<DOCUMENT>
<TYPE>10-Q
<SEQUENCE>1
<FILENAME>cc3qtr10q.txt
<DESCRIPTION>CITIZENS 3QTR 10Q
<TEXT>
CITIZENS COMMUNICATIONS COMPANY
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2001
------------------
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________to__________
Commission file number 001-11001
---------
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-0619596
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
P.O. Box 3801
Stamford, Connecticut 06905
---------------------------
(Address, zip code of principal executive offices)
Registrant's telephone number, including area code (203) 614-5600
-----------------
NO CHANGES
----------
(Former name, former address and former fiscal year, if changed since
last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve 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 ninety days.
Yes X No
----- -----
The number of shares outstanding of the registrant's class of common stock as of
October 31, 2001 was 280,074,616.
<PAGE>
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index to Consolidated Financial Statements
<TABLE>
<CAPTION>
Page No.
Part I. Financial Information (Unaudited)
<S> <C>
Consolidated Balance Sheets at September 30, 2001 and December 31, 2000 2
Consolidated Statements of Income for the three months ended September 30, 2001 and 2000 3
Consolidated Statements of Income for the nine months ended September 30, 2001 and 2000 4
Consolidated Statements Comprehensive Loss for the three and nine months ended
September 30, 2001 and 2000 5
Consolidated Statements of Shareholders' Equity for the year ended December 31, 2000 and the
nine months ended September 30, 2001 6
Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and 2000 7
Notes to Consolidated Financial Statements 8
Management's Discussion and Analysis of Financial Condition and Results of Operations 20
Quantitative and Qualitative Disclosures about Market Risk 35
Part II. Other Information
Legal Proceedings 37
Changes in Securities and Use of Proceeds 37
Defaults upon Senior Securities 37
Submission of Matters to a Vote of Security Holders 37
Other Information 37
Exhibits and Reports on Form 8-K 38
Signature 39
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands except per-share amounts)
Unaudited
<TABLE>
<CAPTION>
September 30, 2001 December 31, 2000
ASSETS
------
Current assets:
<S> <C> <C>
Cash $ 38,922 $ 31,223
Accounts receivable, net 339,382 243,304
Short-term investments 141,496 38,863
Other current assets 42,844 52,545
Assets held for sale 1,093,939 1,212,307
Assets of discontinued operations 743,238 673,515
------------------- ------------------
Total current assets 2,399,821 2,251,757
Property, plant and equipment, net 4,537,291 3,520,712
Intangibles 2,864,454 633,268
Investments 117,124 214,359
Regulatory assets - 175,949
Other assets 466,441 158,961
------------------- ------------------
Total assets $ 10,385,131 $ 6,955,006
=================== ==================
LIABILITIES AND EQUITY
----------------------
Current liabilities:
Long-term debt due within one year $ 155,967 $ 181,014
Accounts payable and other current liabilities 516,520 330,383
Liabilities related to assets held for sale 214,090 290,575
Liabilities of discontinued operations 219,568 190,496
------------------- ------------------
Total current liabilities 1,106,145 992,468
Deferred income taxes 408,975 490,487
Customer advances for construction and contributions
in aid of construction 206,332 205,604
Other liabilities 232,702 108,321
Regulatory liabilities - 24,573
Equity units 460,000 -
Long-term debt 5,783,591 3,062,289
------------------- ------------------
Total liabilities 8,197,745 4,883,742
Equity forward contracts - 150,013
Company Obligated Mandatorily Redeemable Convertible
Preferred Securities* 201,250 201,250
Shareholders' equity:
Common stock, $.25 par value (600,000,000 authorized shares;
280,036,000 and 262,661,000 outstanding and 292,344,000 and
265,768,000 issued at September 30, 2001 and December 31, 2000,
respectively) 73,086 66,442
Additional paid-in capital 1,936,607 1,471,816
Retained earnings 238,179 233,196
Accumulated other comprehensive income (loss) (59,147) 418
Treasury stock (202,589) (51,871)
------------------- ------------------
Total shareholders' equity 1,986,136 1,720,001
------------------- ------------------
Total liabilities and equity $ 10,385,131 $ 6,955,006
=================== ==================
</TABLE>
* Represents securities of a subsidiary trust, the sole assets of which are
securities of a subsidiary partnership, substantially all the assets of which
are convertible debentures of the Company.
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
2
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(In thousands, except per-share amounts)
Unaudited
<TABLE>
<CAPTION>
2001 2000
-------------- --------------
<S> <C> <C>
Revenue $ 661,121 $ 452,710
Operating expenses:
Cost of services 123,214 114,497
Depreciation and amortization 193,662 95,859
Other operating expenses 267,892 187,373
Restructuring expenses 13,002 -
Acquisition assimilation expense 5,119 12,539
-------------- --------------
Total operating expenses 602,889 410,268
-------------- --------------
Operating income 58,232 42,442
Investment and other income, net 3,070 5,096
Gain on sale of assets 139,304 -
Interest expense 123,452 49,559
-------------- --------------
Income (loss) from continuing operations before income taxes, dividends
on convertible preferred securities and extraordinary expense 77,154 (2,021)
Income tax expense (benefit) 39,610 (202)
-------------- --------------
Income (loss) from continuing operations before dividends
on convertible preferred securities and extraordinary expense 37,544 (1,819)
Dividends on convertible preferred securities, net of income tax benefit 1,553 1,553
-------------- --------------
Income (loss) from continuing operations before extraordinary expense 35,991 (3,372)
Income from discontinued operations, net of tax 7,199 4,838
-------------- --------------
Income before extraordinary expense 43,190 1,466
Extraordinary expense - discontinuation of Statement of Financial
Accounting Standards No. 71, net of tax 43,631 -
-------------- --------------
Net income (loss) $ (441) $ 1,466
============== ==============
Carrying cost of equity forward contracts 1,003 -
-------------- --------------
Available for common shareholders $ (1,444) $ 1,466
============== ==============
Basic income (loss) per common share:
Earnings from continuing operations $ 0.12 $ (0.01)
Earnings from discontinued operations 0.03 0.02
Extraordinary expense (0.15) -
Available for common shareholders (0.01) 0.01
Diluted income (loss) per common share:
Earnings from continuing operations $ 0.12 $ (0.01)
Earnings from discontinued operations 0.02 0.02
Extraordinary expense (0.15) -
Available for common shareholders (0.01) 0.01
</TABLE>
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
3
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(In thousands, except per-share amounts)
Unaudited
<TABLE>
<CAPTION>
2001 2000
-------------- --------------
<S> <C> <C>
Revenue $ 1,791,144 $ 1,320,019
Operating expenses:
Cost of services 477,107 338,839
Depreciation and amortization 413,734 278,483
Other operating expenses 662,972 563,427
Restructuring expenses 13,002 -
Acquisition assimilation expense 17,665 24,130
-------------- --------------
Total operating expenses 1,584,480 1,204,879
-------------- --------------
Operating income 206,664 115,140
Investment and other income, net 16,495 14,913
Gain on sale of assets 139,304 -
Minority interest - 12,222
Interest expense 258,033 128,899
-------------- --------------
Income from continuing operations before income taxes, dividends
on convertible preferred securities and extraordinary expense 104,430 13,376
Income tax expense 49,183 5,096
-------------- --------------
Income from continuing operations before dividends
on convertible preferred securities and extraordinary expense 55,247 8,280
Dividends on convertible preferred securities, net of income tax benefit 4,658 4,658
-------------- --------------
Income from continuing operations before extraordinary expense 50,589 3,622
Income from discontinued operations, net of tax 11,675 8,182
-------------- --------------
Income before extraordinary expense 62,264 11,804
Extraordinary expense - discontinuation of Statement of Financial
Accounting Standards No. 71, net of tax 43,631 -
-------------- --------------
Net income $ 18,633 $ 11,804
============== ==============
Carrying cost of equity forward contracts 13,650 -
-------------- --------------
Available for common shareholders $ 4,983 $ 11,804
============== ==============
Basic income per common share:
Earnings from continuing operations $ 0.14 $ 0.01
Earnings from discontinued operations 0.04 0.03
Extraordinary expense (0.16) -
Available for common shareholders 0.02 0.05
Diluted income per common share:
Earnings from continuing operations $ 0.13 $ 0.01
Earnings from discontinued operations 0.04 0.03
Extraordinary expense (0.16) -
Available for common shareholders 0.02 0.04
</TABLE>
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
4
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(In thousands)
Unaudited
<TABLE>
<CAPTION>
For the three months ended September 30, For the nine months ended September 30,
----------------------------------------- -----------------------------------------
2001 2000 2001 2000
------------------ ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
Net income $ (441) $ 1,466 $ 18,633 $ 11,804
Other comprehensive loss, net of tax (34,696) (28,704) (59,565) (69,097)
------------------ ------------------- ------------------- -------------------
Total comprehensive income (loss) $ (35,137) $ (27,238) $ (40,932) $ (57,293)
================== =================== =================== ===================
</TABLE>
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
5
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2000 AND
THE NINE MONTHS ENDED SEPTEMBER 30, 2001
(In thousands, except per-share amounts)
Unaudited
<TABLE>
<CAPTION>
Accumulated
Common Additional Other Total
Stock Paid-In Retained Comprehensive Treasury Shareholders'
($0.25 par) Capital Earnings Income (Loss) Stock Equity
------------ ------------- ------------- -------------------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balances January 1, 2000 $ 65,519 $1,577,903 $ 261,590 $ 14,923 $ - $ 1,919,935
Acquisitions 28 1,770 - - 1,861 3,659
Treasury stock acquisitions - - - - (49,209) (49,209)
Stock plans 895 42,156 - - (4,523) 38,528
Equity forward contracts - (150,013) - - - (150,013)
Net loss - - (28,394) - - (28,394)
Other comprehensive loss, net of tax - - - (14,505) - (14,505)
------------ ------------- ------------- ------------ ------------ -------------
Balances December 31, 2000 66,442 1,471,816 233,196 418 (51,871) 1,720,001
Stock plans 355 26,538 - - (705) 26,188
Common stock offering 6,289 283,272 - - - 289,561
Equity units offering - 4,968 - - - 4,968
Settlement of equity forward contracts - 150,013 (13,650) - (150,013) (13,650)
Net income - - 18,633 - - 18,633
Other comprehensive loss, net of tax - - - (59,565) - (59,565)
------------ ------------- ------------- ------------ ------------ -------------
Balances September 30, 2001 $ 73,086 $1,936,607 $ 238,179 $ (59,147) $ (202,589) $ 1,986,136
============ ============= ============= ============ ============ =============
</TABLE>
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
6
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(In thousands)
<TABLE>
<CAPTION>
2001 2000
---------------- ----------------
<S> <C> <C>
Net cash provided by continuing operating activities $ 403,443 $ 262,962
Cash flows from investing activities:
Acquisitions (3,369,517) (644,300)
Proceeds from sale of assets 363,436 -
Capital expenditures (350,480) (409,342)
Securities purchased (104,018) (52,589)
Securities sold 1,218 129,396
Securities matured - 10,400
ELI share purchases - (38,748)
Other 940 18
---------------- ----------------
Net cash used by investing activities (3,458,421) (1,005,165)
Cash flows from financing activities:
Long-term debt borrowings 3,503,060 819,869
Long-term debt principal payments (956,821) (35,183)
Issuance of equity units 460,000 -
Debt issuance cost (67,499) -
Common stock offering 289,561 -
Issuance of common stock for employee plans 23,490 22,176
Settlement of equity forward contracts (163,663) -
Common stock buybacks - (49,209)
Customer advances for construction and contributions in
aid of construction 3,525 14,159
---------------- ----------------
Net cash provided by financing activities 3,091,653 771,812
Cash used by discontinued operations (28,976) (20,787)
---------------- ----------------
Increase in cash 7,699 8,822
Cash at January 1, 31,223 37,141
---------------- ----------------
Cash at September 30, $ 38,922 $ 45,963
================ ================
Non-cash investing and financing activities:
Increase in capital lease asset $ 33,985 $ 98,555
</TABLE>
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
7
<PAGE>
PART I. FINANCIAL INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies:
------------------------------------------
(a) Basis of Presentation:
Citizens Communications Company and its subsidiaries are referred to
as "we", "us" or "our" in this report. The unaudited consolidated
financial statements include our accounts and have been prepared in
conformity with generally accepted accounting principles and should be
read in conjunction with the consolidated financial statements and
notes included in our 2000 Annual Report on Form 10-K. These unaudited
consolidated financial statements include all adjustments, which
consist of normal recurring accruals necessary to present fairly the
results for the interim periods shown. Certain information and
footnote disclosures have been condensed pursuant to Securities and
Exchange Commission rules and regulations. The results of the interim
periods are not necessarily indicative of the results for the full
year. Certain reclassifications of balances previously reported have
been made to conform to current presentation.
(b) Regulatory Assets and Liabilities:
Certain of our local exchange telephone operations were, and all of
our public utilities services operations are, subject to the
provisions of Statement of Financial Accounting Standards (SFAS) No.
71, "Accounting for the Effects of Certain Types of Regulation". For
these entities, regulators can establish regulatory assets and
liabilities that are required to be reflected on the balance sheet in
anticipation of future recovery through the ratemaking process. In the
third quarter of 2001, due to the continued process of deregulation
and the introduction of competition to our rural local exchange
telephone properties and our expectation that these trends will
continue, we concluded it was appropriate to discontinue the
application of SFAS 71 (see Note 11) for our local exchange telephone
properties.
(c) Revenue Recognition:
Incumbent Local Exchange Carrier (ILEC) - 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 accrued expenses on our 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 on our statement of income
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 exceed
installation fee revenue.
Electric Lightwave, Inc. (ELI) - Revenue is recognized when the
services are provided. Revenue from long-term prepaid network services
agreements are deferred and recognized on a straight-line basis over
the terms of the related agreements. Installation fees and related
costs (up to the amount of installation revenue) are deferred and
recognized over the average customer life. Installation related costs
in excess of installation fees are expensed when incurred.
Public Utilities Services - Revenue is recognized when services are
provided for public utilities services. Certain revenue is based upon
consumption while other revenue is based upon a flat fee. Earned but
unbilled public utilities services revenue is accrued for and included
in accounts receivable and revenue.
(d) Net Income Per Common Share:
Basic net income per common share is computed using the weighted
average number of common shares outstanding during the period being
reported on. Diluted net income per common share reflects the
potential dilution that could occur if securities or other contracts
to issue common stock were exercised or converted into common stock at
the beginning of the period being reported on (see Note 8).
8
<PAGE>
(2) Property, Plant and Equipment, Net:
-----------------------------------
Property, plant and equipment, net at September 30, 2001 and December 31,
2000 is as follows:
<TABLE>
<CAPTION>
($ in thousands) September 30, 2001 December 31, 2000
-------------------- --------------------
<S> <C> <C>
Property, plant and equipment $ 6,593,191 $ 5,307,427
Less accumulated depreciation (2,055,900) (1,786,715)
-------------------- --------------------
Property, plant and equipment, net $ 4,537,291 $ 3,520,712
==================== ====================
</TABLE>
At September 30, 2001, approximately $1,132,069,000 of net property, plant
and equipment was related to our acquisition of Frontier Corp. which was
completed on June 29, 2001 (see Note 3). At December 31, 2000,
approximately $197,952,000 of net property, plant and equipment was related
to our Louisiana gas operations which were disposed of on July 2, 2001 (see
Note 5).
Depreciation expense, calculated using the straight-line method, is based
upon the estimated service lives of various classifications of property,
plant and equipment. Depreciation expense was $141,709,000 and $92,004,000
for the three months ended September 2001 and 2000, respectively, and
$335,452,000 and $273,198,000 for the nine months ended September 30, 2001
and 2000, respectively. We ceased to record depreciation expense on the gas
assets held for sale effective October 1, 2000 and on the electric assets
held for sale effective January 1, 2001 (see Note 5).
(3) Acquisitions:
-------------
From May 27, 1999 through July 12, 2000, we entered into several agreements
to acquire telephone access lines. These transactions have been and will be
accounted for using the purchase method of accounting. The results of
operations of the acquired properties have been and will be included in our
financial statements from the dates of acquisition of each property. These
agreements and the status of each transaction are described as follows:
Verizon Acquisition
-------------------
Between May and December 1999, we announced agreements to purchase
from Verizon Communications Inc., formerly GTE Corp. (Verizon),
approximately 381,200 telephone access lines (as of December 31, 2000)
in Arizona, California, Illinois/Wisconsin, Minnesota and Nebraska for
approximately $1,171,000,000 in cash. To date, we have closed on
approximately 317,500 telephone access lines. We have received all
necessary regulatory approvals and expect that the acquisition of the
remaining access lines in Arizona and California will close during
2002. Our expected cash requirement to complete the Verizon
acquisitions is $222,800,000.
Qwest Acquisition - termination
-------------------------------
In June 1999, we announced agreements to purchase from Qwest
approximately 556,800 telephone access lines (as of December 31, 2000)
in Arizona, Colorado, Idaho/Washington, Iowa, Minnesota, Montana,
Nebraska, North Dakota and Wyoming for approximately $1,650,000,000 in
cash and the assumption of certain liabilities. To date, we have
closed on the purchase of approximately 17,000 telephone access lines
in North Dakota for approximately $38,000,000 in cash. On July 20,
2001, we notified Qwest that we were terminating eight acquisition
agreements with Qwest relating to telephone exchanges in Arizona,
Colorado, Idaho/Washington, Iowa, Minnesota, Montana, Nebraska and
Wyoming for the remaining 539,800 telephone access lines. Qwest
subsequently filed a notice of claim for arbitration in Denver,
Colorado under the rules of the American Arbitration Association with
respect to the terminated acquisition agreements. Qwest asserts that
we wrongfully terminated these agreements and is seeking approximately
$64,000,000, which is the aggregate of liquidation damages under
letters of credit established in the terminated acquisition
agreements. We have filed a notice of claim in the same arbitration
proceeding, contesting Qwest's asserted claims and asserting
substantial claims against Qwest for material breaches of
representations, warranties and covenants in the terminated
acquisition agreements and in the acquisition agreement relating to
North Dakota assets that we purchased from Qwest.
9
<PAGE>
Frontier Acquisition
--------------------
On June 29, 2001, we purchased from Global Crossing Ltd. (Global) 100%
of the stock of Frontier Corp.'s local exchange carrier subsidiaries,
which owned approximately 1,096,700 telephone access lines (as of
December 31, 2000) in Alabama/Florida, Georgia, Illinois, Indiana,
Iowa, Michigan, Minnesota, Mississippi, New York, Pennsylvania and
Wisconsin, for approximately $3,370,000,000 in cash, subject to
adjustment. The operations of Frontier are included in our financial
statements from the date of acquisition.
In conjunction with the Frontier acquisition, we are evaluating our
facilities to take advantage of operational and functional synergies
between the two companies with the objective of concentrating our
resources in the areas where we have the most customers, to better
serve those customers. Accordingly, we intend to close our operations
support center in Plano, Texas by April 2002 (see note 7).
The following pro forma financial information for the nine months ended
September 30, 2001 and 2000 present the combined results of our operations
and the Frontier, Verizon and Qwest acquisitions as if the acquisitions had
occurred at the beginning of the year prior to their acquisition. Pro Forma
financial information for the nine months ended September 30, 2001 includes
approximatley $29 million of revenues for long distance services provided
to customers of Frontier subsequent to the date of acquisition. The pro
forma financial information does not include long distance services revenue
prior to such date. The pro forma financial information does not
necessarily reflect the results of operations that would have occurred had
we constituted a single entity during such periods. The sale of our
Louisiana Gas operations (see note 5) is not presented on a pro forma
basis.
<TABLE>
<CAPTION>
($ in thousands, except per share amounts)
For the nine months ended September 30,
------------------------------------------
2001 2000
-------------------- -------------------
<S> <C> <C>
Revenue $ 2,178,940 $ 2,015,403
Net income (loss) $ (53,522) $ (44,711)
Net income (loss) available to
common shareholders per share $ (0.25) $ (0.16)
</TABLE>
(4) Intangibles:
------------
Intangibles at September 30, 2001 and December 31, 2000 are as follows:
<TABLE>
<CAPTION>
($ in thousands) September 30, 2001 December 31, 2000
-------------------- --------------------
<S> <C> <C>
Goodwill $ 490,012 $ 488,435
Customer base and other 195,243 144,833
Excess of cost over net assets acquired 2,179,199 -
------------------- --------------------
Total intangibles $ 2,864,454 $ 633,268
==================== ====================
</TABLE>
We have reflected assets acquired at fair market values in accordance with
purchase accounting standards. Our allocations are based upon an
independent appraisal of the respective property. We have not received a
valuation of our Frontier purchase and have allocated, temporarily,
approximately $2.2 billion of the purchase price to "excess of cost over
net assets acquired". Upon receipt of a final valuation, the excess of cost
over historical net assets acquired for the Frontier acquisition will be
allocated to property, plant and equipment, customer base, other
identifiable intangibles and goodwill.
(5) Discontinued Operations and Net Assets Held for Sale:
-----------------------------------------------------
On August 24, 1999, our Board of Directors approved a plan of divestiture
for our public utilities services businesses, which include gas, electric
and water and wastewater businesses. Currently, we have agreements to sell
all our water and wastewater operations, one of our electric operations and
one of our natural gas operations and we have sold another of our natural
gas operations. We have received proceeds on the sale of assets of
$363,400,000, and have agreements to sell assets for an aggregate of
$1,026,000,000 plus the assumption of certain liabilities and debt. The
purchase price under one of these agreements may be reduced. These
agreements and the status of each transaction are described as follows:
10
<PAGE>
Water and Wastewater
--------------------
On October 18, 1999, we announced the agreement to sell our water and
wastewater operations to American Water Works, Inc. for $745,000,000
in cash and $90,000,000 of assumed debt. This transaction is expected
to close in the fourth quarter of 2001.
Electric
--------
On February 15, 2000, we announced that we had agreed to sell our
electric utility operations. The Arizona and Vermont electric
divisions were under contract to be sold to Cap Rock Energy Corp. (Cap
Rock). The agreement with Cap Rock was terminated on March 7, 2001. We
intend to pursue the disposition of the Vermont and Arizona electric
divisions with alternative buyers. In August 2000, the Hawaii Public
Utilities Commission denied the initial application requesting
approval of the purchase of our Kauai electric division by the Kauai
Island Electric Co-op for $270,000,000 in cash including the
assumption of certain liabilities. We are discussing a reduction of
the purchase price and other options. Our agreement for the sale of
this division may be terminated if regulatory approval is not received
before February 2002.
Gas
---
On July 2, 2001, we completed on the sale of our Louisiana Gas
operations to Atmos Energy Corporation for $363,436,000 in cash. The
pre-tax gain on the sale recognized in the third quarter was
$139,304,000.
In July 2001, an agreement was signed to sell the Colorado Gas
division to Kinder Morgan for $11,000,000 in cash. This transaction
has received all necessary regulatory approvals and is expected to
close in the fourth quarter of 2001.
Discontinued operations in the consolidated statements of income reflect
the results of operations of the water/wastewater properties including
allocated interest expense for the periods presented. Interest expense was
allocated to the discontinued operations based on the outstanding debt
specifically identified with these businesses. The long-term debt presented
in liabilities of discontinued operations represents the only liability to
be assumed by the buyer pursuant to the water and wastewater asset sale
agreements.
We initially accounted for the planned divestiture of all the public
utilities services properties as discontinued operations. Currently, we do
not have agreements to sell our entire gas and electric segments.
Consequently, we reclassified all of our gas (on September 30, 2000) and
electric (on December 31, 2000) assets and their related liabilities to
"assets held for sale" and "liabilities related to assets held for sale,"
respectively. We also reclassified the results of these operations from
discontinued operations to their original income statement captions as part
of continuing operations. Additionally, we ceased to record depreciation
expense on the gas assets effective October 1, 2000 and on the electric
assets effective January 1, 2001. Such depreciation expense would have been
an additional $11,400,000 and $39,500,000 for the three and nine months
ended September 30, 2001, respectively. We continue to actively pursue
buyers for our remaining gas and electric businesses.
Summarized financial information for the water/wastewater operations
(discontinued operations) is set forth below:
($ in thousands) September 30, 2001 December 31, 2000
------------------ -------------------
Current assets $ 20,424 $ 18,578
Net property, plant and equipment 667,741 639,994
Other assets 55,073 14,943
------------------ ------------------
Total assets $ 743,238 $ 673,515
================== ==================
Current liabilities $ 25,547 $ 21,062
Long-term debt 90,448 90,546
Other liabilities 103,573 78,888
------------------ ------------------
Total liabilities $ 219,568 $ 190,496
================== ==================
11
<PAGE>
($ in thousands) For the three months ended September 30,
------------------------------------------
2001 2000
------------------ ------------------
Revenue $ 34,451 $ 29,272
Operating income $ 14,832 $ 9,716
Income tax expense $ 4,571 $ 2,413
Net income $ 7,199 $ 4,838
($ in thousands) For the nine months ended September 30,
------------------------------------------
2001 2000
------------------ ------------------
Revenue $ 87,880 $ 79,913
Operating income $ 26,777 $ 19,746
Income tax expense $ 6,730 $ 3,924
Net income $ 11,675 $ 8,182
Summarized financial information for the gas and electric operations (held
for sale) is set forth below:
<TABLE>
<CAPTION>
($ in thousands) September 30, 2001 December 31, 2000
-------------------- --------------------
<S> <C> <C>
Current assets $ 76,832 $ 127,495
Net property, plant and equipment 794,456 953,328
Other assets 222,651 131,484
-------------------- --------------------
Total assets held for sale $ 1,093,939 $ 1,212,307
==================== ====================
Current liabilities $ 69,975 $ 169,066
Long-term debt 43,400 43,980
Other liabilities 100,715 77,529
-------------------- --------------------
Total liabilities related to assets held
for sale $ 214,090 $ 290,575
==================== ====================
</TABLE>
(6) Security Issuances:
------------------
We issued the following securities during the nine months ended September
30, 2001 under our $3,800,000,000 shelf registration statement and in a
private placement. The net proceeds from these issuances were used to repay
bank borrowings, fund the Frontier Acquisition (see note 3), to settle the
equity forward contract (see note 12) and for general corporate purposes.
We have $825,600,000 remaining on our shelf registration after these
issuances.
Long-Term Debt
--------------
On May 18, 2001, we issued an aggregate of $1.75 billion of notes
consisting of $700 million principal amount of 8.50% notes, due May 15,
2006 and $1.05 billion principal amount of 9.25% notes due May 15, 2011.
The net proceeds of this issuance was $1,726,000,000 (after underwriting
discounts and commissions and before offering expenses).
Equity Units
------------
On June 13, 2001, we issued 18,400,000 equity units at $25 per unit for net
proceeds of $446,200,000 (after underwriting discounts and commissions and
before offering expenses). Each equity unit initially consists of a 6.75%
senior note due 2006 and a purchase contract (warrant) for our common
stock. The purchase contract obligates the holder to purchase from us, no
later than August 17, 2004 for a purchase price of $25, the following
number of shares of our common stock:
o 1.7218 shares, if the average closing price of our common stock over
the 20-day trading period ending on the third trading day prior to
August 17, 2004 equals or exceeds $14.52;
o A number of shares having a value, based on the average closing price
over that period, equal to $25, if the average closing price of our
common stock over the same period is less than $14.52, but greater
than $12.10; and
o 2.0661 shares, if the average closing price of our common stock over
the same period is less than or equal to $12.10.
The equity units trade on The New York Stock Exchange under the symbol
"CZB."
12
<PAGE>
Common Stock
------------
On June 13, 2001, we issued 25,156,250 shares of our common stock at
$12.10, for net proceeds of $289,561,000 (after underwriting discounts and
commissions).
Private Placement
-----------------
In August 2001, through a sale by private placement to Rule 144A qualified
investors, we issued an aggregate of $1.75 billion of notes consisting of
$300 million principal amount of 6.375% notes due 2004, $750 million
principal amount of 7.625% notes due 2008 and $700 million principal amount
of 9.000% notes due 2031. The net proceeds of this issuance were
$1,728,900,000 (after placement agent discounts and commissions and before
offering expenses). We have filed a registration statement with the
Securities and Exchange Commission (SEC) on Form S-4 in September 2001 to
register a public exchange of publicly traded notes with substantially
identical terms to the notes sold in the private placement, except for
transfer restriction and registration rights relating to the initial notes.
The registration statement has not yet been declared effective by the SEC.
<TABLE>
<CAPTION>
Following is the activity in our long-term debt from December 31, 2000 to September 30, 2001:
For the nine months ended
-----------------------------------------
Remarketing/ Interest Rate at
December 31, Borrowings/ Change in September 30, September 30,
($ in thousands) 2000 Acquisitions Current Portion Payments 2001 2001*
--------------------------------------------------------------------------------------
Fixed Rate
Rural Utilities Service Loan Contracts
<S> <C> <C> <C> <C> <C>
ILEC $ 90,129 $ 1,430 - $ (3,355) $ 88,204 6.378%
Frontier - 43,246 - - 43,246 5.531%
----------- ----------- ------------ --------- -----------
Subtotal 90,129 44,676 - (3,355) 131,450
----------- ----------- ------------ --------- -----------
Debentures 1,000,000 - - (50,000) 950,000 7.464%
2001 Notes
8.500% Due 2006 - 700,000 - - 700,000 8.740%
9.250% Due 2011 - 1,050,000 - - 1,050,000 9.340%
6.375% Due 2004 - 300,000 - - 300,000 6.649%
7.625% Due 2008 - 750,000 - - 750,000 7.835%
9.000% Due 2031 - 700,000 - - 700,000 9.148%
----------- ----------- ----------- ---------- ----------
Subtotal - 3,500,000 - - 3,500,000
----------- ----------- ----------- ---------- ----------
Equity Units
6.750% Due 2006 - 460,000 - - 460,000 7.480%
----------- ----------- ----------- ---------- ----------
Subtotal - 460,000 - - 460,000
----------- ----------- ----------- ---------- ----------
Senior Unsecured Notes
ILEC 36,000 - - - 36,000 8.050%
Frontier - 74,415 - (787) 73,628 7.610%
----------- ----------- ----------- ---------- ----------
Subtotal 36,000 74,415 - (787) 109,628
----------- ----------- ----------- ---------- ----------
ELI notes 325,000 - - - 325,000 6.232%
ELI capital leases 132,248 33,985 - (28,283) 137,950 11.765%
Industrial Development Revenue Bonds 263,595 - $ (14,400) - 249,195 6.435%
Other 308 - - (251) 57 12.986%
----------- ----------- ----------- ---------- ----------
Total fixed rate 1,847,280 4,113,076 (14,400) (82,676) 5,863,280
----------- ----------- ----------- ---------- ----------
Variable Rate
Commercial Paper Notes Payable 109,145 - - (109,145) -
Bank Credit Facility 765,000 - - (765,000) -
ELI Bank Credit Facility 400,000 - - - 400,000 3.822%
Industrial Development Revenue Bonds 121,878 - 14,400 - 136,278 5.221%
----------- ----------- ----------- --------- ----------
Total variable rate 1,396,023 - $ 14,400 (874,145) 536,278
----------- ----------- ---------- --------- ----------
Total $ 3,243,303 $ 4,113,076 - $(956,821) $ 6,399,558
=========== =========== ========== ========= ==========
</TABLE>
* Interest rate includes amortization of debt issuance expenses, debt premiums
or discounts. The interest rate for Rural Utilities Service Loan Contracts,
Debentures, ILEC Senior Unsecured Notes, and Industrial Development Revenue
Bonds represent a weighted average of multiple issuances. The interest rates on
the commercial paper notes payable and the bank credit facility at December 30,
2000 were 6.81% and 7.19%, respectively.
13
<PAGE>
(7) Restructuring Charges:
----------------------
2001
----
In the second quarter of 2001, we approved a plan to close our operations
support center in Plano, Texas by April 2002. In connection with this plan,
we recorded a pre-tax charge of $13,002,000 in other operating expenses in
the third quarter of 2001. The restructuring resulted in the reduction of
749 employees. We communicated with all affected employees during July
2001. Certain employees will be relocated; others will be offered
severance, job training and/or outplacement counseling. We intend to sell
our Plano office building. As of September 30, 2001, approximately $453,000
was paid and 30 employees were terminated. We expect to incur additional
costs of approximately $3,128,000 through the first quarter of 2002.
1999
----
In the fourth quarter of 1999, we approved a plan to restructure our
corporate office activities. In connection with this plan, we recorded a
pre-tax charge of $5,760,000 in other operating expenses in the fourth
quarter of 1999. The restructuring resulted in the reduction of 49
corporate employees. All affected employees were communicated with in the
early part of November 1999.
As of September 30, 2001, approximately $4,413,000 has been paid, 42
employees were terminated and 6 employees who were expected to be
terminated took other positions within the company. The remaining employee
will be terminated during 2001. At December 31, 2000, we adjusted our
original accrual down by $1,008,000 and the remaining accrual of $339,000
is included in other current liabilities at September 30, 2001. These costs
are expected to be paid in the fourth quarter of 2001.
<TABLE>
<CAPTION>
Original Accrued Amount Remaining
Amount Paid to Date Adjustments Accrual
---------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
2001 Restructuring $ 13,002,000 $ 453,000 $ - $ 12,549,000
1999 Restructuring 5,760,000 4,413,000 (1,008,000) 339,000
</TABLE>
(8) Net Income Per Common Share:
----------------------------
The reconciliation of the net income per common share calculation for the
three and nine months ended September 30, 2001 and 2000, respectively, is
as follows:
<TABLE>
<CAPTION>
(In thousands, except per-share amounts) For the three months ended September 30,
--------------------------------------------------------------------------
2001 2000
------------------------------------- -----------------------------------
Weighted Weighted
Average Average
Net Income Shares Per Share Net Income Shares Per Share
------------------------ ----------- ------------------------ ----------
Net income per common share:
<S> <C> <C> <C> <C>
Basic $ (441) 285,615 $ 1,466 260,309
Carrying cost of equity forward contracts 1,003 - - -
----------- ----------- ----------- ------------
Available for common shareholders $ (1,444) 285,615 $ (0.01) $ 1,466 260,309 $ 0.01
Effect of dilutive options - 3,438 - - 7,551 -
----------- ----------- ----------- ------------
Diluted $ (1,444) 289,053 $ (0.01) $ 1,466 267,860 $ 0.01
=========== =========== =========== ============
(In thousands, except per-share amounts) For the nine months ended September 30,
--------------------------------------------------------------------------
2001 2000
------------------------------------- -----------------------------------
Weighted Weighted
Average Average
Net Income Shares Per Share Net Income Shares Per Share
------------------------ ----------- ------------------------ ----------
Net income per common share:
Basic $ 18,633 271,346 $ 11,804 260,046
Carrying cost of equity forward contracts 13,650 - - -
----------- ----------- ----------- ------------
Available for common shareholders $ 4,983 271,346 $ 0.02 $ 11,804 260,046 $ 0.05
Effect of dilutive options - 6,941 - - 7,404 -
----------- ----------- ----------- ------------
Diluted $ 4,983 278,287 $ 0.02 $ 11,804 267,450 $ 0.04
=========== =========== =========== ============
</TABLE>
14
<PAGE>
All share amounts represent weighted average shares outstanding for each
respective period. The diluted net income per common share calculation
excludes the effect of potentially dilutive shares when their effect is
antidilutive. At September 30, 2001, we have 4,025,000 shares of
potentially dilutive Mandatorily Redeemable Convertible Preferred
Securities which are convertible into common stock at a 3.76 to 1 ratio at
an exercise price of $13.30 per share and 9,434,000 potentially dilutive
stock options at a range of $12.91 to $21.47 per share that are not
included in the calculation as they are antidilutive. Restricted stock
awards of 1,150,000 shares and 1,672,000 shares at September 30, 2001 and
2000, 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. See
Note 12 regarding carrying costs of equity forward contracts.
(9) Segment Information:
-------------------
We operate in four segments, Incumbent Local Exchange Carrier (ILEC), ELI
(a competitive local exchange carrier, or CLEC), gas and electric. The ILEC
segment provides both regulated and competitive communications services to
residential, business and wholesale customers and is the incumbent carrier
in its service areas. Our gas and electric segments are intended to be sold
and are classified as "assets held for sale" and "liabilities related to
assets held for sale."
We own all of the Class B Common Stock and 27,571,332 shares of Class A
Common Stock of ELI, a facilities based integrated communications provider
offering a broad range of communications services in the western United
States. This ownership interest represents 85% of the economic interest and
a 96% voting interest. ELI's Class B Common Stock votes on a 10 to 1 basis
with the Class A Common Stock, which is publicly traded. We also guarantee
all of ELI's long-term debt, one of its capital leases and one of its
operating leases. ELI is part of our consolidated federal tax return. In
order to maintain that consolidation, we must maintain an ownership and
voting interest in excess of 80%. During 2000, as a result of the exercise
of employee stock options, our ownership interest dropped and we purchased
2,288,000 shares in the open market to bring our economic ownership
interest back to 85%.
15
<PAGE>
Adjusted EBITDA is operating income (loss) plus depreciation and
amortization. EBITDA is a measure commonly used to analyze companies on the
basis of operating performance. It is not a measure of financial
performance under generally accepted accounting principles and should not
be considered as an alternative to net income as a measure of performance
nor as an alternative to cash flow as a measure of liquidity and may not be
comparable to similarly titled measures of other companies.
<TABLE>
<CAPTION>
($ in thousands) For the three months ended September 30, 2001
-------------------------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Eliminations Segments
-------------- -------------- --------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue $ 507,202 $ 53,330 $ 37,717 $ 63,953 $ (1,081)(1) $ 661,121
Depreciation and Amortization 173,014 19,919 152 335 242 (2) 193,662
Operating Income (Loss) 64,602 (22,042) 3,717 11,648 307 (2)(3) 58,232
Adjusted EBITDA 237,616 (2,123) 3,869 11,983 549 (3) 251,894
($ in thousands) For the three months ended September 30, 2000
-------------------------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Eliminations Segments
-------------- -------------- --------------- ------------- ------------- -------------
Revenue $ 246,767 $ 63,610 $ 80,332 $ 62,770 $ (769)(1) $ 452,710
Depreciation and Amortization 65,857 16,306 6,707 6,729 260 (2) 95,859
Operating Income (Loss) 45,106 (11,530) 1,210 7,685 (29)(2)(3) 42,442
Adjusted EBITDA 110,963 4,776 7,917 14,414 231 (3) 138,301
($ in thousands) For the nine months ended September 30, 2001
-------------------------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Eliminations Segments
-------------- -------------- --------------- ------------- ------------- -------------
Revenue $1,083,335 $ 176,321 $ 360,387 $ 174,114 $ (3,013)(1) $ 1,791,144
Depreciation and Amortization 347,703 58,647 457 6,135 792 (2) 413,734
Operating Income (Loss) 187,957 (53,413) 42,213 28,607 1,300 (2)(3) 206,664
Adjusted EBITDA 535,660 5,234 42,670 34,742 2,092 (3) 620,398
($ in thousands) For the nine months ended September 30, 2000
-------------------------------------------------------------------------------------------
Total
ILEC ELI Gas Electric Eliminations Segments
-------------- -------------- --------------- ------------- ------------- -------------
Revenue $ 700,475 $181,008 $270,753 $169,879 $ (2,096)(1) $ 1,320,019
Depreciation and Amortization 195,628 43,782 19,076 19,806 191 (2) 278,483
Operating Income (Loss) 116,462 (47,106) 24,160 21,073 551 (2)(3) 115,140
Adjusted EBITDA 312,090 (3,324) 43,236 40,879 742 (3) 393,623
</TABLE>
1 Represents revenue received by ELI from our ILEC operations.
2 Represents amortization of the capitalized portion of intercompany interest
related to our guarantees of ELI debt and leases and amortization of
goodwill related to our purchase of ELI stock.
3 Represents the administrative services fee charged to ELI pursuant to our
management services agreement with ELI.
16
<PAGE>
(10) Supplemental Segment Information:
--------------------------------
Supplemental segment income statement information for the nine months ended
September 30, 2001 is as follows:
<TABLE>
<CAPTION>
( $ in thousands) Discontinued Corporate and Consolidated
ILEC ELI Gas Electric Operations Eliminations Total
----------- ----------- ---------- ----------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue $ 1,083,335 $ 176,321 $360,387 $174,114 $ - $ (3,013) $1,791,144
Operating expenses:
Cost of services 80,994 51,014 252,065 95,804 - (2,770) 477,107
Depreciation and amortization 347,703 58,647 457 6,135 - 792 413,734
Other operating expenses 436,014 120,073 65,652 43,568 - (2,335) 662,972
Restructuring expenses 13,002 - - - - - 13,002
Acquisition assimilation expense 17,665 - - - - - 17,665
----------- ----------- ---------- ----------- ------------- --------- -----------
Total operating expenses 895,378 229,734 318,174 145,507 - (4,313) 1,584,480
----------- ----------- ---------- ----------- ------------- --------- -----------
Operating income (loss) 187,957 (53,413) 42,213 28,607 - 1,300 206,664
Investment and other income, net 14,035 387 2,271 (198) - - 16,495
Gain on sale of assets - - - - - 139,304 139,304
Interest expense 191,189 71,788 14,032 12,964 - (31,940) 258,033
----------- ----------- ---------- ----------- ------------- --------- -----------
Income (loss) from continuing operations
before income taxes, dividends on
convertible preferred securities and
extraordinary expense 10,803 (124,814) 30,452 15,445 - 172,544 104,430
Income tax expense 4,030 449 11,359 5,761 - 27,584 49,183
----------- ----------- ---------- ----------- ------------- --------- -----------
Income (loss) from continuing operations
before dividends on convertible preferred
securities and extraordinary expense 6,773 (125,263) 19,093 9,684 - 144,960 55,247
Dividends on convertible preferred securities,
net of income tax benefit 4,658 - - - - - 4,658
----------- ----------- ---------- ----------- ------------- --------- -----------
Income (loss) from continuing operations
before extraordinary expense 2,115 (125,263) 19,093 9,684 - 144,960 50,589
Income from discontinued operations, net
of tax - - - - 11,675 - 11,675
----------- ----------- ---------- ----------- ------------- --------- -----------
Net income (loss) before extraordinary
item 2,115 (125,263) 19,093 9,684 11,675 144,960 62,264
Extraordinary expense - discontinuation of
Statement of Financial Accounting
Standards No. 71, net of tax - - - - - 43,631 43,631
----------- ----------- ---------- ----------- ---------------------- -----------
Net income (loss) $ 2,115 $ (125,263) $ 19,093 $ 9,684 $ 11,675 $101,329 $ 18,633
=========== =========== ========== =========== ====================== ===========
</TABLE>
(11) Discontinuation of SFAS 71:
---------------------------
We have historically applied SFAS 71 in the preparation of our financial
statements because our incumbent local exchange telephone properties
(properties we owned prior to the 2000 and 2001 acquisitions of the
Verizon, Qwest and Frontier properties) were predominantly regulated in the
past following a cost of service/rate of return approach. Beginning in the
third quarter of 2001, these properties no longer met the criteria for
application of SFAS 71 due to the continuing process of deregulation and
the introduction of competition to our existing rural local exchange
telephone properties, and our expectation that these trends will continue
for all our properties.
Currently, pricing for a majority of our revenues is based upon price cap
plans that limit prices to changes in general inflation and estimates of
productivity for the industry at large, or upon market pricing, rather than
on the specific costs of operating our business, a requirement for the
application of SFAS 71. These trends in the deregulation of pricing and the
introduction of competition are expected to continue in the near future as
additional states adopt price cap forms of regulation.
17
<PAGE>
Discontinued application of SFAS 71 required us to write off all of the
regulatory assets and liabilities of our incumbent local exchange telephone
operations. A non-cash extraordinary charge is reflected in our financial
statements in the third quarter of 2001 as follows:
($ in thousands)
Assets:
Deferred income tax assets $ 31,480
Deferred cost of extraordinary plant retirements 25,348
Deferred charges 6,885
Liabilities:
Plant related (10,259)
Deferred income tax liabilities (2,531)
--------
Pre-tax charge 50,923
Income tax benefit 7,292
--------
Extraordinary expense $ 43,631
========
Under SFAS 71, we depreciated our telephone plant for financial reporting
purposes over asset lives approved by the regulatory agencies setting
regulated rates. As part of the discontinuance of SFAS 71, we revised the
depreciation lives of our core technology assets to reflect their estimated
economic useful lives. Based upon our evaluation of the pace of technology
change that is estimated to occur in certain components of our rural
telephone networks, we have concluded that minor modifications in our asset
lives for the major network technology assets as follows:
Average Remaining Life in Years
-------------------------------
Regulated Economic
Life Life
---- ------
Switching Equipment 6.4 5.6
Circuit Equipment 4.3 4.9
Copper Cable 8.5 7.7
Upon discontinuation of SFAS 71, we tested the balances of property, plant
and equipment associated with the incumbent local exchange telephone
properties for impairment under SFAS 121 (as required by SFAS 101). No
impairment charge was required.
To reflect the expectation that competitive entry will occur over time for
certain of our properties acquired in prior purchase business combinations,
we have shortened the amortization life for franchise rights related to
these properties to 20 years. This action was taken to reflect the fact
that our dominant position in the market related to the existence of the
prior monopoly in incumbent local exchange telephone service may be reduced
over time as competitors enter our markets.
(12) Equity Forward Contract:
------------------------
During 2000, we entered into a forward contract to purchase 9,140,000
shares of our common stock. These purchases and others made by us for cash
during 2000 were made in open-market transactions. The forward amount to be
paid in the future included a carrying cost, based on LIBOR plus a spread,
and the dollar amount paid for the shares purchased. Our forward contract
was a temporary financing arrangement that gave us the flexibility to
purchase our stock and pay for those purchases in future periods. Pursuant
to transition accounting rules, commencing December 31, 2000 through June
30, 2001 we were required to report our equity forward contract as a
reduction to shareholders' equity and as a component of temporary equity
for the gross settlement amount of the contract ($150,013,000). On June 28,
2001, we entered into a master confirmation agreement that amended the
equity forward contract to no longer permit share settlement of the
contract. On June 29, 2001, we accrued $42,995,000 net cash to settle a
portion of the contract, plus $12,647,000 in associated carrying costs. In
September 2001, we settled the contract by paying the redemption amount of
$107,018,000 plus $1,003,000 in associated carrying costs and took
possession of our shares.
18
<PAGE>
(13) Commitments and Contingencies:
------------------------------
At September 30, 2001, we have outstanding performance letters of credit as
follows:
($ in thousands)
Qwest $ 64,280
Insurance letters of credit to CNA 12,672
Water/wastewater projects 2,588
ELI projects 60
--------
Total $ 79,600
========
None of the above letters of credit restrict our cash balances. In
addition, we have issued $281,680 of letters of credit where we are
required to maintain restricted cash balances in the same amount. This
amount has been segregated from cash on our balance sheet and is included
as a component of other current assets.
During the past two years the decrease in the availability of power in
certain areas of the country has caused power supply costs to increase
substantially, forcing companies to pay higher operating costs to operate
their electric businesses. As a result, companies have attempted to offset
these increased costs by either renegotiating prices with their power
suppliers or passing these additional costs on to their customers through a
rate proceeding. In Arizona, excessive power costs charged by our power
supplier in the amount of approximately $98 million through September 30,
2001 have been incurred. We are allowed to recover these charges from
ratepayers through the Purchase Power Fuel Adjustment clause. However, in
an attempt to limit "rate shock" to our customers, we requested in
September 2001 that this deferred amount, plus interest, be recovered over
a seven-year period. As a result, we have deferred these costs on the
balance sheet in anticipation of recovery through the regulatory process.
On July 16, 2001, we terminated our existing contract with Arizona Public
Service and entered into a new seven-year purchase power agreement. This
agreement allows us to purchase all power required for operations at a
fixed rate per kilowatt hour. This agreement is retroactive to June 1, 2001
and will mitigate further increases in the deferred power cost account.
19
<PAGE>
PART I. FINANCIAL INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Statements contained in this quarterly report on Form 10-Q that are not
historical facts are forward-looking statements made pursuant to the safe harbor
provisions of the Private Securities Reform Act of 1995. In addition, words such
as "believes," "anticipates," "expects" and similar expressions are intended to
identify forward-looking statements. These forward-looking statements are
subject to:
o Our ability to obtain new financing on favorable terms;
o Our ability to effectively manage our growth, including the
integration of newly acquired operations into our operations, and
otherwise monitor our operations, costs, regulatory compliance and
service quality;
o Our ability to divest our public utilities services businesses;
o Our ability to successfully introduce new product offerings on a
timely and cost effective basis, including our ability to offer
bundled service packages on terms attractive to our customers, and our
ability to offer second lines and enhanced services to markets
currently under-penetrated;
o Our ability to expand through attractively priced acquisitions;
o Our ability to identify future markets and successfully expand
existing ones;
o 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;
o Electric Lightwave, Inc.'s (ELI's) ability to complete a public or
private financing that would provide the funds necessary to finance
its cash requirements;
o The effects of rapid technological changes, including the lack of
assurance that our ongoing network improvements will be sufficient to
meet or exceed the capabilities and quality of competing networks;
o The effects of changes in regulation in the telecommunications
industry as a result of the Telecommunications Act of 1996 and other
similar federal and state legislation and regulation;
o The effects of more general factors, including changes in economic
conditions; changes in the capital markets; changes in industry
conditions; changes in our credit ratings; and changes in accounting
policies or practices adopted voluntarily or as required by generally
accepted accounting principles.
You should consider these important factors in evaluating any statement in this
Form 10-Q or otherwise made by us or on our behalf. These forward-looking
statements are made as of the date of this report based upon current
expectations, and we undertake no obligation to update this information. The
following information is unaudited and should be read in conjunction with the
consolidated financial statements and related notes included in this report and
as presented in our 2000 Annual Report on Form 10-K.
(a) Liquidity and Capital Resources
-------------------------------
For the three and nine months ended September 30, 2001, we used cash flow from
operations, cash on hand and proceeds from the sale of securities to fund
capital expenditures and acquisitions of additional telephone access lines.
In May 2001, we filed a $3.8 billion shelf registration statement with the
Securities and Exchange Commission (SEC) on Form S-3 that permits us to offer
from time to time common stock, preferred stock, depositary shares, debt
securities, warrants to purchase these types of securities and units of the
foregoing. The net proceeds from the sale of these securities have been and are
expected to be used to refinance our bank borrowings and other extensions of
credit, to expand our networks, services and related infrastructure and fund
working capital and pending and future acquisitions, and make further
investments in related telecommunications businesses as well as general
corporate purposes. After the offerings discussed below, we have a remaining
shelf registration of $825.6 million.
20
<PAGE>
In May 2001, we issued an aggregate of $1.75 billion of notes consisting of
$700 million principal amount of 8.50% notes due May 15, 2006 and $1.05
billion principal amount of 9.25% notes due May 15, 2011. This offering was
made under the $3.8 billion shelf registration statement. Net proceeds of
$1,726.0 million (after underwriting discounts and commissions and before
offering expenses) were used to repay bank borrowings and the remainder was
used for general corporate purposes and to finance acquisitions.
In June 2001, we issued equity securities in two concurrent public
offerings. The first offering consisted of 25,156,250 shares of our common
stock. The net proceeds of $289.6 million (after underwriting discounts and
commissions and before offering expenses) were used to partially fund the
acquisition of Frontier Corp. The second offering consisted of $460 million
of equity units. The net proceeds of $446.2 million (after underwriting
discounts and commissions and before offering expenses) were used to
partially fund the acquisition of Frontier Corp. Each equity unit initially
consists of a senior note and a purchase contract for our common stock. The
price for the common stock under the purchase contract will be based upon
the average trading price of the stock at the time the contract is
exercised. These offerings were made under the $3.8 billion shelf
registration statement.
In August 2001, we issued an aggregate of $1.75 billion of notes consisting of
$300 million principal amount of 6.375% notes due 2004, $750 million principal
amount of 7.625% notes due 2008 and $700 million principal amount of 9.000%
notes due 2031. The notes were issued in a private offering. The proceeds were
used to repay our forward equity contract and to refinance outstanding
indebtedness and for general corporate purposes. In September 2001, we filed a
$1.75 billion registration statement with the SEC on Form S-4 that consists of
an exchange offer entitling the holders to exchange the initial notes for new
notes with substantially identical terms as the initial notes, except for
transfer restrictions and registration rights relating to the initial notes. The
registration statement has not yet been declared effective.
On September 30, 2001, we had available lines of credit with financial
institutions in the amounts of $2.0 billion with associated facility fees of
0.125% per annum and $450 million with no associated facility fees. These credit
facilities were in addition to credit commitments under which we may borrow up
to $200 million, with associated facility fees of 0.15% per annum, that expire
on December 16, 2003. As of September 30, 2001, no borrowings were outstanding
under these credit facilities. On October 24, 2001, we replaced these credit
facilities with available revolving lines of credit with financial institutions
in the amounts of $680 million and $100 million. An additional $25 million was
provided by a lender who was added to the credit facilities after October 24,
2001, for total available commitments of $805 million. The credit facilities
have similar terms and conditions. Associated facility fees vary depending on
our credit ratings and currently are 0.25% per annum. The expiration dates are
October 24, 2006. During the term of the facilities we may borrow, repay and
reborrow funds.
In addition, on October 24, 2001, we borrowed $200 million on an unsecured basis
from the Rural Telephone Finance Cooperative (RTFC). This note is due on October
24, 2011 and has a fixed 6.27% rate of interest, payable quarterly.
ELI has $400 million of committed revolving lines of credit with commercial
banks, which expire November 21, 2002. It has borrowed $400 million under these
lines at September 30, 2001. The ELI credit facility has an associated facility
fee of 0.08% per annum. We have guaranteed all of ELI's obligations under these
revolving lines of credit.
We have committed to continue to finance ELI's cash requirements until December
31, 2002. We extended a revolving credit facility to ELI for $450 million with
an interest rate of 15% and a final maturity of October 30, 2005. Funds for
general corporate purposes of $260 million are available to be drawn until
December 31, 2002. The remaining balance may be drawn by ELI to pay interest
expense due under the facility. As of September 30, 2001, we have advanced $150
million to ELI under this facility.
In January 2001, one of our subsidiaries, Citizens Utilities Rural Company, was
advanced $1.0 million under its Rural Utilities Services Loan Contract. The
initial interest rate on the advance was 5.4125% with an ultimate maturity date
of November 1, 2016.
In April 2001, we converted and remarketed $14.4 million of 1991 series
industrial development revenue bonds as money market bonds with an initial
interest rate of 5.25% and a maturity date of April 1, 2026.
In May 2001, we converted and remarketed $23.325 million of the Illinois 1997
series of environmental facilities revenue bonds due May 1, 2032 at an initial
interest rate of 5.85%. We also converted and remarketed $18.250 million of the
Northampton (Pennsylvania) 1998 series of industrial development revenue bonds
due September 1, 2018 at an initial interest rate of 5.75%.
21
<PAGE>
On June 29, 2001, we completed the acquisition of Frontier Corp. from Global
Crossing for $3,370.0 million in cash (see Acquisitions below). The acquisition
was financed on an interim basis by the draw down of our bank credit facility of
$1,780.0 million with the remainder derived from the proceeds of our registered
securities offerings as discussed above.
On July 2, 2001, we completed the sale of our Louisiana Gas operations to Atmos
Energy Corp for $363.4 million in cash. The proceeds were used to repay a
portion of the borrowings under our bank credit facility.
During 2000, we entered into a forward contract to purchase 9,140,000 shares of
our common stock. These purchases and others made by us for cash during 2000
were made in open-market transactions. The forward amount to be paid in the
future included a carrying cost, based on LIBOR plus a spread, and the dollar
amount paid for the shares purchased. Our forward contract was a temporary
financing arrangement that gave us the flexibility to purchase our stock and pay
for those purchases in future periods. Pursuant to transition accounting rules,
commencing December 31, 2000 through June 30, 2001 we were required to report
our equity forward contract as a reduction to shareholders' equity and as a
component of temporary equity for the gross settlement amount of the contract
($150,013,000). On June 28, 2001, we entered into a master confirmation
agreement that amended the equity forward contract to no longer permit share
settlement of the contract. On June 29, 2001, we accrued $42,995,000 net cash to
settle a portion of the contract, plus $12,647,000 in associated carrying costs.
In September 2001, we settled the contract by paying the redemption amount of
$107,018,000 plus $1,003,000 in associated carrying costs and took possession of
our shares.
On September 4, 2001, our $50 million debentures matured at par and were repaid
with cash. On October 1, 2001, $99.2 million of our $100 million debentures due
in 2034 were tendered for redemption at par in accordance with the put option
granted to debenture holders at the time of issuance. These debentures were also
repaid with cash.
For the nine months ended September 30, 2001, our actual capital expenditures
were $256.0 million for the ILEC segment, $43.9 million for the ELI segment and
$71.3 million for the public utilities services segments which includes $20.7
million for the water and wastewater segment. We anticipate that the funds
necessary for our 2001 capital expenditures will be provided from operations and
from commercial paper notes payable, debt, equity and other financing at
appropriate times and borrowings under credit facilities.
Capital expenditures for discontinued operations and assets held for sale will
be funded through requisitions of Industrial Development Revenue Bond
construction fund trust accounts and from parties desiring utility service. Upon
disposition, we will receive reimbursement of certain 1999, 2000 and 2001
capital expenditures pursuant to the terms of each respective sales agreement.
Covenants
---------
The terms and conditions contained in our indentures and credit facility
agreements are of a general nature, and do not impose significant financial
performance criteria on us. These general covenants include the timely and
punctual payment of principal and interest when due, the maintenance of our
corporate existence, keeping proper books and record in accordance with
Generally Accepted Accounting Principles (GAAP), restrictions on the allowance
of liens on our assets, and restrictions on asset sales and transfers, mergers
and other changes in corporate control. We currently have no restrictions on the
payment of dividends by us either by contract, rule or regulation.
The principal financial performance covenant under our $805 million credit
facility and our $200 million loan facility with the rural telephone finance
cooperative which were entered into on October 24, 2001 requires the maintenance
of a minimum net worth of $1.5 billion. Under the rural telephone finance
cooperative loan facility, in the event that our credit rating from either
Moody's Investors Service or Standard & Poor's declines below investment grade
(Baa3/BBB-, respectively), we would also be required to maintain an interest
coverage ratio of 2.00 to 1 or greater and a leverage ratio of 6.00 to 1 or
lower.
22
<PAGE>
Acquisitions
------------
From May 27, 1999 through July 12, 2000, we entered into several agreements to
acquire telephone access lines. These transactions have been and will be
accounted for using the purchase method of accounting. The results of operations
of the acquired properties have been and will be included in our financial
statements from the dates of acquisition of each property. These agreements and
the status of each transaction are described as follows:
Verizon Acquisition
-------------------
Between May and December 1999, we announced agreements to purchase from
Verizon Communications Inc., formerly GTE Corp. (Verizon), approximately
381,200 telephone access lines (as of December 31, 2000) in Arizona,
California, Illinois/Wisconsin, Minnesota and Nebraska for approximately
$1,171.0 million in cash. To date, we have closed on approximately 317,500
telephone access lines. We have received all necessary regulatory approvals
and expect that the acquisition of the remaining access lines in Arizona
and California will close during 2002. Our expected cash requirement to
complete the Verizon acquisitions is $222.8 million.
Qwest Acquisition - termination
-------------------------------
In June 1999, we announced agreements to purchase from Qwest approximately
556,800 telephone access lines (as of December 31, 2000) in Arizona,
Colorado, Idaho/Washington, Iowa, Minnesota, Montana, Nebraska, North
Dakota and Wyoming for approximately $1,650.0 million in cash and the
assumption of certain liabilities. To date, we have closed on the purchase
of approximately 17,000 telephone access lines in North Dakota for
approximately $38.0 million in cash. On July 20, 2001, we notified Qwest
that we were terminating eight acquisition agreements with Qwest relating
to telephone exchanges in Arizona, Colorado, Idaho/Washington, Iowa,
Minnesota, Montana, Nebraska and Wyoming for the remaining 539,800
telephone access lines. Qwest subsequently filed a notice of claim for
arbitration in Denver, Colorado under the rules of the American Arbitration
Association with respect to the terminated acquisition agreements. Qwest
asserts that we wrongfully terminated these agreements and is seeking
approximately $64.0 million, which is the aggregate of liquidation damages
under letters of credit established in the terminated acquisition
agreements. We have filed a notice of claim in the same arbitration
proceeding, contesting Qwest's asserted claims and asserting substantial
claims against Qwest for material breaches of representations, warranties
and covenants in the terminated acquisition agreements and in the
acquisition agreement relating to North Dakota assets that we purchased
from Qwest.
Frontier Acquisition
--------------------
On June 29, 2001, we purchased from Global Crossing Ltd. (Global) 100% of
the stock of Frontier Corp.'s (Frontier) local exchange carrier
subsidiaries, which owned approximately 1,096,700 telephone access lines
(as of December 31, 2000) in Alabama/Florida, Georgia, Illinois, Indiana,
Iowa, Michigan, Minnesota, Mississippi, New York, Pennsylvania and
Wisconsin, for approximately $3,370.0 million in cash, subject to
adjustment. The operations of Frontier are included in our financial
statements from the date of acquisition.
Divestitures
------------
On August 24, 1999, our Board of Directors approved a plan of divestiture for
our public utilities services businesses, which include gas, electric and water
and wastewater businesses. Currently, we have agreements to sell all our water
and wastewater operations, one of our electric operations and one of our natural
gas operations and we have sold another of our natural gas operations. We have
received proceeds on the sale of assets of $363.4 million, and have agreements
to sell assets for an aggregate of $1,026.0 million plus the assumption of
certain liabilities and debt. The purchase price under one of these agreements
may be reduced. These agreements and the status of each transaction are
described as follows:
Water and Wastewater
--------------------
On October 18, 1999, we announced the agreement to sell our water and
wastewater operations to American Water Works, Inc. for $745.0 million in
cash and $90.0 million of assumed debt. This transaction is expected to
close in the fourth quarter of 2001.
Electric
--------
On February 15, 2000, we announced that we had agreed to sell our electric
utility operations. The Arizona and Vermont electric divisions were under
contract to be sold to Cap Rock Energy Corp. (Cap Rock). The agreement with
Cap Rock was terminated on March 7, 2001. We intend to pursue the
disposition of the Vermont and Arizona electric divisions with alternative
buyers. In August 2000, the Hawaii Public Utilities Commission denied the
initial application requesting approval of the purchase of our Kauai
23
<PAGE>
electric division by the Kauai Island Electric Co-op for $270.0 million in
cash including the assumption of certain liabilities. We are discussing a
reduction of the purchase price and other options. Our agreement for the
sale of this division may be terminated if regulatory approval is not
received before February 2002.
Gas
---
On July 2, 2001, we completed the sale of our Louisiana Gas operations to
Atmos Energy Corporation for $363.4 million in cash. The pre-tax gain on
the sale recognized in the third quarter was approximately $139.3 million.
In July 2001, an agreement was signed to sell the Colorado Gas division to
Kinder Morgan for $11.0 million in cash. This transaction has received all
necessary regulatory approvals and is expected to close in the fourth
quarter of 2001.
Discontinued operations in the consolidated statements of income reflect the
results of operations of the water/wastewater properties including allocated
interest expense for the periods presented. Interest expense was allocated to
the discontinued operations based on the outstanding debt specifically
identified with these businesses. The long-term debt presented in liabilities of
discontinued operations represents the only liability to be assumed by the buyer
pursuant to the water and wastewater asset sale agreements.
We initially accounted for the planned divestiture of all the public utilities
services properties as discontinued operations. Currently, we do not have
agreements to sell our entire gas and electric segments. Consequently, we
reclassified all of our gas and electric assets and their related liabilities to
"assets held for sale" and "liabilities related to assets held for sale,"
respectively. We also reclassified the results of these operations from
discontinued operations to their original income statement captions as part of
continuing operations. Additionally, we ceased to record depreciation expense on
the gas assets effective October 1, 2000 and on the electric assets effective
January 1, 2001. Such depreciation expense would have been an additional $11.4
million and $39.5 million for the three and nine months ended September 30,
2001, respectively. We continue to actively pursue buyers for our remaining gas
and electric businesses.
Discontinuation of SFAS 71
--------------------------
Prior to the 2000 and 2001 acquisitions of the Verizon, Qwest and Frontier
Properties, our incumbent local exchange telephone properties have been
predominantly regulated following a cost of service/rate of return approach.
Accordingly, we have applied the provisions of Statement of Financial Accounting
Standards (SFAS) No. 71 in the preparation of our financial statements.
Currently, pricing for a majority of our revenues in our previously existing
incumbent local exchange telephone properties is based upon price cap plans that
limit prices to changes in general inflation and estimates of productivity for
the industry at large or upon market pricing rather than on the specific costs
of operating our business, a requirement for the application of SFAS 71. These
trends in the deregulation of pricing and the introduction of competition are
expected to continue as additional states adopt price cap forms of regulation.
We intend to operate all of our properties as competitive enterprises, to meet
competitive entry and maximize revenue by providing a broad range of products
and services, such as data services. Many of these future services will not be
regulated, further increasing the percentage of our revenue provided by our
networks that is not based upon historical cost/rate of return regulation.
In the third quarter of 2001, we concluded based on the factors mentioned above,
that the provisions of SFAS 71 were no longer applicable to our incumbent local
exchange telephone properties (properties we owned prior to the 2000 and 2001
acquisitions of the Verizon, Qwest and Frontier properties). As part of the
discontinuation of SFAS 71, we will no longer recognize in our financial
statements certain activities of regulators.
As discussed further in Note 11 of the financial statements, we recorded a
non-cash extraordinary charge of $43.6 million net of tax in our income
statement, to write-off regulatory assets and liabilities recorded on our
balance sheet in the past. Based upon our evaluation of the pace of technology
change that is estimated to occur in certain components of our rural telephone
networks, we have concluded that minor modifications in our asset lives are
required for the major network technology assets and expect that depreciation
and amortization expense will not differ significantly from that currently
recorded.
In accordance with the provisions of SFAS 101 and SFAS 121, we performed a test
of the impairment of the property, plant and equipment accounts for our
properties discontinuing SFAS 71 and found that based upon our expectations of
future changes in sales volumes and prices and the anticipated rate of entry of
additional competition into our markets, we concluded that an asset impairment
is not warranted under SFAS 121 at this time.
24
<PAGE>
New Accounting Pronouncements
-----------------------------
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS 141,
"Business Combinations." This statement requires that all business combinations
be accounted for under the purchase method of accounting. SFAS 141 requires that
the purchase method of accounting be used for business combinations initiated
after June 30, 2001 and prohibits the use of the pooling-of-interests method of
accounting. The Frontier acquisition, which closed on June 29, 2001, is
accounted for using the purchase method.
In July 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets."
This statement requires that goodwill no longer be amortized to earnings, but
instead be reviewed for impairment. Impairment tests are required to be
performed at least annually. The amortization of goodwill ceases upon adoption
of the statement. The statement is effective for fiscal years beginning after
December 15, 2001 for companies whose annual reporting period ends on December
31, 2001 and applies to all goodwill and other intangible assets recognized in
the statement of financial position at that date, regardless of when the assets
were initially recognized. We will cease to recognize amortization of the
goodwill portion of intangibles starting January 1, 2002. Amortization of
intangibles for the three and nine months ended September 30, 2001 was $52.0
million and $78.3 million, respectively. We will be required to test for
impairment of goodwill annually starting January 1, 2002. The amount of any
future impairment, if any, cannot be estimated at this time.
In August 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligations." This statement addresses the financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. SFAS 143 requires that the fair value of
a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset and reported as a liability. This statement is effective
for fiscal years beginning after June 15, 2002. We are currently evaluating the
impact of the adoption of SFAS 143.
In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-lived Assets." This statement establishes a single accounting
model, based on the framework established in SFAS 121, for long-lived assets to
be disposed of by sale, whether previously held and used or newly acquired, and
broadens the presentation of discontinued operations to include more disposal
transactions. This statement is effective for fiscal years beginning after
December 15, 2001. We are currently evaluating the impact of the adoption of
SFAS 144.
25
<PAGE>
(b) Results of Operations
---------------------
REVENUE
Consolidated revenue for the three and nine months ended September 30, 2001
increased $208.4 million, or 46%, and $471.1 million, or 36%, respectively, as
compared with the prior year periods. The increases are primarily due to the
$260.4 million and $382.9 million increases in telecommunications revenue in the
respective periods. The increase in the three months ended September 30, 2001
was partially offset by a decrease of $42.6 million in gas revenue primarily due
to the sale of our Louisiana gas operations on July 2, 2001.
<TABLE>
<CAPTION>
ILEC REVENUE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Network access services $ 189,034 $ 114,725 65% $ 461,549 $ 330,018 40%
Local network services 194,398 83,633 132% 390,802 231,557 69%
Long distance and data services 71,860 26,422 172% 135,144 75,404 79%
Directory services 25,253 9,376 169% 46,942 27,299 72%
Other 26,657 12,611 111% 48,898 36,197 35%
-------------- ------------- ------------- --------------
$ 507,202 $ 246,767 106% $ 1,083,335 $ 700,475 55%
============== ============= ============= ==============
</TABLE>
We acquired the Verizon Nebraska access lines on June 30, 2000, the Verizon
Minnesota access lines on August 31, 2000, the Qwest North Dakota access lines
on October 31, 2000 and the Verizon Illinois/Wisconsin access lines on November
30, 2000 and Frontier on June 29, 2001 (collectively referred to as the
Acquisitions). The Acquisitions contributed $245.5 million and $350.3 million to
the increase in revenue for the three and nine months ended September 30, 2001,
respectively, as compared with the prior year periods. The following revenue and
expense discussion identifies as acquisition activity only that activity for
which there was no corresponding amount in the prior period (for example, the
Verizon Nebraska results are not presented in "Acquisitions" for the three
months ended September 30, 2001).
<TABLE>
<CAPTION>
ACCESS LINES
As of September 30,
---------------------------------------------
2001 2000 % Change
-------------- ------------ -------------
<S> <C> <C> <C>
Excluding acquisitions 1,261,406 1,223,876 3%
Acquisitions 1,229,058 -
--------------- ------------
Total 2,490,464 1,223,876
=============== ============
</TABLE>
<TABLE>
<CAPTION>
MINUTES OF USE*
(In millions) For the three months ended September 30, For the nine months ended September 30,
------------------------------------------- -------------------------------------------
2001 2000 % Change 2001 2000 % Change
------------- ------------- -------------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Excluding acquisitions 1,676 1,454 15% 5,037 4,157 21%
Acquisitions 1,426 - 1,817 -
------------- ------------- ------------ -------------
Total 3,102 1,454 6,854 4,157
============= ============= ============ =============
</TABLE>
*Acquisitions represent minutes of use from entities acquired after September
30, 2000.
Network access services revenue for the three months ended September 30, 2001
increased $74.3 million, or 65%, as compared with the prior year period
primarily due to the impact of the Acquisitions which contributed $62.9 million
to the increase. Growth in special access and subsidies contributed $8.1 million
and $4.9 million, respectively. These increases were partially offset by $3.3
million in rate decreases in effect as of July 1, 2001. Network access also
includes a reclassification of $4.0 million in revenue reported as local network
services revenue in the prior year.
26
<PAGE>
Network access services revenue for the nine months ended September 30, 2001
increased $131.5 million, or 40%, as compared with the prior year period
primarily due to the impact of the Acquisitions which contributed $107.4 million
to the increase. Growth in minutes of use contributed $3.7 million and growth in
special access and subsidies contributed $11.5 million and $12.3 million,
respectively. These increases were partially offset by $7.7 million from the
effect of the FCC's CALLS mandate which reduced access charges paid by long
distance companies and $3.3 million in rate decreases in effect as of July 1,
2001. Network access also includes a reclassification of $10.3 million in
revenue reported as local network services revenue in the prior year.
Local network services revenue for the three months ended September 30, 2001
increased $110.8 million, or 132%, as compared with the prior year period
primarily due to the impact of the Acquisitions which contributed $110.6 million
to the increase and growth in enhanced services of $3.2 million. Local network
services revenue also reflects a reduction for the reclassification of $4.0
million in revenue reported as network access revenue in the prior year.
Local network services revenue for the nine months ended September 30, 2001
increased $159.2 million, or 69%, as compared with the prior year period
primarily due to the impact of the Acquisitions which contributed $161.9 million
to the increase and growth in enhanced services of $5.5 million. Local network
services revenue also reflects a reduction for the reclassification of $10.3
million in revenue reported as network access revenue in the prior year.
Long distance and data services revenue for the three months ended September 30,
2001 increased $45.4 million, or 172%, as compared with the prior year period
primarily due to the impact of the Acquisitions, including the long-distance
revenue associated with Frontier, which contributed $38.5 million to the
increase, growth in Digital Subscriber Line (DSL) and Internet services of $2.1
million, growth related to data and dedicated circuits of $1.8 million and
growth in long distance services of $1.4 million.
Long distance and data services revenue for the nine months ended September 30,
2001 increased $59.7 million, or 79%, as compared with the prior year period
primarily due to the impact of the Acquisitions, principally the long-distance
and data revenue associated with Frontier, which contributed $41.6 million to
the increase, growth in DSL and Internet services of $4.9 million, growth
related to data and dedicated circuits of $4.3 million and growth in long
distance services of $6.8 million.
Directory services revenue for the three months ended September 30, 2001
increased $15.9 million, or 169%, as compared with the prior year period
primarily due to the impact of the Acquisitions which contributed $15.2 million
to the increase and growth of $0.7 million.
Directory services revenue for the nine months ended September 30, 2001
increased $19.6 million, or 72%, as compared with the prior year period
primarily due to the impact of the Acquisitions which contributed $18.5 million
to the increase and growth of $1.2 million.
Other revenue for the three months ended September 30, 2001 increased $14.0
million, or 111%, as compared with the prior year period. The Acquisitions
contributed $18.3 million to the increase which was partially offset by a
decrease of $5.4 million in miscellaneous revenue categories.
Other revenue for the nine months ended September 30, 2001 increased $12.7
million, or 35%, as compared with the prior year period. The Acquisitions
contributed $20.9 million to the increase which was partially offset by a
decrease of $8.2 million in miscellaneous revenue categories.
27
<PAGE>
<TABLE>
<CAPTION>
ELI REVENUE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Network services $ 26,077 $ 21,627 21% $ 77,966 $ 54,804 42%
Local telephone services 14,450 25,187 -43% 58,114 75,412 -23%
Long distance services 3,131 3,728 -16% 9,314 12,590 -26%
Data services 9,672 13,068 -26% 30,927 38,202 -19%
-------------- ------------- ------------- --------------
53,330 63,610 -16% 176,321 181,008 -3%
Intersegment revenue * (1,081) (769) N/A (3,013) (2,096) N/A
-------------- ------------- ------------- --------------
$ 52,249 $ 62,841 -17% $ 173,308 $ 178,912 -3%
============== ============= ============= ==============
</TABLE>
*Intersegment revenue reflects revenue received by ELI from our ILEC operations.
Included in revenue for the three and nine months ended September 30, 2001 is
approximately $0.2 million and $4.0 million, respectively, of revenue
representing a "net settlement" of past billing disputes between ELI and Qwest.
Additionally, we are currently providing service to customers that have filed
for protection under Chapter 11 of the Bankruptcy Code. Of our largest
twenty-five customers, two are under Chapter 11 protection. These two customers
contribute approximately $0.4 million of revenue monthly.
Network services include Private Line Interstate (Long Haul) and Private Line
Intrastate (MAN). Network services revenue for the three and nine months ended
September 30, 2001 increased $4.4 million, or 21%, and $23.2 million, or 42%,
respectively, as compared with the prior year periods. The increase is due to
continued growth in our network and sales of additional circuits to new and
existing customers.
Revenue for the three and nine months ended September 30, 2001 from our
Long Haul services decreased $0.1 million, or .4%, and increased $5.8
million, or 21%, respectively, as compared with the prior year periods.
Revenue for the three and nine months ended September 30, 2001 from our MAN
services increased $4.5 million, or 43%, and $17.4 million, or 63%,
respectively, as compared with the prior year periods.
Local telephone services revenue for the three and nine months ended September
30, 2001 decreased $10.7 million, or 43%, and $17.3 million, or 23%,
respectively, as compared with the prior year periods. Local telephone services
include ISDN PRI, dial tone, Carrier Access Billings and reciprocal
compensation.
<TABLE>
<CAPTION>
($ In thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
ISDN PRI $ 6,788 $ 9,296 -27% $ 21,572 $ 25,527 -15%
Dial tone 3,614 5,509 -34% 12,845 14,258 -10%
Carrier access billings 1,351 1,180 14% 5,275 6,399 -18%
Reciprocal compensation 2,697 9,202 -71% 18,422 29,228 -37%
-------------- ------------- ------------- --------------
$ 14,450 $ 25,187 -43% $ 58,114 $ 75,412 -23%
============== ============= ============= ==============
</TABLE>
ISDN PRI revenue for the three and nine months ended September 30, 2001
decreased $2.5 million, or 27%, and $3.9 million, or 15%, respectively, as
compared with the prior year periods primarily due to a decrease in ISDN
revenue to three customers resulting from less demand for ISDN PRI trunks
servicing internet routers.
Dial tone revenue decreased $1.9 million, or 34%, and $1.4 million, or 10%,
respectively, as compared with the prior year periods, primarily due to the
bankruptcy of a customer, and decreased installation fees resulting from
fewer new customers.
28
<PAGE>
Reciprocal compensation revenue for the three and nine months ended
September 30, 2001 decreased $6.5 million, or 71%, and $10.8 million, or
37%, respectively, as compared with the prior year periods. The decrease is
due to a decrease in average monthly minutes processed of 211.0 million, or
18%, and 93.3 million, or 8%, for the three and nine months ended September
30, 2001, respectively, as compared with the prior year periods and lower
weighted average rates per minute.
ELI has various interconnection agreements with Qwest, Verizon and PacBell,
the ILECs in the states in which it operates. These agreements govern
reciprocal compensation relating to the transport and termination of
traffic between the ILEC's networks and our network. We recognize
reciprocal compensation revenues as earned, based on the terms of the
interconnection agreements.
Long distance services revenue for the three and nine months ended September 30,
2001 decreased $0.6 million, or 16%, and $3.3 million, or 26%, respectively, as
compared with the prior year periods. The decrease is due to a decrease in
wholesale average monthly minutes processed of 3.3 million, or 20%, and 4.5
million or 25%, for the three and nine months ended September 30, 2001, as
compared to prior year periods. The decrease is also attributable to the
discontinuation of the Voice Solutions portion of our business.
Data services include Internet, RSVP, Frame Relay and other services. Data
services revenue for the three and nine months ended September 30, 2001
decreased $3.4 million, or 26%, and $7.3 million, or 19%, respectively, as
compared with the prior year periods, primarily due to the expiration on
February 28, 2001 of an 18-month take-or-pay contract with a significant
customer. This take-or-pay contract was not renewed.
<TABLE>
<CAPTION>
GAS REVENUE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Gas revenue $ 37,717 $ 80,332 -53% $ 360,387 270,753 33%
</TABLE>
Gas revenue for the three months ended September 30, 2001 decreased $42.6
million, or 53%, as compared with the prior year period primarily due to the
sale of our Louisiana gas operations. There was no revenue from the Louisiana
gas operations for the three months ended September 30, 2001 since the sale
closed on July 2, 2001.
Gas revenue for the nine months ended September 30, 2001 increased $89.6
million, or 33%, as compared with the prior year period, primarily due to higher
purchased gas costs and increased consumption. Under tariff provisions,
increases in our costs of gas purchased are largely passed on to customers. The
increase was partially offset by decreased revenue due to the sale of our
Louisiana gas operations on July 2, 2001. Included in gas revenue is
approximately $203.5 million for the nine months ended September 30, 2001 of
revenue from our Louisiana gas operations. This revenue will not continue since
the sale closed on July 2, 2001.
<TABLE>
<CAPTION>
ELECTRIC REVENUE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Electric revenue $ 63,953 $ 62,770 2% $ 174,114 $ 169,879 2%
</TABLE>
Electric revenue for the three and nine months ended September 30, 2001
increased $1.2 million, or 2%, and $4.2 million, or 2%, respectively, as
compared with the prior year periods, primarily due to customer growth and
increased consumption due to warmer weather conditions.
29
<PAGE>
<TABLE>
<CAPTION>
COST OF SERVICES
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Gas purchased $ 24,988 $ 48,182 -48% $ 252,065 $ 148,238 70%
Electric energy and fuel oil purchased 36,149 32,540 11% 95,804 84,514 13%
Network access 63,078 34,544 83% 132,008 108,183 22%
Eliminations * (1,001) (769) N/A (2,770) (2,096) N/A
-------------- ------------- ------------- --------------
$ 123,214 $ 114,497 8% $ 477,107 $338,839 41%
============== ============= ============= ==============
</TABLE>
*Eliminations represent expenses incurred by our ILEC operations related to
network services provided by ELI.
Gas purchased for the three months ended September 30, 2001 decreased $23.2
million, or 48%, as compared with the prior year period, primarily due to the
sale of our Louisiana gas operations. There was no gas purchased for the
Louisiana gas operations for the three months ended September 30, 2001 since the
sale closed on July 2, 2001.
Gas purchased for the nine months ended September 30, 2001 increased $103.8
million, or 70%, as compared with the prior year period, primarily due to an
increase in the cost of gas. Under tariff provisions, increases in our costs of
gas purchased are largely passed on to customers. The increase was partially
offset by decreased gas purchased due to the sale of our Louisiana gas
operations on July 2, 2001. Included in gas purchased is approximately $161.3
million for the nine months ended September 30, 2001, respectively, of gas
purchased by our Louisiana gas operations. This cost will not continue since the
sale of our Louisiana gas operations closed on July 2, 2001.
Electric energy and fuel oil purchased for the three and nine months ended
September 30, 2001 increased $3.6 million, or 11%, and $11.3 million, or 13%,
respectively, as compared with the prior year periods, primarily due to higher
purchased power prices, customer growth and increased consumption due to warmer
weather conditions.
During the past two years the decrease in the availability of power in certain
areas of the country has caused power supply costs to increase substantially,
forcing companies to pay higher operating costs to operate their electric
businesses. As a result, companies have attempted to offset these increased
costs by either renegotiating prices with their power suppliers or passing these
additional costs on to their customers through a rate proceeding. In Arizona,
excessive power costs charged by our power supplier in the amount of
approximately $98 million through September 30, 2001 have been incurred. We are
allowed to recover these charges from ratepayers through the Purchase Power Fuel
Adjustment clause. However, in an attempt to limit "rate shock" to our
customers, we requested in September 2001 that this deferred amount, plus
interest, be recovered over a seven-year period. As a result, we have deferred
these costs on the balance sheet in anticipation of recovery through the
regulatory process.
On July 16, 2001, we terminated our existing contract with Arizona Public
Service and entered into a new seven-year purchase power agreement. This
agreement allows us to purchase all power required for operations at a fixed
rate per kilowatt hour. This agreement is retroactive to June 1, 2001 and will
mitigate further increases in the deferred power cost account.
Network access expenses for the three months ended September 30, 2001 increased
$28.5 million, or 83%, as compared with the prior year period, primarily due to
the impact of the Acquisitions and increased circuit expense associated with
additional data product introductions partially offset by a reduction in long
distance access expense related to rate changes in the ILEC sector.
Network access expenses for the nine months ended September 30, 2001 increased
$23.8 million, or 22%, as compared with the prior year period, primarily due to
the impact of the Acquisitions and increased circuit expense associated with
additional data product introductions and an Internet remote call forwarding
adjustment partially offset by a reduction in long distance access expense
related to rate changes in the ILEC sector and reduced variable costs at ELI.
30
<PAGE>
<TABLE>
<CAPTION>
DEPRECIATION AND AMORTIZATION EXPENSE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Depreciation expense $ 141,709 $ 92,004 54% $ 335,452 $ 273,198 23%
Amortization expense 51,953 3,855 1248% 78,282 5,285 1381%
-------------- ------------- ------------- --------------
$ 193,662 $ 95,859 102% $ 413,734 $ 278,483 49%
============== ============= ============= ==============
</TABLE>
Depreciation expense for the three and nine months ended September 30, 2001
increased $49.7 million, or 54%, and $62.3 million, or 23%, respectively, as
compared with the prior year periods, primarily due to the impact of the
Acquisitions of $47.1 million and $78.5 million, respectively, and $8.8 million
of accelerated depreciation related to the change in useful life of our
accounting and human resource systems and our Plano, Texas office building,
land, furniture and fixtures as a result of our restructuring. The accelerated
depreciation will continue over the next nine months. The incremental increase
to depreciation is estimated to be $13.2 million, $11.9 million and $.9 million
for the fourth quarter of 2001, first quarter of 2002 and second quarter of
2002, respectively. Higher property, plant and equipment balances in the
telecommunications and ELI sectors also contributed to the increase. The
increases were partially offset by decreased depreciation expense related to our
classifying our gas and electric sectors as "assets held for sale" which
requires us to cease depreciating these assets. Such depreciation expense would
have been an additional $11.4 million and $39.5 million for the three and nine
months ended September 20, 2001, respectively. The increase for the nine months
ended September 30, 2001 is also offset by $17.4 million in the prior year
period of accelerated depreciation related to the change in useful life of an
operating system in the telecommunications sector.
Amortization expense for the three and nine months ended September 30, 2001
increased $48.1 million, or 1,248%, and $73.0 million, or 1,381%, respectively,
as compared with the prior year periods, primarily due to amortization of
goodwill of $47.6 million and $71.0 million, respectively, related to the
Acquisitions.
<TABLE>
<CAPTION>
OTHER OPERATING EXPENSES
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Operating expenses $ 203,625 $ 143,888 42% $ 506,861 $ 427,465 19%
Taxes other than income taxes 34,789 25,704 35% 85,062 80,793 5%
Sales and marketing 29,478 17,781 66% 71,049 55,169 29%
-------------- ------------- ------------- --------------
$ 267,892 $ 187,373 43% $ 662,972 $ 563,427 18%
============== ============= ============= ==============
</TABLE>
Operating expenses for the three and nine months ended September 30, 2001
increased $59.7 million, or 42%, and $79.4 million, or 19%, as compared with the
prior year periods, primarily due to increased operating expenses due to the
impact of the Acquisitions. The increases were partially offset by decreased
operating expenses at ELI primarily due to a reduction in personnel, increased
operating efficiencies in the telecommunications sector, decreased operating
expenses in the gas sector primarily due to the sale of the Louisiana gas
operations on July 2, 2001, and a decrease in compensation expense related to
variable stock plans. A $1.00 change in our stock price can impact compensation
expense by $1.0 million annually.
Taxes other than income taxes increased $9.1 million, or 35%, and $4.3 million,
or 5%, respectively, as compared with the prior year periods, primarily due the
impact of the Acquisitions. The increase for the nine months ended September 30,
2001 was partially offset by franchise tax refunds received by the gas sector.
Sales and marketing expenses increased $11.7 million, or 66%, and $15.9 million,
or 29%, respectively, as compared with the prior year periods, primarily due to
the impact of the Acquisitions and increased telemarketing costs in the
telecommunications sector.
31
<PAGE>
<TABLE>
<CAPTION>
RESTRUCTURING EXPENSES
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Restructuring expenses $ 13,002 $ - 100% $ 13,002 $ - 100%
</TABLE>
Restructuring expenses of $13.0 million for the three and nine months ended
September 30, 2001 is related to our plan to close our operations support center
in Plano, Texas by April 2002. The restructuring resulted in the reduction of
749 employees. These expenses primarily consist of severance, benefits,
retention, early lease termination costs and other planning and communication
costs. We expect to incur additional costs of approximately $3,128,000 through
the first quarter of 2002.
<TABLE>
<CAPTION>
ACQUISITION ASSIMILATION EXPENSE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Acquisition assimilation expense $ 5,119 $ 12,539 -59% $ 17,665 $ 24,130 -27%
</TABLE>
Acquisition assimilation expense of $5.1 million and $12.5 million for the three
months ended September 30, 2001 and 2000, respectively, and $17.7 million and
$24.1 million for the nine months ended September 30, 2001 and 2000,
respectively, is related to the completed and pending acquisitions. These
expenses represent incremental costs incurred by us in advance of the respective
acquisitions which are solely related to preparation for businesses to be
acquired and have no relationship with then existing operations, and as a
result, have no revenue offset. Costs incurred during 2001 were significant due
to the unprecedented level of planned and completed acquisitions. We anticipate
a lower level of assimilation expense associated with our pending acquisitions
in California and Arizona which are expected to close in 2002. Material
components of acquisition expenses include incremental pre-staffing and training
costs incurred in anticipation of acquisitions, incremental costs associated
with the integration of the acquired networks into our existing networks and
network operating center, and costs associated with the preparation for the
conversion of billing, accounting and plant records.
<TABLE>
<CAPTION>
OPERATING INCOME
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Operating Income $ 58,232 $ 42,442 37% $ 206,664 $ 115,140 79%
</TABLE>
Operating income for the three and nine months ended September 30, 2001
increased $15.8 million, or 37%, and $91.5 million, or 79%, respectively, as
compared with prior year periods, primarily due to ILEC growth and acquisitions
partially offset by the restructuring expenses and increased ELI losses.
Included in operating income is approximately $11.8 million of operating income
for the nine months ended September 30, 2001 from our Louisiana gas operations.
This operating income will not continue since the sale of our Louisiana gas
operations closed on July 2, 2001.
<TABLE>
<CAPTION>
INVESTMENT AND OTHER INCOME, NET / MINORITY INTEREST
INTEREST EXPENSE/INCOME TAXES
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Investment and other income, net $ 3,070 $ 5,096 -40% $ 16,495 $ 14,913 11%
Gain on sale of assets $ 139,304 $ - 100% $ 139,304 $ - 100%
Minority interest $ - $ - - $ - $ 12,222 -100%
Interest expense $ 123,452 $ 49,559 149% $ 258,033 $ 128,899 100%
Income taxes $ 39,610 $ (202) - $ 49,183 $ 5,096 -
</TABLE>
32
<PAGE>
Investment and other income, net for the three months ended September 30, 2001
decreased $2.0 million, or 40%, as compared with the prior year period,
primarily due to lower average investment balances. Investment and other income,
net for the nine months ended September 30, 2001 increased $1.6 million, or 11%,
as compared with the prior year period, primarily due to increased income from
higher money market balances resulting from the temporary investment of proceeds
from debt issuances, an increase in the equity component of the allowance for
funds used during construction (AFUDC) and increases in miscellaneous income
items.
Gain on sale of assets for the three and nine months ended September 30, 2001
represents the gain recognized from the sale of our Louisiana Gas operations to
Atmos Energy Corporation on July 2, 2001.
Minority interest, as presented on the income statement, represents the
minority's share of ELI's net loss which we were able to recognize in prior
periods to the extent of minority interest on our balance sheet. As of June 30,
2000, the minority interest on the balance sheet had been reduced to zero.
Therefore, from that point going forward, we discontinued recording minority
interest income on our income statement, as there is no obligation for the
minority interests to provide additional funding for ELI.
Interest expense for the three months ended September 30, 2001 increased $73.9
million, or 149%, as compared with the prior year periods, primarily due to
$39.2 million of interest expense on our $1.75 billion of notes issued in May
2001, $17.5 million of interest expense on our $1.75 billion of notes issued in
August, 2001, $2.9 million of interest expense on our lines of credit, $8.0
million of interest expense on our equity units issued in June 2001 and $3.1
million for amortization of costs associated with our committed bank credit
facilities and $3.2 million of increased amortization of debt discount expense.
During the three months ended September 30, 2001, we had average long-term debt
outstanding of $6.3 billion compared to $2.7 billion during the three months
ended September 30, 2000. Our composite average borrowing rate paid for the
three months ended September 30, 2001 as compared with the prior year period was
51 basis points higher, increasing from 6.87% to 7.38% due to the impact of
higher interest rates on our new borrowings.
Interest expense for the nine months ended September 30, 2001 increased $129.1
million, or 100%, as compared with the prior year periods, primarily due to
$56.1 million of interest expense on our $1.75 billion of notes issued in May
2001, $17.5 million of interest expense on our $1.75 billion of notes issued in
August 2001, $26.9 million of interest expense on our lines of credit, a $4.2
million increase in ELI's interest expense related to increased borrowings, $9.2
million for amortization of costs associated with our committed bank credit
facilities, $3.7 million of increased amortization of debt discount expense and
$8.9 million of interest expense on our equity units issued in June. During the
nine months ended September 30, 2001, we had average long-term debt outstanding
of $4.7 billion compared to $2.5 billion during the nine months ended September
30, 2000. Our composite average borrowing rate paid for the nine months ended
September 30, 2001 as compared with the prior year period was 63 basis points
higher, increasing from 6.77% to 7.40%, due to the impact of higher interest
rates on our new borrowings.
Income taxes for the three and nine months ended September 30, 2001 increased
$39.8 million and $44.1 million, respectively, as compared with the prior year
periods, primarily due to changes in taxable income. The estimated annual
effective tax rate for 2001 and 2000 is 37%. Income tax expense for the three
and nine months ended September 30, 2000 includes adjustments made in the
current period to arrive at this rate.
<TABLE>
<CAPTION>
DISCONTINUED OPERATIONS
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Revenue $ 34,451 $ 29,272 18% $ 87,880 $ 79,913 10%
Operating income $ 14,832 $ 9,716 53% $ 26,777 $ 19,746 36%
Net income $ 7,199 $ 4,838 49% $ 11,675 $ 8,182 43%
</TABLE>
Revenue from discontinued operations for the three and nine months ended
September 30, 2001 increased $5.2 million, or 18%, and $8.0 million, or 10%,
respectively, as compared with the prior year periods, primarily due to customer
growth and new water sales related to the completion of a multi-year $50 million
water pipeline project in Illinois in March 2001.
Operating income from discontinued operations for the three and nine months
ended September 30, 2001 increased $5.1 million, or 53%, and $7.0 million, or
36%, respectively, as compared with the prior year periods, primarily due to
customer growth and new water sales related to the completion of a water
pipeline project in Illinois in March 2001.
33
<PAGE>
Net income from discontinued operations for the three and nine months ended
September 30, 2001 increased $2.4 million, or 49%, and $3.5 million, or 43%,
respectively, as compared with prior year periods, primarily due to the
respective changes in operating income net of income taxes.
<TABLE>
<CAPTION>
EXTRAORDINARY EXPENSE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
Extraordinary expense - discontinuation
of Statement of Financial Accounting
<S> <C> <C> <C> <C> <C> <C>
Standards No. 71, net of tax $ 43,631 $ - 100% $ 43,631 $ - 100%
</TABLE>
Extraordinary expense - discontinuation of Statement of Financial Accounting
Standards No. 71, net of tax, of $43.6 million for the three and nine months
ended September 30, 2001, relates to the write off of regulatory assets and
liabilities previously recognized under SFAS 71. Deregulation of most of our
local exchange telephone properties required us to cease application of SFAS 71
in the third quarter, resulting in a non cash extraordinary charge of $43.6
million, net of tax, in our income statement. See discussion in Note 11 of the
financial statements.
<TABLE>
<CAPTION>
NET INCOME/AVAILABLE TO COMMON SHAREHOLDERS/
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS PER COMMON SHARE
($ in thousands) For the three months ended September 30, For the nine months ended September 30,
---------------------------------------- ----------------------------------------
2001 2000 % Change 2001 2000 % Change
-------------- ------------- ----------- ------------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net income $ (441) $ 1,466 -130% $ 18,633 $ 11,804 58%
Carrying cost of equity forward contracts 1,003 - n/a 13,650 - n/a
-------------- ------------- ----------- ------------- -------------- -----------
Available to common shareholders $(1,444) $ 1,466 -198% $ 4,983 $ 11,804 -58%
============== ============= =========== ============= ============== ===========
Net income available to common
shareholders per common share $ (0.01) $ 0.01 -100% $ 0.02 $ 0.05 -60%
</TABLE>
Net income for the three months ended September 30, 2001 decreased $1.9 million,
or 130%, as compared with the prior year period, primarily due to restructuring
expenses, extraordinary expense and increased interest expense partially offset
by increased operating income and the gain from the sale of our Louisiana gas
operations.
Net income for the nine months ended September 30, 2001 increased $6.8 million,
or 58%, as compared with the prior year period, primarily due to increased
operating income and the gain from the sale of our Louisiana gas operations
partially offset by restructuring expenses, extraordinary expense and increased
interest expense.
During 2000, we entered into an equity forward contract for the acquisition of
9,140,000 shares as part of our share repurchase programs. Pursuant to
transition accounting rules, commencing December 31, 2000 through June 30, 2001
we were required to report our equity forward contract as a reduction to
shareholders' equity and a component of temporary equity for the gross
settlement amount of the contract ($150,013,000). On June 28, 2001, we entered
into a master confirmation agreement that amended the equity forward contract to
no longer permit share settlement of the contract. We were required to report
the accrued carrying costs as a reduction of net income available to common
shareholders. Accordingly, on June 29, 2001, we accrued $42,995,000 to net cash
settle a portion of the contract, plus $12,647,000 in associated carrying costs.
At September 30, 2001, we settled the contract by paying the redemption amount
of $107,018,000 plus $1,003,000 in associated carrying costs.
34
<PAGE>
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities. Market risk refers to the
potential change in fair value of a financial instrument as a result of
fluctuations in interest rates and equity 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. Our primary market risk exposures are
interest rate risk and equity and commodity price risk as follows:
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest bearing portion of our investment portfolio and 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 and variable rate debt is refinanced when advantageous.
Consequently, we have no 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 September 30, 2001, a near-term change in interest rates would not
materially affect our consolidated financial position, results of operations or
cash flows.
Sensitivity analysis of interest rate exposure
At September 30, 2001, the fair value of our long-term debt and capital lease
obligations was estimated to be approximately $6,244.6 million, based on our
overall weighted average rate of 7.8% and our overall weighted maturity of
approximately 12 years. There has been no material change in the weighted
average maturity applicable to our obligations since December 31, 2000. However,
the overall weighted average interest rate applicable to our obligations has
increased by approximately 85 basis points since December 31, 2000. A
hypothetical increase of 78 basis points (10% of our overall weighted average
borrowing rate) would result in an approximate $305.5 million decrease in the
fair value of our fixed rate obligations.
Equity Price Exposure
Our exposure to market risk for changes in equity prices relate primarily to the
equity portion of our investment portfolio. The equity portion of our investment
portfolio includes marketable equity securities of media and telecommunications
companies.
Sensitivity analysis of equity price exposure
At September 30, 2001, the fair value of the equity portion of our investment
portfolio was estimated to be $117.1 million. A hypothetical 10% decrease in
quoted market prices would result in an approximate $11.7 million decrease in
the fair value of the equity portion of our investment portfolio.
35
<PAGE>
Commodity Price Exposure
We purchase monthly gas future contracts to manage well-defined commodity price
fluctuations, caused by weather and other unpredictable factors, associated with
our commitments to deliver natural gas to customers at fixed prices. Customers
pay for gas service based upon prices that are defined by a tariff. A tariff is
an agreement with the public utility commission that determines the price that
we will charge to the customer. Fluctuations in gas prices are routinely handled
through a pricing mechanism called the purchase gas adjustor (PGA). The PGA
allows for a process whereby any price change from the agreed upon tariff will
be settled as a pass through to the customer. As a result, if gas prices
increase, the PGA will increase and pass more costs on to the customer. If gas
prices decrease, the PGA will decrease and refunds will be provided to the
customer. This commodity activity relates to our gas businesses and is not
material to our consolidated financial position or results of operations. In all
instances we take physical delivery of the gas supply purchased or contracted
for. These gas future contracts and gas supply contracts are considered
derivative instruments as defined by SFAS 133. However, such contracts are
excluded from the provisions of SFAS 133 since they are purchases made in the
normal course of business and not for speculative purposes. Based upon our
overall commodity price exposure at September 30, 2001, a material near-term
change in the quoted market price of gas would not materially affect our
consolidated financial position or results of operations.
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 September 30, 2001. 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.
36
<PAGE>
PART II. OTHER INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Item 1. Legal Proceedings
-----------------
On July 20, 2001, we notified Qwest Corporation that we were terminating eight
acquisition agreements with Qwest relating to telephone exchanges in Arizona,
Colorado, Idaho/ Washington, Iowa, Minnesota, Montana, Nebraska and Wyoming. On
July 23, 2001, Qwest informed us that it intends to file a notice of claim for
arbitration in Denver, Colorado under the rules of the American Arbitration
Association with respect to the terminated acquisition agreements. Qwest asserts
that we wrongfully terminated these agreements and is seeking approximately $64
million in damages, which is the aggregate of liquidated damages under letters
of credit established in the terminated acquisition agreements. We intend to
file a notice of claim in the same arbitration proceeding, contesting Qwest's
asserted claims and asserting substantial claims against Qwest for material
breaches of representations, warranties and covenants in the terminated
acquisition agreements and in the acquisition agreement relating to North Dakota
assets that we purchased from Qwest.
We are party to 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 2. Changes in Securities and Use of Proceeds
-----------------------------------------
None.
Item 3. Defaults upon Senior Securities
-------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None.
Item 5. Other Information
-----------------
On April 2, 2001, ELI received a notice from the Nasdaq Stock Market, Inc. that
its stock would be subject to delisting from the Nasdaq National Market after
July 2, 2001 because its Class A Common Stock failed to maintain a minimum bid
price.
On June 29, 2001, ELI filed an application for its listing to be transferred to
the Nasdaq SmallCap Market. As part of the application process, we converted
approximately 25.3 million shares of our Class B Common Stock into the same
number of shares of ELI's Class A Common Stock on August 27, 2001.
On August 31, 2001, ELI received a notice from Nasdaq indicating that it had
failed to comply with the shareholders' equity, market capitalization, market
value/total assets and revenue and minimum bid price requirements for continued
listing, and that ELI's stock was, therefore, subject to delisting from the
Nasdaq National Market. ELI was granted a hearing before a Nasdaq Listing
Qualifications Panel to review the delisting.
On September 27, 2001, Nasdaq implemented a moratorium on the minimum bid price
and market value of public float requirements for continued listing on the
Nasdaq Stock Market until January 2, 2002. ELI received a notice from Nasdaq on
that date stating that as a result of that action the hearing scheduled
regarding the delisting of ELI's stock had been canceled and ELI's hearing file
closed for now.
As of January 2, 2002, compliance with the minimum requirements for listing on
the Nasdaq National and SmallCap Markets will start anew. If ELI does not meet
these requirements for 30 consecutive days, and is unable to regain compliance
within 90 days, ELI's stock could be subject to delisting at that time. It is
uncertain whether ELI will be able to meet the applicable listing requirements.
If the requirements are not met, ELI's Class A Common Stock may not be eligible
for trading on Nasdaq and ELI expects it would trade in the over-the-counter
market. If ELI's Class A Common Stock fails to remain included on Nasdaq, the
delisting may have a material adverse impact on the market value of ELI's Class
A Common Stock.
37
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a) Exhibits:
10.38 Competitive Advance and Revolving Credit Facility Agreement
for $680,000,000 dated October 24, 2001.
10.39 Loan Agreement between Citizens Communications Company and
Rural Telephone Finance Cooperative for $200,000,000 dated
October 24, 2001.
b) Reports on Form 8-K:
We filed on Form 8-K on July 2, 2001 under Item 5 "Other Events" and
Item 7 "Financial Statements, Exhibits," a press release announcing
the completion of our acquisition of Global Crossing's local exchange
telephone business, which operates under the name Frontier Telephone.
We filed on Form 8-K on July 2, 2001 under Item 5 "Other Events" and
Item 7 "Financial Statements, Exhibits," a press release announcing
that we had completed the sale of our Louisiana gas operations to
Atmos Energy Corporation for approximately $365 million in cash.
We filed on Form 8-K on July 24, 2001 under Item 5 "Other Events" and
Item 7 "Financial Statements, Exhibits," a press release announcing
that we delivered a notice of termination of our pending acquisition
agreements with Qwest Communications International, Inc.
We filed on Form 8-K on August 10, 2001 under Item 5 "Other Events"
and Item 7 "Financial Statements, Pro Forma Financial Information and
Exhibits," financial statements of the Frontier business acquired and
pro forma financial information related to the Frontier business
acquired and the disposition of our Louisiana gas operations for
period ended March 31, 2001.
We filed on Form 8-K on August 10, 2001 under Item 7 "Financial
Statements, Exhibits," a press release announcing earnings for the
quarter and six months ended June 30, 2001 and certain financial and
operating data.
We filed on Form 8-K on August 15, 2001 under Item 5 "Other Events"
and Item 7 "Financial Statements, Exhibits," a press release
announcing that we priced a private offering $1.75 billion of senior
notes for resale under Rule 144A of the Securities Act of 1933.
We filed on Form 8-K on August 22, 2001 under Item 5 "Other Events"
and Item 7 "Financial Statements, Exhibits," certain agreements
related to our private offering of $1.75 billion of senior notes.
We filed on Form 8-K on September 17, 2001 under Item 5 "Other Events"
and Item 7 "Financial Statements, Pro Forma Financial Information and
Exhibits," financial statements of the Frontier business acquired and
pro forma financial information related to the Frontier business
acquired, the remaining Verizon acquisitions and the public utilities
services dispositions for period ended June 30, 2001.
We filed on Form 8-K on September 21, 2001 under Item 5 "Other Events"
and Item 7 "Financial Statements, Exhibits," a press release
announcing we received California PUC approval to sell our water and
wastewater operations.
38
<PAGE>
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Robert J. Larson
---------------------------------------
Robert J. Larson
Vice President and Chief Accounting Officer
Date: November 13, 2001
39
</TEXT>
</DOCUMENT>