-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DZ3JmaA9Gehp1YugE1RDghO46fk1FgKxliBJTNPl899gr4mLG9fXwsFkRA6UL/Ki fWXHXjHJztsSOoxDj+09Gw== 0000020520-04-000028.txt : 20040804 0000020520-04-000028.hdr.sgml : 20040804 20040804172508 ACCESSION NUMBER: 0000020520-04-000028 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040804 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CITIZENS COMMUNICATIONS CO CENTRAL INDEX KEY: 0000020520 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 060619596 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-11001 FILM NUMBER: 04952507 BUSINESS ADDRESS: STREET 1: HIGH RIDGE PK BLDG 3 CITY: STAMFORD STATE: CT ZIP: 06905 BUSINESS PHONE: 2036145600 MAIL ADDRESS: STREET 1: THREE HIGH RIDGE PARK CITY: STAMFORD STATE: CT ZIP: 06905 FORMER COMPANY: FORMER CONFORMED NAME: CITIZENS UTILITIES CO DATE OF NAME CHANGE: 19920703 10-Q 1 qtr2nd10q2004.txt 2ND QTR 2004 10-Q CITIZENS COMMUNICATIONS COMPANY FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 ------------- or -- |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________to__________ Commission file number: 001-11001 --------- CITIZENS COMMUNICATIONS COMPANY ---------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 06-0619596 - ------------------------------ ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 3 High Ridge Park Stamford, Connecticut 06905 - ---------------------------------------- ------------ (Address of principal executive offices) (Zip Code) (203) 614-5600 -------------------------------------------------- (Registrant's telephone number, including area code) N/A --------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No --- --- The number of shares outstanding of the registrant's Common Stock as of July 30, 2004 was 291,447,809.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES Index Page No. -------- Part I. Financial Information (Unaudited) Financial Statements Consolidated Balance Sheets at June 30, 2004 and December 31, 2003 2 Consolidated Statements of Operations for the three months ended June 30, 2004 and 2003 3 Consolidated Statements of Operations for the six months ended June 30, 2004 and 2003 4 Consolidated Statements of Shareholders' Equity for the year ended December 31, 2003 and the six months ended June 30, 2004 5 Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2004 and 2003 5 Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003 6 Notes to Consolidated Financial Statements 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 22 Quantitative and Qualitative Disclosures about Market Risk 35 Controls and Procedures 37 Part II. Other Information Legal Proceedings 38 Submission of Matters to a Vote of Security Holders 39 Other Information 39 Exhibits and Reports on Form 8-K 39 Signature 41
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PART I. FINANCIAL INFORMATION Item 1. Financial Statements -------------------- CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ($ in thousands) (Unaudited) June 30, 2004 December 31, 2003 -------------- ----------------- ASSETS - ------ Current assets: Cash and cash equivalents $ 740,359 $ 583,671 Accounts receivable, less allowances of $31,114 and $47,332, respectively 224,281 248,473 Other current assets 38,312 40,984 Assets held for sale - 23,130 -------------- ----------------- Total current assets 1,002,952 896,258 Property, plant and equipment, net 3,437,099 3,525,640 Goodwill, net 1,940,318 1,940,318 Other intangibles, net 749,147 812,407 Investments 63,654 53,383 Other assets 447,428 461,104 -------------- ----------------- Total assets $ 7,640,598 $ 7,689,110 ============== ================= LIABILITIES AND EQUITY - ---------------------- Current liabilities: Long-term debt due within one year $ 6,490 $ 88,002 Accounts payable 128,902 161,640 Other current liabilities 324,501 322,805 Liabilities related to assets held for sale - 11,128 -------------- ----------------- Total current liabilities 459,893 583,575 Deferred income taxes 481,632 447,056 Customer advances for construction and contributions in aid of construction 94,830 122,035 Other liabilities 264,746 264,382 Equity units 460,000 460,000 Long-term debt 4,378,131 4,195,629 Company Obligated Mandatorily Redeemable Convertible Preferred Securities* - 201,250 Shareholders' equity: Common stock, $0.25 par value (600,000,000 authorized shares; 287,661,000 and 284,709,000 outstanding at June 30, 2004 and December 31, 2003, respectively, and 295,434,000 issued at June 30, 2004 and Decemember 31, 2003) 73,858 73,858 Additional paid-in capital 1,925,663 1,953,317 Accumulated deficit (298,521) (365,181) Accumulated other comprehensive loss (72,716) (71,676) Treasury stock (126,918) (175,135) -------------- ------------------ Total shareholders' equity 1,501,366 1,415,183 -------------- ------------------ Total liabilities and equity $ 7,640,598 $ 7,689,110 ============== ==================
* 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 consolidation of this item changed effective January 1, 2004 as a result of the application of a newly mandated accounting standard "FIN 46R." Please see footnote 14 for a complete discussion. The accompanying Notes are an integral part of these Consolidated Financial Statements. 2
PART I. FINANCIAL INFORMATION (Continued) CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003 ($ in thousands, except per-share amounts) (Unaudited) 2004 2003 -------------- -------------- Revenue $544,091 $ 643,954 Operating expenses: Cost of services (exclusive of depreciation and amortization) 48,295 113,537 Other operating expenses 211,648 232,493 Depreciation and amortization 144,412 150,359 Reserve for telecommunications bankruptcies - 2,260 Restructuring and other expenses - 10,113 Strategic alternatives and management succession expenses (see Note 12) 11,561 - -------------- -------------- Total operating expenses 415,916 508,762 -------------- -------------- Operating income 128,175 135,192 Investment and other income, net 5,213 31,237 Interest expense 97,652 106,436 -------------- -------------- Income before income taxes, dividends on convertible preferred securities 35,736 59,993 Income tax expense 11,944 24,384 -------------- -------------- Income before dividends on convertible preferred securities 23,792 35,609 Dividends on convertible preferred securities, net of tax benefit of $0 and $(963), respectively* - 1,552 -------------- -------------- Net income available to common shareholders $ 23,792 $ 34,057 ============== ============== Basic and diluted income per common share $ 0.08 $ 0.12 ============== ==============
* The consolidation of this item changed effective January 1, 2004 as a result of the application of a newly mandated accounting standard "FIN 46R." Please see footnote 14 for a complete discussion. The accompanying Notes are an integral part of these Consolidated Financial Statements. 3
PART I. FINANCIAL INFORMATION (Continued) CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003 ($ in thousands, except per-share amounts) (Unaudited) 2004 2003 -------------- -------------- Revenue $ 1,102,559 $ 1,295,816 Operating expenses: Cost of services (exclusive of depreciation and amortization) 105,359 226,756 Other operating expenses 424,457 468,314 Depreciation and amortization 288,270 288,907 Reserve for telecommunications bankruptcies - 2,260 Restructuring and other expenses - 10,092 Strategic alternatives and management succession expenses (see Note 12) 16,492 - -------------- -------------- Total operating expenses 834,578 996,329 -------------- -------------- Operating income 267,981 299,487 Investment and other income, net 30,507 79,409 Interest expense 195,434 215,712 -------------- -------------- Income before income taxes, dividends on convertible preferred securities, and cumulative effect of change in accounting principle 103,054 163,184 Income tax expense 36,394 64,360 -------------- -------------- Income before dividends on convertible preferred securities and cumulative effect of change in accounting principle 66,660 98,824 Dividends on convertible preferred securities, net of tax benefit of $0 and $(1,926), respectively* - 3,105 -------------- -------------- Income before cumulative effect of change in accounting principle 66,660 95,719 Cumulative effect of change in accounting principle, net of tax of $0 and $41,591, respectively - 65,769 -------------- -------------- Net income available to common shareholders $ 66,660 $ 161,488 ============== ============== Basic income per common share: Income before cumulative effect of change in accounting principle $ 0.23 $ 0.34 Cumulative effect of change in accounting principle - 0.23 -------------- -------------- Net income available to common shareholders $ 0.23 $ 0.57 ============== ============== Diluted income per common share: Income before cumulative effect of change in accounting principle $ 0.23 $ 0.33 Cumulative effect of change in accounting principle - 0.22 -------------- -------------- Net income available to common shareholders $ 0.23 $ 0.55 ============== ==============
* The consolidation of this item changed effective January 1, 2004 as a result of the application of a newly mandated accounting standard "FIN 46R." Please see footnote 14 for a complete discussion. The accompanying Notes are an integral part of these Consolidated Financial Statements. 4
PART I. FINANCIAL INFORMATION (Continued) CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEAR ENDED DECEMBER 31, 2003 AND THE SIX MONTHS ENDED JUNE 30, 2004 ($ in thousands) (Unaudited) Accumulated Common Stock Additional Other Treasury Stock Total ------------------- Paid-In Accumulated Comprehensive -------------------- Shareholders' Shares Amount Capital Deficit Loss Shares Amount Equity --------- --------- ----------- ------------ ------------ -------- ----------- ----------- Balances January 1, 2003 294,080 $73,520 $ 1,943,406 $ (553,033) $(102,169) (11,598) $ (189,585) $1,172,139 Stock plans 1,354 338 9,911 - - 873 14,450 24,699 Net income - - - 187,852 - - - 187,852 Other comprehensive income, net of tax and reclassifications adjustments - - - - 30,493 - - 30,493 --------- --------- ----------- ------------ ------------ -------- ----------- ----------- Balances December 31, 2003 295,434 73,858 1,953,317 (365,181) (71,676) (10,725) (175,135) 1,415,183 Stock plans - - (27,654) - - 2,952 48,217 20,563 Net income - - - 66,660 - - - 66,660 Other comprehensive loss, net of tax and reclassifications adjustments - - - - (1,040) - - (1,040) --------- --------- ----------- ------------ ------------ -------- ----------- ----------- Balances June 30, 2004 295,434 $73,858 $ 1,925,663 $ (298,521) $ (72,716) (7,773) $ (126,918) $1,501,366 ========= ========= =========== ============ ============ ======== =========== =========== The accompanying Notes are an integral part of these Consolidated Financial Statements. CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003 ($ in thousands) (Unaudited) For the three months ended June 30, For the six months ended June 30, -------------------------------------- -------------------------------------- 2004 2003 2004 2003 ------------------ ------------------ ------------------ ------------------ Net income $ 23,792 $ 34,057 $ 66,660 $ 161,488 Other comprehensive income (loss), net of tax and reclassifications adjustments* (282) 908 (1,040) 4,798 ------------------ ------------------ ------------------ ------------------ Total comprehensive income $ 23,510 $ 34,965 $ 65,620 $ 166,286 ================== ================== ================== ==================
* Consists of unrealized holding gains/(losses) of marketable securities. The accompanying Notes are an integral part of these Consolidated Financial Statements. 5
PART I. FINANCIAL INFORMATION (Continued) CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003 ($ in thousands) (Unaudited) 2004 2003 -------------- ------------- Income before cumulative effect of change in accounting principle $ 66,660 $ 95,719 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization expense 288,270 288,907 Gain on expiration/settlement of customer advances (25,345) (6,165) Gain on capital lease termination/restructuring - (65,724) Other non-cash adjustments 8,928 (5,117) Deferred taxes 42,307 104,591 Change in accounts receivable 18,730 39,407 Change in accounts payable and other liabilities (37,567) (118,337) Change in other current assets 2,672 10,479 -------------- -------------- Net cash provided by operating activities 364,655 343,760 Cash flows from investing activities: Proceeds from sale of assets, net of selling expenses 13,992 54,900 Capital expenditures (133,434) (115,602) Securities purchased - (605) -------------- -------------- Net cash used by investing activities (119,442) (61,307) Cash flows from financing activities: Long-term debt payments (99,786) (301,583) Issuance of common stock 13,121 15,706 Repayment of customer advances for construction and contributions in aid of construction (1,860) (4,715) -------------- -------------- Net cash used by financing activities (88,525) (290,592) Increase (decrease) in cash and cash equivalents 156,688 (8,139) Cash and cash equivalents at January 1, 583,671 393,177 -------------- -------------- Cash and cash equivalents at June 30, $ 740,359 $ 385,038 ============== ============== Cash paid during the period for: Interest $ 204,293 $ 212,634 Income taxes $ 1,126 $ 1,243 Non-cash investing and financing activities: Change in fair value of interest rate swaps $ (10,980) $ 864
The accompanying Notes are an integral part of these Consolidated Financial Statements. 6 PART I. FINANCIAL INFORMATION (Continued) CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES (1) Summary of Significant Accounting Policies: ------------------------------------------ (a) Basis of Presentation and Use of Estimates: Citizens Communications Company and its subsidiaries are referred to as "we," "us" "our" or the "Company" in this report. Our unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and should be read in conjunction with the consolidated financial statements and notes included in our 2003 Annual Report on Form 10-K. Certain reclassifications of balances previously reported have been made to conform to current presentation. All significant intercompany balances and transactions have been eliminated in consolidation. These unaudited consolidated financial statements include all adjustments, which consist of normal recurring accruals necessary to present fairly the results for the interim periods shown. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions which affect the amounts of assets, liabilities, revenue and expenses we have reported and our disclosure of contingent assets and liabilities at the date of the financial statements. Actual results may differ from those estimates. We believe that our critical estimates are depreciation rates, pension assumptions, calculations of impairment amounts, reserves established for receivables, income taxes and contingencies. Certain information and footnote disclosures have been excluded and/or condensed pursuant to Securities and Exchange Commission rules and regulations. The results of the interim periods are not necessarily indicative of the results for the full year. (b) Cash Equivalents: We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. (c) Revenue Recognition: 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 other liabilities on our consolidated balance sheet and recognized in revenue over the period that the services are provided. Revenue that is billed in arrears includes: non-recurring network access services, switched access services, non-recurring local services and long-distance services. The earned but unbilled portion of this revenue is recognized in revenue in our statement of operations and accrued in accounts receivable in the period that the services are provided. Excise taxes are recognized as a liability when billed. Installation fees and their related direct and incremental costs are initially deferred and recognized as revenue and expense over the average term of a customer relationship. We recognize as current period expense the portion of installation costs that exceeds installation fee revenue. Electric Lightwave, LLC. (ELI) - Revenue is recognized when the services are provided. Revenue from long-term prepaid network services agreements including Indefeasible Rights to Use (IRU), are deferred and recognized on a straight-line basis over the terms of the related agreements. Installation fees and their related direct and incremental costs are initially deferred and recognized as revenue and expense over the average term of a customer relationship. We recognize as current period expense the portion of installation costs that exceeds installation fee revenue. (d) Goodwill and Other Intangibles: Intangibles represent the excess of purchase price over the fair value of identifiable tangible assets acquired. We undertake studies to determine the fair values of assets and liabilities acquired and allocate purchase prices to assets and liabilities, including property, plant and equipment, goodwill and other identifiable intangibles. On January 1, 2002, we adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," which 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. This 7 Statement requires that goodwill and other intangibles with indefinite useful lives no longer be amortized to earnings, but instead be tested for impairment, at least annually. In performing this test, the Company first compares the carrying amount of its reporting units to their respective fair values. If the carrying amount of any reporting unit exceeds its fair value, the Company is required to perform step two of the impairment test by comparing the implied fair value of the reporting unit's goodwill with its carrying amount. The amortization of goodwill and other intangibles with indefinite useful lives ceased upon adoption of the Statement on January 1, 2002. We annually (during the fourth quarter) examine the carrying value of our goodwill and trade name to determine whether there are any impairment losses. SFAS No. 142 also requires that intangible assets with estimated useful lives be amortized over those lives and be reviewed for impairment in accordance with SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" to determine whether any changes to these lives are required. We periodically reassess the useful life of our intangible assets with estimated useful lives to determine whether any changes to those lives are required. (e) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed of: We adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" as of January 1, 2002. In accordance with SFAS No. 144, we review long-lived assets to be held and used and long-lived assets to be disposed of, including intangible assets with estimated useful lives, for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by comparing the carrying amount of the asset to the future undiscounted net cash flows expected to be generated by the asset. If any assets are considered to be impaired, the impairment is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value. (f) Derivative Instruments and Hedging Activities: We account for derivative instruments and hedging activities in accordance with SFAS No. 149, "Accounting for Derivative Instruments and Hedging Activities," as amended. SFAS No. 149, as amended, requires that all derivative instruments, such as interest rate swaps, be recognized in the financial statements and measured at fair value regardless of the purpose or intent of holding them. We have interest rate swap arrangements related to a portion of our fixed rate debt. These hedge strategies satisfy the fair value hedging requirements of SFAS No. 133. As a result, the fair value of the hedges is carried on the balance sheet in other assets and the related underlying liabilities are also adjusted to fair value by the same amount. (g) Employee Stock Plans: We have various employee stock-based compensation plans. Awards under these plans are granted to eligible officers, management employees and non-management employees. Awards may be made in the form of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock or other stock based awards. As permitted by current accounting rules, we apply Accounting Principles Board Opinions (APB) No. 25 and related interpretations in accounting for the employee stock plans resulting in the use of the intrinsic value to value the stock. SFAS No. 123, "Accounting for Stock-Based Compensation" and SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No. 123," established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As permitted by existing accounting standards, the Company has elected to continue to apply the intrinsic-valued-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123, as amended. We provide pro forma net income and pro forma net income per common share disclosures for employee stock option grants on the fair value of the options at the date of grant. For purposes of presenting pro forma information, the fair value of options granted is computed using the Black Scholes option-pricing model. 8 Had we determined compensation cost based on the fair value at the grant date for the Management Equity Incentive Plan (MEIP), Equity Incentive Plan (EIP), Employee Stock Purchase Plan (ESPP) and Directors' Deferred Fee Equity Plan, our pro forma net income and net income per common share available for common shareholders would have been as follows:
Three Months Ended June 30, Six Months Ended June 30, --------------------------- ---------------------------- 2004 2003 2004 2003 ----------- ----------- ------------ ------------ ($ in thousands) Net income available for common shareholders As reported $ 23,792 $ 34,057 $ 66,660 $ 161,488 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 1,726 2,721 3,817 3,748 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (3,764) (5,208) (7,854) (8,508) --------- --------- ---------- --------- Pro forma $ 21,754 $ 31,570 $ 62,623 $ 156,728 ========= ========= ========== ========= Net income per common share available for common shareholders As reported: Basic $ 0.08 $ 0.12 $ 0.23 $ 0.57 Diluted $ 0.08 $ 0.12 $ 0.23 $ 0.55 Pro forma: Basic $ 0.08 $ 0.11 $ 0.22 $ 0.56 Diluted $ 0.07 $ 0.11 $ 0.22 $ 0.53
(h) Net Income Per Common Share Available for Common Shareholders: Basic net income per common share is computed using the weighted average number of common shares outstanding during the period being reported on. Except when the effect would be antidilutive, diluted net income per common share reflects the dilutive effect of the assumed exercise of stock options using the treasury stock method at the beginning of the period being reported on as well as common shares that would result from the conversion of convertible preferred stock. In addition, the related interest on preferred stock dividends (net of tax) is added back to income since it would not be paid if the preferred stock was converted to common stock. (2) Recent Accounting Literature and Changes in Accounting Principles: ----------------------------------------------------------------- Accounting for Asset Retirement Obligations ------------------------------------------- In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, "Accounting for Asset Retirement Obligations." We adopted SFAS No. 143 effective January 1, 2003. As a result of our adoption of SFAS No. 143, we recognized an after tax non-cash gain of approximately $65,769,000. This gain resulted from the elimination of the cumulative cost of removal included in accumulated depreciation as a cumulative effect of a change in accounting principle in our statement of operations in the first quarter of 2003 as the Company has no legal obligation to remove certain of its long-lived assets. 9 Exit or Disposal Activities --------------------------- In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which nullified Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, rather than on the date of commitment to an exit plan. This Statement is effective for exit or disposal activities that are initiated after December 31, 2002. We adopted SFAS No. 146 on January 1, 2003. The adoption of SFAS No. 146 did not have any material impact on our financial position or results of operations. Guarantees ---------- In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness of Others." FIN 45 requires that a guarantor be required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation assumed under the guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with the guarantee. The provisions of FIN 45 are effective for guarantees issued or modified after December 31, 2002, whereas the disclosure requirements were effective for financial statements for periods ending after December 15, 2002. The adoption of FIN 45 on January 1, 2003 did not have any material impact on our financial position or results of operations (see Note 16). Variable Interest Entities -------------------------- In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003) ("FIN 46R"), "Consolidation of Variable Interest Entities," which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, "Consolidation of Variable Interest Entities," which was issued in January 2003. We are required to apply FIN 46R to variable interests in variable interest entities or VIEs created after December 31, 2003. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. We reviewed all of our investments and determined that the Trust Convertible Preferred Securities (EPPICS), issued by our consolidated wholly-owned subsidiary, Citizens Utilities Trust and the related Citizens Utilities Capital L.P., were our only VIEs. The adoption of FIN 46R on January 1, 2004 did not have any material impact on our financial position or results of operations. Derivative Instruments and Hedging ---------------------------------- In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging," which clarifies financial accounting and reporting for derivative instruments including derivative instruments embedded in other contracts. This Statement is effective for contracts entered into or modified after June 30, 2003. We adopted SFAS No. 149 on July 1, 2003. The adoption of SFAS No. 149 did not have any material impact on our financial position or results of operations. Financial Instruments with Characteristics of Both Liabilities and Equity ------------------------------------------------------------------------- In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." The Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. Generally, the Statement is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. We adopted the provisions of the Statement on July 1, 2003. The adoption of SFAS No. 150 did not have any material impact on our financial position or results of operations. Pension and Other Postretirement Benefits ----------------------------------------- In December 2003, the FASB issued SFAS No. 132 (revised), "Employers' Disclosures about Pensions and Other Postretirement Benefits." This Statement retains and revises the disclosure requirements contained in the original Statement. It requires additional disclosures including information describing the types of plan assets, investment strategy, measurement date(s), plan obligations, cash flows, and components of net periodic benefit cost recognized in interim periods. This Statement is effective for fiscal years ending after December 15, 2003. We have adopted the expanded disclosure requirements of SFAS No. 132 (revised). 10 The FASB also recently issued an Exposure Draft that would require stock-based employee compensation to be recorded as a charge to earnings beginning in 2005. We will continue to monitor the progress on the issuance of this standard. (3) Accounts Receivable: ------------------- The components of accounts receivable, net at June 30, 2004 and December 31, 2003 are as follows: ($ in thousands) June 30, 2004 December 31, 2003 ----------------- --------------------- Customers $ 223,415 $ 250,515 Other 31,980 45,290 Less: Allowance for doubtful accounts (31,114) (47,332) ----------------- --------------------- Accounts receivable, net $ 224,281 $ 248,473 ================= ===================== The Company maintains an allowance for estimated bad debts based on its estimate of collectibility of its accounts receivables. Bad debt expense, which is recorded as a reduction of revenue, was $4,339,000 and $5,788,000 for the three months ended June 30, 2004 and 2003, respectively and $6,558,000 and $10,798,000 for the six months ended June 30, 2004 and 2003, respectively. Additional reserves are provided for known or impending telecommunications bankruptcies, disputes or other significant collection issues. (4) Property, Plant and Equipment, Net: ---------------------------------- Property, plant and equipment, net at June 30, 2004 and December 31, 2003 is as follows:
($ in thousands) June 30, 2004 December 31, 2003 ---------------- -------------------- Property, plant and equipment $ 6,361,161 $ 6,221,307 Less: Accumulated depreciation (2,924,062) (2,695,667) ---------------- -------------------- Property, plant and equipment, net $ 3,437,099 $ 3,525,640 ================ ====================
Depreciation expense is principally based on the composite group method. Depreciation expense was $112,782,000 and $118,729,000 for the three months ended June 30, 2004 and 2003, respectively and $225,010,000 and $225,565,000 for the six months ended June 30, 2004 and 2003, respectively. Effective January 1, 2003, as a result of the adoption of SFAS No. 143, "Accounting for Asset Retirement Obligations," we ceased recognition of the cost of removal provision in depreciation expense and eliminated the cumulative cost of removal included in accumulated depreciation. In addition, we increased the average depreciable lives for certain of our equipment in our ILEC segment. As part of the preparation and adoption of SFAS No. 143, we analyzed depreciation rates for the ILEC segment and compared them to industry averages and historical expense data. Based on this review, the Company identified certain assets for which the Company's analysis of historical/estimated lives indicated that the existing estimated depreciable life was shorter than such revised estimates. (5) Dispositions: ------------ On April 1, 2003, we completed the sale of approximately 11,000 access lines in North Dakota for approximately $25,700,000 in cash. The pre-tax gain on the sale was $2,274,000. On April 4, 2003, we completed the sale of our wireless partnership interest in Wisconsin for approximately $7,500,000 in cash. The pre-tax gain on the sale was $2,173,000. (6) 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 included our water, gas and electric businesses. All of these properties have been sold. 11 Electric and Gas ---------------- On August 8, 2003, we completed the sale of The Gas Company in Hawaii division for $119,290,000 in cash and assumed liabilities. The pre-tax loss on the sale recognized in 2003 was $19,180,000. On August 11, 2003, we completed the sale of our Arizona gas and electric divisions for $224,100,000 in cash. The pre-tax loss on the sale recognized in 2003 was $18,491,000. On December 2, 2003, we completed the sale of substantially all of our Vermont electric division's transmission assets for $7,344,000 in cash (less $1,837,000 in refunds to customers as ordered by the Vermont Public Service Board). On April 1, 2004, we completed the sale of our Vermont electric distribution operations for approximately $13,992,000 in cash, net of selling expenses. Losses on the sales of our Vermont properties were included in the impairment charges recorded during 2003. Summarized balance sheet information for the electric operations (assets held for sale) is set forth below (no data for June 30, 2004 because all of the properties had been sold as of that date). ($ in thousands) December 31, 2003 -------------------- Current assets $ 4,688 Net property, plant and equipment 7,225 Other assets 11,217 -------------------- Total assets held for sale $ 23,130 ==================== Current liabilities $ 3,651 Other liabilities 7,477 -------------------- Total liabilities related to assets held for sale $ 11,128 ==================== (7) Intangibles: ----------- Intangibles at June 30, 2004 and December 31, 2003 are as follows:
($ in thousands) June 30, 2004 December 31, 2003 ------------------------ --------------------- Customer base - amortizable over 96 months $ 995,853 $ 995,853 Trade name - non-amortizable 122,058 122,058 ------------------------ --------------------- Other intangibles 1,117,911 1,117,911 Accumulated amortization (368,764) (305,504) ------------------------ --------------------- Total other intangibles, net $ 749,147 $ 812,407 ======================== =====================
Amortization expense was $31,630,000 for the three months ended June 30, 2004 and 2003, respectively and $63,260,000 and $63,342,000 for the six months ended June 30, 2004 and 2003, respectively. Amortization expense for each of the next five years, based on our estimate of useful lives, is estimated to be $126,520,000 per year. 12 (8) Long-Term Debt: -------------- The activity in our long-term debt from December 31, 2003 to June 30, 2004 is as follows:
Six Months Ended June 30, 2004 ---------------------------------------- Interest Rate* at December 31, Interest June 30, June 30, ($ in thousands) 2003 Payments Rate Swap Other 2004 2004 -------- ---------- --------- --------- ----------- -------- Rural Utilities Service Loan Contracts $ 30,010 $ (456) $ - $ - $ 29,554 6.120% Senior Unsecured Debt $ 4,167,123 (80,955) (10,980) - 4,075,188 8.139% EPPICS** (reclassified as a result of adopting FIN 46R) - - - 211,756 211,756 5.000% Equity Units 460,000 - - - 460,000 7.480% ELI Notes 5,975 (5,975) - - - - ELI Capital Leases 10,061 (91) - - 9,970 9.745% Industrial Development Revenue Bonds 70,440 (12,300) - - 58,140 5.559% Other 22 (9) - - 13 12.985% ------------ ----------- ----------- --------- ---------- TOTAL LONG TERM DEBT $ 4,743,631 $ (99,786) $ (10,980) $ 211,756 $4,844,621 ------------ =========== =========== ========= ---------- Less: Current Portion (88,002) (6,490) Less: Equity Units (460,000) (460,000) ------------ ---------- $ 4,195,629 $4,378,131 ============ ==========
* Interest rate includes amortization of debt issuance expenses, debt premiums or discounts. The interest rate for Rural Utilities Service Loan Contracts, Senior Unsecured Debt, and Industrial Development Revenue Bonds represent a weighted average of multiple issuances. ** In accordance with FIN 46R, the Trust holding the EPPICS and the related Citizens Utilities Capital L.P. are now deconsolidated (see Note 14). No new debt has been issued and our debt to outside third parties remains unchanged at $201,250,000. On January 15, 2004 we repaid at maturity the remaining outstanding $80,955,000 of our 7.45% Debentures. On January 15, 2004, we redeemed at 101% the remaining outstanding $12,300,000 of our Hawaii Special Purpose Revenue Bonds, Series 1993A and Series 1993B. On May 17, 2004, we repaid at maturity the remaining outstanding $5,975,000 of Electric Lightwave, LLC's 6.05% Notes. These Notes had been guaranteed by Citizens. Total future minimum cash payment commitments over the next 23 years under ELI's long-term capital leases amounted to $29,362,000 as of June 30, 2004. In July 2004, we retired, in full, an ELI capital lease obligation of $5,524,000. This reduced the length of ELI's future cash payment commitments to 20 years and the amount to $10,185,000. 13 (9) Net Income Per Common Share: --------------------------- The reconciliation of the income per common share calculation for the three and six months ended June 30, 2004 and 2003, respectively, is as follows:
For the three For the six ($ in thousands, except per-share amounts) months ended June 30 months ended June 30, ------------------------------- ------------------------------- 2004 2003 2004 2003 -------------- --------------- -------------- --------------- Net income used for basic and diluted earnings - ---------------------------------------------- per common share: ---------------- Income before cumulative effect of change in accounting principle $ 23,792 $ 34,057 $ 66,660 $ 95,719 Cumulative effect of change in accounting principle - - - 65,769 -------------- --------------- -------------- --------------- Total basic net income available to common shareholders $ 23,792 $ 34,057 $ 66,660 $ 161,488 ============== =============== ============== =============== Effect of conversion of preferred securities - 1,552 3,255 3,105 -------------- --------------- -------------- --------------- Total diluted net income available to common shareholders $ 23,792 $ 35,609 $ 69,915 $ 164,593 ============== =============== ============== =============== Basic earnings per common share: - ------------------------------- Weighted-average shares outstanding - basic 284,782 282,180 284,378 281,934 ============== =============== ============== =============== Income before cumulative effect of change in accounting principle $ 0.08 $ 0.12 $ 0.23 $ 0.34 Cumulative effect of change in accounting principle - - - 0.23 -------------- --------------- -------------- --------------- Net income available to common shareholders $ 0.08 $ 0.12 $ 0.23 $ 0.57 ============== =============== ============== =============== Diluted earnings per common share: - --------------------------------- Weighted-average shares outstanding 284,782 282,180 284,378 281,934 Effect of dilutive shares 6,572 5,389 5,921 4,763 Effect of conversion of preferred securities - 15,134 15,134 15,134 -------------- --------------- -------------- --------------- Weighted-average shares outstanding - diluted 291,354 302,703 305,433 301,831 ============== =============== ============== =============== Income before cumulative effect of change in accounting principle $ 0.08 $ 0.12 $ 0.23 $ 0.33 Cumulative effect of change in accounting principle - - - 0.22 -------------- --------------- -------------- --------------- Net income available to common shareholders $ 0.08 $ 0.12 $ 0.23 $ 0.55 ============== =============== ============== ===============
For the three and six months ended June 30, 2004, 7,267,000 options at exercise prices ranging from $12.91 to $21.47 issuable under employee compensation plans were excluded from the computation of diluted EPS for those periods because the exercise prices were greater than the average market price of common shares and, therefore, the effect would be antidilutive. For the three and six months ended June 30, 2003, options of 10,505,000 and 11,284,000, respectively, at exercise prices ranging from $11.09 to $21.47 issuable under employee compensation plans were excluded from the computation of diluted EPS for those periods because the exercise prices were greater than the average market price of common shares and, therefore, the effect would be antidilutive. For the three and six months ended June 30, 2004 and 2003, restricted stock awards of 2,639,000 and 1,553,000 shares, respectively, are excluded from our basic weighted average shares outstanding and included in our dilutive shares until the shares are no longer contingent upon the satisfaction of all specified conditions. We also have 18,400,000 potentially dilutive equity units with each equity unit consisting 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: * 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; * 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 * 2.0661 shares, if the average closing price of our common stock over the same period is less than or equal to $12.10. 14 These securities have no impact on the computation of diluted EPS for all periods reflected above. On August 17, 2004, we will issue $460,000,000 of common stock to our equity unit holders (see Note 9 for a more complete description of the equity units). Of this amount, $300,000,000 is held in escrow and will be distributed to us on August 17, 2004. The remaining $160,000,000 will be settled in cash by current equity unit holders, or if not in cash by settlements of their notes. In July 2004 we retired $300,000,000 of such senior notes. As a condition to the retirement, the note holders placed $300,000,000 in escrow which will be used to settle their common stock purchase obligation on August 17, 2004. This retirement will result in a pre-tax charge of approximately $15,000,000 in the third quarter of 2004 but will reduce interest expense by $20,000,000 annually. We expect to remarket the remaining outstanding senior notes on August 12, 2004. Our interest expense on the remaining notes could increase if, as a result of such remarketing, the interest rate increases from the current rate of 6.75%. If the remarketing is not successful then we would retire the notes in satisfaction of the purchase price. We also 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 $13.30 per share that have been included in the diluted income per common share calculation for the six months ended June 30, 2004 and the three and six months ended June 30, 2003. These securities have not been included in the diluted income per share calculation for the three months ended June 30, 2004 because their inclusion would have had an antidilutive effect. (10) Segment Information: ------------------- As of April 1, 2004, we operate in two segments, ILEC and ELI (a competitive local exchange carrier (CLEC)). The ILEC segment provides both regulated and unregulated communications services to residential, business and wholesale customers and is typically the incumbent provider in its service areas. Our remaining electric property was sold on April 1, 2004. As an ILEC, we compete with CLECs that may operate in our markets. As a CLEC, we provide telecommunications services, principally to businesses, in competition with the ILEC. As a CLEC, we frequently obtain the "last mile" access to customers through arrangements with the applicable ILEC. ILECs and CLECs are subject to different regulatory frameworks of the Federal Communications Commission (FCC) and state regulatory agencies. Our ILEC operations and ELI do not compete with each other. As permitted by SFAS No. 131, we have utilized the aggregation criteria in combining our markets because all of the Company's ILEC properties share similar economic characteristics: they provide the same products and services to similar customers using comparable technologies in all the states we operate. The regulatory structure is generally similar. Differences in the regulatory regime of a particular state do not materially impact the economic characteristics or operating results of a particular property.
($ in thousands) For the three months ended June 30, 2004 ------------------------------------------------------------ Total ILEC ELI Electric (1) Segments -------------- -------------- --------------- ------------- Revenue $ 505,789 $ 38,302 $ - $ 544,091 Depreciation and amortization 138,467 5,945 - 144,412 Strategic alternatives and management succession expenses 11,133 428 - 11,561 Operating income (loss) 127,237 1,957 (1,019) 128,175 Capital expenditures 73,678 4,397 - 78,075
15
For the three months ended June 30, 2003 --------------------------------------------------------------------------- ($ in thousands) Total ILEC ELI Gas Electric Segments -------------- -------------- --------------- ------------- -------------- Revenue $ 510,153 $ 43,719 $ 56,150 $ 33,932 $ 643,954 Depreciation and amortization 144,374 5,985 - - 150,359 Reserve for telecommunications bankruptcies 1,113 1,147 - - 2,260 Restructuring and other expenses 9,482 631 - - 10,113 Operating income 121,814 2,350 6,159 4,869 135,192 Capital expenditures 56,415 2,254 4,296 4,827 67,792 (1) Consists principally of post-sale activities associated with the completion of our utility divestiture program. These costs could not be accrued as a selling cost at the time of sale. The Company believes it has an adequate provision for its remaining post-divestiture liabilities. We do not anticipate any material future costs associated with these activities. For the six months ended June 30, 2004 ------------------------------------------------------------ ($ in thousands) Total ILEC ELI Electric Segments -------------- -------------- --------------- ------------- Revenue $ 1,014,757 $ 78,067 $ 9,735 $ 1,102,559 Depreciation and amortization 276,490 11,780 - 288,270 Strategic alternatives and management succession expenses 15,882 610 - 16,492 Operating income (loss) 265,955 4,347 (2,321) 267,981 Capital expenditures 126,531 6,159 573 133,263 For the six months ended June 30, 2003 --------------------------------------------------------------------------- ($ in thousands) Total ILEC ELI Gas Electric Segments -------------- -------------- --------------- ------------- -------------- Revenue $ 1,023,762 $ 84,812 $ 119,681 $ 67,561 $ 1,295,816 Depreciation and amortization 276,729 12,178 - - 288,907 Reserve for telecommunications bankruptcies 1,113 1,147 - - 2,260 Restructuring and other expenses 9,482 610 - - 10,092 Operating income 268,729 2,885 18,010 9,863 299,487 Capital expenditures 94,292 3,401 7,465 9,972 115,130 The following table reconciles sector capital expenditures to total consolidated capital expenditures. For the three months ended For the six months ended ($ in thousands) June 30, June 30, ------------------------------ ----------------------------- 2004 2003 2004 2003 -------------- -------------- --------------- ------------- Total segment capital expenditures $ 78,075 $ 67,792 $ 133,263 $ 115,130 General capital expenditures 171 58 171 472 -------------- -------------- --------------- ------------- Consolidated reported capital expenditures $ 78,246 $ 67,850 $ 133,434 $ 115,602 ============== ============== =============== =============
(11) Derivative Instruments and Hedging Activities: --------------------------------------------- Interest rate swap agreements are used to hedge a portion of our debt that is subject to fixed interest rates. Under our interest rate swap agreements, we agree to pay an amount equal to a specified variable rate of interest times a notional principal amount, and to receive in return an amount equal to a specified fixed rate of interest times the same notional principal amount. The notional amounts of the contracts are not exchanged. No other cash payments are made unless the agreement is terminated prior to maturity, in which case the amount paid or received in settlement is established by agreement at the time of termination and represents the market value, at the then current rate of interest, of the remaining obligations to exchange payments under the terms of the contracts. 16 The interest rate swap contracts are reflected at fair value in our consolidated balance sheet and the related portion of fixed-rate debt being hedged is reflected at an amount equal to the sum of its book value and an amount representing the change in fair value of the debt obligations attributable to the interest rate risk being hedged. Changes in the fair value of interest rate swap contracts, and the offsetting changes in the adjusted carrying value of the related portion of the fixed-rate debt being hedged, are recognized in the consolidated statements of operations in interest expense. The notional amounts of fixed-rate indebtedness hedged as of June 30, 2004 and December 31, 2003 were $550,000,000 and $400,000,000, respectively. Such contracts require us to pay variable rates of interest (estimated average pay rates of approximately 6.02% as of June 30, 2004 and approximately 5.46% as of December 31, 2003) and receive fixed rates of interest (average receive rates of 8.47% and 8.38% as of June 30, 2004 and December 31, 2003, respectively). The fair value of these derivatives is reflected in other assets as of June 30, 2004, in the amount of $(379,000) and the related underlying debt has been decreased by a like amount. The net amounts received during the three and six months ended June 30, 2004 as a result of these contracts amounted to $4,021,000 and $5,516,000, respectively, and are included as a reduction of interest expense. We do not anticipate any nonperformance by counterparties to our derivative contracts as all counterparties have investment grade credit ratings. (12) Strategic Alternatives and Management Succession Expenses: --------------------------------------------------------- On July 11, 2004, our Board of Directors announced that it had completed its review of the Company's financial and strategic alternatives. Through the first six months of 2004, we expensed approximately $16,500,000 related to our exploration of financial and strategic alternatives and management succession costs. We are evaluating the costs that will be incurred as a result of these matters and the final amount of some of these costs has not yet been determined. Our best estimate, at this time, indicates that we will record approximately $80,000,000 - $85,000,000 of such expenses in the second half of 2004, most of which will be recorded in the third quarter. Compensation arrangements entered into in connection with these matters will result in stock compensation expense of approximately $5,100,000 in 2005, $5,000,000 in 2006 and $1,000,000 in 2007. (13) Investment and Other Income, Net: -------------------------------- The components of investment and other income, net are as follows:
Three Months Ended June 30, Six Months Ended June 30, ----------------------------- ------------------------------ ($ in thousands) 2004 2003 2004 2003 -------------- -------------- -------------- -------------- Investment income $ 2,576 $ 2,246 $ 5,611 $ 5,303 Gain on capital lease termination/restructuring - 25,021 - 65,724 Gain on expiration/settlement of customer advances 1,163 - 25,345 6,165 Gain (loss) on sale of assets - 6,671 (1,370) 5,021 Other, net 1,474 (2,701) 921 (2,804) -------------- -------------- -------------- -------------- Total investment and other income, net $ 5,213 $ 31,237 $ 30,507 $ 79,409 ============== ============== ============== ==============
During 2003 and 2004, we recognized income in connection with certain retained liabilities associated with customer advances for construction from our disposed water properties, as a result of some of these liabilities terminating. During 2003, we recognized gains in connection with the termination/restructuring of capital leases at ELI. Loss on sale of assets represents the loss recognized on the sale of fixed assets in 2004, and in 2003 is attributable to the sale of our Plano office building. (14) Company Obligated Mandatorily Redeemable Convertible Preferred Securities: ------------------------------------------------------------------------- In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust (the Trust), issued, in an underwritten public offering, 4,025,000 shares of 5% Company Obligated Mandatorily Redeemable Convertible Preferred Securities due 2036 (EPPICS), representing preferred undivided interests in the assets of the Trust, with a liquidation preference of $50 per security (for a total liquidation amount of $201,250,000). The proceeds from the issuance of the Trust Convertible Preferred Securities and a Company capital contribution were used to purchase $207,475,000 aggregate liquidation amount of 5% Partnership Convertible Preferred Securities due 2036 from another wholly-owned subsidiary, Citizens Utilities Capital L.P. (the Partnership). The proceeds from the issuance of the Partnership Convertible Preferred Securities and a Company capital contribution were used to purchase from us $211,756,000 aggregate principal amount of 5% Convertible Subordinated Debentures due 2036. The sole assets of the Trust 17 are the Partnership Convertible Preferred Securities, and our Convertible Subordinated Debentures are substantially all the assets of the Partnership. Our obligations under the agreements related to the issuances of such securities, taken together, constitute a full and unconditional guarantee by us of the Trust's obligations relating to the Trust Convertible Preferred Securities and the Partnership's obligations relating to the Partnership Convertible Preferred Securities. In accordance with the terms of the issuances, we paid the annual 5% interest in quarterly installments on the Convertible Subordinated Debentures in the first and second quarters of 2004 and the four quarters of 2003. Only cash was paid (net of investment returns) to the Partnership in payment of the interest on the Convertible Subordinated Debentures. The cash was then distributed by the Partnership to the Trust and then by the Trust to the holders of the EPPICS. During July 2004, EPPICS representing a total principal amount of $4,854,000 were converted into 364,990 shares of Citizens common stock. We have adopted the provisions of FIN 46R (revised December 2003) ("FIN 46R"), "Consolidation of Variable Interest Entities," effective January 1, 2004. We have not restated prior periods. We have included the following description to provide readers a comparative analysis of the accounting impact of this standard. Both the Trust and the Partnership have been consolidated from the date of their creation through December 31, 2003. As a result of the new consolidation standards established by FIN 46R, the Company, effective January 1, 2004, deconsolidated the activities of the Trust and the Partnership. We have highlighted the comparative effect of this change in the following table:
Balance Sheet - ------------- ($ in thousands) As of --------------------------------------------------------- December 31, 2003 June 30, 2004 Change --------------------- ---------------- -------------- Assets: Cash $ 2,103 $ - $(2,103) (1) Investments - 12,645 12,645 (2) Liabilities: Long-term debt - 211,756 (3) 10,506 (3) EPPICS 201,250 - (3) Statement of Operations - ----------------------- ($ in thousands) As reported for the six months ended --------------------------------------------------------- June 30, 2003 June 30, 2004 Change --------------------- ---------------- -------------- Investment income $ - $ 316 $ 316 (4) Interest expense - 5,294 5,294 (5) Dividends on EPPICS (before tax) 5,032 - (5,032) (6) --------------------- ---------------- -------------- Net $ 5,032 $ 4,978 $ (54) ===================== ================ ==============
(1) Represents a cash balance on the books of the Partnership that is removed as a result of the deconsolidation. (2) Represents Citizens' investments in the Partnership and the Trust. At December 31, 2003, these investments were eliminated in consolidation against the equity of the Partnership and the Trust. (3) As a result of the deconsolidation, the Trust and the Partnership balance sheets are removed, leaving debt issued by Citizens to the Partnership in the amount of $211,756,000. The nominal effect of an increase in debt of $10,506,000 is debt that is "intercompany." FIN 46R does not impact the economics of the EPPICS structure. Citizens continues to have $201,250,000 of debt outstanding to third parties and will continue to pay interest on that amount at 5%. 18 (4) Represents interest income to be paid by the Partnership and the Trust to Citizens for its investments noted in (2) above. The Partnership and the Trust have no source of cash except as provided by Citizens. Interest is payable at the rate of 5% per annum. (5) Represents interest expense on the convertible debentures issued by Citizens to the Partnership in the amount of $211,756,000. Interest is payable at the rate of 5% per annum. (6) As a result of the deconsolidation of the Trust, previously reported dividends on the convertible preferred securities issued to the public by the Trust are removed and replaced by the interest accruing on the debt issued by Citizens to the Partnership. Citizens remains the guarantor of the EPPICS debt and continues to be the sole source of cash for the Trust to pay dividends. (15) Retirement Plans: ---------------- The following tables provides the components of net periodic benefit cost for the three and six months ended June 30, 2004 and 2003:
Pension Benefits -------------------------------------------------------- For the three months ended For the six months ended June 30, June 30, ---------------------------- ------------------------- ($ in thousands) 2004 2003 2004 2003 ------------- ------------- ------------ ------------ Components of net periodic benefit cost - --------------------------------------- Service cost $ 1,589 $ 1,922 $ 3,178 $ 3,844 Interest cost on projected benefit obligation 11,496 14,569 22,992 29,138 Return on plan assets (14,308) (16,021) (28,616) (32,042) Amortization of prior service cost and unrecognized net obligation (61) (51) (122) (102) Amortization of unrecognized loss 1,854 3,271 3,708 6,542 ------------- ------------- ------------ ------------ Net periodic benefit cost $ 570 $ 3,690 $ 1,140 $ 7,380 ============= ============= ============ ============ Other Postretirement Benefits -------------------------------------------------------- For the three months ended For the six months ended June 30, June 30, ---------------------------- ------------------------- ($ in thousands) 2004 2003 2004 2003 ------------- ------------- ------------ ------------ Components of net periodic benefit cost - --------------------------------------- Service cost $ 399 $ 292 $ 798 $ 584 Interest cost on projected benefit obligation 3,157 2,863 6,314 5,728 Return on plan assets (530) (449) (1,060) (898) Amortization of prior service cost and unrecognized net obligation 6 5 12 10 Amortization of unrecognized loss 1,559 838 3,118 1,677 ------------- ------------- ------------ ------------ Net periodic benefit cost $ 4,591 $ 3,549 $ 9,182 $ 7,101 ============= ============= ============ ============
We expect that our pension expense for 2004 will be $2,000,000 - $4,000,000 (it was $12,400,000 in 2003) and no contribution will be required to be made by us to the pension plan in 2004. No contribution was made, or required, for 2003. In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) became law. The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to the Medicare benefit. The amount of the federal subsidy will be based on 28 percent of an individual beneficiary's annual eligible prescription drug costs ranging between $250 and $5,000. Currently, the Company does not believe it will need to amend its plan to receive the federal subsidy. The Company has not fully quantified the effects, if any, that the Act will have on its future benefits costs or accumulated postretirement benefit obligation and accordingly, the effects of the Act have not been reflected in the accompanying unaudited consolidated financial statements. 19 (16) Commitments and Contingencies: ----------------------------- The City of Bangor, Maine, filed suit against us on November 22, 2002, in the U.S. District Court for the District of Maine (City of Bangor v. Citizens Communications Company, Civ. Action No. 02-183-B-S). We intend to defend ourselves vigorously against the City's lawsuit. The City has alleged, among other things, that we are responsible for the costs of cleaning up environmental contamination alleged to have resulted from the operation of a manufactured gas plant by Bangor Gas Company, which we owned from 1948-1963. The City alleged the existence of extensive contamination of the Penobscot River and has asserted that money damages and other relief at issue in the lawsuit could exceed $50,000,000. The City also requested that punitive damages be assessed against us. We have filed an answer denying liability to the City, and have asserted a number of counterclaims against the City. In addition, we have identified a number of other potentially responsible parties that may be liable for the damages alleged by the City and have joined them as parties to the lawsuit. These additional parties include Honeywell Corporation, the Army Corps of Engineers, Guilford Transportation (formerly Maine Central Railroad), UGI Utilities, Inc., and Centerpoint Energy Resources Corporation. On March 11, 2004, the Magistrate in charge of the case granted our motion for partial summary judgment with respect to the City's CERCLA claims, and that decision was affirmed by the District Court on May 5, 2004. In an order issued on July 6, 2004, the Magistrate dismissed the City's claim for punitive damages. The City is currently appealing that decision to the District Court. We have demanded that various of our insurance carriers defend and indemnify us with respect to the City's lawsuit, and on December 26, 2002, we filed a declaratory judgment action against those insurance carriers in the Superior Court of Penobscot County, Maine, for the purpose of establishing their obligations to us with respect to the City's lawsuit. We intend to vigorously pursue this lawsuit to obtain from our insurance carriers indemnification for any damages that may be assessed against us in the City's lawsuit as well as to recover the costs of our defense of that lawsuit. On June 7, 2004, representatives of Robert A. Katz Technology Licensing, LP, contacted us regarding possible infringement of several patents held by that firm. The patents cover a wide range of operations in which telephony is supported by computers, including obtaining information from databases via telephone, interactive telephone transactions, and customer and technical support applications. We are cooperating with the patent holder to determine if we are currently using any of the processes that are protected by its patents. If we determine that we are utilizing the patent holder's intellectual property, we expect to commence negotiations on a license agreement. On June 24, 2004, one of our subsidiaries, Frontier Subsidiary Telco Inc., received a "Notice of Indemnity Claim" from Citibank, N.A., that is related to a complaint pending against Citibank and others in the U.S. Bankruptcy Court for the Southern District of New York as a part of the Global Crossing Bankruptcy proceeding. Citibank bases its claim for indemnity on the provisions of a credit agreement that was entered into in October 2000 between Citibank and our subsidiary. We purchased Frontier Subsidiary Telco, Inc., in June 2001 as part of our acquisition of the Frontier telephone companies. The complaint against Citibank, for which it seeks indemnification, alleges that the seller improperly used a portion of the proceeds from the Frontier transaction to pay off the Citibank credit agreement, thereby defrauding certain debt holders of Global Crossing North America Inc. Although the credit agreement was paid off at the closing of the Frontier transaction, Citibank claims the indemnification obligation survives. Damages sought against Citibank and its co-defendants could exceed $1,000,000,000. We are currently reviewing Citibank's claims to determine what action we should take to respond to those claims. We are party to other legal proceedings arising in the normal course of our business. The outcome of individual matters is not predictable. However, we believe that the ultimate resolution of all such matters, after considering insurance coverage, will not have a material adverse effect on our financial position, results of operations, or our cash flows. We have budgeted capital expenditures in 2004 of approximately $276,000,000, including $265,000,000 for ILEC (approximately $10,300,000 of which relates to our billing system conversion) and $11,000,000 for ELI. Capitalized costs during 2004 associated with our billing system conversion amounted to $3,939,000. 20 The Company has sold all of its utility businesses as of April 1, 2004. However, we have retained a potential payment obligation associated with our previous electric utility activities in the state of Vermont. The Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities, including us, entered into a purchase power agreement with Hydro-Quebec in 1987. The agreement contains "step-up" provisions that state that if any VJO member defaults on its purchase obligation under the contract to purchase power from Hydro-Quebec the other VJO participants will assume responsibility for the defaulting party's share on a pro-rata basis. Our pro-rata share of the purchase power obligation was 10%. If any member of the VJO defaults on its obligations under the Hydro-Quebec agreement, the remaining members of the VJO, including us, may be required to pay for a substantially larger share of the VJO's total power purchase obligation for the remainder of the agreement (which runs through 2015). Paragraph 13 of FIN 45 requires that we disclose "the maximum potential amount of future payments (undiscounted) the guarantor could be required to make under the guarantee." Paragraph 13 also states that we must make such disclosure "... even if the likelihood of the guarantor's having to make any payments under the guarantee is remote..." As noted above, our obligation only arises as a result of default by another VJO member such as upon bankruptcy. Therefore, to satisfy the "maximum potential amount" disclosure requirement we must assume that all members of the VJO simultaneously default, a highly unlikely scenario given that the two members of the VJO that have the largest potential payment obligations are publicly traded with credit ratings of BBB or better, and that all VJO members are regulated utility providers with regulated cost recovery. Regardless, despite the remote chance that such an event could occur, or that the State of Vermont could or would allow such an event, assuming that all the members of the VJO defaulted by January 1, 2005 and remained in default for the duration of the contract (another 10 years), we estimate that our undiscounted purchase obligation for 2005 through 2015 would be approximately $1,600,000,000. In such a scenario the Company would then own the power and could seek to recover its costs. We would do this by seeking to recover our costs from the defaulting members and/or reselling the power to other utility providers or the northeast power grid. There is an active market for the sale of power. We believe that we would receive full recovery of our costs through sales to others. If pricing became more favorable we could potentially sell the power on the open market at a profit. We could potentially lose money if we were unable to sell the power at cost. We caution that all of the above-described scenarios are unlikely to occur and we cannot predict with any degree of certainty any potential outcome. (17) Subsequent Events: ----------------- On July 11, 2004, the Company announced that on September 2, 2004 it will pay a special dividend of $2 per common share and a quarterly dividend of $0.25 per common share to shareholders of record on August 18, 2004. Concurrently, Leonard Tow decided to step down from his position as chief executive officer, effective immediately, and resign his position as chairman of the board by the end of 2004. The Board of Directors named Rudy J. Graf, currently a director and former president and chief operating officer of Citizens, to serve as CEO and President on an interim basis until a new CEO is named. In July 2004, we retired, in full, an ELI capital lease obligation of $5,524,000. In July 2004, we purchased $300,000,000 of the 6.75% notes that are a component of our equity units at 105.075% of par, plus accrued interest. During July 2004, EPPICS representing a total principal amount of $4,854,000 were converted into 364,990 shares of Citizens common stock. In July 2004, our independent directors elected David H. Ward as the Lead Director. 21 Item 2. Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operations --------------------- This quarterly report on Form 10-Q contains forward-looking statements that are subject to risks and uncertainties, which could cause actual results to differ materially from those expressed or implied in the statements. Forward-looking statements (including oral representations) are only predictions or statements of current plans, which we review continuously. Forward-looking statements may differ from actual future results due to, but not limited to, and our future results may be materially affected by, any of the following possibilities: * Changes in the number of our access lines; * The effects of competition from wireless, other wireline carriers (through Unbundled Network Elements (UNE), Unbundled Network Elements Platform (UNEP), voice over internet protocol (VOIP) or otherwise), high speed cable modems and cable telephony; * The effects of general and local economic and employment conditions on our revenues; * Our ability to effectively manage and otherwise monitor our operations, costs, regulatory compliance and service quality; * Our ability to successfully introduce new product offerings including our ability to offer bundled service packages on terms that are both profitable to us and attractive to our customers, and our ability to sell enhanced and data services; * The effects of changes in regulation in the telecommunications industry as a result of the Telecommunications Act of 1996 and other federal and state legislation and regulation, including potential changes in access charges and subsidy payments and regulatory network upgrade requirements; * Our ability to successfully renegotiate certain ILEC state regulatory plans as they expire or come up for renewal from time to time; * Our ability to manage our operating expenses, capital expenditures, pay dividends and reduce or refinance our debt; * The effects of greater than anticipated competition requiring new pricing, marketing strategies or new product offerings and the risk that we will not respond on a timely or profitable basis; * The effects of bankruptcies in the telecommunications industry which could result in more price competition and potential bad debts; * The effects of technological changes on our capital expenditures and product and service offerings, including the lack of assurance that our ongoing network improvements will be sufficient to meet or exceed the capabilities and quality of competing networks; * The effects of increased medical expenses and related funding requirements; * The effect of changes in the telecommunications market, including the likelihood of significantly increased price and service competition; * Our ability to successfully convert the billing system for approximately 770,000 of our access lines on a timely basis and within our expected amount for 2004 of $18.0 - $20.0 million (a portion of which is expected to be capitalized and amortized) and, beginning in 2005, to achieve our expected cost savings from conversion; * The effects of state regulatory cash management policies on our ability to transfer cash among our subsidiaries and to the parent company; 22 * Our ability to successfully renegotiate expiring union contracts covering approximately 900 employees that are scheduled to expire during the remainder of 2004; * Our ability to pay a $1.00 per common share dividend annually may be affected by our cash flow from operations, amount of capital expenditures, debt service requirements and cash taxes and our liquidity; and * 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 or regulators. You should consider these important factors in evaluating any statement in this Form 10-Q or otherwise made by us or on our behalf. The following information is unaudited and should be read in conjunction with the consolidated financial statements and related notes included in this report and as presented in our 2003 Annual Report on Form 10-K. We have no obligation to update or revise these forward-looking statements. Overview - -------- We are a telecommunications company providing wireline communications services to rural areas and small and medium-sized towns and cities as an incumbent local exchange carrier, or ILEC. We offer our ILEC services under the "Frontier" name. In addition, we provide competitive local exchange carrier, or CLEC, services to business customers and to other communications carriers in certain metropolitan areas in the western United States through Electric Lightwave, LLC, or ELI, our wholly-owned subsidiary. We also provided (through March 31, 2004), electric distribution services to primarily rural customers in Vermont. Competition in the telecommunications industry is increasing. We experience competition from other wireline local carriers through Unbundled Network Elements (UNE), VOIP and potentially in the future through Unbundled Network Elements Platform (UNEP), from other long distance carriers (including Regional Bell Operating Companies), from cable companies and internet service providers with respect to internet access and cable telephony, and from wireless carriers. Most of the wireline competition we face is in our Rochester, New York market, with competition also present in a few other areas. Time Warner Cable is selling VOIP service in our Rochester market and other portions of our New York markets. Competition from cable companies and other internet service providers with respect to internet access is intense. Competition from wireless companies and other long distance companies is increasing in all of our markets. The telecommunications industry is undergoing significant changes and difficulties. The market for internet access, long distance, long-haul and related services in the United States is extremely competitive, with substantial overcapacity in the market. Demand and pricing for certain CLEC services (such as long-haul services) have decreased substantially. There is also increasing price pressure on certain of our ILEC services such as long distance and internet access. These trends are likely to continue and result in a challenging revenue environment. These factors could also result in more bankruptcies in the sector and therefore affect our ability to collect money owed to us by carriers. Several long distance and Interexchange Carriers (IXCs) have filed for bankruptcy protection, which will allow them to substantially reduce their cost structure and debt. This could enable such companies to further reduce prices and increase competition. Our ILEC business has been experiencing declining access lines, switched minutes of use and revenues because of economic conditions, unemployment levels, increasing competition (as described above), changing consumer behavior (such as wireless displacement of wireline use, email use, instant messaging and increasing use of VOIP) and regulatory constraints. During the six months ended June 30, 2004, our access lines declined 2.3%, our switched minutes of use declined 1.8% and our ILEC revenues declined 0.7%, in each case as compared to the first six months of 2003. These factors are likely to cause our local network service, switched network access, long distance and subsidy revenues to continue to decline during the remainder of 2004. During the six months ended June 30, 2004, our switched network access revenue declined 8.1%, our long distance revenue declined 9.8% and our subsidy revenue declined 6.4%, in each case as compared to 2003. One of the ways we are responding to competition is by bundling services and products and offering them for a single price, which results in lower pricing than purchasing the services separately. During the six months ended June 30, 2004, approximately 37,700 customers started buying one of our bundled packages and we increased our revenue from enhanced services by 7.3%. In addition, we added approximately 43,700 DSL subscribers during the six months ended June 30, 2004 and increased our data revenue by 25.2%. Our average ILEC revenue per month per average number of ILEC access lines during the six months ended June 30, 2004 was $71.24 compared to $70.20 during the six months ended June 30, 2003. The above discussion excludes the sale of approximately 11,000 access lines in North Dakota on April 1, 2003. 23 Revenues from data services such as DSL continue to increase as a percentage of our total revenues and revenues from high margin services such as local line and access charges and subsidies are decreasing as a percentage of our revenues. These factors, along with increasing operating and employee costs may cause our profitability to decrease. In addition, costs we will incur during the remainder of 2004 to convert the billing system for some of our access lines, to enable our systems to be capable of LNP and to retain certain employees will affect our profitability and capital expenditures during the remainder of 2004. In July 2004, our Board of Directors concluded a review of financial and strategic alternatives. After analysis of alternatives by the Board of Directors and its financial and legal advisors, the Board determined to pay a special dividend of $2 per common share and institute a regular annual dividend of $1 per common share which will be paid quarterly. The special dividend and first quarterly dividend will be payable on September 2, 2004 to shareholders of record on August 18, 2004, utilizing the Company's available cash on hand. (a) Liquidity and Capital Resources ------------------------------- For the six months ended June 30, 2004, we used cash flow from operations, cash and cash equivalents to fund capital expenditures, interest payments and debt repayments. As of June 30, 2004, we maintained cash and cash equivalents aggregating $740.4 million. We have budgeted approximately $276.0 million for our 2004 capital projects, including $265.0 million for the ILEC segment (approximately $10.3 million of which relates to our billing system conversion) and $11.0 million for the ELI segment. Capitalized costs during 2004 associated with our billing system conversion amount to $3.9 million through June 30. For the six months ended June 30, 2004, our capital expenditures were $133.4 million, including $126.5 million for the ILEC segment, $6.2 million for the ELI segment, $0.6 million for the public utilities segment and $0.1 million for general capital expenditures. Our capital spending has been trending lower over the last several years as we continue to closely scrutinize all of our capital projects, emphasize return on investment and focus our capital expenditures on areas and services that have the greatest opportunities with respect to revenue growth and cost reduction. We will continue to focus on managing our costs while increasing our investment in certain new product areas such as DSL and VOIP. We have an available shelf registration for $825.6 million. We have available lines of credit with financial institutions in the aggregate amount of $805.0 million. Associated facility fees vary depending on our credit ratings and are 0.25% per annum as of June 30, 2004. As a result of the downgrades in our credit ratings described below, these fees will increase to 0.40% per annum. The expiration date for these facilities is October 24, 2006. During the term of the facilities we may borrow, repay and reborrow funds. As of June 30, 2004, there were no outstanding borrowings under these facilities. As a result of our dividend policy, Standard and Poor's lowered its ratings on Citizens debt from "BBB" to "BB-plus", Moody's Investors Service lowered its ratings from "Baa3" to "Ba3" and Fitch Ratings lowered its ratings from "BBB" to "BB". We believe our operating cash flows, existing cash balances, and the current credit facilities will be adequate to finance our working capital requirements, make required debt payments through 2005, pay dividends to our shareholders in accordance with our dividend policy, and support our short-term and long-term operating strategies. Our credit facilities expire, and we have approximately $1,035.0 million of debt that matures in 2006 (including the $160.0 million of debt that remains part of our Equity Units). We are likely to refinance a significant amount of this debt prior to maturity and to extend the term of our credit facilities prior to expiration. The payment of the $2.00 special dividend per common share will significantly reduce our cash balances and liquidity. In addition, our ongoing annual dividends will reduce our operating and financial flexibility and ability to significantly increase our capital expenditures. While we believe that the amount of our dividends will allow for adequate amounts of cash flow for other purposes, any reduction in cash generated by operations and any increases in capital expenditures, interest expense or cash taxes would reduce the amount of cash generated in excess of dividends. Increases in competition, lower subsidy and access revenues and the other factors described above may reduce our cash generated by operations and require us to increase capital expenditures. The downgrades in our credit ratings described above may make it more difficult and expensive to refinance our maturing debt. We have in recent years paid relatively low amounts of cash taxes. We expect that over time our cash taxes will increase. 24 Issuance of Common Stock - ------------------------ On August 17, 2004, we will issue $460.0 million of common stock to our equity unit holders (see Note 9 for a more complete description of the equity units). Of this amount, $300.0 million is held in escrow and will be distributed to us on August 17, 2004. The remaining $160 million will be settled in cash by current equity unit holders, or if not in cash by settlements of their note. In July 2004 we retired $300.0 million of such senior notes. As a condition to the retirement, the note holders placed $300.0 million in escrow which will be used to settle their common stock purchase obligation on August 17, 2004. This retirement will result in a pre-tax charge of approximately $15.0 million in the third quarter of 2004 but will reduce interest expense by $20.0 million annually. We expect to remarket the remaining outstanding senior notes on August 12, 2004. Our interest expense on the remaining notes could increase if, as a result of such remarketing, the interest rate increases from the current rate of 6.75%. If the remarketing is not successful then we would retire the notes in satisfaction of the purchase price. Debt Reduction - -------------- On January 15, 2004, we repaid at maturity the remaining outstanding $81.0 million of our 7.45% Debentures. On January 15, 2004, we redeemed at 101% the remaining outstanding $12.3 million of our Hawaii Special Purpose Revenue Bonds, Series 1993A and Series 1993B. On May 17, 2004, we repaid at maturity the remaining outstanding $6.0 million of Electric Lightwave, LLC's 6.05% Notes. These Notes had been guaranteed by Citizens. In July 2004, we purchased $300.0 million of the 6.75% notes that are a component of our equity units at 105.075% of par, plus accrued interest. We may from time to time repurchase our debt in the open market, through tender offers or privately negotiated transactions. Interest Rate Management - ------------------------ In order to manage our interest expense, we have entered into interest swap agreements. Under the terms of these agreements, we make semi-annual, floating rate interest payments based on six month LIBOR and receive a fixed rate on the notional amount. The underlying variable rate on these swaps is set either in advance, in arrears or, based on each period's daily average six-month LIBOR. The notional amounts of fixed-rate indebtedness hedged as of June 30, 2004 and December 31, 2003 was $550.0 million and $400.0 million, respectively. Such contracts require us to pay variable rates of interest (estimated average pay rates of approximately 6.02% as of June 30, 2004 and approximately 5.46% as of December 31, 2003) and receive fixed rates of interest (average receive rates of 8.47% and 8.38% as of June 30, 2004 and December 31, 2003, respectively). All swaps are accounted for under SFAS No. 133 as fair value hedges. For the three and six months ended June 30, 2004, the cash interest savings resulting from these interest rate swaps was approximately $4.0 million and $5.5 million, respectively, and is reflected as a reduction of interest expense in the accompanying statements of operations. Off-Balance Sheet Arrangements - ------------------------------ We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect upon our financial statements. Strategic Alternatives and Management Succession Expenses - --------------------------------------------------------- On July 11, 2004, our Board of Directors announced that it completed its review of the Company's financial and strategic alternatives. Through the first six months of 2004, we expensed approximately $16.5 million related to our exploration of financial and strategic alternatives and related management succession costs. We are evaluating the costs that will be incurred as a result of these matters and the final amount of some of these costs has not yet been determined. Our best estimate, at this time, indicates that we will record approximately $80.0 million - $85.0 million of such expenses in the second half of 2004, most of which will be recorded in the third quarter. Compensation arrangements entered into in connection with these matters will result in compensation expense of approximately $5.1 million in 2005, $5.0 million in 2006 and $1.0 million in 2007. 25 EPPICS - ------ In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust (the Trust), issued, in an underwritten public offering, 4,025,000 shares of 5% Company Obligated Mandatorily Redeemable Convertible Preferred Securities due 2036 (Trust Convertible Preferred Securities or EPPICS), representing preferred undivided interests in the assets of the Trust, with a liquidation preference of $50 per security (for a total liquidation amount of $201.3 million). The proceeds from the issuance of the Trust Convertible Preferred Securities and a Company capital contribution were used to purchase $207.5 million aggregate liquidation amount of 5% Partnership Convertible Preferred Securities due 2036 from another wholly owned consolidated subsidiary, Citizens Utilities Capital L.P. (the Partnership). These securities have a conversion price of $13.30 per share and are convertible into a total of 15,134,000 common shares. Immediately prior to the opening of business on the ex-dividend date of August 16, 2004, any EPPICS not previously converted will be convertible at a reduced price determined by a formula contained in the First Supplemental Indenture dated as of January 15, 1996 between Citizens Utilities Company and Chemical Bank. The proceeds from the issuance of the Partnership Convertible Preferred Securities and a Company capital contribution were used to purchase from us $211.8 million aggregate principal amount of 5% Convertible Subordinated Debentures due 2036. The sole assets of the Trust are the Partnership Convertible Preferred Securities, and our Convertible Subordinated Debentures are substantially all the assets of the Partnership. Our obligations under the agreements related to the issuances of such securities, taken together, constitute a full and unconditional guarantee by us of the Trust's obligations relating to the Trust Convertible Preferred Securities and the Partnership's obligations relating to the Partnership Convertible Preferred Securities. In accordance with the terms of the issuances, we paid the annual 5% interest in quarterly installments on the Convertible Subordinated Debentures in the first and second quarters of 2004 and the four quarters of 2003. Only cash was paid (net of investment returns) to the Partnership in payment of the interest on the Convertible Subordinated Debentures. The cash was then distributed by the Partnership to the Trust and then by the Trust to the holders of the EPPICS. During July 2004, EPPICS representing a total principal amount of $4.9 million were converted into 364,990 shares of Citizens common stock. We have adopted the provisions of FASB Interpretation No. 46R (revised December 2003) ("FIN 46R"), "Consolidation of Variable Interest Entities," effective January 1, 2004. We have not restated prior periods. We have included the following description to provide readers a comparative analysis of the accounting impact of this standard. Both the Trust and the Partnership have been consolidated from the date of their creation through December 31, 2003. As a result of the new consolidation standards established by FIN 46R, the Company, effective January 1, 2004, deconsolidated the activities of the Trust and the Partnership. We have highlighted the comparative effect of this change in the following table:
Balance Sheet - ------------- ($ in thousands) As of --------------------------------------------------------- December 31, 2003 June 30, 2004 Change --------------------- ---------------- -------------- Assets: Cash $ 2,103 $ - $(2,103) (1) Investments - 12,645 12,645 (2) Liabilities: Long-term debt - 211,756 (3) 10,506 (3) EPPICS 201,250 - (3) Statement of Operations - ----------------------- ($ in thousands) As reported for the six months ended --------------------------------------------------------- June 30, 2003 June 30, 2004 Change --------------------- ---------------- -------------- Investment income $ - $ 316 $ 316 (4) Interest expense - 5,294 5,294 (5) Dividends on EPPICS (before tax) 5,032 - (5,032) (6) --------------------- ---------------- -------------- Net $ 5,032 $ 4,978 $ (54) ===================== ================ ==============
26 (1) Represents a cash balance on the books of the Partnership that is removed as a result of the deconsolidation. (2) Represents Citizens' investments in the Partnership and the Trust. At December 31, 2003, these investments were eliminated in consolidation against the equity of the Partnership and the Trust. (3) As a result of the deconsolidation, the Trust and the Partnership balance sheets are removed, leaving debt issued by Citizens to the Partnership in the amount of $211.8 million. The nominal effect of an increase in debt of $10.5 million is debt that is "intercompany." FIN 46R does not impact the economics of the EPPICS structure. Citizens continues to have $201.3 million of debt outstanding to third parties and will continue to pay interest on that amount at 5%. (4) Represents interest income to be paid by the Partnership and the Trust to Citizens for its investments noted in (2) above. The Partnership and the Trust have no source of cash except as provided by Citizens. Interest is payable at the rate of 5% per annum. (5) Represents interest expense on the convertible debentures issued by Citizens to the Partnership in the amount of $211.8 million. Interest is payable at the rate of 5% per annum. (6) As a result of the deconsolidation of the Trust, previously reported dividends on the convertible preferred securities issued to the public by the Trust are removed and replaced by the interest accruing on the debt issued by Citizens to the Partnership. Citizens remains the guarantor of the EPPICS debt and continues to be the sole source of cash for the Trust to pay dividends. Covenants - --------- The terms and conditions contained in our indentures and credit facilities agreements include the timely and punctual payment of principal and interest when due, the maintenance of our corporate existence, keeping proper books and records in accordance with GAAP, restrictions on the allowance of liens on our assets, and restrictions on asset sales and transfers, mergers and other changes in corporate control. We currently have no restrictions on the payment of dividends by us either by contract, rule or regulation. Our $805.0 million credit facilities and our $200.0 million term loan facility with the Rural Telephone Finance Cooperative (RTFC) contain a maximum leverage ratio covenant. Under the leverage ratio covenant, we are required to maintain a ratio of (i) total indebtedness minus cash and cash equivalents in excess of $50.0 million to (ii) consolidated adjusted EBITDA (as defined in the agreements) over the last four quarters no greater than 4.25 to 1 through December 30, 2004, and 4.00 to 1 thereafter. We are in compliance with all of our material debt and credit facility covenants. Divestitures - ------------ On August 24, 1999, our Board of Directors approved a plan of divestiture for our public utilities services businesses, which included gas, electric and water and wastewater businesses. As of April 1, 2004, we have sold all of these properties. All of the agreements relating to the sales provide that we will indemnify the buyer against certain liabilities (typically liabilities relating to events that occurred prior to sale), including environmental liabilities, for claims made by specified dates and that exceed threshold amounts specified in each agreement. On January 15, 2002, we sold our water and wastewater services operations for $859.1 million in cash and $122.5 million in assumed debt and other liabilities. On October 31, 2002, we completed the sale of approximately 4,000 access lines in North Dakota for approximately $9.7 million in cash. On November 1, 2002, we completed the sale of our Kauai electric division for $215.0 million in cash. On April 1, 2003, we completed the sale of approximately 11,000 access lines in North Dakota for approximately $25.7 million in cash. On April 4, 2003, we completed the sale of our wireless partnership interest in Wisconsin for approximately $7.5 million in cash. On August 8, 2003, we completed the sale of The Gas Company in Hawaii division for $119.3 million in cash and assumed liabilities. 27 On August 11, 2003, we completed the sale of our Arizona gas and electric divisions for $224.1 million in cash. On December 2, 2003, we completed the sale of our electric transmission facilities in Vermont for $7.3 million in cash. On April 1, 2004, we completed the sale of our electric distribution facilities in Vermont for $14.0 million in cash, net of selling expenses. Critical Accounting Policies and Estimates - ------------------------------------------ We review all significant estimates affecting our consolidated financial statements on a recurring basis and record the effect of any necessary adjustment prior to their publication. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements; accordingly, it is possible that actual results could differ from those estimates and changes to estimates could occur in the near term. The preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of the contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates and judgments are used when accounting for allowance for doubtful accounts, impairment of long-lived assets, intangible assets, depreciation and amortization, employee benefit plans, income taxes, contingencies, and pension and postretirement benefits expenses among others. Management has discussed the development and selection of these critical accounting estimates with the audit committee of our board of directors and our audit committee has reviewed our disclosures relating to them. There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations included in our 2003 Form 10-K. New Accounting Pronouncements - ----------------------------- Accounting for Asset Retirement Obligations In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, "Accounting for Asset Retirement Obligations." We adopted SFAS No. 143 effective January 1, 2003. As a result of our adoption of SFAS No. 143, we recognized an after tax non-cash gain of approximately $65.8 million. This gain resulted from the elimination of the cumulative cost of removal included in accumulated depreciation as a cumulative effect of a change in accounting principle in our statement of operations in the first quarter of 2003 as the Company has no legal obligation to remove certain of its long-lived assets. Exit or Disposal Activities In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which nullified Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, rather than on the date of commitment to an exit plan. This Statement is effective for exit or disposal activities that are initiated after December 31, 2002. We adopted SFAS No. 146 on January 1, 2003. The adoption of SFAS No. 146 did not have any material impact on our financial position or results of operations. Guarantees In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness of Others." FIN 45 requires that a guarantor be required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation assumed under the guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with the guarantee. The provisions of FIN 45 are effective for guarantees issued or modified after December 31, 2002, whereas the disclosure requirements were effective for financial statements for period ending after December 15, 2002. The adoption of FIN 45 on January 1, 2003 did not have any material impact on our financial position or results of operations. 28 The Company has sold all of its utility businesses as of April 1, 2004. However, we have retained a potential payment obligation associated with our previous electric utility activities in the state of Vermont. The Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities, including us, entered into a purchase power agreement with Hydro-Quebec in 1987. The agreement contains "step-up" provisions that state that if any VJO member defaults on its purchase obligation under the contract to purchase power from Hydro-Quebec the other VJO participants will assume responsibility for the defaulting party's share on a pro-rata basis. Our pro-rata share of the purchase power obligation was 10%. If any member of the VJO defaults on its obligations under the Hydro-Quebec agreement, the remaining members of the VJO, including us, may be required to pay for a substantially larger share of the VJO's total power purchase obligation for the remainder of the agreement (which runs through 2015). Paragraph 13 of FIN 45 requires that we disclose, "the maximum potential amount of future payments (undiscounted) the guarantor could be required to make under the guarantee." Paragraph 13 also states that we must make such disclosure "... even if the likelihood of the guarantor's having to make any payments under the guarantee is remote..." As noted above, our obligation only arises as a result of default by another VJO member such as upon bankruptcy. Therefore, to satisfy the "maximum potential amount" disclosure requirement we must assume that all members of the VJO simultaneously default, a highly unlikely scenario given that the two members of the VJO that have the largest potential payment obligations are publicly traded with credit ratings of BBB or better, and that all VJO members are regulated utility providers with regulated cost recovery. Regardless, despite the remote chance that such an event could occur, or that the State of Vermont could or would allow such an event, assuming that all the members of the VJO defaulted by January 1, 2005 and remained in default for the duration of the contract (another 10 years), we estimate that our undiscounted purchase obligation for 2005 through 2015 would be approximately $1.6 billion. In such a scenario the Company would then own the power and could seek to recover its costs. We would do this by seeking to recover our costs from the defaulting members and/or reselling the power to other utility providers or the northeast power grid. There is an active market for the sale of power. We believe that we would receive full recovery of our costs through sales to others. If pricing became more favorable we could potentially sell the power on the open market at a profit. We could potentially lose money if we were unable to sell the power at cost. We caution that all of the above-described scenarios are unlikely to occur and we cannot predict with any degree of certainty any potential outcome. Variable Interest Entities In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003) ("FIN 46R"), "Consolidation of Variable Interest Entities," which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, "Consolidation of Variable Interest Entities," which was issued in January 2003. We are required to apply FIN 46R to variable interests in variable interest entities or VIEs created after December 31, 2003. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. We reviewed all of our investments and determined that the EPPICS, issued by our consolidated wholly-owned subsidiary, Citizens Utilities Trust, was our only VIE. The adoption of FIN 46R on January 1, 2004 did not have any material impact on our financial position or results of operations. Derivative Instruments and Hedging In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging," which clarifies financial accounting and reporting for derivative instruments including derivative instruments embedded in other contracts. This Statement is effective for contracts entered into or modified after June 30, 2003. We adopted SFAS No. 149 on July 1, 2003. The adoption of SFAS No. 149 did not have any material impact on our financial position or results of operations. Financial Instruments with Characteristics of Both Liabilities and Equity In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." The Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. Generally, the Statement is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. We adopted the provisions of the Statement on July 1, 2003. The adoption of SFAS No. 150 did not have any material impact on our financial position or results of operations. 29 Pension and Other Postretirement Benefits In December 2003, the FASB issued SFAS No. 132 (revised), "Employers' Disclosures about Pensions and Other Postretirement Benefits." This Statement retains and revises the disclosure requirements contained in the original Statement. It requires additional disclosures including information describing the types of plan assets, investment strategy, measurement date(s), plan obligations, cash flows, and components of net periodic benefit cost recognized in interim periods. This Statement is effective for fiscal years ending after December 15, 2003. We have adopted the expanded disclosure requirements of SFAS No. 132 (revised). The FASB also recently issued an Exposure Draft that would require stock-based employee compensation to be recorded as a charge to earnings beginning in 2005. We will continue to monitor the progress on the issuance of this standard. (b) Results of Operations --------------------- REVENUE ILEC revenue is generated primarily through the provision of local, network access, long distance and data services. Such services are provided under either a monthly recurring fee or based on usage at a tariffed rate and is not dependent upon significant judgments by management, with the exception of a determination of a provision for uncollectible amounts. CLEC revenue is generated through local, long distance, data and long-haul services. These services are primarily provided under a monthly recurring fee or based on usage at agreed upon rates and are not dependent upon significant judgments by management with the exception of the determination of a provision for uncollectible amounts and realizability of reciprocal compensation. CLEC usage based revenue includes amounts determined under reciprocal compensation agreements. While this revenue is governed by specific contracts with the counterparty, management defers recognition of portions of such revenue until realizability is assured. Revenue earned from long-haul contracts is recognized over the term of the related agreement. Consolidated revenue for the three and six months ended June 30, 2004 decreased $99.9 million, or 16% and $193.3 million, or 15%, and as compared with the prior year periods. The decrease for the three months ended June 30, 2004 is due to a $4.4 million decrease in ILEC revenue, a $5.4 million decrease in ELI revenue and a $90.1 million decrease in gas and electric revenue. The decrease for the six months ended June 30, 2004 is due to a $9.0 million decrease in ILEC revenue, a $6.8 million decrease in ELI revenue and a $177.5 million decrease in gas and electric revenue. On April 1, 2003, we sold approximately 11,000 access lines in North Dakota. The revenues related to these access lines totaled $1.9 million for the six months ended June 30, 2003.
TELECOMMUNICATIONS REVENUE ($ in thousands) For the three months ended June 30, For the six months ended June 30, -------------------------------------------- ---------------------------------------------- 2004 2003 $ Change % Change 2004 2003 $ Change % Change ----------- ----------- ------------ -------- ------------ ----------- ------------ -------- Access services $ 155,224 $ 167,025 $ (11,801) -7% $ 316,707 $ 336,196 $ (19,489) -6% Local services 213,417 213,889 (472) 0% 426,159 428,162 (2,003) 0% Long distance and data services 79,170 76,487 2,683 4% 158,175 154,170 4,005 3% Directory services 28,201 26,736 1,465 5% 55,675 53,779 1,896 4% Other 29,777 26,016 3,761 14% 58,041 51,455 6,586 13% ----------- ----------- ------------ ----------- ----------- ------------ ILEC revenue 505,789 510,153 (4,364) -1% 1,014,757 1,023,762 (9,005) -1% ELI 38,302 43,719 (5,417) -12% 78,067 84,812 (6,745) -8% ----------- ----------- ------------ ----------- ----------- ------------ $ 544,091 $ 553,872 $ (9,781) -2% $1,092,824 $1,108,574 $ (15,750) -1% =========== =========== ============ =========== =========== ============
Change in the number of our access lines is the most fundamental driver of changes in our telecommunications revenue. Many rural local telephone companies (including us) have been experiencing a loss of access lines primarily because of difficult economic conditions, increased competition from competitive wireline providers, from wireless providers and from cable companies (with respect to broadband and cable telephony), and by some customers disconnecting second lines when they add DSL or cable modem service. We lost approximately 24,200 access lines during the six months ended June 30, 2004 but added approximately 43,700 DSL subscribers during this period. The loss of lines during the first six months of 2004 was primarily residential customers. The non-residential line losses were principally in Rochester, while the residential losses were throughout our markets. We expect to continue to lose access lines during 2004. A continued decrease in access lines, combined with increased competition and the other factors discussed in this MD&A, may cause our revenues to decrease during the remainder of 2004. 30 Access Services Access services revenue for the three months ended June 30, 2004 decreased $11.8 million or 7%, as compared with the prior year period. Switched access revenue decreased $6.9 million, as compared with the prior year period, primarily due to the $3.8 million effect of federally mandated access rate reductions effective as of July 1, 2003, $2.7 million associated with prospective state intrastate access rate reductions and $1.4 million attributable to a decline in minutes of use partially offset by collections on accounts previously reserved. Special access revenue for the three months ended June 30, 2004 decreased $1.8 million as compared with the prior year period resulting from a reclassification in the first quarter of 2004 related to the clearing of affiliate revenue among revenue categories partially offset by growth in high-capacity sales of $0.5 million. Subsidies revenue decreased $3.1 million, as compared with the prior year period, primarily due to lower federal universal service fund support because of true ups related to 2002 and increases in the national average cost per loop. Access services revenue for the six months ended June 30, 2004 decreased $19.5 million or 6%, as compared with the prior year period. Switched access revenue decreased $13.0 million, as compared with the prior year period, primarily due to the $7.4 million effect of federally mandated access rate reductions effective as of July 1, 2003, $2.7 million associated with prospective state intrastate access rate reductions, a $1.4 million decrease related to carrier disputes and other rate reductions effective July 2003 resulting in a decrease of $0.9 million. Special access revenue for the six months ended June 30, 2004 decreased $0.7 million as compared with the prior year period due to a $4.1 million decrease resulting from a reclassification in the first quarter of 2004 related to the clearing of affiliate revenue among revenue categories partially offset by growth in high-capacity sales of $3.2 million. Subsidies revenue decreased $5.7 million, as compared with the prior year period, primarily due to lower federal universal service fund support because of true ups related to 2002 and increases in the national average cost per loop. We expect our subsidy revenue to be approximately $8.0 million lower in 2004 than in 2003 primarily because of increases implemented during 2003 and 2004 in the ceiling on national average loop costs that is compared to our costs to determine the amount of subsidy payments we receive. Our switched access revenues are impacted by the program, known as the Coalition for Affordable Local and Long Distance Services, or CALLS plan, which establishes a price floor for interstate-switched access services. We have been able to offset some of the reduction in interstate access rates through end-user charges. There are no material increases in end-user charges scheduled to take effect during the remainder of 2004 or 2005. We believe the net effect of reductions in interstate access rates and increases in end-user charges will reduce our revenues by approximately $10.0 million in 2004 compared to 2003 assuming constant interstate switched access minutes of use (which have been declining). Annual reductions in interstate switched access rates will continue through 2005. Our switched access revenues have also been adversely affected by declining switched access minutes of use, which we expect to continue. Our subsidy and switched access revenues are very profitable so any reductions in those revenues will reduce our profitability. Local Services Local services revenue for the three months ended June 30, 2004 was essentially unchanged as compared with the prior year period. Local revenue decreased $3.3 million primarily due to the termination of an operator services contract of $1.5 million and $1.2 million related to continued losses of access lines. Enhanced services revenue increased $2.9 million, as compared with the prior year period, primarily due to $5.5 million attributable to sales of additional feature packages partially offset by lower individual calling feature revenue of $1.9 million and a decrease of $0.7 million in inside wire revenue. Local services revenue for the six months ended June 30, 2004 decreased $2.0 million as compared with the prior year period. Local revenue decreased $7.1 million primarily due to the termination of an operator services contract of $1.6 million, $2.8 million related to continued losses of access lines, $1.4 million in decreased local measured service revenue and $1.2 million in lower Centrex and PBX revenue. Enhanced services revenue increased $5.1 million, as compared with the prior year period, due primarily to sales of additional feature packages ($10.1 million comparative increase), partially offset by lower individual calling feature revenue of $3.8 million and a decrease of $1.2 million in inside wire revenue. Economic conditions or increasing competition could make it more difficult to sell our packages and bundles and cause us to lower our prices for those products and services, which would adversely affect our revenues. 31 Long Distance and Data Services Long distance and data services revenue for the three months ended June 30, 2004 increased $2.7 million or 4%, as compared with the prior period primarily due to growth of $7.2 million related to data services (data includes DSL) partially offset by decreased long distance revenue of $4.6 million primarily attributable to a 20% decline in the average rate per minute. Long distance revenue also reflects an increase of $2.0 million as a result of a reclassification in the first quarter of 2004 related to the clearing of affiliate revenue among revenue categories. Long distance and data services revenue for the six months ended June 30, 2004 increased $4.0 million or 3%, as compared with the prior period primarily due to growth of $14.2 million related to data services (data includes DSL) partially offset by decreased long distance revenue of $10.1 million primarily attributable to an 18% decline in the average rate per minute. Long distance revenue also reflects an increase of $3.2 million as a result of a reclassification in the first quarter of 2004 related to the clearing of affiliate revenue among revenue categories. Our long distance revenues could decrease in the future due to lower long distance minutes of use because consumers are increasingly using their wireless phones or calling cards to make long distance calls and lower average rates per minute because of unlimited and packages of minutes for long distance plans. We expect these factors will continue to adversely affect our long distance revenues during the remainder of 2004. Directory Services Directory revenue for the three months ended June 30, 2004 increased $1.5 million or 5%, as compared with the prior period primarily due to growth in yellow pages and internet advertising. Directory revenue for the six months ended June 30, 2004 increased $1.9 million or 4%, as compared with the prior period primarily due to modest growth in yellow pages and internet advertising. Other Other revenue for the three months ended June 30, 2004 increased $3.8 million or 14%, as compared with the prior period primarily due to a $3.9 million carrier dispute settlement, a decline in bad debt expense of $1.2 million, and $1.1 million in increased conferencing revenue, partially offset by decreases of $1.0 million in sales of customer premise equipment and $0.5 million in paystation revenue. Other revenue for the six months ended June 30, 2004 increased $6.6 million or 13%, as compared with the prior period primarily due to a $3.9 million carrier dispute settlement, a decline in bad debt expense of $4.5 million, and $1.9 million in increased conferencing revenue, partially offset by a decrease of $2.1 million in sales of customer premise equipment. ELI revenue for the three and six months ended June 30, 2004 decreased $5.4 million, or 12%, and $6.7 million, or 8%, respectively, as compared to the prior year period primarily due to lower demand and prices for long-haul services.
GAS AND ELECTRIC REVENUE ($ in thousands) For the three months ended June 30, For the six months ended June 30, --------------------------------------------- ---------------------------------------------- 2004 2003 $ Change % Change 2004 2003 $ Change % Change ----------- ----------- ------------ -------- ------------ ----------- ------------ -------- Gas revenue $ - $ 56,150 $ (56,150) -100% $ - $ 119,681 $ (119,681) -100% Electric revenue $ - $ 33,932 $ (33,932) -100% $ 9,735 $ 67,561 $ (57,826) -86%
We did not have any gas or electric operations in the quarter ended June 30, 2004 due to the sales of our Vermont Electric division, The Gas Company in Hawaii, and our Arizona gas and electric divisions. Electric revenue for the six months ended June 30, 2004 decreased $57.8 million, or 86%, as compared with the prior year period. We completed the sale of our remaining electric utility property on April 1, 2004. We have sold all of our electric operations and as a result will have no operating results in future periods for these businesses. 32
COST OF SERVICES ($ in thousands) For the three months ended June 30, For the six months ended June 30, -------------------------------------------- ---------------------------------------------- 2004 2003 $ Change % Change 2004 2003 $ Change % Change ----------- ----------- ------------ ------- ------------- ----------- ------------ ------- Network access $ 48,295 $ 58,168 $ (9,873) -17% $ 99,836 $ 114,683 $ (14,847) -13% Gas purchased - 34,041 (34,041) -100% - 69,987 (69,987) -100% Electric energy and fuel oil purchased - 21,328 (21,328) -100% 5,523 42,086 (36,563) -87% ----------- ----------- ------------ ----------- ----------- ------------ $ 48,295 $ 113,537 $ (65,242) -57% $ 105,359 $ 226,756 $(121,397) -54% =========== =========== ============ =========== =========== ============
Network access expenses for the three months ended June 30, 2004 decreased $9.9 million, or 17%, as compared with the prior year period primarily due to decreased costs in long distance access expense related to rate changes partially offset by increased circuit expense associated with additional data product sales in the ILEC sector. ELI costs have declined due to a drop in demand coupled with improved network cost efficiencies. Network access expenses for the six months ended June 30, 2004 decreased $14.8 million, or 13%, as compared with the prior year period primarily due to decreased costs in long distance access expense related to rate changes partially offset by increased circuit expense associated with additional data product sales in the ILEC sector. If we continue to increase our sales of data products such as DSL or expand the availability of our unlimited calling plans, our network access expense could increase. We did not have any gas or electric operations in the quarter ended June 30, 2004 due to the sales of our Vermont Electric division, The Gas Company in Hawaii, and our Arizona gas and electric divisions. Electric energy and fuel oil purchased for the six months ended June, 2004 decreased $36.6 million, or 87%, as compared with the prior year period. We completed the sale of our remaining electric utility property on April 1, 2004. We have sold all of our electric operations and as a result will have no operating results in future periods for these businesses.
OTHER OPERATING EXPENSES ($ in thousands) For the three months ended June 30, For the six months ended June 30, --------------------------------------------- ---------------------------------------------- 2004 2003 $ Change % Change 2004 2003 $ Change % Change ----------- ----------- ------------ -------- ------------ ----------- ------------ -------- Operating expenses $ 155,833 $ 178,038 $ (22,205) -12% $ 315,104 $ 355,618 $ (40,514) -11% Taxes other than income taxes 25,729 28,566 (2,837) -10% 52,065 58,887 (6,822) -12% Sales and marketing 30,086 25,889 4,197 16% 57,288 53,809 3,479 6% ----------- ----------- ------------ ----------- ----------- ------------ $ 211,648 $ 232,493 $ (20,845) -9% $ 424,457 $ 468,314 $ (43,857) -9% =========== =========== ============ =========== =========== ============
Operating expenses for the three months ended June 30, 2004 decreased $22.2 million, or 12%, as compared with the prior year period primarily due to increased operating efficiencies and a reduction of personnel in the ILEC and ELI sectors and decreased operating expenses in the public services sector due to the sales of our Vermont Electric division, The Gas Company in Hawaii, and our Arizona gas and electric divisions. Expenses were negatively impacted by $11.6 million of expenses related to our exploration of financial and strategic alternatives and related compensation arrangements. Operating expenses for the six months ended June 30, 2004 decreased $40.5 million, or 11%, as compared with the prior year period primarily due to increased operating efficiencies and a reduction of personnel in the ILEC and ELI sectors and decreased operating expenses in the public services sector due to the sales of our Vermont Electric division, The Gas Company in Hawaii, and our Arizona gas and electric divisions. Expenses were negatively impacted by $16.5 million of expenses related to our exploration of financial and strategic alternatives and related compensation arrangements. We routinely review our operations, personnel and facilities to achieve greater efficiencies. These reviews may result in reductions in personnel and an increase in severance costs. 33 Included in operating expenses is pension expense. In future periods, if the value of our pension assets decline and/or projected benefit costs increase, we may have increased pension expenses. Based on current assumptions and plan asset values, we estimate that our pension expense will decrease from $12.4 million in 2003 to approximately $2 - $4 million in 2004 and that no contribution to our pension plans will be required to be made by us to the pension plan in 2004. In addition, as medical costs increase the costs of our postretirement benefit costs also increase. Our retiree medical costs for 2003 were $16.9 million and our current estimate for 2004 is $19 - $20 million. Taxes other than income taxes for the three months ended June 30, 2004 decreased $2.8 million, or 10%, as compared with the prior year period primarily due to decreased property taxes in the public services sector due to the sales of The Gas Company in Hawaii and our Arizona gas and electric divisions of $4.3 million partially offset by increased state unemployment, franchise and gross receipts taxes of $2.1 million in the ILEC sector. Taxes other than income taxes for the six months ended June 30, 2004 decreased $6.8 million, or 12%, as compared with the prior year period primarily due to decreased property taxes in the public services sector due to the sales of our Vermont Electric division, The Gas Company in Hawaii, and our Arizona gas and electric divisions of $9.2 million partially offset by increased state unemployment, gross receipts, property and franchise taxes of $3.1 million in the ILEC sector. Sales and marketing expenses for the three months ended June 30, 2004 increased $4.2 million, or 16%, as compared with the prior year period primarily due to increased costs in the ILEC sector. Sales and marketing expenses for the six months ended June 30, 2004 increased $3.5 million, or 6%, as compared with the prior year period primarily due to increased costs in the ILEC sector.
DEPRECIATION AND AMORTIZATION EXPENSE ($ in thousands) For the three months ended June 30, For the six months ended June 30, --------------------------------------------- ---------------------------------------------- 2004 2003 $ Change % Change 2004 2003 $ Change % Change ----------- ----------- ------------ -------- ----------- ----------- ------------ --------- Depreciation expense $ 112,782 $ 118,729 $ (5,947) -5% $ 225,010 $ 225,565 $ (555) 0% Amortization expense 31,630 31,630 - 0% 63,260 63,342 (82) 0% ----------- ----------- ------------ ----------- ----------- ------------ $ 144,412 $ 150,359 $ (5,947) -4% $ 288,270 $ 288,907 $ (637) 0% =========== =========== ============ =========== =========== ============ Depreciation expense for the three and six months ended June 30, 2004 decreased $6.0 million, or 5%, as compared to the prior year because the net asset base is declining. RESERVE FOR TELECOMMUNICATIONS BANKRUPTCIES / RESTRUCTURING AND OTHER EXPENSES / STRATEGIC ALTERNATIVES AND MANAGEMENT SUCCESSION EXPENSES ($ in thousands) For the three months ended June 30, For the six months ended June 30, --------------------------------------------- ---------------------------------------------- 2004 2003 $ Change % Change 2004 2003 $ Change % Change ----------- ----------- ------------ -------- ----------- ----------- ------------ --------- Reserve for telecommunications bankruptcies $ - $ 2,260 $ (2,260) -100% $ - $ 2,260 $ (2,260) -100% Restructuring and other expenses $ - $ 10,113 $ (10,113) -100% $ - $ 10,092 $ (10,092) -100% Strategic alternatives and management succession expenses $11,561 $ - $ 11,561 100% $ 16,492 $ - $ 16,492 100%
During the second quarter 2003, we reserved approximately $2.3 million of trade receivables with Touch America as a result of Touch America's filing for bankruptcy. These receivables were generated as a result of providing ordinary course telecommunication services. If other telecommunications companies file for bankruptcy we may have additional significant reserves in future periods. Restructuring and other expenses for 2003 primarily consist of expenses related to reductions in personnel at our telecommunications operations and the write off of software no longer useful. Strategic alternatives and management succession expenses in 2004 include a mix of cash retention payments, equity awards and severance agreements (see Note 12 for a complete discussion). 34
INVESTMENT AND OTHER INCOME, NET / INTEREST EXPENSE / INCOME TAX EXPENSE ($ in thousands) For the three months ended June 30, For the six months ended June 30, --------------------------------------------- ---------------------------------------------- 2004 2003 $ Change % Change 2004 2003 $ Change % Change ----------- ----------- ------------ -------- ------------ ----------- ------------ -------- Investment and other income, net $ 5,213 $ 31,237 $ (26,024) -83% $ 30,507 $ 79,409 $ (48,902) -62% Interest expense $ 97,652 $106,436 $ (8,784) -8% $195,434 $215,712 $ (20,278) -9% Income tax expense $ 11,944 $ 24,384 $ (12,440) -51% $ 36,394 $ 64,360 $ (27,966) -43%
Investment and other income, net for the three months ended June 30, 2004 decreased $26.0 million, or 83%, as compared with the prior year period primarily due to the recognition in 2003 of a $25.0 million non-cash pre-tax gain related to a capital lease restructuring at ELI and net gains on sales of assets of $6.7 million. Investment and other income, net for the six months ended June 30, 2004 decreased $48.9 million, or 62%, as compared with the prior year period primarily due to the recognition in 2003 of $65.7 million in non-cash pre-tax gains related to a capital lease termination and a capital lease restructuring at ELI, $6.2 million of income from the expiration of certain retained liabilities at less than face value, which are associated with customer advances for construction from our disposed water properties, and net gains on sales of assets of $5.0 million, partially offset by $25.3 million of income in 2004 from the expiration of certain retained liabilities at less than face value. Interest expense for the three months ended June 30, 2004 decreased $8.8 million, or 8%, as compared with the prior year period primarily due to the retirement of debt. During the three months ended June 30, 2004, we had average long-term debt (excluding equity units and convertible preferred stock) outstanding of $4.2 billion compared to $4.7 billion during the three months ended June 30, 2003. Our composite average borrowing rate for the three months ended June 30, 2004 as compared with the prior year period was 6 basis points lower, decreasing from 8.03% to 7.97%, due to the inclusion in 2004 of the EPPICS, partially offset by the repayment of debt with interest rates below our average rate. Interest expense for the six months ended June 30, 2004 decreased $20.3 million, or 9%, as compared with the prior year period primarily due to the retirement of debt. During the six months ended June 30, 2004, we had average long-term debt (excluding equity units and convertible preferred stock) outstanding of $4.2 billion compared to $4.8 billion during the six months ended June 30, 2003. Our composite average borrowing rate for the six months ended June 30, 2004 as compared with the prior year period was 2 basis points lower, decreasing from 8.04% to 8.02%, due to the inclusion in 2004 of the EPPICS, partially offset by the repayment of debt with interest rates below our average rate. Income taxes for the three and six months ended June 30, 2004 decreased $12.4 million, or 51%, and $28.0 million, or 43%, respectively, as compared with the prior year period primarily due to changes in taxable income. The effective tax rate for the first six months of 2004 was 35.3% as compared with 39.4% for the first six months of 2003. Our effective tax rate has declined as a result of the sales of our utility properties and changes in the structure of certain of our subsidiaries. Our income tax expense is computed utilizing an estimated annual effective income tax rate in accordance with Accounting Principles Board Opinions (APB) No. 28, "Interim Financial Reporting." The tax rate is computed using estimates as to the Company's net income before income taxes for the entire year and the impact of estimated permanent book tax differences relative to that forecast. We expect to reach conclusion on various state and federal income tax audits during the remainder of 2004. Our 2004 effective income tax rate may vary from that of prior periods as a result of the conclusion of these audits. 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 other than in the normal course of business or to hedge long-term interest rate risk. Our primary market risk exposures are interest rate risk and equity and commodity price risk as follows: 35 Interest Rate Exposure Our exposure to market risk for changes in interest rates relates primarily to the interest-bearing portion of our investment portfolio and interest on our long-term debt and capital lease obligations. The long term debt and capital lease obligations include various instruments with various maturities and weighted average interest rates. Our objectives in managing our interest rate risk are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, a majority of our borrowings have fixed interest rates. Consequently, we have limited material future earnings or cash flow exposures from changes in interest rates on our long-term debt and capital lease obligations. A hypothetical 10% adverse change in interest rates would increase the amount that we pay on our variable obligations and could result in fluctuations in the fair value of our fixed rate obligations. Based upon our overall interest rate exposure at June 30, 2004, a near-term change in interest rates would not materially affect our consolidated financial position, results of operations or cash flows. In order to manage our interest rate risk exposure, we have entered into interest rate swap agreements. Under the terms of the agreements, we make semi-annual, floating interest rate interest payments based on six month LIBOR and receive a fixed rate on the notional amount. Sensitivity analysis of interest rate exposure At June 30, 2004, the fair value of our long-term debt and capital lease obligations was estimated to be approximately $4.3 billion, based on our overall weighted average rate of 7.9% and our overall weighted maturity of 13 years. There has been no material change in the weighted average maturity applicable to our obligations since December 31, 2003. The overall weighted average interest rate decreased approximately 14 basis points during the first six months of 2004. A hypothetical increase of 79 basis points (10% of our overall weighted average borrowing rate) would result in an approximate $230.0 million decrease in the fair value of our fixed rate obligations. Equity Price Exposure Our exposure to market risks for changes in equity prices is minimal and relates primarily to the equity portion of our investment portfolio. The equity portion of our investment portfolio consists of equity securities (principally common stock) of D & E Communications, Inc. (D & E) and Hungarian Telephone and Cable Corp. (HTCC). As of June 30, 2004 and December 31, 2003, we owned 3,059,000 shares of Adelphia common stock. The stock price of Adelphia was $0.51 and $0.55 at June 30, 2004 and December 31, 2003, respectively. As of June 30, 2004 and December 31, 2003, we owned 2,305,908 common shares, which represent an ownership of 19% of the equity in HTCC, a company of which our Chairman is a member of the Board of Directors. In addition, we hold 30,000 shares of non-voting convertible preferred stock, each share having a liquidation value of $70 per share and are convertible at our option into 10 shares of common stock. The stock price of HTCC was $9.66 and $9.86 at June 30, 2004 and December 31, 2003, respectively. As of June 30, 2004 and December 31, 2003, we owned 1,333,500 shares of D & E common stock. The stock price of D & E was $13.42 and $14.51 at June 30, 2004 and December 31, 2003, respectively. Sensitivity analysis of equity price exposure At June 30, 2004, the fair value of the equity portion of our investment portfolio was estimated to be $54.9 million. A hypothetical 10% decrease in quoted market prices would result in an approximate $5.5 million decrease in the fair value of the equity portion of our investment portfolio. 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 June 30, 2004. 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 Item 4. Controls and Procedures ----------------------- (a) Evaluation of disclosure controls and procedures We carried out an evaluation, under the supervision and with the participation of our management, regarding the effectiveness of the design and operation of our disclosure controls and procedures. Based upon this evaluation, our principal executive officer and principal financial officer concluded, as of the end of the period covered by this report, June 30, 2004, that our disclosure controls and procedures are effective. (b) Changes in internal control over financial reporting We reviewed our internal control over financial reporting at June 30, 2004. There have been no changes in our internal control over financial reporting identified in an evaluation thereof that occurred during the first six months of 2004, that materially affected or is reasonably likely to materially affect our internal control over financial reporting. 37 PART II. OTHER INFORMATION CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES Item 1. Legal Proceedings ----------------- The City of Bangor, Maine, filed suit against us on November 22, 2002, in the U.S. District Court for the District of Maine (City of Bangor v. Citizens Communications Company, Civ. Action No. 02-183-B-S). We intend to defend ourselves vigorously against the City's lawsuit. The City has alleged, among other things, that we are responsible for the costs of cleaning up environmental contamination alleged to have resulted from the operation of a manufactured gas plant by Bangor Gas Company, which we owned from 1948-1963. The City alleged the existence of extensive contamination of the Penobscot River and has asserted that money damages and other relief at issue in the lawsuit could exceed $50.0 million. The City also requested that punitive damages be assessed against us. We have filed an answer denying liability to the City, and have asserted a number of counterclaims against the City. In addition, we have identified a number of other potentially responsible parties that may be liable for the damages alleged by the City and have joined them as parties to the lawsuit. These additional parties include Honeywell Corporation, the Army Corps of Engineers, Guilford Transportation (formerly Maine Central Railroad), UGI Utilities, Inc., and Centerpoint Energy Resources Corporation. On March 11, 2004, the Magistrate in charge of the case granted our motion for partial summary judgment with respect to the City's CERCLA claims, and that decision was affirmed by the District Court on May 5, 2004. In an order issued on July 6, 2004, the Magistrate dismissed the City's claim for punitive damages. The City is currently appealing that decision to the District Court. We have demanded that various of our insurance carriers defend and indemnify us with respect to the City's lawsuit, and on December 26, 2002, we filed a declaratory judgment action against those insurance carriers in the Superior Court of Penobscot County, Maine, for the purpose of establishing their obligations to us with respect to the City's lawsuit. We intend to vigorously pursue this lawsuit to obtain from our insurance carriers indemnification for any damages that may be assessed against us in the City's lawsuit as well as to recover the costs of our defense of that lawsuit. On June 18, 2004, we received a notice from the Securities and Exchange Commission (SEC) stating that it is conducting an informal investigation regarding the methodologies used by numerous communications companies to count access lines and/or customers. We are cooperating with the SEC in this informal investigation and have provided information requested by the SEC and have agreed to preserve records that the SEC believes may be relevant to the inquiry. On June 7, 2004, representatives of Robert A. Katz Technology Licensing, LP, contacted us regarding possible infringement of several patents held by that firm. The patents cover a wide range of operations in which telephony is supported by computers, including obtaining information from databases via telephone, interactive telephone transactions, and customer and technical support applications. We are cooperating with the patent holder to determine if we are currently using any of the processes that are protected by its patents. If we determine that we are utilizing the patent holder's intellectual property, we expect to commence negotiations on a license agreement. On June 24, 2004, one of our subsidiaries, Frontier Subsidiary Telco Inc., received a "Notice of Indemnity Claim" from Citibank, N.A., that is related to a complaint pending against Citibank and others in the U.S. Bankruptcy Court for the Southern District of New York as part of the Global Crossing bankruptcy proceeding. Citibank bases its claim for indemnity on the provisions of a credit agreement that was entered into in October 2000 between Citibank and our subsidiary. We purchased Frontier Subsidiary Telco, Inc., in June 2001 as part of our acquisition of the Frontier telephone companies. The complaint against Citibank, for which it seeks indemnification, alleges that the seller improperly used a portion of the proceeds from the Frontier transaction to pay off the Citibank credit agreement, thereby defrauding certain debt holders of Global Crossing North America Inc. Although the credit agreement was paid off at the closing of the Frontier transaction, Citibank claims the indemnification obligation survives. Damages sought against Citibank and its co-defendants could exceed $1 billion. We are currently reviewing Citibank's claims to determine what action we will take to respond to those claims. We are party to other legal proceedings arising in the normal course of our business. The outcome of individual matters is not predictable. However, we believe that the ultimate resolution of all such matters, after considering insurance coverage, will not have a material adverse effect on our financial position, results of operations, or our cash flows. 38 Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- (a) The registrant held its 2004 Annual Meeting of the Stockholders on May 18, 2004. (b) Proxies for the Annual Meeting were solicited pursuant to Regulation 14A; there was no solicitation in opposition to management's nominees for directors as listed in the Proxy Statement. All such nominees were elected pursuant to the following votes: Number of Votes --------------- DIRECTORS FOR WITHHELD --------- --- -------- Aaron I. Fleischman 242,341,613 13,784,408 Rudy J. Graf 247,326,699 8,799,322 Stanley Harfenist 248,900,403 7,225,618 Andrew N. Heine 249,021,785 7,104,236 William M. Kraus 249,052,179 7,073,842 Scott N. Schneider 247,527,709 8,598,312 John L. Schroeder 248,836,063 7,289,958 Robert A. Stanger 249,525,992 6,600,029 Edwin Tornberg 248,889,390 7,236,631 Claire L. Tow 238,817,873 17,308,148 Leonard Tow 242,868,145 13,257,876 David H. Ward 249,766,699 6,359,323 (c) Other matters voted upon: Ratification of appointment of KPMG LLP as the Company's independent public accountants for 2004. Number of votes FOR 251,277,520 Number of votes AGAINST/WITHHELD 2,165,664 Number of votes ABSTAINING 2,682,837 Number of BROKER NON-VOTES 0 Shareholder approval of severance agreements. Number of votes FOR 115,864,958 Number of votes AGAINST/WITHHELD 83,880,905 Number of votes ABSTAINING 3,524,251 Number of BROKER NON-VOTES 52,855,907 Item 5. Other Information ----------------- As disclosed in our Proxy Statement for the 2004 Annual Meeting under our bylaws, if any stockholder intends to propose any matter at the 2005 annual meeting, the proponent must give written notice to us not earlier than January 19, 2005 nor later than February 18, 2005. Furthermore, in accordance with the proxy rules and regulations of the Securities and Exchange Commission, if a stockholder does not notify us by February 18, 2005 of a proposal, then our proxies would be able to use their discretionary voting authority if a stockholder's proposal is raised at the meeting. Item 6. Exhibits and Reports on Form 8-K -------------------------------- a) Exhibits: 10.1.2 Amended and Restated Non-Employee Directors' Deferred Fee Equity Plan dated as of May 18, 2004. 10.2.4 Separation Agreement between Citizens Communications Company and Leonard Tow, effective July 10, 2004. 31.1 Certification of Principal Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934. 39 31.2 Certification of Principal Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. b) Reports on Form 8-K: We filed on Form 8-K on April 14, 2004 under Item 5 "Other Events," a press release announcing the completion of the sales of our Vermont Electric division. We filed on Form 8-K on April 28, 2004 under Item 5 "Other Events," a press release announcing that the remarketing of our 6-3/4% senior notes due 2006 issued in June 2001 would not occur on May 12, 2004. We furnished on Form 8-K on May 6, 2004 under Item 12 "Disclosure of Results of Operations and Financial Condition," a press release announcing our earnings for the quarter ended March 31, 2004. 40 SIGNATURE --------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CITIZENS COMMUNICATIONS COMPANY ------------------------------- (Registrant) By: /s/ Robert J. Larson ------------------------- Robert J. Larson Senior Vice President and Chief Accounting Officer Date: August 4, 2004 41 EX-10.1.2 2 exhibit10-12.txt DIRECTORS DEFERRED EQUITY PLAN Exhibit 10.1.2 CITIZENS UTILITIES COMPANY NON-EMPLOYEE DIRECTORS' DEFERRED FEE EQUITY PLAN ARTICLE 1 PURPOSES OF THE PLAN 1.1 Purposes. The purpose of this Citizens Utilities Company Deferred Fee Equity Plan For Non-Employee Directors (the "Plan") is to provide each Director with an opportunity to defer some or all of the Director's Fees and receive compensation for services in the form of options to purchase Citizens' Common Stock or in Plan Units which are equivalent to Citizens' Common Stock. The Plan will implement corporate policy that all employees, officers and directors are to be encouraged to share in the Company's long-term prospects by taking part of their compensation in Common Stock and options. 1.2 Introduction. The Plan, as amended, is comprised of three separate plans. Because a number of administrative and procedural provisions of each of the plans are similar or identical, the plans have been combined in a single plan for convenience. The Plan consists of an option plan through which a director may elect to receive his or her Fees for a period of up to five years (or a shorter period in the case of 1994) in an equivalent amount of options to purchase Common Stock. This plan is referred to as the Option Plan. The provisions of Articles 3 and 4 apply exclusively to the Option Plan. The Plan also includes a separate stock plan through which a director may elect (a "Stock Plan Election") to receive his or her Fees for the next calendar year (or a shorter period in the case of 1994 or a newly elected director) in an equivalent amount of Plan Units. Upon termination of directorship, a Stock Plan Participant will receive the value of his Plan Units in either stock or cash or installments of cash as selected by the Participant at the time of the related Stock Plan Election. The provisions of Articles 5, 6 and 7 apply exclusively to the Stock Plan. The Plan also includes a formula stock option plan under which each Director is automatically granted an option to purchase shares of Common Stock on January 1 of each year, starting with 1997. The provisions of Article 12 apply exclusively to the Formula Plan. The term "Plan" includes the Stock Plan, Option Plan and Formula Plan, all as amended by Amendment No. 1. Plan and Option Plan include the Formula Plan; Option includes a Formula Plan Option; Option Under the Option Plan includes an Option under the Formula Plan; Participant includes an Option Plan Participant, a Stock Plan Participant and a Formula Plan Participant; Election includes an Option Plan Election and a Stock Plan Election; and Committee includes the Option Plan Committee and Stock Plan Committee; unless, in each case, the context requires otherwise. 1 ARTICLE 2 DEFINITIONS As used herein, the following words shall have following meanings unless otherwise specifically provided: 2.1 "Accounting Date" means, for purposes of the Stock Plan, each January 1, April 1 , July 1 and October 1, except that the first Accounting Date in 1995 shall be February 1. 2.2 "Administrator" means the person or persons appointed by the Board of Directors to represent the Company in the administration of each Plan pursuant to the provisions of Article 10.1. 2.3 "Act" means the Securities Act of 1933. 2.4 "Applicable Rate of Interest" means, as of any date, 120% of the then applicable Federal rate of interest pursuant to the Internal Revenue Code. The Federal short-term rate of interest shall be the interest component applicable to deferred Fees from the date of deferral until the date of investment in Plan Units under the Stock Plan. The Federal medium term rate of interest shall apply to distributions in annual installments deferred after Termination pursuant to the Stock Plan. 2.5 "Beneficiary" means the person or persons designated in writing by the Participant as entitled to receive a Stock Plan Participant's Account upon his death, or to exercise an Option Plan Participant's Option upon his death, or failing such designation, the person or persons who, upon the death of a Participant, shall have acquired by will, or the laws of descent and distribution, the right to receive the benefits specified under this Plan. Beneficiary designations shall be made in writing and delivered to the Administrator and shall comply with any applicable state law relating to testamentary dispositions and other requirements. A Participant may designate a new Beneficiary or Beneficiaries at any time by notifying the Administrator. The last such designation received by the Administrator shall be controlling; provided, however, that no designation, or change or revocation thereof, shall be effective unless received by the Administrator prior to the Participant's death, and in no event shall it be effective as of a date prior to such receipt. "Beneficiary" shall include the person or persons who, upon the disability or incompetence of a Participant, shall have acquired on behalf of the Participant, by legal proceeding or otherwise, the right to receive the benefits specified in this Plan on behalf of the Participant. 2.6 "Board of Directors" means the Board of Directors of the Company. 2.7 "Code" means the Internal Revenue Code of 1986. 2.8 "Company" means Citizens Utilities Company and its successors and assigns. 2.9 "Common Stock" means Common Stock Series B, par value $.25 per share, of the Company or any successor Common Stock. 2 2.10 "Director" means any director of the Company who is not a full-time employee of the Company. For the purposes of the Plan, an individual who is both a full-time employee of the Company and a director of the Company and therefore ineligible to participate in the Plan and who ceases to be a full-time employee but remains in office as a director shall become eligible to participate in the Plan as a Director as of the termination of his or her service as a full-time employee. 2.11 "Effective Date" means, for Option Plan Elections before July 20, 1994, August 1, 1994; and for other Option Plan Elections, the next January 1. 2.12 "Exchange Act" means the Securities Exchange Act of 1934. "Rule 16b-3" shall mean such rule promulgated by the Securities and Exchange Commission under the Exchange Act and, unless the circumstances require otherwise, shall include any other rule or regulation adopted under Sections 16(a) or 16(b) of the Exchange Act relating to compliance with, or an exemption from, Section 16(b). Reference to any section of the Exchange Act or any rule promulgated thereunder shall include any successor section or rule. 2.13 "Fair Market Value" means, unless another reasonable method for determining fair market value is specified by the Committee, the average of the high and low sales prices of a share of the Common Stock as reported by the New York Stock Exchange (or if such shares are listed on another national stock exchange or national quotation system, as reported or quoted by such exchange or system) on the date in question or, if no such sales were reported for such date, for the most recent date on which sales prices were quoted. 2.13A "Family Entity," "Family Member Transfer," "Family Transferee" and "Family Trust" mean such terms as defined in Section 4.8. 2.14 "Option Plan Committee" means the Committee described in Section 10.1 hereof to administer the Option Plan. 2.15 "Option Plan Election" is an election to receive Options equivalent in value to Option Plan Fees to be earned during the period August 1 - December 31, 1994 or during one or more subsequent Plan Years. 2.16 "Option Plan Fees" are those Directors' Fees which may be the subject of an Option Plan Election. These are limited to future retainer fees at the rate in effect in the year in which the Option Plan Election is made and board and committee meeting fees, up to a maximum of $30,000 per year. Option Plan Fees for 1994 shall be limited to $12,500. 2.17 "Option Plan Participant" means a Director who has elected to receive Directors' Fees in the form of Options. 2.18 "Option Value" - For each Option Plan Election, the options granted hereunder shall be in an amount equivalent to the value of the Directors' Fees subject to such Option Plan Election. In order to implement this standard, the Board of Directors has determined at the time of adoption of the Plan that the "Option Value" of an Option with the terms and conditions of the Option described herein to purchase one share of Common Stock of the Company is 20% of the Fair Market Value of such share on the Effective Date of the Option in question, 3 2.19 "Plan" means this Citizens Utilities Company Deferred Fee Equity Plan For Non-Employee Directors. 2.20 "Plan Unit" shall mean a credit established in a Participant's Stock Plan Account reflecting the number of shares of Common Stock which could be purchased at Fair Market Value as of each Accounting Date as provided in Section 6.1. A Plan Unit shall be deemed to be the equivalent of a share of Common Stock and shall be subject to adjustment in the event of change in Common Stock as provided in Section 11.5. 2.21 "Plan Year" means the fiscal year of the Company, currently the twelve-month period ended December 31. 2.22 "Stock Plan Account" shall mean the account established for each Stock Plan Participant to reflect the amount of Fees which such Participant has elected to defer under the Stock Plan, any interest component and all Plan Units which have been acquired with such Fees and interest component. 2.23 "Stock Plan Committee" means the Committee described in Section 10.1 hereof to administer the Stock Plan. 2.24 "Stock Plan Election" means a Stock Plan Participant's delivery of a written notice of election to the Administrator (a) electing to defer payment of his or her Fees, and (b) further electing to receive payment of his or her Stock Plan Account either (i) at Time of Distribution in either (A) Common Stock or (B) cash, or (ii) in installments in cash annually over a five-year period. All such elections shall be irrevocable except as otherwise provided in the Stock Plan. 2.25 "Stock Plan Fees" and "Fees" each mean the retainer fees and Board of Directors and committee meeting attendance fees unless the context otherwise requires. 2.26 "Stock Plan Participant" means a Director who has elected to defer payment of all or a portion of his or her Stock Plan Fees and to establish a Stock Plan Account. 2.27 "Termination" means retirement from the Board of Directors or termination of service as a Director for death, disability or any other reason. 2.28 "Time of Distribution" means a date ten (10) calendar days after Termination, except as may be otherwise specified in Article 7; provided that, if payment is to be made in cash and the Time of Distribution is within six months after the date of acquisition or crediting of Plan Units within the contemplation of Rule 16b-3(c)(1) or any successor rule under the Exchange Act, the Time of Distribution shall be delayed, solely for such Plan Units, until more than six months shall have elapsed from the date of acquisition or crediting of such Plan Units. 4 2.29 "Trust Agreement" means any Trust Agreement entered into between the Company and any Trustee in connection with the Plan. 2.30 "Trustee" means any entity named as Trustee in the Trust Agreement, or any successor corporate Trustee thereunder. The term "Plan" shall mean the original Plan as amended by Amendment No. 1. The term "Plan" and "Option Plan" shall include the Formula Plan; "Option" shall include a Formula Plan Option; "Option under the Option Plan" shall include an Option under the Formula Plan; and "Participant" shall include a Formula Plan Participant. ARTICLE 3 ELECTIONS BY OPTION PLAN PARTICIPANTS 3.1 Directors may elect to receive Fees in the form of Options. Option Plan Fees to be earned by Directors for the Plan Years 1995 through 1999 may, at the election of a Director, be received as Options as herein provided. Option Plan Fees to be earned by Directors for the period August 1, 1994 through December 31, 1994 may also, at the election of a Director, be received as Options. 3.2 Annual Option Plan Elections. On or before December 15 of each year (except for 1994 when the Option Plan Election must be made on or before July 20, 1994) a Director may deliver to the Administrator his or her Option Plan Election to receive a stated percentage of his or her Option Plan Fees for one or more of the Plan Years 1995 through 1999 or the period August 1 - December 31, 1994, in Options to purchase the number of shares of Common Stock specified in Section 4.1. For example: the annual Option Plan Election may cover the Plan Year or Years set forth below (to the extent not theretofore the subject of an Option Plan Election). Plan Years or Periods for Which Option Plan Fees May Be Elected Date of Option Plan Election On or Before July 20, 1994 August 1 -December 31, 1994 On or Before July 20, 1994 1995-1999 On or Before December 15, 1995 1996-1999 On or Before December 15, 1996 1997-1999 On or Before December 15, 1997 1998-1999 On or Before December 15, 1998 1999 Elections must include the earliest Plan Year for which unelected Fees exist and (if additional years are included in the Election) consecutive successive years. An Option Plan Election covering Option Plan Fees for this period shall preclude a Stock Plan Election purporting to cover the same Fees. 5 3.3 Effective Date. Option Plan Elections made on or before July 20, 1994 shall become effective on August 1, 1994. Later years' Option Plan Elections shall become effective as of the next Option Plan Effective Date. 3.4 Adjustment for Actual Fees Earned. If by the end of any Plan Year a Director shall not have earned the amount of Option Plan Fees elected by him or her to be received in Options, the number of shares of Common Stock covered by Options granted for such Plan Year shall be diminished pro rata. Any Fees earned which have not been the subject of an Option Plan Election shall be paid in cash in accordance with the normal payment practices of the Company for Directors' Fees. If a Participant's directorship shall terminate during a Plan Year which has been the subject of an Option Plan Election, the portion of the Option which related to Option Plan Fees earned by the Participant prior to termination of directorship shall remain in effect and the portion of the Option which relates to Option Plan Fees which are unearned shall terminate. 3.5 Cancellation of Election. At any time an Option Plan Participant may cancel one or more Options or installments of Options held by him or her which relate to future Plan Years and consequently have not been earned as of the date of such cancellation. Cancellation shall be effected by delivering a written notice of cancellation to the Administrator. Such cancellation shall not affect any options held by the Participant relating to the year in which cancellation occurs or to any prior year. Option Plan Fees to be earned by a Director covered by a canceled Election shall thenceforth be paid in cash in accordance with the Company's practices, and may not thereafter become the subject of an Option Plan Election. ARTICLE 4 TERMS OF OPTIONS 4.1 Number of Shares covered by an Option. The number of shares of Common Stock covered by an Option resulting from an Option Plan Election shall be equal to the Option Plan Fees covered by the Election divided by the Option Value. 4.2 Maximum Duration. The maximum exercise period for each Option granted under the Option Plan shall be ten years from the Effective Date of the Option. 6 4.3 Initial Exercisability in Installments. Options representing Option Plan Fees to be earned in one Plan Year shall become exercisable on January 1 of the following Plan Year. Options which relate to Fees to be earned in more than one Plan Year shall become exercisable in installments on the January 1 of the year following the year in which Fees represented by the installment are earned. For example: An Election covering the years 1996, 1997 and 1998 would become exercisable: as to shares representing 1996 Fees, on January 1, 1997; as to shares representing 1997 Fees, on January 1, 1998; as to the remainder of the shares, on January 1, 1999. An Election covering Fees to be earned in 1999 will first become exercisable on January 1, 2000. Options relating to the period August 1, 1994 - December 31 , 1994 shall first become exercisable on February 1, 1995. 4.4 Exercise Price. The Exercise Price for all shares of Common Stock purchasable upon exercise of an Option shall be 90% of the Fair Market Value as of the Effective Date applicable to the Option exercised. 4.5 Notice of Exercise. An Option Plan Participant wishing to exercise an Option may do so by giving written notice of exercise in the form adopted for the Option Plan. 4.6 Payment of Purchase Price. At the choice of the holder of the Option, the Purchase Price may be paid either in cash, or in shares of Common Stock valued at Fair Market Value on the trading day immediately preceding the date of exercise specified in the notice of exercise. 4.7 Exercisability Continuing after Termination. If the directorship of a Participant who has not either reached age 60 or rendered three years of service terminates for any reason, the portion of the Option which relates to Option Plan Fees earned by a Participant prior to termination of directorship shall continue to be exercisable by the Participant or his or her Family Trustee or Beneficiary for a period of twelve months after termination of directorship. If the directorship of a Participant who has either reached age 60 or rendered three years or more of service terminates for any reason, the portion of the Option which relates to Option Plan Fees earned by a Participant prior to termination of directorship shall continue to be exercisable by the Participant or his or her Family Trustee or Beneficiary for the remainder of the stated term of the Option. In no event shall the exercise date be later than the date specified in Section 4.2. 7 4.8 Options not transferable; Exceptions. No Option granted under the Option Plan shall be transferable other than by will or the laws of descent or distribution except pursuant to a domestic relations order as defined by the Internal Revenue Code or Title I of the Employee Retirement Income Security Act ("ERISA") or the rules thereunder and except that, with the consent of the Committee acting in its sole discretion, an Option Plan or Formula Plan Participant may transfer (a "Family Member Transfer") an Option to (i) a member of the Participant's immediate family (which for the purposes of the Plan shall have the same meaning as defined in Rule 16a-1 promulgated under the Exchange Act); (ii) a trust (the "Family Trust") the beneficiaries of which consist exclusively of members of the Participant's immediate family; and (iii) a partnership, limited partnership or other limited liability entity ("Family Entity") the members of which consist exclusively of members of the Participant's immediate family, Family Trusts and Family Entities; provided that no consideration is paid for the transfer and that each Family Member Transferee execute an instrument agreeing to be bound by the provisions of the Plan and the restrictions as to its transferability of the option. During the lifetime of a Participant, an Option shall be exercisable only by the Participant or his or her Family Transferee or beneficiary. A ("Family Transferee") is transferee that is a member of the immediate family of a Participant or a Family Trust or Family Entity." ARTICLE 5 ELECTIONS BY STOCK PLAN PARTICIPANTS 5.1 Directors may elect to receive Fees in the form of Plan Units. Directors may elect to receive Directors' Fees (to the extent such Directors' Fees are not the subject of an Option Plan Election) in the form of Plan Units. 5.2 Stock Plan Election to Defer. A Director of the Company may become a Stock Plan Participant by electing, on an annual basis and prior to December 31 of a Plan Year, to defer receipt of all or a portion of the Stock Plan Fees payable to such Director for the next ensuing Plan Year; provided, that no Fees may be allocated to any Director's Stock Plan Account after May 22, 2007. An Election shall be effective upon the delivery by a Stock Plan Participant to the Administrator of a written Stock Plan Election to evidence his or her decision. Such Stock Plan Election shall indicate the portion of Directors' Fees to be deferred and credited to his or her Stock Plan Account. The following special provisions shall apply to Directors' Fees for 1994 and 1995: On or before July 20, 1994, a Director may deliver a Stock Plan Election to the Administrator in which he or she elects to defer receipt of all or a portion of the Directors' Fees payable to such Director for services during the period August 1, 1994 through December 31, 1994. In such a case, all deferred Fees will be held by the Company in the Participant's Stock Plan Account and will not be invested in Plan Units until February 1, 1995. An election to defer Fees to be accrued during the period January 1, 1995 through December 31, 1995 shall be made on or before July 20, 1994 as provided herein except that the first Accounting Date for investment of such Fees shall be April 1, 1995. 8 If a person becomes a Director after the beginning of any Plan Year, he or she may elect to defer receipt of Fees for future services in such Plan Year. Such Stock Plan Election must be made in writing and delivered to the Administrator within twenty days after the individual becomes a Director and will take effect as of the first calendar quarter to start after the date of such Election. In such a case, deferred Fees will be held by the Company in the Participant's Stock Plan Account and will not be invested in Common Stock or Plan Units until the first Accounting Date which is at least six (6) months after the date that such Stock Plan Election is first delivered to the Administrator. 5.3 Effectiveness of Elections. Elections for each Plan Year shall be effective and irrevocable upon the delivery of a Stock Plan Election to the Administrator, except as specifically provided in this Plan. Fees deferred pursuant to such Stock Plan Election shall be credited to the Participant's Stock Plan Account and distributed at the times and in the manner set forth in such Election. In the absence of an effective Stock Plan Election to take effect on the Time of Distribution as to the time and/or manner of distribution, the payout of a Stock Plan Account shall be in one lump sum cash payment at the Time of Distribution or as soon thereafter as possible, as provided by Section 2.28. ARTICLE 6 STOCK PLAN ACCOUNTS AND PLAN UNITS 6.1 Crediting Stock Plan Accounts. The Stock Plan Account of each Stock Plan Participant shall be credited as of each Accounting Date with Plan Units equal to the total cash value of fees earned in a quarter divided by 85% of the average of the high and low prices of the stock on the first trading day of the year the election is in effect ("Initial Market Value"). Plan Units will be credited to the director's account as of the first business day of the fiscal quarter following the fiscal quarter in which such Stock Plan Fees were earned. An adjustment equal to the excess of the number of Plan Units calculated at the Fair Market Value on the last trading day of the month of November of a Plan Year over the number of Plan Units calculated at the Initial Market Value for such Plan Year shall be credited to each participant's Stock Plan Account in December of the applicable Plan Year. The quarterly crediting of the Plan Units has been established for administrative convenience. As of the date of any payment of a stock dividend or stock split by the Company, a participant's Stock Plan Account will be credited with Plan Units equal to the number of shares of Common Stock (including fractional share entitlements) which are payable by the Company with respect to the number of shares (including fractional share entitlements) equal to the number of Plan Units credited to the Participant's Stock Plan Account on the record date for such stock dividend or stock split. As of the date of any dividend in cash or property or other distribution payable to holders of Common Stock, the Participant's Stock Plan Account shall be credited with additional Plan units equal to the number of shares of Common Stock (including fractional share entitlements) that could have been purchased at the Fair Market Value as of such payment date with the amount which would have been received as a dividend or distribution on the number of shares (including fractional share entitlements) equal to the Plan Units credited to the Participant's Stock Plan Account as of the record date. 9 On a quarterly basis, or as otherwise appropriate to match increases in Plan Units held in the Plan, the Company may, but shall not be required to, purchase Common Stock on the open market and hold the same in the "Deferred Fee Stock Plan for Non-Employee Directors Account." Also, the Company may enter into a Trust Agreement with a Trustee and may, but shall not be required to, transfer to the Trustee either (a) the number of shares of Common Stock approximately equal in Fair Market Value as of the last Accounting Date to the aggregate dollar amount of credits in the Participants' Stock Plan Accounts for Stock Plan Fees deferred by the Directors and any interest component on such Accounting Date, or (b) cash with instructions to purchase shares of Common Stock either from the Company or in the open market, as determined by the Company. Purchases in the open market by the Trustee shall not be subject to any direct or indirect control or influence over the times when, or the prices at which, or the broker or dealer through which, the Trustee shall buy such shares. 6.2 Establishment of Stock Plan Accounts. The Company, Administrator or the Trustee, as appropriate, shall establish a separate "Stock Plan Account" for each Stock Plan Participant who defers Stock Plan Fees pursuant to the Plan, and credit each Participant's Stock Plan Account with his or her entitlement to deferred Fees, an interest component at the Applicable Rate of Interest and Plan Units. 6.3 Adjustment of Stock Plan Accounts. As of each Accounting Date of each Plan Year and on such other dates as the Administrator directs, the value of each Stock Plan Account shall be determined by the Company, the Administrator, or the Trustee, as appropriate. ARTICLE 7 PAYMENT OF STOCK PLAN ACCOUNTS 7.1 Time and Method of Distribution. Distribution of a Participant's Stock Plan Account shall commence at Time of Distribution. Distribution shall be made in a lump sum or in equal annual cash installments over a period of five years. If a distribution is to be made in a lump sum it may be made either in shares of Common Stock or in cash. If a distribution is to be made in cash, it shall be in an amount equal to the Fair Market Value as of the Time of Distribution (or such later date as may be required to continue an exemption under Rule 16b-3) of all Plan Units credited to a Participant's Stock Plan Account plus any uninvested deferred Stock Plan Fees and related interest component. The distribution shall be paid to the Stock Plan Participant or his or her Beneficiary. 10 If a distribution is to be made in shares of Common Stock, the distribution shall be such number of shares of Common Stock as shall equal the Plan Units credited to such Participant's Stock Plan Account plus shares of Common Stock equivalent in Fair Market Value to the amount of any accumulated uninvested deferred Fees and interest component in such Participant's Stock Plan Account as of the Time of Distribution. Any remaining fractional interest shall be paid in cash. If a distribution is made in annual installments, each annual installment shall be in cash and equal to one-fifth of the amount of the lump sum payable as of the Time of Distribution or later date as aforesaid, with interest on each unpaid installment at the Applicable Rate of Interest in effect on the date of Termination by a Director of his directorship. 7.2 Election of Method of Distribution. At the time that a Director first makes a Stock Plan Election to defer Fees for a Plan Year, such Director may elect whether the payments to be made at the Time of Distribution for that Plan Year shall be distributed in a lump sum or in five equal annual cash installments. At the same time, any Stock Plan Participant electing lump sum payment may also elect for the payment of such lump sum to be in shares of Common Stock credited to the Stock Plan Account or in cash. A Stock Plan Participant may, in connection with his or her retirement, death or disability, change his or her Stock Plan Election as to the method of payment (shares or cash) of any lump sum distribution from time to time. Subject to the provisions of Articles 9 and 10, either the Committee or the Administrator, in their sole discretion, may direct the distribution of the Director's entitlement in a lump sum or in annual installments, and the Committee or Administrator may take into account, but need not take into account, any request by a Director concerning the period over which his entitlement will be distributed. 7.3 Merger, consolidation, sale of assets or tender for shares. In the event of a proposed merger or consolidation in which the Company will not be the surviving corporation, or a sale of a majority of the assets of the Company, or in the case of a tender offer or the Company's Common Stock or a similar corporate transaction which is expected in the view of the Committee to result in another company, firm, or group acquiring 20% or more of the voting power of the Company's outstanding securities, the Plan shall take steps to convert Plan Units held by participants into shares of Common Stock. The Plan shall obtain such shares with a view to making the same available for participation by Stock Plan Participants in the transaction (subject to the fourth from last sentence of this Section). Such shares may be obtained by the Plan from the "Deferred Fee Stock Plan for Non-Employee Directors Account," any trust account for the benefit of Plan Participants, the Company, or any other source, including authorized and unissued, or issued and reacquired, shares of Common Stock. In the event that shares of Common Stock are convertible into or otherwise exchangeable for securities of another corporation, or cash or other property without the need for action or tender by an individual shareholder, the Company shall take all necessary steps to carry out such conversion or exchange and shall deliver to each Stock Plan Participant the securities, cash or other property into which his or her shares have been exchanged or converted. In the event of a tender offer or similar event in which an individual shareholder of the Company may elect to tender shares or otherwise take steps to receive securities, cash or other property, the Company shall so advise the Participants and take such action, including tender, or shall refrain from action, as directed in writing by each Stock Plan Participant. Prior to the completion of such tender offer or similar event, no Participant shall have any entitlement to any shares, and if such event is not completed each participant shall be entitled to Plan Units and not shares of Common Stock. Upon the completion of such tender offer or similar event, the Company shall distribute to each Stock Plan Participant any shares of Common Stock, securities, cash or other property held by the Plan for his or her Stock Plan Account. The Administrator may delay such distribution to any Stock Plan Participant in order to comply with, or continue the availability of an exemption under, the Act or Exchange Act. Upon the completion of such distribution the Stock Plan shall terminate. 11 7.4 Change in Tax Law. The Stock Plan is intended to be treated as an unfunded deferred compensation plan under the Code. It is the intention of the Company that the amounts deferred pursuant to this Plan shall not be included in the gross income of the Participants or their Beneficiaries until such time as the deferred amounts are distributed from the Plan. If, at any time, it is determined or claimed by the Internal Revenue Service ("Service") that amounts deferred in earlier plan Years have become currently taxable to the Participants or their Beneficiaries, the Committee may, in its discretion, terminate the Plan and distribute amounts credited to the Stock Plan Participants or their Beneficiaries. Such determination shall be based on a ruling or publicly available Pronouncement from the Service, or on the position taken by the Service in audit, or a written opinion from tax counsel. ARTICLE 8 CREDITORS AND INSOLVENCY 8.1 Unfunded Status. Any and all payments made to a Stock Plan Participant pursuant to the Plan shall be made from the general assets of the Company or assets available to its general creditors. Any payments made in good faith under the terms of the Plan to a Stock Plan Participant or his Beneficiary shall fully discharge the Plan, the Company, the Trustee, if any, the Administrator and the Committee from all further obligations with respect to such payments. The Company intends that the Plan shall be considered unfunded for all purposes, including tax purposes and purposes of Title I of ERISA. 12 8.2 Claims of the Company's Creditors. All assets held pursuant to the provisions of this Plan shall be subject to the claims of general creditors of the Company, including judgment creditors and bankruptcy creditors. The rights of a Stock Plan Participant or Beneficiary to any assets of the Plan or Trust shall be no greater than the rights of an unsecured creditor of the Company. No Stock Plan Participant shall have any claim or entitlement to any shares of Common Stock which have been purchased, acquired or held by the Plan, Company or any Trustee. Any and all such shares shall be the property of the Company and shall only represent funds or assets available to the Company which it shall have designated to match its obligations and accruals with respect to the Plan. 8.3 Notification of Trustee, if any. If the Company has appointed a Trustee for the Plan, the following provisions shall obtain: In the event the Company becomes insolvent, the Board of Directors and the Chief Executive Officer of the Company shall immediately notify the Trustee of that fact. The Trustee shall not make any payments from the Trust to any Stock Plan Participant or any Beneficiary under the Plan after such notification is received or at any time after the Trustee has knowledge of such insolvency. Under any such circumstances, the Trustee shall make available any property held in the Trust to satisfy the claims of the Company's general creditors or, upon satisfaction of such claims, to the Participants, as a court of competent jurisdiction may direct. For purposes of this Plan, the Company shall be deemed to be insolvent if the Company is subject to a pending voluntary or involuntary proceeding as a debtor under the United States Bankruptcy Code, or is unable to pay its debts as they mature. All trust assets shall be subject to the claims of general creditors of the Company to the fullest extent contemplated by Revenue Procedure 92-64. ARTICLE 9 PAYMENT OF SHARES 9.1 Delivery of Certificates for Stock. At the Time of Distribution or as soon thereafter as practicable, subject to the fourth paragraph of this Section, the Company shall deliver to a Stock Plan Participant who has elected to receive shares of Common Stock or to his Beneficiary a certificate for the shares of Common Stock to which he or she is entitled. At the time of exercise of an Option, subject to the fourth paragraph of this Section, the Company shall deliver to the Option Plan Participant or his or her Beneficiary a certificate for shares of Common Stock to which he or she is entitled. Such certificates shall be registered in the name of the Participant or Beneficiary. The Company shall not be required to issue or deliver any certificates for, or make book-entry reflecting, shares of Common Stock prior to (a) the listing of such shares on any stock exchange or quotation system on which the Common Stock may then be listed or quoted and (b) the completion of any registration, qualification, approval or authorization of such shares under any federal or state law, or any ruling or regulation or approval or authorization of any governmental body which the Company shall, in its sole discretion, determine to be necessary or advisable. 13 All certificates for shares of Common Stock delivered under the Plan, and book entries reflecting such shares, shall be subject to such restrictions as the Administrator may deem advisable under the rules, regulations, and other requirements of the Securities and Exchange Commission, any stock exchange upon which the Common Stock is then listed and any applicable federal or state securities laws. If the registration of ownership of Common Stock is then being maintained by the Company or its transfer agent in book-entry form, then the delivery of shares of Common Stock to the Participant or his Beneficiary may be evidenced by book entry, unless the Participant or Beneficiary requests otherwise in writing. 9.2 Taxes. The Company or the Trustee, as appropriate, shall deduct the amount of any taxes, if so required by law, from any payments made pursuant to the Plan and shall transmit the withheld amounts to the appropriate taxing authority, and provide the Stock Plan Participant or any Beneficiary of appropriate evidence of withholding. In the case of exercise of an Option under the Option Plan or payment in shares of Common Stock under the Stock Plan, the Participant may request the Company to accept payment of any related withholding taxes in the form of shares of Common Stock valued at Fair Market Value on the trading day immediately prior to the related exercise of the Option or payment in shares of Common Stock, as the case may be. 9.3 Payment to Beneficiary, Exercise of Option by Beneficiary. Upon the death of a Stock Plan Participant, the Stock Plan Account of the deceased Stock Plan Participant shall be paid to the Beneficiary either (i) in the same manner as it would have been paid to the Stock Plan Participant or (ii) in a lump sum settlement, as determined by the Committee or the Administrator in their sole discretion, consistent with the guidelines referred to in Article 10. Upon the death of an Option Plan Participant, the Beneficiary may exercise any Option to the extent exercisable on the date of death. 9.4 Redesignation of Beneficiary. Amendments which serve only to change the Beneficiary designation shall be permitted at any time and as often as necessary. ARTICLE 10 ADMINISTRATION 10.1 Appointment of Committee and Administrator The Board of Directors shall appoint a Stock Plan Committee and an Option Plan Committee (which may be the same Committee), each consisting of not less than two persons, to administer and interpret the Plan. Members of a Committee shall hold office at the pleasure of the Board of Directors and may be dismissed at any time with or without cause. 14 The Board of Directors shall also designate one or more officers or employees of the Company to be the Administrator to have the primary administrative responsibility with respect to each Plan, in coordination with and under the direction of the Committee. 10.2 Powers of the Administrator and the Committee. The Stock Plan and Option Plan Committees and the Administrator shall together administer the Plan. The Committees shall not, under any circumstances, have authority to select those Directors who will be eligible to participate in the Plan or to make decisions concerning the timing, pricing or amount of any benefit, Plan Unit, share of Common Stock or Option under the Plan. All such matters are determined solely by the provisions of the Plan. The Committees shall interpret or supplement the provisions of the Plan where desirable or necessary and may resolve ambiguities or omissions or adopt procedures for the administration of the Plan consistent with the purpose and provisions of the Plan and any rules adopted by the Committee. Whenever directions, designations, applications, requests or other notices are to be given by a Participant under the Plan, they shall be filed with the Administrator. Except as provided in the next paragraph, all decisions, determinations or actions of a Committee made or taken pursuant to grants of authority under the Plan shall be made or taken in the sole discretion of a Committee and shall be final, conclusive and binding on all persons for all purposes. If the taking of any action or the making of any determination by a Committee or Administrator shall jeopardize the effectiveness of the deferral of Fees or of credits in Participants' Stock Plan Accounts or Options for federal income tax purposes or any exemption of any plan of the Company from Section 16(a) and (b) of the Exchange Act, the Committee or Administrator, as the case may be, shall be deemed to be without the power to take such action or make such determination. 10.3 Rendering of Quarterly Plan Accounts. After the close of each quarter, the Administrator will deliver to each Participant a statement showing the Plan Units which have been credited to his or her account as of the end of such quarter and any accumulated deferred fees. The accounting shall also indicate the price per unit for all Plan Units credited since the end of the previous account. The statement will also show the Options held and/or elected by a Participant and the terms of such Options. 10.4 Both Elections may apply to a Plan Year. Subject to the limitations contained in each Plan, a Director may elect to include all or any portion of his Fees to be earned in any future Plan Year in one or both of the Plans, but without duplication. If a Director has delivered an Option Plan Election and a Stock Plan Election for the same Plan Year or period, the Fees covered by such Elections shall be allocated as specified in such Elections or in other instructions from the Director. In the event of a conflict in instructions from a Director, the Administrator shall advise the Director. 15 10.5 Advance Notification by Administrator. On or before May 31 of each year, the Administrator shall notify each Director that he or she must deliver a written Stock Plan Election to the Administrator prior to June 30 (or any later cut-off date permitted by the Administrator) in order to defer Fees during the next calendar year. On or before November 30 of each year, the Administrator shall notify each Director that he or she must deliver a written Option Plan Election to the Administrator prior to December 15 (or any later cut-off date permitted by the Administrator) in order to elect to receive Options in payment for future services as a Director in upcoming Plan Years. ARTICLE 11 MISCELLANEOUS 11.1 Term of Plan. The Plan shall become effective as provided in Section 11.9 and the Stock Plan shall continue through May 22, 2007 unless earlier terminated pursuant to Sections 7.3 or 7.4 11.2 Shares Subject to the Plan. As of any date the maximum number of shares of Common Stock which the Plan may be obligated to deliver pursuant to the Stock Plan and the maximum number of shares of Common Stock which shall have been purchased by Participants pursuant to Options and which may be issued pursuant to outstanding Options under the Option Plan shall not be more than one (1%) percent of the total outstanding shares of Common Stock of the Company as of June 30, 2003, subject to adjustment in the event of changes in the corporate structure of the Company affecting capital stock. Any Common Stock transferred by the Company to a Stock Plan Account or to the Trustee or delivered by the Company upon exercise of an Option hereunder may consist, in whole or in part, of authorized and unissued shares or treasury shares as the Company shall determine. Cash transferred to the Trustee may be used to purchase Common Stock in the open market or from the Company. In the event that the total number of shares of Common Stock subject to, or issued pursuant to, the Plan at any one time is in excess of the above-stated limit, the number need not be reduced if such excess has resulted from a reduction in the amount of issued and outstanding shares of Common Stock subsequent to the time that such Options were granted or such shares were issued. If any shares of Common Stock subject to purchase by a Participant under an Option under the Plan are not purchased, such shares of Stock shall be deemed not to have been purchased pursuant to the Plan for purposes of this Section. Shares of Common Stock received or retained by the Company in payment of the exercise price of Options or in payment, or in lieu of payment, of withholding taxes shall not reduce the number of shares deemed to have been purchased pursuant to the Plan. 16 11.3 Non-alienation of Benefits. The rights of a Stock Plan Participant to the payment of deferred compensation, to funds or shares as provided in this Plan and with respect to amounts credited to his or her Stock Plan Account and the rights of an Option Plan Participant with respect to an Option or to purchase shares of Common Stock upon exercise of an Option are not transferable by a Participant other than by will or the laws of descent and distribution and shall not be assigned, transferred, pledged or encumbered or be subject in any manner to alienation or anticipation, except that an Option Plan Participant and Formula Plan Participant ay make a Family Member Transfer. No Participant may borrow against his or her Stock Plan Account or Options. No Stock Plan Account nor Option shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, charge, garnishment, execution or levy of any kind, whether voluntary or involuntary, including, but not limited to, any liability which is for alimony or other payments for the support of a spouse or former spouse, or for any other relative of a Participant, except that an Option Plan Participant and Formula Plan Participant may make a Family Member Transfer. Neither a Participant's Stock Plan Account or Option hereunder nor a Participant's rights to benefits hereunder may be assigned to any other party by means of a judgment, decree or order (including approval of a property settlement agreement) relating to the provision of child support, alimony payments, or marital property rights of a spouse, former Spouse, child or other dependent of the Participant. As contemplated by Revenue Procedure 92-65 under the Code, a Stock Plan Participant's rights to benefit payments under the Plan shall not be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by creditors of the Participant or the Participant's Beneficiary. This Plan shall not in any manner be liable for or subject to the debts, contracts, liabilities, engagements or torts of any persons entitled to benefits hereunder. In the event that, notwithstanding the foregoing, any Participant's benefits are garnisheed or attached by order of any court, the Administrator may elect to bring an action for a declaratory judgment in a court of competent jurisdiction to determine the proper recipient of the benefits to be paid by the Plan. During the pendency of said action, any benefits that become payable may be paid into the court as they become payable, to be distributed by a court to the recipient as it deems proper at the close of said action. In addition, a Participant or Beneficiary shall have no rights against or security interest in the assets of the Plan, Company or Trust, if any, and shall have only the Company's unsecured promise to pay benefits. All assets of the Trust, if any, shall remain subject to the claims of the Company's general creditors. 11.4 Participants' Rights. Nothing contained in this Plan shall be construed as giving any Participant the right to be retained as a Director of the Company. Nothing contained in this Plan shall be construed as limiting, in any way, any right that any party or parties may have to remove a Participant as a Director of the Company or to appoint or to elect another individual to replace a Participant as a Director of the Company. Nothing contained in this Plan shall be construed as giving any Participant the right to receive any benefit not specifically provided by the Plan. Any other provision of the Plan notwithstanding, a Stock Plan Participant shall not have any interest in the amounts credited to his Stock Plan Account until such Stock Plan Account is distributed in accordance with the provisions of Article 7, and all deferred Fees, and all earnings, gains and losses with respect thereto shall remain subject to the claims of the Company's general creditors in accordance with the provisions of the Stock Plan. With respect to amounts credited to a Participant's Stock Plan Account, the rights of the Stock Plan Participant, the Beneficiary of the Participant or any other person claiming through the Participant under this Stock Plan shall be solely those of unsecured general creditors of the Company, and the obligations of the Company hereunder shall be purely contractual. Such benefits shall be paid from the general assets of the Company. As contemplated by Revenue Procedure 92-65 under the Code, Participants shall have the status of general unsecured creditors of the Company and each Plan, and all rights thereunder, shall constitute a mere promise of the Company to make benefit payments in the future. 17 11.5 Adjustments in Event of Change in Common Stock. Subject to the provisions of Sections 6.1 and 7.3, in the event of any stock dividend, stock split, recapitalization, or reclassification of shares of Common Stock, merger or consolidation of the Company or sale by the Company of all or a portion of its assets, or tender offer for its securities, or other event which could distort the implementation of the Plan or the realization of its objectives, the Administrator shall make such appropriate adjustments in the number and kind of securities which a Plan Unit will represent or which may be paid out under the Plan, and in the number of shares of Common Stock or other securities or number and kind of securities, and the purchase price therefor, for which an Option may be exercisable or in terms, conditions or restrictions on securities as the Administrator deems equitable. In the event of a stock split or stock dividend, the number of shares purchasable upon exercise of an Option shall be increased to the new number of shares which result from the shares covered by the Option immediately before the split or dividend. The purchase price per share shall be reduced proportionately and the total purchase price will remain the same. In the case of a distribution in property other than cash the number of shares covered shall be increased to reflect, in shares valued at the then current market, the fair value of the distribution. All events occurring between the Effective Date of the Option and its exercise shall result in an adjustment to the Option terms. 11.6 Amendments; Other. The Board or the Committee may amend the Plan to the extent necessary or appropriate to effect compliance with Rule 16b-3 in order to continue or provide an exemption from Section 16(a) and (b) of the Exchange Act for either Plan or any other equity plan of the Company, and the Administrator may change the cut-off dates for Elections or the dates of effectiveness of transactions or other events under the Plan to the same end; provided that no such amendments or change shall materially increase the benefits to or adversely affect the rights of the Participants. In addition, the Board may amend the Plan in any other manner, provided, however, that no amendment shall adversely and materially affect the rights of a Participant, taken as a whole, to amounts previously credited to his or her Stock Plan Account or to Options which have been granted unless such amendment is required by Rule 16b-3 in order to continue or provide an exemption from Section 16(b) of the Exchange Act for either Plan or any other equity plan of the Company, or for the deferral of Directors' Fees until the year of payout or exercise of Options under either Plan for Federal income tax purposes. 18 Amendments may not be made more frequently than permitted by Rule 16b-3. No amendment shall require shareholder approval unless required under Rule 16b-3. If shareholders' approval is necessary or desirable for the continued validity of the Plan or if the failure to obtain such approval would adversely affect the compliance of the Plan with Rule 16b-3, no such amendment shall become effective unless approved by affirmative vote of the Company's shareholders. Transactions under each Plan are intended to comply with applicable conditions of Rule 16b-3, except that a purchase under the Option Plan may be deemed to occur on an Effective Date. To the extent any provision of each Plan intended to comply, or action by the Administrator, fails to so comply, it shall be deemed null and void, to the extent permitted by law and declared advisable by the Administrator. 11.7 Notices. All elections, designations, requests, notices, instructions and other communications from a Director, Participant, Beneficiary or other person to the Administrator, required or permitted under the Plan, shall be in such form as is prescribed from time to time by the Administrator and shall be mailed by first class mail, delivered by facsimile or otherwise delivered to such location as shall be specified by the Administrator. 11.8 Binding Effect. The terms of the Plan shall be binding upon the Company and its successors and assigns. 11.9 Effective Date of Original Plan. The Plan shall be effective as of June 28, 1994, subject to approval by the shareholders of the Company. All deferrals or credits to a Stock Plan Account, and all Options, made prior to such shareholder approval shall be contingent on such approval. The existing Citizens Utilities Company Deferred Compensation Plan for Directors shall continue to be available for compensation deferrals and shall not be affected by the adoption of this Plan. ARTICLE 12 FORMULA PLAN 12.1 Eligibility. All Directors of the Company shall automatically participate in the Formula Plan. 19 12.2 Grant. Effective with the calendar year 2005, options to purchase common stock of the Company shall no longer be granted pursuant to the Formula Plan. On the first business day of each Plan Year, starting with the calendar year 2005, and continuing through 2007, 3,500 stock units shall be awarded to each Director in office on such date, without the need for further corporate action. 12.3 Subsequently Elected Directors. Individuals who are not Directors on the first day of a Plan Year but who become Directors of the Company shall be awarded, without need for further corporate action, 3,500 stock units. The Grant Date for such stock units shall be the date upon which such individual first becomes a Director. 12.4 Other. To the extent not inconsistent with the provisions set forth in this Article 12, stock units awarded pursuant to the Formula Plan, Participant's rights and the Company's obligations shall be subject to the provisions of Sections 6.2 and Articles 2, 7, 9, 10 and 11 of the Plan. 12.5 Duration of the Formula Plan; Effective Date. Amendment No. 1 to the Plan shall become effective on August 20, 1996, provided that the effectiveness of the Formula Plan and the amendment to the Plan modifying Section 4.7 shall be subject to approval of the stockholders of the Company at the first annual meeting of the stockholders held after the end of the 1996 to the extent, in each case, that such approval is called for by the rules or policies of the New York Stock Exchange or is otherwise deemed advisable by the Company. The period during which Option awards may be made under the Formula Plan shall terminate on May 22, 2007. Such termination shall not affect the terms of any then outstanding Options." 20 EX-10.2.4 3 towagreement.txt SEPARATION AGREEMENT Exhibit 10.2.4 SEPARATION AGREEMENT This Separation Agreement ("Agreement"), dated as of July 10, 2004, is entered into by and between Leonard Tow (the "Executive") and Citizens Communications Company (the "Company"). WHEREAS, the Company and the Executive entered into an Employment Agreement, dated as of October 1, 2000, and amended as of May 16, 2002 (the "Employment Agreement"), pursuant to which the Executive serves as Chief Executive Officer of the Company; and WHEREAS, the Company has requested, and the Executive has agreed that, in furtherance of the Company's succession plans, effective as of July 10, 2004 (the "Termination Date"), the Executive's employment with the Company and its subsidiaries and affiliates shall terminate, and the Executive shall relinquish his title of Chief Executive Officer of the Company and any other positions that he presently holds with the Company or any of its subsidiaries or affiliates, except as provided in Section 2 of this Agreement; and WHEREAS, the Company has determined not to engage the Executive to provide the advisory services under the terms of Section 11 of the Employment Agreement; and WHEREAS, the Company desires to provide the Executive with certain benefits upon the Executive's termination of employment by the Company, on the terms and subject to the conditions more fully set forth in this Agreement; and WHEREAS, the Executive and the Company have agreed to resolve and settle any disputed claims and differences between them with respect to the Executive's employment with the Company and the termination of such employment; and NOW, THEREFORE, in consideration of the recitals, promises and other good and valuable consideration specified herein, the receipt and sufficiency of which is hereby acknowledged, the Executive and the Company agree as follows: 1. PAYMENTS AND BENEFITS 1.1 Payments. The Company will pay to the Executive the following amounts at the times and periods specified in this Section 1, in consideration for the Executive entering into this Agreement, specifically including the General Release (as described in Section 4 below, and attached hereto as Exhibit A) and the restrictive covenants in Section 6 of this Agreement and subject to the General Release becoming effective (i.e., the Executive not exercising his right to revoke this Agreement/the Release as described in Section 4.2 of this Agreement) and the Executive's continued compliance with the restrictive covenants in Section 6 of this Agreement: (a) Base Salary and Bonus Severance Payments. On the Payment Date, the Company shall make a lump sum payment to the Executive in an amount equal to the sum of (i) $2,250,000.00 in respect of the Base Salary (as defined in the Employment Agreement) that would otherwise be payable with respect to the period commencing on the Termination Date and ending on December 31, 2006 (the "Severance Period"), reduced by any Base Salary paid to the Executive in respect of July 2004 prior to the date of this Agreement, and (ii) an amount equal to $3,500,000.00 (in respect of the cash bonus amount payable under Section 15b.B of the Employment Agreement). In addition, on the Payment Date, the Company shall grant to the Executive 300,000 shares of common stock of the Company ("Stock"), which shares shall be (i) issued pursuant to the Company's 1996 Equity Incentive Plan, 2000 Equity Incentive Plan or such other equity or long-term incentive plan as may be established by the Company following the date of this Agreement (each, a "Company Equity Plan"), (ii) fully vested as of the date of grant, and (iii) delivered to the Executive in three equal installments in March of 2005, 2006 and 2007, respectively; provided, that, the delivery of such shares shall be subject to the Executive's continued compliance with the restrictive covenants set forth in Section 6 of this Agreement; provided, further, that, in the event of a Change in Control (as defined in the Company Equity Plan pursuant to which such shares are granted) such shares shall be delivered to the Executive immediately prior to such Change in Control, notwithstanding such vesting schedule. The Company agrees to maintain the registration on a Form S-8 (or successor forms) under the Securities Act of 1933, as amended, in respect of the Stock granted pursuant to this Section 1.1(a). (b) Settlement of Advisory Services Amounts. The Executive hereby acknowledges and agrees that the Executive shall not perform the advisory services described in Section 11 of the Agreement, and the Company hereby agrees that, on the Payment Date, in exchange for the Executive's agreement not to provide such services, the Company shall pay the Executive an amount equal to $3,200,000.00, as provided in Section 15.c of the Employment Agreement, which shall be in lieu of the Advisory Period and Advisory Support (as such terms are defined in the Employment Agreement) and in full satisfaction of the Company's obligations under Section 11 and Section 15.c of the Employment Agreement. (c) Certain Change in Control Benefits. In the event of a Change in Control (as defined in the Employment Agreement), the Executive shall have the right, under Section 19 of the Employment Agreement, to, acquire up to 10,000,000 shares of Stock, upon prior written notice by the Executive to the Company, which notice shall be given on or before July 1, 2007, on which date the right set forth in Section 19 of the Employment Agreement and in this Section 1.1(c) shall expire. In addition, to the extent that any of the payments to which the Executive is entitled under Section 15 of the Employment Agreement are determined by the U.S. Internal Revenue Service to be "Excess Parachute Payments" within the meaning of Section 280G of the Internal Revenue Code of 1986, as amended, the Executive shall have the right to receive the additional payments set forth in Section 15.f of the Employment Agreement. (d) Continued Participation in Company Plans. The Executive shall be entitled to continue to participate in all Company benefit plans during the Severance Period, to the extent permitted by the terms of such plans and by applicable law. (e) Expenses. The Company shall reimburse the Executive, upon reasonable substantiation by the Executive, for costs incurred by the Executive in respect of the Severance Period for all (i) tax, financial, estate planning, legal and accounting services; (ii) membership dues and other non-discretionary charges, for Rockrimmon Country Club and University Club; (iii) computer, phone and internet expenses at the Executive's homes in Connecticut and Martha's Vineyard and for all cell phone and pager charges; provided, that, in no event shall reimbursements set forth in clauses (i) through (iii) in the aggregate exceed an amount equal to $150,000 for each full calendar year during the Severance Period, and $150,000, pro-rated for 2004. 2 (f) Travel. To the extent the Company maintains a Company aircraft, the Executive shall be able to use such aircraft during the Severance Period, and SIFL rates will be used to determine the value of such use; provided, that, the Executive shall be entitled to use such aircraft only to the extent such aircraft is available and not being used by the Company and only upon the Executive's reasonable advance notice to the Company and on a schedule mutually agreed upon by the Company and the Executive. (g) Office and Certain Staff Members. The Executive shall be entitled to continue to use his current office at the Company through December 31, 2004, after which time he shall be entitled to retain his office furniture and furnishings, and the Executive hereby agrees that he shall have responsibility for removing such furniture and furnishings from the office as soon as reasonably practicable following December 31, 2004. In addition, the Company agrees to continue to (i) employ the Executive's current driver and secretary during the Severance Period, such employees to be made available for use primarily by the Executive with such schedule and pursuant to such other terms as shall be mutually agreed upon by the Company and the Executive, and (ii) during the Severance Period, provide the Executive with the use of the Company car which is being made available to the Executive as of the Termination Date or such other Company car as the Company and the Executive may agree. (h) Accrued Rights. On the Payment Date, the Company will pay the Executive a lump sum payment equal to the sum of (i) any unpaid Base Salary accrued through the Termination Date, (ii) an amount in respect of all accrued but unused vacation days, and (iii) the amount of any unreimbursed expenses and fees incurred by the Executive prior to the Termination Date, for which reimbursement is provided for under the Employment Agreement, upon reasonable substantiation by the Executive for all such expenses in accordance with Company policy and consistent with past practice as in effect on the Termination Date. (i) Indemnification. The Company shall continue to provide the Executive with the protections and benefits under, and honor the provisions of, Section 16(a) of the Employment Agreement. In addition, the Company shall indemnify the Executive with respect to any claims, threatened claims or investigations by, or on behalf of, the Company or any governmental or regulatory entity, to the fullest extent not prohibited under applicable law. 1.2 Equity Awards and Deferred Compensation. (a) Stock Options and Restricted Stock. With respect to the outstanding options to purchase shares of Stock held by the Executive as of the date hereof (the "Options") and the outstanding restricted shares of Stock (the "Restricted Stock"), notwithstanding the provisions of any of the option or restricted stock plans or award agreements pursuant to which the Executive was granted such Options and Restricted Stock (as amended, if applicable) (the "Award Documents"), effective as of the Termination Date: (a) all of the Options and Restricted Stock that have not already vested as of the Termination Date shall vest and the Options shall become fully exercisable, and all restrictions on the Restricted Stock shall lapse, and (b) all of the Options shall remain exercisable until (and may not be exercised at any time after) the later of (i) the expiration date of the Options as set forth in the applicable Award Documents, as if no termination of employment had occurred and (ii) the first anniversary of the Termination Date. Except as set forth specifically herein, nothing in this Section 1.2 shall be construed to amend, alter, revise or change any other terms or conditions of the applicable Award Documents. The Company agrees to maintain the registration on a Form S-8 (or successor forms) under the Securities Act of 1933, as amended, in respect of the Company Equity Plans pursuant to which the Options, Restricted Stock and the Stock awards in Section 1.2(b), below, were granted. 3 (b) Other Stock Awards; Deferred Compensation. On the Payment Date, the Company shall grant to the Executive 1,816,477 shares of Stock in full satisfaction of its obligations under any plans, agreements, letters, policies or other arrangements to grant such shares under the Company Equity Plans to the Executive following the Executive's retirement from, or termination of employment with, the Company. In addition, the Executive shall be entitled to receive all amounts in respect of his account balances in any deferred compensation plans of the Company as of the Termination Date and payments in respect of any phantom equity awards granted to the Executive on or prior to the Termination Date, subject to the terms of such plans. (c) With respect to any Stock awards provided for in this Agreement that are granted under any of the Company Equity Plans, the terms of such Company Equity Plans shall control, except to the extent otherwise provided herein; provided, however, that, to the extent that the Executive's ability to utilize or avail himself of any right or privilege otherwise available to holders of similar awards (including the right to share withholding) and the exercise of such right, requires the approval of the committee or other body under the applicable Company Equity Plan, such consent shall not be unreasonably withheld. 1.3 Other Employee Benefits. (a) Health Benefits. The Company shall continue to provide the Executive and his wife during their joint lives and the life of the survivor of them, at the sole cost of the Company, the medical, dental, hospitalization and health plan and insurance benefits as are contained in the plans available for the Executive immediately preceding the Termination Date (the "Health Benefits"). Notwithstanding the foregoing, (i) the Health Benefits provided to the Executive and his eligible dependents by the Company under this Agreement shall be in full satisfaction of the Company's obligations to the Executive and his eligible dependents under COBRA, the Employment Agreement and this Agreement, and (ii) if at any time it is not possible for the Company to provide the benefits in accordance with this Section 1.3(a), the Company shall pay the Executive an amount which, after payment by the Executive of applicable taxes, is sufficient for him to purchase equivalent benefits, in accordance with Section 13(a) of the Employment Agreement. To the extent not covered by the Health Benefits or by any equivalent benefits purchased by the Executive at the Company's cost pursuant to clause (ii) of the preceding sentence, the Company shall reimburse the Executive for (i) all medical, health care, dental and catastrophic illness-related expenses for the life of the Executive and the Executive's spouse, including, without limitation, those expenses that were incurred prior to the Termination Date, and (ii) home care costs (whether or not provided by a licensed caregiver); provided, that, in no event shall the Company's aggregate obligations in respect of all such amounts for both Executive and his spouse exceed $2,000,000 in the aggregate. 4 (b) Company Doctor. The Executive shall continue to be able to utilize the services of Dr. Martin Fox, but only for so long as Dr. Fox's employment with the Company continues, and nothing in this Section 1.3(b) shall require the Company to continue the employment of Dr. Fox. (c) Life Insurance Policies. With respect to the life insurance policies set forth on Exhibit B to this Agreement (the "Executive Policies"), the Company agrees that it shall (i) on the Payment Date, fund a rabbi trust, with David Rosenzweig, Esq. serving as trustee, or, in the event that Mr. Rosenzweig shall not be able to serve as trustee, with Alex McDonald, Esq. (of Boston, Massachusetts) serving as trustee, and, in the event that neither Mr. Rosenzweig nor Mr. McDonald are able to serve as trustee, with a trustee designated by the Company and reasonably satisfactory to the Executive, (the "Executive Trust"), in an amount sufficient to pay the remaining balance of the premiums as set out in Schedule 1 of Exhibit B, which the Company believes to be the remaining premiums due under the Executive Policies; provided, further, that, in the event of the death of both the Executive and his spouse before the payment of all premiums to the Executive Trust, any remaining balance in the Executive Trust will revert back to the Company; (ii) fund the Executive Trust in an amount that is sufficient, after taking into account the proceeds that are likely to be received by the insurance trusts identified on Schedule B (the "Tow Trusts") from the Executive Policies upon the death of the first to die of the Executive and his spouse and all interest to be earned on such proceeds less any reasonable administrative expenses of the Executive Trust, to pay gift and income taxes (and any gross-up thereon) that may be incurred in the future by the Executive or his spouse under such Executive Policies; and (iii) on an ongoing basis, pay such additional amounts to the Executive or his spouse for any income or gift taxes that are incurred (and any gross-up thereon) to the extent that such amounts are not covered by the Executive Trust in clause (ii); provided, that, nothing in this Section 1.3(c) shall serve to release the Company's collateral interest in the Executive Policies, and provided, further, that, the Company's obligations in clauses (i) through (iii) do not affect the Company's rights, upon the second to die of the Executive and his spouse, to retain or recover from the Tow Trust and the Executive Trust all amounts in excess of the death benefits payable upon the death of the survivor of Executive and his wife under the various split dollar life insurance agreements between the Executive and the Company, which benefits, in the aggregate, shall not exceed the amounts indicated on Exhibit B to this agreement. 1.4 Tax Withholding. The Company may withhold from any amounts payable in cash under this Agreement such Federal, state and local income, employment and other taxes as may be required to be withheld in respect of any payment and/or any benefit provided for under this Agreement pursuant to any applicable law or regulation. 1.5 Full Satisfaction of Potential Claims. The Executive hereby acknowledges and agrees that his receipt and satisfaction of all payments and benefits provided in this Section 1 will constitute full and final payment, accord and satisfaction of any and all potential claims to the extent described in the General Release (as defined in Section 4 of this Agreement) against the Company and the Company Releasees (as defined in Exhibit A to this Agreement) and other persons described on Exhibit A hereto. 5 2. RELINQUISHMENT OF TITLE, POSITIONS Effective as of the Termination Date, the Executive hereby relinquishes his title of Chief Executive Officer of the Company and any other positions that he presently holds with the Company or any of its subsidiaries or affiliates, except to the extent provided in this Section 2. The Executive shall resign as Chairman of the board of directors of the Company (the "Board"), effective as of December 31, 2004, or such earlier time as requested by the Board or as the Executive may determine. Notwithstanding the foregoing, the Executive shall continue to serve as the Company's nominee on the board of directors of Hungarian Telephone until the expiration of the Executive's current term in such position. 3. RETURN OF COMPANY PROPERTY All memoranda, notes, lists, records and other documents or papers (and all copies thereof), including items stored in computer memories, on microfilm or by other means, made or compiled by the Executive, or made available to the Executive relating to the Company or its affiliates or its businesses, are and shall remain the property of the Company and shall be delivered to the Company promptly upon the execution of this Agreement. 4. RELEASES AND REPRESENTATIONS 4.1 Executive's Release. For and in consideration of the payment of the amounts and the provision of the benefits described in Section 1 of this Agreement and the Company's agreement set forth in Section 4.3 below, the Executive hereby agrees to execute a release of all claims against the Company and the Releasees in the form attached as Exhibit A hereto (the "General Release"). 4.2 The Executive's Representations and Warranties. The Executive represents that he has read carefully and fully understands the terms of this Agreement, and that the Executive has been advised to consult with an attorney and has availed himself of the opportunity to consult with an attorney prior to signing this Agreement. The Executive acknowledges and agrees that he is executing this Agreement willingly, voluntarily and knowingly, of his own free will, in exchange for the payments and benefits described in Section 1 of this Agreement and for the Company Release contained in Section 4.3 hereof, and that he has not relied on any representations, promises or agreements of any kind made to him in connection with his decision to accept the terms of this Agreement, other than those set forth in this Agreement. The Executive further acknowledges, understands and agrees that as of the Termination Date his employment with the Company will be terminated, that the provisions of Section 1 of this Agreement are in lieu of any and all payments and benefits to which the Executive may otherwise be entitled to receive pursuant to the Employment Agreement, that the Executive will not be reemployed by the Company, and that the Executive will not apply for or otherwise seek employment with the Company or any of its parents, companies, subsidiaries, divisions or affiliates. The Executive understands that, except as otherwise expressly provided for under this Agreement, he will not receive any payments under this Agreement until the seven (7) day revocation period provided for under the General Release has passed, and then, only if he has not revoked the General Release (such period during which no such revocation has occurred, the "Revocation Period"). 6 4.3 Company Release. For and in consideration of the undertakings of the Executive in Section 4.1 and Section 4.2 above, and for other good and valuable consideration the receipt of which is hereby acknowledged, the Company hereby agrees on behalf of the Company and each of its parents, subsidiaries and affiliates, together with their officers, directors, shareholders, affiliates, agents, partners, joint venturers, attorneys, predecessors, successors and assigns, or anyone purporting to act by, through or on behalf of any of the foregoing (the "Company Releasors") to, and the Company Releasors do hereby, fully and completely forever release the Executive, his agents, assignees, attorneys, successors and assigns, heirs and executors (hereinafter collectively referred to as the "Executive Releasees") from any and all causes of action, suits, agreements, promises, damages, disputes, controversies, contentions, differences, judgments, claims, debts, dues, sums of money, accounts, reckonings, bonds, bills, specialties, covenants, contracts, variances, trespasses, extents, executions and demands of any kind whatsoever which the Company Releasors ever had, now have or may have against the Executive Releasees or any of them, in law, admiralty or equity, whether known or unknown to the Company Releasors, for, upon, or by reason of, any matter, action, omission, course or thing whatsoever occurring up to the date this Agreement is signed by the Company (such released claims are collectively referred to herein as the "Company Released Claims"); provided, that such Company Released Claims shall not include (i) any claims to enforce the Company Releasors' rights or obligations under, or with respect to, this Agreement, or (ii) any claim alleging conduct in the nature of fraud or any other action or omission by the Executive for which the Executive would not be indemnified under the terms of Section 1.1(i) of this Agreement. 5. EFFECTS OF SETTLEMENT; WAIVER OF JURY TRIAL 5.1 No Admission. The Executive and the Company agree that the payments and benefits by the Company, and the acceptance by the Executive of the same, all as provided in Section 1 of this Agreement, and the execution of this Agreement, are the result of a compromise of disputed claims, and shall never for any purpose be considered an admission of liability or responsibility by the Company or the Executive, and the Company and the Executive expressly deny any liability. 5.2 Waiver of Jury Trial. TO THE FULLEST EXTENT PERMITTED BY LAW, EACH OF THE PARTIES HERETO HEREBY WAIVES THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS AGREEMENT OR ANY DEALINGS BETWEEN THEM RELATING TO THE SUBJECT MATTER OF THE TRANSACTIONS CONTEMPLATED HEREIN. Each of the parties hereto also waives any bond or surety or security upon such bond, which might, but for this waiver, be required of any of the other parties. The scope of this waiver is intended to be all-encompassing of any and all disputes that may be filed in any court and that relate to the subject matter of this Agreement or the General Release, including, without limitation, contract claims, tort claims, breach of duty claims and all other common law and statutory claims. Each of the parties hereto acknowledges that this waiver is a material inducement to enter into a business relationship, that each has already relied on the waiver in entering into this Agreement, and that each will continue to rely on the waiver in their related future dealings. Each of the parties hereto further warrants and represents that each has reviewed this waiver with his legal counsel and that each knowingly and voluntarily waives his jury trial rights following consultation with legal counsel. This waiver is irrevocable, meaning that it may not be modified either orally or in writing, and the waiver shall apply to any subsequent amendments, renewals, supplements or modifications to this Agreement. In the event of litigation, this Agreement may be filed as a written consent to a trial by the court. 7 6. CONFIDENTIALITY OF THIS AGREEMENT; CONTINUING EFFECTIVENESS OF COVENANTS IN EMPLOYMENT AGREEMENT 6.1 Confidentiality; Press Release. (a) The Executive and the Company understand that confidentiality is of the essence in this Agreement and to ensure such, both the Executive and the Company hereby mutually promise and covenant to keep this Agreement and the General Release confidential and agree not to publish, declare or disclose in any manner whatsoever the terms or conditions of this Agreement, other than as required by law. Notwithstanding the prohibition in the preceding sentence: (a) the Executive and the Company may disclose this Agreement and the General Release in confidence to their respective attorneys, accountants, auditors, tax preparers and financial advisors; and (b) the Executive and the Company may disclose this Agreement and the General Release insofar as such disclosure may be necessary to enforce its terms in a court of law or as may be otherwise required by law. In the event the Executive may be required by subpoena to disclose the terms of this Agreement and the General Release, he agrees to notify the Company of such request promptly, and prior to responding to such, provided that such disclosure is not prohibited by applicable law. (b) Except as otherwise required by law, the Executive and the Company hereby mutually agree not to issue any press release or otherwise publicize this Agreement or the General Release or the settlement of their disputes, and to limit any statement in response to inquiry from the news media or otherwise to: "The matter has been resolved on a confidential basis." 6.2 Statements by the Company. The Company shall not issue or make any press release or public statement about the Executive (and the Company shall further use its commercially reasonable efforts to prevent any director, officer, employee, successor, parent, subsidiary or agent or representative of, or attorney to the Company (any of the foregoing, a "Company Affiliate") from issuing any press release or other public statement or making any statement), which is intended or reasonably likely to disparage the Executive, or otherwise degrade the Executive's personal or business reputation; provided, that, each of the Company and any Company Affiliate shall be permitted to (a) make any statement that is required by applicable securities or other laws to be included in a filing or disclosure document, subject to prior notice to the Executive thereof, (b) issue any press release or public statement regarding the fact of a termination of the Executive's employment, subject to the Executive's prior review and approval thereof, which approval shall not be unreasonably withheld by the Executive, (c) defend itself against any statement made by the Executive that is intended or reasonably likely to disparage the Company or any Company Affiliate, or otherwise degrade any Company Affiliate's reputation in the business, industry or legal community in which such Company Affiliate operates, only if the Company and/or the Company Affiliate reasonably believes that the statements made in such defense are not false statements, and (d) provide truthful testimony in any legal proceeding. 8 6.3 Statements by the Executive. The Executive shall not at any time issue any press release or make any public statement about the Company or any Company Affiliate regarding (i) any of the foregoing's financial status, business, services, business methods, compliance with laws, or ethics or otherwise, or (ii) regarding Company partners, personnel, directors, officers, employees, attorneys, agents, including, without limitation, in respect of both clauses (i) and (ii), any statement that is intended or reasonably likely to disparage the Company or any Company Affiliate, or otherwise degrade any Company Affiliate's reputation in the business, industry or legal community in which any such Company Affiliate operates; provided, that, the Executive shall be permitted to (a) make any statement that is required by applicable securities or other laws to be included in a filing or disclosure document, subject to prior notice to the Company thereof, and (b) defend himself against any statement made by the Company or any Company Affiliate that is intended or reasonably likely to disparage the Executive or his spouse or otherwise degrade the Executive's reputation in the business, industry or legal community in which the Executive operates, only if the Executive reasonably believes that the statements made in such defense are not false statements and (c) provide truthful testimony in any legal proceeding. 6.4 Non-Competition. The Executive acknowledges the highly competitive nature of the businesses of the Company and its subsidiaries and affiliates and accordingly agrees that from the Termination Date until the first anniversary of the Termination Date (the "Non-Compete Period"), the Executive shall not (i) be a shareholder, partner, joint venturer or other equity owner in, or sole proprietor of, or officer, director, employee, consultant, agent or representative of, or otherwise engage, directly or indirectly in any business which is competitive with the business conducted by the Company or its parents or subsidiaries at the Termination Date in locations in which any such entities are conducting business (including, without limitation, businesses that the Company or its affiliates have specific plans, approved by a resolution of the Board, to conduct in the future and as to which the Executive is aware of such planning at the time he commences engaging in such activity); provided, however, that this provision shall not apply to the ownership of not more than 5% of any publicly traded entity, provided the Executive is not actively involved in the activities of any such entity, and holds such interest solely for investment. 6.5 Separate Liability. The Executive agrees and understands that his obligations set forth in Sections 6.1, 6.3 and 6.4 of this Agreement are separate from any other provisions in this Agreement and that any breach of those provisions may be treated by the Company as a breach of this covenant for which the Executive may be separately liable, and for which the Company may, at its option, elect to cease payment of any amounts hereunder and/or seek the return of the monetary consideration paid hereunder, in addition to other remedies. Notwithstanding the foregoing, the Company may only cease payment of any amounts hereunder and/or seek the return of the monetary consideration paid hereunder following a final non-appealable judgment by a court of competent jurisdiction that such a breach has occurred. 7. GOVERNING LAW; RESOLUTION OF DISPUTES; LEGAL FEES 7.1 Governing Law. This Agreement and the General Release shall each be governed and interpreted in accordance with and enforced in all respects pursuant to the laws of the State of New York, irrespective of the choice of law rules of that or any other state. 9 7.2 Resolution of Disputes. Any disagreement or controversy arising out of or relating to this Agreement, other than any violation of Section 6 of this Agreement, shall be exclusively resolved by way of confidential arbitration. Either party may submit the disagreement or controversy to arbitration in accordance with the National Rules for the Resolution of Employment Disputes of the American Arbitration Association ("AAA"), such arbitration to be conducted before a panel of three arbitrators, one selected by each of the parties hereto and the third by the two other arbitrators so selected. The arbitration shall be held in New York, New York. The arbitrators shall be bound by the express terms of the Agreement. The award rendered in any such proceeding, which shall not include an award of attorneys' fees (which are expressly governed by the terms of Section 7.3 hereof), shall be made in writing and shall be final and binding on the parties, and judgment upon the award may be entered in any court having competent jurisdiction thereof. 7.3 Legal Fees. The Company shall fully reimburse the Executive for all reasonable legal fees, costs and other out-of-pocket expenses actually incurred in connection with (i) the negotiation of this Agreement; provided, that, in no event shall the Company's aggregate obligations in respect of such amounts exceed $100,000, and (ii) any disputes, or enforcement of the Executive's rights, under this Agreement or otherwise relating to termination of the Executive's employment, to the extent such dispute arises out of or is in connection with a dispute between the Executive and the Company under this Agreement (which reimbursement shall not be subject to any dollar limitation hereunder). The Company shall advance any such fees, costs and expenses upon the Executive's prior written request, but only to the extent such payment is required to be paid pursuant to the arrangements under which such fees, costs and expenses are incurred or as required by applicable law. 8. SEVERABILITY If any provision of this Agreement is determined to be invalid or unenforceable, in whole or in part, this determination will not affect any other provision of this Agreement or the remaining portion of a partially invalid provision, which shall remain in force, and the provision in question shall be modified by the court so as to be rendered enforceable. 9. CONSTRUCTION Each party and its counsel have reviewed this Agreement and the General Release and have been provided the opportunity to review this Agreement and the General Release and accordingly, the normal rule of construction to the effect that any ambiguities are to be resolved against the drafting party shall not be employed in the interpretation of this Agreement or the General Release. Instead, the language of all parts of this Agreement and the General Release shall be construed as a whole, and according to their fair meaning, and not strictly for or against either party. 10. ACCEPTANCE AND EFFECTIVENESS This Agreement shall become effective immediately upon the Executive's execution of this Agreement; provided, however, that the Company shall not be obligated to make any of the payments provided for in Section 1 of this Agreement until the eighth (8th) day following the Termination Date (the "Payment Date"), or such later date provided in this Agreement, in any case, so long as the Executive has not then revoked the General Release. 10 11. ENTIRE AGREEMENT; COUNTERPARTS 11.1 The Agreement and the General Release together set forth the entire agreement between the parties hereto, and fully supersede any and all prior agreements or understandings, including the Employment Agreement (other than as expressly set forth herein) between the parties hereto pertaining to the subject matter hereof. 11.2 This Agreement may be executed in one or more counterparts and by the different parties hereto in separate counterparts, each of which when executed shall be deemed to be an original but all of which taken together shall constitute one and the same agreement. [Remainder of the page is intentionally left blank] 11 IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the day and year first above written. Dated: July 10, 2004 CITIZENS COMMUNICATIONS COMPANY ---------------- By: /s/ Rudy J. Graf -------------------------------------- Title: Chief Executive Officer and President -------------------------------------- By: /s/ Jerry Elliott -------------------------------------- Title: Executive Vice President and Chief -------------------------------------- Financial Officer -------------------------------------- LEONARD TOW Dated: July 10, 2004 /s/ Leonard Tow --------------------- ----------------------------------------------- 12 Exhibit A --------- GENERAL RELEASE Section 1. Release ------- For and in consideration of the payment of the amounts and the provision of the benefits described in Section 1 of that certain Separation Agreement dated as of July 8, 2004 by and between Leonard Tow (the "Executive") and Citizens Communications Company (the "Company") (the "Agreement"), the Executive hereby agrees on behalf of himself, his agents, assignees, attorneys, successors, assigns, heirs and executors, to, and the Executive does hereby, fully and completely forever release the Company and the Company Affiliates (as such term is defined in the Agreement) and their respective past, current and future affiliates, predecessors and successors and all of their respective past and/or present representatives, administrators, attorneys, insurers and fiduciaries, in their individual and/or representative capacities (hereinafter collectively referred to as the "Company Releasees"), from any and all causes of action, suits, agreements, promises, damages, disputes, controversies, contentions, differences, judgments, claims, debts, dues, sums of money, accounts, reckonings, bonds, bills, specialities, covenants, contracts, variances, trespasses, extents, executions and demands of any kind whatsoever, which the Executive or his agents, assignees, attorneys, successors, assigns, heirs and executors ever had, now have or may have against the Company Releasees or any of them, in law, admiralty or equity, whether known or unknown to the Executive, for, upon, or by reason of, any matter, action, omission, course or thing whatsoever occurring up to the date this General Release is signed by the Executive. Without limiting the generality of the foregoing, the Executive hereby agrees on behalf of himself, his agents, assignees, attorneys, successors, assigns, heirs and executors, to, and the Executive does hereby, fully and completely forever release the Company Releasees and all of their respective past and/or present officers, directors, partners, members, managing members, managers, employees, agents, representatives, administrators, attorneys, insurers and fiduciaries, in their individual and/or representative capacities in connection with or in relationship to the Executive's employment or other service relationship with the Company, the termination of any such employment or service relationship and any applicable employment, compensatory or equity arrangement with the Company (including, without limitation, the Employment Agreement (as such term is defined in the Agreement), any exhibits attached thereto, any amendments thereto, and any equity or employee benefit plans, programs, policies or other arrangements), any claims of breach of contract, wrongful termination, retaliation, fraud, defamation, infliction of emotional distress or national origin, race, age, sex, sexual orientation, disability, medical condition or other discrimination or harassment, (such released claims are collectively referred to herein as the "Released Claims"); provided that such Released Claims shall not include (i) any claims to enforce the Executive's rights or obligations under, or with respect to, the Agreement, and (ii) any claims arising out of or in connection with any obligations by the Company in respect of certain litigation matters addressed in that certain resolution of the board of directors of the Company adopted July 30, 2002 and the minutes of the meeting of the board of directors of the Company, dated December 17, 2002. Section 2. Waiver. Notwithstanding the generality of Section 1 above, the Released Claims include, without limitation: (i) any and all claims relating to base salary or bonus payments or benefits pursuant to the Employment Agreement, other than those payments and benefits specifically provided for in Section 1 of the Agreement; (ii) any and all claims under Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act of 1967, the Civil Rights Act of 1971, the Civil Rights Act of 1991, the Fair Labor Standards Act, Employee Retirement Income Security Act of 1974, the Americans with Disabilities Act, the Family and Medical Leave Act of 1993, the Fair Employment and Housing Act, and any and all other federal, state or local laws, statutes, rules and regulations pertaining to employment or otherwise; and (iii) any claims for wrongful discharge, breach of contract, fraud, misrepresentation or any compensation claims or any other claims under any statute, rule or regulation or under the common law, including compensatory damages, punitive damages, attorney's fees, costs, expenses and all claims for any other type of damage or relief. THIS MEANS THAT, BY SIGNING THIS GENERAL RELEASE, THE EXECUTIVE WILL HAVE WAIVED ANY RIGHT THE EXECUTIVE MAY HAVE HAD TO BRING A LAWSUIT OR MAKE ANY CLAIM AGAINST COMPANY RELEASEES BASED ON ANY ACTS OR OMISSIONS OF COMPANY RELEASEES UP TO THE DATE OF THE SIGNING OF THIS GENERAL RELEASE. Section 3. The Executive's Representations and Warranties ---------------------------------------------- The Executive represents that he has read carefully and fully understands the terms of this General Release, and that the Executive has been advised to consult with an attorney and has availed himself of the opportunity to consult with an attorney prior to signing this General Release. The Executive acknowledges and agrees that he is executing this General Release willingly, voluntarily and knowingly, of his own free will, in exchange for the payments and benefits described in Section 1 of the Agreement, and that he has not relied on any representations, promises or agreements of any kind made to him in connection with his decision to accept the terms of the Agreement or the General Release, other than those set forth in the Agreement. The Executive further acknowledges, understands, and agrees that his employment with the Company has terminated and that the provisions of Section 1 of the Agreement are in lieu of any and all payments and benefits to which the Executive may otherwise be entitled to receive pursuant to the Employment Agreement. The Executive acknowledges that he has been advised that he is entitled to take at least twenty-one (21) days to consider whether he wants to sign this General Release and that the Age Discrimination in Employment Act gives him the right to revoke this General Release within seven (7) days after it is signed, and the Executive understands that he will not receive any payments under the Separation Agreement until such seven (7) day revocation period has passed and then, only if he has not revoked this General Release. To the extent the Executive has executed this General Release within less than twenty-one (21) days after its delivery to him, the Executive hereby acknowledges that his decision to execute this General Release prior to the expiration of such twenty-one (21) day period was entirely voluntary, and taken after consultation with and upon the advice of his attorney. This General Release is final and binding and may not be changed or modified, except by written agreement by both of the Company and The Executive. EXHIBIT B Insurance Policies Funding Split Dollar Benefits for Dr. & Mrs. Tow
POLICY NUMBER OWNER/ BENEFIT/CARRIER INSURED(S) BENEFICIARY - ----------------------------------------- ------------------------ -------------- ----------- $3.0M Split Dollar Benefit: Dr. Tow 1,513.822 * Security Life of Denver $18.6M Split Dollar Benefit: Aetna (1st Death) Dr. & Mrs. Tow G1557534 ** Phoenix (1st Death) Dr. & Mrs. Tow 2,638,418 ** Prudential Dr. & Mrs. Tow 77,695,241 ** $6M Split Dollar Benefit: Aetna (1st Death) Dr. & Mrs. Tow G1606642 *** MassMutual Dr. & Mrs. Tow 9,668,011 *** $7.5M Split Dollar Benefit: Aetna (1st Death) Dr. & Mrs. Tow G1603269 *** MassMutual Dr. & Mrs. Tow 9,668,012 *** $15M Employment Agreement: Lincoln Life Dr. Tow 7,114,586 **** Manulife Dr. & Mrs. Tow 58,907,874 **** Travelers Dr. & Mrs. Tow 7,389,146 **** $15M SWAP: Lincoln Life Dr. Tow 7,127,037 **** Manulife Dr. & Mrs. Tow 58,906,041 **** Manulife Dr. & Mrs. Tow 58,906,058 **** Manulife Dr. & Mrs. Tow 58,959,651 **** Pacific Life Dr. & Mrs. Tow 1A2389740 **** Transamerica Dr. & Mrs. Tow 60077090-3 **** * David Z. Rosensweig, the Trustee of the Leonard & Claire Tow 1st Insurance Trust U/A/D May 27, 1992. ** David Z. Rosensweig, the Trustee of the Leonard & Claire Tow 2nd Insurance Trust U/A/D November 18, 1993. *** David Z. Rosensweig, the Trustee of the Leonard & Claire Tow 3rd Insurance Trust U/A/D April 4, 1996. **** David Z. Rosensweig, the Trustee of the Tow Family Trusts Insurance Trust U/A/D December 15, 2000.
EX-31.1 4 ex31-1.txt GRAF CERTIFICATION Exhibit 31.1 CERTIFICATIONS I, Rudy Graf, certify that: 1. I have reviewed this quarterly report of Citizens Communications Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 4, 2004 By: /s/ Rudy Graf ----------------------------- Rudy Graf Chief Executive Officer (principal executive officer) EX-31.2 5 ex31-2.txt ELLIOTT CERTIFICATION Exhibit 31.2 CERTIFICATIONS I, Jerry Elliott, certify that: 1. I have reviewed this quarterly report of Citizens Communications Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 4, 2004 By: /s/ Jerry Elliott ----------------------------- Jerry Elliott Chief Financial Officer (principal financial officer) EX-32.1 6 ex32-1.txt GRAF 906 CERTIFICATION Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350. AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Citizens Communications Company (the "Company") on Form 10-Q for the quarter ended June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Rudy Graf, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Rudy Graf - ------------------------- Rudy Graf Chief Executive Officer August 4, 2004 This certification is made solely for purpose of 18 U.S.C. Section 1350, subject to the knowledge standard contained therein, and not for any other purpose. A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Citizens Communications Company and will be retained by Citizens Communications Company and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 7 ex32-2.txt ELLIOTT 906 CERTIFICATION Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350. AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Citizens Communications Company (the "Company") on Form 10-Q for the quarter ended June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Jerry Elliott, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Jerry Elliott - ------------------------ Jerry Elliott Chief Financial Officer August 4, 2004 This certification is made solely for purpose of 18 U.S.C. Section 1350, subject to the knowledge standard contained therein, and not for any other purpose. A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Citizens Communications Company and will be retained by Citizens Communications Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----