CITIZENS COMMUNICATIONS COMPANY
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
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OF THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE YEAR ENDED DECEMBER 31, 2005
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2005
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OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________ to ___________
Commission file number 001-11001
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CITIZENS COMMUNICATIONS COMPANY
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(Exact name of registrant as specified in its charter)
Delaware 06-0619596
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 614-5600
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Common Stock, par value $.25 per share New York Stock Exchange
Guarantee of Convertible Preferred Securities of Citizens Utilities Trust New York Stock Exchange
Citizens Convertible Debentures N/A
Guarantee of Partnership Preferred Securities of Citizens Utilities Capital L.P. N/A
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes X No
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Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Act.
Yes No X
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
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Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes No X
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The aggregate market value of common stock held by non-affiliates of the
registrant on June 30, 2005 was approximately $4,590,836,087 based on the
closing price of $13.44 per share.
The number of shares outstanding of the registrant's Common Stock as of January
31, 2006 was 328,457,505.
DOCUMENT INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Company's 2006 Annual Meeting of
Stockholders to be held on May 25, 2006 are incorporated by reference into Part
III of this Form 10-K.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
TABLE OF CONTENTS
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Page
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PART I
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Item 1. Business 2
Item 1A. Risk Factors 9
Item 1B. Unresolved Staff Comments 12
Item 2. Properties 12
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Executive Officers 14
PART II
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Item 5. Market for Registrant's Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities 16
Item 6. Selected Financial Data 21
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 22
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 38
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants on Accounting 39
and Financial Disclosure
Item 9A. Controls and Procedures 39
Item 9B. Other Information 39
PART III
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Item 10. Directors and Executive Officers of the Registrant 39
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 40
Item 13. Certain Relationships and Related Transactions 40
Item 14. Principal Accountant Fees and Services 40
PART IV
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Item 15. Exhibits and Financial Statement Schedules 40
Signatures 45
Index to Consolidated Financial Statements F-1
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
PART I
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Item 1. Business
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Citizens Communications Company and its subsidiaries (Citizens) will be referred
to as the "Company," "we," "us" or "our" throughout this report. Citizens was
incorporated in the state of Delaware in 1935 as Citizens Utilities Company.
We are a communications company providing services to rural areas and small and
medium-sized towns and cities. We offer our services under the "Frontier" name.
In addition, we provide competitive local exchange carrier, or CLEC, services to
business customers and to other communications carriers in certain metropolitan
areas in the western United States through Electric Lightwave, LLC, or ELI, our
wholly-owned subsidiary. Revenue from our Frontier and ELI operations was
$2,003.3 million and $159.2 million, respectively, in 2005. In February 2006, we
entered into a definitive agreement to sell ELI and we expect the sale to close
in the third quarter of 2006. Among the highlights for 2005:
* Cash Generation
We continued to grow free cash flow through further growth of
broadband and value added services, productivity improvements,
and a disciplined capital expenditure program that emphasizes
return on investment.
* Stockholder Value
During 2005, we repurchased $250.0 million of our common stock
and we continued to pay an annual dividend of $1.00 per common
share. The share repurchase program was completed during the
fourth quarter of 2005.
* Growth
During 2005, we added approximately 99,000 new high-speed
internet customers and almost 84,000 customers began buying a
bundle or package of our services. At December 31, 2005, we had
more than 311,000 high-speed data customers and almost 442,000
customers buying a bundle or package of services. During 2005, we
also began offering a television product in partnership with
Echostar's DISH Network, and at the end of 2005 we had
approximately 32,000 customers buying a "triple play" package of
telephone, television and high-speed internet service.
Our objective is to be the leading provider of communications services to homes
and businesses in our service areas. We are committed to delivering innovative
and reliable products and solutions with an emphasis on convenience, service and
customer satisfaction. We offer a variety of voice, television and internet
services that are available as bundled or package solutions or, for some
products, a la carte. We believe that superior customer service and innovative
product positioning will continue to differentiate us from our competitors in
the marketplace.
Telecommunications Services
As of December 31, 2005, we operated incumbent local exchange carriers in 23
states. Our CLEC services consist of a variety of integrated telecommunications
products.
Frontier is typically the dominant incumbent carrier in the markets we serve and
provides the "last mile" of telecommunications services to residential and
business customers in these markets. As a CLEC, we provide telecommunications
services to businesses and other carriers in competition with the incumbent. As
a CLEC, we frequently obtain the "last mile" access to customers through
arrangements with the applicable incumbent. Frontier and ELI are subject to
different regulatory frameworks of the Federal Communications Commission (FCC).
ELI does not compete with our Frontier business.
The telecommunications industry is undergoing significant changes and
difficulties and our financial results reflect the impact of this challenging
environment. As discussed in more detail in Management's Discussion & Analysis
of Financial Condition and Results of Operations (MD&A), we operate in an
increasingly challenging environment and our Frontier revenues have not been
growing.
2
Frontier
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Frontier accounted for $2,003.3 million, or 93%, of our total revenues in 2005.
Approximately 8% of our 2005 Frontier revenues came from federal and state
subsidies and approximately 14% from regulated access charges.
Our Frontier business is primarily with residential customers and, to a lesser
extent, non-residential customers. Our Frontier segment principally provides:
* access services,
* local services,
* long distance services,
* data and internet services,
* directory services, and
* television services.
Access services. We provide both switched and non-switched network access
services. Switched access services allow other carriers the use of our
facilities to originate and terminate their long distance voice and data
traffic. These services are generally offered on a month-to-month basis and the
service is billed on a minutes-of-use basis and access charges are based on
access rates filed with the FCC for interstate services and with the respective
state regulatory agency for intrastate services. Non-switched network access
services provide other carriers and high-volume commercial customers with
dedicated high-capacity circuits. Such services are generally offered on a
contract basis and the service is billed on a fixed monthly recurring charge
basis. In addition, subsidies received from state and federal universal service
funds based on the high cost of providing telephone service to certain rural
areas are a part of our access services revenue.
Revenue is recognized when services are provided to customers or when products
are delivered to customers. Monthly recurring network access service revenue is
billed in advance. The unearned portion of this revenue is initially deferred on
our balance sheet and recognized in revenue over the period that the services
are provided. Non-recurring network access service revenue is billed in arrears.
The earned but unbilled portion of this revenue is recognized in revenue in the
period that the services are provided.
Local services. We provide basic telephone wireline access services to
residential and non-residential customers in our service areas. Our service
areas are largely residential and are generally less densely populated than the
primary service areas of the largest incumbent local exchange carriers. We also
provide enhanced services to our customers by offering a number of calling
features including call forwarding, conference calling, caller identification,
voicemail and call waiting. We offer packages of communications services. These
packages permit customers to bundle their basic telephone line with their choice
of enhanced, long distance, television and internet services for a monthly fee
and/or usage fee depending on the plan.
We intend to continue to increase the penetration of enhanced services. We
believe that increased sales of such services will produce revenue with higher
operating margins due to the relatively low marginal operating costs necessary
to offer such services. We believe that our ability to integrate these services
with other services will provide us with the opportunity to capture an increased
percentage of our customers' communications expenditures.
Long distance services. We offer long distance services in our territories to
our customers. We believe that many customers prefer the convenience of
obtaining their long distance service through their local telephone company and
receiving a single bill. Long distance network service to and from points
outside of our operating territories is provided by interconnection with the
facilities of interexchange carriers, or IXCs.
Data and internet services. We offer data services including internet access
(via dial up or high-speed internet access), frame relay, ethernet and
asynchronous transfer mode (ATM) switching in portions of our system.
3
Directory services. Directory services involves the provision of white and
yellow page directories of residential and business listings. We provide this
service through a third-party contractor and are paid a percentage of revenues
from the sale of advertising in these directories. Our directory service also
includes "Frontier Pages," an internet-based directory service which generates
advertising revenue. We recognize the revenue from these services over the life
of the related white or yellow pages book.
Television services. During 2005, we began offering a television product in
partnership with Echostar's DISH Network. We provide access to all-digital
television channels featuring movies, sports, news, music, and high-definition
TV programming. We offer packages that include 60, 120 or 180 channels,
high-definition channels, family channels and ethnic channels.
Wireless and VOIP services. During 2006, we expect to begin offering wireless
data and voice services and commercial voice over internet protocol (VOIP)
solutions in certain markets. Our wireless data and VOIP services utilize
technologies that are relatively new, and we depend to some degree on the
representations of equipment vendors, lab testing and the experiences of others
who have been successful at deploying these new technologies. In addition, our
success in offering wireless voice service will, to a great extent, be
determined by the relationships we are developing with both wireless carriers
and third-party wireless support organizations, and is also dependent on their
capabilities.
The following table sets forth certain information with respect to our revenue
generating units (RGUs), which consists of access lines plus high-speed internet
subscribers, as of December 31, 2005 and 2004.
Frontier RGUs at December 31,
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State 2005 2004
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New York............ 994,600 1,029,700
Minnesota........... 293,600 289,300
Arizona............. 191,400 182,000
California.......... 184,100 179,400
West Virginia....... 169,100 165,000
Illinois............ 129,200 128,600
Tennessee........... 108,500 104,500
Wisconsin........... 78,600 77,600
Iowa................ 61,900 62,100
Nebraska............ 54,500 54,400
All other states (13)... 264,400 260,400
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Total 2,529,900 2,533,000
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Change in the number of our access lines is important to our revenue and
profitability. We have lost access lines primarily because of competition,
changing consumer behavior, economic conditions, changing technology and because
some customers disconnect second lines when they add high-speed internet
service. We lost approximately 102,000 access lines during the year ended
December 31, 2005, but added over 99,000 high-speed internet subscribers during
this same period. The loss of lines during 2005 was primarily among residential
customers. The non-residential line losses were principally in Rochester, New
York, while the residential losses were throughout our markets. We expect to
continue to lose access lines but to increase high-speed internet subscribers
during 2006. A continued loss of access lines, combined with increased
competition and the other factors discussed in MD&A, may cause our profitability
and cash flows to decrease during 2006.
ELI
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In February 2006, we entered into a definitive agreement to sell all of the
outstanding membership interests in ELI 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 is
expected to close during the third quarter of 2006. The closing of the sale is
subject to several conditions, including the funding of Integra's fully
committed financing and regulatory approvals.
4
ELI provides a broad range of wireline communications products and services to
businesses and other carriers in the western United States. ELI accounted for
$159.2 million, or 7%, of our total revenues in 2005. Our ELI revenues have
declined from a peak of $240.8 million in 2000, however 2005 revenues were
higher than 2004.
ELI's facilities-based network consists of optical fiber and voice and data
switches. ELI has a national internet and data network with switches and routers
in key cities, linked by leased transport facilities. These assets are not being
sold and will continue to be owned and utilized by Frontier to carry our
customers' voice, internet and data traffic. In addition, ELI has a long-haul,
fiber-optic network connecting the cities it serves in the western United
States, which utilizes an optically self-healing Synchronous Optical Network
(SONET) architecture. ELI currently provides the full range of its services in
the following cities and their surrounding areas: Boise, Idaho; Portland,
Oregon; Salt Lake City, Utah; Seattle, Washington; Spokane, Washington; Phoenix,
Arizona; and Sacramento, California.
Regulatory Environment
Frontier Regulation
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The majority of our operations are regulated extensively by various state
regulatory agencies, often called public service or utility commissions, and the
FCC.
Our Frontier segment revenue is subject to regulation by the FCC and various
state regulatory agencies. We expect federal and state lawmakers to continue to
review the statutes governing the level and type of regulation for
telecommunications services.
The Telecommunications Act of 1996, or the 1996 Act, dramatically changed the
telecommunications industry. The main purpose of the 1996 Act was to open local
telecommunications marketplaces to competition. The 1996 Act preempts state and
local laws to the extent that they prevent competition with respect to
communications services. Under the 1996 Act, however, states retain authority to
impose requirements on carriers necessary to preserve universal service, protect
public safety and welfare, ensure quality of service and protect consumers.
States are also responsible for mediating and arbitrating interconnection
agreements between CLECs and ILECs if voluntary negotiations fail. In order to
create an environment in which local competition is a practical possibility, the
1996 Act imposes a number of requirements for access to network facilities and
interconnection on all local communications providers. All incumbent local
carriers must interconnect with other carriers, unbundle some of their services
at wholesale rates, permit resale of some of their services, enable collocation
of equipment, provide local telephone number portability and dialing parity,
provide access to poles, ducts, conduits and rights-of-way, and complete calls
originated by competing carriers under termination arrangements.
At the federal level and in a number of the states in which we operate, we are
subject to price cap or incentive regulation plans under which prices for
regulated services are capped in return for the elimination or relaxation of
earnings oversight. The goal of these plans is to provide incentives to improve
efficiencies and increased pricing flexibility for competitive services while
ensuring that customers receive reasonable rates for basic services. Some of
these plans have limited terms and, as they expire, we may need to renegotiate
with various states. These negotiations could impact rates, service quality
and/or infrastructure requirements which could impact our earnings and capital
expenditures. In the other states in which we operate, we are subject to rate of
return regulation that limits levels of earnings and returns on investments. In
some states, we have been required to refund customers as a result of exceeding
earnings limitations. We continue to advocate our position of less regulation
with various regulatory agencies.
For interstate services regulated by the FCC, we have elected a form of
incentive regulation known as "price caps" for most of our operations. In May
2000, the FCC adopted a methodology for regulating the interstate access rates
of price cap companies through May 2005. The program, known as the Coalition for
Affordable Local and Long Distance Services, or CALLS plan, reduced prices for
interstate-switched access services and phased out many of the implicit
subsidies in interstate access rates. The CALLS program expired in 2005. The FCC
may address future changes in interstate access charges during 2006 and such
changes may adversely affect our revenues and profitability.
Another goal of the 1996 Act was to remove implicit subsidies from the rates
charged by local telecommunications companies. The CALLS plan addressed this
requirement for interstate services. State legislatures and regulatory agencies
are beginning to reduce the implicit subsidies in intrastate rates. The most
common subsidies are in access rates that historically have been priced above
their costs to allow basic local rates to be priced below cost. Legislation has
been considered in several states to require regulators to eliminate these
subsidies and implement state universal service programs where necessary to
maintain reasonable basic local rates. However, not all the reductions in access
charges would be fully offset. We anticipate additional state legislative and
regulatory pressure to lower intrastate access rates.
5
Some state legislatures and regulators are also examining the provision of
telecommunications services to previously unserved areas. Since many unserved
areas are located in rural markets, we could be required to expand our service
territory into some of these areas.
Recent and Potential Regulatory Developments
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Wireline and wireless carriers are required to provide local number portability
(LNP). LNP is the ability of customers to switch from a wireline or wireless
carrier to another wireline or wireless carrier without changing telephone
numbers. We are 100% LNP capable in our largest markets and over 98% of our
exchanges are LNP capable. We will upgrade the remaining exchanges in response
to bona fide requests as required by the FCC order.
LNP will promote further competition in an environment where the displacement of
traditional wireline services has been increasing because of technological
substitutions such as cell phones, e-mail, cable telephony and Internet phone
calling.
In 1994, Congress passed the Communications Assistance for Law Enforcement Act
(CALEA) to ensure that telecommunication networks can meet law enforcement
wiretapping needs. We expect to be fully compliant by June 2006.
The FCC is expected to address issues involving inter-carrier compensation, the
universal service fund and internet telephony in 2006. The FCC adopted a Further
Notice of Proposed Rulemaking (FNPRM) addressing inter-carrier compensation on
February 10, 2005. Some of the proposals being discussed with respect to
inter-carrier compensation, such as "bill and keep" (under which switched access
charges would be reduced or eliminated), could reduce our access revenues and
our profitability. The universal service fund is under pressure as local
exchange companies lose access lines and more entities, such as wireless
companies, seek to receive monies from the fund. The rules surrounding the
eligibility of Competitive Eligible Telecommunication Carriers, such as wireless
companies, to receive universal service funds are expected to be clarified by
the Federal-State Joint Board on Universal Service and the clarification of the
rules may heighten the pressures on the fund. Changes in the funding or payout
rules of the universal service fund could further reduce our subsidy revenues
and our profitability. As discussed in MD&A, our access and subsidy revenues are
important to our cash flows and both our access and subsidy revenues declined in
2005 compared to 2004. Our access revenues are likely to decline again in 2006.
The development and growth of internet telephony (also known as VOIP) by cable
and other companies has increased the importance of regulators at both the
federal and state levels addressing whether such services are subject to the
same or different regulatory and financial schemes as traditional telephony. On
November 9, 2004, the FCC issued an order in response to a petition by Vonage
Holdings Corp. (Vonage), declaring that Vonage-style VOIP services are
jurisdictionally interstate in nature and are thereby exempt from state
telecommunications regulations. The FCC stated that its order was not limited to
Vonage, but rather applied to all Vonage-type VOIP offerings provided over
broadband services. The FCC did not address other related issues, such as:
whether or under what terms VOIP traffic may be subject to intercarrier
compensation; if VOIP services are subject to general state requirements
relating to taxation and general commercial business requirements; or whether
VOIP is subject to 911, universal service fund (USF), and CALEA obligations. The
FCC is planning on addressing these open questions in subsequent orders in its
ongoing "IP-Enabled Services Proceeding," which opened in February 2004.
Internet telephony may have an advantage over our traditional services if it
remains less regulated. We are actively participating in the FCC's consideration
of all these issues. On June 3, 2005, the FCC issued an order requiring VOIP
services interconnected to the public switched telephone network to include
E-911 calling capabilities by November 28, 2005. Subsequently, the FCC issued a
number of public notices detailing the steps that could be considered sufficient
interim compliance. The FCC stated in a public notice that providers not in full
compliance would not be required to disconnect existing subscribers but would be
expected not to connect new subscribers in areas where they are not transmitting
911 calls in full compliance with the rules. On September 23, 2005, the FCC
issued an order stating that both interconnected VOIP services and broadband
internet access services will be required to comply with CALEA by May 12, 2007.
Both the VOIP E-911 order and the CALEA order are subject to petitions for
clarification and reconsideration and both have been appealed and are pending
before federal courts.
6
The FCC's service outage reporting rules require telecommunications providers
(regardless of whether they are cable, wireless or wireline communications
providers) to report outages of at least a 30 minute duration that potentially
affect at least 900,000 user-minutes. The initial FCC order, which included
required reporting of certain non-service interrupting network outages, was
partially stayed. The network modifications necessary to comply with the stayed
portion of the order would cost us in excess of $16.0 million. The New York
Public Service Commission is also considering network reliability requirements.
We and other carriers are opposing these proposed requirements.
Some state regulators (including New York and Illinois) have in the past
considered imposing on regulated companies (including us) cash management
practices that could limit the ability of a company to transfer cash between its
subsidiaries or to its parent company. None of the existing state requirements
materially affect our cash management but future changes by state regulators
could affect our ability to freely transfer cash within our consolidated
companies.
ELI Regulation
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As a CLEC, ELI is subject to federal, state and local regulation. However, the
level of regulation is typically less than that experienced by an incumbent
carrier. Local governments may require ELI to obtain licenses or franchises
regulating the use of public rights-of-way necessary to install and operate its
networks.
ELI has various interconnection agreements in the states in which it operates.
These agreements govern reciprocal compensation relating to the transport and
termination of traffic between the incumbent's and ELI's networks. The FCC has
significantly reduced intercarrier compensation for internet service provider
(ISP) traffic, also known as "reciprocal compensation." On December 15, 2004,
the FCC adopted rules that will increase costs to ELI for services that it buys
from incumbent carriers.
Most state public service commissions require competitive communications
providers, such as ELI, to obtain operating authority prior to initiating
intrastate services. Most states also require the filing of tariffs or price
lists and/or customer-specific contracts. ELI is not currently subject to
rate-of-return or price regulation. However, ELI is subject to state-specific
quality of service, universal service, periodic reporting and other regulatory
requirements, although the extent of these requirements is generally less than
those applicable to incumbent carriers.
Competition
Frontier Competition
--------------------
Competition in the telecommunications industry is intense and increasing. We
experience competition from many communications service providers including
cable operators, wireless carriers, VOIP providers, long distance providers,
competitive local exchange carriers, internet providers and other wireline
carriers. We believe that competition will continue to intensify in 2006 across
all products and in all of our markets. Our Frontier business experienced
erosion in access lines and switched access minutes of use in 2005 as a result
of competition. Competition in our markets may result in reduced revenues in
2006.
We are responding to this competitive environment with new product offers and by
bundling products and services together with an end user contract term
commitment. Revenues from data services and packages continue to increase as a
percentage of our total revenues. There will continue to be price and margin
pressures in our business that may result in less revenues and profitability.
The telecommunications industry is undergoing significant changes. The market is
extremely competitive, resulting in lower prices, and consumers are changing
behavior, such as using wireless in place of wireline services and using email
instead of making calls. These trends are likely to continue and result in a
challenging revenue environment. These factors could also result in more
bankruptcies in the sector and therefore affect our ability to collect money
owed to us by bankrupt carriers.
ELI Competition
---------------
ELI faces significant competition from incumbents in each of its markets.
Principal incumbent competitors include Qwest, at&t and Verizon. ELI also
competes with all of the major IXCs, internet access providers and other CLECs.
CLEC service providers have generally encountered intense competitive pressures,
the result of which is the failure of a number of CLECs and substantial
financial pressures on others.
7
Competitors in ELI's markets include, in addition to the incumbent providers:
at&t, Sprint, Time Warner Telecom, Verizon, Integra Telecom and XO
Communications. In each of the markets in which ELI operates, at least one other
CLEC, and in some cases several other CLECs, offer many of the same services
that ELI provides, generally at similar prices.
Competition is based on price, quality, network reliability, customer service,
service features and responsiveness to the customer's needs. Many of our
competitors have greater market presence and greater financial, technical,
marketing and human resources, more extensive infrastructure and stronger
customer and strategic relationships than are available to us. Competition in
the CLEC industry is intense and pricing continues to decline. ELI's revenues
have declined since 2000, however 2005 revenues were higher than 2004.
Divestiture of Public Utilities Services
In the past we provided public utilities services including natural gas
transmission and distribution, electric transmission and distribution, water
distribution and wastewater treatment services to primarily rural and suburban
customers throughout the United States. In 1999, we announced a plan of
divestiture for our public utilities services properties. Since then, we have
divested all of our public utility operations for an aggregate of $1.9 billion.
We have retained a potential payment obligation associated with our previous
electric utility activities in the state of Vermont. The Vermont Joint Owners
(VJO), a consortium of 14 Vermont utilities, including us, entered into a
purchase power agreement with Hydro-Quebec in 1987. The agreement contains
"step-up" provisions which state that if any VJO member defaults on its purchase
obligation under the contract to purchase power from Hydro-Quebec, then the
other VJO participants will assume responsibility for the defaulting party's
share on a pro-rata basis. Our pro-rata share of the purchase power obligation
is 10%. If any member of the VJO defaults on its obligations under the
Hydro-Quebec agreement, the remaining members of the VJO, including us, may be
required to pay for a substantially larger share of the VJO's total power
purchase obligation for the remainder of the agreement (which runs through
2015). Paragraph 13 of FIN 45 requires that we disclose "the maximum potential
amount of future payments (undiscounted) the guarantor could be required to make
under the guarantee." Paragraph 13 also states that we must make such disclosure
"... even if the likelihood of the guarantor's having to make any payments under
the guarantee is remote..." As noted above, our obligation only arises as a
result of default by another VJO member, such as upon bankruptcy. Therefore, to
satisfy the "maximum potential amount" disclosure requirement we must assume
that all members of the VJO simultaneously default, a highly unlikely scenario
given that the two members of the VJO that have the largest potential payment
obligations are publicly traded with credit ratings that are equal to or
superior to ours, and that all VJO members are regulated utility providers with
regulated cost recovery. Regardless, despite the remote chance that such an
event could occur, or that the State of Vermont could or would allow such an
event, assuming that all the members of the VJO defaulted on January 1, 2007 and
remained in default for the duration of the contract (another 9 years), we
estimate that our undiscounted purchase obligation for 2007 through 2015 would
be approximately $1.26 billion. In such a scenario we would then own the power
and could seek to recover our costs. We would do this by seeking to recover our
costs from the defaulting members and/or reselling the power to other utility
providers or the northeast power grid. There is an active market for the sale of
power. We could potentially lose money if we were unable to sell the power at
cost. We caution that we cannot predict with any degree of certainty any
potential outcome.
Segment Information
Note 22 to Consolidated Financial Statements provides financial information
about our industry segments, Frontier and ELI, for the last three fiscal years.
Financial Information about Foreign and Domestic Operations and Export Sales
We have no foreign operations.
General
Order backlog is not a significant consideration in our businesses. We have no
material contracts or subcontracts that may be subject to renegotiation of
profits or termination at the election of the Federal government. We hold no
patents, licenses or concessions that are material.
8
Employees
As of December 31, 2005, we had 6,103 employees, 5,644 of whom were associated
with Frontier operations and 459 were associated with ELI. At December 31, 2005,
the total number of our employees affiliated with a union was 3,302, of which
approximately 1,400 are covered by agreements set to expire during 2006. We
consider our relations with our employees to be good.
Available Information
We make available on our website, free of charge, the periodic reports that we
file with or furnish to the Securities and Exchange Commission, or SEC, as well
as all amendments to these reports, as soon as reasonably practicable after such
reports are filed with or furnished to the SEC. We also make available on our
website, or in printed form upon request, free of charge, our Corporate
Governance Guidelines, Code of Business Conduct and Ethics, and the charters for
the Audit, Compensation, and Nominating and Corporate Governance committees of
the Board of Directors. Stockholders may request printed copies of these
materials by writing to: 3 High Ridge Park, Stamford, Connecticut 06905
Attention: Corporate Secretary. Our website address is http://www.czn.net.
Item 1A. Risk Factors
------------
Before you invest in our securities, you should carefully consider all the
information we have included or incorporated by reference in this Form 10-K and
our subsequent periodic filings with the SEC. In particular, you should
carefully consider the risk factors described below and read the risks and
uncertainties related to "forward-looking statements" as set forth in the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" section of this Form 10-K. The risks and uncertainties described
below are not the only ones facing our company. Additional risks and
uncertainties that are not presently known to us or that we currently deem
immaterial or that are not specific to us, such as general economic conditions,
may also adversely affect our business and operations.
Risks Related to Competition and Our Industry
---------------------------------------------
We face intense competition, which could adversely affect us.
The telecommunications industry is extremely competitive and competition is
increasing. The traditional dividing lines between long distance, local,
wireless, cable and internet services are becoming increasingly blurred. Through
mergers and various service expansion strategies, services providers are
striving to provide integrated solutions both within and across geographic
markets. Our competitors include CLECs and other providers (or potential
providers) of services, such as internet service providers, or ISPs, wireless
companies, neighboring incumbents, VOIP providers such as Vonage and cable
companies that may provide services competitive with ours or services that we
intend to introduce. Competition is intense and increasing and we cannot assure
you that we will be able to compete effectively. For example, at December 31,
2005 we had 102,000 fewer access lines than we had at December 31, 2004 and we
believe wireless and cable telephony providers have increased their market share
in our markets. We expect to continue to lose access lines and that competition
with respect to all our products and services will increase.
We expect competition to intensify as a result of the entrance of new
competitors and the development of new technologies, products and services. We
cannot predict which of the many possible future technologies, products or
services will be important to maintain our competitive position or what
expenditures will be required to develop and provide these technologies,
products or services. Our ability to compete successfully will depend on
marketing and on our ability to anticipate and respond to various competitive
factors affecting the industry, including a changing regulatory environment that
may affect our competitors and us differently, new services that may be
introduced, changes in consumer preferences, demographic trends, economic
conditions and pricing strategies by competitors. Increasing competition may
reduce our revenues and increase our costs as well as require us to increase our
capital expenditures and thereby decrease our cash flow.
Some of our competitors have superior resources, which may place us at a
cost and price disadvantage.
Some of our current and potential competitors have market presence,
engineering, technical and marketing capabilities, and financial, personnel and
other resources substantially greater than ours. In addition, some of our
competitors can raise capital at a lower cost than we can. Consequently, some
competitors may be able to develop and expand their communications and network
infrastructures more quickly, adapt more swiftly to new or emerging technologies
and changes in customer requirements, take advantage of acquisition and other
opportunities more readily and devote greater resources to the marketing and
sale of their products and services than we can. Additionally, the greater brand
name recognition of some competitors may require us to price our services at
lower levels in order to retain or obtain customers. Finally, the cost
advantages of some competitors may give them the ability to reduce their prices
for an extended period of time if they so choose.
9
ELI faces substantial competition for its telecommunications services from
larger companies.
ELI's competitors for telecommunications services are primarily larger
incumbents, CLECs and IXCs. Because it is not an incumbent provider, ELI's
ability to succeed in the telecommunications services market depends to a large
extent on its ability to provide differentiated services for business customers
and to maintain its customer base and develop additional business customers.
We anticipate that general pricing competition and pressures for CLECs will
increase, including ELI. We have not obtained significant market share in any of
the areas where we offer our CLEC services, nor do we expect to do so given the
size of our ELI markets, the intense competition therein and the diversity of
customer requirements. There can be no assurance that ELI will be able to
compete effectively in any of our markets. Furthermore, the bankruptcies and
weakened financial position of a number of CLECs have resulted in a more
demanding operating environment for CLECs, as both customers and suppliers are
more concerned about each CLEC's creditworthiness.
Risks Related to Our Business
-----------------------------
Decreases in certain types of our revenues will impact our profitability.
Our Frontier business has been experiencing declining access lines,
switched access minutes of use, long distance prices and related revenues
because of economic conditions, increasing competition, changing consumer
behavior (such as wireless displacement of wireline use, email use, instant
messaging and increasing use of VOIP), technology changes and regulatory
constraints. These factors are likely to cause our local network service,
switched network access, long distance and subsidy revenues to continue to
decline, and these factors, together with our increasing employee costs, and the
potential need to increase our capital spending, may cause our cash generated by
operations to decrease.
We may be unable to grow our revenue and cash flow despite the initiatives
we have implemented.
We must produce adequate cash flow that, when combined with funds available
under our revolving credit facility, will be sufficient to service our debt,
fund our capital expenditures, pay our taxes and maintain our current dividend
policy. We have implemented several growth initiatives, including increasing our
marketing expenditures and launching new products and services with a focus on
areas that are growing or demonstrate meaningful demand such as high-speed
internet. There is no assurance that these initiatives will result in an
improvement in our financial position or our results of operations.
We may complete a significant business combination or other transaction
that could increase our shares outstanding, affect our debt, result in a change
in control, or both.
From time to time we evaluate potential acquisitions and other arrangements
that would extend our geographic markets, expand our services, enlarge the
capacity of our networks or increase the types of services provided through our
networks. If we complete any acquisition or other arrangement, we may require
additional financing that could result in an increase in our shares outstanding
and/or debt, result in a change in control, or both. There can be no assurance
that we will enter into any transaction.
Our business is sensitive to the creditworthiness of our wholesale
customers.
We have substantial business relationships with other telecommunications
carriers for whom we provide service. During the past few years, several of our
customers have filed for bankruptcy. While these bankruptcies have not had a
material adverse effect on our business to date, future bankruptcies in our
industry could result in our loss of significant customers, more price
competition and uncollectible accounts receivable. As a result, our revenues and
results of operations could be materially and adversely affected.
10
Risks Related to Liquidity, Financial Resources, and Capitalization
-------------------------------------------------------------------
Substantial debt and debt service obligations may adversely affect us.
We have a significant amount of indebtedness. We may also obtain additional
long-term debt and working capital lines of credit to meet future financing
needs, subject to certain restrictions under our existing indebtedness, which
would increase our total debt.
The significant negative consequences on our financial condition and
results of operations that could result from our substantial debt include:
* limitations on our ability to obtain additional debt or equity
financing;
* instances in which we are unable to meet the financial covenants
contained in our debt agreements or to generate cash sufficient
to make required debt payments, which circumstances have the
potential of accelerating the maturity of some or all of our
outstanding indebtedness;
* the allocation of a substantial portion of our cash flow from
operations to service our debt, thus reducing the amount of our
cash flow available for other purposes, including operating
costs, dividends and capital expenditures that could improve our
competitive position or results of operations;
* requiring us to sell debt or equity securities or to sell some of
our core assets, possibly on unfavorable terms, to meet payment
obligations;
* compromising our flexibility to plan for, or react to,
competitive challenges in our business and the communications
industry; and
* the possibility of our being put at a competitive disadvantage
with competitors who do not have as much debt as us, and
competitors who may be in a more favorable position to access
additional capital resources.
We will require substantial capital to upgrade and enhance our operations.
Replacing or upgrading our infrastructure will result in significant
capital expenditures. If this capital is not available when needed, our business
will be adversely affected. Increasing competition, offering new services,
improving the capabilities or reducing the maintenance costs of our plant may
cause our capital expenditures to increase in the future. In addition, our
ongoing annual dividend of $1.00 per share under our current policy utilizes a
significant portion of our cash generated by operations and therefore limits our
operating and financial flexibility and our ability to significantly increase
capital expenditures. While we believe that the amount of our dividend will
allow for adequate amounts of cash flow for capital spending and other purposes,
any material reduction in cash generated by operations and any increases in
capital expenditures, interest expense or cash taxes would reduce the amount of
cash generated in excess of dividends. Losses of access lines, increases in
competition, lower subsidy and access revenues and the other factors described
above may reduce our cash generated by operations and may require us to increase
capital expenditures. In addition, we expect our cash paid for taxes to increase
significantly over the next several years.
Risks Related to Regulation
---------------------------
The access charge revenues we receive may be reduced at any time.
A significant portion of our revenues is derived from access charges paid
by IXCs for services we provide in originating and terminating intrastate and
interstate traffic. The amount of access charge revenues we receive for these
services is regulated by the FCC and state regulatory agencies. Recent rulings
regarding access charges have lowered the amount of revenue we receive from this
source. Additional actions by these agencies could further reduce the amount of
access revenues we receive. In addition, a portion of our access revenues is
received from state and federal universal service funds based upon the high cost
of providing telephone service to certain rural areas. In the future, there may
be proposals by state or federal regulatory agencies to eliminate or reduce
these revenues. A material reduction in the revenues we receive from these funds
would adversely affect our financial results.
11
We are reliant on support funds provided under federal and state laws.
We receive a significant portion of our revenues from the federal universal
service fund and, to a lesser extent, state support funds. These governmental
programs are reviewed and amended from time to time, and we cannot assure you
that they will not be changed or impacted in a manner adverse to us.
Our company and industry are highly regulated, imposing substantial
compliance costs and restricting our ability to compete in our target markets.
As an incumbent, we are subject to significant regulation from federal,
state and local authorities. This regulation restricts our ability to change our
rates, especially on our basic services, and imposes substantial compliance
costs on us. Regulation restricts our ability to compete and, in some
jurisdictions, it may restrict how we are able to expand our service offerings.
In addition, changes to the regulations that govern us may have an adverse
effect upon our business by reducing the allowable fees that we may charge,
imposing additional compliance costs, or otherwise changing the nature of our
operations and the competition in our industry.
Recent rule changes now allow customers to retain their wireline number
when switching to another service provider. This is likely to increase the
number of our customers who decide to disconnect their service from us. Other
pending rulemakings, including those relating to intercarrier compensation,
universal service and VOIP regulations, could have a substantial adverse impact
on our operations.
Risks Related to Technology
---------------------------
In the future as competition intensifies within our markets, we may be
unable to meet the technological needs or expectations of our customers, and may
lose customers as a result.
The telecommunications industry is subject to significant changes in
technology. If we do not replace or upgrade technology and equipment, we will be
unable to compete effectively because we will not be able to meet the needs or
expectations of our customers. Replacing or upgrading our infrastructure could
result in significant capital expenditures.
In addition, rapidly changing technology in the telecommunications industry
may influence our customers to consider other service providers. For example, we
may be unable to retain customers who decide to replace their wireline telephone
service with wireless telephone service. In addition, VOIP technology, which
operates on broadband technology, now provides our competitors with a low-cost
alternative to provide voice services to our customers.
Item 1B. Unresolved Staff Comments
-------------------------
None.
Item 2. Properties
----------
Our principal corporate offices are located in leased premises at 3 High Ridge
Park, Stamford, Connecticut.
An operations support office is currently located in leased premises at 180
South Clinton Avenue, Rochester, New York. In addition, our Frontier segment
leases and owns space in various markets throughout the United States.
An operations support office for ELI is located in a building we own at 4400 NE
77th Avenue, Vancouver, Washington. In addition, our ELI segment leases local
office space in various markets throughout the United States, and also maintains
a warehouse facility in Portland, Oregon. Our ELI segment also leases network
hub and network equipment installation sites in various locations throughout the
areas in which it provides services. For additional information regarding
obligations under lease, see Note 25 to Consolidated Financial Statements.
12
Our Frontier and ELI segments own telephone properties which include: connecting
lines between customers' premises and the central offices; central office
switching equipment; fiber-optic and microwave radio facilities; buildings and
land; and customer premise equipment. The connecting lines, including aerial and
underground cable, conduit, poles, wires and microwave equipment, are located on
public streets and highways or on privately owned land. We have permission to
use these lands pursuant to local governmental consent or lease, permit,
franchise, easement or other agreement.
Item 3. Legal Proceedings
-----------------
The City of Bangor, Maine, filed suit against us on November 22, 2002, in the
U.S. District Court for the District of Maine (City of Bangor v. Citizens
Communications Company, Civ. Action No. 02-183-B-S). The City alleged, among
other things, that we are responsible for the costs of cleaning up environmental
contamination alleged to have resulted from the operation of a manufactured gas
plant owned by Bangor Gas Company from 1852-1948 and by us from 1948-1963. In
acquiring the operation in 1948 we acquired the stock of Bangor Gas Company and
merged it into us. The City alleged the existence of extensive contamination of
the Penobscot River and 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 Honeywell Corporation, Guilford Transportation
(operating as Maine Central Railroad), 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. Trial was conducted in September
and October 2005 for the first (liability) phase of the case, and a decision
from the court is anticipated by the end of the first quarter of 2006. We intend
to continue to defend ourselves vigorously against the City's lawsuit. 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.
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 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 $1.0 billion. 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.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None in fourth quarter 2005.
13
Executive Officers of the Registrant
Our Executive Officers as of February 7, 2006 were:
Name Age Current Position and Officer
---- --- ----------------------------
Mary Agnes Wilderotter 51 Chairman of the Board and Chief Executive Officer
John H. Casey, III 49 Executive Vice President
Jerry Elliott 46 President and Acting Chief Financial Officer
Hilary E. Glassman 43 Senior Vice President, General Counsel and Secretary
Peter B. Hayes 48 Executive Vice President Sales, Marketing and Business Development
Robert J. Larson 46 Senior Vice President and Chief Accounting Officer
Daniel J. McCarthy 41 Executive Vice President and Chief Operating Officer
Cecilia K. McKenney 43 Senior Vice President, Human Resources
There is no family relationship between directors or executive officers. The
term of office of each of the foregoing officers of Citizens will continue until
the next annual meeting of the Board of Directors and until a successor has been
elected and qualified.
MARY AGNES WILDEROTTER has been associated with Citizens since November 2004.
She was elected Chairman of the Board and Chief Executive Officer in December
2005. Previously, she was President and Chief Executive Officer from November
2004 to December 2005. Prior to joining Citizens, she was Senior Vice President
- Worldwide Public Sector in 2004, Microsoft Corp. and Senior Vice President -
Worldwide Business Strategy, Microsoft Corp., 2002 to 2004. Before that she was
President and Chief Executive Officer, Wink Communications, 1997 to 2002.
JOHN H. CASEY, III has been associated with Citizens since November 1999. He is
currently Executive Vice President. Previously, he was Executive Vice President
and President and Chief Operating Officer of our ILEC Sector from July 2002 to
December 2004. He was Vice President of Citizens, President and Chief Operating
Officer, ILEC Sector from January 2002 to July 2002, Vice President and Chief
Operating Officer, ILEC Sector from February 2000 to January 2002, and Vice
President, ILEC Sector from December 1999 to February 2000.
JERRY ELLIOTT has been associated with Citizens since March 2002. He was elected
President in December 2005 and remains Acting Chief Financial Officer until a
successor Chief Financial Officer joins the Company. Previously, he was
Executive Vice President and Chief Financial Officer from July 2004 to December
2005. He was Senior Vice President and Chief Financial Officer from December
2002 to July 2004 and Vice President and Chief Financial Officer from March 2002
to December 2002. Prior to joining Citizens, he was Managing Director of Morgan
Stanley's Media and Communications Investment Banking Group.
HILARY E. GLASSMAN has been associated with Citizens since July 2005. Prior to
joining Citizens, from February 2003, she was associated with Sandler O'Neill &
Partners, L.P., an investment bank with a specialized financial institutions
practice, first as Managing Director, Associate General Counsel and then as
Managing Director, Deputy General Counsel. From February 2000 through February
2003, Ms. Glassman was Vice President and General Counsel of Newview
Technologies, Inc. (formerly e-Steel Corporation), a privately-held software
company.
PETER B. HAYES has been associated with Citizens since February 2005. He is
currently Executive Vice President, Sales, Marketing and Business Development.
Previously, he was Senior Vice President, Sales, Marketing and Business
Development from February 2005 to December 2005. Prior to joining Citizens, he
was associated with Microsoft Corp. and served as Vice President, Public Sector,
Europe, Middle East, Africa from 2003 to 2005 and Vice President and General
Manager, Microsoft U.S. Government from 1997 to 2003.
ROBERT J. LARSON has been associated with Citizens since July 2000. He was
elected Senior Vice President and Chief Accounting Officer of Citizens in
December 2002. Previously, he was Vice President and Chief Accounting Officer
from July 2000 to December 2002. Prior to joining Citizens, he was Vice
President and Controller of Century Communications Corp.
DANIEL J. McCARTHY has been associated with Citizens since December 1990. He is
currently Executive Vice President and Chief Operating Officer. Previously, he
was Senior Vice President, Field Operations from December 2004 to December 2005.
He was Senior Vice President Broadband Operations from January 2004 to December
2004, President and Chief Operating Officer of Electric Lightwave from January
2002 to December 2004, President and Chief Operating Officer, Public Services
Sector from November 2001 to January 2002, Vice President and Chief Operating
Officer, Public Services Sector from March 2001 to November 2001 and Vice
President, Citizens Arizona Energy from April 1998 to March 2001.
14
CECILIA K. McKENNEY has been associated with Citizens since February 2006. Prior
to joining Citizens, she was the Group Vice President, Headquarters Human
Resources of The Pepsi Bottling Group (PBG) from 2004 to 2005. Previously at
PBG, Ms. McKenney was the Vice President, Headquarters Human Resources from 2000
to 2004.
15
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
PART II
-------
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
----------------------------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
PRICE RANGE OF COMMON STOCK
Our common stock is traded on the New York Stock Exchange under the symbol CZN.
The following table indicates the high and low prices per share during the
periods indicated.
2005 2004
------------------- -------------------
High Low High Low
---- --- ---- ---
First Quarter $14.05 $12.25 $13.25 $11.37
Second Quarter $13.74 $12.16 $13.54 $12.06
Third Quarter $13.98 $13.05 $14.80 $12.04
Fourth Quarter $13.57 $12.08 $14.63 $13.11
As of January 31, 2006, the approximate number of security holders of record of
our common stock was 26,226. This information was obtained from our transfer
agent.
DIVIDENDS
The amount and timing of dividends payable on our common stock are within the
sole discretion of our Board of Directors. In 2004, we paid a special,
non-recurring dividend of $2.00 per share of common stock, and instituted a
regular annual dividend of $1.00 per share of common stock to be paid quarterly.
Cash dividends paid to shareholders were approximately $338.4 million and $832.8
million in 2005 and 2004, respectively. There are no material restrictions on
our ability to pay dividends. The table below sets forth dividends paid during
the periods indicated.
2005 2004
----------- -----------
First Quarter $ 0.25 $ -
Second Quarter $ 0.25 $ -
Third Quarter $ 0.25 $ 2.25
Fourth Quarter $ 0.25 $ 0.25
RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM REGISTERED
SECURITIES
None.
16
ISSUER PURCHASES OF EQUITY SECURITIES
The following tables display issuer purchases of equity securities for the years
ended December 31, 2005 and 2004.
(d) Maximum
Approximiate
(c) Total Number Dollar Value of
of Shares Shares that
(a) Total Purchased as Part May Yet Be
Number of (b) Average of Publicly Purchased
Shares Price Paid Announced Plans Under the Plans
Period Purchaed per Share or Programs or Programs
--------------------------------------------------------------------------------------------------------
January 1, 2005 to January 31, 2005
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
February 1, 2005 to February 28, 2005
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
March 1, 2005 to March 31, 2005
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 128,049 $ 12.62 N/A N/A
Totals January 1, 2005 to March 31, 2005
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 128,049 $ 12.62 N/A N/A
April 1, 2005 to April 30, 2005
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
May 1, 2005 to May 31, 2005
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
June 1, 2005 to June 30, 2005
Share Repurchase Program (1) 1,400,000 $ 13.28 1,400,000 $231,400,000
Employee Transactions (2) - $ - N/A N/A
Totals April 1, 2005 to June 30, 2005
Share Repurchase Program (1) 1,400,000 $ 13.28 1,400,000 $231,400,000
Employee Transactions (2) - $ - N/A N/A
17
(d) Maximum
Approximiate
(c) Total Number Dollar Value of
of Shares Shares that
(a) Total Purchased as Part May Yet Be
Number of (b) Average of Publicly Purchased
Shares Price Paid Announced Plans Under the Plans
Period Purchaed per Share or Programs or Programs
-----------------------------------------------------------------------------------------------------------
July 1, 2005 to July 31, 2005
Share Repurchase Program (1) - $ - - $231,400,000
Employee Transactions (2) - $ - N/A N/A
August 1, 2005 to August 31, 2005
Share Repurchase Program (1) 6,576,100 $ 13.68 6,576,100 $141,500,000
Employee Transactions (2) - $ - N/A N/A
September 1, 2005 to September 30, 2005
Share Repurchase Program (1) 4,680,400 $ 13.56 4,680,400 $ 78,000,000
Employee Transactions (2) 629 $ 13.51 N/A N/A
Totals July 1, 2005 to September 30, 2005
Share Repurchase Program (1) 11,256,500 $ 13.62 11,256,500 $ 78,000,000
Employee Transactions (2) 629 $ 13.51 N/A N/A
October 1, 2005 to October 31, 2005
Share Repurchase Program (1) - $ - - $ 78,000,000
Employee Transactions (2) - $ - N/A N/A
November 1, 2005 to November 30, 2005
Share Repurchase Program (1) 375,000 $ 13.06 375,000 $ 73,100,000
Employee Transactions (2) 12,435 $ 12.17 N/A N/A
December 1, 2005 to December 31, 2005
Share Repurchase Program (1) 5,743,656 $ 12.73 5,743,656 $ -
Employee Transactions (2) 1,155 $ 12.85 N/A N/A
Totals October 1, 2005 to December 31, 2005
Share Repurchase Program (1) 6,118,656 $ 12.75 6,118,656 $ -
Employee Transactions (2) 13,590 $ 12.23 N/A N/A
Totals January 1, 2005 to December 31, 2005
Share Repurchase Program (1) 18,775,156 $ 13.32 18,775,156 $ -
Employee Transactions (2) 142,268 $ 12.59 N/A N/A
18
(d) Maximum
Approximiate
(c) Total Number Dollar Value of
of Shares Shares that
(a) Total Purchased as Part May Yet Be
Number of (b) Average of Publicly Purchased
Shares Price Paid Announced Plans Under the Plans
Period Purchaed per Share or Programs or Programs
-----------------------------------------------------------------------------------------------------------
January 1, 2004 to January 31, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
February 1, 2004 to February 28, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
March 1, 2004 to March 31, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 3,123 $ 12.64 N/A N/A
Totals January 1, 2004 to March 31, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 3,123 $ 12.64 N/A N/A
April 1, 2004 to April 30, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
May 1, 2004 to May 31, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
June 1, 2004 to June 30, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
Totals April 1, 2004 to June 30, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
19
(d) Maximum
Approximiate
(c) Total Number Dollar Value of
of Shares Shares that
(a) Total Purchased as Part May Yet Be
Number of (b) Average of Publicly Purchased
Shares Price Paid Announced Plans Under the Plans
Period Purchaed per Share or Programs or Programs
-----------------------------------------------------------------------------------------------------------
July 1, 2004 to July 31, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
August 1, 2004 to August 31, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 1,503,748 $ 14.32 N/A N/A
September 1, 2004 to September 30, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
Totals July 1, 2004 to September 30, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 1,503,748 $ 14.32 N/A N/A
October 1, 2004 to October 31, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
November 1, 2004 to November 30, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
December 1, 2004 to December 31, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
Totals October 1, 2004 to December 31, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
Totals January 1, 2004 to December 31, 2004
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 1,506,871 $ 14.32 N/A N/A
(1) On May 25, 2005, our Board of Directors authorized the Company to
repurchase up to $250.0 million of the Company's common stock, either in
the open market or through negotiated transactions. This share repurchase
program commenced on June 13, 2005 and was completed during December of
2005.
(2) Includes restricted shares withheld (under the terms of grants under
employee stock compensation plans) to offset minimum tax withholding
obligations that occur upon the vesting of restricted shares. The Company's
stock compensation plans provide that the value of shares withheld shall be
the average of the high and low price of the Company's common stock on the
date the relevant transaction occurs.
20
Item 6. Selected Financial Data
-----------------------
($ in thousands, except per share amounts) Year Ended December 31,
------------------------------------------ --------------------------------------------------------------
2005 2004 2003 2002 2001
------------ ----------- ------------ ------------ -----------
Revenue (1) $ 2,162,479 $ 2,168,422 $ 2,424,174 $ 2,647,671 $ 2,435,489
Income (loss) from continuing operations before
extraordinary expense and cumulative effect of
changes in accounting principle (2) $ 200,168 $ 66,919 $ 117,703 $ (828,140) $ (68,434)
Net income (loss) $ 202,375 $ 72,150 $ 187,852 $ (682,897) $ (89,682)
Basic income (loss) per share of common stock
from continuing operations before extraordinary
expense and cumulative effect of changes in
accounting principle (2) $ 0.59 $ 0.22 $ 0.42 $ (2.95) $ (0.30)
Available for common shareholders per basic share $ 0.60 $ 0.24 $ 0.67 $ (2.43) $ (0.38)
Available for common shareholders per diluted share $ 0.60 $ 0.23 $ 0.64 $ (2.43) $ (0.38)
Cash dividends declared (and paid) per common share $ 1.00 $ 2.50 $ - $ - $ -
As of December 31,
-----------------------------------------------------------------
2005 2004 2003 2002 2001
------------- ----------- ------------ ------------ -----------
Total assets $ 6,412,109 $ 6,668,419 $ 7,445,545 $ 8,144,502 $10,551,351
Long-term debt $ 3,999,376 $ 4,266,998 $ 4,195,626 $ 4,957,338 $ 5,534,867
Equity units (3) $ - $ - $ 460,000 $ 460,000 $ 460,000
Company Obligated Mandatorily Redeemable
Convertible Preferred Securities (4) $ - $ - $ 201,250 $ 201,250 $ 201,250
Shareholders' equity $ 1,041,809 $ 1,362,240 $ 1,415,183 $ 1,172,139 $ 1,946,142
(1) Represents revenue from continuing operations. Revenue from acquisitions
contributed $569.8 million for the year ended December 31, 2001. Revenue
from gas operations sold was $137.7 million in 2003 and $218.8 million in
2001. Revenue from electric operations sold was $9.7 million, $67.4
million, $76.6 million and $94.3 million in 2004, 2003, 2002 and 2001,
respectively. Total revenue associated with these operations is available
in Note 22, "Segment Information."
(2) Extraordinary expense represents an extraordinary after tax expense of
$43.6 million related to the discontinuance of the application of Statement
of Financial Accounting Standards No. 71 to our local exchange telephone
operations in 2001. The cumulative effect of changes in accounting
principles represents the $65.8 million after tax non-cash gain resulting
from the adoption of Statement of Financial Accounting Standards No. 143 in
2003, and the write-off of ELI's goodwill of $39.8 million resulting from
the adoption of Statement of Financial Accounting Standards No. 142 in
2002.
(3) On August 17, 2004, we issued common stock to equity unit holders in
settlement of the equity purchase contract.
(4) The consolidation of this item changed effective January 1, 2004 as a
result of the adoption of FIN 46R, "Consolidation of Variable Interest
Entities." See Note 15 for a complete discussion.
21
Item 7. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
Forward-Looking Statements
--------------------------
This annual report on Form 10-K contains forward-looking statements that are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed or implied in the statements. Statements that
are not historical facts are forward-looking statements made pursuant to the
Safe Harbor Provisions of the Litigation Reform Act of 1995. Words such as
"believes," "anticipates," "expects" and similar expressions are intended to
identify forward-looking statements. Forward-looking statements (including oral
representations) are only predictions or statements of current plans, which we
review continuously. Forward-looking statements may differ from actual future
results due to, but not limited to, and our future results may be materially
affected by, any of the following possibilities:
* 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 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, access services and
subsidies;
* Our ability to comply with Section 404 of the Sarbanes-Oxley Act of
2002, which requires management to assess its internal control systems
and disclose whether the internal control systems are effective, and
the identification of any material weaknesses in our internal control
over financial reporting;
* 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 greater than anticipated competition requiring new
pricing, marketing strategies or new product offerings and the risk
that we will not respond on a timely or profitable basis;
* The effects of bankruptcies in the telecommunications industry which
could result in more price competition and potential bad debts;
22
* The effects of technological changes and competition on our capital
expenditures and product and service offerings, including the lack of
assurance that our ongoing network improvements will be sufficient to
meet or exceed the capabilities and quality of competing networks;
* The effects of increased medical, retiree and pension expenses and
related funding requirements;
* Changes in income tax rates, tax laws, regulations or rulings, and/or
federal or state tax assessments;
* The effect of changes in the communications market, including
significantly increased price and service competition;
* The effects of state regulatory cash management policies on our
ability to transfer cash among our subsidiaries and to the parent
company;
* Our ability to successfully renegotiate expiring union contracts
covering approximately 1,468 employees that are scheduled to expire
during 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" above, in evaluating any statement in this Form
10-K or otherwise made by us or on our behalf. The following information is
unaudited and should be read in conjunction with the consolidated financial
statements and related notes included in this report. We have no obligation to
update or revise these forward-looking statements.
Overview
--------
We are a communications company providing services to rural areas and small and
medium-sized towns and cities as an incumbent local exchange carrier, or ILEC.
We offer our ILEC services under the "Frontier" name. In addition, we provide
competitive local exchange carrier, or CLEC, services to business customers and
to other communications carriers in certain metropolitan areas in the western
United States through Electric Lightwave, LLC, or ELI, our wholly-owned
subsidiary. In February 2006, we entered into a definitive agreement to sell ELI
and we expect the sale to close in the third quarter of 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 experienced erosion in access lines and switched access
minutes in 2005 as a result of competition. Competition in our markets may
result in reduced revenues in 2006.
The communications industry is undergoing significant changes. The market is
extremely competitive, resulting in lower prices. Demand and pricing for certain
CLEC services have decreased substantially, particularly for long-haul services.
These trends are likely to continue and result in a challenging revenue
environment. These factors could also result in more bankruptcies in the sector
and therefore affect our ability to collect money owed to us by carriers.
23
Revenues from data and internet services such as high-speed internet continue to
increase as a percentage of our total revenues and revenues from services such
as local line and access charges and subsidies are decreasing as a percentage of
our revenues. These factors, along with increasing operating costs, could cause
our profitability and our cash generated by operations to decrease.
(a) Liquidity and Capital Resources
-------------------------------
For the year ended December 31, 2005, we used cash flows from continuing
operations, the proceeds from the sale of non-strategic assets, stock option
exercises and cash and cash equivalents to fund capital expenditures, dividends,
interest payments, debt repayments and stock repurchases. As of December 31,
2005, we had cash and cash equivalents aggregating $265.8 million.
For the year ended December 31, 2005, our capital expenditures were $268.5
million, including $252.2 million for the Frontier segment, $16.1 million for
the ELI segment and $0.2 million of general capital expenditures. We continue to
closely scrutinize all of our capital projects, emphasize return on investment
and focus our capital expenditures on areas and services that have the greatest
opportunities with respect to revenue growth and cost reduction. For example, we
will allocate significant capital to services such as high-speed internet in
areas that are growing or demonstrate meaningful demand as well as the launch of
new products such as wireless and VOIP services.
Increasing competition, offering new services such as wireless and VOIP, and
improving the capabilities or reducing the maintenance costs of our plant may
cause our capital expenditures to increase in the future. For 2006, we expect
our capital expenditures to increase in order to build wireless data networks
and expand the capabilities of our data networks.
As of December 31, 2005, we have available lines of credit with financial
institutions in the aggregate amount of $250.0 million. Associated facility fees
vary, depending on our debt leverage ratio, and are 0.375% per annum as of
December 31, 2005. The expiration date for the facility is October 29, 2009.
During the term of the facility we may borrow, repay and reborrow funds. The
credit facility is available for general corporate purposes but may not be used
to fund dividend payments. We have never borrowed any money under the facility.
Our ongoing annual dividends of $1.00 per share under our current policy utilize
a significant portion of our cash generated by operations and therefore limits
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 in July
2004 to below investment grade may make it more difficult and expensive to
refinance our maturing debt. We have in recent years paid relatively low amounts
of cash taxes. We expect that over the next several years our cash taxes will
increase substantially.
We believe our operating cash flows, existing cash balances, and credit
facilities will be adequate to finance our working capital requirements, fund
capital expenditures, make required debt payments through 2007, pay taxes, pay
dividends to our shareholders in accordance with our dividend policy, and
support our short-term and long-term operating strategies. We have approximately
$227.8 million, $37.9 million and $701.1 million of debt maturing in 2006, 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 common shares 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. We may in the future purchase additional shares
of our common stock.
Issuance of Common Stock
------------------------
On August 17, 2004 we issued 32,073,633 shares of common stock, including
3,591,000 treasury shares, to our equity unit holders in settlement of the
equity purchase contract component of the equity units. With respect to the
$460.0 million senior note component of the equity units, we repurchased $300.0
million principal amount of these notes in July 2004. The remaining $160.0
million of the senior notes were repriced and a portion was remarketed on August
12, 2004 as our 6.75% notes due August 17, 2006.
24
Issuance of Debt Securities
---------------------------
On November 8, 2004, we issued an aggregate $700.0 million principal amount of
6.25% senior notes due January 15, 2013 through a registered underwritten public
offering. Proceeds from the sale were used to redeem our outstanding $700.0
million of 8.50% Notes due 2006.
Debt Reduction and Debt Exchanges
---------------------------------
For the year ended December 31, 2005, we retired an aggregate principal amount
of $36.4 million of debt, including $30.0 million of 5% Company Obligated
Mandatorily Redeemable Convertible Preferred Securities due 2036 (EPPICS) that
were converted into our common stock. During the second quarter of 2005, we
entered into two debt-for-debt exchanges of our debt securities. As a result,
$50.0 million of our 7.625% notes due 2008 were exchanged for approximately
$52.2 million of our 9.00% notes due 2031. The 9.00% notes are callable on the
same general terms and conditions as the 7.625% notes exchanged. No cash was
exchanged in these transactions, however a non-cash pre-tax loss of
approximately $3.2 million was recognized in accordance with EITF No. 96-19,
"Debtor's Accounting for a Modification or Exchange of Debt Instruments," which
is included in other income (loss), net. In February 2006, our Board of
Directors authorized us to repurchase up to $150.0 million of our outstanding
debt securities 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 other income (loss), net.
For the year ended December 31, 2004, we retired an aggregate $1,362.0 million
of debt (including $148.0 million of EPPICS conversions), representing
approximately 28% of total debt outstanding at December 31, 2003.
During August and September 2004, we repurchased an additional $108.2 million of
our 6.75% notes which, in addition to the $300.0 million we purchased in July,
resulted in a pre-tax charge of approximately $20.1 million during the third
quarter of 2004, but resulted in an annual reduction in interest expense of
about $27.6 million per year. See the discussion below concerning EPPICS
conversions for further information regarding the issuance of common stock.
We may from time to time repurchase our debt in the open market, through tender
offers or privately negotiated transactions. We may also exchange existing debt
obligations for newly issued debt obligations.
Interest Rate Management
------------------------
In order to manage our interest expense, we have entered into interest rate swap
agreements. Under the terms of the agreements, which qualify for hedge
accounting, we make semi-annual, floating rate interest payments based on six
month LIBOR and receive a fixed rate on the notional amount. The underlying
variable rate on these swaps is set in arrears.
The notional amounts of fixed-rate indebtedness hedged as of December 31, 2005
and December 31, 2004 were $500.0 million and $300.0 million, respectively. Such
contracts require us to pay variable rates of interest (average pay rates of
approximately 8.60% and 6.12% as of December 31, 2005 and 2004, respectively)
and receive fixed rates of interest (average receive rates of 8.46% and 8.44% as
of December 31, 2005 and 2004, respectively). All swaps are accounted for under
SFAS No. 133 (as amended) as fair value hedges. For the years ended December 31,
2005 and 2004, the cash interest savings resulting from these interest rate
swaps totaled approximately $2.5 million and $9.4 million, respectively.
During September 2005, we entered into a series of forward rate agreements 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. At
December 31, 2005, the rates obtained under these forward rate agreements were
below market rates. Changes in the fair value of these forward rate agreements,
which do not qualify for hedge accounting, are recorded in other income (loss),
net. Gains of $1.3 million and $0.6 million, respectively, were recorded during
the third and fourth quarters of 2005.
Sale of Non-Strategic Investments
---------------------------------
In February 2006, we entered into a definitive agreement to sell all of the
outstanding membership interests in ELI 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. We anticipate the
recognition of a pre-tax gain on the sale of ELI of approximately $130.0
million. The transaction is expected to close in the third quarter of 2006 and
is subject to regulatory and other customary approvals and conditions, as well
as the funding of Integra's fully committed financing. We expect that for
periods subsequent to December 31, 2005, ELI will be accounted for as a
discontinued operation.
25
On February 1, 2005, we sold shares of Prudential Financial, Inc. for
approximately $1.1 million in cash, and we recognized a pre-tax gain of
approximately $0.5 million that is included in other income (loss), net.
On March 15, 2005, we completed the sale of our conferencing business for
approximately $43.6 million in cash. The pre-tax gain on the sale of CCUSA was
$14.1 million.
In June 2005, we sold for cash our interests in certain key man life insurance
policies on the lives of Leonard Tow, our former Chairman and Chief Executive
Officer, and his wife, a former director. The cash surrender value of the
policies purchased by Dr. Tow totaled approximately $24.2 million, and we
recognized a pre-tax gain of approximately $457,000 that is included in other
income (loss), net.
During 2005, we sold shares of Global Crossing Limited for approximately $1.1
million in cash, and we recognized a pre-tax gain for the same amount that is
included in other income (loss), net.
Off-Balance Sheet Arrangements
------------------------------
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationship with unconsolidated entities that would be expected to
have a material current or future effect upon our financial statements.
Future Commitments
------------------
A summary of our future contractual obligations and commercial commitments as of
December 31, 2005 is as follows:
Contractual Obligations:
------------------------ Payment due by period
------------------------------------------------------------
Less than More than
($ in thousands) Total 1 year 1-3 years 3-5 years 5 years
-------------- ------ ------ --------- --------- --------
Long-term debt obligations,
excluding interest (see Note 11) (1) $4,201,730 $227,693 $738,709 $ 5,393 $3,229,935
ELI capital lease
obligations (see Note 25) 4,287 41 236 310 3,700
Operating lease
obligations (see Note 25) 92,088 19,062 24,445 19,307 29,274
Purchase obligations (see Note 25) 76,384 30,619 29,354 11,296 5,115
Other long-term liabilities (2) 33,785 - - - 33,785
----------- --------- --------- -------- ----------
Total $4,408,274 $277,415 $792,744 $36,306 $3,301,809
=========== ========= ========= ======== ==========
(1) Includes interest rate swaps ($(8.7) million).
(2) Consists of our Equity Providing Preferred Income Convertible Securities
(EPPICS) reflected on our balance sheet.
At December 31, 2005, we have outstanding performance letters of credit totaling
$22.4 million.
Management Succession and Strategic Alternatives Expenses
---------------------------------------------------------
On July 11, 2004, our Board of Directors announced that it completed its review
of our financial and strategic alternatives. In 2004, we expensed $90.6 million
of costs related to management succession and our exploration of financial and
strategic alternatives. Included are $36.6 million of non-cash expenses for the
acceleration of stock benefits, cash expenses of $19.2 million for advisory
fees, $19.3 million for severance and retention arrangements and $15.5 million
primarily for tax reimbursements.
26
EPPICS
------
In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust (the
Trust), issued, in an underwritten public offering, 4,025,000 shares of 5%
Company Obligated Mandatorily Redeemable Convertible Preferred Securities due
2036 (Trust Convertible Preferred Securities or EPPICS), representing preferred
undivided interests in the assets of the Trust, with a liquidation preference of
$50 per security (for a total liquidation amount of $201.3 million). These
securities have an adjusted conversion price of $11.46 per Citizens common
share. The conversion price was reduced from $13.30 to $11.46 during the third
quarter of 2004 as a result of our $2.00 per share special, non-recurring
dividend paid on our common stock. The proceeds from the issuance of the Trust
Convertible Preferred Securities and a Company capital contribution were used to
purchase $207.5 million aggregate liquidation amount of 5% Partnership
Convertible Preferred Securities due 2036 from another wholly owned consolidated
subsidiary, Citizens Utilities Capital L.P. (the Partnership). The proceeds from
the issuance of the Partnership Convertible Preferred Securities and a Company
capital contribution were used to purchase from us $211.8 million aggregate
principal amount of 5% Convertible Subordinated Debentures due 2036. The sole
assets of the Trust are the Partnership Convertible Preferred Securities, and
our Convertible Subordinated Debentures are substantially all the assets of the
Partnership. Our obligations under the agreements related to the issuances of
such securities, taken together, constitute a full and unconditional guarantee
by us of the Trust's obligations relating to the Trust Convertible Preferred
Securities and the Partnership's obligations relating to the Partnership
Convertible Preferred Securities.
In accordance with the terms of the issuances, we paid the annual 5% interest in
quarterly installments on the Convertible Subordinated Debentures in 2005, 2004
and 2003. 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 December 31, 2005, EPPICS representing a total principal amount of $178.0
million had been converted into 14,237,807 shares of our common stock, and a
total of $23.3 million remains outstanding to third parties. Our long-term debt
footnote indicates $33.8 million of EPPICS outstanding at December 31, 2005 of
which $10.5 million is intercompany debt. Our accounting treatment of the EPPICS
debt is in accordance with FIN 46R (see Notes 2 and 15).
We adopted the provisions of FASB Interpretation No. 46R (revised December 2003)
(FIN 46R), "Consolidation of Variable Interest Entities," effective January 1,
2004. Accordingly, the Trust holding the EPPICS and the related Citizens
Utilities Capital L.P. are deconsolidated.
Covenants
---------
The terms and conditions contained in our indentures and credit facility
agreement 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
the provision of guarantees of debt by our subsidiaries, 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 agreements) over the last four
quarters of 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 of no greater than 4.50 to 1. Although the credit facility is
unsecured, it will be equally and ratably secured by certain liens and equally
and ratably guaranteed by certain of our subsidiaries if we issue debt that is
secured or guaranteed. We are in compliance with all of our debt and credit
facility covenants.
Divestitures
------------
On August 24, 1999, our Board of Directors approved a plan of divestiture for
our public utilities services businesses, which included gas, electric and water
and wastewater businesses. We have sold all of these properties. All of the
agreements relating to the sales provide that we will indemnify the buyer
against certain liabilities (typically liabilities relating to events that
occurred prior to sale), including environmental liabilities, for claims made by
specified dates and that exceed threshold amounts specified in each agreement.
In February 2006, we entered into a definitive agreement to sell ELI. We
anticipate the recognition of a pre-tax gain on the sale of ELI of approximately
$130.0 million. ELI had revenues of $159.2 million and operating income of $18.3
million for the year ended December 31, 2005. At December 31, 2005, ELI's net
assets totaled $123.1 million.
27
Discontinued Operations
-----------------------
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 Administration approved the
appropriate provisions in the 2006 federal budget necessary for dissolution of
the RTB. We expect to receive during the second quarter of 2006 approximately
$64.6 million in cash from the dissolution of the RTB, which would result in a
pre-tax gain of approximately $62.0 million when we receive the cash.
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.
Telecommunications Bankruptcies
Our estimate of anticipated losses related to telecommunications bankruptcies is
a "critical accounting estimate." We have significant on-going normal course
business relationships with many telecom providers, some of which have filed for
bankruptcy. We generally reserve approximately 95% of the net outstanding
pre-bankruptcy balances owed to us and believe that our estimate of the net
realizable value of the amounts owed to us by bankrupt entities is appropriate.
In 2005 and 2004, we had no "critical estimates" related to telecommunications
bankruptcies.
Asset Impairment
In 2005 and 2004, we had no "critical estimates" related to asset impairments.
Depreciation and Amortization
The calculation of depreciation and amortization expense is based on the
estimated economic useful lives of the underlying property, plant and equipment
and identifiable intangible assets. An independent study of the estimated useful
lives of our plant assets was completed in 2005. We adopted the lives proposed
in that study effective October 1, 2005.
Intangibles
Our indefinite lived intangibles consist of goodwill and trade name, which
resulted from the purchase of ILEC properties. We test for impairment of these
assets annually, or more frequently, as circumstances warrant. All of our ILEC
properties share similar economic characteristics and as a result, our reporting
unit is the ILEC segment. In determining fair value of goodwill during 2005 we
compared the net book value of the ILEC assets to trading values of our publicly
traded common stock. Additionally, we utilized a range of prices to gauge
sensitivity. Our test determined that fair value exceeded book value of
goodwill. An independent third party appraiser analyzed trade name.
Pension and Other Postretirement Benefits
Our estimates of pension expense, other post retirement benefits including
retiree medical benefits and related liabilities are "critical accounting
estimates." We sponsor a noncontributory defined benefit pension plan covering a
significant number of our employees and other post retirement benefit plans that
provide medical, dental, life insurance benefits and other benefits for covered
retired employees and their beneficiaries and covered dependents. The accounting
results for pension and post retirement benefit costs and obligations are
dependent upon various actuarial assumptions applied in the determination of
such amounts. These actuarial assumptions include the following: discount rates,
expected long-term rate of return on plan assets, future compensation increases,
employee turnover, healthcare cost trend rates, expected retirement age,
optional form of benefit and mortality. We review these assumptions for changes
annually with its outside actuaries. We consider our discount rate and expected
long-term rate of return on plan assets to be our most critical assumptions.
28
The discount rate is used to value, on a present basis, our pension and post
retirement benefit obligation as of the balance sheet date. The same rate is
also used in the interest cost component of the pension and post retirement
benefit cost determination for the following year. The measurement date used in
the selection of our discount rate is the balance sheet date. Our discount rate
assumption is determined annually with assistance from our actuaries based on
the duration of our pension and postretirement benefit liabilities, the pattern
of expected future benefit payments and the prevailing rates available on
long-term, high quality corporate bonds that approximate the benefit obligation.
In making this determination we consider, among other things, the yields on the
Citigroup Pension Discount Curve and Bloomberg Finance. This rate can change
from year-to-year based on market conditions that impact corporate bond yields.
Our discount rate declined from 6.00% at year-end 2004 to 5.625% at year-end
2005.
The expected long-term rate of return on plan assets is applied in the
determination of periodic pension and post retirement benefit cost as a
reduction in the computation of the expense. In developing the expected
long-term rate of return assumption, we considered published surveys of expected
market returns, 10 and 20 year actual returns of various major indices, and our
own historical 5-year and 10-year investment returns. The expected long-term
rate of return on plan assets is based on an asset allocation assumption of 30%
to 45% in fixed income securities, 45% to 55% in equity securities and 5% to 15%
in alternative investments. We review our asset allocation at least annually and
make changes when considered appropriate. In 2005, we did not change our
expected long-term rate of return from the 8.25% used in 2004. Our pension plan
assets are valued at actual market value as of the measurement date.
Accounting standards require that we record an additional minimum pension
liability when the plan's "accumulated benefit obligation" exceeds the fair
market value of plan assets at the pension plan measurement (balance sheet)
date. In the fourth quarter of 2004, mainly due to a decrease in the year-end
discount rate, we recorded an additional minimum pension liability in the amount
of $17.4 million with a corresponding charge to shareholders' equity of $10.7
million, net of taxes of $6.7 million. In the fourth quarter of 2005, primarily
due to another decrease in the year-end discount rate, we recorded an additional
minimum pension liability in the amount of $36.4 million with a corresponding
charge to shareholders' equity of $22.5 million, net of taxes of $13.9 million.
These adjustments did not impact our net income or cash flows.
Actual results that differ from our assumptions are added or subtracted to our
balance of unrecognized actuarial gains and losses. For example, if the year-end
discount rate used to value the plan's projected benefit obligation decreases
from the prior year-end then the plan's actuarial loss will increase. If the
discount rate increases from the prior year-end then the plan's actuarial loss
will decrease. Similarly, the difference generated from the plan's actual asset
performance as compared to expected performance would be included in the balance
of unrecognized gains and losses.
The impact of the balance of accumulated actuarial gains and losses are
recognized in the computation of pension cost only to the extent this balance
exceeds 10% of the greater of the plan's projected benefit obligation or market
value of plan assets. If this occurs, that portion of gain or loss that is in
excess of 10% is amortized over the estimated future service period of plan
participants as a component of pension cost. The level of amortization is
affected each year by the change in actuarial gains and losses and could
potentially be eliminated if the gain/loss activity reduces the net accumulated
gain/loss balance to a level below the 10% threshold.
We expect that our pension and other postretirement benefit expenses for 2006
will be $15.0 million to $18.0 million (they were $19.0 million in 2005) and
that no contribution will be required to be made by us to the pension plan in
2006. No contribution was made to our pension plan during 2005.
Income Taxes
Our effective tax rate is below statutory rate levels as a result of the
completion of audits with federal and state taxing authorities and changes in
the structure of certain of our subsidiaries.
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.
29
New Accounting Pronouncements
-----------------------------
Accounting for Asset Retirement Obligations
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 applies to fiscal years beginning after June 15,
2002, and addresses financial accounting and reporting obligations associated
with the retirement of tangible long-lived assets and the associated asset
retirement costs. We adopted SFAS No. 143 effective January 1, 2003. The
standard applies to legal obligations associated with the retirement of
long-lived assets that result from acquisition, construction, development or
normal use of the assets and requires that a legal liability for an asset
retirement obligation be recognized when incurred, recorded at fair value and
classified as a liability in the balance sheet. When the liability is initially
recorded, the entity will capitalize the cost and increase the carrying value of
the related long-lived asset. The liability is then accreted to its present
value each period and the capitalized cost is depreciated over the estimated
useful life of the related asset. At the settlement date, we will settle the
obligation for our recorded amount or recognize a gain or loss upon settlement.
Depreciation expense for our wireline operations had historically included an
additional provision for cost of removal. Effective with the adoption of SFAS
No. 143, on January 1, 2003, the Company ceased recognition of the cost of
removal provision in depreciation expense and eliminated the cumulative cost of
removal included in accumulated depreciation, as the Company has no legal
obligation to remove certain long-lived assets. The cumulative effect of
retroactively applying these changes to periods prior to January 1, 2003,
resulted in an after tax non-cash gain of approximately $65.8 million recognized
in 2003.
Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123, "Accounting for Stock-Based Compensation." SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based compensation and amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements. This statement is effective for fiscal years
ending after December 15, 2002. We have adopted the expanded disclosure
requirements of SFAS No. 148.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment," (SFAS No. 123R). SFAS No. 123R requires that stock-based employee
compensation be recorded as a charge to earnings. In April 2005, the Securities
and Exchange Commission required adoption of SFAS No. 123R for annual periods
beginning after June 15, 2005. Accordingly, we will adopt SFAS 123R commencing
January 1, 2006 and expect to recognize approximately $2.8 million of expense
related to the non-vested portion of previously granted stock options for the
year ended December 31, 2006.
Variable Interest Entities
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003) (FIN 46R), "Consolidation of Variable Interest Entities," which addresses
how a business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities," which was issued in January 2003.
We are required to apply FIN 46R to variable interests in variable interest
entities, or VIEs, created after December 31, 2003. For any VIEs that must be
consolidated under FIN 46R that were created before January 1, 2004, the assets,
liabilities and noncontrolling interests of the VIE initially would be measured
at their carrying amounts with any difference between the net amount added to
the balance sheet and any previously recognized interest being recognized as the
cumulative effect of an accounting change. If determining the carrying amounts
is not practicable, fair value at the date FIN 46R first applies may be used to
measure the assets, liabilities and noncontrolling interest of the VIE. We
reviewed all of our investments and determined that the Trust Convertible
Preferred Securities (EPPICS), issued by our consolidated wholly-owned
subsidiary, Citizens Utilities Trust and the related Citizens Utilities Capital
L.P., were our only VIEs. Except as described in Note 15, the adoption of FIN
46R on January 1, 2004 did not have a material impact on our financial position
or results of operations.
Investments
In March 2004, the FASB issued EITF Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments"
(EITF 03-1) which provides new guidance for assessing impairment losses on debt
and equity investments. Additionally, EITF 03-1 includes new disclosure
requirements for investments that are deemed not to be temporarily impaired. In
September 2004, the FASB delayed the accounting provisions of EITF 03-1;
however, the disclosure requirements remain effective and were adopted for our
year ended December 31, 2004. Although we have no material investments at the
present time, we will evaluate the effect, if any, of EITF 03-1 when final
guidance is released.
30
Exchanges of Productive Assets
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets," an amendment of APB Opinion No. 29. SFAS No. 153 addresses the
measurement of exchanges of certain non-monetary assets (except for certain
exchanges of products or property held for sale in the ordinary course of
business). The Statement requires that non-monetary exchanges be accounted for
at the fair value of the assets exchanged, with gains or losses being
recognized, if the fair value is determinable within reasonable limits and the
transaction has commercial substance. SFAS No. 153 is effective for nonmonetary
exchanges occurring in fiscal periods beginning after June 15, 2005. We do not
expect the adoption of the new standard to have a material impact on our
financial position, results of operations and cash flows.
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 or
results of operations.
Accounting Changes and Error Corrections
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections," a replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS
No. 154 changes the accounting for, and reporting of, a change in accounting
principle. SFAS No. 154 requires retrospective application to prior period's
financial statements of voluntary changes in accounting principle, and changes
required by new accounting standards when the standard does not include specific
transition provisions, unless it is impracticable to do so. SFAS No. 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005.
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 does not expect
the adoption of EITF No. 04-5 to have a material impact on our financial
position, results of operations or cash flows.
(b) Results of Operations
---------------------
REVENUE
Frontier revenue is generated primarily through the provision of local, network
access, long distance and data services. Such services are provided under either
a monthly recurring fee or based on usage at agreed upon rates and are not
dependent upon significant judgments by management, with the exception of a
determination of a provision for uncollectible amounts.
CLEC revenue is generated through local, long distance, data and long-haul
services. These services are primarily provided under a monthly recurring fee or
based on usage at agreed upon rates and are not dependent upon significant
judgments by management with the exception of the determination of a provision
for uncollectible amounts and realizability of reciprocal compensation. CLEC
usage based revenue includes amounts determined under reciprocal compensation
agreements. While this revenue is governed by specific contracts with the
counterparty, management defers recognition of disputed portions of such revenue
until realizability is assured. Revenue earned from long-haul contracts is
recognized over the term of the related agreement.
Consolidated revenue decreased $5.9 million in 2005. The decrease in 2005 is
primarily due to a $9.7 million decrease resulting from the sale in 2004 of our
electric utility property, partially offset by an increase of $3.8 million in
ILEC and ELI revenue.
31
Consolidated revenue decreased $255.8 million, or 11% in 2004. The decrease in
2004 was primarily due to $228.9 million of decreased gas and electric revenue
primarily due to the disposition of our Arizona gas and electric operations, The
Gas Company in Hawaii and our Vermont electric division and $26.9 million of
decreased telecommunications revenue.
Consolidated revenue decreased $223.5 million, or 8% in 2003. The decrease in
2003 was primarily due to $192.7 million of decreased gas and electric revenue
primarily due to the disposition of our Arizona gas and electric operations and
The Gas Company in Hawaii division and $30.8 million of decreased
telecommunications revenue.
On March 15, 2005, we completed the sale of our conferencing service business.
As a result of the sale, we have classified the results of operations as
discontinued operations in our consolidated statement of operations and restated
prior periods.
On April 1, 2003, we sold approximately 11,000 telephone access lines in North
Dakota. The revenues related to these access lines totaled $1.9 million for the
year ended December 31, 2003.
Change in the number of our access lines is important to our revenue and
profitability. We have lost access lines primarily because of competition,
changing consumer behavior, economic conditions, changing technology, and by
some customers disconnecting second lines when they add high-speed internet or
cable modem service. We lost approximately 102,000 access lines during 2005 but
added approximately 99,000 high-speed internet subscribers during this same
period. The loss of lines during 2005 was primarily among residential customers.
The non-residential line losses were principally in Rochester, New York, while
the residential losses were throughout our markets. We expect to continue to
lose access lines but to increase high-speed internet subscribers during 2006. A
continued loss of access lines, combined with increased competition and the
other factors discussed in MD&A, may cause our revenues, profitability and cash
flows to decrease in 2006.
TELECOMMUNICATIONS REVENUE
($ in thousands) 2005 2004 2003
---------------- ------------------------------ ------------------------------- ----------
Amount $ Change % Change Amount $ Change % Change Amount
---------- -------------------- ----------- ------------------ ----------
Access services $ 623,918 $ (10,278) -2% $ 634,196 $ (32,846) -5% $ 667,042
Local services 829,801 (21,376) -3% 851,177 (7,825) -1% 859,002
Long distance services 169,496 (14,127) -8% 183,623 (15,759) -8% 199,382
Data and internet services 175,026 36,795 27% 138,231 30,779 29% 107,452
Directory services 113,092 2,469 2% 110,623 3,689 3% 106,934
Other 91,985 7,178 8% 84,807 4,448 6% 80,359
---------- ---------- ----------- ---------- ----------
ILEC revenue 2,003,318 661 0% 2,002,657 (17,514) -1% 2,020,171
ELI 159,161 3,131 2% 156,030 (9,359) -6% 165,389
---------- ---------- ----------- ---------- ----------
$2,162,479 $ 3,792 0% $2,158,687 $ (26,873) -1% $2,185,560
========== ========== =========== ========== ==========
Access Services
Access services revenue for the year ended December 31, 2005 decreased $10.3
million or 2%, as compared with the prior year. Switched access revenue
decreased $9.5 million, as compared with the prior year period, primarily due to
a decline in minutes of use. Access service revenue includes subsidy payments we
receive from federal and state agencies. Subsidy revenue decreased $15.9 million
primarily due to decreased Universal Service Fund (USF) support of $19.2 million
because of increases in the national average cost per loop (NACPL) and a
decrease of $2.0 million related to changes in measured factors, partially
offset by an increase of $6.4 million in USF surcharge rates. Special access
revenue increased $15.1 million primarily due to growth in high-capacity
circuits.
Access services revenue for the year ended December 31, 2004 decreased $32.8
million or 5%, as compared with the prior year. Switched access revenue
decreased $19.6 million primarily due to $8.3 million attributable to a decline
in minutes of use, the $7.4 million effect of federally mandated access rate
reductions and $2.7 million associated with state intrastate access rate
reductions. Subsidies revenue decreased $12.8 million primarily due to an $8.3
million decline in federal USF support because of increases in the NACPL,
including a $3.5 million accrual recorded during the third quarter of 2004 for
mistakes made during 2002 and 2003 by the agency that calculates subsidy
payments and true-ups related to 2002. The decreases were partially offset by an
increase in USF surcharge revenue of $2.1 million resulting from a rate
increase.
32
Increases in the number of competitive communications companies (including
wireless companies) receiving federal subsidies may lead to further increases in
the NACPL, thereby resulting in further decreases in our subsidy revenue in the
future. The FCC and state regulators are currently considering a number of
proposals for changing the manner in which eligibility for federal subsidies is
determined as well as the amounts of such subsidies. The FCC is also reviewing
the mechanism by which subsidies are funded. We cannot predict when or how these
matters will be decided nor the effect on our subsidy revenues. Future
reductions in our subsidy and access revenues are not expected to be accompanied
by proportional decreases in our costs, so any further reductions in those
revenues will directly affect our profitability and cash flow.
Local Services
Local services revenue for the year ended December 31, 2005 decreased $21.4
million or 3% as compared with the prior year. This decline is comprised of
$18.8 million related to the continued loss of access lines and $4.0 million
related to a reserve associated with state rate of return limitations on
earnings. Enhanced services revenue increased $5.9 million, as compared with the
prior year, primarily due to sales of additional product packages. 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 and profitability and cash
flow.
Local services revenue for the year ended December 31, 2004 decreased $7.8
million or 1% as compared with the prior year. Local revenue decreased $17.9
million primarily due to $4.7 million related to continued losses of access
lines, $2.2 million as a result of refunds to customers because of state
earnings limitations, the termination of an operator services contract of $3.4
million, $3.5 million in decreased local measured service revenue and a decline
of $2.0 million in certain business services revenue. Enhanced services revenue
increased $10.1 million, primarily due to sales of additional product packages.
Long Distance Services
Long distance services revenue for the year ended December 31, 2005 decreased
$14.1 million or 8%, as compared with the prior year primarily due to a decline
in the average rates we bill for long distance services. Our long distance
minutes of use increased slightly during 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 2006.
Long distance services revenue for the year ended December 31, 2004 decreased
$15.8 million or 8%, as compared with the prior year primarily due to a decline
in the average rate per minute. Our long distance minutes of use increased
during 2004.
Data and Internet Services
Data and internet services revenue for the years ended December 31, 2005 and
2004 increased $36.8 million, or 27%, and $30.8 million, or 29%, respectively,
as compared with the prior year primarily due to growth in data and high-speed
internet services.
Directory Services
Directory revenue for the years ended December 31, 2005 and 2004 increased $2.5
million, or 2%, and $3.7 million, or 3%, respectively, as compared with the
prior year due to growth in yellow pages advertising.
Other
Other revenue for the year ended December 31, 2005 increased $7.2 million, or
8%, compared with the prior year primarily due to a $4.8 million decrease in bad
debt expense and sales of television service.
Other revenue for the year ended December 31, 2004 increased $4.4 million or 6%,
as compared with the prior year primarily due to a $4.1 million carrier dispute
settlement, a decline in bad debt expense of $3.2 million and an increase in
service activation revenue of $2.5 million, partially offset by decreases of
$3.6 million in sales of customer premise equipment (CPE) and $1.5 million in
call center services revenue.
ELI
ELI revenue for the year ended December 31, 2005 increased $3.1 million, or 2%,
primarily due to increased demand and growth in local and data services. For the
year ended December 31, 2004, ELI revenue decreased $9.4 million, or 6%,
primarily due to lower demand and prices for long-haul services and lower
reciprocal compensation revenues.
33
GAS AND ELECTRIC REVENUE
($ in thousands) 2005 2004 2003
---------------- ------------------------------- -------------------------------- ----------
Amount $ Change % Change Amount $ Change % Change Amount
---------- -------------------- ----------- ------------------- -----------
Gas revenue $ - $ - 0% $ - $ (137,686) -100% $ 137,686
Electric revenue $ - $ (9,735) -100% $ 9,735 $ (91,193) -90% $ 100,928
Gas revenue
We did not have any gas operations in the years ended December 31, 2005 and
2004.
Electric revenue
Electric revenue for the year ended December 31, 2005 decreased $9.7 million as
compared with the prior year due to the sale of our Vermont electric division on
April 1, 2004. Electric revenue for the year ended December 31, 2004 decreased
$91.2 million, or 90%, as compared with the prior year. We have sold all of our
electric operations and as a result will have no operating results in future
periods for these businesses.
COST OF SERVICES
($ in thousands) 2005 2004 2003
---------------- ------------------------------- -------------------------------- ----------
Amount $ Change % Change Amount $ Change % Change Amount
---------- -------------------- ----------- ------------------- ----------
Network access $ 195,491 $ 2,076 1% $ 193,415 $ (26,006) -12% $ 219,421
Gas purchased - - 0% - (82,311) -100% 82,311
Electric energy and fuel
oil purchased - (5,523) -100% 5,523 (58,308) -91% 63,831
---------- ---------- ----------- ---------- ----------
$ 195,491 $(3,447) -2% $ 198,938 $(166,625) -46% $ 365,563
========== ========== =========== ========== ==========
Network access
Network access expenses for the year ended December 31, 2005 increased $2.1
million, or 1%, as compared with the prior year primarily due to increased costs
in circuit expense due to more data traffic associated with increased high-speed
internet customers and greater long distance minutes of use in the Frontier
sector, and higher costs at ELI due to increased demand. 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.
Network access expenses for the year ended December 31, 2004 decreased $26.0
million, or 12%, as compared with the prior year primarily due to decreased
costs in long distance access expense related to rate changes partially offset
by increased circuit expense associated with additional high-speed internet
customers. ELI costs declined due to a drop in demand coupled with improved
network cost efficiencies.
Gas purchased
We did not have any gas operations in the years ended December 31, 2005 and
2004.
Electric energy and fuel oil purchased
Electric energy and fuel oil purchased for the year ended December 31, 2005
decreased $5.5 million as compared with the prior year due to the sale of our
Vermont electric division on April 1, 2004. Electric energy and fuel oil
purchased for the year ended December 31, 2004 decreased $58.3 million, or 91%,
as compared with the prior year. We have sold all of our electric operations and
as a result will have no operating results in future periods for these
businesses.
OTHER OPERATING EXPENSES
($ in thousands) 2005 2004 2003
---------------- ------------------------------ ------------------------------- ----------
Amount $ Change % Change Amount $ Change % Change Amount
---------- ------------------- ------------ ----------------- ----------
Operating expenses $ 607,581 $ (15,436) -2% $ 623,017 $ (61,952) -9% $ 684,969
Taxes other than income taxes 93,115 (771) -1% 93,886 (2,870) -3% 96,756
Sales and marketing 117,484 2,448 2% 115,036 2,653 2% 112,383
---------- ---------- ----------- ---------- ----------
$ 818,180 $ (13,759) -2% $ 831,939 $ (62,169) -7% $ 894,108
========== ========== =========== ========== ==========
34
Operating Expenses
Operating expenses for the year ended December 31, 2005 decreased $15.4 million,
or 2%, as compared with the prior year primarily due to lower billing expenses
as a result of the conversion of one of our billing systems in 2004 partially
offset by rate increases for federal USF mandated contributions and annual fees
to regulatory agencies. We routinely review our operations, personnel and
facilities to achieve greater efficiencies. These reviews may result in
reductions in personnel and an increase in severance costs. As a result of early
retirement being offered to certain of our employees during the first quarter of
2006 we expect to recognize $3.5 million to $4.0 million of severance costs in
the first quarter of 2006.
Operating expenses for the year ended December 31, 2004 decreased $62.0 million,
or 9%, as compared with the prior year primarily due to decreased operating
expenses in the public services sector due to the sales of our utilities and
increased operating efficiencies and a reduction of personnel in our
communications business.
Operating expenses in 2004 include $4.2 million of expenses attributable to our
efforts to comply with the internal control requirements of the Sarbanes-Oxley
Act of 2002.
Included in operating expenses is stock compensation expense. Stock compensation
expense was $8.4 million and $11.0 million for the years ended December 31, 2005
and 2004, respectively. In 2006, we expect to begin expensing the cost of the
unvested portion of outstanding stock options pursuant to SFAS No. 123R. We
expect to recognize approximately $2.8 million of stock option expense related
to the non-vested portion of previously granted stock options for the year ended
December 31, 2006.
Included in operating expenses is pension and other postretirement benefit
expenses. In future periods, if the value of our pension assets decline and/or
projected benefit costs increase, we may have increased pension expenses. Based
on current assumptions and plan asset values, we estimate that our pension and
other postretirement benefit 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. No contribution
was made to our pension plan during 2005.
Taxes Other than Income Taxes
Taxes other than income taxes for the year ended December 31, 2004 decreased
$2.9 million, or 3%, as compared with the prior year primarily due to decreased
property taxes in the public services sector of $11.6 million due to the sales
of our utilities and lower gross receipts taxes of $3.7 million in the Frontier
sector that were partially offset by higher payroll, property and franchise
taxes of $13.0 million.
Sales and Marketing
Sales and marketing expenses for the year ended December 31, 2005 increased $2.4
million, or 2%, as compared with the prior year 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.
Sales and marketing expenses for the year ended December 31, 2004 increased $2.7
million, or 2%, as compared with the prior year primarily due to increased costs
in the Frontier sector.
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) 2005 2004 2003
---------------- ------------------------------- ------------------------------- ----------
Amount $ Change % Change Amount $ Change % Change Amount
---------- -------------------- ----------- ------------------ ----------
Depreciation expense $ 415,581 $ (28,707) -6% $ 444,288 $ (22,035) -5% $ 466,323
Amortization expense 126,378 (142) 0% 126,520 (318) 0% 126,838
---------- ---------- ----------- ---------- ----------
$ 541,959 $ (28,849) -5% $ 570,808 $ (22,353) -4% $ 593,161
========== ========== =========== ========== ==========
Depreciation expense for the years ended December 31, 2005 and 2004 decreased
$28.7 million, or 6%, and $22.0 million, or 5%, respectively, as compared with
the prior years due to a declining asset base. Effective with the completion of
an independent study of the estimated useful lives of our plant assets we
adopted new lives beginning October 1, 2005. Based on the study and our planned
capital expenditures, we expect that our depreciation expense will decline in
2006 by approximately 12.5% compared to 2005. The decline is principally the
result of extending the remaining useful lives of our copper facilities from
approximately 16 years to a range of 26 to 30 years.
35
RESERVE FOR TELECOMMUNICATIONS BANKRUPTCIES / RESTRUCTURING AND OTHER EXPENSES /
MANAGEMENT SUCCESSION AND STRATEGIC ALTERNATIVES EXPENSES
($ in thousands) 2005 2004 2003
---------------- ------------------------------ ------------------------------- ----------
Amount $ Change % Change Amount $ Change % Change Amount
---------- ------------------- ------------ ------------------ -----------
Reserve for (recovery of)
telecommunications bankruptcies $ - $ - 0% $ - $ 4,377 -100% $ (4,377)
Restructuring and other expenses $ - $ - 0% $ - $ (9,687) -100% $ 9,687
Management succession and
strategic alternatives expenses $ - $ (90,632) -100% $ 90,632 $ - 0% $ 90,632
On July 11, 2004, our Board of Directors announced that it completed its review
of our financial and strategic alternatives. In 2004, we expensed $90.6 million
of costs related to management succession and our exploration of financial and
strategic alternatives. Included are $36.6 million of non-cash expenses for the
acceleration of stock benefits, cash expenses of $19.2 million for advisory
fees, $19.3 million for severance and retention arrangements and $15.5 million
primarily for tax reimbursements.
During the fourth quarter of 2003, an agreement with WorldCom/MCI was approved
by the bankruptcy court settling all pre-bankruptcy petition obligations and
receivables. This settlement resulted in reduction to our reserve of
approximately $6.6 million in the fourth quarter of 2003. During the second
quarter of 2003, we reserved approximately $2.3 million of trade receivables
with Touch America as a result of Touch America's filing for bankruptcy. These
receivables were generated as a result of providing ordinary course
telecommunication services. If other telecommunications companies file for
bankruptcy, we may have additional significant reserves in future periods.
Restructuring and other expenses for 2003 primarily consisted of severance
expenses related to reductions in personnel at our telecommunications operations
and the write-off of software no longer used.
LOSS ON IMPAIRMENT
($ in thousands) 2003
---------------- ----------
Amount
----------
Loss on impairment $ 15,300
During the third and fourth quarters of 2003, we recognized additional pre-tax
impairment losses of $4.0 million and $11.3 million related to our Vermont
property to write down assets to be sold to our best estimate of their net
realizable value upon sale.
INVESTMENT AND OTHER INCOME (LOSS), NET / INTEREST EXPENSE /
INCOME TAX EXPENSE (BENEFIT)
($ in thousands) 2005 2004 2003
---------------- ------------------------------- ------------------------------- ----------
Amount $ Change % Change Amount $ Change % Change Amount
---------- -------------------- ----------- ------------------ ----------
Investment income $ 18,236 $ (15,380) -46% $ 33,616 $ 23,198 -223% $ 10,418
Other income (loss),
net $ (1,674) $ 51,685 -97% $ (53,359) $ (97,418) -221% $ 44,059
Interest expense $ 338,903 $ (40,118) -11% $ 379,021 $ (37,499) -9% $ 416,520
Income tax expense $ 84,340 $ 73,918 709% $ 10,422 $ (54,354) 84% $ 64,776
Investment Income
Investment income for the year ended December 31, 2005 decreased $15.4 million,
or 46%, as compared with the prior year primarily due to the sale in 2004 of our
investments in D & E Communications, Inc. (D & E) and Hungarian Telephone and
Cable Corp. (HTCC), partially offset by higher income in 2005 from short-term
investments.
Investment income for the year ended December 31, 2004 increased $23.2 million
as compared with the prior year primarily due to the sale of our investments in
D & E and HTCC and higher income from short-term investments.
36
Other Income (Loss), net
Other income, net for the year ended December 31, 2005 increased $51.7 million,
or 97%, as compared to prior year. The increase is primarily due to a pre-tax
loss from the early extinguishment of debt of $66.5 million in 2004 and a net
loss on sales of assets of $1.9 million, which is primarily attributable to the
loss on the sale of our corporate aircraft, partially offset by $25.3 million in
income from the expiration of certain retained liabilities at less than face
value, which are associated with customer advances for construction from our
disposed water properties. In addition, during 2005 $7.0 million was reserved in
the fourth quarter in connection with a lawsuit, and during the second quarter
we incurred a $3.2 million loss on the exchange of debt, partially offset by
gains on our forward rate agreements
Other loss, net for the year ended December 31, 2004 increased $97.4 million as
compared to prior year primarily due to a pre-tax loss from the early
extinguishment of debt of $66.5 million in 2004, and the recognition in 2003 of
$69.5 million in non-cash pre-tax gains related to a capital lease termination
and a capital lease restructuring at ELI, partially offset in 2004 by $25.3
million in income from the expiration of certain retained liabilities at less
than face value, which are associated with customer advances for construction
from our disposed water properties and a net loss on sales of assets in 2004 of
$1.9 million, which is primarily attributable to the loss on the sale of our
corporate aircraft, compared to a net loss on sales of assets in 2003 of $20.5
million.
Interest Expense
Interest expense for the year ended December 31, 2005 decreased $40.1 million,
or 11%, as compared with the prior year primarily due to the retirement and
refinancing of debt. Our composite average borrowing rate for the year ended
December 31, 2005 as compared with the prior year was 2 basis points lower,
decreasing from 7.96% to 7.94%.
Interest expense for the year ended December 31, 2004 decreased $37.5 million,
or 9%, as compared with the prior year primarily due to the retirement of debt.
Our composite average borrowing rate for the year ended December 31, 2004 as
compared with the prior year was 11 basis points lower, decreasing from 8.07% to
7.96%.
Income Taxes
Income taxes for the year ended December 31, 2005 increased $73.9 million, as
compared with the prior year primarily due to changes in taxable income and the
effective tax rate. The effective tax rate for 2005 was 29.6% as compared with
13.5% for 2004. Our effective tax rate was below statutory rates in both years
as a result of the completion of audits with federal and state taxing
authorities and changes in the structure of certain of our subsidiaries.
Income taxes for the year ended December 31, 2004 decreased $54.4 million, or
84%, as compared with the prior year primarily due to changes in taxable income
(loss). The effective tax rate for 2004 was 13.5% as compared with an effective
tax rate of 34.3% for 2003.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
($ in thousands) 2003
---------------- ----------
Amount
----------
Cumulative effect of change in accounting principle $ 65,769
During the first quarter of 2003, as a result of our adoption of SFAS No. 143,
"Accounting for Asset Retirement Obligations," we recognized an after tax
non-cash gain of approximately $65.8 million.
DISCONTINUED OPERATIONS
($ in thousands) 2005 2004 2003
---------------- ---------- ---------- --------
Amount Amount Amount
---------- ---------- --------
Revenue $ 4,607 $ 24,558 $ 20,764
Operating income $ 1,489 $ 8,188 $ 6,820
Income taxes $ 449 $ 2,957 $ 2,440
Net income $ 1,040 $ 5,231 $ 4,380
On March 15, 2005, we completed the sale of CCUSA for $43.6 million in cash. The
pre-tax gain on the sale of CCUSA was $14.1 million. Our after-tax gain was $1.2
million. The book income taxes recorded upon sale are primarily attributable to
a low tax basis in the assets sold.
37
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities, including those associated with
our pension assets. Market risk refers to the potential change in fair value of
a financial instrument as a result of fluctuations in interest rates and equity
and commodity prices. We do not hold or issue derivative instruments, derivative
commodity instruments or other financial instruments for trading purposes. As a
result, we do not undertake any specific actions to cover our exposure to market
risks and we are not party to any market risk management agreements other than
in the normal course of business or to hedge long-term interest rate risk.
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest-bearing portion of our investment portfolio and interest on our
long-term debt and capital lease obligations. The long-term debt and capital
lease obligations include various instruments with various maturities and
weighted average interest rates.
Our objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, a majority of our borrowings have
fixed interest rates. Consequently, we have limited material future earnings or
cash flow exposures from changes in interest rates on our long-term debt and
capital lease obligations. A hypothetical 10% adverse change in interest rates
would increase the amount that we pay on our variable obligations and could
result in fluctuations in the fair value of our fixed rate obligations. Based
upon our overall interest rate exposure at December 31, 2005, a near-term change
in interest rates would not materially affect our consolidated financial
position, results of operations or cash flows.
In order to manage our interest expense, we have entered into interest rate swap
agreements. Under the terms of the agreements, which qualify for hedge
accounting, we make semi-annual, floating rate interest payments based on six
month LIBOR and receive a fixed rate on the notional amount. The underlying
variable rate for these interest rate swaps is set in arrears. For the years
ended December 31, 2005 and 2004, the cash interest savings resulting from these
interest rate swaps totaled approximately $2.5 million and $9.4 million,
respectively.
During September 2005, we entered into a series of forward rate agreements 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. At
December 31, 2005, the rates obtained under these forward rate agreements were
below market rates. A gain for the changes in the fair value of these forward
rate agreements of $1.9 million is included in other income (loss) net for the
year ended December 31, 2005.
Sensitivity analysis of interest rate exposure
At December 31, 2005, the fair value of our long-term debt and capital lease
obligations was estimated to be approximately $4.0 billion, based on our overall
weighted average borrowing rate of 8.05% and our overall weighted maturity of 12
years. There has been no material change in the weighted average maturity since
December 31, 2004.
The overall weighted average interest rate increased in 2005 by approximately 22
basis points. A hypothetical increase of 81 basis points in our weighted average
interest rate (10% of our overall weighted average borrowing rate) would result
in an approximate $210.3 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 December 31,
2005 is limited to our investment in Adelphia, and our pension assets of $762.2
million.
As of December 31, 2005 and December 31, 2004, we owned 3,059,000 shares of
Adelphia common stock. The stock price of Adelphia was $0.04 and $0.39 at
December 31, 2005 and December 31, 2004, respectively.
Sensitivity analysis of equity price exposure
At December 31, 2005, the fair value of the equity portion of our investment
portfolio was estimated to be $0.1 million. A hypothetical 10% decrease in
quoted market prices would result in an approximate $12,000 decrease in the fair
value of the equity portion of our investment portfolio.
38
Disclosure of limitations of sensitivity analysis
Certain shortcomings are inherent in the method of analysis presented in the
computation of fair value of financial instruments. Actual values may differ
from those presented should market conditions vary from assumptions used in the
calculation of the fair value. This analysis incorporates only those exposures
that exist as of December 31, 2005. It does not consider those exposures or
positions which could arise after that date. As a result, our ultimate exposure
with respect to our market risks will depend on the exposures that arise during
the period and the fluctuation of interest rates and quoted market prices.
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
The following documents are filed as part of this Report:
1. Financial Statements, See Index on page F-1.
2. Supplementary Data, Quarterly Financial Data is included in the
Financial Statements (see 1. above).
Item 9. Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
---------------------
None.
Item 9A. Controls and Procedures
-----------------------
(i) Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the
participation of our management, including our principal executive officer
and principal financial officer, regarding the effectiveness of the design
and operation of our disclosure controls and procedures. Based upon this
evaluation, our principal executive officer and principal financial officer
concluded, as of the end of the period covered by this report, December 31,
2005, that our disclosure controls and procedures are effective.
(ii) Internal Control Over Financial Reporting
(a) Management's annual report on internal control over financial reporting
Our management report on internal control over financial reporting appears
on page F-2 and is incorporated by reference.
(b) Attestation report of registered public accounting firm The attestation
report of KPMG LLP, our independent registered public accounting firm, on
management's assessment of the effectiveness of our internal control over
financial reporting appears on page F-3 and is incorporated by reference.
(c) Changes in internal control over financial reporting We reviewed our
internal control over financial reporting at December 31, 2005. There has
been no change in our internal control over financial reporting during the
last fiscal quarter of 2005 that materially affected or is reasonably
likely to materially affect our internal control over financial reporting.
Item 9B. Other Information
-----------------
None.
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
--------------------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2006 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2005. See "Executive Officers of the Registrant" in Part I of this Report
following Item 4 for information relating to executive officers.
Item 11. Executive Compensation
----------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2006 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2005.
39
Item 12. Security Ownership of Certain Beneficial Owners and Management and
------------------------------------------------------------------
Related Stockholder Matters
---------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2006 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2005.
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2006 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2005.
Item 14. Principal Accountant Fees and Services
--------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2006 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2005.
PART IV
-------
Item 15. Exhibits and Financial Statement Schedules
------------------------------------------
List of Documents Filed as a Part of This Report:
(1) Index to Consolidated Financial Statements:
Independent Auditors' Report
Consolidated balance sheets as of December 31, 2005 and 2004
Consolidated statements of operations for the years ended
December 31, 2005, 2004 and 2003
Consolidated statements of shareholders' equity for the years ended
December 31, 2005, 2004 and 2003
Consolidated statements of comprehensive income (loss) for the years ended
December 31, 2005, 2004 and 2003
Consolidated statements of cash flows for the years ended
December 31, 2005, 2004 and 2003
Notes to consolidated financial statements
(2) Index to Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts
All other schedules have been omitted because the required information is
included in the consolidated financial statements or the notes thereto, or is
not applicable or required.
(3) Index to Exhibits:
Exhibit
No. Description
------- -----------
3.1 Restated Certificate of Incorporation of Citizens Communications
Company, (incorporated by reference to Exhibit 3.200.1 to the
Registrant's Quarterly Report on Form 10-Q for the six months ended
June 30, 2000, File No. 001-11001).
40
3.2 By-laws of Citizens Communications Company, as amended (incorporated
by reference to Exhibit 3.200.5 to the Registrant's Quarterly Report
on Form 10-Q for the nine months ended September 30, 2004, File No.
001-11001).
4.1 Certificate of Trust of Citizens Communications Trust dated as of
April 27, 2001 (incorporated by reference to Exhibit 4.5 of the
Registrant's Amendment No.1 to Form S-3 filed May 7, 2001
(Registration No. 333-58044)).
4.2 Trust Agreement of Citizens Capital Trust I, dated as of April 27,
2001 (incorporated by reference to Exhibit 4.6 of the Registrant's
Amendment No.1 to Form S-3 filed May 7, 2001 (Registration No.
333-58044)).
4.3 Form of Senior Note due 2011 (incorporated by reference to Exhibit 4.4
of the Registrant's Current Report on Form 8-K filed on May 24, 2001,
File No. 001-11001).
4.5 Form of Senior Note due 2008 and due 2031 (incorporated by reference
to Exhibit 4.1 of the Registrant's Current Report on Form 8-K filed on
August 22, 2001, File No. 001-11001).
4.6 Form of Senior Note due 2013 (incorporated by reference to Exhibit 4.2
of the Registrant's Current Report on Form 8-K filed on November 12,
2004, File No. 001-11001).
4.7 5% Convertible Subordinated Debenture due 2036 (incorporated by
reference to Exhibit A to Exhibit 4.200.2 to the Registrant's Form 8-K
Current Report filed May 28, 1996, File No. 001-11001).
4.8 Amended and Restated Declaration of Trust dated as of January 15,
1996, of Citizens Utilities Trust (incorporated by reference to
Exhibit 4.200.4 to the Registrant's Form 8-K Current Report filed May
28, 1996, File No. 001-11001).
4.9 Convertible Preferred Security Certificate (incorporated by reference
to Exhibit A-1 to Exhibit 4.200.4 to the Registrant's Form 8-K Current
Report filed May 28, 1996, File No. 001-11001).
4.10 Amended and Restated Limited Partnership Agreement dated as of January
15, 1996 of Citizens Utilities Capital L.P. (incorporated by reference
to Exhibit 4.200.6 to the Registrant's Form 8-K Current Report filed
May 28, 1996, File No. 001-11001).
4.11 Partnership Preferred Security Certificate (incorporated by reference
to Annex A to Exhibit 4.200.6 to the Registrant's Form 8-K Current
Report filed May 28, 1996, File No. 001-11001).
4.12 Convertible Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Communications Company (f/k/a
Citizens Utilities Company) and JPMorgan Chase Bank, N.A. (as
successor to Chemical Bank), as guarantee trustee (incorporated by
reference to Exhibit 4.200.8 to the Registrant's Form 8-K Current
Report filed May 28, 1996, File No. 001-11001).
4.13 Partnership Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Communications Company (f/k/a
Citizens Utilities Company) and JPMorgan Chase Bank, N.A. (as
successor to Chemical Bank), as guarantee trustee (incorporated by
reference to Exhibit 4.200.9 to the Registrant's Form 8-K Current
Report filed May 28, 1996, File No. 001-11001).
4.14 Letter of Representations dated January 18, 1996, from Citizens
Communications Company (f/k/a Citizens Utilities Company) and JPMorgan
Chase Bank, N.A. (as successor to Chemical Bank), as trustee, to DTC,
for deposit of Convertible Preferred Securities with DTC (incorporated
by reference to Exhibit 4.200.10 to the Registrant's Form 8-K Current
Report filed May 28, 1996, File No. 001-11001).
4.15 Indenture of Securities, dated as of August 15, 1991, and JPMorgan
Chase Bank, N.A. (as successor to Chemical Bank), as Trustee
(incorporated by reference to Exhibit 4.100.1 to the Registrant's
Quarterly Report on Form 10-Q for the nine months ended September 30,
1991, File No. 001-11001).
4.16 Indenture, dated as of January 15, 1996, between Citizens
Communications Company (f/k/a Citizens Utilities Company) and JPMorgan
Chase Bank, N.A. (as successor to Chemical Bank), as indenture trustee
(incorporated by reference to Exhibit 4.200.1 to the Registrant's Form
8-K Current Report filed May 28, 1996, File No. 001-11001).
4.16 First Supplemental Indenture, dated as of January 15, 1996, between
Citizens Communications Company (f/k/a Citizens Utilities Company) and
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), as
indenture trustee (incorporated by reference to Exhibit 4.200.2 to the
Registrant's Form 8-K Current Report filed May 28, 1996, File No.
001-11001).
4.17 Third Supplemental Indenture, dated April 15, 1994, to JPMorgan Chase
Bank, N.A. (as successor to Chemical Bank), as Trustee (incorporated
by reference to Exhibit 4.100.6 to the Registrant's Form 8-K Current
Report filed July 5, 1994, File No. 001-11001).
4.18 Fourth Supplemental Indenture, dated October 1, 1994, to JPMorgan
Chase Bank, N.A. (as successor to Chemical Bank), as Trustee
(incorporated by reference to Exhibit 4.100.7 to Registrant's Form 8-K
Current Report filed January 3, 1995, File No. 001-11001).
41
4.19 Fifth Supplemental Indenture, dated as of June 15, 1995, to JPMorgan
Chase Bank, N.A. (as successor to Chemical Bank), as Trustee
(incorporated by reference to Exhibit 4.100.8 to Registrant's Form 8-K
Current Report filed March 29, 1996, File No. 001-11001).
4.20 Sixth Supplemental Indenture, dated as of October 15, 1995, to
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), as Trustee
(incorporated by reference to Exhibit 4.100.9 to Registrant's Form 8-K
Current Report filed March 29, 1996, File No. 001-11001).
4.21 Seventh Supplemental Indenture, dated as of June 1, 1996 to JPMorgan
Chase Bank, N.A. (as successor to Chemical Bank), (incorporated by
reference to Exhibit 4.100.11 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1996, File No. 001-11001).
4.22 Eighth Supplemental Indenture, dated as of December 1, 1996 to
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank),
(incorporated by reference to Exhibit 4.100.12 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1996, File
No. 001-11001).
4.23 Senior Indenture, dated as of May 23, 2001, between Citizens
Communications Company and JPMorgan Chase Bank, N.A. (as successor to
The Chase Manhattan Bank), as trustee (incorporated by reference to
Exhibit 4.1 of the Registrant's Current Report on Form 8-K filed on
May 24, 2001, File No. 001-11001).
4.24 First Supplemental Indenture, dated as of May 23, 2001, to Senior
Indenture, (incorporated by reference to Exhibit 4.2 of the
Registrant's Current Report on Form 8-K filed on May 24, 2001, File
No. 001-11001).
4.25 Second Supplemental Indenture, dated as of June 19, 2001, to Senior
Indenture, dated as of May 23, 2001 (incorporated by reference to
Exhibit 4.3 of the Registrant's Current Report on Form 8-K filed on
June 21, 2001, File No. 001-11001).
4.26 Third Supplemental Indenture, dated as of November 12, 2004, to Senior
Indenture, dated as of May 23, 2001 (incorporated by reference to
Exhibit 4.1 of the Registrant's Current Report on Form 8-K filed on
November 12, 2004, File No. 001-11001).
4.27 Indenture, dated as of August 16, 2001, between Citizens
Communications Company and JPMorgan Chase Bank, N.A. (as successor to
The Chase Manhattan Bank), as Trustee (incorporated by reference to
Exhibit 4.1 of the Registrant's Current Report on Form 8-K filed on
August 22, 2001, File No. 001-11001).
4.28 Underwriting Agreement dated November 8, 2004, between Citizens
Communications Company and J.P. Morgan Securities Inc., as
Representative of the several listed Underwriters, relating to the
sale of $700,000,000 principal amount of the 6 1/4% Senior Notes due
2013 (incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on November 12, 2004, File No.
001-11001).
10.1 Competitive Advance and Revolving Credit Facility Agreement for
$250,000,000 dated October 29, 2004 (incorporated by reference to
Exhibit 10.19 to the Registrant's Quarterly Report on Form 10-Q for
the nine months ended September 30, 2004, File No. 001-11001).
10.2 Amended and Restated Non-Employee Directors' Deferred Fee Equity Plan
dated as of May 18, 2004, (incorporated by reference to Exhibit 10.1.2
to the Registrant's Quarterly Report on Form 10-Q for the three months
ended June 30, 2004, File No. 001-11001).
10.3 Amendment No. 1 to the Citizens Communications Company (f/k/a Citizens
Utilities Company) Non-Employee Directors' Deferred Fee Equity Plan
(incorporated by reference to Exhibit 10.2 to the Registrant's Current
Report on Form 8-K, filed on December 20, 2005, File No. 001-11001).
10.4 Separation Agreement between Citizens Communications Company and
Leonard Tow effective July 10, 2004 (incorporated by reference to
Exhibit 10.2.4 of the Registrants' Quarterly Report on Form 10-Q for
the six months ended June 30, 2004, File No. 001-11001).
10.5 Incentive Award Agreement between Citizens Communications Company and
Scott N. Schneider, effective March 11, 2004 (incorporated by
reference to Exhibit 10.3 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 2003, File No. 001-11001).
10.6 Citizens Executive Deferred Savings Plan dated January 1, 1996
(incorporated by reference to Exhibit 10.19 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1999, File No.
001-11001).
10.7 Citizens Incentive Plan restated as of March 21, 2000 (incorporated by
reference to Exhibit 10.19 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1999, File No. 001-11001).
10.8 1996 Equity Incentive Plan (incorporated by reference to Appendix A to
the Registrant's definitive proxy statement on Schedule 14A filed on
March 29, 1996, File No. 001-11001).
10.8.1 2000 Equity Incentive Plan, as amended (incorporated by reference to
Appendix A to the Registrant's definitive proxy statement on Schedule
14A filed on April 20, 2005, File No. 001-11001).
10.9 Amendment to 1996 Equity Incentive Plan (incorporated by reference to
Exhibit B to the Registrant's definitive proxy statement on Schedule
14A filed on March 31, 1997, File No. 001-11001).
42
10.10 Amendment to 1996 Equity Incentive Plan (effective March 4, 2005)
(incorporated by reference to Exhibit 10.1 to the Registrant's
Quarterly Report on Form 10-Q for the three months ended March 31,
2005, File No. 001-11001).
10.11 Citizens 401(K) Savings Plan effective as of January 1, 1997, as
amended (incorporated by reference to Exhibit 10.37 to the
Registrant's Quarterly Report on Form 10-Q for the six months ended
June 30, 2001, File No. 001-11001).
10.12 Loan Agreement between Citizens Communications Company and Rural
Telephone Finance Cooperative for $200,000,000 dated October 24, 2001
(incorporated by reference to Exhibit 10.39 to the Registrant's
Quarterly Report on Form 10-Q for the nine months ended September 30,
2001, File No. 001-11001).
10.13 Amendment No. 1, dated as of March 31, 2003, to Loan Agreement
between Citizens Communications Company and Rural Telephone Finance
Cooperative (incorporated by reference to Exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the three months ended
March 31, 2003, File No. 001-11001).
10.14 Employment Agreement between Citizens Communications Company and Mary
Agnes Wilderotter, effective November 1, 2004 (incorporated by
reference to Exhibit 10.16 to the Registrant's Quarterly Report on
Form 10-Q for the nine months ended September 30, 2004, File No.
001-11001).
10.15 Employment Agreement between Citizens Communications Company and
Jerry Elliott, effective September 1, 2004 (incorporated by reference
to Exhibit 10.17 to the Registrant's Quarterly Report on Form 10-Q for
the nine months ended September 30, 2004, File No. 001-11001).
10.16 Employment Agreement between Citizens Communications Company and
Robert Larson, effective September 1, 2004 (incorporated by reference
to Exhibit 10.18 to the Registrant's Quarterly Report on Form 10-Q for
the nine months ended September 30, 2004, File No. 001-11001).
10.17 Employment Agreement between Citizens Communications Company and John
H. Casey, III, effective February 15, 2005 (incorporated by reference
to Exhibit 10.20 to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 2004, File No. 001-11001).
10.18 Offer of Employment Letter between Citizens Communications Company
and Peter B. Hayes, effective February 1, 2005 (incorporated by
reference to Exhibit 10.23 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 2004, File No. 001-11001).
10.19 Separation Agreement between Citizens Communications Company and L.
Russell Mitten dated July 13, 2005 (incorporated by reference to
Exhibit 10.24 to the Registrant's Quarterly Report on Form 10-Q for
the nine months ended September 30, 2005, File No. 001-11001).
10.20 Amendment to the Separation Agreement between Citizens Communications
Company and L. Russell Mitten dated August 31, 2005 (incorporated by
reference to Exhibit 10.24.1 to the Registrant's Quarterly Report on
Form 10-Q for the nine months ended September 30, 2005, File No.
001-11001).
10.21 Summary of Compensation Arrangements for Named Executive Officers
Outside of Employment Agreements (incorporated by reference to Exhibit
10.1 to the Registrant's Current Report on Form 8-K filed February 28,
2006, File No. 001-11001).
10.22 Summary of Non-Employee Directors' Compensation Arrangements Outside
of Formal Plans, as amended, effective December 15, 2005 (incorporated
by reference to Exhibit 10.1 to the Registrant's Current Report on
Form 8-K filed on December 20, 2005, File No. 001-11001).
10.23 Membership Interest Purchase Agreement between Citizens
Communications Company and Integra Telecom Holdings, Inc. dated
February 6, 2006 (incorporated by reference to Exhibit 10.1 to the
Registrant's Current Report on Form 8-K filed on February 9, 2006,
File No. 001-11001).
10.24 Stock Redemption Agreement between Citizens Utilities Rural Company,
Inc. and The Rural Telephone Bank effective November 10, 2005
(including schedule of substantially identical agreements with other
Subsidiaries of the Registrant).
12.1 Computation of ratio of earnings to fixed charges (this item is
included herein for the sole purpose of incorporation by reference).
21.1 Subsidiaries of the Registrant
23.1 Auditors' Consent
31.1 Certification of Principal Executive Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934.
31.2 Certification of Principal Financial Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
43
Exhibits 10.2, 10.3, 10.4, 10.5, 10.6, 10.7, 10.8, 10.8.1, 10.9, 10.10, 10.11,
10.14, 10.15, 10.16, 10.17, 10.18, 10.20, 10.21 and 10.22 are management
contracts or compensatory plans or arrangements.
44
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Mary Agnes Wilderotter
----------------------------------
Mary Agnes Wilderotter
Chairman of the Board and Chief Executive Officer
March 1, 2006
45
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 1st day of March 2006.
Signature Title
--------- -----
/s/ Leroy T. Barnes, Jr. Director
---------------------------------------
(Leroy T. Barnes, Jr.)
/s/ Jerry Elliott President; Acting Chief
--------------------------------------- Finiancial Officer and Director
(Jerry Elliott)
/s/ Jeri B. Finard Director
---------------------------------------
(Jeri B. Finard)
/s/ Lawton Fitt Director
---------------------------------------
(Lawton Fitt)
/s/ Stanley Harfenist Director
---------------------------------------
(Stanley Harfenist)
/s/ William Kraus Director
---------------------------------------
(William Kraus)
/s/ Robert J. Larson Senior Vice President and Chief
--------------------------------------- Accounting Officer
(Robert J. Larson)
/s/ Howard L. Schrott Director
---------------------------------------
(Howard L. Schrott)
/s/ Larraine D. Segil Director
---------------------------------------
(Larraine D. Segil)
/s/ Bradley E. Singer Director
---------------------------------------
(Bradley E. Singer)
/s/ Edwin Tornberg Director
---------------------------------------
(Edwin Tornberg)
/s/ David H. Ward Director
---------------------------------------
(David H. Ward)
/s/ Myron A. Wick, III Director
---------------------------------------
(Myron A. Wick, III)
/s/ Mary Agnes Wilderotter Chairman and Chief Executive
--------------------------------------- Officer
(Mary Agnes Wilderotter)
46
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index to Consolidated Financial Statements
Item Page
---- ----
Management's Report on Internal Control Over Financial Reporting F-2
Report of Independent Registered Public Accounting Firm F-3
Report of Independent Registered Public Accounting Firm F-4
Consolidated balance sheets as of December 31, 2005 and 2004 F-5
Consolidated statements of operations for the years ended
December 31, 2005, 2004 and 2003 F-6
Consolidated statements of shareholders' equity for the years ended
December 31, 2005, 2004 and 2003 F-7
Consolidated statements of comprehensive income (loss) for the years ended
December 31, 2005, 2004 and 2003 F-7
Consolidated statements of cash flows for the years ended
December 31, 2005, 2004 and 2003 F-8
Notes to consolidated financial statements F-9
F-1
Management's Report on Internal Control Over Financial Reporting
----------------------------------------------------------------
The Board of Directors and Shareholders
Citizens Communications Company:
The management of Citizens Communications Company and subsidiaries is
responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and
15d-15(f).
Under the supervision and with the participation of our management, we conducted
an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal Control--Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on our evaluation our management concluded that our internal control over
financial reporting was effective as of December 31, 2005 and for the period
then ended.
Our management's assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2005 has been audited by KPMG LLP, an
independent registered public accounting firm, as stated in their report which
is included herein.
Stamford, Connecticut
March 1, 2006
F-2
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Citizens
Communications Company and subsidiaries maintained effective internal control
over financial reporting as of December 31, 2005, based on criteria established
in Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Citizens Communications
Company's management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Citizens Communications Company and
subsidiaries maintained effective internal control over financial reporting as
of December 31, 2005, is fairly stated, in all material respects, based on
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also,
in our opinion, Citizens Communications Company and subsidiaries maintained, in
all material respects, effective internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Citizens Communications Company and subsidiaries as of December 31, 2005 and
2004, and the related consolidated statements of operations, shareholders'
equity and comprehensive income (loss), and cash flows for each of the years in
the three-year period ended December 31, 2005, and our report dated March 1,
2006 expressed an unqualified opinion on those consolidated financial
statements.
/s/ KPMG LLP
Stamford, Connecticut
March 1, 2006
F-3
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited the accompanying consolidated balance sheets of Citizens
Communications Company and subsidiaries as of December 31, 2005 and 2004, and
the related consolidated statements of operations, shareholders' equity,
comprehensive income (loss) and cash flows for each of the years in the
three-year period ended December 31, 2005. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Citizens
Communications Company and subsidiaries as of December 31, 2005 and 2004 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2005, in conformity with U.S. generally
accepted accounting principles. As discussed in Note 2 to the consolidated
financial statements, the Company adopted Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations" as of January
1, 2003.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Citizens
Communications Company and subsidiaries internal control over financial
reporting as of December 31, 2005, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report dated March 1,
2006 expressed an unqualified opinion on management's assessment of, and the
effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Stamford, Connecticut
March 1, 2006
F-4
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
($ in thousands)
2005 2004
-------------- --------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 265,775 $ 163,759
Accounts receivable, less allowances of $32,408 and $35,996, respectively 229,107 233,690
Prepaid expenses 27,449 30,551
Other current assets 19,764 18,758
Assets of discontinued operations - 24,122
-------------- --------------
Total current assets 542,095 470,880
Property, plant and equipment, net 3,186,465 3,335,850
0 0
Goodwill, net 1,921,465 1,921,465
Other intangibles, net 558,733 685,111
Investments 19,136 23,062
Other assets 184,215 232,051
-------------- --------------
Total assets $ 6,412,109 $ 6,668,419
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Long-term debt due within one year $ 227,734 $ 6,380
Accounts payable 152,081 169,754
Advanced billings 29,245 29,446
Income taxes accrued 5,776 27,446
Other taxes accrued 28,970 30,179
Interest accrued 101,030 82,534
Other current liabilities 71,806 71,046
Liabilities of discontinued operations - 735
-------------- --------------
Total current liabilities 616,642 417,520
Deferred income taxes 325,084 232,766
Other liabilities 429,198 388,895
Long-term debt 3,999,376 4,266,998
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares; 328,168,000 and 339,633,000
outstanding and 343,956,000 and 339,635,000 issued at December 31, 2005 and 2004,
respectively) 85,989 84,909
Additional paid-in capital 1,374,610 1,664,627
Accumulated deficit (85,344) (287,719)
Accumulated other comprehensive loss, net of tax (123,242) (99,569)
Treasury stock (210,204) (8)
-------------- --------------
Total shareholders' equity 1,041,809 1,362,240
-------------- --------------
Total liabilities and shareholders' equity $ 6,412,109 $ 6,668,419
============== ==============
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-5
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 and 2003
($ in thousands, except for per-share amounts)
2005 2004 2003
--------------- -------------- --------------
Revenue $ 2,162,479 $ 2,168,422 $ 2,424,174
Operating expenses:
Cost of services (exclusive of depreciation and amortization) 195,491 198,938 365,563
Other operating expenses 818,180 831,939 894,108
Depreciation and amortization 541,959 570,808 593,161
Recovery of telecommunications bankruptcies - - (4,377)
Restructuring and other expenses - - 9,687
Loss on impairment - - 15,300
Management succession and strategic alternatives expenses
(see Note 13) - 90,632 -
--------------- -------------- --------------
Total operating expenses 1,555,630 1,692,317 1,873,442
--------------- -------------- --------------
Operating income 606,849 476,105 550,732
Investment income 18,236 33,616 10,418
Other income (loss), net (1,674) (53,359) 44,059
Interest expense 338,903 379,021 416,520
--------------- -------------- --------------
Income from continuing operations before income taxes, dividends
on convertible preferred securities and cumulative effect
of change in accounting principle 284,508 77,341 188,689
Income tax expense 84,340 10,422 64,776
--------------- -------------- --------------
Income from continuing operations before dividends on convertible
preferred securities and cumulative effect of change in
accounting principle 200,168 66,919 123,913
Dividends on convertible preferred securities, net of income tax
benefit of $(3,853)* - 6,210
--------------- -------------- --------------
Income from continuing operations before cumulative effect of change
in accounting principle 200,168 66,919 117,703
Discontinued operations (see Note 8):
Income from operations of discontinued conferencing business
(including gain on disposal of $14,061 in 2005) 15,550 8,188 6,820
Income tax expense 13,343 2,957 2,440
--------------- -------------- --------------
Income from discontinued operations 2,207 5,231 4,380
--------------- -------------- --------------
Income before cumulative effect of change in accounting principle 202,375 72,150 122,083
Cumulative effect of change in accounting principle, net of tax of
$0, $0 and $41,591, respectively - - 65,769
--------------- -------------- --------------
Net income available for common shareholders $ 202,375 $ 72,150 $ 187,852
=============== ============== ==============
Basic income per common share:
Income from continuing operations before cumulative effect of
change in accounting principle $ 0.59 $ 0.22 $ 0.42
Income from discontinued operations 0.01 0.02 0.02
Income from cumulative effect of change in accounting principle - - 0.23
--------------- -------------- --------------
Net income per common share available for common shareholders $ 0.60 $ 0.24 $ 0.67
=============== ============== ==============
Diluted income per common share:
Income from continuing operations before cumulative effect of
change in accounting principle $ 0.59 $ 0.22 $ 0.41
Income from discontinued operations 0.01 0.01 0.01
Income from cumulative effect of change in accounting principle - - 0.22
--------------- -------------- --------------
Net income per common share available for common shareholders $ 0.60 $ 0.23 $ 0.64
=============== ============== ==============
* The consolidation of this item changed effective January 1, 2004 as a
result of the application of a newly mandated accounting standard "FIN
46R." See Note 15 for a complete discussion.
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-6
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 and 2003
($ in thousands, except for per-share amounts)
Accumulated
Common Stock Additional Retained Other Treasury Stock Total
------------------- Paid-In Earnings Comprehensive ----------------- Shareholders'
Shares Amount Capital (Deficit) Income (Loss) Shares Amount Equity
--------- --------- ------------ -------------- ------------- -------- ---------- ------------
Balance December 31, 2002 294,080 $ 73,520 $1,943,406 $ (553,033) $(102,169) (11,598) $ (189,585) $ 1,172,139
Stock plans 1,354 338 9,911 - - 873 14,450 24,699
Net income - - - 187,852 - - - 187,852
Other comprehensive income, net of tax
and reclassifications adjustments - - - - 30,493 - - 30,493
--------- --------- ------------ -------------- ------------ --------- ---------- ------------
Balance December 31, 2003 295,434 73,858 1,953,317 (365,181) (71,676) (10,725) (175,135) 1,415,183
Stock plans 4,821 1,206 14,236 - - 6,407 106,823 122,265
Conversion of EPPICS 10,897 2,724 133,621 - - 725 11,646 147,991
Conversion of Equity Units 28,483 7,121 396,221 - - 3,591 56,658 460,000
Dividends on common stock of
$2.50 per share - - (832,768) - - - - (832,768)
Net income - - - 72,150 - - - 72,150
Tax benefit on equity forward contracts - - - 5,312 - - - 5,312
Other comprehensive loss, net of tax
and reclassifications adjustments - - - - (27,893) - - (27,893)
--------- --------- ------------ -------------- ----------- --------- ---------- ------------
Balance December 31, 2004 339,635 84,909 1,664,627 (287,719) (99,569) (2) (8) 1,362,240
Stock plans 2,096 524 24,039 - - 2,598 34,689 59,252
Conversion of EPPICS 2,225 556 24,308 - - 391 5,115 29,979
Dividends on common stock of
$1.00 per share - - (338,364) - - - - (338,364)
Shares repurchased - - - - - (18,775) (250,000) (250,000)
Net income - - - 202,375 - - - 202,375
Other comprehensive loss, net of tax
and reclassifications adjustments - - - - (23,673) - - (23,673)
--------- --------- ------------ -------------- ------------ --------- ---------- ------------
Balance December 31, 2005 343,956 $ 85,989 $1,374,610 $ (85,344) $(123,242) (15,788) $ (210,204) $ 1,041,809
========= ========= ============ ============== ============ ========= ========== ============
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 and 2003
($ in thousands, except for per-share amounts)
2005 2004 2003
-------------- ------------- -------------
Net income $ 202,375 $ 72,150 $ 187,852
Other comprehensive income (loss), net of tax
and reclassifications adjustments* (23,673) (27,893) 30,493
-------------- ------------- -------------
Total comprehensive income $ 178,702 $ 44,257 $ 218,345
============== ============= =============
* Consists of unrealized holding (losses)/gains of marketable securities,
realized gains taken to income as a result of the sale of securities and
minimum pension liability (see Note 21).
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-7
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 and 2003
($ in thousands)
2005 2004 2003
--------------- ---------------- ----------------
Cash flows provided by (used in) operating activities:
Net income $ 202,375 $ 72,150 $ 187,852
Deduct: Gain on sale of discontinued operations (1,167) - -
Income from discontinued operations (1,040) (5,231) (4,380)
Cumulative effect of change in accounting principle for
the adoption of SFAS No. 143 - - (65,769)
Adjustments to reconcile income to net cash provided by
operating activities:
Depreciation and amortization expense 541,959 570,808 593,161
Gain on expiration/settlement of customer advance (681) (25,345) (6,165)
Gain on capital lease termination/restructuring - - (69,512)
Stock based compensation expense 8,427 47,581 8,956
Loss on debt exchange 3,175 - -
Loss on extinguishment of debt - 66,480 10,851
Investment gains (492) (12,066) -
Gain on sales of assets - 1,945 20,492
Loss on impairment - - 15,300
Other non-cash adjustments 20,481 30,397 20,091
Deferred taxes 100,636 24,016 74,508
Change in accounts receivable 4,583 11,895 69,619
Change in accounts payable and other liabilities (33,399) (67,499) (113,532)
Change in other current assets (640) (3,694) 748
--------------- ---------------- ----------------
Net cash provided by operating activities 844,217 711,437 742,220
Cash flows provided from (used by) investing activities:
Proceeds from sales of assets, net of selling expenses 24,195 30,959 388,079
Proceeds from sale of discontinued operations 43,565 - -
Capital expenditures (268,459) (275,204) (277,371)
Securities purchased - - (1,680)
Securities sold 1,112 26,514 -
Other asset (purchased) distributions received 5,724 (28,110) 68
--------------- ---------------- ----------------
Net cash provided from (used by) investing activities (193,863) (245,841) 109,096
Cash flows provided from (used by) financing activities:
Repayment of customer advances for construction
and contributions in aid of construction (1,662) (2,089) (10,030)
Long-term debt borrowings - 700,000 -
Debt issuance costs - (15,502) -
Long-term debt payments (6,433) (1,214,018) (653,442)
Premium to retire debt - (66,480) (10,851)
Issuance of common stock 47,550 544,562 13,209
Shares repurchased (250,000) - -
Dividends paid (338,364) (832,768) -
--------------- ---------------- ----------------
Net cash used by financing activities (548,909) (886,295) (661,114)
Cash flows of discontinued operations
Operating cash flows 578 1,361 956
Investing cash flows (7) (571) (644)
Financing cash flows - (3) (20)
--------------- ---------------- ----------------
571 787 292
Increase (decrease) in cash and cash equivalents 102,016 (419,912) 190,494
Cash and cash equivalents at January 1, 163,759 583,671 393,177
--------------- ---------------- ----------------
Cash and cash equivalents at December 31, $ 265,775 $ 163,759 $ 583,671
=============== ================ ================
Cash paid during the period for:
Interest $ 318,638 $ 370,128 $ 418,561
Income taxes (refunds) $ 4,711 $ (4,901) $ (2,532)
Non-cash investing and financing activities:
Change in fair value of interest rate swaps $ (13,193) $ (6,135) $ (6,057)
Conversion of EPPICS $ 29,980 $ 147,991 $ -
Debt-for-debt exchange $ 2,171 $ - $ -
Investment write-downs $ - $ 5,286 $ -
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-8
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Description of Business and Summary of Significant Accounting Policies:
-----------------------------------------------------------------------
(a) Description of Business:
------------------------
Citizens Communications Company and its subsidiaries are referred to
as "we," "us," the "Company," or "our" in this report. We are a
communications company providing services to rural areas and small and
medium-sized towns and cities as an incumbent local exchange carrier,
or ILEC. We offer our ILEC services under the "Frontier" name. In
addition, we provide competitive local exchange carrier, or CLEC,
services to business customers and to other communications carriers in
certain metropolitan areas in the western United States through
Electric Lightwave, LLC, or ELI, our wholly-owned subsidiary. In
February 2006, we entered into a definitive agreement to sell ELI and
we expect the sale to close in the third quarter of 2006.
(b) Principles of Consolidation and Use of Estimates:
-------------------------------------------------
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (GAAP). Certain reclassifications of balances previously
reported have been made to conform to the current presentation. All
significant intercompany balances and transactions have been
eliminated in consolidation.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions which affect the
amounts of assets, liabilities, revenue and expenses we have reported
and our disclosure of contingent assets and liabilities at the date of
the financial statements. Actual results may differ from those
estimates. We believe that our critical estimates are depreciation
rates, pension assumptions, calculations of impairment amounts,
reserves established for receivables, income taxes and contingencies.
(c) Cash Equivalents:
-----------------
We consider all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
(d) Revenue Recognition:
--------------------
Frontier - Revenue is recognized when services are provided or when
products are delivered to customers. Revenue that is billed in advance
includes: monthly recurring network access services, special access
services and monthly recurring local line charges. The unearned
portion of this revenue is initially deferred as a component of other
liabilities on our consolidated balance sheet and recognized in
revenue over the period that the services are provided. Revenue that
is billed in arrears includes: non-recurring network access services,
switched access services, non-recurring local services and
long-distance services. The earned but unbilled portion of this
revenue is recognized in revenue in our statement of operations and
accrued in accounts receivable in the period that the services are
provided. Excise taxes are recognized as a liability when billed.
Installation fees and their related direct and incremental costs are
initially deferred and recognized as revenue and expense over the
average term of a customer relationship. We recognize as current
period expense the portion of installation costs that exceeds
installation fee revenue.
Electric Lightwave, LLC (ELI) - Revenue is recognized when the
services are provided. Revenue from long-term prepaid network services
agreements including Indefeasible Rights to Use (IRU), are deferred
and recognized on a straight-line basis over the terms of the related
agreements. Installation fees and their related direct and incremental
costs are initially deferred and recognized as revenue and expense
over the average term of a customer relationship. We recognize as
current period expense the portion of installation costs that exceeds
installation fee revenue.
(e) Property, Plant and Equipment:
------------------------------
Property, plant and equipment are stated at original cost or fair
market value for our acquired properties, including capitalized
interest. Maintenance and repairs are charged to operating expenses as
incurred. The gross book value of routine property, plant and
equipment retired is charged against accumulated depreciation.
F-9
(f) Goodwill and Other Intangibles:
-------------------------------
Intangibles represent the excess of purchase price over the fair value
of identifiable tangible assets acquired. We undertake studies to
determine the fair values of assets and liabilities acquired and
allocate purchase prices to assets and liabilities, including
property, plant and equipment, goodwill and other identifiable
intangibles. We annually (during the fourth quarter) examine the
carrying value of our goodwill and trade name to determine whether
there are any impairment losses and have determined for the year ended
December 31, 2005 that there was no impairment (see Notes 2 and 7).
All intangibles at December 31, 2005 are associated with the Frontier
segment, which is the reporting unit.
SFAS No. 142 also requires that intangible assets with estimated
useful lives be amortized over those lives and be reviewed for
impairment in accordance with SFAS No. 144, "Accounting for Impairment
or Disposal of Long-Lived Assets" to determine whether any changes to
these lives are required. We periodically reassess the useful life of
our intangible assets with estimated useful lives to determine whether
any changes to those lives are required.
(g) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
---------------------------------------------------------------------
Of:
---
We review long-lived assets to be held and used and long-lived assets
to be disposed of, including intangible assets with estimated useful
lives, for impairment whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be
recoverable. Recoverability of assets to be held and used is measured
by comparing the carrying amount of the asset to the future
undiscounted net cash flows expected to be generated by the asset.
Recoverability of assets held for sale is measured by comparing the
carrying amount of the assets to their estimated fair market value. If
any assets are considered to be impaired, the impairment is measured
by the amount by which the carrying amount of the assets exceeds the
estimated fair value (see Note 5).
(h) Derivative Instruments and Hedging Activities:
----------------------------------------------
We account for derivative instruments and hedging activities in
accordance with SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended. SFAS No. 133, as amended,
requires that all derivative instruments, such as interest rate swaps,
be recognized in the financial statements and measured at fair value
regardless of the purpose or intent of holding them.
On the date we enter into a derivative contract that qualifies for
hedge accounting, we designate the derivative as either a fair value
or cash flow hedge. A hedge of the fair value of a recognized asset or
liability or of an unrecognized firm commitment is a fair value hedge.
A hedge of a forecasted transaction or the variability of cash flows
to be received or paid related to a recognized asset or liability is a
cash flow hedge. We formally document all relationships between
hedging instruments and hedged items, as well as our risk-management
objective and strategy for undertaking the hedge transaction. This
process includes linking all derivatives that are designated as
fair-value or cash flow hedges to specific assets and liabilities on
the balance sheet or to specific firm commitments or forecasted
transactions.
We also formally assess, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. If it is determined that a derivative
is not highly effective as a hedge or that it has ceased to be a
highly effective hedge, we would discontinue hedge accounting
prospectively.
All derivatives are recognized on the balance sheet at their fair
value. Changes in the fair value of derivative financial instruments
are either recognized in income or stockholders' equity (as a
component of other comprehensive income), depending on whether the
derivative is being used to hedge changes in fair value or cash flows.
We have interest rate swap arrangements related to a portion of our
fixed rate debt. These hedge strategies satisfy the fair value hedging
requirements of SFAS No. 133, as amended. As a result, the fair value
of the swaps is carried on the balance sheet in other current assets
and the related hedged liabilities are also adjusted to fair value by
the same amount.
F-10
(i) Investments:
------------
Marketable Securities
We classify our cost method investments at purchase as
available-for-sale. We do not maintain a trading portfolio or
held-to-maturity securities.
Securities classified as available-for-sale are carried at estimated
fair market value. These securities are held for an indefinite period
of time, but might be sold in the future as changes in market
conditions or economic factors occur. Net aggregate unrealized gains
and losses related to such securities, net of taxes, are included as a
separate component of shareholders' equity. Interest, dividends and
gains and losses realized on sales of securities are reported in
Investment income.
We evaluate our investments periodically to determine whether any
decline in fair value, below the cost basis, is other than temporary.
To determine whether an impairment is other than temporary, we
consider whether we have the ability and intent to hold the investment
until a market price recovery and whether evidence indicating the cost
of the investment is recoverable outweighs evidence to the contrary.
Evidence considered in this assessment includes the reasons for the
impairment, the severity and duration of the impairment, changes in
value subsequent to year-end, and forecasted performance of the
investee. If we determine that a decline in fair value is other than
temporary, the cost basis of the individual investment is written down
to fair value, which becomes the new cost basis. The amount of the
write-down is transferred from other comprehensive income (loss) and
included in the statement of operations as a loss.
Investments in Other Entities
Investments in entities that we do not control, but where we have the
ability to exercise significant influence over operating and financial
policies, are accounted for using the equity method of accounting.
(j) Income Taxes and Deferred Income Taxes:
---------------------------------------
We file a consolidated federal income tax return. We utilize the asset
and liability method of accounting for income taxes. Under the asset
and liability method, deferred income taxes are recorded for the tax
effect of temporary differences between the financial statement basis
and the tax basis of assets and liabilities using tax rates expected
to be in effect when the temporary differences are expected to
reverse.
(k) Stock Plans:
------------
We have various stock-based compensation plans. Awards under these
plans are granted to eligible officers, management, 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. As
permitted by current accounting rules, we apply Accounting Principles
Board Opinions (APB) No. 25 and related interpretations in accounting
for the employee stock plans resulting in the use of the intrinsic
value to value the stock.
SFAS No. 123, "Accounting for Stock-Based Compensation" and SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of SFAS No. 123," established accounting and
disclosure requirements using a fair-value-based method of accounting
for stock-based employee compensation plans. As permitted by existing
accounting standards, we have elected to continue to apply the
intrinsic-valued-based method of accounting described above, and have
adopted only the disclosure requirements of SFAS No. 123, as amended.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment," ("SFAS No. 123R"). SFAS 123R requires that
stock-based employee compensation be recorded as a charge to earnings.
In April 2005, the Securities and Exchange Commission required the
adoption of SFAS No. 123R for annual periods beginning after June 15,
2005. Accordingly, we will adopt SFAS 123R commencing January 1, 2006
and expect to recognize approximately $2,800,000 of expense related to
the non-vested portion of previously granted stock options for the
year ended December 31, 2006.
We provide pro forma net income and pro forma net income per common
share disclosures for employee and non-employee director stock option
grants based on the fair value of the options at the date of grant
(see Note 18). For purposes of presenting pro forma information, the
fair value of options granted is computed using the Black Scholes
option-pricing model.
F-11
Had we determined compensation cost based on the fair value at the
grant date for the Management Equity Incentive Plan (MEIP), Equity
Incentive Plan (EIP) and Directors' Deferred Fee Equity Plan, our pro
forma net income and net income per common share available for common
shareholders would have been as follows:
2005 2004 2003
---------------- ----------------- --------------
($ in thousands)
----------------
Net income available for common
shareholders As reported $202,375 $72,150 $ 187,852
Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects 5,267 29,381 6,014
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (8,165) (38,312) (16,139)
-------- --------- ---------
Pro forma $199,477 $63,219 $ 177,727
======== ========= =========
Net income per common share As reported:
available for common shareholders Basic $ 0.60 $ 0.24 $ 0.67
Diluted 0.60 0.23 0.64
Pro forma:
Basic $ 0.59 $ 0.21 $ 0.63
Diluted 0.59 0.20 0.61
In connection with the payment of the special, non-recurring dividend
of $2.00 per common share on September 2, 2004, the exercise price and
number of all outstanding options was adjusted such that each option
had the same value to the holder after the dividend as it had before
the dividend. In accordance with FASB Interpretation No. 44 (FIN 44),
"Accounting for Certain Transactions Involving Stock Compensation" and
EITF 00-23, "Issues Related to the Accounting for Stock Compensation
under APB No. 25 and FIN 44," there is no accounting consequence for
changes made to the exercise price and the number of shares of a fixed
stock option or award as a direct result of the special, non-recurring
dividend.
(l) Net Income Per Common Share Available for Common Shareholders:
--------------------------------------------------------------
Basic net income per common share is computed using the weighted
average number of common shares outstanding during the period being
reported on. Except when the effect would be antidilutive, diluted net
income per common share reflects the dilutive effect of the assumed
exercise of stock options using the treasury stock method at the
beginning of the period being reported on as well as common shares
that would result from the conversion of convertible debt. In
addition, the related interest on debt (net of tax) is added back to
income since it would not be paid if the debt was converted to common
stock.
(2) Recent Accounting Literature and Changes in Accounting Principles:
------------------------------------------------------------------
Accounting for Asset Retirement Obligations
-------------------------------------------
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." We adopted SFAS No. 143 effective January 1, 2003.
As a result of our adoption of SFAS No. 143, we recognized an after tax
non-cash gain of approximately $65,769,000. This gain resulted from the
elimination of the cumulative cost of removal included in accumulated
depreciation and is reflected as a cumulative effect of a change in
accounting principle in our statement of operations in 2003, as we have no
legal obligation to remove certain of our long-lived assets.
F-12
Stock-Based Compensation
------------------------
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement
No. 123, "Accounting for Stock-Based Compensation." SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based compensation and amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements. This statement is effective
for fiscal years ending after December 15, 2002. We have adopted the
expanded disclosure requirements of SFAS No. 148.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment," (SFAS No. 123R). SFAS No. 123R requires that stock-based employee
compensation be recorded as a charge to earnings. In April 2005, the
Securities and Exchange Commission required adoption of SFAS No. 123R for
annual periods beginning after June 15, 2005. Accordingly, we will adopt
SFAS 123R commencing January 1, 2006 and expect to recognize approximately
$2,800,000 of expense related to the non-vested portion of previously
granted stock options for the year ended December 31, 2006.
Variable Interest Entities
--------------------------
In December 2003, the FASB issued FASB Interpretation No. 46 (revised
December 2003) (FIN 46R), "Consolidation of Variable Interest Entities,"
which addresses how a business enterprise should evaluate whether it has a
controlling financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. FIN 46R replaces FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities," which
was issued in January 2003. We are required to apply FIN 46R to variable
interests in variable interest entities, or VIEs, created after December
31, 2003. For any VIEs that must be consolidated under FIN 46R that were
created before January 1, 2004, the assets, liabilities and noncontrolling
interests of the VIE initially would be measured at their carrying amounts
with any difference between the net amount added to the balance sheet and
any previously recognized interest being recognized as the cumulative
effect of an accounting change. If determining the carrying amounts is not
practicable, fair value at the date FIN 46R first applies may be used to
measure the assets, liabilities and noncontrolling interest of the VIE. We
reviewed all of our investments and determined that the Trust Convertible
Preferred Securities (EPPICS), issued by our consolidated wholly-owned
subsidiary, Citizens Utilities Trust and the related Citizens Utilities
Capital L.P., were our only VIEs. Except as described in Note 15, the
adoption of FIN 46R on January 1, 2004 did not have a material impact on
our financial position or results of operations.
Investments
-----------
In March 2004, the FASB issued EITF Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments"
(EITF 03-1), which provides new guidance for assessing impairment losses on
debt and equity investments. Additionally, EITF 03-1 includes new
disclosure requirements for investments that are deemed to be temporarily
impaired. In September 2004, the FASB delayed the accounting provisions of
EITF 03-1; however, the disclosure requirements remain effective and were
adopted for our year ended December 31, 2004. Although we have no material
investments at the present time, we will evaluate the effect, if any, of
EITF 03-1 when final guidance is released.
Exchanges of Productive Assets
------------------------------
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets," an amendment of APB Opinion No. 29. SFAS No. 153 addresses the
measurement of exchanges of certain non-monetary assets (except for certain
exchanges of products or property held for sale in the ordinary course of
business). The Statement requires that non-monetary exchanges be accounted
for at the fair value of the assets exchanged, with gains or losses being
recognized, if the fair value is determinable within reasonable limits and
the transaction has commercial substance. SFAS No. 153 is effective for
nonmonetary exchanges occurring in fiscal periods beginning after June 15,
2005. We do not expect the adoption of the new standard to have a material
impact on our financial position, results of operations and cash flows.
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
F-13
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 or
results of operations.
Accounting Changes and Error Corrections
----------------------------------------
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections," a replacement of APB Opinion No. 20 and FASB Statement No. 3.
SFAS No. 154 changes the accounting for, and reporting of, a change in
accounting principle. SFAS No. 154 requires retrospective application to
prior period's financial statements of voluntary changes in accounting
principle, and changes required by new accounting standards when the
standard does not include specific transition provisions, unless it is
impracticable to do so. SFAS No. 154 is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005.
Partnerships
------------
In June 2005, the FASB issued EITF No. 04-5, "Determining Whether a General
Partner, or the General Partners as a Group, Controls a Limited Partnership
or Similar Entity When the Limited Partners Have Certain Rights," which
provides new guidance on how general partners in a limited partnership
should determine whether they control a limited partnership. EITF No. 04-5
is effective for fiscal periods beginning after December 15, 2005. We do
not expect the adoption of EITF No. 04-5 to have a material impact on our
financial position, results of operations or cash flows.
(3) Accounts Receivable:
--------------------
The components of accounts receivable at December 31, 2005 and 2004 are as
follows:
($ in thousands) 2005 2004
---------------- -------------- ---------------
End user $ 226,717 $ 227,385
Other 34,798 42,301
Less: Allowance for doubtful accounts (32,408) (35,996)
------------- -------------
Accounts receivable, net $ 229,107 $ 233,690
============= =============
We maintain an allowance for estimated bad debts based on our estimate of
collectibility of our accounts receivable. Bad debt expense, which is
recorded as a reduction of revenue, was $13,510,000, $17,906,000 and
$21,540,000 for the years ended December 31, 2005, 2004, and 2003,
respectively.
(4) Property, Plant and Equipment:
------------------------------
The components of property, plant and equipment at December 31, 2005 and
2004 are as follows:
Estimated
($ in thousands) Useful Lives 2005 2004
---------------- ------------------- ----------------- -----------------
Land N/A $ 20,748 $ 21,481
Buildings and leasehold improvements 30 to 41 years 359,339 357,983
General support 3 to 17 years 413,512 414,360
Central office/electronic circuit equipment 5 to 11 years 2,611,934 2,536,579
Cable and wire 15 to 60 years 3,085,338 2,972,919
Other 5 to 30 years 35,458 31,993
Construction work in progress 99,746 93,049
---------------- ----------------
6,626,075 6,428,364
Less: accumulated depreciation (3,439,610) (3,092,514)
---------------- ----------------
Property, plant and equipment, net $ 3,186,465 $ 3,335,850
================ ================
F-14
Depreciation expense is principally based on the composite group method.
Depreciation expense was $415,581,000, $444,288,000 and $466,323,000 for
the years ended December 31, 2005, 2004 and 2003, respectively. Effective
January 1, 2003, as a result of the adoption of SFAS No. 143, "Accounting
for Asset Retirement Obligations," we ceased recognition of the cost of
removal provision in depreciation expense and eliminated the cumulative
cost of removal included in accumulated depreciation. 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.
(5) Losses on Impairment:
---------------------
During 2005 and 2004, we did not recognize any impairment charges.
During 2003, we recognized non-cash pre-tax impairment losses of
$15,300,000 related to our Vermont electric division assets held for sale
in accordance with the provisions of SFAS No. 144.
(6) Dispositions:
-------------
Pre-tax gains (losses) in connection with the following transactions were
recorded in other income (loss), net:
2005
----
On February 1, 2005, we sold shares of Prudential Financial, Inc. for
approximately $1,112,000 in cash, and we recognized a pre-tax gain of
approximately $493,000.
In June 2005, we sold for cash our interests in certain key man life
insurance policies on the lives of Leonard Tow, our former Chairman and
Chief Executive Officer, and his wife, a former director. The cash
surrender value of the policies purchased by Dr. Tow totaled approximately
$24,195,000, and we recognized a pre-tax gain of approximately $457,000.
During 2005, we sold shares of Global Crossing Limited for approximately
$1,084,000 in cash, and we recognized a pre-tax gain for the same amount.
2004
----
In October 2004, we sold cable assets in California, Arizona, Indiana, and
Wisconsin for approximately $2,263,000 in cash. The pre-tax gain on the
sale was $40,000.
During the third quarter of 2004, we sold our corporate aircraft for
approximately $15,298,000 in cash. The pre-tax loss on the sale was
$1,087,000.
2003
----
On April 1, 2003, we completed the sale of approximately 11,000 telephone
access lines in North Dakota for approximately $25,700,000 in cash. The
pre-tax gain on the sale was $2,274,000.
On April 4, 2003, we completed the sale of our wireless partnership
interest in Wisconsin for approximately $7,500,000 in cash. The pre-tax
gain on the sale was $2,173,000.
(7) Other Intangibles:
------------------
Other intangibles at December 31, 2005 and 2004 are as follows:
($ in thousands) 2005 2004
---------------- --------------- --------------
Customer base - amortizable over 96 months $ 994,605 $ 994,605
Trade name - non-amortizable 122,058 122,058
--------------- --------------
Other intangibles 1,116,663 1,116,663
Accumulated amortization (557,930) (431,552)
--------------- --------------
Total other intangibles, net $ 558,733 $ 685,111
=============== ==============
F-15
Amortization expense was $126,378,000, $126,520,000 and $126,838,000 for
the years ended December 31, 2005, 2004 and 2003, 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.
(8) Discontinued Operations:
------------------------
Conference Call USA
-------------------
In February 2005, we entered into a definitive agreement to sell
Conference-Call USA, LLC (CCUSA), our conferencing services business. On
March 15, 2005, we completed the sale for $43,565,000 in cash, subject to
adjustments under the terms of the agreement. The pre-tax gain on the sale
of CCUSA was $14,061,000. Our after-tax gain was approximately $1,167,000.
The book income taxes recorded upon sale are primarily attributable to a
low tax basis in the assets sold.
In accordance with SFAS No. 144, any component of our business that we
dispose of or classify as held for sale that has operations and cash flows
clearly distinguishable from operations, and for financial reporting
purposes, and that will be eliminated from the ongoing operations, should
be classified as discontinued operations. Accordingly, we have classified
the results of operations of CCUSA as discontinued operations in our
consolidated statements of operations and have restated prior periods.
CCUSA had revenues of approximately $24,600,000 and operating income of
approximately $8,000,000 for the year ended December 31, 2004. At December
31, 2004, CCUSA's net assets totaled approximately $23,400,000. The company
had no outstanding debt specifically identified with CCUSA and therefore no
interest expense was allocated to discontinued operations. In addition, we
ceased to record depreciation expense effective February 16, 2005.
Summarized financial information for CCUSA (discontinued operations) is set
forth below:
( $ in thousands) For the years ended December 31,
----------------- -----------------------------------------
2005 2004 2003
------------ ------------- -------------
Revenue $ 4,607 $ 24,558 $ 20,764
Operating income $ 1,489 $ 8,188 $ 6,820
Income taxes $ 449 $ 2,957 $ 2,440
Net income $ 1,040 $ 5,231 $ 4,380
Gain on disposal of CCUSA, net of tax $ 1,167 $ - $ -
December 31,
($ in thousands) 2004
---------------- -----------------
Current assets $ 2,819
Net property, plant and equipment 2,450
Goodwill 18,853
-----------------
Total assets of discontinued operations $ 24,122
=================
Current liabilities $ 735
-----------------
Total liabilities of discontinued operations $ 735
=================
Public Utilities
----------------
On April 1, 2004, we completed the sale of our Vermont electric distribution
operations for approximately $13,992,000 in cash, net of selling expenses. With
that transaction, we completed the divestiture of our public utilities services
business pursuant to plans announced in 1999. Losses on the sales of our Vermont
properties were included in the impairment charges recorded in 2003.
F-16
(9) Investments:
------------
The components of investments at December 31, 2005 and 2004 are as follows:
($ in thousands) 2005 2004
---------------- ---------------- ----------------
Marketable equity securities $ 122 $ 2,336
Equity method investments 19,014 20,726
---------------- ----------------
$19,136 $ 23,062
================ ================
Marketable Securities
As of December 31, 2005 and 2004, we owned 3,059,000 shares of Adelphia
Communications Corp. (Adelphia) common stock. As a result of write downs
recorded in 2002 and 2001, our "book cost basis" was reduced to zero and
subsequent increases and decreases, except for those deemed other than
temporary, are included in accumulated other comprehensive income (loss).
During 2004, we sold our investments in D & E Communications, Inc. (D & E)
and Hungarian Telephone and Cable Corp. (HTCC) for approximately
$13,300,000 and $13,200,000 in cash, respectively. We recorded net realized
gains of $12,066,000 in our statement of operations for the sale of these
marketable securities.
The following summarizes the adjusted cost, gross unrealized holding gains
and losses and fair market value for marketable securities:
($ in thousands) Adjusted Unrealized Holding Aggregate Fair
---------------- ---------------------------------
Investment Classification Cost Gains (Losses) Market Value
------------------------- ---------------- ---------------- ---------------- ----------------
As of December 31, 2005
-----------------------
Available-for-Sale $ - $ 122 $ - $ 122
As of December 31, 2004
-----------------------
Available-for-Sale $ 1,138 $ 1,198 $ - $ 2,336
At December 31, 2005 and 2004, we did not have any investments that have
been in a continuous unrealized loss position deemed to be temporary for
more than 12 months. We determined that market fluctuations during the
period are not other than temporary because the severity and duration of
the unrealized losses were not significant.
Investments in Other Entities
During 2004, we reclassified our investments accounted for under the equity
method from other assets to the investment caption in our consolidated
balance sheets and conformed prior periods to the current presentation.
Our investments in entities that are accounted for under the equity method
of accounting consist of the following: (1) a 33% interest in the Mohave
Cellular Limited Partnership which is engaged in cellular mobile telephone
service in the Arizona area; (2) a 16.8% interest in the Fairmount Cellular
Limited Partnership which is engaged in cellular mobile telephone service
in the Rural Service Area (RSA) designated by the FCC as Georgia RSA No. 3;
and (3) our investments in CU Capital and CU Trust with relation to our
convertible preferred securities. The investments in these entities
amounted to $19,014,000 and $20,726,000 at December 31, 2005 and 2004,
respectively.
(10) Fair Value of Financial Instruments:
------------------------------------
The following table summarizes the carrying amounts and estimated fair
values for certain of our financial instruments at December 31, 2005 and
2004. For the other financial instruments, representing cash, accounts
receivables, long-term debt due within one year, accounts payable and other
accrued liabilities, the carrying amounts approximate fair value due to the
relatively short maturities of those instruments.
F-17
The fair value of our marketable securities and long-term debt is estimated
based on quoted market prices at the reporting date for those financial
instruments. Other securities and investments for which market values are
not readily available are carried at cost.
($ in thousands) 2005 2004
---------------- ----------------------------------- ---------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------------- ------------------ ---------------- ----------------
Investments $ 19,136 $ 19,136 $ 23,062 $ 23,062
Long-term debt (1) $ 3,999,376 $ 4,026,453 $ 4,266,998 $ 4,607,298
(1) 2005 and 2004 includes interest rate swaps of $(8,727,000) and
$4,466,000, respectively. 2005 and 2004 includes EPPICS of $33,785,000
and $63,765,000, respectively.
(11) Long-term Debt:
---------------
The activity in our long-term debt from December 31, 2004 to December 31,
2005 is summarized as follows:
Twelve Months Ended
--------------------------------------
Interest Interest Rate* at
December 31, Rate December 31, December 31,
($ in thousands) 2004 Payments Swap Other 2005 2005
----------------
Rural Utilities Service Loan
Contracts $ 29,108 $ (6,299) $ - $ - $ 22,809 6.070%
Senior Unsecured Debt 4,131,803 - (13,193) 2,171 4,120,781 8.117%
EPPICS** (reclassified as a
result of adopting FIN 46R) 63,765 - - (29,980) 33,785 5.000%
ELI Capital Leases 4,421 (134) - - 4,287 10.364%
Industrial Development Revenue
Bonds 58,140 - - - 58,140 5.559%
------------ ------------ ----------- ---------- -----------
TOTAL LONG TERM DEBT $4,287,237 $ (6,433) $(13,193) $(27,809) $4,239,802
------------ ============ =========== ========== -----------
Less: Debt Discount (13,859) (12,692)
Less: Current Portion (6,380) (227,734)
------------ -----------
$4,266,998 $3,999,376
============ ===========
* Interest rate includes amortization of debt issuance expenses, debt
premiums or discounts. The interest rate for Rural Utilities Service Loan
Contracts, Senior Unsecured Debt, and Industrial Development Revenue Bonds
represent a weighted average of multiple issuances.
** In accordance with FIN 46R, the Trust holding the EPPICS and the related
Citizens Utilities Capital L.P. are now deconsolidated (see Note 15).
F-18
Additional information regarding our Senior Unsecured Debt at December 31,
2005 is as follows:
Principal Interest
($ in thousands) Outstanding Rate
---------------- ----------------- ----------
Senior Notes:
Due 8/17/2006 $ 51,770 6.750%
Due 8/15/2008 698,470 7.625%
Due 5/15/2011 1,044,256 9.250%
Due 10/24/2011 200,000 6.270%
Due 1/15/2013 698,537 6.250%
Due 8/15/2031 748,006 9.000%
----------------
3,441,039
Debentures due 2006 - 2046 643,742 7.263%
Subsidiary Senior
Notes due 12/1/2012 36,000 8.050%
----------------
Total $ 4,120,781
================
In February 2006, our Board of Directors authorized us to repurchase up to
$150.0 million of our outstanding debt securities 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 other income (loss),
net.
For the year ended December 31, 2005, we retired an aggregate $36,412,000
of debt (including $29,980,000 of EPPICS conversions), representing
approximately 1% of total debt outstanding at December 31, 2004. During the
second quarter of 2005, we entered into two debt-for-debt exchanges of our
debt securities. As a result, $50,000,000 of our 7.625% Notes due 2008 were
exchanged for approximately $52,171,000 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 exchanged. No cash was exchanged in these transactions,
however a non-cash pre-tax loss of approximately $3,175,000 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 December 31, 2005, EPPICS representing a total principal amount of
$177,971,000 had been converted into 14,237,807 shares of our common stock.
Total future minimum cash payment commitments under ELI's long-term capital
leases including interest amounted to $9,113,000 as of December 31, 2005.
The total outstanding principal amounts of industrial development revenue
bonds were $58,140,000 at December 31, 2005 and 2004. The earliest maturity
date for these bonds is in August 2015. Under the terms of our agreements
to sell our former gas and electric operations in Arizona, completed in
2003, we are obligated to call for redemption, at their first available
call dates, three Arizona industrial development revenue bond series
aggregating to approximately $33,440,000. These bonds' first call dates are
in 2007. We expect to retire all called bonds with cash. In addition,
holders of $11,150,000 principal amount of industrial development bonds may
tender such bonds to us at par and we have the simultaneous option to call
such bonds at par on August 7, 2007. We expect to call the bonds and retire
them with cash.
As of December 31, 2005 we had available lines of credit with financial
institutions in the aggregate amount of $250,000,000 with a maturity date
of October 29, 2009. Associated facility fees vary depending on our
leverage ratio and were 0.375% as of December 31, 2005. During the term of
the credit facility we may borrow, repay and re-borrow funds. The credit
facility is available for general corporate purposes but may not be used to
fund dividend payments. There have never been any borrowings under the
facility.
For the year ended December 31, 2004, we retired an aggregate
$1,362,012,000 of debt (including $147,991,000 of EPPICS conversions),
representing approximately 28% of total debt outstanding at December 31,
2003.
F-19
On January 15, 2004, we repaid at maturity the remaining outstanding
$80,955,000 of our 7.45% Debentures.
On January 15, 2004, we redeemed at 101% the remaining outstanding
$12,300,000 of our Hawaii Special Purpose Revenue Bonds, Series 1993A and
Series 1993B.
On May 17, 2004, we repaid at maturity the remaining outstanding $5,975,000
of ELI's 6.05% Notes. These Notes had been guaranteed by the Company.
On July 15, 2004, we renegotiated and prepaid with $4,954,000 of cash the
entire remaining $5,524,000 ELI capital lease obligation to a third party.
On July 30, 2004, we purchased $300,000,000 of the 6.75% notes that were a
component of our equity units at 105.075% of par, plus accrued interest, at
a premium of approximately $15,225,000 recorded in investment and other
income (loss), net.
During August and September 2004, we repurchased through a series of
transactions an additional $108,230,000 of the 6.75% notes due 2006 at a
weighted average price of 104.486% of par, plus accrued interest, at a
premium of approximately $4,855,000 recorded in investment and other income
(loss), net.
On November 8, 2004, we issued an aggregate $700,000,000 principal amount
of 6.25% senior notes due January 15, 2013 through a registered
underwritten public offering. Proceeds from the sale were used to redeem
our outstanding $700,000,000 of 8.50% Notes due 2006, which is discussed
below.
On November 12, 2004, we called for redemption on December 13, 2004 the
entire $700,000,000 of our 8.50% Notes due 2006 at a price of 107.182% of
the principal amount called, plus accrued interest, at a premium of
approximately $50,300,000.
As of December 31, 2004, EPPICS representing a total principal amount of
$147,991,000 had been converted into 11,622,749 shares of our common stock.
During the twelve months ended December 31, 2003, we executed a series of
purchases in the open market of our outstanding debt securities. The
aggregate principal amount of debt securities purchased was $94,895,000 and
they generated a pre-tax loss on the early extinguishment of debt at a
premium of approximately $3,117,000 recorded in other income (loss), net.
Our principal payments and capital lease payments (principal only) for the
next five years are as follows:
($ in thousands)
----------------
Principal ELI Capital
--------- --------------
Payments Lease Payments
--------- --------------
2006 227,693 41
2007 37,771 110
2008 700,938 126
2009 1,006 145
2010 4,387 165
(12) Derivative Instruments and Hedging Activities:
----------------------------------------------
Interest rate swap agreements are used to hedge a portion of our debt that
is subject to fixed interest rates. Under our interest rate swap
agreements, we agree to pay an amount equal to a specified variable rate of
interest times a notional principal amount, and to receive in return an
amount equal to a specified fixed rate of interest times the same notional
principal amount. The notional amounts of the contracts are not exchanged.
No other cash payments are made unless the agreement is terminated prior to
maturity, in which case the amount paid or received in settlement is
established by agreement at the time of termination and represents the
market value, at the then current rate of interest, of the remaining
obligations to exchange payments under the terms of the contracts.
F-20
The interest rate swap contracts are reflected at fair value in our
consolidated balance sheets and the related portion of fixed-rate debt
being hedged is reflected at an amount equal to the sum of its book value
and an amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. Changes in the fair
value of interest rate swap contracts, and the offsetting changes in the
adjusted carrying value of the related portion of the fixed-rate debt being
hedged, are recognized in the consolidated statements of operations in
interest expense. The notional amounts of interest rate swap contracts
hedging fixed-rate indebtedness as of December 31, 2005 and December 31,
2004 were $500,000,000 and $300,000,000, respectively. Such contracts
require us to pay variable rates of interest (average pay rates of
approximately 8.60% and 6.12% as of December 31, 2005 and 2004,
respectively) and receive fixed rates of interest (average receive rates of
8.46% and 8.44% as of December 31, 2005 and 2004, respectively). The fair
value of these derivatives is reflected in other assets as of December 31,
2005 and 2004, in the amount of $(8,727,000) and $4,466,000, respectively.
The related underlying debt has been decreased in 2005 and increased in
2004 by a like amount. The amounts received during the year ended December
31, 2005 and 2004 as a result of these contracts amounted to $2,522,000 and
$9,363,000, respectively, and are included as a reduction of 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. At December 31, 2005, the
rates obtained under these forward rate agreements were below market rates.
The fair value of these derivatives is reflected in other current assets as
of December 31, 2005, in the amount of $1,129,000. A gain for the changes
in the fair value of these forward rate agreements of $1,851,000 is
included in other income (loss), net for the year ended December 31, 2005.
As the result of our call of all of our 8.50% Notes in November 2004, we
terminated five interest rate swaps involving an aggregate $250,000,000
notional amount of indebtedness. Proceeds from the swap terminations of
approximately $3,026,000 and U.S. Treasury rate lock agreements of
approximately $971,000 were applied against the cost to retire the debt,
resulting in a net premium of approximately $46,277,000 recorded in other
income (loss), net.
We do not anticipate any nonperformance by counter-parties to our
derivative contracts as all counter-parties have investment grade credit
ratings.
(13) Management Succession and Strategic Alternatives Expenses:
----------------------------------------------------------
On July 11, 2004, our Board of Directors announced that it had completed
its review of our financial and strategic alternatives, and on September 2,
2004, we paid a special, non-recurring dividend of $2.00 per common share
and a quarterly dividend of $0.25 per common share to shareholders of
record on August 18, 2004. Concurrently, Leonard Tow decided to step down
from his position as chief executive officer, effective immediately, and
resigned his position as Chairman of the Board on September 27, 2004. The
Board of Directors named Mary Agnes Wilderotter president and chief
executive officer in November 2004.
In 2004, we expensed approximately $90,632,000 of costs related to
management succession and our exploration of financial and strategic
alternatives. Included are $36,618,000 of non-cash expenses for the
acceleration of stock benefits, cash expenses of $19,229,000 for advisory
fees, $19,339,000 for severance and retention arrangements and $15,446,000
primarily for tax reimbursements.
F-21
(14) Other Income (Loss), net:
-------------------------
The components of other income (loss), net for the years ended December 31,
2005, 2004 and 2003 are as follows:
($ in thousands) 2005 2004 2003
---------------- ----------------- ----------------- -----------------
Legal contingencies $ (7,000) $ - $ -
Gain on capital lease termination/restructuring - - 69,512
Gain on expiration/settlement of customer advances 681 25,345 6,165
Loss on exchange of debt (3,175) - -
Premium on debt repurchases - (66,480) (10,851)
Gain on forward rate agreements 1,851 - -
Gain (loss) on sale of assets - (1,945) (20,492)
Other, net 5,969 (10,279) (275)
----------------- ----------------- -----------------
Total other income (loss), net $ (1,674) $ (53,359) $ 44,059
================= ================= =================
In the fourth quarter of 2005, we recorded $7,000,000 of expense was
recorded in connection with a legal matter. In connection with our exchange
of debt during the second quarter of 2005, we recognized a non-cash,
pre-tax loss of approximately $3,175,000. 2005 also includes a gain for the
changes in fair value of our forward rate agreements.
During 2005, 2004 and 2003, we recognized income in connection with certain
retained liabilities associated with customer advances for construction
from our disposed water properties, as a result of some of these
liabilities terminating. During 2003, we recognized gains in connection
with the termination/restructuring of capital leases at ELI. Gain (loss) on
sale of assets in 2004 is primarily attributable to the loss on the sale of
our corporate aircraft during the third quarter. In 2003, the amount
represents the sales of The Gas Company in Hawaii and our Arizona gas and
electric divisions, access lines in North Dakota and our wireless
partnership interest in Wisconsin, and our Plano, Texas office building.
(15) Company Obligated Mandatorily Redeemable Convertible Preferred Securities:
--------------------------------------------------------------------------
In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust
(the Trust), issued, in an underwritten public offering, 4,025,000 shares
of 5% Company Obligated Mandatorily Redeemable Convertible Preferred
Securities due 2036 (EPPICS), representing preferred undivided interests in
the assets of the Trust, with a liquidation preference of $50 per security
(for a total liquidation amount of $201,250,000). These securities have an
adjusted conversion price of $11.46 per Citizens common share. The
conversion price was reduced from $13.30 to $11.46 during the third quarter
of 2004 as a result of the $2.00 per share special, non-recurring dividend.
The proceeds from the issuance of the Trust Convertible Preferred
Securities and a Company capital contribution were used to purchase
$207,475,000 aggregate liquidation amount of 5% Partnership Convertible
Preferred Securities due 2036 from another wholly-owned subsidiary,
Citizens Utilities Capital L.P. (the Partnership). The proceeds from the
issuance of the Partnership Convertible Preferred Securities and a Company
capital contribution were used to purchase from us $211,756,000 aggregate
principal amount of 5% Convertible Subordinated Debentures due 2036. The
sole assets of the Trust are the Partnership Convertible Preferred
Securities, and our Convertible Subordinated Debentures are substantially
all the assets of the Partnership. Our obligations under the agreements
related to the issuances of such securities, taken together, constitute a
full and unconditional guarantee by us of the Trust's obligations relating
to the Trust Convertible Preferred Securities and the Partnership's
obligations relating to the Partnership Convertible Preferred Securities.
In accordance with the terms of the issuances, we paid the annual 5%
interest in quarterly installments on the Convertible Subordinated
Debentures in the four quarters of 2005, 2004 and 2003. 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 December 31, 2005, EPPICS representing a total principal amount of
$177,971,000 had been converted into 14,237,807 shares of our common stock.
F-22
We adopted the provisions of FIN 46R (revised December 2003) (FIN 46R),
"Consolidation of Variable Interest Entities," effective January 1, 2004.
Accordingly, the Trust holding the EPPICS and the related Citizens
Utilities Capital L.P. are deconsolidated.
(16) Capital Stock:
--------------
We are authorized to issue up to 600,000,000 shares of common stock. The
amount and timing of dividends payable on common stock are within the sole
discretion of our Board of Directors.
(17) Stock Plans:
------------
At December 31, 2005, we have four stock based compensation plans, which
are described below. We apply APB Opinion No. 25 and related
interpretations in accounting for the employee stock plans resulting in the
use of the intrinsic value to value the stock option. Compensation cost has
not generally been recognized in the financial statements for options
issued pursuant to the Management Equity Incentive Plan (MEIP), the 1996
Equity Incentive Plan (1996 EIP) or the Amended and Restated 2000 Equity
Incentive Plan (2000 EIP), as the exercise price for such options was equal
to the market price of the stock at the time of grant.
In connection with our Directors' Deferred Fee Equity Plan, compensation
costs associated with the issuance of stock units was $1,069,000,
$2,222,000 and $607,000 in 2005, 2004 and 2003, respectively. Cash
compensation associated with this plan was $434,000, $642,000 and $374,000
in 2005, 2004 and 2003, respectively. These costs are recognized in other
operating expenses.
We have granted restricted stock awards to key employees in the form of our
common stock. The number of shares issued as restricted stock awards during
2005, 2004 and 2003 were 352,000, 2,172,000 and 312,000, respectively. None
of the restricted stock awards may be sold, assigned, pledged or otherwise
transferred, voluntarily or involuntarily, by the employees until the
restrictions lapse. The restrictions are time based. At December 31, 2005,
1,456,000 shares of restricted stock were outstanding. Compensation
expense, recognized in operating expense, of $7,358,000, $45,313,000 and
$8,552,000, for the years ended December 31, 2005, 2004 and 2003,
respectively, has been recorded in connection with these grants.
Management Equity Incentive Plan
--------------------------------
Under the MEIP, 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, stock appreciation
rights (SARs), restricted stock or other stock-based awards. The
Compensation Committee of the Board of Directors administers the MEIP.
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 generally not exercisable on
the date of grant but vest over a period of time. 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
----------------------
In May 1996, our shareholders approved the 1996 EIP and in May 2001, our
shareholders approved the 2000 EIP. Under the EIP plans, 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. Directors may receive awards under the 2000 EIP (other than options
for annual retainer fees). SARs may be granted under the 1996 EIP. The
Compensation Committee of the Board of Directors administers the EIP plans.
The maximum number of shares of common stock, which may be issued pursuant
to awards at any time for both plans, is 25,358,000 shares, which has been
adjusted for subsequent stock dividends. No awards will be granted more
than 10 years after the effective dates (May 23, 1996 and May 18, 2000) of
the EIP plans. The exercise price of stock options and SARs 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 generally not exercisable on
the date of grant but vest over a period of time.
F-23
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.
In connection with the payment of the special, non-recurring dividend of
$2.00 per common share on September 2, 2004, the exercise price and number
of all outstanding options was adjusted such that each option had the same
value to the holder after the dividend as it had before the dividend. In
accordance with FASB Interpretation No. 44 (FIN 44), "Accounting for
Certain Transactions Involving Stock Compensation" and EITF 00-23, "Issues
Related to the Accounting for Stock Compensation under APB No. 25 and FIN
44," there is no accounting consequence for changes made to the exercise
price and the number of shares of a fixed stock option or award as a direct
result of the special, non-recurring dividend.
The following is a summary of share activity subject to option under the
MEIP and EIP plans.
Weighted
Shares Average
Subject to Option Price
Option Per Share
------------------------------------------------------------------- --------------------- -----------------
Balance at January 1, 2003 19,132,000 $11.66
Options granted 2,017,000 12.14
Options exercised (1,612,000) 7.97
Options canceled, forfeited or lapsed (1,572,000) 12.92
------------------------------------------------------------------- ---------------------
Balance at December 31, 2003 17,965,000 11.94
Options granted - -
Options exercised (7,411,000) 9.69
Options canceled, forfeited or lapsed (355,000) 12.14
Effect of special, non-recurring dividend 2,212,000 -
------------------------------------------------------------------- ---------------------
Balance at December 31, 2004 12,411,000 11.15
Options granted 183,000 11.58
Options exercised (4,317,000) 10.52
Options canceled, forfeited or lapsed (292,000) 10.48
------------------------------------------------------------------- ---------------------
Balance at December 31, 2005 7,985,000 $11.52
=================================================================== =====================
The following table summarizes information about shares subject to options
under the MEIP and EIP plans at December 31, 2005.
Options Outstanding Options Exercisable
--------------------------------------------------------------------------------- ---------------------------------
Weighted Average Weighted
Number Range of Weighted Average Remaining Number Average
Outstanding Exercise Prices Exercise Price Life in Years Exercisable Exercise Price
------------------ -------------------- -------------------- -------------------- ----------------- ---------------
517,000 $ 6.45 - 6.67 $ 6.54 2.64 517,000 $ 6.54
300,000 7.33 - 7.98 7.37 1.92 289,000 7.35
1,228,000 8.19 - 8.19 8.19 6.38 737,000 8.19
173,000 8.80 - 9.68 9.02 1.55 173,000 9.02
1,399,000 10.44 - 10.44 10.44 7.41 519,000 10.44
815,000 10.64 - 11.15 11.13 4.78 815,000 11.13
1,430,000 11.79 - 11.79 11.79 5.38 1,430,000 11.79
2,123,000 11.90 - 18.46 16.14 4.95 2,068,000 16.24
------------------ -----------------
7,985,000 $ 6.45 - 18.46 $11.52 5.32 6,548,000 $11.92
================== =================
The number of options exercisable at December 31, 2004 and 2003 were
9,235,000 and 11,690,000, respectively.
The weighted average fair value of options granted during 2005 was $2.98.
There were no option grants made during 2004. The weighted average fair
value of options granted during 2003 was $6.04. For purposes of the pro
forma calculation, the fair value of each option grant is estimated on the
date of grant using the Black Scholes option-pricing model with the
following weighted average assumptions used for grants in 2005 and 2003:
F-24
2005 2003
--------------------------- --------------- --------------
Dividend yield 7.72% -
Expected volatility 46% 44%
Risk-free interest rate 4.16% 2.94%
Expected life 6 years 7 years
--------------------------- --------------- --------------
Non-Employee Directors' Compensation Plan
-----------------------------------------
Upon commencement of his or her service on the Board of Directors, each
non-employee director receives a grant of 10,000 stock options, which is
awarded under our 2000 EIP. The price of these options, which are
immediately exercisable, is set at the average of the high and low market
prices of our common stock on the effective date of the director's initial
election to the board.
Annually, each non-employee director also receives a grant of 3,500 stock
units under our Formula Plan, which commenced in 1997 and continues through
May 22, 2007. Prior to April 20, 2004, each non-employee director received
an award of 5,000 stock options. The exercise price of the options granted
under the Formula Plan was set at 100% of the average of the high and low
market prices of our common stock on the third, fourth, fifth, and sixth
trading days of the year in which the options were granted. The options are
exercisable six months after the grant date and remain exercisable for ten
years after the grant date. In addition, on September 1, 1996, each
non-employee director received a grant, under the Formula Plan, of options
to purchase 2,500 shares of common stock. These options granted under the
Formula Plan became exercisable six months after the grant date and remain
exercisable for ten years after the grant date.
Effective April 2004, the Formula Plan was amended to replace the annual
grant of stock options with an annual grant of 3,500 stock units. The stock
units are awarded on the first business day of each calendar year. Each
non-employee director must elect, by December 31 of the preceding year,
whether the stock units awarded under the Formula Plan will be redeemed in
cash or stock upon the director's retirement or death, whichever occurs
first.
In addition, each non-employee director is also entitled to annually
receive a retainer, meeting fees, and, when applicable, fees for serving as
a committee chair or as Lead Director, which are awarded under the
Non-Employee Directors' Deferred Fee Equity Plan. For 2005, each
non-employee director had to elect, by December 31 of the preceding year,
to receive $30,000 cash or 5,000 stock units as an annual retainer.
Directors making a stock unit election must also elect to convert the units
to either common stock (convertible on a one-to-one basis) or cash upon
retirement or death. Prior to June 30, 2003, a director could elect to
receive 20,000 stock options as an annual retainer in lieu of cash or stock
units. The exercise price of the stock options was set at the average of
the high and low market prices of our common stock on the date of grant.
The options were exercisable six months after the date of grant and had a
10-year term.
As of any date, the maximum number of shares of common stock which the
Non-Employee Directors' Deferred Fee Equity Plan is obligated to deliver
shall not be more than one percent (1%) of the total outstanding shares of
our common stock as of June 30, 2003, subject to adjustment in the event of
changes in our corporate structure affecting capital stock. There were 14
directors participating in the Directors' Plan during all or part of 2005.
In 2005, the total options, plan units, and stock earned were 0, 64,000 and
0, respectively. In 2004, the total options, plan units, and stock earned
were 50,000, 57,226 and 0, respectively. In 2003, the total options, plan
units, and stock earned were 83,125, 46,034 and 0, respectively. At
December 31, 2005, 473,252 options were exercisable at a weighted average
exercise price of $9.80.
For 2005, each non-employee director received fees of $2,000 for each Board
of Directors and committee meeting attended. The chairs of the Audit,
Compensation, Nominating and Corporate Governance and Retirement Plan
Committees were paid an additional annual fee of $25,000, $15,000, $7,500
and $5,000, respectively. In addition, the Lead Director, who heads the ad
hoc committee of non-employee directors, received an additional annual fee
of $17,000 (based on an annual fee that was changed from $20,000 to $15,000
mid-year). A director must elect, by December 31 of the preceding year, to
receive meeting and other fees in cash, stock units, or a combination of
both. All fees paid to the non-employee directors in 2005 were paid
quarterly (except for the retainer which was paid at the beginning of the
year. If the director elects stock units, the number of units credited to
the director's account is determined as follows: the total cash value of
the fees payable to the director are divided by 85% of the average of the
high and low market prices of our common stock on the first trading day of
the year the election is in effect. Units are credited to the director's
account quarterly.
F-25
We account for the Directors' Deferred Fee Equity Plan in accordance with
APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations. Compensation expense is recorded if cash or stock units
are elected. If stock units are elected, the compensation expense is based
on the market value of our common stock at the date of grant. If the stock
option election is chosen, compensation expense is not recorded because the
options are granted at the fair market value of our common stock on the
grant date.
We had also maintained a Non-Employee Directors' Retirement Plan providing
for the payment of specified sums annually to our non-employee directors,
or their designated beneficiaries, starting at the director's retirement,
death or termination of directorship. In 1999, we terminated this Plan. The
vested benefit of each non-employee director, as of May 31, 1999, was
credited to the director's account in the form of stock units. Such benefit
will be payable to each director upon retirement, death or termination of
directorship. Each participant had until July 15, 1999 to elect whether the
value of the stock units awarded would be payable in our common stock
(convertible on a one-for-one basis) or in cash. As of December 31, 2005,
the liability for such payments was $634,000 all of which will be payable
in stock (based on the July 15, 1999 stock price).
(18) Restructuring and Other Expenses:
---------------------------------
2005 and 2004
During 2005 and 2004, we did not recognize any restructuring and other
expenses. We continue to review our operations, personnel and facilities to
achieve greater efficiency.
2003
Restructuring and other expenses primarily consist of expenses related to
reductions in personnel at our telecommunications operations and the
write-off of software no longer useful.
F-26
(19) Income Taxes:
-------------
The following is a reconciliation of the provision for income taxes for
continuing operations computed at federal statutory rates to the effective
rates for the years ended December 31, 2005, 2004 and 2003:
2005 2004 2003
------------ ----------- -----------
Consolidated tax provision at federal statutory rate 35.0 % 35.0 % 35.0 %
State income tax provisions, net of federal income tax
benefit 2.0 % 1.8 % 6.6 %
Tax reserve adjustment (7.9)% (19.3)% (8.4)%
All other, net 0.5 % (4.0)% 1.1 %
------------ ----------- -----------
29.6 % 13.5 % 34.3 %
============ =========== ===========
The components of the net deferred income tax liability (asset) at December
31 are as follows:
($ in thousands) 2005 2004
---------------- ------------ -----------
Deferred income tax liabilities:
--------------------------------
Property, plant and equipment basis differences $ 567,411 $ 578,501
Intangibles 168,703 161,955
Other, net 7,752 9,004
------------ -----------
743,866 749,460
------------ -----------
Deferred income tax assets:
---------------------------
Minimum pension liability 76,368 62,435
Tax operating loss carryforward 260,053 394,797
Alternate minimum tax credit carryforward 43,678 37,796
Employee benefits 66,853 55,566
Other, net 21,279 23,095
------------ -----------
468,231 573,689
Less: Valuation allowance (38,131) (43,503)
------------ -----------
Net deferred income tax asset 430,100 530,186
------------ -----------
Net deferred income tax liability $ 313,766 $ 219,274
============ ===========
Deferred tax assets and liabilities are reflected in the following
------------------------------------------------------------------
captions on the balance sheet:
------------------------------
Deferred income taxes $ 325,084 $ 232,766
Other current assets (11,318) (13,492)
------------ -----------
Net deferred income tax liability $ 313,766 $ 219,274
============ ===========
Our federal and state tax operating loss carryforwards as of December 31,
2005 are estimated at $584,476,000 and $1,409,983,000, respectively. Our
federal loss carryforward will begin to expire in the year 2021. A portion
of our state loss carryforward will begin to expire in 2006. Our
alternative minimum tax credit as of December 31, 2005 can be carried
forward indefinitely to reduce future regular tax liability.
F-27
The provision (benefit) for federal and state income taxes, as well as the
taxes charged or credited to shareholders' equity, includes amounts both
payable currently and deferred for payment in future periods as indicated
below:
($ in thousands) 2005 2004 2003
---------------- ------------ ----------- -----------
Income taxes charged (credited) to the income statement for
continuing operations:
Current:
Federal $ 16,708 $ (9,951) $ (12,632)
State (33,004) (3,643) 2,900
------------ ----------- -----------
Total current (16,296) (13,594) (9,732)
Deferred:
Federal 96,163 26,586 77,794
Federal tax credits (18) (40) (3,128)
State 4,491 (2,530) (158)
------------ ----------- -----------
Total deferred 100,636 24,016 74,508
------------ ----------- -----------
Subtotal income taxes for continuing operations 84,340 10,422 64,776
Income taxes charged to the income statement for
discontinued operations:
Current:
State - 3 -
------------ ----------- -----------
Total current - 3 -
Deferred:
Federal 12,156 2,816 2,358
State 1,187 138 82
------------ ----------- -----------
Total deferred 13,343 2,954 2,440
------------ ----------- -----------
Subtotal income taxes for discontinued operations 13,343 2,957 2,440
Income tax benefit on dividends on convertible preferred
securities:
Current:
Federal - - (3,344)
State - - (508)
------------ ----------- -----------
Subtotal income taxes on dividends on convertible
preferred securities - - (3,852)
Income taxes charged to the income statement for
cumulative effect of change in accounting principle:
Deferred:
Federal - - 35,414
State - - 6,177
------------ ----------- -----------
Subtotal income taxes for cumulative effect of
change in accounting principle - - 41,591
------------ ----------- -----------
Total income taxes charged to the income statement (a) 97,683 13,379 104,955
Income taxes charged (credited) to shareholders' equity:
Deferred income taxes (benefits) on unrealized/realized
gains or losses on securities classified as available-
for-sale (411) (10,982) 5,539
Current benefit arising from stock options exercised and
restrict (5,976) (13,765) (2,535)
Deferred income taxes (benefits) arising from recognition of
a minimum pension liability (13,933) (6,645) 13,373
----------- ----------- -----------
Income taxes charged (credited) to shareholders'
equity (b) (20,320) (31,392) 16,377
------------ ----------- -----------
Total income taxes: (a) plus (b) $ 77,363 $(18,013) $ 121,332
============ =========== ===========
F-28
(20) Net Income Per Common Share:
----------------------------
The reconciliation of the net income per common share calculation for the
years ended December 31, 2005, 2004 and 2003 is as follows:
($ in thousands, except per-share amounts)
------------------------------------------ 2005 2004 2003
------------------ ------------------ ------------------
Net income used for basic and diluted
earnings per common share:
Income from continuing operations before cumulative
effect of change in accounting principle $ 200,168 $ 66,919 $ 117,703
Income from discontinued operations 2,207 5,231 4,380
------------------ ------------------ ------------------
Income before cumulative effect of change in accounting principle 202,375 72,150 122,083
Income from cumulative effect of change in accounting principle - - 65,769
------------------ ------------------ ------------------
Total basic net income available for common shareholders $ 202,375 $ 72,150 $ 187,852
================== ================== ==================
Effect of conversion of preferred securities 1,255 - 6,210
------------------ ------------------ ------------------
Total diluted net income available for common shareholders $ 203,630 $ 72,150 $ 194,062
================== ================== ==================
Basic earnings per common share:
Weighted-average shares outstanding - basic 337,065 303,989 282,434
------------------ ------------------ ------------------
Income from continuing operations before cumulative
effect of change in accounting principle $ 0.59 $ 0.22 $ 0.42
Income from discontinued operations 0.01 0.02 0.02
------------------ ------------------ ------------------
Income before cumulative effect of change in accounting principle 0.60 0.24 0.44
Income from cumulative effect of change in accounting principle - - 0.23
------------------ ------------------ ------------------
Net income per share available for common shareholders $ 0.60 $ 0.24 $ 0.67
================== ================== ==================
Diluted earnings per common share:
Weighted-average shares outstanding 337,065 303,989 282,434
Effect of dilutive shares 1,417 5,194 4,868
Effect of conversion of preferred securities 3,193 - 15,134
------------------ ------------------ ------------------
Weighted-average shares outstanding - diluted 341,675 309,183 302,436
================== ================== ==================
Income from continuing operations before cumulative
effect of change in accounting principle $ 0.59 $ 0.22 $ 0.41
Income from discontinued operations 0.01 0.01 0.01
------------------ ------------------ ------------------
Income before cumulative effect of change in accounting principle 0.60 0.23 0.42
Income from cumulative effect of change in accounting principle - - 0.22
------------------ ------------------ ------------------
Net income per share available for common shareholders $ 0.60 $ 0.23 $ 0.64
================== ================== ==================
Stock Options
-------------
For the years ended December 31, 2005, 2004 and 2003 options of 1,930,000
and 2,495,000 (at exercise prices ranging from $13.09 to $18.46), and
10,190,000 (at exercise prices ranging from $9.18 to $21.47), respectively,
issuable under employee compensation plans were excluded from the
computation of diluted earnings per share (EPS) for those periods because
the exercise prices were greater than the average market price of common
shares and, therefore, the effect would be antidilutive.
In connection with the payment of the special, non-recurring dividend of
$2.00 per common share on September 2, 2004, the exercise price and number
of all outstanding options was adjusted such that each option had the same
value to the holder after the dividend as it had before the dividend. In
accordance with FASB Interpretation No. 44 (FIN 44), "Accounting for
Certain Transactions involving Stock Compensation" and EITF 00-23, "Issues
Related to the Accounting for Stock Compensation under APB No. 25 and FIN
44," there is no accounting consequence for changes made to the exercise
price and the number of shares of a fixed stock option or award as a direct
result of the special, non-recurring dividend. In addition, for the years
ended December 31, 2005, 2004 and 2003, restricted stock awards of
1,456,000, 1,686,000 and 1,249,000 shares, respectively, are excluded from
our basic weighted average shares outstanding and included in our dilutive
shares until the shares are no longer contingent upon the satisfaction of
all specified conditions.
F-29
Equity Units and EPPICS
-----------------------
On August 17, 2004 we issued 32,073,633 shares of common stock, including
3,591,000 treasury shares, to our equity unit holders in settlement of the
equity purchase contract component of the equity units. With respect to the
$460,000,000 Senior Note component of the equity units, we repurchased
$300,000,000 principal amount of these Notes in July 2004. The remaining
$160,000,000 of the Senior Notes were repriced and a portion was remarketed
on August 12, 2004 as the 6.75% Notes due August 17, 2006. During 2004, we
repurchased an additional $108,230,000 of the 6.75% Notes which, in
addition to the $300,000,000 purchased in July, resulted in a pre-tax
charge of approximately $20,080,000 during the third quarter of 2004.
As a result of our July dividend announcement with respect to our common
shares, our 5% Company Obligated Mandatorily Redeemable Convertible
Preferred Securities due 2036 (EPPICS) began to convert into shares of our
common stock. As of December 31, 2005, approximately 88% of the EPPICS
outstanding, or about $177,971,000 aggregate principal amount of units,
have converted to 14,237,807 shares of common stock, including 1,116,000
issued from treasury.
At December 31, 2005 and 2004, we had 465,588 and 1,065,171 shares,
respectively, of potentially dilutive EPPICS, which were convertible into
common stock at a 4.36 to 1 ratio at an exercise price of $11.46 per share.
As a result of the September 2004 special, non-recurring dividend, the
EPPICS exercise price for conversion into common stock was reduced from
$13.30 to $11.46. These securities have been included in the diluted income
per common share calculation for the period ended December 31, 2005,
however, they have not been included in the diluted income per share
calculation for the period ended December 31, 2004 because their inclusion
would have had an antidilutive effect.
At December 31, 2003 we had 4,025,000 shares of potentially dilutive EPPICS
that have been included in the diluted income per common share calculation
for the period ended December 31, 2003.
Stock Units
-----------
At December 31, 2005, 2004 and 2003, we had 206,630, 464,879 and 427,475
stock units, respectively, issuable under our Directors' Deferred Fee
Equity Plan and Non-Employee Directors' Retirement Plan. These securities
have not been included in the diluted income per share calculation because
their inclusion would have had an antidilutive effect.
(21) Comprehensive Income (Loss):
----------------------------
Comprehensive income consists of net income (loss) and other gains and
losses affecting shareholder's investment and minimum pension liability
that, under GAAP, are excluded from net income (loss).
F-30
Our other comprehensive income (loss) for the years ended December 31,
2005, 2004 and 2003 is as follows:
2005
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- -------------- --------------- -------------
Net unrealized holding losses on securities
arising during period $ (1,055) $ (395) $ (660)
Minimum pension liability (36,416) (13,933) (22,483)
Less: Reclassification adjustments for net gains
on securities realized in net income (537) (7) (530)
-------------- --------------- -------------
Other comprehensive loss $ (38,008) $ (14,335) $ (23,673)
============== =============== =============
2004
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- -------------- --------------- -------------
Net unrealized holding losses on securities
arising during period $ (1,901) $ (742) $ (1,159)
Minimum pension liability (17,372) (6,645) (10,727)
Less: Reclassification adjustments for net gains
on securities realized in net income (26,247) (10,240) (16,007)
-------------- --------------- -------------
Other comprehensive loss $ (45,520) $ (17,627) $ (27,893)
============== =============== =============
2003
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- -------------- --------------- -------------
Net unrealized holding gains on securities
arising during period $ 14,470 $ 5,539 $ 8,931
Minimum pension liability 34,935 13,373 21,562
-------------- --------------- -------------
Other comprehensive income $ 49,405 $ 18,912 $ 30,493
============== =============== =============
(22) Segment Information:
--------------------
We operate in two segments, Frontier and ELI (a CLEC). The Frontier segment
provides both regulated and unregulated communications services to
residential, business and wholesale customers and is typically the
incumbent provider in its service areas. ELI provides telecommunications
services, principally to businesses. ELI frequently obtains the "last mile"
access to customers through arrangements with the applicable ILEC.
As permitted by SFAS No. 131, we have utilized the aggregation criteria in
combining our markets because all of our Frontier properties share similar
economic characteristics, in that they provide the same products and
services to similar customers using comparable technologies in all of the
states that we operate in. The regulatory structure is generally similar.
Differences in the regulatory regime of a particular state do not impact
the economic characteristics or operating results of a particular property.
F-31
($ in thousands) For the year ended December 31, 2005
---------------- --------------------------------------------------------
Total
Frontier ELI Segments
---------------- ---------------- ----------------
Revenue $ 2,003,318 $ 159,161 $ 2,162,479
Depreciation and Amortization 516,982 24,977 541,959
Operating Income 588,543 18,306 606,849
Capital Expenditures 252,213 16,099 268,312
Assets 5,805,423 168,342 5,973,765
($ in thousands) For the year ended December 31, 2004
---------------- ---------------------------------------------------------------------
Total
Frontier ELI Electric Segments
---------------- ---------------- ---------------- -------------
Revenue $ 2,002,657 $ 156,030 $ 9,735 $ 2,168,422
Depreciation and Amortization 546,747 24,061 - 570,808
Management Succession and
Strategic Alternatives Expenses 87,279 3,353 - 90,632
Operating Income (Loss) 468,889 10,350 (3,134) 476,105
Capital Expenditures 263,193 11,644 - 274,837
Assets 6,077,424 173,369 - 6,250,793
($ in thousands) For the year ended December 31, 2003
---------------- --------------------------------------------------------------------------------------
Total
Frontier ELI Gas Electric Segments
---------------- ---------------- ---------------- ------------- --------------
Revenue $ 2,020,171 $ 165,389 $ 137,686 $ 100,928 $ 2,424,174
Depreciation and Amortization 569,651 23,510 - - 593,161
Reserve for Telecommunications
Bankruptcies (5,524) 1,147 - - (4,377)
Restructuring and Other Expenses 9,373 314 - - 9,687
Loss on Impairment - - - 15,300 15,300
Operating Income (Loss) 530,368 9,710 14,013 (3,359) 550,732
Capital Expenditures 243,445 9,496 9,877 13,984 276,802
Assets 6,399,953 184,559 - 23,130 6,607,642
The following table presents supplemental financial data for ELI.
Summary Income Statement for ELI
-------------------------------------------------------------------------------
( $ in thousands) For the years ended December 31,
----------------- ------------------------------------
2005 2004
----------------- ------------------
Revenue $ 159,161 $ 156,030
Operating expenses 115,878 121,619
Depreciation expense 24,977 24,061
Non-operating expense, net 185 629
----------------- ------------------
Income before income taxes $ 18,121 $ 9,721
================= ==================
F-32
The following tables are reconciliations of certain sector items to the
total consolidated amount.
Capital Expenditures 2005 2004 2003
---------------- ---------------- -------------
Total segment capital expenditures $ 268,312 $ 274,837 $ 276,802
General capital expenditures 147 367 569
---------------- ---------------- -------------
Consolidated reported capital expenditures $ 268,459 $ 275,204 $ 277,371
================ ================ =============
Assets 2005 2004
---------------- ----------------
Total segment assets $ 5,973,765 $ 6,250,793
General assets 438,344 393,504
Discontinued operations assets - 24,122
---------------- ----------------
Consolidated reported assets $ 6,412,109 $ 6,668,419
================ ================
(23) Quarterly Financial Data (Unaudited):
-------------------------------------
($ in thousands, except per share amounts)
------------------------------------------
2005 First quarter Second quarter Third quarter Fourth quarter
---- ------------- -------------- ------------- --------------
Revenue $ 537,223 $ 531,798 $ 537,346 $ 556,112
Operating income 145,112 146,897 141,617 173,223
Net income 42,634 44,584 38,376 76,781
Net income available for common shareholders per basic share $ 0.13 $ 0.13 $ 0.11 $ 0.23
Net income available for common shareholders per diluted share $ 0.12 $ 0.13 $ 0.11 $ 0.23
2004
----
Revenue $ 552,311 $ 537,796 $ 539,188 $ 539,127
Operating income 137,598 126,014 70,087 142,406
Net income (loss) 42,868 23,792 (11,290) 16,780
Net income (loss) available for common shareholders per basic share $ 0.15 $ 0.08 $ (0.04) $ 0.05
Net income (loss) available for common shareholders per diluted shares $ 0.15 $ 0.08 $ (0.04) $ 0.05
The quarterly net income (loss) per common share amounts are rounded to the
nearest cent. Annual net income (loss) per common share may vary depending
on the effect of such rounding.
2005 Transactions
-----------------
On February 1, 2005, we sold shares of Prudential Financial, Inc. for
approximately $1,112,000 in cash, and we recognized a pre-tax gain of
approximately $493,000 that is included in other income (loss), net.
On March 15, 2005, we completed the sale of our conferencing business for
approximately $43,565,000 million in cash. The pre-tax gain on the sale of
CCUSA was $14,061,000. The after-tax gain was approximately $1,167,000.
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 pre-tax gain of approximately $457,000
that is included in other income (loss), net.
During 2005, we sold shares of Global Crossing Limited for approximately
$1,084,000 in cash, and we recognized a pre-tax gain for the same amount
that is included in other income (loss), net.
2004 Transactions
-----------------
On April 1, 2004, we completed the sale of our Vermont electric
distribution operations for approximately $13,992,000 in cash, net of
selling expenses.
F-33
During the third quarter of 2004, we sold our corporate aircraft for
approximately $15,298,000 in cash. The pre-tax loss on the sale was
$1,087,000.
In October 2004, we sold cable assets in California, Arizona, Indiana, and
Wisconsin for approximately $2,263,000 in cash. The pre-tax gain on these
sales was $40,000.
(24) Retirement Plans:
-----------------
We sponsor a noncontributory defined benefit pension plan covering a
significant number of our employees and other postretirement benefit plans
that provide medical, dental, life insurance benefits and other benefits
for covered retired employees and their beneficiaries and covered
dependents. The benefits are based on years of service and final average
pay or career average pay. Contributions are made in amounts sufficient to
meet ERISA funding requirements while considering tax deductibility. Plan
assets are invested in a diversified portfolio of equity and fixed-income
securities and alternative investments.
The accounting results for pension and postretirement benefit costs and
obligations are dependent upon various actuarial assumptions applied in the
determination of such amounts. These actuarial assumptions include the
following: discount rates, expected long-term rate of return on plan
assets, future compensation increases, employee turnover, healthcare cost
trend rates, expected retirement age, optional form of benefit and
mortality. We review these assumptions for changes annually with its
outside actuaries. We consider our discount rate and expected long-term
rate of return on plan assets to be our most critical assumptions.
The discount rate is used to value, on a present value basis, our pension
and postretirement benefit obligation as of the balance sheet date. The
same rate is also used in the interest cost component of the pension and
postretirement benefit cost determination for the following year. The
measurement date used in the selection of our discount rate is the balance
sheet date. Our discount rate assumption is determined annually with
assistance from our actuaries based on the duration of our pension and
postretirement benefit liabilities, the pattern of expected future benefit
payments and the prevailing rates available on long-term, high quality
corporate bonds that approximate the benefit obligation. In making this
determination we consider, among other things, the yields on the Citigroup
Pension Discount Curve and Bloomberg Finance. This rate can change from
year-to-year based on market conditions that impact corporate bond yields.
The expected long-term rate of return on plan assets is applied in the
determination of periodic pension and postretirement benefit cost as a
reduction in the computation of the expense. In developing the expected
long-term rate of return assumption, we considered published surveys of
expected market returns, 10 and 20 year actual returns of various major
indices, and our own historical 5-year and 10-year investment returns.
The expected long-term rate of return on plan assets is based on an asset
allocation assumption of 30% to 45% in fixed income securities, 45% to 55%
in equity securities and 5% to 15% in alternative investments. We review
our asset allocation at least annually and make changes when considered
appropriate. In 2005, we did not change our expected long-term rate of
return from the 8.25% used in 2004. Our pension plan assets are valued at
actual market value as of the measurement date. The measurement date used
to determine pension and other postretirement benefit measures for the
pension plan and the postretirement benefit plan is December 31.
Accounting standards require that we record an additional minimum pension
liability when the plan's "accumulated benefit obligation" exceeds the fair
market value of plan assets at the pension plan measurement (balance sheet)
date. In the fourth quarter of 2005, mainly due to a decrease in the
year-end discount rate, we recorded an additional minimum pension liability
in the amount of $36,416,000 with a corresponding charge to shareholders'
equity of $22,483,000, net of taxes of $13,933,000. In the fourth quarter
of 2004, mainly due to a decrease in the year-end discount rate, we
recorded an additional minimum pension liability in the amount of
$17,372,000 with a corresponding charge to shareholders' equity of
$10,727,000, net of taxes of $6,645,000. These adjustments did not impact
our net income or cash flows for either year. If discount rates and the
equity markets performance decline, we would be required to increase our
minimum pension liabilities and record additional charges to shareholder's
equity in the future.
F-34
Actual results that differ from our assumptions are added or subtracted to
our balance of unrecognized actuarial gains and losses. For example, if the
year-end discount rate used to value the plan's projected benefit
obligation decreases from the prior year-end, then the plan's actuarial
loss will increase. If the discount rate increases from the prior year-end
then the plan's actuarial loss will decrease. Similarly, the difference
generated from the plan's actual asset performance as compared to expected
performance would be included in the balance of unrecognized gains and
losses.
The impact of the balance of accumulated actuarial gains and losses are
recognized in the computation of pension cost only to the extent this
balance exceeds 10% of the greater of the plan's projected benefit
obligation or market value of plan assets. If this occurs, that portion of
gain or loss that is in excess of 10% is amortized over the estimated
future service period of plan participants as a component of pension cost.
The level of amortization is affected each year by the change in actuarial
gains and losses and could potentially be eliminated if the gain/loss
activity reduces the net accumulated gain/loss balance to a level below the
10% threshold.
F-35
Pension Plan
------------
The following tables set forth the plan's benefit obligations and fair
values of plan assets as of December 31, 2005 and 2004 and net periodic
benefit cost for the years ended December 31, 2005, 2004 and 2003.
($ in thousands) 2005 2004
---------------- ------------- --------------
Change in benefit obligation
----------------------------
Benefit obligation at beginning of year $ 799,458 $ 761,683
Service cost 6,117 5,748
Interest cost 46,416 46,468
Actuarial loss 48,750 44,350
Benefits paid (58,139) (58,791)
------------- --------------
Benefit obligation at end of year $ 842,602 $ 799,458
============= ==============
Change in plan assets
---------------------
Fair value of plan assets at beginning of year $ 761,168 $ 719,622
Actual return on plan assets 59,196 80,337
Employer contribution - 20,000
Benefits paid (58,139) (58,791)
------------- --------------
Fair value of plan assets at end of year $ 762,225 $ 761,168
============= ==============
(Accrued)/Prepaid benefit cost
------------------------------
Funded status $ (80,377) $ (38,290)
Unrecognized prior service cost (1,745) (1,988)
Unrecognized net actuarial loss 223,525 183,481
------------- --------------
Prepaid benefit cost $ 141,403 $ 143,203
============= ==============
Amounts recognized in the statement of financial position
---------------------------------------------------------
Accrued benefit liability $ (58,250) $ (20,034)
Other comprehensive income 199,653 163,237
------------- --------------
Net amount recognized $ 141,403 $ 143,203
============= ==============
($ in thousands) 2005 2004 2003
---------------- ------------- -------------- ---------------
Components of net periodic benefit cost
---------------------------------------
Service cost $ 6,117 $ 5,748 $ 6,479
Interest cost on projected benefit obligation 46,416 46,468 49,103
Return on plan assets (60,371) (57,203) (53,999)
Amortization of prior service cost and unrecognized
net obligation (244) (244) (172)
Amortization of unrecognized loss 9,882 8,806 11,026
------------- -------------- ---------------
Net periodic benefit cost 1,800 3,575 12,437
Curtailment/settlement charge - - 6,585
------------- -------------- ---------------
Total periodic benefit cost $ 1,800 $ 3,575 $ 19,022
============= ============== ===============
The plan's weighted average asset allocations at December 31, 2005 and 2004
by asset category are as follows:
2005 2004
---- ----
Asset category:
---------------
Equity securities 50% 57%
Debt securities 34% 32%
Alternative investments 13% 8%
Cash and other 3% 3%
------ ------
Total 100% 100%
====== ======
F-36
The plan's expected benefit payments by year are as follows:
($ in thousands)
----------------
Year Amount
------------- --------------
2006 $ 55,350
2007 57,171
2008 58,523
2009 61,394
2010 62,006
2011 - 2015 319,075
--------------
Total $ 613,519
==============
Our required contribution to the plan in 2006 is $0.
The accumulated benefit obligation for the plan was $820,475,000 and
$781,202,000 at December 31, 2005 and 2004, respectively.
Assumptions used in the computation of pension and postretirement benefits
other than pension costs/year-end benefit obligations were as follows:
2005 2004
---- ----
Discount rate 6.00%/5.625% 6.25%/6.00%
Expected long-term rate of return on plan assets 8.25%/8.25% 8.25%/8.25%
Rate of increase in compensation levels 4.0%/4.0% 4.0%/4.0%
F-37
Postretirement Benefits Other Than Pensions
-------------------------------------------
The following table sets forth the plan's benefit obligations, fair values
of plan assets and the postretirement benefit liability recognized on our
balance sheets at December 31, 2005 and 2004 and net periodic
postretirement benefit costs for the years ended December 31, 2005, 2004
and 2003:
In 2005, we approved changes to certain retiree medical plans. The plan
changes (reflected as amendments in the table below) and the related impact
are included in the accumulated postretirement benefit obligation (APBO) as
of December 31, 2005. The plan changes resulted in a reduction in the APBO
of $59,798,000 which will be amortized as a reduction of retiree medical
expense over the average remaining service life.
($ in thousands) 2005 2004
---------------- ------------- --------------
Change in benefit obligation
----------------------------
Benefit obligation at beginning of year $ 217,380 $ 223,337
Service cost 1,046 1,128
Interest cost 12,055 12,698
Plan participants' contributions 3,461 4,118
Actuarial (gain) loss 3,770 (1,706)
Amendments (59,798) (3,045)
Benefits paid (16,992) (19,150)
------------- --------------
Benefit obligation at end of year $ 160,922 $ 217,380
============= ==============
Change in plan assets
---------------------
Fair value of plan assets at beginning of year $ 15,126 $ 27,493
Actual return on plan assets 397 987
Benefits paid (13,530) (15,032)
Employer contribution 9,431 1,678
------------- --------------
Fair value of plan assets at end of year $ 11,424 $ 15,126
============= ==============
Accrued benefit cost
--------------------
Funded status $(149,498) $(202,254)
Unrecognized prior service cost (61,161) (2,617)
Unrecognized loss 42,325 44,319
------------- --------------
Accrued benefit cost $(168,334) $(160,552)
============= ==============
($ in thousands)
---------------- 2005 2004 2003
------------- -------------- ---------------
Components of net periodic postretirement benefit cost
------------------------------------------------------
Service cost $ 1,046 $ 1,128 $ 1,387
Interest cost on projected benefit obligation 12,055 12,698 13,606
Return on plan assets (1,248) (2,268) (2,133)
Amortization of prior service cost and transition obligation (1,255) (204) 26
Amortization of unrecognized (gain)/loss 6,615 5,238 3,985
------------- -------------- ---------------
Net periodic postretirement benefit cost $ 17,213 $ 16,592 $ 16,871
============= ============== ===============
The plan's weighted average asset allocations at December 31, 2005 and 2004
by asset category are as follows:
2005 2004
--------- --------
Asset category:
---------------
Equity securities 0% 0%
Debt securities 100% 100%
Cash and other 0% 0%
--------- --------
Total 100% 100%
========= ========
F-38
The plan's expected benefit payments by year are as follows:
($ in thousands)
----------------
Gross Medicare D
Year Benefits Subsidy Total
--------------- -------------- ------------- --------------
2006 $ 9,847 $ 676 $ 9,171
2007 10,375 712 9,663
2008 10,843 742 10,101
2009 11,282 770 10,512
2010 11,656 793 10,863
2011 - 2015 60,619 4,049 56,570
-------------- ------------- --------------
Total $ 114,622 $ 7,742 $ 106,880
============== ============= ==============
Our expected contribution to the plan in 2006 is $9,847,000.
For purposes of measuring year-end benefit obligations, we used, depending
on medical plan coverage for different retiree groups, a 9.5% annual rate
of increase in the per-capita cost of covered medical benefits, gradually
decreasing to 5% in the year 2015 and remaining at that level thereafter.
The effect of a 1% increase in the assumed medical cost trend rates for
each future year on the aggregate of the service and interest cost
components of the total postretirement benefit cost would be $1,306,000 and
the effect on the accumulated postretirement benefit obligation for health
benefits would be $13,397,000. The effect of a 1% decrease in the assumed
medical cost trend rates for each future year on the aggregate of the
service and interest cost components of the total postretirement benefit
cost would be $(1,068,000) and the effect on the accumulated postretirement
benefit obligation for health benefits would be $(11,480,000).
In December 2003, the Medicare Prescription Drug Improvement and
Modernization Act of 2003 (the Act) became law. The Act introduces a
prescription drug benefit under Medicare. It includes a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that
is at least actuarially equivalent to the Medicare Part D benefit. The
amount of the federal subsidy will be based on 28% of an individual
beneficiary's annual eligible prescription drug costs ranging between $250
and $5,000. We have determined that the Company-sponsored postretirement
healthcare plans that provide prescription drug benefits are actuarially
equivalent to the Medicare Prescription Drug benefit. The impact of the
federal subsidy has been incorporated in the December 31, 2005 measurement
date.
401(k) Savings Plans
--------------------
We sponsor an employee retirement savings plan under section 401(k) of the
Internal Revenue Code. The Plan covers substantially all full-time
employees. Under the Plan, we provide matching and certain profit-sharing
contributions. Employer contributions were $7,181,000, $8,403,000 and
$9,724,000 for 2005, 2004 and 2003, respectively.
(25) Commitments and Contingencies:
------------------------------
The City of Bangor, Maine, filed suit against us on November 22, 2002, in
the U.S. District Court for the District of Maine (City of Bangor v.
Citizens Communications Company, Civ. Action No. 02-183-B-S). The City
alleged, among other things, that we are responsible for the costs of
cleaning up environmental contamination alleged to have resulted from the
operation of a manufactured gas plant owned by Bangor Gas Company from
1852-1948 and by us from 1948-1963. In acquiring the operation in 1948 we
acquired the stock of Bangor Gas Company and merged it into the Company.
The City alleged the existence of extensive contamination of the Penobscot
River and 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 Honeywell Corporation,
Guilford Transportation (operating as Maine Central Railroad), 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. Trial was conducted in September and October 2005 for the
first (liability) phase of the case, and a decision from the court is
anticipated by the end of the first quarter of 2006. We intend to continue
to defend ourselves vigorously against the City's lawsuit. We have demanded
that various of our insurance carriers defend and indemnify us with respect
to the City's lawsuit, and on December 26, 2002, we filed a declaratory
judgment action against those insurance carriers in the Superior Court of
Penobscot County, Maine, for the purpose of establishing their obligations
to us with respect to the City's lawsuit. We intend to vigorously pursue
this lawsuit to obtain from our insurance carriers indemnification for any
damages that may be assessed against us in the City's lawsuit as well as to
recover the costs of our defense of that lawsuit.
F-39
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 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 $1,000,000,000. In August 2004, we notified Citibank by letter that
we believe its claims for indemnification are invalid and are not supported
by applicable law. We have received no further communications from Citibank
since our August 2004 letter.
We are party to other legal proceedings arising in the normal course of our
business. The outcome of individual matters is not predictable. However, we
believe that the ultimate resolution of all such matters, after considering
insurance coverage, will not have a material adverse effect on our
financial position, results of operations, or our cash flows.
For 2006, we expect our capital expenditures to increase in order to build
wireless data networks and expand the capabilities of our data networks.
Although we from time to time make short-term purchasing commitments to
vendors with respect to these expenditures, we generally do not enter into
firm, written contracts for such activities.
F-40
We conduct certain of our operations in leased premises and also lease
certain equipment and other assets pursuant to operating leases. The lease
arrangements have terms ranging from 1 to 99 years and several contain rent
escalation clauses providing for increases in monthly rent at specific
intervals. When rent escalation clauses exist, we record total expected
rent payments on a straight-line basis over the lease term. Certain leases
also have renewal options. Renewal options that are reasonably assured are
included in determining the lease term. Future minimum rental commitments
for all long-term noncancelable operating leases and future minimum capital
lease payments for continuing operations as of December 31, 2005 are as
follows:
($ in thousands)
---------------- ELI
Capital Operating
Leases Leases
---------- ----------
Year ending December 31:
2006 $ 179 $ 19,062
2007 549 12,605
2008 555 11,840
2009 561 10,416
2010 566 8,891
Thereafter 6,703 29,274
--------- -----------
Total minimum lease payments 9,113 $ 92,088
===========
Less amount representing interest (rates range from 9.75% to 10.65%) (4,826)
---------
Present value of net minimum capital lease payments 4,287
Less current installments of obligations under capital leases (41)
--------
Obligations under capital leases, excluding
current installments $4,246
========
Total rental expense included in our results of operations for the years
ended December 31, 2005, 2004 and 2003 was $24,146,000, $26,349,000 and
$33,801,000, respectively. Until March 1, 2005, we sublet certain office
space in our corporate office to a charitable foundation formed by our
former Chairman.
We are a party to contracts with several unrelated long distance carriers.
The contracts provide fees based on traffic they carry for us subject to
minimum monthly fees.
At December 31, 2005, the estimated future payments for obligations under
our noncancelable long distance contracts and service agreements are as
follows:
($ in thousands)
----------------
Year ILEC / ELI
---------------- ---------------
2006 $ 30,619
2007 18,337
2008 11,017
2009 10,244
2010 1,052
thereafter 5,115
---------------
Total $ 76,384
===============
F-41
We sold all of our utility businesses as of April 1, 2004. However, we have
retained a potential payment obligation associated with our previous
electric utility activities in the state of Vermont. The Vermont Joint
Owners (VJO), a consortium of 14 Vermont utilities, including us, entered
into a purchase power agreement with Hydro-Quebec in 1987. The agreement
contains "step-up" provisions that state that if any VJO member defaults on
its purchase obligation under the contract to purchase power from
Hydro-Quebec the other VJO participants will assume responsibility for the
defaulting party's share on a pro-rata basis. Our pro-rata share of the
purchase power obligation is 10%. If any member of the VJO defaults on its
obligations under the Hydro-Quebec agreement, then the remaining members of
the VJO, including us, may be required to pay for a substantially larger
share of the VJO's total power purchase obligation for the remainder of the
agreement (which runs through 2015). Paragraph 13 of FIN 45 requires that
we disclose "the maximum potential amount of future payments (undiscounted)
the guarantor could be required to make under the guarantee." Paragraph 13
also states that we must make such disclosure "... even if the likelihood
of the guarantor's having to make any payments under the guarantee is
remote..." As noted above, our obligation only arises as a result of
default by another VJO member, such as upon bankruptcy. Therefore, to
satisfy the "maximum potential amount" disclosure requirement we must
assume that all members of the VJO simultaneously default, a highly
unlikely scenario given that the two members of the VJO that have the
largest potential payment obligations are publicly traded with credit
ratings equal to or superior to ours, and that all VJO members are
regulated utility providers with regulated cost recovery. Regardless,
despite the remote chance that such an event could occur, or that the State
of Vermont could or would allow such an event, assuming that all the
members of the VJO defaulted on January 1, 2007 and remained in default for
the duration of the contract (another 9 years), we estimate that our
undiscounted purchase obligation for 2007 through 2015 would be
approximately $1,264,000,000. In such a scenario the Company would then own
the power and could seek to recover its costs. We would do this by seeking
to recover our costs from the defaulting members and/or reselling the power
to other utility providers or the northeast power grid. There is an active
market for the sale of power. We could potentially lose money if we were
unable to sell the power at cost. We caution that we cannot predict with
any degree of certainty any potential outcome.
At December 31, 2005, we have outstanding performance letters of credit as
follows:
($ in thousands)
----------------
CNA $19,404
State of New York 2,993
ELI projects 50
-----------
Total $22,447
===========
CNA serves as our agent with respect to general liability claims (auto,
workers compensation and other insured perils of the Company). As our
agent, they administer all claims and make payments for claims on our
behalf. We reimburse CNA for such services upon presentation of their
invoice. To serve as our agent and make payments on our behalf, CNA
requires that we establish a letter of credit in their favor. CNA could
potentially draw against this letter of credit if we failed to reimburse
CNA in accordance with the terms of our agreement. The value of the letter
of credit is reviewed annually and adjusted based on claims history.
None of the above letters of credit restrict our cash balances.
(26) Subsequent Event:
----------------
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 $247,000,000, including $243,000,000
in cash plus the assumption of approximately $4,000,000 in capital lease
obligations, subject to customary adjustments under the terms of the
agreement. This transaction is expected to close during the third quarter
of 2006 and is subject to regulatory and other customary approvals and
conditions, as well as the funding of Integra's fully committed financing.
We expect that for periods subsequent to December 31, 2005, ELI will be
accounted for as a discontinued operation.
F-42
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
Citizens Communications Company:
Under date of March 1, 2006, we reported separately on the consolidated
balance sheets of Citizens Communications Company and subsidiaries as of
December 31, 2005 and 2004, and the related consolidated statements of
operations, shareholders' equity, comprehensive income (loss) and cash
flows for each of the years in the three-year period ended December 31,
2005. In connection with our audits of the aforementioned consolidated
financial statements, we have also audited the related financial statement
schedule. The financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on the
financial statement schedule based on our audits. In our opinion, such
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
Our report refers to the adoption of Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations" as of
January 1, 2003.
/s/ KPMG LLP
Stamford, Connecticut
March 1, 2006
F-43
Schedule II
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Valuation and Qualifying Accounts
($ In thousands)
Additions
--------------------------------
Balance at Charges to Charged to other Balance at
beginning of costs and accounts - End of
Accounts period expenses Revenue Deductions Period
------------------------------ -------------------------------------------------------------------------
Allowance for doubtful accounts
2003 38,871 21,540 32,240 (45,342) 47,309
2004 47,309 17,906 13,446 (42,665) 35,996
2005 35,996 13,510 10,791 (27,889) 32,408
F-44