employee Transactions (2) - $ - N/A N/A
Totals April 1, 2006 to June 30, 2006
Share Repurchase Program (1) 7,397,000 $ 13.16 7,397,000 $ 164,800,000
Employee Transactions (2) 31,571 $ 13.00 N/A N/A
(1) 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.
(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 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
(a) The registrant held its 2006 Annual Meeting of the Stockholders on May
25, 2006 (the "Meeting").
(b) Election of directors. At the Meeting, all nominees were elected
pursuant to the following votes:
Number of Votes
---------------
DIRECTORS FOR WITHHELD
--------- --- --------
Kathleen Q. Abernathy 272,733,496 4,608,106
Leroy T. Barnes, Jr. 267,948,700 9,392,902
Jeri Finard 266,511,432 10,830,170
Lawton Wehle Fitt 271,350,832 5,990,770
Stanley Harfenist 267,347,217 9,994,385
William Kraus 272,412,971 4,928,632
Howard L. Schrott 272,966,556 4,375,046
Larraine D. Segil 272,944,274 4,397,328
Bradley E. Singer 272,950,905 4,390,698
Edwin Tornberg 268,536,513 8,805,089
David H. Ward 272,875,779 4,465,823
Myron A. Wick, III 271,037,814 6,303,788
Mary Agnes Wilderotter 267,336,499 10,005,103
36
(c) Other matters submitted to stockholders at the Meeting:
(1) Adoption of the Non-Employee Directors' Equity Incentive Plan.
The matter passed with the following vote:
Number of votes FOR 163,713,519
Number of votes AGAINST/WITHHELD 26,163,305
Number of votes ABSTAINING 2,085,764
Number of BROKER NON-VOTES 85,379,014
(2) Stockholder proposal relating to the Company's future severance
agreements with executive officers. The matter passed with the
following vote:
Number of votes FOR 128,714,742
Number of votes AGAINST/WITHHELD 58,240,714
Number of votes ABSTAINING 5,041,812
Number of BROKER NON-VOTES 85,379,014
(3) Ratification of appointment of KPMG LLP as the Company's
independent registered public accounting firm for 2006. The
matter passed with the following vote:
Number of votes FOR 269,499,125
Number of votes AGAINST 5,525,370
Number of votes ABSTAINING 2,317,105
Item 5. Other Information
-----------------
As disclosed in our Proxy Statement for the 2006 Annual Meeting, proposals that
stockholders wish to include in our proxy statement and form of proxy for our
2007 annual stockholders meeting must be received by the Secretary of the
Company no later than December 19, 2006. For a stockholder proposal that is not
intended to be included in our proxy statement for our 2007 annual meeting, the
proposal must be received by the Secretary of the Company not earlier than
January 25, 2007 nor later than February 26, 2007 in order to be properly
presented at the 2007 annual meeting. Furthermore, in accordance with the proxy
rules and regulations of the Securities and Exchange Commission, if a
stockholder does not notify us of a proposal by February 26, 2007, then our
proxies would be able to use their discretionary voting authority if a
stockholder's proposal is raised at the meeting.
Item 6. Exhibits
--------
a) Exhibits:
10.1 Summary of Non-Employee Directors' Compensation.
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.
37
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.
38
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: August 3, 2006