-----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, L7M8Exv8rlv2EcMNqzD9yyBUHUbNLatYB/4l4h/nJ1tIY6fhvBM1MfEH5+QiIJRw xTkaDbU9X6ws/NLnGfFyEg== 0000020520-05-000011.txt : 20050314 0000020520-05-000011.hdr.sgml : 20050314 20050314164906 ACCESSION NUMBER: 0000020520-05-000011 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050314 DATE AS OF CHANGE: 20050314 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-11001 FILM NUMBER: 05678908 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-K 1 a200410k.txt 2004 10-K CITIZENS COMMUNICATIONS COMPANY ------------------------------- FORM 10-K --------- ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) --------------------------------------------- OF THE SECURITIES EXCHANGE ACT OF 1934 -------------------------------------- FOR THE YEAR ENDED DECEMBER 31, 2004 ------------------------------------ CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark one) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 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) Registrant's telephone number, including area code: (203) 614-5600 ---------------
Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered - ------------------------------------------------------------------------ ----------------------------------------- Common Stock, par value $.25 per share New York Stock Exchange Guarantee of Convertible Preferred Securities of Citizens Utilities Trust New York Stock Exchange Citizens Convertible Debentures N/A Guarantee of Partnership Preferred Securities of Citizens Utilities Capital L.P. N/A
Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes X No --- --- The aggregate market value of common stock held by non-affiliates of the registrant on June 30, 2004 was approximately $3,351,287,851 based on the closing price of $12.10 per share. The number of shares outstanding of the registrant's Common Stock as of February 28, 2005 was 340,187,920. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the registrant's 2005 Annual Meeting of Stockholders to be held on May 26, 2005 are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS ----------------- Page ---- PART I - ------ Item 1. Business 2 Item 2. Properties 9 Item 3. Legal Proceedings 10 Item 4. Submission of Matters to a Vote of Security Holders 10 Executive Officers 11 PART II - ------- Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 13 Item 6. Selected Financial Data 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 34 Item 8. Financial Statements and Supplementary Data 35 Item 9. Changes in and Disagreements with Accountants on Accounting 35 and Financial Disclosure Item 9A. Controls and Procedures 35 Item 9B. Other Information 35 PART III - -------- Item 10. Directors and Executive Officers of the Registrant 35 Item 11. Executive Compensation 36 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 36 Item 13. Certain Relationships and Related Transactions 36 Item 14. Principal Accountant Fees and Services 36 PART IV - ------- Item 15. Exhibits and Financial Statement Schedules 36 Signatures 40 Index to Consolidated Financial Statements F-1
PART I ------ Item 1. Business -------- Citizens Communications Company and its subsidiaries (Citizens) will be referred to as the "Company," "we," "us" or "our" throughout this report. We are a communications company providing services to rural areas and small and medium-sized towns and cities as an incumbent local exchange carrier, or ILEC. We offer our ILEC services under the "Frontier" name. In addition, we provide competitive local exchange carrier, or CLEC, services to business customers and to other communications carriers in certain metropolitan areas in the western United States through Electric Lightwave, LLC, or ELI, our wholly-owned subsidiary. On April 1, 2004, we announced the completion of the sale of our Vermont Electric Division. With that transaction, we completed the divestiture of our public utilities services segments pursuant to plans announced in 1999. Among the highlights for 2004: * Cash Generation The Company continued to drive free cash flow through further growth of broadband and value added services, productivity improvements, and a disciplined capital expenditure program that emphasizes return on investment. * Debt Reduction In our concerted efforts to maintain the quality and strength of our balance sheet, we retired $662.0 million of debt in 2004 ($514.0 million from cash on hand and $148.0 million of Equity Providing Preferred Income Convertible Securities (EPPICS) converted to our common stock). In addition, we refinanced $700.0 million of debt that reduced the coupon from 8.5% to 6.25% a year and extended the maturity from 2006 to 2013. The annual cost savings from these debt repayments, conversions and the refinancing will be approximately $60.4 million. * Stockholder Value In 2004, the Board of Directors determined that the best alternative for enhancing stockholder value was to capitalize on the Company's strong free cash flow by returning significant cash to stockholders by paying a special, non-recurring dividend of $2 per common share and instituting a regular annual dividend of $1 per common share to be paid quarterly. * Growth We continue to have success in selling enhanced services and high-speed internet products and we expect continued demand and growth opportunities. The telecommunications industry is facing significant changes and difficulties and our financial results reflect the impact of this challenging environment. As discussed in more detail in Management's Discussion & Analysis of Financial Condition and Results of Operations (MD&A), our ILEC revenues have been decreasing, and demand and pricing for CLEC services have decreased substantially, particularly for long-haul services, and these trends are likely to continue. Revenue from our ILEC, CLEC and public utility operations was $2,027.2 million, $156.0 million, and $9.7 million, respectively, in 2004. Telecommunications Services Our telecommunications services are principally ILEC services and also include CLEC services delivered through ELI. As of December 31, 2004, we operated ILECs in 23 states, serving approximately 2.321 million access lines and 212,300 high-speed internet customers. Our CLEC services consist of a variety of integrated telecommunications products. As an ILEC, we are typically the dominant incumbent carrier in the markets we serve and provide the "last mile" of telecommunications services to residential and business customers in these markets. As a CLEC, we provide telecommunications services to businesses and other carriers in competition with the 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). ELI does not compete with our ILEC business. 2 ILEC Services - ------------- Our ILEC segment accounted for $2,027.2 million, or 93%, of our total revenues in 2004. Approximately 8% of our 2004 ILEC segment revenues came from federal and state subsidies and approximately 14% from regulated access charges. Our ILEC business is primarily with residential customers and, to a lesser extent, non-residential customers. Our ILEC segment principally provides: * local network services, * enhanced services, * network access services, * long distance, * data services, and * directory services. Local network services. We provide telephone wireline access services to residential and non-residential customers in our service areas. Our service areas are largely residential and are generally less densely populated than the primary service areas of the five largest ILECs. Enhanced services. We provide our ILEC customers a number of calling features including call forwarding, conference calling, caller identification, voicemail and call waiting. We offer packages of telecommunications services. These packages permit customers to bundle their basic telephone line with their choice of enhanced, long distance and internet services for a monthly fee and/or usage depending on the plan. We intend to increase the penetration of enhanced services. We believe that increased sales of such services in our ILEC markets will produce revenue with higher operating margins due to the relatively low marginal operating costs necessary to offer such services. We believe that our ability to integrate these services with other ILEC services will provide us with the opportunity to capture an increased percentage of our customers' telecommunications expenditures. Network access services. We provide network access services to other carriers in connection with the use of our facilities to originate and terminate interstate and intrastate telephone calls. Such services are generally offered on a month-to-month basis and the service is billed on a minutes-of-use basis. Access charges are based on access rates filed with the FCC for interstate services and with the respective state regulatory agency for intrastate services. Revenue is recognized when services are provided to customers or when products are delivered to customers. Monthly recurring network access service revenue is billed in advance. The unearned portion of this revenue is initially deferred on our balance sheet and recognized in revenue over the period that the services are provided. Non-recurring network access service revenue is billed in arrears. The earned but unbilled portion of this revenue is recognized in revenue in the period that the services are provided. Long distance. Long distance network service to and from points outside of a telephone company's operating territories is provided by interconnection with the facilities of interexchange carriers, or IXCs. We offer long distance services in our territories to our ILEC customers. We believe that many customers prefer the convenience of obtaining their long distance service through their local telephone company and receiving a single bill. Data services. We offer data services including internet access via dial up or high-speed internet access, frame relay, ethernet and asynchronous transfer mode (ATM) switching in portions of our system. Directory services. Directory services involves the provision of white and yellow page listings of residential and business directories. We provide this service through a third party contractor who pays us a percentage of revenues realized from the sale of advertising in these directories. Our directory service also includes "Frontier Pages," an internet-based directory service which generates advertising revenue. We recognize the revenue from these services over the life of the related white or yellow pages book. 3 During 2005 we will begin selling voice over internet protocol or VOIP solutions to commercial customers in certain of our markets and, through a relationship with a satellite television operator, we will be bundling and selling television services to our residential customers in all our markets. We will also consider providing wireless internet access in some of our markets. The following table sets forth certain information with respect to our revenue generating units (RGUs), which consists of access lines plus high-speed internet subscribers, as of December 31, 2004 and 2003. ILEC RGUs at December 31, ------------------------- State 2004 2003 ----- ---- ---- New York............ 1,029,700 1,034,300 Minnesota........... 289,300 284,300 Arizona............. 182,000 175,500 West Virginia....... 179,400 167,200 California.......... 165,000 163,200 Illinois............ 128,600 127,900 Tennessee........... 104,500 101,800 Wisconsin........... 77,600 76,800 Iowa................ 62,100 63,000 Nebraska............ 54,400 54,900 All other states (13)... 260,400 258,000 --------- --------- Total 2,533,000 2,506,900 ========= ========= Change in the number of our access lines is the most fundamental driver of changes in our revenue. We have been experiencing a loss of access lines primarily because of difficult economic conditions, changing consumer behavior, 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 high-speed internet service. We lost approximately 65,700 access lines during the year ended December 31, 2004 but added approximately 91,800 high-speed internet subscribers during this period. The loss of lines during 2004 was primarily residential customers. The non-residential line losses were principally in Rochester, New York, while the residential losses were throughout our markets. We expect to continue to lose access lines but to increase high-speed internet subscribers during 2005. A continued decrease in access lines, combined with increased competition and the other factors discussed in MD&A, will cause our revenues to decrease during 2005. CLEC Services - ------------- ELI provides a broad range of wireline communications products and services to businesses and other carriers in the western United States. ELI accounted for $156.0 million, or 7%, of our total revenues in 2004. Our CLEC revenues have declined from a peak of $240.8 million in 2000. ELI's facilities-based network consists of optical fiber and voice and data switches. ELI has a national internet and data network with switches and routers in key cities, linked by leased transport facilities. In addition, ELI has a long-haul, fiber-optic network connecting the cities it serves in the western United States which utilizes an optically self-healing Synchronous Optical Network (SONET) architecture. ELI currently provides the full range of its services in the following cities and their surrounding areas: Boise, Idaho; Portland, Oregon; Salt Lake City, Utah; Seattle, Washington; Spokane, Washington; Phoenix, Arizona; and Sacramento, California. Regulatory Environment ILEC Services Regulation - ------------------------ The majority of our operations are regulated extensively by various state regulatory agencies, often called public service commissions, and the FCC. 4 The Telecommunications Act of 1996, or the 1996 Act, dramatically changed the telecommunications industry. The main purpose of the 1996 Act was to open local telecommunications marketplaces to competition. The 1996 Act preempts state and local laws to the extent that they prevent competitive entry into the provision of any switched communications service. Under the 1996 Act, however, states retain authority to impose requirements on carriers necessary to preserve universal service, protect public safety and welfare, ensure quality of service and protect consumers. States are also responsible for mediating and arbitrating interconnection agreements between CLECs and ILECs if voluntary negotiations fail. In order to create an environment in which local competition is a practical possibility, the 1996 Act imposes a number of requirements for access to network facilities and interconnection on all local communications providers. All local carriers must interconnect with other carriers, unbundle their services at wholesale rates, permit resale of their services, enable collocation of equipment, provide local telephone number portability and dialing parity, provide access to poles, ducts, conduits, and rights-of-way, and complete calls originated by competing carriers under termination arrangements. At the federal level and in a number of the states in which we operate we are subject to price cap or incentive regulation plans under which prices for regulated services are capped in return for the elimination or relaxation of earnings oversight. The goal of these plans is to provide incentives to improve efficiencies and increased pricing flexibility for competitive services while ensuring that customers receive reasonable rates for basic services. Some of these plans have limited terms and, as they expire, we may need to renegotiate with various states. These negotiations could impact rates, service quality and/or infrastructure requirements which could impact our earnings. In the other states in which we operate, we are subject to rate of return regulation that limits levels of earnings and returns on investments. Our ILEC services segment revenue is subject to regulation by the FCC and various state regulatory agencies. We expect federal and state lawmakers to continue to review the statutes governing the level and type of regulation for telecommunications services. For interstate services regulated by the FCC, we have elected a form of incentive regulation known as price caps for most of our operations. Under price caps, interstate access rates are capped and adjusted annually by the difference between the level of inflation and a productivity factor. Given the relatively low inflation rate in recent years, interstate access rates have been adjusted downward annually. In May 2000, the FCC adopted a revised methodology for regulating the interstate access rates of price cap companies through May 2005. The program, known as the Coalition for Affordable Local and Long Distance Services, or CALLS plan, establishes a price floor for interstate-switched access services and phases out many of the subsidies in interstate access rates. We have been able to offset some of the reduction in interstate access rates through end-user charges. We believe the net effect of reductions in interstate access rates and increases in end-user charges will reduce our revenues by approximately $4.0 million in 2005 compared to 2004. The CALLS program is set to expire in 2005. The FCC is expected to address future changes in interstate access charges during the year. Another goal of the 1996 Act was to remove implicit subsidies from the rates charged by local telecommunications companies. The CALLS plan addressed this requirement for interstate services. State legislatures and regulatory agencies are beginning to reduce the implicit subsidies in intrastate rates. The most common subsidies are in access rates that historically have been priced above their costs to allow basic local rates to be priced below cost. Legislation has been considered in several states to require regulators to eliminate these subsidies and implement state universal service programs where necessary to maintain reasonable basic local rates. However, not all the reductions in access charges would be fully offset. We anticipate additional state legislative and regulatory pressure to lower intrastate access rates in the near future. Many states are embracing the need for state universal service funds to ensure protection for customers while ensuring that local telecommunications companies continue to have the incentive to recover in rates their investment in their networks and new services. Some state legislatures and regulators are also examining the provision of telecommunications services to previously unserved areas. Since many unserved areas are located in rural markets, we could be required to expand our service territory into some of these areas. Recent and Potential Regulatory Developments - -------------------------------------------- Effective November 24, 2003, the FCC issued an order requiring wireline and wireless carriers to provide local number portability (LNP). LNP is the ability of customers to switch from a wireline carrier to a wireless carrier, or from one wireless carrier to another wireless carrier, without changing telephone numbers. We are 100% LNP capable in our largest markets and will deploy in each of the remaining exchanges in response to bona fide requests as required by the FCC order. 5 LNP will most likely promote further competition between wireline and wireless carriers in an environment where the displacement of traditional wireline services has been increasing because of technological substitutions such as cell phones, e-mail and Internet phone calling. In 1994, Congress passed the Communications Assistance for Law Enforcement Act (CALEA) to ensure that telecommunication networks can meet law enforcement wiretapping needs. In June 2004, the Company filed for additional extensions of time to make our entire network CALEA compliant. However, failure to be granted further extensions could increase our budgeted capital expenditures by up to $6.2 million in 2005. The FCC in 2003 issued an order as a result of its triennial review of the 1996 Act. The order essentially kept in place the existing regulatory regime with respect to Unbundled Network Elements Platform (UNEP) competition, provided significant authority to state regulators to implement UNEP competition and pricing, and eliminated a previous requirement of ILECs to share their high-speed lines with competitors. The Federal appeals court in the District of Columbia overturned many aspects of the FCC's order, in particular the broad delegation to state authorities to implement UNEP competition and pricing. The appeals court did, however, uphold the line sharing provisions of the order. On February 4, 2005, the FCC released permanent rules governing UNEPs. It is anticipated that portions of these new rules will be appealed, and we cannot predict the impact of such appeals. We anticipate that there will be little or no impact on our ILEC operations because the impairment thresholds set by the FCC are at a level beyond Citizens' demographics and we do not currently have UNEP competition in our markets. The FCC is expected to address issues involving inter-carrier compensation, the universal service fund and internet telephony in 2005. The FCC adopted a Further Notice of Proposed Rulemaking (FNPRM) addressing inter-carrier compensation on February 10, 2005. Some of the proposals being discussed with respect to inter-carrier compensation, such as "bill and keep" (under which switched access charges and reciprocal compensation would be reduced or eliminated), could reduce our access revenues. The universal service fund is under pressure as local exchange companies lose access lines and more entities, such as wireless companies, seek to receive monies from the fund. The rules surrounding the eligibility of Competitive Eligible Telecommunication Carriers such as wireless companies to receive universal service funds are expected to be clarified by the Federal State Joint Board on Universal Service in 2005 and the outcome may heighten the pressures on the fund. Changes in the funding or payout rules of the universal service fund could further reduce our subsidy revenues. As discussed in MD&A, our subsidy revenues are expected to decline in 2005 compared to 2004. The development and growth of internet telephony (also known as VOIP) by cable and other companies has increased the importance of regulators at both the federal and state levels addressing whether such services are subject to the same or different regulatory and financial schemes as traditional telephony. On November 9, 2004, the FCC issued an order in response to a petition by Vonage Holdings Corp. (Vonage), declaring that Vonage-style VOIP services are jurisdictionally interstate in nature and are thereby exempt from state telecommunications regulations. The FCC stated that its order was not limited to Vonage, but rather applied to all Vonage-type VOIP offerings provided over broadband services. The FCC did not address other related issues, such as: whether or under what terms VOIP traffic may be subject to intercarrier compensation; if VOIP services are subject to general state requirements relating to taxation and general commercial business requirements; or whether VOIP is subject to 911, USF, and CALEA obligations. The FCC is planning on addressing these open questions in subsequent orders in its ongoing "IP-Enabled Services Proceeding," which was opened in February 2004. Internet telephony may have an advantage over our traditional services if it remains less regulated. We are actively participating in the FCC's consideration of all these issues. The FCC's revised service outage reporting rules require telecommunications providers (regardless of whether they are cable, satellite, wireless, SS7, E911, or wireline communications providers) to report outages of at least 30 minutes duration that potentially affect at least 900,000 user-minutes. The initial FCC order, which included required reporting of certain non-service interrupting network outages, was partially stayed. The required network modifications to be compliant with the stayed portion of the order would cost us in excess of $16.0 million. The New York Public Service Commission is also considering network reliability requirements that could cost us as much as $65.0 million. We and other carriers are opposing these proposed requirements. Some state regulators (including New York and Illinois) have recently considered imposing on regulated companies (including us) cash management practices that could limit the ability of companies to transfer cash between subsidiaries or to the parent company. None of the existing state requirements materially affect our cash management but future changes by state regulators could affect our ability to freely transfer cash within our consolidated companies. 6 CLEC Services Regulation - ------------------------ As a CLEC, ELI is subject to federal, state and local regulation. However, the level of regulation is typically less than that experienced by an ILEC. Local governments may require ELI to obtain licenses or franchises regulating the use of public rights-of-way necessary to install and operate its networks. ELI has various interconnection agreements in the states in which it operates. These agreements govern reciprocal compensation relating to the transport and termination of traffic between the ILEC's and ELI's networks. The FCC has significantly reduced intercarrier compensation for ISP traffic, also known as "reciprocal compensation." On December 15, 2004, the FCC adopted permanent rules governing UNEPs. It is anticipated that portions of these new rules will be appealed, and we cannot predict the impact of such appeals. If the rules take effect, we anticipate that there will be increased costs to ELI for services that they buy today from ILECs. Most state public service commissions require competitive communications providers, such as ELI, to obtain operating authority prior to initiating intrastate services. Most states also require the filing of tariffs or price lists and/or customer-specific contracts. ELI is not currently subject to rate-of-return or price regulation. However, ELI is subject to state-specific quality of service, universal service, periodic reporting and other regulatory requirements, although the extent of these requirements is generally less than those applicable to ILECs. Competition ILEC Services Competition - ------------------------- Competition in the telecommunications industry is increasing. We experience competition from other wireline carriers, VOIP providers such as Vonage, from other long distance carriers (including Regional Bell Operating Companies), from cable companies, internet service providers 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 markets. Competition from cable companies with respect to high-speed internet access is intense and increasing in many of our markets. The cable company in Rochester and other parts of our New York markets began offering a telephony product during 2004. We expect cable telephony competition to increase in Rochester and elsewhere during 2005. Competition from wireless companies, other long distance companies and internet service providers is increasing in all of our markets. Our ILEC business has been experiencing declining access lines, switched access 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 and email use, technology changes and regulatory constraints. These factors are likely to cause our local service, network access, long distance and subsidy revenues to continue to decline during 2005. One of the ways we are responding to actual and potential competition is by bundling services and products and offering them for a single price, which results in lower pricing than purchasing the services separately. Revenues from data services such as high-speed internet access 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 costs, will cause our profitability to decrease. The telecommunications industry is undergoing significant changes and difficulties. The market is extremely competitive, resulting in lower prices. Demand and pricing for CLEC services have decreased substantially, particularly for long-haul services. These trends are likely to continue. These factors result in a challenging environment with respect to revenues. These factors could also result in more bankruptcies in the sector and therefore affect our ability to collect money owed to us by bankrupt carriers. Several 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. CLEC Services Competition - ------------------------- ELI faces significant competition from ILECs in each of its markets. Principal ILEC competitors include Qwest, SBC and Verizon. ELI also competes with all of the major IXCs, internet access providers and other CLECs. CLEC service providers have generally encountered intense competitive pressures, the result of which is the failure of a number of CLECs and substantial financial pressures on others. 7 Competitors in ELI's markets include, in addition to the incumbent providers: AT&T, Sprint, Time Warner Telecom, MCI, Integra and XO Communications. In each of the markets in which ELI operates, at least one other CLEC, and in some cases several other CLECs, offer many of the same services that ELI provides, generally at similar prices. Competition is based on price, quality, network reliability, customer service, service features and responsiveness to the customer's needs. Many of these competitors have greater market presence and greater financial, technical, marketing and human resources, more extensive infrastructure and stronger customer and strategic relationships than are available to us. Competition in the CLEC industry is intense and pricing continues to decline. ELI's revenues have declined every year since 2000. Divestiture of Public Utilities Services In the past we provided public utilities services including natural gas transmission and distribution, electric transmission and distribution, water distribution and wastewater treatment services to primarily rural and suburban customers throughout the United States. In 1999, we announced a plan of divestiture for our public utilities services properties. Since then, we have divested all of our public utility operations for an aggregate of $1.9 billion. In 2001, we sold our Louisiana gas operations for $363.4 million in cash and our Colorado gas division for $8.9 million in cash. In 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, and our Kauai electric division for $215.0 million in cash. In 2003, we completed the sales of The Gas Company in Hawaii division for $119.3 million in cash and assumed liabilities, our Arizona gas and electric divisions for $224.1 million in cash and our electric transmission operations in Vermont for $7.3 million in cash. In 2004, we completed the sale of our Vermont electric division for an aggregate of approximately $14.0 million in cash, net of selling expenses. These transactions are subject to routine purchase price adjustments. Our electric segment accounted for $9.7 million of our total revenues in 2004. At December 31, 2004, we had sold all of our public utilities services segments and, as a result, will have no operating results in future periods for these businesses. We have retained a potential payment obligation associated with our previous electric utility activities in the state of Vermont. The Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities, including us, entered into a purchase power agreement with Hydro-Quebec in 1987. The agreement contains "step-up" provisions which state that if any VJO member defaults on its purchase obligation under the contract to purchase power from Hydro-Quebec, then the other VJO participants will assume responsibility for the defaulting party's share on a pro-rata basis. Our pro-rata share of the purchase power obligation is 10%. If any member of the VJO defaults on its obligations under the Hydro-Quebec agreement, the remaining members of the VJO, including us, may be required to pay for a substantially larger share of the VJO's total power purchase obligation for the remainder of the agreement (which runs through 2015). Paragraph 13 of FIN 45 requires that we disclose "the maximum potential amount of future payments (undiscounted) the guarantor could be required to make under the guarantee." Paragraph 13 also states that we must make such disclosure "... even if the likelihood of the guarantor's having to make any payments under the guarantee is remote..." As noted above, our obligation only arises as a result of default by another VJO member such as upon bankruptcy. Therefore, to satisfy the "maximum potential amount" disclosure requirement we must assume that all members of the VJO simultaneously default, a highly unlikely scenario given that the two members of the VJO that have the largest potential payment obligations are publicly traded with investment grade credit ratings, and that all VJO members are regulated utility providers with regulated cost recovery. Regardless, despite the remote chance that such an event could occur, or that the State of Vermont could or would allow such an event, assuming that all the members of the VJO defaulted on January 1, 2006 and remained in default for the duration of the contract (another 10 years), we estimate that our undiscounted purchase obligation for 2006 through 2015 would be approximately $1.4 billion. In such a scenario the Company would then own the power and could seek to recover its costs. We would do this by seeking to recover our costs from the defaulting members and/or reselling the power to other utility providers or the northeast power grid. There is an active market for the sale of power. We could potentially lose money if we were unable to sell the power at cost. We caution that we cannot predict with any degree of certainty any potential outcome. Segment Information Note 23 to Consolidated Financial Statements provides financial information about our industry segments for the last three fiscal years. 8 Financial Information about Foreign and Domestic Operations and Export Sales We have no foreign operations. General Order backlog is not a significant consideration in our businesses. We have no contracts or subcontracts that may be subject to renegotiations of profits or termination at the election of the Federal government. We hold no patents, licenses or concessions that are material. Employees As of December 31, 2004, we had 6,373 employees, of whom 5,912 were associated with ILEC operations and 461 were associated with ELI. At December 31, 2004, the total number of our employees affiliated with a union was 3,333, of which 78 are covered by agreements set to expire during 2005. We consider our relations with our employees to be good. Available Information We make available on our website, free of charge, the periodic reports that we file with or furnish to the Securities and Exchange Commission (the "SEC"), as well as all amendments to these reports, as soon as reasonably practicable after such reports are filed with or furnished to the SEC. We also make available on our website, or in printed form upon request, free of charge, our Corporate Governance Guidelines, Code of Business Conduct and Ethics, and the charters for the Audit, Compensation and Retirement, and Nominating and Corporate Governance committees of the Board of Directors. Stockholders may request printed copies of these materials by writing to: 3 High Ridge Park, Stamford, Connecticut 06905 Attention: Corporate Secretary. Our website address is http://www.czn.com. Item 2. Properties ---------- Our principal corporate offices are located in leased premises at 3 High Ridge Park, Stamford, Connecticut. An operations support office is currently located in leased premises at 180 South Clinton Avenue, Rochester, New York. In addition, our ILEC segment leases and owns space in various markets throughout the United States. An operations support office for ELI is located in a building we own at 4400 NE 77th Avenue, Vancouver, Washington. In addition, our CLEC segment leases local office space in various markets throughout the United States, and also maintains a warehouse facility in Portland, Oregon. Our CLEC segment also leases network hub and network equipment installation sites in various locations throughout the areas in which it provides services. For additional information regarding obligations under lease, see Note 26 to Consolidated Financial Statements. Our ILEC and CLEC services segments own telephone properties which include: connecting lines between customers' premises and the central offices; central office switching equipment; fiber-optic and microwave radio facilities; buildings and land; and customer premise equipment. The connecting lines, including aerial and underground cable, conduit, poles, wires and microwave equipment, are located on public streets and highways or on privately owned land. We have permission to use these lands pursuant to local governmental consent or lease, permit, franchise, easement or other agreement. 9 Item 3. Legal Proceedings ----------------- The City of Bangor, Maine, filed suit against us on November 22, 2002, in the U.S. District Court for the District of Maine (City of Bangor v. Citizens Communications Company, Civ. Action No. 02-183-B-S). 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. The Court has dismissed all but two of the City's claims including its CERCLA claims and the claim against us for punitive damages. We are currently pursuing settlement discussions with the other parties, but if those efforts fail a trial of the City's remaining claims could begin as early as May 2005. 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 part of the Global Crossing bankruptcy proceeding. Citibank bases its claim for indemnity on the provisions of a credit agreement that was entered into in October 2000 between Citibank and our subsidiary. We purchased Frontier Subsidiary Telco, Inc., in June 2001 as part of our acquisition of the Frontier telephone companies. The complaint against Citibank, for which it seeks indemnification, alleges that the seller improperly used a portion of the proceeds from the Frontier transaction to pay off the Citibank credit agreement, thereby defrauding certain debt holders of Global Crossing North America Inc. Although the credit agreement was paid off at the closing of the Frontier transaction, Citibank claims the indemnification obligation survives. Damages sought against Citibank and its co-defendants could exceed $1.0 billion. In August 2004 we notified Citibank by letter that we believe its claims for indemnification are invalid and are not supported by applicable law. We have received no further communications from Citibank since our August letter. We are party to other legal proceedings arising in the normal course of our business. The outcome of individual matters is not predictable. However, we believe that the ultimate resolution of all such matters, after considering insurance coverage, will not have a material adverse effect on our financial position, results of operations, or our cash flows. Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- None in fourth quarter 2004. 10 Executive Officers of the Registrant - ------------------------------------ Information as to Executive Officers of the Company as of March 4, 2005 follows:
Name Age Current Position and Officer ---- --- ---------------------------- Mary Agnes Wilderotter 50 President and Chief Executive Officer Donald B. Armour 57 Senior Vice President, Finance and Treasurer John H. Casey, III 48 Executive Vice President Jeanne M. DiSturco 41 Senior Vice President, Human Resources Jerry Elliott 45 Executive Vice President and Chief Financial Officer Peter B. Hayes 47 Senior Vice President Sales, Marketing and Business Development Robert J. Larson 45 Senior Vice President and Chief Accounting Officer Daniel J. McCarthy 40 Senior Vice President, Field Operations L. Russell Mitten 53 Senior Vice President, General Counsel and Secretary
There is no family relationship between directors or executive officers. The term of office of each of the foregoing officers of Citizens will continue until the next annual meeting of the Board of Directors and until a successor has been elected and qualified. MARY AGNES WILDEROTTER has been associated with Citizens since September 30, 2004 when she was elected President and Chief Executive Officer. Previously, she was Senior Vice President - Worldwide Public Sector in 2004, Microsoft Corp. and Senior Vice President - Worldwide Business Strategy, Microsoft Corp., 2002 to 2004. Before that she was President and Chief Executive Officer, Wink Communications, 1996 to 2002. DONALD B. ARMOUR has been associated with Citizens since October 2000. He was elected Senior Vice President, Finance and Treasurer in December 2002. Previously, he was Vice President, Finance and Treasurer from October 2000 to December 2002. Prior to joining Citizens, he was the Treasurer of the cable television division of Time Warner Inc. JOHN H. CASEY, III has been associated with Citizens since November 1999. He is currently Executive Vice President of Citizens. He was Executive Vice President and President and Chief Operating Officer of our ILEC Sector from July 2002 to December 2004. He was Vice President of Citizens, President and Chief Operating Officer, ILEC Sector from January 2002 to July 2002, Vice President and Chief Operating Officer, ILEC Sector from February 2000 to January 2002, and Vice President, ILEC Sector from December 1999 to February 2000. JEANNE M. DISTURCO has been associated with Citizens since 1987. She was elected Senior Vice President, Human Resources in December 2002. Previously, she was Vice President, Human Resources from October 2001 to December 2002, Vice President, Compensation and Benefits from March 2001 to October 2001 and Director of Compensation from 1996 to March 2001. JERRY ELLIOTT has been associated with Citizens since March 2002. He was elected Executive Vice President and Chief Financial Officer in July 2004. Previously, he was Senior Vice President and Chief Financial Officer from December 2002 to July 2004 and Vice President and Chief Financial Officer from March 2002 to December 2002. Prior to joining Citizens, he was Managing Director of Morgan Stanley's Media and Communications Investment Banking Group. PETER B. HAYES has been associated with Citizens since February 1, 2005 when he was elected Senior Vice President, Sales, Marketing and Business Development. Prior to joining Citizens, he was associated with Microsoft Corp. and served as Vice President, Public Sector, Europe, Middle East, Africa from 2003 to 2005, Vice President and General Manager, Microsoft U.S. Government from 1997 to 2003, Director, Worldwide Enterprise Field Strategy, from 1995 to 1997, and Director, Field and Customer Relations, from 1994 to 1995. ROBERT J. LARSON has been associated with Citizens since July 2000. He was elected Senior Vice President and Chief Accounting Officer of Citizens in December 2002. Previously, he was Vice President and Chief Accounting Officer from July 2000 to December 2002. Prior to joining Citizens, he was Vice President and Controller of Century Communications Corp. 11 DANIEL J. McCARTHY has been associated with Citizens since December 1990. He is currently Senior Vice President, Field Operations. He was previously Senior Vice President Broadband Operations from January 2004 to December 2004, and President and Chief Operating Officer of Electric Lightwave from January 2002 to December 2004. Previously, he was President and Chief Operating Officer, Public Services Sector from November 2001 to January 2002, Vice President and Chief Operating Officer, Public Services Sector from March 2001 to November 2001, Vice President, Citizens Arizona Energy from April 1998 to March 2001. L. RUSSELL MITTEN has been associated with Citizens since June 1990. He was elected Senior Vice President, General Counsel and Secretary in December 2002. Previously, he was Vice President, General Counsel and Secretary from September 2000 to December 2002. He was also Vice President, General Counsel and Assistant Secretary from June 1991 to September 2000. 12 CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES PART II ------- Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and ---------------------------------------------------------------------- Issuer Purchases of Equity Securities ------------------------------------- PRICE RANGE OF COMMON STOCK Our Common Stock is traded on the New York Stock Exchange under the symbol CZN. The following table indicates the high and low prices per share during the periods indicated. 2004 2003 ------------------- ------------------- High Low High Low First Quarter $13.25 $11.37 $11.55 $8.81 Second Quarter $13.54 $12.06 $13.40 $9.99 Third Quarter $14.80 $12.04 $13.39 $10.93 Fourth Quarter $14.63 $13.11 $12.80 $10.23 As of February 28, 2005, the approximate number of security holders of record of our Common Stock was 27,366. This information was obtained from our transfer agent. DIVIDENDS The amount and timing of dividends payable on our Common Stock are within the sole discretion of our Board of Directors. In 2004, the Board of Directors approved a special, non-recurring dividend of $2.00 per share of Common Stock, and instituted a regular annual dividend of $1.00 per share of Common Stock to be paid quarterly. Cash dividends paid to shareholders were approximately $832.8 million in 2004. No dividends were paid in 2003. There are no material restrictions on our ability to pay dividends. RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM REGISTERED SECURITIES None ISSUER PURCHASES OF EQUITY SECURITIES None 13 Item 6. Selected Financial Data -----------------------
($ in thousands, except per share amounts) Year Ended December 31, - ------------------------------------------ -------------------------------------------------------------- 2004 2003 2002 2001 2000 ------------ ----------- ------------ ------------ ----------- Revenue (1) $ 2,192,980 $ 2,444,938 $ 2,669,332 $ 2,456,993 $ 1,802,358 Income (loss) from continuing operations before extraordinary expense and cumulative effect of changes in accounting principle (2) $ 72,150 $ 122,083 $ (822,976) $ (63,926) $ (40,071) Net income (loss) $ 72,150 $ 187,852 $ (682,897) $ (89,682) $ (28,394) Basic income (loss) per share of Common Stock from continuing operations before extraordinary expense and cumulative effect of changes in accounting principle (2) $ 0.24 $ 0.44 $ (2.93) $ (0.28) $ (0.15) Available for common shareholders per basic share $ 0.24 $ 0.67 $ (2.43) $ (0.38) $ (0.11) Available for common shareholders per diluted share $ 0.23 $ 0.64 $ (2.43) $ (0.38) $ (0.11) Cash dividends declared (and paid) per common share $ 2.50 $ - $ - $ - $ - As of December 31, -------------------------------------------------------------- 2004 2003 2002 2001 2000 ------------ ----------- ------------ ------------ ----------- Total assets $ 6,668,419 $ 7,445,545 $ 8,144,502 $10,551,351 $ 6,954,954 Long-term debt $ 4,266,998 $ 4,195,629 $ 4,957,361 $ 5,534,906 $ 3,062,289 Equity units (3) $ - $ 460,000 $ 460,000 $ 460,000 $ - Company Obligated Mandatorily Redeemable Convertible Preferred Securities (4) $ - $ 201,250 $ 201,250 $ 201,250 $ 201,250 Shareholders' equity $ 1,362,240 $ 1,415,183 $ 1,172,139 $ 1,946,142 $ 1,720,001
(1) Represents revenue from continuing operations. Revenue from acquisitions contributed $569.8 million and $49.5 million for the years ended December 31, 2001 and 2000, respectively. Revenue from gas operations sold represented $137.7 million, $218.8 million and $232.3 million in 2003, 2001 and 2000, respectively. Revenue from electric operations sold represented $9.7 million, $67.4 million, $76.6 million, $94.3 million and $95.1 million in 2004, 2003, 2002, 2001 and 2000, respectively. (2) Extraordinary expense represents an extraordinary after tax expense of $43.6 million related to the discontinuance of the application of Statement of Financial Accounting Standards No. 71 to our local exchange telephone operations in 2001. The cumulative effect of changes in accounting principles represents the $65.8 million after tax non-cash gain resulting from the adoption of Statement of Financial Accounting Standards No. 143 in 2003, and the write-off of ELI's goodwill of $39.8 million resulting from the adoption of Statement of Financial Accounting Standards No. 142 in 2002. (3) On August 17, 2004, we issued common stock to equity unit holders in settlement of the equity purchase contract. (4) The consolidation of this item changed effective January 1, 2004 as a result of the adoption of FIN 46R, "Consolidation of Variable Interest Entities." See Note 16 for a complete discussion. 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations ------------- This annual report on Form 10-K contains forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the statements. Statements that are not historical facts are forward-looking statements made pursuant to the Safe Harbor Provisions of the Litigation Reform Act of 1995. In addition, words such as "believes", "anticipates", "expects" and similar expressions are intended to identify forward-looking statements. Forward-looking statements (including oral representations) are only predictions or statements of current plans, which we review continuously. Forward-looking statements may differ from actual future results due to, but not limited to, any of the following possibilities: * Changes in the number of our revenue generating units, which consists of access lines plus high-speed internet subscribers; * The effects of competition from wireless, other wireline carriers (through Unbundled Network Elements (UNE), Unbundled Network Elements Platform (UNEP), 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 in order to offset declines in highly profitable revenue from local services, access services and subsidies; * Our ability to comply with Section 404 of the Sarbanes-Oxley Act of 2002, which requires management to assess its internal control systems and disclose whether the internal control systems are effective, and the identification of any material weaknesses in our internal control over financial reporting; * The effects of changes in regulation in the telecommunications industry as a result of federal and state legislation and regulation, including potential changes in access charges and subsidy payments, regulatory network upgrade and reliability requirements, and portability 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; 15 * The effects of state regulatory cash management policies on our ability to transfer cash among our subsidiaries and to the parent company; * Our ability to successfully renegotiate expiring union contracts covering approximately 78 employees that are scheduled to expire during 2005; * Our ability to pay a $1.00 per common share dividend annually may be affected by our cash flow from operations, amount of capital expenditures, debt service requirements, cash paid for income taxes and our liquidity; * The effects of any future liabilities or compliance costs in connection with environmental and worker health and safety matters; * The effects of any unfavorable outcome with respect to any of our current or future legal, governmental, or regulatory proceedings, audits or disputes; and * The effects of more general factors, including changes in economic 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-K or otherwise made by us or on our behalf. The following information is unaudited and should be read in conjunction with the consolidated financial statements and related notes included in this report. We have no obligation to update or revise these forward-looking statements. Overview - -------- We are a communications company providing services to rural areas and small and medium-sized towns and cities as an incumbent local exchange carrier, or ILEC. We offer our ILEC services under the "Frontier" name. In addition, we provide competitive local exchange carrier, or CLEC, services to business customers and to other communications carriers in certain metropolitan areas in the western United States through Electric Lightwave, LLC, or ELI, our wholly-owned subsidiary. Competition in the telecommunications industry is increasing. We experience competition from other wireline local carriers, VOIP providers such as Vonage, 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 markets. Competition from cable companies and other high-speed internet service providers with respect to internet access is intense and increasing in many of our markets. The cable company in Rochester and other parts of our New York markets began offering a telephony product during 2004. We expect cable telephony competition to increase in Rochester and elsewhere during 2005. 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 is extremely competitive, resulting in lower prices. Demand and pricing for certain CLEC services have decreased substantially, particularly for long-haul services. These trends are likely to continue and result in a challenging revenue environment. These factors could also result in more bankruptcies in the sector and therefore affect our ability to collect money owed to us by carriers. Several long distance and 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. Revenues from data services such as high-speed internet continue to increase as a percentage of our total revenues and revenues from high margin services such as local line and access charges and subsidies are decreasing as a percentage of our revenues. These factors, along with increasing operating and employee costs will cause our cash generated by operations to decrease. 16 (a) Liquidity and Capital Resources ------------------------------- For the year ended December 31, 2004, we used cash flows from continuing operations, the proceeds from the sale of utility properties and investments, cash and cash equivalents to fund capital expenditures, dividends, interest payments, a $20.0 million voluntary contribution to our pension plan and debt repayments. As of December 31, 2004, we had cash and cash equivalents aggregating $167.5 million. For the year ended December 31, 2004, our capital expenditures were $276.3 million, including $264.3 million for the ILEC segment, $11.6 million for the ELI segment and $0.4 million of general capital expenditures. We continue to closely scrutinize all of our capital projects, emphasize return on investment and focus our capital expenditures on areas and services that have the greatest opportunities with respect to revenue growth and cost reduction. For example, in 2005 we will allocate significant capital to services such as high-speed internet in areas that are growing or demonstrate meaningful demand. In the past, large capital outlays were made in newly acquired properties to be able to offer all of our services across all of our areas and in order to improve network capability and service quality. After those investments were made, the total amount of capital spending has been further reduced because of declining revenues and lower costs from vendors. We will continue to focus on managing our costs while increasing our investment in certain product areas such as high-speed internet. Increasing competition, offering new services or a decision to improve the capabilities and reduce the maintenance costs of our plant may cause our capital expenditures to increase in the future. We have budgeted approximately $270.0 million for our 2005 capital projects including $255.0 million for the ILEC segment and $15.0 million for the ELI segment. Included in these budgeted capital amounts are approximately $6.9 million of capital expenditures associated with CALEA. We have received extensions of time to make our entire network CALEA compliant, however, failure to be granted further extensions could increase our budgeted capital expenditures by up to $6.2 million in 2005. As of December 31, 2004, we have available lines of credit with financial institutions in the aggregate amount of $250.0 million. Associated facility fees vary, depending on our debt leverage ratio, and are 0.375% per annum as of December 31, 2004. The expiration date for the facility is October 29, 2009. During the term of the facility we may borrow, repay and reborrow funds. The credit facility is available for general corporate purposes but may not be used to fund dividend payments. There are no outstanding advances under the facility. 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, non-recurring dividend of $2 per common share and institute a regular annual dividend of $1 per share of Common Stock which will be paid quarterly. The special, non-recurring dividend and first quarterly dividend were paid on September 2, 2004 utilizing the Company's cash on hand. The next quarterly dividend of $0.25 per share of Common Stock was paid on December 31, 2004. The $832.8 million of dividends paid during 2004 significantly reduced our cash balances and liquidity. In addition, our ongoing annual dividends of approximately $340.0 million will reduce our operating and financial flexibility and our ability to significantly increase 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. Losses of access lines, increases in competition, lower subsidy and access revenues and the other factors described above is expected to reduce our cash generated by operations and may require us to increase capital expenditures. The downgrades in our credit ratings in July 2004 to below investment grade may make it more difficult and expensive to refinance our maturing debt. We have in recent years paid relatively low amounts of cash taxes. We expect that over time our cash taxes will increase. As a result of the adoption 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 credit facilities will be adequate to finance our working capital requirements, fund capital expenditures, make required debt payments through 2007, pay dividends to our shareholders in accordance with our dividend policy, and support our short-term and long-term operating strategies. We have approximately $6.4 million, $227.8 million and $37.9 million of debt maturing in 2005, 2006 and 2007, respectively. 17 Issuance of Common Stock - ------------------------ On August 17, 2004 we issued 32,073,633 shares of common stock, including 3,591,000 treasury shares, to our equity unit holders in settlement of the equity purchase contract component of the equity units. With respect to the $460.0 million senior note component of the equity units, we repurchased $300.0 million principal amount of these notes in July 2004. The remaining $160.0 million of the senior notes were repriced and a portion was remarketed on August 12, 2004 as the 6.75% notes due August 17, 2006. During August and September, 2004, we repurchased an additional $108.2 million of the 6.75% notes which, in addition to the $300.0 million purchased in July, resulted in a pre-tax charge of approximately $20.1 million during the third quarter of 2004, but will result in an annual reduction in interest expense of about $27.6 million per year. See discussion below concerning EPPICS conversions for further information regarding the issuance of common stock. Issuance of Debt Securities - --------------------------- On November 8, 2004, we issued an aggregate $700.0 million principal amount of 6.25% senior notes due January 15, 2013 through a registered underwritten public offering. Proceeds from the sale were used to redeem our outstanding $700.0 million of 8.50% Notes due 2006, which is discussed below. Debt Reduction - -------------- For the year ended December 31, 2004, we retired an aggregate principal amount of $1,362.0 million of debt, including $148.0 million of EPPICS that were converted to our common stock. 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. On July 15, 2004, we renegotiated and prepaid with $5.0 million of cash the entire remaining $5.5 million ELI capital lease obligation to a third party. On July 30, 2004, we purchased $300.0 million of the 6.75% notes that were a component of our equity units at 105.075% of par, plus accrued interest, at a premium of approximately $15.2 million. During August and September 2004, we repurchased through a series of transactions an additional $108.2 million of the 6.75% notes due 2006 at a weighted average price of 104.486% of par, plus accrued interest, at a premium of approximately $4.9 million. On November 12, 2004, we called for redemption on December 13, 2004 the entire $700.0 million of our 8.50% notes due 2006 at a price of 107.182% of the principal amount called, plus accrued interest, at a premium of approximately $50.3 million. 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 the 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 December 31, 2004 and December 31, 2003 were $300.0 million and $400.0 million, respectively. Such contracts require us to pay variable rates of interest (average pay rate of approximately 6.12% as of December 31, 2004) and receive fixed rates of interest (average receive rate of 8.44% as of December 31, 2004). All swaps are accounted for under SFAS No. 133 as fair value hedges. For the year ended December 31, 2004, the interest savings resulting from these interest rate swaps totaled approximately $9.4 million. 18 As the result of our call of all of our 8.50% Notes due 2006 in November 2004, we terminated five interest rate swaps used to hedge our interest rate exposure on that issue, each swap having a notional amount of $50.0 million. Proceeds from the swap terminations of approximately $3.0 million and U.S. Treasury rate lock agreements of approximately $1.0 million were used to offset the call premium associated with the notes retired. Sale of Non-Strategic Investments - --------------------------------- On August 13, 2004, we sold our entire 1,333,500 shares of D & E Communications, Inc. (D & E) for approximately $13.3 million in cash. On September 3, 2004, we sold our entire holdings of 2,605,908 common share equivalents in Hungarian Telephone and Cable Corp. (HTCC) for approximately $13.2 million in cash. During the third quarter of 2004, we sold our corporate aircraft for approximately $15.3 million in cash. Off-Balance Sheet Arrangements - ------------------------------ We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationship with unconsolidated entities that would be expected to have a material current or future effect upon our financial statements. Future Commitments - ------------------ A summary of our future contractual obligations and commercial commitments as of December 31, 2004 is as follows:
Payment due by period ---------------------------------------------------------- Contractual Obligations: Less than More than - ------------------------ Total 1 year 1-3 years 3-5 years 5 years ($ in thousands) ------ ------ --------- ---------- -------- - --------------- Long-term debt obligations, excluding interest (see Note 11) (1) $ 4,219,054 $ 6,302 $ 265,464 $ 751,938 $ 3,195,350 Capital lease obligations (see Note 26) 4,421 81 204 271 3,865 Operating lease obligations (see Note 26) 104,992 21,198 26,765 21,535 35,494 Purchase obligations (see Note 26) 70,880 35,831 33,159 900 990 Other long-term liabilities (2) 63,765 - - - 63,765 ----------- --------- --------- --------- ----------- Total $ 4,463,112 $ 63,412 $ 325,592 $ 774,644 $ 3,299,464 =========== ========= ========= ========= ===========
(1) Includes interest rate swaps ($4.5 million). (2) Consists of our Equity Providing Preferred Income Convertible Securities (EPPICS) reflected on our balance sheet. At December 31, 2004, we have outstanding performance letters of credit totaling $22.4 million. Management Succession and Strategic Alternatives Expenses - --------------------------------------------------------- On July 11, 2004, our Board of Directors announced that it completed its review of the Company's financial and strategic alternatives. In 2004, we expensed approximately $90.6 million of costs related to management succession and our exploration of financial and strategic alternatives. Included are $36.6 million of non-cash expenses for the acceleration of stock benefits, cash expenses of $19.2 million for advisory fees, $19.3 million for severance and retention arrangements and $15.5 million primarily for tax reimbursements. 19 EPPICS - ------ In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust (the Trust), issued, in an underwritten public offering, 4,025,000 shares of 5% Company Obligated Mandatorily Redeemable Convertible Preferred Securities due 2036 (Trust Convertible Preferred Securities or EPPICS), representing preferred undivided interests in the assets of the Trust, with a liquidation preference of $50 per security (for a total liquidation amount of $201.3 million). These securities have an adjusted conversion price of $11.46 per Citizens common share. The conversion price was reduced from $13.30 to $11.46 during the third quarter of 2004 as a result of the $2.00 per share special, non-recurring dividend. The proceeds from the issuance of the Trust Convertible Preferred Securities and a Company capital contribution were used to purchase $207.5 million aggregate liquidation amount of 5% Partnership Convertible Preferred Securities due 2036 from another wholly owned consolidated subsidiary, Citizens Utilities Capital L.P. (the Partnership). The proceeds from the issuance of the Partnership Convertible Preferred Securities and a Company capital contribution were used to purchase from us $211.8 million aggregate principal amount of 5% Convertible Subordinated Debentures due 2036. The sole assets of the Trust are the Partnership Convertible Preferred Securities, and our Convertible Subordinated Debentures are substantially all the assets of the Partnership. Our obligations under the agreements related to the issuances of such securities, taken together, constitute a full and unconditional guarantee by us of the Trust's obligations relating to the Trust Convertible Preferred Securities and the Partnership's obligations relating to the Partnership Convertible Preferred Securities. In accordance with the terms of the issuances, we paid the annual 5% interest in quarterly installments on the Convertible Subordinated Debentures in 2004, 2003 and 2002. Only cash was paid (net of investment returns) to the Partnership in payment of the interest on the Convertible Subordinated Debentures. The cash was then distributed by the Partnership to the Trust and then by the Trust to the holders of the EPPICS. As of December 31, 2004, EPPICS representing a total principal amount of $148.0 million had been converted into 11,622,749 shares of Citizens common stock, and a total of $53.3 million EPPICS remains outstanding. We have adopted the provisions of FASB Interpretation No. 46R (revised December 2003) ("FIN 46R"), "Consolidation of Variable Interest Entities," effective January 1, 2004. We have not restated prior periods. We have included the following description to provide readers a comparative analysis of the accounting impact of this standard. Both the Trust and the Partnership have been consolidated from the date of their creation through December 31, 2003. As a result of the new consolidation standards established by FIN 46R, the Company, effective January 1, 2004, deconsolidated the activities of the Trust and the Partnership. We have highlighted the comparative effect of this change in the following table:
Balance Sheet - ------------- As of ------------------------------------------------------------- ($ in thousands) December 31, 2003 December 31, 2004 Change - ---------------- --------------------- -------------------- -------------- Assets: Cash $ 2,103 $ - $ (2,103) (1) Investments - 12,645 12,645 (2) Liabilities: Long-term debt - 63,765 (3) (137,485) (3) EPPICS 201,250 - (3) Statement of Operations - ----------------------- As reported for the year ended ------------------------------------------------------------- ($ in thousands) December 31, 2003 December 31, 2004 Change - ---------------- --------------------- -------------------- -------------- Investment income $ - $ 632 $ 632 (4) Interest expense - 8,082 8,082 (5) Dividends on EPPICS (before tax) 10,063 - (10,063) (6) --------------------- -------------------- -------------- Net $ 10,063 $ 7,450 $ (2,613) ===================== ==================== ==============
(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. 20 (3) As a result of the deconsolidation, the Trust and the Partnership balance sheets were 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." As of December 31, 2004, Citizens has $53.3 million ($63.8 million less $10.5 million of intercompany debt) 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. 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 either by contract, rule or regulation. Our $200.0 million term loan facility with the Rural Telephone Finance Cooperative (RTFC) contains a maximum leverage ratio covenant. Under the leverage ratio covenant, we are required to maintain a ratio of (i) total indebtedness minus cash and cash equivalents in excess of $50.0 million to (ii) consolidated adjusted EBITDA (as defined in the agreements) over the last four quarters no greater than 4.25 to 1 through December 30, 2004, and 4.00 to 1 thereafter. Our new $250 million credit facility contains a maximum leverage ratio covenant. Under the leverage ratio covenant, we are required to maintain a ratio of (i) total indebtedness minus cash and cash equivalents in excess of $50.0 million to (ii) consolidated adjusted EBITDA (as defined in the agreement) over the last four quarters no greater than 4.50 to 1. Although the new credit facility is unsecured, it will be equally and ratably secured by certain liens and equally and ratably guaranteed by certain of our subsidiaries if we issue debt that is secured or guaranteed. We are in compliance with all of our debt and credit facility covenants. Divestitures - ------------ On August 24, 1999, our Board of Directors approved a plan of divestiture for our public utilities services businesses, which included gas, electric and water and wastewater businesses. As of April 1, 2004, we 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. On August 11, 2003, we completed the sale of our Arizona gas and electric divisions for $224.1 million in cash. 21 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. In February 2005, we entered into a definitive agreement to sell Conference-Call USA, LLC, (CCUSA) our conferencing services business for $41.0 million in cash, subject to adjustments under the terms of the agreement. This transaction is expected to close by March 31, 2005. CCUSA had revenues of $24.6 million and operating income of $8.0 million for the year ended December 31, 2004. At December 31, 2004, CCUSA's net assets totaled $24.4 million. Critical Accounting Policies and Estimates - ------------------------------------------ We review all significant estimates affecting our consolidated financial statements on a recurring basis and record the effect of any necessary adjustment prior to their publication. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements; accordingly, it is possible that actual results could differ from those estimates and changes to estimates could occur in the near term. The preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of the contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates and judgments are used when accounting for allowance for doubtful accounts, impairment of long-lived assets, intangible assets, depreciation and amortization, employee benefit plans, income taxes, contingencies, and pension and postretirement benefits expenses among others. Telecommunications Bankruptcies Our estimate of anticipated losses related to telecommunications bankruptcies is a "critical accounting estimate." We have significant on-going normal course business relationships with many telecom providers, some of which have filed for bankruptcy. We generally reserve approximately 95% of the net outstanding pre-bankruptcy balances owed to us and believe that our estimate of the net realizable value of the amounts owed to us by bankrupt entities is appropriate. Asset Impairment Our asset impairment charges in 2002 were critical estimates. In 2003 and 2004, we had no "critical estimates" related to asset impairments. Depreciation and Amortization The calculation of depreciation and amortization expense is based on the estimated economic useful lives of the underlying property, plant and equipment and identifiable intangible assets. Rapid changes in technology or changes in market conditions could result in revisions to such estimates that could affect the carrying value of these assets and our future consolidated operating results. Our depreciation expense has decreased substantially from prior periods as a result of the impairment write-down we recorded during 2002, the adoption of SFAS No. 143 and the increase in the average depreciable lives for certain of our equipment. Intangibles Our indefinite lived intangibles consist of goodwill and trade name, which resulted from the purchase of ILEC properties. We test for impairment of these assets annually, or more frequently, as circumstances warrant. All of our ILEC properties share similar economic characteristics and as a result, our reporting unit is the ILEC segment. In determining fair value of goodwill during 2004 we compared the net book value of the ILEC assets to trading values of the Company's publicly traded common stock. Additionally, we utilized a range of prices to gauge sensitivity. Our test determined that fair value exceeded book value of goodwill. An independent third party appraiser analyzed trade name. Pension and Other Postretirement Benefits Our estimates of pension expense, other post retirement benefits including retiree medical benefits and related liabilities are "critical accounting estimates." We sponsor a noncontributory defined benefit pension plan covering a significant number of our employees and other post retirement benefit plans that provide medical, dental, life insurance benefits and other benefits for covered retired employees and their beneficiaries and covered dependents. The accounting results for pension and post retirement benefit costs and obligations are dependent upon various actuarial assumptions applied in the determination of such amounts. These actuarial assumptions include the following: discount rates, expected long-term rate of return on plan assets, future compensation increases, employee turnover, healthcare cost trend rates, expected retirement age, optional form of benefit and mortality. The Company reviews these assumptions for changes annually with its outside actuaries. We consider our discount rate and expected long-term rate of return on plan assets to be our most critical assumptions. 22 The discount rate is used to value, on a present basis, our pension and post retirement benefit obligation as of the balance sheet date. The same rate is also used in the interest cost component of the pension and post retirement benefit cost determination for the following year. The measurement date used in the selection of our discount rate is the balance sheet date. Our discount rate assumption is determined annually with assistance from our actuaries based on the interest rates for long-term high quality corporate bonds. This rate can change from year-to-year based on market conditions that impact corporate bond yields. Our discount rate declined from 6.25% at year-end 2003 to 6.0% at year-end 2004. The expected long-term rate of return on plan assets is applied in the determination of periodic pension and post retirement benefit cost as a reduction in the computation of the expense. In developing the expected long-term rate of return assumption, we considered published surveys of expected market returns, 10 and 20 year actual returns of various major indices, and our own historical 5-year and 10-year investment returns. The expected long-term rate of return on plan assets is based on an asset allocation assumption of 30% to 45% in fixed income securities and 55% to 70% in equity securities. We review our asset allocation at least annually and make changes when considered appropriate. In 2004, we did not change our expected long-term rate of return from the 8.25% used in 2003. Our pension plan assets are valued at actual market value as of the measurement date. Accounting standards require that we record an additional minimum pension liability when the plan's "accumulated benefit obligation" exceeds the fair market value of plan assets at the pension plan measurement (balance sheet) date. In the fourth quarter of 2003, due to strong performance in the equity markets during 2003, partially offset by a decrease in the year-end discount rate, the Company recorded a reduction to its minimum pension liability in the amount of $35.0 million with a corresponding increase to shareholders' equity of $22.0 million, net of taxes of $13.0 million. In the fourth quarter of 2004, mainly due to a decrease in the year-end discount rate, the Company recorded an additional minimum pension liability in the amount of $17.4 million with a corresponding charge to shareholders' equity of $10.7 million, net of taxes of $6.7 million. These adjustments did not impact our earnings or cash flows. Actual results that differ from our assumptions are added or subtracted to our balance of unrecognized actuarial gains and losses. For example, if the year-end discount rate used to value the plan's projected benefit obligation decreases from the prior year-end then the plan's actuarial loss will increase. If the discount rate increases from the prior year-end then the plan's actuarial loss will decrease. Similarly, the difference generated from the plan's actual asset performance as compared to expected performance would be included in the balance of unrecognized gains and losses. The impact of the balance of accumulated actuarial gains and losses are recognized in the computation of pension cost only to the extent this balance exceeds 10% of the greater of the plan's projected benefit obligation or market value of plan assets. If this occurs, that portion of gain or loss that is in excess of 10% is amortized over the estimated future service period of plan participants as a component of pension cost. The level of amortization is affected each year by the change in actuarial gains and losses and could potentially be eliminated if the gain/loss activity reduces the net accumulated gain/loss balance to a level below the 10% threshold. We expect that our pension expense for 2005 will be $5.0 million to $7.0 million (it was $3.6 million in 2004) and no contribution will be required to be made by us to the pension plan in 2005. In October 2004, we made a voluntary contribution of $20.0 million to the pension plan. Income Taxes Our effective tax rate has declined as a result of the completion of audits with federal and state taxing authorities during 2004 and changes in the structure of certain of our subsidiaries. Management has discussed the development and selection of these critical accounting estimates with the audit committee of our board of directors and our audit committee has reviewed our disclosures relating to them. 23 New Accounting Pronouncements - ----------------------------- Goodwill and Other Intangibles In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." This statement requires that goodwill and other intangibles with indefinite useful lives no longer be amortized to earnings, but instead be reviewed for impairment. We have no intangibles with indefinite useful lives other than goodwill and trade name. The amortization of goodwill and trade name ceased upon adoption of the statement on January 1, 2002. We were required to test for impairment of goodwill and other intangibles with indefinite useful lives as of January 1, 2002 and at least annually thereafter. Any transitional impairment loss at January 1, 2002 was recognized as the cumulative effect of a change in accounting principle in our statement of operations. As a result of our adoption of SFAS No. 142, we recognized a transitional impairment loss related to ELI of $39.8 million as a cumulative effect of a change in accounting principle in our statement of operations in 2002. We annually examine the carrying value of our goodwill and other intangibles with estimated useful lives to determine whether there are any impairment losses and have determined for the year ended December 31, 2004 that there was no impairment. 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." We reassess the useful life of our intangible assets with estimated useful lives annually. The impact of the adoption of SFAS No. 142 is discussed in Note 2 to Consolidated Financial Statements. Accounting for Asset Retirement Obligations In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 applies to fiscal years beginning after June 15, 2002, and addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. We adopted SFAS No. 143 effective January 1, 2003. The standard applies to legal obligations associated with the retirement of long-lived assets that result from acquisition, construction, development or normal use of the assets and requires that a legal liability for an asset retirement obligation be recognized when incurred, recorded at fair value and classified as a liability in the balance sheet. When the liability is initially recorded, the entity will capitalize the cost and increase the carrying value of the related long-lived asset. The liability is then accreted to its present value each period and the capitalized cost is depreciated over the estimated useful life of the related asset. At the settlement date, the entity will settle the obligation for its recorded amount or recognize a gain or loss upon settlement. Depreciation expense for our wireline operations had historically included an additional provision for cost of removal. Effective with the adoption of SFAS No. 143, on January 1, 2003, the Company ceased recognition of the cost of removal provision in depreciation expense and eliminated the cumulative cost of removal included in accumulated depreciation, as the Company has no legal obligation to remove certain long-lived assets. The cumulative effect of retroactively applying these changes to periods prior to January 1, 2003, resulted in an after tax non-cash gain of approximately $65.8 million recognized in 2003. Long-Lived Assets In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement establishes a single accounting model, based on the framework established in SFAS No. 121, for impairment of long-lived assets held and used and for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. We adopted this statement on January 1, 2002. Debt Retirement In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement eliminates the requirement that gains and losses from extinguishment of debt be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. The statement requires gains and losses from extinguishment of debt to be classified as extraordinary items only if they meet the criteria in Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" which provides guidance for distinguishing transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification as an extraordinary item. We adopted SFAS No. 145 in the second quarter of 2002. 24 During the year ended December 31, 2004 and 2003, we recognized $66.5 million and $10.9 million, respectively, of losses from the early retirement of debt. During the year ended December 31, 2002, we recognized $5.6 million of gains from early debt retirement. In addition, for the year ended December 31, 2002, we recognized a $12.8 million loss due to a tender offer related to certain debt securities. These gains/losses were recorded in other income (loss), net. 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, and the disclosure requirements were effective for financial statements for periods ending after December 15, 2002. We adopted FIN 45 on January 1, 2003. The adoption of FIN 45 did not have any material impact on our financial position or results of operations. Stock-Based Compensation In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123, "Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation and amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements. This statement is effective for fiscal years ending after December 15, 2002. We have adopted the expanded disclosure requirements of SFAS No. 148. In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment," ("SFAS No. 123R"). SFAS No. 123R requires that stock-based employee compensation be recorded as a charge to earnings for interim or annual periods beginning after June 15, 2005. Accordingly, we will adopt SFAS No. 123R commencing July 1, 2005 (third quarter) and expect to recognize approximately $3.0 million of expense for the last six months of 2005. 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." SFAS No. 150 establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. Generally, SFAS No. 150 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 SFAS No. 150 on July 1, 2003. The adoption of SFAS No. 150 did not have any material impact on our financial position or results of operations. 25 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. Pension and Other Postretirement Benefits In December 2003, the FASB issued SFAS No. 132 (revised), "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132 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. SFAS No. 132 is effective for fiscal years ending after December 15, 2003. We adopted the expanded disclosure requirements of SFAS No. 132 (revised). Investments In March 2004, the FASB issued EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" (EITF 03-1) which provides new guidance for assessing impairment losses on debt and equity investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed not to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however, the disclosure requirements remain effective and have been adopted for our year ended December 31, 2004. Although we have no material investments at the present time, we will evaluate the effect, if any, of EITF 03-1 when final guidance is released. (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 are not dependent upon significant judgments by management, with the exception of a determination of a provision for uncollectible amounts. CLEC revenue is generated through local, long distance, data and long-haul services. These services are primarily provided under a monthly recurring fee or based on usage at agreed upon rates and are not dependent upon significant judgments by management with the exception of the determination of a provision for uncollectible amounts and realizability of reciprocal compensation. CLEC usage based revenue includes amounts determined under reciprocal compensation agreements. While this revenue is governed by specific contracts with the counterparty, management defers recognition of disputed portions of such revenue until realizability is assured. Revenue earned from long-haul contracts is recognized over the term of the related agreement. Consolidated revenue decreased $252.0 million, or 10% in 2004. The decrease in 2004 was primarily due to $228.9 million of decreased gas and electric revenue primarily due to the disposition of our Arizona gas and electric operations, The Gas Company in Hawaii and our Vermont electric division and $23.1 million of decreased telecommunications revenue. Consolidated revenue decreased $224.4 million, or 8% in 2003. The decrease in 2003 was primarily due to $192.7 million of decreased gas and electric revenue primarily due to the disposition of our Arizona gas and electric operations and The Gas Company in Hawaii division and $31.7 million of decreased telecommunications revenue. 26 Consolidated revenue increased $212.3 million, or 9%, in 2002. The increase in 2002 was primarily due to $420.5 million of increased telecommunications revenue, largely due to the impact of the Frontier acquisition on June 29, 2001, partially offset by $195.0 million of decreased gas revenue largely due to the disposition of the Louisiana and Colorado gas operations and the disposition of the Kauai electric division. On October 31, 2002 and April 1, 2003, we sold approximately 4,000 and 11,000 telephone access lines, respectively, in North Dakota. The revenues related to these access lines totaled $1.9 million; $10.2 million and $11.1 million for the years ended December 31, 2003, 2002 and 2001, respectively. Change in the number of our access lines is the most fundamental driver of changes in our telecommunications revenue. We have been losing 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 high-speed internet or cable modem service. We lost approximately 65,700 access lines during 2004 but added approximately 91,800 high-speed internet subscribers during this period. The loss of lines during 2004 was primarily among residential customers. The non-residential line losses were principally in Rochester, New York, while the residential losses were throughout our markets. We expect to continue to lose access lines but to increase high-speed internet subscribers during 2005. A continued loss of access lines, combined with increased competition and the other factors discussed in MD&A, will cause our revenues to decrease in 2005. In addition, we have entered into a definitive agreement to sell our conferencing services business, which had revenue of $24.6 million during 2004.
TELECOMMUNICATIONS REVENUE ($ in thousands) 2004 2003 2002 ---------------- ----------------------------- ----------------------------- --------- Amount $ Change % Change Amount $ Change % Change Amount --------- ------------------ ----------- ----------------- --------- Access services $ 634,196 $ (32,846) -5% $ 667,042 $ (24,852) -4% $ 691,894 Local services 851,177 (7,825) -1% 859,002 8,683 1% 850,319 Long distance and data services 321,854 15,020 5% 306,834 7,508 3% 299,326 Directory services 110,623 3,689 3% 106,934 2,551 2% 104,383 Other 109,365 8,242 8% 101,123 (15,860) -14% 116,983 --------- --------- ---------- ---------- --------- ILEC revenue 2,027,215 (13,720) -1% 2,040,935 (21,970) -1% 2,062,905 ELI 156,030 (9,359) -6% 165,389 (9,690) -6% 175,079 --------- --------- ---------- ---------- --------- $2,183,245 $ (23,079) -1% $2,206,324 $ (31,660) -1% $2,237,984 ========= ========= ========== ========== =========
Access Services Access services revenue for the year ended December 31, 2004 decreased $32.8 million or 5%, as compared with the prior year. Switched access revenue decreased $19.6 million primarily due to $8.3 million attributable to a decline in minutes of use, the $7.4 million effect of federally mandated access rate reductions and $2.7 million associated with state intrastate access rate reductions. Access service revenue includes subsidy payments we receive from federal and state agencies. Subsidies revenue decreased $12.8 million primarily due to an $8.3 million decline in federal Universal Service Fund (USF) support because of increases in the national average cost per loop, including a $3.5 million accrual recorded during the third quarter of 2004 for mistakes made during 2002 and 2003 by the agency that calculates subsidy payments and true-ups related to 2002. The decreases were partially offset by an increase in USF surcharge revenue of $2.1 million resulting from a rate increase. Access services revenue for the year ended December 31, 2003 decreased $24.9 million or 4% as compared with the prior year. Switched access revenue decreased $20.7 million primarily due to the $18.1 million effect of federally mandated access rate reductions, $2.6 million in increased disputes and $1.2 million related to the sale of our North Dakota exchanges. Special access revenue increased $4.6 million primarily due to growth in special (point-to-point) circuits of $8.4 million partially offset by a decrease of $1.7 million attributable to the sale of our North Dakota exchanges and $1.2 million in increased disputes. Subsidy revenue decreased $8.7 million primarily due to decreased USF support of $11.8 million partially offset by an increase of $4.9 million in USF surcharge rates. We currently expect that our subsidy revenue in 2005 will be at least $20.0 million lower than 2004 because of the improvement in prior years in the profitability of our operations and lower expenses and capital expenditures in prior years than previously anticipated, and because of increases in the national average cost per loop (NACPL). Increases in the number of competitive communications companies (including wireless companies) receiving federal subsidies may lead to further increases in the NACPL, thereby resulting in further decreases in our subsidy revenue in the future. The FCC and state regulators are currently considering a number of proposals for changing the manner in which eligibility for federal subsidies is determined as well as the 27 amounts of such subsidies. The FCC is also reviewing the mechanism by which subsidies are funded. We cannot predict when or how these matters will be decided nor the effect on our subsidy revenues. Our subsidy and access revenues are very profitable so any reductions in those revenues will reduce our profitability. Local Services Local services revenue for the year ended December 31, 2004 decreased $7.8 million or 1% as compared with the prior year. Local revenue decreased $17.9 million primarily due to $4.7 million related to continued losses of access lines, $2.2 million as a result of refunds to customers because of state earnings limitations, the termination of an operator services contract of $3.4 million, $3.5 million in decreased local measured service revenue and a decline of $2.0 million in certain business services revenue. Enhanced services revenue increased $10.1 million, primarily due to sales of additional feature packages. Economic conditions or increasing competition could make it more difficult to sell our packages and bundles and cause us to lower our prices for those products and services, which would adversely affect our revenues. Local services revenue for the year ended December 31, 2003 increased $8.7 million, or 1% as compared with the prior year. Local revenue decreased $1.1 million primarily due to a $7.6 million decrease from continued losses of access lines and the $4.0 million impact of the sale of our North Dakota exchanges in 2003, partially offset by an $10.4 million increase in subscriber line charges due to rate changes. Enhanced services revenue increased $9.8 million primarily due to the sale of additional feature packages. Long Distance and Data Services Long distance and data services revenue for the year ended December 31, 2004 increased $15.0 million or 5%, as compared with the prior year. Data services (data includes high-speed internet) increased primarily due to growth of $30.7 million, partially offset by decreased long distance revenue of $15.8 million primarily attributable to a 21% decline in the average rate per minute. Our long distance minutes of use increased approximately 6.0% during 2004. 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 2005. Long distance and data services revenue for the year ended December 31, 2003 increased $7.5 million or 3% as compared with the prior year primarily due to growth of $17.6 million related to data services, partially offset by a decrease of $10.0 million in long distance revenue. Our long distance revenues decreased during 2003 due to lower average rates per minute related to the introduction of new products including unlimited long distance and lower long distance minutes of use because consumers are increasingly using their wireless phones or calling cards to make long distance calls. Directory Services Directory revenue for the year ended December 31, 2004 increased $3.7 million or 3%, as compared with the prior year due to growth in yellow pages advertising. Directory revenue for the year ended December 31, 2003 increased $2.6 million or 2%, as compared with the prior year primarily due to growth in yellow pages advertising. Other Other revenue for the year ended December 31, 2004 increased $8.2 million or 8%, as compared with the prior year primarily due to a $4.1 million carrier dispute settlement, $3.6 million in increased conferencing revenue, a decline in bad debt expense of $3.2 million and an increase in service activation revenue of $2.5 million, partially offset by decreases of $3.6 million in sales of customer premise equipment (CPE) and $1.5 million in call center services revenue. Other revenue for the year ended December 31, 2003 decreased $15.9 million, or 14% compared with the prior year primarily due to $7.8 million in increased dispute reserves, the termination in 2002 of $2.5 million in contract services provided to Global Crossing and a decrease of $2.0 million in CPE sales. In addition, revenue from collocation/rents declined $1.1 million and conferencing revenue decreased $1.0 million. 28 ELI - --- ELI revenue for the years ended December 31, 2004 and 2003 decreased $9.4 million, or 6%, and $9.7 million, or 6%, respectively, primarily due to lower demand and prices for long-haul services and lower reciprocal compensation revenues.
GAS AND ELECTRIC REVENUE ($ in thousands) 2004 2003 2002 ---------------- ----------------------------- --------------------------------- --------- Amount $ Change % Change Amount $ Change % Change Amount --------- ------------------ ----------- --------------------- --------- Gas revenue $ - $ (137,686) -100% $ 137,686 $ (78,831) -36% $ 216,517 Electric revenue $ 9,735 $ (91,193) -90% $ 100,928 $ (113,903) -53% $ 214,831
Gas revenue We did not have any gas operations in the year ended December 31, 2004. Gas revenue for the year ended December 31, 2003 decreased $78.8 million, or 36%, as compared with the prior year due to the sales of The Gas Company in Hawaii and our Arizona gas division, which were sold on August 8, 2003 and August 11, 2003, respectively. Electric revenue Electric revenue for the year ended December 31, 2004 decreased $91.2 million, or 90%, as compared with the prior year. 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. Electric revenue for the year ended December 31, 2003 decreased $113.9 million, or 53%, as compared with the prior year primarily due to the sales of our Arizona electric division and Kauai Electric. Included in electric revenue for the year ended December 31, 2002 is approximately $183.5 million of revenue from our Arizona electric division and Kauai Electric, which were sold on August 11, 2003 and November 1, 2002, respectively. We had just one remaining electric utility property as of December 31, 2003.
COST OF SERVICES ($ in thousands) 2004 2003 2002 ---------------- ----------------------------- ----------------------------- --------- Amount $ Change % Change Amount $ Change % Change Amount --------- ------------------ ----------- ----------------- --------- Network access $ 199,643 $ (23,904) -11% $ 223,547 $ (11,915) -5% $ 235,462 Gas purchased - (82,311) -100% 82,311 (40,604) -33% 122,915 Electric energy and fuel oil purchased 5,523 (58,308) -91% 63,831 (54,712) -46% 118,543 --------- --------- ---------- ---------- --------- $ 205,166 $(164,523) -45% $ 369,689 $ (107,231) -22% $ 476,920 ========= ========= ========== ========== =========
Network access Network access expenses for the year ended December 31, 2004 decreased $23.9 million, or 11%, as compared with the prior year primarily due to decreased costs in long distance access expense related to rate changes partially offset by increased circuit expense associated with additional data product sales in the ILEC sector. ELI costs have declined due to a drop in demand coupled with improved network cost efficiencies. If we continue to increase our sales of data products such as high-speed internet or expand the availability of our unlimited calling plans, our network access expense could increase. Network access expenses for the year ended December 31, 2003 decreased $11.9 million, or 5%, as compared with the prior year primarily due to decreased costs in long distance access expense related to rate changes partially offset by increased circuit expense associated with additional data product sales in the ILEC sector. ELI costs have declined due to a drop in demand coupled with improved network cost efficiencies. Gas purchased We did not have any gas operations in the year ended December 31, 2004. Gas purchased for the year ended December 31, 2003 decreased $40.6 million, or 33%, as compared with the prior year primarily due to the sales of The Gas Company in Hawaii and our Arizona gas division. 29 Electric energy and fuel oil purchased Electric energy and fuel oil purchased for the year ended December 31, 2004 decreased $58.3 million, or 91%, as compared with the prior year. We 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. Electric energy and fuel oil purchased for the year ended December 31, 2003 decreased $54.7 million, or 46%, as compared with the prior year primarily due to the sales of our Arizona electric division and Kauai Electric.
OTHER OPERATING EXPENSES ($ in thousands) 2004 2003 2002 ---------------- ----------------------------- ----------------------------- ---------- Amount $ Change % Change Amount $ Change % Change Amount --------- ------------------ ----------- ----------------- ---------- Operating expenses $630,669 $ (61,580) -9% $ 692,249 $ (70,624) -9% $ 762,873 Taxes other than income taxes 94,481 (2,638) -3% 97,119 (34,139) -26% 131,258 Sales and marketing 115,036 2,653 2% 112,383 4,159 4% 108,224 --------- --------- ---------- ---------- ---------- $ 840,186 $ (61,565) -7% $ 901,751 $ (100,604) -10% $1,002,355 ========= ========= ========== ========== ==========
Operating Expenses Operating expenses for the year ended December 31, 2004 decreased $61.6 million, or 9%, as compared with the prior year primarily due to decreased operating expenses in the public services sector due to the sales of our utilities and increased operating efficiencies and a reduction of personnel in our communications business. 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. Included in operating expenses are expenses attributable to our efforts to comply with the internal control requirements of the Sarbanes-Oxley Act of 2002. As of December 31, 2004, we have incurred approximately $4.2 million in connection with this initiative. Included in operating expenses is stock compensation expense. Compensation arrangements entered into in connection with management succession and strategic alternatives will result in stock compensation expense of approximately $5.2 million in 2005, $5.1 million in 2006 and $1.0 million in 2007. In addition, during the third quarter of 2005, we will begin expensing the cost of the unvested portion of outstanding stock options pursuant to SFAS No. 123R. We expect to recognize approximately $3.0 million of expense for the last six months of 2005. 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 increase from $3.6 million in 2004 to approximately $5.0 million to $7.0 million in 2005 and that no contribution to our pension plans will be required to be made by us to the pension plan in 2005. In addition, as medical costs increase the costs of our postretirement benefit costs also increase. Our retiree medical costs for 2004 were $16.6 million and our current estimate for 2005 is approximately $17.0 million. Operating expenses for the year ended December 31, 2003 decreased $70.6 million, or 9%, as compared with the prior year primarily due to increased operating efficiencies and a reduction of personnel in the ILEC and ELI sectors (310 fewer employees than 2002) and decreased operating expenses in the gas and electric sectors due to the sales of The Gas Company in Hawaii ($11.3 million), our Arizona gas and electric divisions ($16.4 million) and Kauai Electric ($21.5 million). Expenses were negatively impacted by increased compensation expense of $1.5 million related to variable stock plans and increased pension expenses. Taxes Other than Income Taxes Taxes other than income taxes for the year ended December 31, 2004 decreased $2.6 million, or 3%, as compared with the prior year primarily due to decreased property taxes in the public services sector due to the sales of our utilities and lower gross receipts taxes of $3.7 million in the ILEC sector that were partially offset by higher payroll, property and franchise taxes of $13.0 million. Taxes other than income taxes for the year ended December 31, 2003 decreased $34.1 million, or 26%, as compared with the prior year primarily due to decreased property taxes at ELI as a result of lower asset values and the sales of our utilities. 30 Sales and Marketing Sales and marketing expenses for the year ended December 31, 2004 increased $2.7 million, or 2%, as compared with the prior year primarily due to increased costs in the ILEC sector. Sales and marketing expenses for the year ended December 31, 2003 increased $4.2 million, or 4%, as compared to the prior year due to increased marketing costs in the ILEC sector primarily related to enhanced services and high-speed internet.
DEPRECIATION AND AMORTIZATION EXPENSE ($ in thousands) 2004 2003 2002 ---------------- ----------------------------- ----------------------------- --------- Amount $ Change % Change Amount $ Change % Change Amount --------- ------------------ ----------- ----------------- --------- Depreciation expense $ 446,190 $ (22,248) -5% $ 468,438 $ (161,675) -26% $ 630,113 Amortization expense 126,520 (318) 0% 126,838 1,429 1% 125,409 --------- --------- ---------- ---------- --------- $ 572,710 $ (22,566) -4% $ 595,276 $ (160,246) -21% $ 755,522 ========= ========= ========== ========== =========
Depreciation expense for the year ended December 31, 2004 decreased $22.2 million, or 5% as compared to the prior year because the net asset base is declining. Depreciation expense for the year ended December 31, 2003 decreased $161.7 million, or 26%, as compared with the prior year primarily due to the ELI impairment charge recognized during the third quarter of 2002, which reduced ELI's asset base, the adoption of SFAS No. 143 and the increase in the average depreciable lives for certain of our equipment. Accelerated depreciation in 2002 of $23.4 million relating to the closing of our Plano, Texas facility also contributed to the decrease. Amortization expense for the year ended December 31, 2003 increased $1.4 million, or 1% as compared with the prior year primarily due to the receipt of the final valuation report of our Frontier acquisition during the second quarter of 2002, which resulted in an increase in our customer base.
RESERVE FOR TELECOMMUNICATIONS BANKRUPTCIES / RESTRUCTURING AND OTHER EXPENSES / MANAGEMENT SUCCESSION AND STRATEGIC ALTERNATIVES EXPENSES ($ in thousands) 2004 2003 2002 - ---------------- ------------------------------ ----------------------------- --------- Amount $ Change % Change Amount $ Change % Change Amount --------- ------------------- ---------- ------------------ --------- Reserve for (recovery of) telecommunications bankruptcies $ - $ 4,377 -100% $ (4,377) $ (15,257) -140% $ 10,880 Restructuring and other expenses $ - $ (9,687) -100% $ 9,687 $ (27,499) -74% $ 37,186 Management succession and strategic alternatives expenses $ 90,632 $ 90,632 100% $ - $ - 0% $ -
Management succession and strategic alternatives expenses in 2004 include a mix of cash retention payments, equity awards and severance agreements (see Note 13 to Consolidated Financial Statements for a complete discussion). During the fourth quarter of 2003, an agreement with WorldCom/MCI settling all pre-bankruptcy petition obligations and receivables was approved by the bankruptcy court. This settlement resulted in reduction to our reserve of approximately $6.6 million in the fourth quarter of 2003. During the second quarter of 2003, we reserved approximately $2.3 million of trade receivables with Touch America as a result of Touch America's filing for bankruptcy. These receivables were generated as a result of providing ordinary course telecommunication services. If other telecommunications companies file for bankruptcy, we may have additional significant reserves in future periods. Concurrent with the acquisition of Frontier, we entered into several operating agreements with Global Crossing. We have ongoing commercial relationships with Global Crossing affiliates. We reserved a total of $29.0 million of Global Crossing receivables during 2001 and 2002 as a result of Global Crossing's filing for bankruptcy to reflect our best estimate of the net realizable value of receivables resulting from these commercial relationships. We recorded a write-down of such receivables in the amount of $7.8 million in 2002 and $21.2 million in 2001. In 2002, as the result of a settlement agreement with Global Crossing, we reversed $17.9 million of our previous write-down reserve of the net realizable value of these receivables. 31 Restructuring and other expenses for 2003 primarily consist of severance expenses related to reductions in personnel at our telecommunications operations and the write-off of software no longer used. LOSS ON IMPAIRMENT ($ in thousands) 2003 2002 ---------------- --------- --------- Amount Amount --------- --------- Loss on impairment $ 15,300 $ 1,074,058 During the third and fourth quarters of 2003, we recognized additional pre-tax impairment losses of $4.0 million and $11.3 million related to our Vermont property to write down assets to be sold to our best estimate of their net realizable value upon sale. In the third quarter of 2002, we recognized non-cash pre-tax impairment losses of $656.7 million related to property, plant and equipment in the ELI sector and $417.4 million related to the gas and electric sector assets held for sale. Our assessment of impairment for ELI was a result of continued losses at ELI and continued actual revenue declines in excess of projected revenue declines. The gas and electric sector impairments were associated with the sale of our Arizona and Hawaii gas and electric properties at prices that were less than the previous carrying values and the write-down of our remaining utility to our best estimate of net realizable sales price. Previously, we believed that the net realizable value of these properties was equal to or above their carrying values. However, as a result of market conditions, and the desire to complete the divestiture process quickly in order to focus on our core telecommunications operations and raise money to further reduce debt, in the third quarter of 2002 we made a strategic decision to accept proceeds less than carrying values rather than continue to market these properties for higher prices (See Critical Accounting Policies and Estimates above).
INVESTMENT AND OTHER INCOME (LOSS), NET / INTEREST EXPENSE / INCOME TAX EXPENSE (BENEFIT) ($ in thousands) 2004 2003 2002 ---------------- ----------------------------- ----------------------------- --------- Amount $ Change % Change Amount $ Change % Change Amount --------- ------------------ ----------- ----------------- --------- Investment income (loss), net $ 33,626 $ 23,194 222% $ 10,432 $ 108,791 111% $ (98,359) Other income (loss), net $ (53,359) $ (97,348) -221% $ 43,989 $ 21,452 95% $ 22,537 Interest expense $ 379,024 $ (37,500) -9% $ 416,524 $ (51,705) -11% $ 468,229 Income tax expense (benefit) $ 13,379 $ (53,837) -80% $ 67,216 $ 482,090 116% $(414,874)
Investment Income Investment income for the year ended December 31, 2004 increased $23.2 million as compared with the prior year primarily due to the sale of our investments in D & E and HTCC and higher income from money market balances and short-term investments. Investment income for the year ended December 31, 2003 increased $108.8 million as compared to prior year primarily due to the recognition in 2002 of non-cash pre-tax losses of $95.3 million resulting from an other than temporary decline in the value of our investment in Adelphia and $16.4 million resulting from an other than temporary decline in the value of our investment in D & E (see Note 9 to Consolidated Financial Statements), partially offset by lower income in 2003 from money market balances and short-term investments. Other Income (Loss) Other loss, net for the year ended December 31, 2004 increased $97.3 million as compared to prior year primarily due to a pre-tax loss from the early extinguishment of debt of $66.5 million in 2004, and the recognition in 2003 of $69.5 million in non-cash pre-tax gains related to a capital lease termination and a capital lease restructuring at ELI, partially offset in 2004 by $25.3 million in income from the expiration of certain retained liabilities at less than face value, which are associated with customer advances for construction from our disposed water properties and a net loss on sales of assets in 2004 of $1.9 million, which is primarily attributable to the loss on the sale of our corporate aircraft, compared to a net loss on sales of assets in 2003 of $20.5 million. Other income, net for the year ended December 31, 2003 increased $21.5 million, or 95%, as compared to the prior year primarily due to $69.5 million in non-cash pre-tax gains in 2003 related to capital lease restructurings at ELI, $6.2 million of income in 2003 from the settlement of certain retained liabilities at less than face value, which are associated with customer advances for construction from our disposed water properties, a decrease of $20.1 million compared to income of $26.3 million in 2002, partially offset by a net loss on sales of assets in 2003 of $20.5 million, compared with the prior year's gain of $9.8 million, primarily due to the sales of The Gas Company in Hawaii and our Arizona gas and electric divisions, the sale of access lines in North Dakota and 32 our wireless partnership interest in Wisconsin, and the sale of our Plano, Texas office building. During 2003, we executed a series of purchases in the open market of our outstanding notes and debentures that generated a pre-tax loss from the early extinguishment of debt of approximately $3.1 million. Interest Expense Interest expense for the year ended December 31, 2004 decreased $37.5 million, or 9%, as compared with the prior year primarily due to the retirement of debt. During the year ended December 31, 2004, we had average long-term debt (excluding equity units and convertible preferred stock) outstanding of $4.2 billion compared to $4.6 billion during the year ended December 31, 2003. Our composite average borrowing rate for the year ended December 31, 2004 as compared with the prior year period was 11 basis points lower, decreasing from 8.07% to 7.96%. Interest expense for the year ended December 31, 2003 decreased $51.7 million, or 11%, as compared with the prior year primarily due to the retirement of debt partially offset by higher average interest rates. During the year ended December 31, 2003, we had average long-term debt (excluding equity units and convertible preferred stock) outstanding of $4.6 billion compared to $5.2 billion during the year ended December 31, 2002. Our weighted average borrowing rate for the year ended December 31, 2003 as compared with the prior year period was 20 basis points higher, increasing from 7.87% to 8.07%, due to the repayment of debt with interest rates below our average rate. Income Taxes Income taxes for the year ended December 31, 2004 decreased $53.8 million, or 80%, as compared with the prior year primarily due to changes in taxable income (loss). Income tax benefit for the year ended December 31, 2003 increased $482.1 million as compared with the prior year primarily due to changes in taxable income (loss). The effective tax rate for 2004 is 15.6% as compared with an effective tax rate of 34.4% for 2003. Our effective tax rate has declined as a result of the completion of audits with federal and state taxing authorities during 2004 and changes in the structure of certain of our subsidiaries. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ($ in thousands) 2003 2002 - ---------------- --------- --------- Amount Amount --------- --------- Cumulative effect of change in accounting principle $ 65,769 $ (39,812) During the first quarter of 2003, as a result of our adoption of SFAS No. 143, "Accounting for Asset Retirement Obligations," we recognized an after tax non-cash gain of approximately $65.8 million. During the first quarter of 2002, as a result of our adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," we recognized a transitional impairment loss of $39.8 million for goodwill related to ELI (see Note 2 to Consolidated Financial Statements). DISCONTINUED OPERATIONS ($ in thousands) 2002 - ---------------- ----------- Amount ----------- Revenue $ 4,650 Operating income (loss) $ (415) Income (loss) from discontinued operations, net of tax $ (1,478) Gain on disposal of water segment net of tax $ 181,369 On January 15, 2002, we completed the sale of our water and wastewater operations for $859.1 million in cash and $122.5 million of assumed debt and other liabilities. The gain on the disposal of the water segment, net of tax, was $181.4 million. 33 Item 7A. Quantitative and Qualitative Disclosures about Market Risk ---------------------------------------------------------- Disclosure of primary market risks and how they are managed We are exposed to market risk in the normal course of our business operations due to ongoing investing and funding activities, including those associated with our pension assets. Market risk refers to the potential change in fair value of a financial instrument as a result of fluctuations in interest rates and equity and commodity prices. We do not hold or issue derivative instruments, derivative commodity instruments or other financial instruments for trading purposes. As a result, we do not undertake any specific actions to cover our exposure to market risks and we are not party to any market risk management agreements other than in the normal course of business or to hedge long-term interest rate risk. Our primary market risk exposure is interest rate risk as follows: Interest Rate Exposure Our exposure to market risk for changes in interest rates relates primarily to the interest-bearing portion of our investment portfolio and interest on our long term debt and capital lease obligations. The long term debt and capital lease obligations include various instruments with various maturities and weighted average interest rates. Our objectives in managing our interest rate risk are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, a majority of our borrowings have fixed interest rates. Consequently, we have limited material future earnings or cash flow exposures from changes in interest rates on our long-term debt and capital lease obligations. A hypothetical 10% adverse change in interest rates would increase the amount that we pay on our variable obligations and could result in fluctuations in the fair value of our fixed rate obligations. Based upon our overall interest rate exposure at December 31, 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. For the year ended December 31, 2004, the interest savings resulting from these interest rate swaps totaled approximately $9.4 million. Sensitivity analysis of interest rate exposure At December 31, 2004, the fair value of our long-term debt and capital lease obligations was estimated to be approximately $4.6 billion, based on our overall weighted average borrowing rate of 7.83% and our overall weighted maturity of 13 years. There has been no material change in the weighted average maturity since December 31, 2003. The overall weighted average interest rate decreased in 2004 by approximately 26 basis points. A hypothetical increase of 78 basis points in our weighted average interest rate (10% of our overall weighted average borrowing rate) would result in an approximate $218.4 million decrease in the fair value of our fixed rate obligations. Equity Price Exposure Our exposure to market risks for changes in equity prices as of December 31, 2004 is limited to our investment in Adelphia, and our pension assets of $761.2 million. As of December 31, 2004 and December 31, 2003, we owned 3,059,000 shares of Adelphia common stock. The stock price of Adelphia was $0.39 and $0.55 at December 31, 2004 and December 31, 2003, respectively. On August 13, 2004, we sold our entire 1,333,500 shares of D & E for approximately $13.3 million in cash. On September 3, 2004, we sold our entire holdings of 2,605,908 common share equivalents in HTCC for approximately $13.2 million in cash. Sensitivity analysis of equity price exposure At December 31, 2004, the fair value of the equity portion of our investment portfolio was estimated to be $1.2 million. A hypothetical 10% decrease in quoted market prices would result in an approximate $120,000 decrease in the fair value of the equity portion of our investment portfolio. 34 Disclosure of limitations of sensitivity analysis Certain shortcomings are inherent in the method of analysis presented in the computation of fair value of financial instruments. Actual values may differ from those presented should market conditions vary from assumptions used in the calculation of the fair value. This analysis incorporates only those exposures that exist as of December 31, 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. Item 8. Financial Statements and Supplementary Data ------------------------------------------- The following documents are filed as part of this Report: 1. Financial Statements, See Index on page F-1. 2. Supplementary Data, Quarterly Financial Data is included in the Financial Statements (see 1. above). Item 9. Changes in and Disagreements with Accountants on Accounting and --------------------------------------------------------------- Financial Disclosure -------------------- None Item 9A. Controls and Procedures ----------------------- (i) Disclosure Controls and Procedures We carried out an evaluation, under the supervision and with the participation of our management including our principal executive officer and principal financial officer, regarding the effectiveness of the design and operation of our disclosure controls and procedures. Based upon this evaluation, our principal executive officer and principal financial officer concluded, as of the end of the period covered by this report, December 31, 2004, that our disclosure controls and procedures are effective. (ii) Internal Control Over Financial Reporting (a) Management's annual report on internal control over financial reporting Our management report on internal control over financial reporting appears on page F-2 and is incorporated by reference. (b) Attestation report of registered public accounting firm The attestation report of KPMG LLP, our independent registered public accounting firm, on management's assessment of the effectiveness of our internal control over financial reporting appears on page F-3 and is incorporated by reference. (c) Changes in internal control over financial reporting We reviewed our internal control over financial reporting at December 31, 2004. During the fourth quarter of 2004, we engaged the tax consulting services of PricewaterhouseCoopers, LLP to supplement our internal tax staff and enhance our internal controls over income tax accounting. We made no other change in our internal control over financial reporting during the last fiscal quarter of 2004 that materially affected or is reasonably likely to materially affect our internal control over financial reporting. Item 9B. Other Information ----------------- None PART III -------- Item 10. Directors and Executive Officers of the Registrant -------------------------------------------------- The information required by this Item is incorporated by reference from our definitive proxy statement for the 2005 Annual Meeting of Stockholders to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 2004. See "Executive Officers of the Registrant" in Part I of this Report following Item 4 for information relating to executive officers. 35 Item 11. Executive Compensation ---------------------- The information required by this Item is incorporated by reference from our definitive proxy statement for the 2005 Annual Meeting of Stockholders to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 2004. Item 12. Security Ownership of Certain Beneficial Owners and Management and ------------------------------------------------------------------ Related Stockholder Matters --------------------------- The information required by this Item is incorporated by reference from our definitive proxy statement for the 2005 Annual Meeting of Stockholders to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 2004. Item 13. Certain Relationships and Related Transactions ---------------------------------------------- The information required by this Item is incorporated by reference from our definitive proxy statement for the 2005 Annual Meeting of Stockholders to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 2004. Item 14. Principal Accountant Fees and Services -------------------------------------- The information required by this Item is incorporated by reference from our definitive proxy statement for the 2005 Annual Meeting of Stockholders to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 2004. PART IV ------- Item 15. Exhibits and Financial Statement Schedules ------------------------------------------ List of Documents Filed as a Part of This Report: (1) Index to Consolidated Financial Statements: Independent Auditors' Report Consolidated balance sheets as of December 31, 2004 and 2003 Consolidated statements of operations for the years ended December 31, 2004, 2003 and 2002 Consolidated statements of shareholders' equity for the years ended December 31, 2004, 2003 and 2002 Consolidated statements of comprehensive income (loss) for the years ended December 31, 2004, 2003 and 2002 Consolidated statements of cash flows for the years ended December 31, 2004, 2003 and 2002 Notes to consolidated financial statements (2) Index to Financial Statement Schedules: Schedule II - Valuation and Qualifying Accounts All other schedules have been omitted because the required information is included in the consolidated financial statements or the notes thereto, or is not applicable or required. 36 (3) Index to Exhibits: Exhibit No. Description - ------- ----------- 3.200.1 Restated Certificate of Incorporation of Citizens Communications Company, as restated May 19, 2000 (incorporated by reference to Exhibit 3.200.1 to the Registrant's Quarterly Report on Form 10-Q for the six months ended June 30, 2000, File No. 001-11001). 3.200.5 By-laws of Citizens Communications Company, as amended through July 10, 2004 (incorporated by reference to Exhibit 3.200.5 to the Registrant's Quarterly Report on Form 10-Q for the nine months ended September 30, 2004, File No. 001-11001). 4.100.1 Certificate of Trust of Citizens Communications Trust dated as of April 27, 2001 (incorporated by reference to Exhibit 4.5 of the Registrant's Amendment No.1 to Form S-3 filed May 7, 2001 (Registration No. 333-58044). 4.100.2 Trust Agreement of Citizens Capital Trust I, dated as of April 27, 2001 (incorporated by reference to Exhibit 4.6 of the Registrant's Amendment No.1 to Form S-3 filed May 7, 2001 (Registration No. 333-58044). 4.100.3 Form of 2011 Note (incorporated by reference to Exhibit 4.4 of the Registrant's Current Report on Form 8-K filed on May 24, 2001, File No. 001-11001). 4.100.4 Form of Senior Note due 2006 (incorporated by reference to Exhibit 4.5 of the Registrant's Current Report on Form 8-K filed on June 21, 2001, File No. 001-11001). 4.100.5 Form of Senior Notes due 2008 and due 2031 (incorporated by reference to Exhibit 4.1 of the Registrant's Current Report on Form 8-K filed on August 22, 2001, File No. 001-11001). 4.100.6 Form of 2013 Note (incorporated by reference to Exhibit 4.2 of the Registrant's Current Report on Form 8-K filed on November 12, 2004, File No. 001-11001). 4.200.1 First Supplemental Indenture dated as of January 15, 1996, between Citizens Utilities Company and Chemical Bank, as indenture trustee (incorporated by reference to Exhibit 4.200.2 to the Registrant's Form 8-K Current Report filed May 28, 1996, File No. 001-11001). 4.200.2 5% Convertible Subordinated Debenture due 2036 (contained as Exhibit A to Exhibit 4.200.2), (incorporated by reference to Exhibit 4.200.2 to the Registrant's Form 8-K Current Report filed May 28, 1996, File No. 001-11001). 4.200.3 Amended and Restated Declaration of Trust dated as of January 15, 1996, of Citizens Utilities Trust (incorporated by reference to Exhibit 4.200.4 to the Registrant's Form 8-K Current Report filed May 28, 1996, File No. 001-11001). 4.200.4 Convertible Preferred Security Certificate (contained as Exhibit A-1 to Exhibit 4.200.4), (incorporated by reference to Exhibit 4.200.4 to the Registrant's Form 8-K Current Report filed May 28, 1996, File No. 001-11001). 4.200.5 Amended and Restated Limited Partnership Agreement dated as of January 15, 1996 of Citizens Utilities Capital L.P. (incorporated by reference to Exhibit 4.200.6 to the Registrant's Form 8-K Current Report filed May 28, 1996, File No. 001-11001). 4.200.6 Partnership Preferred Security Certificate (contained as Annex A to Exhibit 4.200.6), (incorporated by reference to Exhibit 4.200.6 to the Registrant's Form 8-K Current Report filed May 28, 1996, File No. 001-11001). 4.200.7 Convertible Preferred Securities Guarantee Agreement dated as of January 15, 1996 between Citizens Utilities Company and Chemical Bank, as guarantee trustee (incorporated by reference to Exhibit 4.200.8 to the Registrant's Form 8-K Current Report filed May 28, 1996, File No. 001-11001). 4.200.8 Partnership Preferred Securities Guarantee Agreement dated as of January 15, 1996 between Citizens Utilities Company and Chemical Bank, as guarantee trustee (incorporated by reference to Exhibit 4.200.9 to the Registrant's Form 8-K Current Report filed May 28, 1996, File No. 001-11001). 4.200.9 Letter of Representations dated January 18, 1996, from Citizens Utilities Company and Chemical Bank, as trustee, to DTC, for deposit of Convertible Preferred Securities with DTC (incorporated by reference to Exhibit 4.200.10 to the Registrant's Form 8-K Current Report filed May 28, 1996, File No. 001-11001). 4.300 Indenture of Securities, dated as of August 15, 1991, to Chemical Bank, as Trustee (incorporated by reference to Exhibit 4.100.1 to the Registrant's Quarterly Report on Form 10-Q for the nine months ended September 30, 1991, File No. 001-11001). 4.300.1 Second Supplemental Indenture, dated January 15, 1992, to Chemical Bank, as Trustee (incorporated by reference to Exhibit 4.100.4 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 001-11001). 4.300.2 Third Supplemental Indenture, dated April 15, 1994, to Chemical Bank, as Trustee (incorporated by reference to Exhibit 4.100.6 to the Registrant's Form 8-K Current Report filed July 5, 1994, File No. 001-11001). 37 4.300.3 Fourth Supplemental Indenture, dated October 1, 1994, to Chemical Bank, as Trustee (incorporated by reference to Exhibit 4.100.7 to Registrant's Form 8-K Current Report filed January 3, 1995, File No. 001-11001). 4.300.4 Fifth Supplemental Indenture, dated as of June 15, 1995, to Chemical Bank, as Trustee (incorporated by reference to Exhibit 4.100.8 to Registrant's Form 8-K Current Report filed March 29, 1996, File No. 001-11001). 4.300.5 Sixth Supplemental Indenture, dated as of October 15, 1995, to Chemical Bank, as Trustee (incorporated by reference to Exhibit 4.100.9 to Registrant's Form 8-K Current Report filed March 29, 1996, File No. 001-11001). 4.300.6 Seventh Supplemental Indenture, dated as of June 1, 1996 (incorporated by reference to Exhibit 4.100.11 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, File No. 001-11001). 4.300.7 Eighth Supplemental Indenture, dated as of December 1, 1996 (incorporated by reference to Exhibit 4.100.12 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, File No. 001-11001). 4.400 Senior Indenture, dated as of May 23, 2001, between Citizens Communications Company and The Chase Manhattan Bank, as trustee (incorporated by reference to Exhibit 4.1 of the Registrant's Current Report on Form 8-K filed on May 24, 2001, File No. 001-11001). 4.400.1 First Supplemental Indenture to Senior Indenture, dated as of May 23, 2001 (incorporated by reference to Exhibit 4.2 of the Registrant's Current Report on Form 8-K filed on May 24, 2001, File No. 001-11001). 4.400.2 Second Supplemental Indenture, dated as of June 19, 2001, to Senior Indenture, dated as of May 23, 2001 (incorporated by reference to Exhibit 4.3 of the Registrant's Current Report on Form 8-K filed on June 21, 2001, File No. 001-11001). 4.400.3 Third Supplemental Indenture, dated as of November 12, 2004, to Senior I ndenture, dated as of May 23, 2001 (incorporated by reference to Exhibit 4.1 of the Registrant's Current Report on Form 8-K filed on November 12, 2004, File No. 001-11001). 4.400.4 Indenture, dated as of August 16, 2001, between Citizens Communications Company and The Chase Manhattan Bank, as Trustee (incorporated by reference to Exhibit 4.1 of the Registrant's Current Report on Form 8-K filed on August 22, 2001, File No. 001-11001). 4.400.5 Underwriting Agreement dated November 8, 2004, between Citizens Communications Company and J.P. Morgan Securities Inc., as Representative of the several listed Underwriters, relating to the sale of $700,000,000 principal amount of the 6 1/4% Senior Notes due 2013 (incorporated by reference to Exhibit 4.1 of the Registrant's Current Report on Form 8-K filed on November 12, 2004, File No. 001-11001). 10.1 Amended and Restated Non-Employee Directors' Deferred Fee Equity Plan dated as of May 18, 2004,(incorporated by reference to Exhibit 10.1.2 to the Registrant's Quarterly Report on Form 10-Q for the three months ended June 30, 2004,File No.001-11001). 10.2.1 Separation Agreement between Citizens Communications Company and Leonard Tow effective July 10, 2004 (incorporated by reference to Exhibit 10.2.4 of the Registrants' Quarterly Report on Form 10-Q for the six months ended June 30, 2004, File No. 001-11001). 10.3 Incentive Award Agreement between Citizens Communications Company and Scott N. Schneider, effective March 11, 2004 (incorporated by reference to Exhibit 10.3 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2003, File No. 001-11001). 10.4 Citizens Executive Deferred Savings Plan dated January 1, 1996 (incorporated by reference to Exhibit 10.19 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 001-11001). 10.5 Citizens Incentive Plan restated as of March 21, 2000 (incorporated by reference to Exhibit 10.19 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 001-11001). 10.6.1 1996 Equity Incentive Plan (incorporated by reference to Appendix A to the Registrant's definitive proxy statement on Schedule 14A filed on March 29, 1996, File No. 001-11001). 10.6.2 Amendment to 1996 Equity Incentive Plan (incorporated by reference to Exhibit B to the Registrant's definitive proxy statement on Schedule 14A filed on March 31, 1997, File No. 001-11001). 10.7.1 2000 Equity Incentive Plan dated May 18, 2000 (incorporated by reference to Exhibit 10.33 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000, File No. 001-11001). 10.7.2 Amendment No. 2 to 2000 Equity Incentive Plan (effective June 30, 2003) (incorporated by reference to Exhibit 10.7.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2003, File No. 001-11001). 38 10.8 Citizens 401(K) Savings Plan effective as of January 1, 1997 reflecting amendments made through April 2001 (incorporated by reference to Exhibit 10.37 to the Registrant's Quarterly Report on Form 10-Q for the six months ended June 30, 2001, File No. 001-11001). 10.9 Loan Agreement between Citizens Communications Company and Rural Telephone Finance Cooperative for $200,000,000 dated October 24, 2001 (incorporated by reference to Exhibit 10.39 to the Registrant's Quarterly Report on Form 10-Q for the nine months ended September 30, 2001, File No. 001-11001). 10.10.1 Amendment No. 1, dated as of March 31, 2003, to Loan Agreement between Citizens Communications Company and Rural Telephone Finance Cooperative (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the three months ended March 31, 2003, File No. 001-11001). 10.16 Employment Agreement between Citizens Communications Company and Mary Agnes Wilderotter, effective November 1, 2004 (incorporated by reference to Exhibit 10.16 to the Registrant's Quarterly Report on Form 10-Q for the nine months ended September 30, 2004, File No. 001-11001). 10.17 Employment Agreement between Citizens Communications Company and Jerry Elliott, effective September 1, 2004 (incorporated by reference to Exhibit 10.17 to the Registrant's Quarterly Report on Form 10-Q for the nine months ended September 30, 2004, File No. 001-11001). 10.18 Employment Agreement between Citizens Communications Company and Robert Larson, effective September 1, 2004 (incorporated by reference to Exhibit 10.18 to the Registrant's Quarterly Report on Form 10-Q for the nine months ended September 30, 2004, File No. 001-11001). 10.19 Summary of Compensation Arrangements for Named Executive Officers Outside of Employment Agreements and Summary of Non-Employee Directors' Compensation Arrangements. 10.19.1 Split Dollar Life Insurance Agreement between Citizens Communications Company and L. Russell Mitten, effective April 28, 1994. 10.20 Employment Agreement between Citizens Communications Company and John H. Casey, III, effective February 15, 2005. 10.21 1996 Equity Incentive Plan restated as of March 21, 2000, (incorporated by reference to Exhibit A to the Registrant's Proxy Statement dated March 29, 1996 and Exhibit B to Proxy Statement dated March 28, 1997, respectively, File No.001-11001). 10.22 Competitive Advance and Revolving Credit Facility Agreement for $250,000,000 dated October 29, 2004 (incorporated by reference to Exhibit 10.19 to the Registrant's Quarterly Report on Form 10-Q for the nine months ended September 30, 2004, File No. 001-11001). 10.23 Offer of Employment Letter between Citizens Communications Company and Peter B. Hayes, effective February 1, 2005. 12 Computation of ratio of earnings to fixed charges (this item is included herein for the sole purpose of incorporation by reference). 21 Subsidiaries of the Registrant 23 Auditors' Consent 31.1 Certification of Principal Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934. 31.2 Certification of Principal Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibits 10.1, 10.2.1, 10.3, 10.4, 10.5, 10.6.1, 10.6.2, 10.7.1, 10.7.2, 10.8, 10.16, 10.17, 10.18, 10.19, 10.19.1, 10.20, 10.21 and 10.23 are management contracts or compensatory plans or arrangements. 39 SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CITIZENS COMMUNICATIONS COMPANY ------------------------------- (Registrant) By: /s/ Mary Agnes Wilderotter --------------------------- Mary Agnes Wilderotter President; Chief Executive Officer and Director March 11, 2005 40 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 11th day of March 2005. Signature Title --------- ----- /s/ Jerry Elliott Executive Vice President and Chief - ----------------------------------------- Financial Officer and Director (Jerry Elliott) Director - ----------------------------------------- (Lawton Fitt) /s/ Rudy J. Graf Chairman of the Board - ----------------------------------------- (Rudy J. Graf) /s/ Stanley Harfenist Director - ----------------------------------------- (Stanley Harfenist) /s/ William Kraus Director - ----------------------------------------- (William Kraus) /s/ Robert J. Larson Senior Vice President and Chief - ----------------------------------------- Accounting Officer (Robert J. Larson) /s/ Scott N. Schneider Director - ----------------------------------------- (Scott N. Schneider) Director - ----------------------------------------- (Larraine D. Segil) /s/ Robert A. Stanger Director - ----------------------------------------- (Robert A. Stanger) /s/ Edwin Tornberg Director - ----------------------------------------- (Edwin Tornberg) /s/ David H. Ward Director - ----------------------------------------- (David H. Ward) Director - ----------------------------------------- (Myron A. Wick, III) /s/ Mary Agnes Wilderotter President and Chief Executive - ----------------------------------------- Officer and Director (Mary Agnes Wilderotter) 41
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES Index to Consolidated Financial Statements Item Page - ---- ---- Management's Report on Internal Control Over Financial Reporting F-2 Report of Independent Registered Public Accounting Firm F-3 Report of Independent Registered Public Accounting Firm F-4 Consolidated balance sheets as of December 31, 2004 and 2003 F-5 Consolidated statements of operations for the years ended December 31, 2004, 2003 and 2002 F-6 Consolidated statements of shareholders' equity for the years ended December 31, 2004, 2003 and 2002 F-7 Consolidated statements of comprehensive income (loss) for the years ended December 31, 2004, 2003 and 2002 F-7 Consolidated statements of cash flows for the years ended December 31, 2004, 2003 and 2002 F-8 Notes to consolidated financial statements F-9
F-1 Management's Report on Internal Control Over Financial Reporting ---------------------------------------------------------------- The Board of Directors and Shareholders Citizens Communications Company: The management of Citizens Communications Company and subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2004. Our management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein. Stamford, Connecticut March 11, 2005 F-2 Report of Independent Registered Public Accounting Firm ------------------------------------------------------- The Board of Directors and Shareholders Citizens Communications Company: We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that Citizens Communications Company and subsidiaries maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Citizens Communications Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Citizens Communications Company and subsidiaries maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Citizens Communications Company and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Citizens Communications Company and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders' equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 11, 2005 expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP New York, New York March 11, 2005 F-3 Report of Independent Registered Public Accounting Firm ------------------------------------------------------- The Board of Directors and Shareholders Citizens Communications Company: We have audited the accompanying consolidated balance sheets of Citizens Communications Company and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders' equity, comprehensive income (loss) and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Citizens Communications Company and subsidiaries as of December 31, 2004 and 2003 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" as of January 1, 2003. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Citizens Communications Company and subsidiaries internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 11, 2005 expressed an unqualified opinion on management's assessment of, and the effective operation of, internal control over financial reporting. /s/ KPMG LLP New York, New York March 11, 2005 F-4
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2004 AND 2003 ($ in thousands) 2004 2003 -------------- -------------- ASSETS - ------ Current assets: Cash and cash equivalents $ 167,463 $ 583,671 Accounts receivable, less allowances of $36,042 and $47,332, respectively 236,306 248,750 Prepaid expenses 30,753 39,434 Other current assets 15,055 11,648 Assets held for sale - 23,130 -------------- -------------- Total current assets 449,577 906,633 Property, plant and equipment, net 3,338,300 3,530,542 Goodwill, net 1,940,318 1,940,318 Other intangibles, net 685,111 812,407 Investments 23,062 57,103 Other assets 232,051 198,542 -------------- -------------- Total assets $ 6,668,419 $ 7,445,545 ============== ============== LIABILITIES AND EQUITY - ---------------------- Current liabilities: Long-term debt due within one year $ 6,383 $ 88,002 Accounts payable 169,999 192,607 Advanced billings 29,446 29,473 Income taxes accrued 27,446 77,159 Other taxes accrued 30,203 32,039 Interest accrued 82,534 81,244 Customer deposits 927 2,105 Other current liabilities 70,582 74,997 Liabilities related to assets held for sale - 11,128 -------------- -------------- Total current liabilities 417,520 588,754 Deferred income taxes 232,766 198,312 Customer advances for construction and contributions in aid of construction 94,601 122,035 Other liabilities 294,294 264,382 Equity units - 460,000 Long-term debt 4,266,998 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; 339,633,000 and 284,709,000 outstanding and 339,635,000 and 295,434,000 issued at December 31, 2004 and 2003, respectively) 84,909 73,858 Additional paid-in capital 1,664,627 1,953,317 Accumulated deficit (287,719) (365,181) Accumulated other comprehensive loss, net of tax (99,569) (71,676) Treasury stock (8) (175,135) -------------- -------------- Total shareholders' equity 1,362,240 1,415,183 -------------- -------------- Total liabilities and equity $ 6,668,419 $ 7,445,545 ============== ==============
* 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." See Note 16 for a complete discussion. The accompanying Notes are an integral part of these Consolidated Financial Statements. F-5
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 and 2002 ($ in thousands, except for per-share amounts) 2004 2003 2002 --------------- -------------- -------------- Revenue $ 2,192,980 $ 2,444,938 $ 2,669,332 Operating expenses: Cost of services (exclusive of depreciation and amortization) 205,166 369,689 476,920 Other operating expenses 840,186 901,751 1,002,355 Depreciation and amortization 572,710 595,276 755,522 Reserve for (recovery of) telecommunications bankruptcies - (4,377) 10,880 Restructuring and other expenses - 9,687 37,186 Loss on impairment - 15,300 1,074,058 Management succession and strategic alternatives expenses (see Note 13) 90,632 - - --------------- -------------- -------------- Total operating expenses 1,708,694 1,887,326 3,356,921 --------------- -------------- -------------- Operating income (loss) 484,286 557,612 (687,589) Investment income (loss), net 33,626 10,432 (98,359) Other income (loss), net (53,359) 43,989 22,537 Interest expense 379,024 416,524 468,229 --------------- -------------- -------------- Income (loss) from continuing operations before income taxes, dividends on convertible preferred securities and cumulative effect of change in accounting principle 85,529 195,509 (1,231,640) Income tax expense (benefit) 13,379 67,216 (414,874) --------------- -------------- -------------- Income (loss) from continuing operations before dividends on convertible preferred securities and cumulative effect of change in accounting principle 72,150 128,293 (816,766) Dividends on convertible preferred securities, net of income tax benefit of $(3,853)* - 6,210 6,210 --------------- -------------- -------------- Income (loss) from continuing operations before cumulative effect of change in accounting principle 72,150 122,083 (822,976) Loss from discontinued operations, net of income tax benefit of $0, $0 and $554, respectively - - (1,478) Gain on disposal of water segment, net of income taxes of $135,303 - - 181,369 --------------- -------------- -------------- Total income from discontinued operations, net of income taxes of $0, $0 and $134,749, respectively - - 179,891 --------------- -------------- -------------- Income (loss) before cumulative effect of change in accounting principle 72,150 122,083 (643,085) Cumulative effect of change in accounting principle, net of tax of $0, $41,591 and $0, respectively - 65,769 (39,812) --------------- -------------- -------------- Net income (loss) available for common shareholders $ 72,150 $ 187,852 $ (682,897) =============== ============== ============== Basic income (loss) per common share: Income (loss) from continuing operations before cumulative effect of change in accounting principle $ 0.24 $ 0.44 $ (2.93) Income from discontinued operations - - 0.64 Income (loss) from cumulative effect of change in accounting principle - 0.23 (0.14) --------------- -------------- -------------- Net income (loss) per common share available for common shareholders $ 0.24 $ 0.67 $ (2.43) =============== ============== ============== Diluted income (loss) per common share: Income (loss) from continuing operations before cumulative effect of change in accounting principle $ 0.23 $ 0.42 $ (2.93) Income from discontinued operations - - 0.64 Income (loss) from cumulative effect of change in accounting principle - 0.22 (0.14) --------------- -------------- -------------- Net income (loss) per common share available for common shareholders $ 0.23 $ 0.64 $ (2.43) =============== ============== ==============
* The consolidation of this item changed effective January 1, 2004 as a result of the application of a newly mandated accounting standard "FIN 46R." See Note 16 for a complete discussion. The accompanying Notes are an integral part of these Consolidated Financial Statements. F-6
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 and 2002 ($ in thousands, except for per-share amounts) Accumulated Common Stock Additional Retained Other Treasury Stock Total ------------------- Paid-In Earnings Comprehensive ------------------- Shareholders' Shares Amount Capital (Deficit) Income (Loss) Shares Amount Equity --------- --------- ----------- -------------- ------------ -------- ---------- ----------- Balance January 1, 2002 292,840 $ 73,210 $1,927,518 $ 129,864 $ 4,907 (11,551) $(189,357) $ 1,946,142 Stock plans 1,240 310 15,888 - - (47) (228) 15,970 Net loss - - - (682,897) - - - (682,897) Other comprehensive loss, net of tax and reclassifications adjustments - - - - (107,076) - - (107,076) --------- --------- ----------- ------------ ----------- -------- ---------- ------------- Balance December 31, 2002 294,080 73,520 1,943,406 (553,033) (102,169) (11,598) (189,585) 1,172,139 Stock plans 1,354 338 9,911 - - 873 14,450 24,699 Net income - - - 187,852 - - - 187,852 Other comprehensive income, net of tax and reclassifications adjustments - - - - 30,493 - - 30,493 --------- --------- ----------- ------------ ----------- -------- ---------- ------------- Balance December 31, 2003 295,434 73,858 1,953,317 (365,181) (71,676) (10,725) (175,135) 1,415,183 Stock plans 4,821 1,206 14,236 - - 6,407 106,823 122,265 Conversion of EPPICS 10,897 2,724 133,621 - - 725 11,646 147,991 Conversion of Equity Units 28,483 7,121 396,221 - - 3,591 56,658 460,000 Dividends on common stock of $2.50 per share - - (832,768) - - - - (832,768) Net income - - - 72,150 - - - 72,150 Tax benefit on equity forward contracts - - - 5,312 - - - 5,312 Other comprehensive loss, net of tax and reclassifications adjustments - - - - (27,893) - - (27,893) --------- --------- ----------- ------------ ----------- -------- ---------- ------------- Balance December 31, 2004 339,635 $ 84,909 $1,664,627 $(287,719) $(99,569) (2) $ (8) $ 1,362,240 ========= ========= =========== ============ =========== ======== ========== ============= CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 and 2002 ($ in thousands, except for per-share amounts) 2004 2003 2002 -------------- ------------- ------------- Net income (loss) $ 72,150 $ 187,852 $(682,897) Other comprehensive income (loss), net of tax and reclassifications adjustments* (27,893) 30,493 (107,076) -------------- ------------- ------------- Total comprehensive income (loss) $ 44,257 $ 218,345 $(789,973) ============== ============= =============
* Consists of unrealized holding (losses)/gains of marketable securities, realized gains taken to income as a result of the sale of securities and minimum pension liability (see Note 22). The accompanying Notes are an integral part of these Consolidated Financial Statements. F-7
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 and 2002 ($ in thousands) 2004 2003 2002 --------------- ---------------- ---------------- Income (loss) from continuing operations before cumulative effect of change in accounting principle $ 72,150 $ 122,083 $ (822,976) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization expense 572,710 595,276 755,522 Investment write-downs - - 117,455 Gain on expiration/settlement of customer advance (25,345) (6,165) (26,330) Gain on capital lease termination/restructuring - (69,512) - Stock based compensation expense 45,313 8,552 7,029 (Gain)/loss on extinguishment of debt 66,480 10,851 (5,550) Investment (gains)/losses (12,066) - (3,363) (Gain)/loss on sales of assets, net 1,945 20,492 (9,798) Loss on impairment - 15,300 1,074,058 Other non-cash adjustments 21,923 14,574 18,762 Deferred taxes, net 13,379 67,216 (414,874) Change in accounts receivable 11,877 70,077 1,373 Change in accounts payable and other liabilities (51,460) (106,567) (161,367) Change in other current assets 169 999 101,376 --------------- ---------------- ---------------- Net cash provided by continuing operating activities 717,075 743,176 631,317 Cash flows from investing activities: Proceeds from sales of assets, net of selling expenses 30,959 388,079 224,678 Capital expenditures (276,348) (278,015) (468,742) Securities purchased - (1,680) (1,175) Securities sold 26,514 - 8,212 Securities matured - - 2,014 ELI share purchases - - (6,800) Other asset purchases (28,110) 68 727 --------------- ---------------- ---------------- Net cash provided from (used by) investing activities (246,985) 108,452 (241,086) Cash flows from financing activities: Repayment of customer advances for construction and contributions in aid of construction (2,089) (10,030) (4,895) Long-term debt borrowings 700,000 - - Debt issuance costs (15,502) - - Long-term debt payments (1,214,021) (653,462) (1,062,169) (Premium) discount to retire debt (66,480) (10,851) 5,550 Issuance of common stock 544,562 13,209 14,943 Dividends paid (832,768) - - --------------- ---------------- ---------------- Net cash used by financing activities (886,298) (661,134) (1,046,571) Cash provided by (used by) discontinued operations Proceeds from sale of discontinued operations - - 859,064 Net cash used by discontinued operations - - (25,416) --------------- ---------------- ---------------- Increase (decrease) in cash and cash equivalents (416,208) 190,494 177,308 Cash and cash equivalents at January 1, 583,671 393,177 215,869 --------------- ---------------- ---------------- Cash and cash equivalents at December 31, $ 167,463 $ 583,671 $ 393,177 =============== ================ ================ Cash paid during the period for: Interest $ 370,128 $ 418,561 $ 473,029 Income taxes (refunds) $ (4,901) $ (2,532) $ (17,621) Non-cash investing and financing activities: Assets acquired under capital lease $ - $ - $ 38,000 Change in fair value of interest rate swaps $ (6,135) $ (6,057) $ 16,229 Investment write-downs $ 5,286 $ - $ 117,455 Conversion of EPPICS $ 147,991 $ - $ -
The accompanying Notes are an integral part of these Consolidated Financial Statements. F-8 CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) Description of Business and Summary of Significant Accounting Policies: ---------------------------------------------------------------------- (a) Description of Business: ----------------------- Citizens Communications Company and its subsidiaries are referred to as "we", "us", the "Company" or "our" in this report. We are a communications company providing services to rural areas and small and medium-sized towns and cities as an incumbent local exchange carrier, or ILEC. We offer our ILEC services under the "Frontier" name. In addition, we provide competitive local exchange carrier, or CLEC, services to business customers and to other communications carriers in certain metropolitan areas in the western United States through Electric Lightwave, LLC, or ELI, our wholly-owned subsidiary. On April 1, 2004, we announced the completion of the sale of our Vermont Electric Division. With that transaction, we completed the divestiture of our public utilities services segment pursuant to plans announced in 1999. (b) Principles of Consolidation and Use of Estimates: ------------------------------------------------ Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). Certain reclassifications of balances previously reported have been made to conform to the current presentation. All significant intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions which affect the amounts of assets, liabilities, revenue and expenses we have reported and our disclosure of contingent assets and liabilities at the date of the financial statements. Actual results may differ from those estimates. We believe that our critical estimates are depreciation rates, pension assumptions, calculations of impairment amounts, reserves established for receivables, income taxes and contingencies. (c) Cash Equivalents: ---------------- We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. (d) Revenue Recognition: ------------------- 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. ELI - Revenue is recognized when the services are provided. Revenue from long-term prepaid network services agreements including Indefeasible Rights to Use (IRU), are deferred and recognized on a straight-line basis over the terms of the related agreements. Installation fees and their related direct and incremental costs are initially deferred and recognized as revenue and expense over the average term of a customer relationship. We recognize as current period expense the portion of installation costs that exceeds installation fee revenue. (e) Property, Plant and Equipment: ----------------------------- Property, plant and equipment are stated at original cost or fair market value for our acquired properties, including capitalized interest. Maintenance and repairs are charged to operating expenses as incurred. The book value, net of salvage, of routine property, plant and equipment dispositions is charged against accumulated depreciation. F-9 (f) Goodwill and Other Intangibles: ------------------------------ Intangibles represent the excess of purchase price over the fair value of identifiable tangible assets acquired. We undertake studies to determine the fair values of assets and liabilities acquired and allocate purchase prices to assets and liabilities, including property, plant and equipment, goodwill and other identifiable intangibles. 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 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 and have determined for the year ended December 31, 2004 that there was no impairment (see Notes 2 and 7). All remaining intangibles at December 31, 2004 are associated with the ILEC segment, which is the reporting unit. SFAS No. 142 also requires that intangible assets with estimated useful lives be amortized over those lives and be reviewed for impairment in accordance with SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" to determine whether any changes to these lives are required. We periodically reassess the useful life of our intangible assets with estimated useful lives to determine whether any changes to those lives are required. (g) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed ---------------------------------------------------------------------- Of: -- We 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. Recoverability of assets held for sale is measured by comparing the carrying amount of the assets to their estimated fair market value. If any assets are considered to be impaired, the impairment is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value (see Note 5). (h) Derivative Instruments and Hedging Activities: --------------------------------------------- We account for derivative instruments and hedging activities in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended. SFAS No. 133, as amended, requires that all derivative instruments, such as interest rate swaps, be recognized in the financial statements and measured at fair value regardless of the purpose or intent of holding them. On the date the derivative contract is entered into, we designate the derivative as either a fair value or cash flow hedge. A hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment is a fair value hedge. A hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability is a cash flow hedge. We formally document all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking the hedge transaction. This process includes linking all derivatives that are designated as fair-value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. We also formally assess, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. If it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, we would discontinue hedge accounting prospectively. F-10 All derivatives are recognized on the balance sheet at their fair value. Changes in the fair value of derivative financial instruments are either recognized in income or stockholders' equity (as a component of other comprehensive income), depending on whether the derivative is being used to hedge changes in fair value or cash flows. We have interest rate swap arrangements related to a portion of our fixed rate debt. These hedge strategies satisfy the fair value hedging requirements of SFAS No. 133, as amended. As a result, the fair value of the hedges is carried on the balance sheet in other current assets and the related underlying liabilities are also adjusted to fair value by the same amount. (i) Investments: ----------- Marketable Securities We classify our cost method investments at purchase as available-for-sale. We do not maintain a trading portfolio or held-to-maturity securities. Securities classified as available-for-sale are carried at estimated fair market value. These securities are held for an indefinite period of time, but might be sold in the future as changes in market conditions or economic factors occur. Net aggregate unrealized gains and losses related to such securities, net of taxes, are included as a separate component of shareholders' equity. Interest, dividends and gains and losses realized on sales of securities are reported in Investment income. Investments in Other Entities Investments in entities that we do not control, but where we have the ability to exercise significant influence over operating and financial policies, are accounted for using the equity method of accounting. We evaluate our investments periodically to determine whether any decline in fair value, below the cost basis, is other than temporary. To determine whether an impairment is other than temporary, we consider whether we have the ability and intent to hold the investment until a market price recovery and whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to year-end, and forecasted performance of the investee. If we determine that a decline in fair value is other than temporary, the cost basis of the individual investment is written down to fair value, which becomes the new cost basis. The amount of the write-down is transferred from other comprehensive income (loss) and included in the statement of operations as a loss. (j) Income Taxes and Deferred Income Taxes: -------------------------------------- We file a consolidated federal income tax return. We utilize the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recorded for the tax effect of temporary differences between the financial statement basis and the tax basis of assets and liabilities using tax rates to be in effect when the temporary differences are expected to reverse. (k) Employee Stock Plans: -------------------- We have various employee stock-based compensation plans. Awards under these plans are granted to eligible officers, management 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. In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment," ("SFAS No. 123R"). SFAS 123R requires that stock-based employee compensation be recorded as a charge to earnings for interim or annual periods beginning after June 15, 2005. Accordingly, we will adopt SFAS 123R commencing July 1, 2005 (third quarter) and expect to recognize approximately $3,000,000 of expense for the last six months of 2005. F-11 We provide pro forma net income (loss) and pro forma net income (loss) per common share disclosures for employee stock option grants based on the fair value of the options at the date of grant (see Note 18). For purposes of presenting pro forma information, the fair value of options granted is computed using the Black Scholes option-pricing model. Had we determined compensation cost based on the fair value at the grant date for the Management Equity Incentive Plan (MEIP), Equity Incentive Plan (EIP), Employee Stock Purchase Plan (ESPP) and Directors' Deferred Fee Equity Plan, our pro forma net income (loss) and net income (loss) per common share available for common shareholders would have been as follows:
2004 2003 2002 ----------------- --------------- -------------- ($ in thousands) ---------------- Net income (loss) available for common shareholders As reported $ 72,150 $ 187,852 $ (682,897) Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects 29,381 6,014 4,899 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (38,312) (16,139) (16,990) -------- ------------ ----------- Pro forma $ 63,219 $ 177,727 $(694,988) ========= ============ =========== Net income (loss) per common share As reported: available for common shareholders Basic $ 0.24 $ 0.67 $ (2.43) Diluted 0.23 0.64 (2.43) Pro forma: Basic $ 0.21 $ 0.63 $ (2.48) Diluted 0.20 0.61 (2.48)
In connection with the payment of the special, non-recurring dividend of $2 per common share on September 2, 2004, the exercise price and number of all outstanding options was adjusted such that each option had the same value to the holder after the dividend as it had before the dividend. In accordance with FASB Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation" and EITF 00-23, "Issues Related to the Accounting for Stock Compensation under APB No. 25 and FIN 44", there is no accounting consequence for changes made to the exercise price and the number of shares of a fixed stock option or award as a direct result of the special, non-recurring dividend. (l) Net Income (Loss) Per Common Share Available for Common Shareholders: -------------------------------------------------------------------- Basic net income (loss) 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. F-12 (2) Recent Accounting Literature and Changes in Accounting Principles: ----------------------------------------------------------------- Goodwill and Other Intangibles ------------------------------ In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." This statement requires that goodwill and other intangibles with indefinite useful lives no longer be amortized to earnings, but instead be reviewed for impairment. We have no intangibles with indefinite useful lives other than goodwill and trade name. The amortization of goodwill and trade name ceased upon adoption of the statement on January 1, 2002. We were required to test for impairment of goodwill and other intangibles with indefinite useful lives as of January 1, 2002 and at least annually thereafter. Any transitional impairment loss at January 1, 2002 was recognized as the cumulative effect of a change in accounting principle in our statement of operations. As a result of our adoption of SFAS No. 142, we recognized a transitional impairment loss related to ELI of $39,812,000 as a cumulative effect of a change in accounting principle in our statement of operations in 2002. We annually examine the carrying value of our goodwill and other intangibles with indefinite useful lives to determine whether there are any impairment losses and have determined for the year ended December 31, 2004 that there was no impairment. 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." We reassess the useful life of our intangible assets with estimated useful lives annually. Accounting for Asset Retirement Obligations ------------------------------------------- In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." We adopted SFAS No. 143 effective January 1, 2003. As a result of our adoption of SFAS No. 143, we recognized an after tax non-cash gain of approximately $65,769,000. This gain resulted from the elimination of the cumulative cost of removal included in accumulated depreciation and is reflected as a cumulative effect of a change in accounting principle in our statement of operations in 2003 as the Company has no legal obligation to remove certain of its long-lived assets. The following table presents a reconciliation between reported net income (loss) and adjusted net income (loss) related to the adoption of SFAS 143. Adjusted net income (loss) excludes depreciation expense recognized in prior periods related to the cost of removal provision as required by SFAS No. 143.
(In thousands, except per-share amounts) 2004 2003 2002 - ---------------------------------------- ------------------- ------------------- ------------------ Reported available for common shareholders $ 72,150 $ 187,852 $ (682,897) Add back: Cost of removal in depreciation expense - - 15,990 ------------------- ------------------- ------------------ Adjusted available for common shareholders $ 72,150 $ 187,852 $ (666,907) =================== =================== ================== Basic income (loss) per share: - ------------------------------ Reported available for common shareholders per share $ 0.24 $ 0.67 $ (2.43) Cost of removal in depreciation expense - - 0.06 ------------------- ------------------- ------------------ Adjusted available for common shareholders per share $ 0.24 $ 0.67 $ (2.37) =================== =================== ================== Diluted income (loss) per share: - -------------------------------- Reported available for common shareholders per share $ 0.23 $ 0.64 $ (2.43) Cost of removal in depreciation expense - - 0.06 ------------------- ------------------- ------------------ Adjusted available for common shareholders per share $ 0.23 $ 0.64 $ (2.37) =================== =================== ==================
Long-Lived Assets ----------------- In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement establishes a single accounting model, based on the framework established in SFAS No. 121, for impairment of long-lived assets held and used and for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. We adopted this statement on January 1, 2002. F-13 Debt Retirement --------------- In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement eliminates the requirement to aggregate gains and losses from extinguishment of debt and, if material, classified as an extraordinary item, net of related income tax effect. The statement requires gains and losses from extinguishment of debt to be classified as extraordinary items only if they meet the criteria in Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" which provides guidance for distinguishing transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification as an extraordinary item. We adopted SFAS No. 145 in the second quarter of 2002. For the year ended December 31, 2004 and 2003, we recognized $66,480,000 and $10,851,000, respectively, of losses on early retirement of debt. For the year ended December 31, 2002, we recognized $5,550,000 of gains from early debt retirement. In addition, for the year ended December 31, 2002, we recognized a $12,800,000 loss due to a tender offer related to certain debt securities. 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 (see Note 26). We adopted FIN No. 45 on January 1, 2003. The adoption of FIN 45 did not have any material impact on our financial position or results of operations. Stock-Based Compensation ------------------------ In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123, "Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation and amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements. This statement is effective for fiscal years ending after December 15, 2002. We have adopted the expanded disclosure requirements of SFAS No. 148. In December 2004, the FASB issued SFAS No. 123R. SFAS 123R requires that stock-based employee compensation be recorded as a charge to earnings for interim or annual periods beginning after June 15, 2005. Accordingly, we will adopt SFAS 123R commencing July 1, 2005 (third quarter) and expect to recognize approximately $3,000,000 of expense for the last six months of 2005. 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. F-14 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. 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. 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). Investments ----------- In March 2004, the FASB issued EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" (EITF 03-1) which provides new guidance for assessing impairment losses on debt and equity investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however, the disclosure requirements remain effective and have been adopted for our year ended December 31, 2004. Although we have no material investments at the present time, we will evaluate the effect, if any, of EITF 03-1 when final guidance is released. (3) Accounts Receivable: ------------------- The components of accounts receivable, net at December 31, 2004 and 2003 are as follows: ($ in thousands) 2004 2003 - ---------------- -------------- --------------- Customers $ 230,029 $ 250,515 Other 42,319 45,567 Less: Allowance for doubtful accounts (36,042) (47,332) -------------- --------------- Accounts receivable, net $ 236,306 $ 248,750 ============== =============== F-15 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 $17,859,000, $21,525,000 and $24,249,000 for the years ended December 31, 2004, 2003, and 2002, respectively. In addition, additional reserves are provided for known or impending telecommunications bankruptcies, disputes or other significant collection issues. An agreement was reached with WorldCom/MCI settling all pre-petition obligations and receivables. The bankruptcy court approved the agreement and we reduced our reserves by approximately $6,600,000 in the fourth quarter 2003 as a result of the settlement. During the second quarter 2002, we reserved approximately $21,600,000 of trade receivables with WorldCom as a result of WorldCom's filing for bankruptcy. These receivables were generated as a result of providing ordinary course telecommunications services. We have ongoing commercial relationships with WorldCom. Concurrent with the acquisition of Frontier, we entered into several operating agreements with Global Crossing. We have ongoing commercial relationships with Global Crossing affiliates. We reserved a total of $29,000,000 of Global Crossing receivables during 2001 and 2002 as a result of Global Crossing's filing for bankruptcy to reflect our best estimate of the net realizable value of receivables resulting from these commercial relationships. We recorded a write-down of such receivables in the amount of $7,800,000 in 2002 and $21,200,000 in 2001. In 2002, as the result of a settlement agreement with Global Crossing, we reversed $17,900,000 of our previous write-down reserve of the net realizable value of these receivables. (4) Property, Plant and Equipment: ----------------------------- The components of property, plant and equipment at December 31, 2004 and 2003 are as follows:
Estimated ($ in thousands) Useful Lives 2004 2003 - ---------------- ------------------- ----------------- ----------------- Land N/A $ 21,481 $ 21,650 Buildings and leasehold improvements 30 to 41 years 357,983 354,855 General support 3 to 17 years 425,720 411,660 Central office/electronic circuit equipment 5 to 11 years 2,536,579 2,421,341 Cable and wire 15 to 55 years 2,972,919 2,848,412 Other 5 to 20 years 31,993 53,303 Construction work in progress 93,049 114,988 ----------------- ----------------- 6,439,724 6,226,209 Less: accumulated depreciation (3,101,424) (2,695,667) ----------------- ----------------- Property, plant and equipment, net $ 3,338,300 $ 3,530,542 ================= =================
Depreciation expense is principally based on the composite group method. Depreciation expense was $446,190,000, $468,438,000 and $630,113,000 for the years ended December 31, 2004, 2003 and 2002, 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 increased the depreciable lives of certain assets. During 2002, we recognized accelerated depreciation of $23,379,000 related to the change in useful lives of our accounting and human resource systems and our Plano, Texas office building, furniture and fixtures as a result of a restructuring. (5) Losses on Impairment: -------------------- In the third and fourth quarters of 2003, we recognized non-cash pre-tax impairment losses of $4,000,000 and $11,300,000, respectively, related to our Vermont electric division assets held for sale in accordance with the provisions of SFAS No. 144. F-16 In the third quarter 2002, we recognized non-cash pre-tax impairment losses of $656,658,000 related to property, plant and equipment in the ELI sector and $417,400,000 related to the gas and electric sector assets held for sale, in each case in accordance with the provisions of SFAS No. 144. ELI --- Prior to the third quarter of 2002, we tested for impairment of ELI and determined that, based on our assumptions, the sum of the expected future cash flows, undiscounted and without interest charges, exceeded the carrying value of its long-lived assets and therefore we did not recognize an impairment. Because sales for the nine months ended September 30, 2002 were lower than those in 2001 and were significantly below our original 2002 budget (which was used in the test for impairment at December 31, 2001), we evaluated the long-lived assets of ELI as of September 30, 2002. At that date, we estimated that our undiscounted future cash flows were less than the carrying value of our long-lived assets. As a result we recognized a non-cash pre-tax impairment loss of $656,658,000, equal to the difference between the estimated fair value of the assets (which we determined by calculating the discounted value of the estimated future cash flows weighting various possible scenarios for management's assessment of probability of occurrence and discounting the probability-weighted cash flows at an appropriate rate) and the carrying amount of the assets. Making the determinations of impairment and the amount of impairment require significant judgment by management and assumptions with respect to the future cash flows of the ELI sector. The telecommunications industry in general and the CLEC sector in particular is undergoing significant change and disruption, which makes judgments and assumptions with respect to the future cash flows highly subjective. (6) Dispositions: ------------ Pre-tax gains (losses) in connection with the following transactions were recorded in Other income (loss), net: In October 2004, we sold cable assets in California, Arizona, Indiana, and Wisconsin for approximately $2,263,000 in cash. The pre-tax gain on the sale was $40,000. During the third quarter of 2004, we sold our corporate aircraft for approximately $15,298,000 in cash. The pre-tax loss on the sale was $1,087,000. On April 1, 2003, we completed the sale of approximately 11,000 telephone access lines in North Dakota for approximately $25,700,000 in cash. The pre-tax gain on the sale was $2,274,000. On April 4, 2003, we completed the sale of our wireless partnership interest in Wisconsin for approximately $7,500,000 in cash. The pre-tax gain on the sale was $2,173,000. (7) Intangibles: ----------- Intangibles at December 31, 2004 and 2003 are as follows:
($ in thousands) 2004 2003 - ---------------- --------------- ---------------- Customer base - amortizable over 96 months $ 994,605 $ 995,853 Trade name - non-amortizable 122,058 122,058 --------------- ---------------- Other intangibles 1,116,663 1,117,911 Accumulated amortization (431,552) (305,504) --------------- ---------------- Total other intangibles, net $ 685,111 $ 812,407 =============== ================
Amortization expense was $126,520,000, $126,838,000 and $125,409,000 for the years ended December 31, 2004, 2003 and 2002, respectively. Amortization expense, based on our estimate of useful lives, is estimated to be $126,520,000 per year for the next four years and $57,113,000 in the fifth year, at which point these assets will have been fully amortized. The decrease in customer base is due to the sale of cable assets in 2004. F-17 (8) Discontinued Operations and Net Assets Held for Sale: ---------------------------------------------------- On August 24, 1999, our Board of Directors approved a plan of divestiture for our public utilities services businesses, which included our water, gas and electric businesses. All of these properties have been sold. Water and Wastewater -------------------- On January 15, 2002, we completed the sale of our water and wastewater operations for $859,100,000 in cash and $122,500,000 of assumed debt and other liabilities. The pre-tax gain on the disposal of the water segment was $316,700,000. Discontinued operations in the consolidated statements of operations reflect the results of operations of the water/wastewater properties sold in January 2002 including allocated interest expense for the periods presented. Interest expense was allocated to the discontinued operations based on the outstanding debt specifically identified with these businesses. Summarized financial information for the water/wastewater operations (discontinued operations) is set forth below: ($ in thousands) For the year ended ----------------- December 31, 2002 -------------------- Revenue $ 4,650 Operating loss $ (415) Income tax benefit $ (554) Net loss $ (1,478) Gain on disposal of water segment, net of tax $ 181,369 Electric and Gas ---------------- 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. 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). Losses on the sales of our Vermont properties were included in the impairment charges recorded during 2003. Pre-tax gains/(losses) in connection with the following transactions were included in Other income (loss), net: 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 November 1, 2002, we completed the sale of our Kauai electric division for $215,000,000 in cash. On July 2, 2001, we completed the sale of our Louisiana Gas operations for $363,436,000 in cash. On November 30, 2001, we sold our Colorado Gas division for approximately $8,900,000 in cash after purchase price adjustments. F-18 Summarized balance sheet information for the gas and electric operations (assets held for sale) is set forth below: ($ in thousands) 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 ============== (9) Investments: ----------- The components of investments at December 31, 2004 and 2003 are as follows: ($ in thousands) 2004 2003 - ---------------- ---------------- ---------------- Marketable equity securities $ 2,336 $ 44,314 Other fixed income securities - 2 Equity method investments 20,726 12,787 ---------------- ---------------- $ 23,062 $ 57,103 ================ ================ Marketable Securities During 2004, we sold our investments in D & E Communications, Inc. (D & E) and Hungarian Telephone and Cable Corp. (HTCC) for approximately $13,300,000 and $13,200,000 in cash, respectively. Accordingly, we recorded net realized gains of $12,066,000 in our statement of operations for the sale of these marketable securities. As of December 31, 2004 and 2003, we owned 3,059,000 shares of Adelphia Communications Corp. (Adelphia) common stock. As a result of Adelphia's price declines and filing for bankruptcy, we recognized losses of $95,300,000 and $79,000,000 on our investment for the years ended December 31, 2002 and 2001, respectively, as the declines were determined to be other than temporary. As a result of the write downs, our "book cost basis" was reduced to zero and subsequent increases and decreases, except for those deemed other than temporary, are included in accumulated other comprehensive income (loss). The following summarizes the adjusted cost, gross unrealized holding gains and losses and fair market value for marketable securities:
($ in thousands) Unrealized Holding - ---------------- Adjusted --------------------------------- Aggregate Fair Investment Classification Cost Gains (Losses) Market Value - ------------------------- ---------------- ---------------- ---------------- ---------------- As of December 31, 2004 - ----------------------- Available-for-Sale $ 1,138 $ 1,198 $ - $ 2,336 As of December 31, 2003 - ----------------------- Available-for-Sale $ 14,452 $ 29,864 $ - $ 44,316
At December 31, 2004 and 2003, we did not have any investments that have been in a continuous unrealized loss position deemed to be temporary for more than 12 months. The Company has determined that market fluctuations during the period are not other than temporary because the severity and duration of the unrealized losses were not significant. F-19 As of December 31, 2003, we owned 1,333,500 shares of D & E common stock. As the result of an other than temporary decline in D & E's stock price, we recognized a loss of $16,400,000 on our investment for the year ended December 31, 2002. Marketable equity securities for 2003 include 2,305,908 common shares which represent an ownership of 19% of the equity in HTCC a company of which our former Chairman and Chief Executive Officer was a member of the Board of Directors. In addition, in 2003 we held 30,000 shares of non-voting convertible preferred stock, each share having a liquidation value of $70 per share and is convertible at our option into 10 shares of common stock. Investments in Other Entities During 2004, we reclassified our investments accounted for under the equity method from other assets to the investment caption in our consolidated balance sheets and conformed prior periods to the current presentation. The Company's investments in entities that are accounted for under the equity method of accounting consist of the following: (1) a 33% interest in the Mohave Cellular Limited Partnership which is engaged in cellular mobile telephone service in the Arizona area; (2) a 25% interest in the Fairmount Cellular Limited Partnership which is engaged in cellular mobile telephone service in the Rural Service Area (RSA) designated by the FCC as Georgia RSA No. 3; and (3) our investments in CU Capital and CU Trust with relation to our convertible preferred securities (for 2004 only). The investments in these entities amounted to $20,726,000 and $12,787,000 at December 31, 2004 and 2003, respectively. (10) Fair Value of Financial Instruments: ----------------------------------- The following table summarizes the carrying amounts and estimated fair values for certain of our financial instruments at December 31, 2004 and 2003. For the other financial instruments, representing cash, accounts receivables, long-term debt due within one year, accounts payable and other accrued liabilities, the carrying amounts approximate fair value due to the relatively short maturities of those instruments.
($ in thousands) 2004 2003 - ---------------- ----------------------------------- --------------------------------- Carrying Carrying Amount Fair Value Amount Fair Value ---------------- ------------------ ---------------- ---------------- Investments $ 23,062 $ 23,062 $ 57,103 $ 57,103 Long-term debt (1) $ 4,266,998 $ 4,607,298 $ 4,195,629 $ 4,608,205 Equity Providing Preferred Income Convertible Securities (EPPICS) $ - $ - $ 201,250 $ 205,275
The fair value of the above financial instruments is based on quoted prices at the reporting date for those financial instruments. (1) 2004 and 2003 includes interest rate swaps of $4,466,000 and $10,601,000, respectively. 2003 excludes the $460,000,000 debt portion of the equity units. 2004 includes EPPICS of $63,765,000. F-20 (11) Long-term Debt: -------------- The activity in our long-term debt from December 31, 2003 to December 31, 2004 is summarized as follows:
Twelve Months Ended ---------------------------------------------------- Interest Interest Rate* at December 31, Rate December 31, December 31, ($ in thousands) 2003 Borrowings Payments*** Swap Reclassification 2004 2004 - ---------------- Rural Utilities Service Loan Contracts $ 30,010 $ - $ (902) $ - $ - $ 29,108 6.120% Senior Unsecured Debt 4,167,123 700,000 (780,955) (6,135) 51,770 4,131,803 7.912% EPPICS** (reclassified as a result of adopting FIN 46R) - - - - 63,765 63,765 5.000% Equity Units 460,000 - (408,230) - (51,770) - - ELI Notes 5,975 - (5,975) - - - - ELI Capital Leases 10,061 - (5,640) - - 4,421 10.363% Industrial Development Revenue Bonds 70,440 - (12,300) - - 58,140 5.559% Other 22 - (19) - - 3 12.990% ---------- ---------- ------------- -------- ----------- ----------- TOTAL LONG TERM DEBT $4,743,631 $ 700,000 $ (1,214,021) $(6,135) $ 63,765 $4,287,240 ---------- ========== ============= ======== =========== ----------- Less: Debt Discount - (13,859) Less: Current Portion (88,002) (6,383) Less: Equity Units (460,000) - ----------- ---------- $4,195,629 $4,266,998 =========== ==========
* 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 16). *** Includes purchases on the open market (see note 2). 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. On July 15, 2004, we renegotiated and prepaid with $4,954,000 of cash the entire remaining $5,524,000 Electric Lightwave capital lease obligation to a third party. On July 30, 2004, we purchased $300,000,000 of the 6.75% notes that were a component of our equity units at 105.075% of par, plus accrued interest, at a premium of approximately $15,225,000 recorded in investment and other income (loss), net. During August and September 2004, we repurchased through a series of transactions an additional $108,230,000 of the 6.75% notes due 2006 at a weighted average price of 104.486% of par, plus accrued interest, at a premium of approximately $4,855,000 recorded in investment and other income (loss), net. On November 8, 2004, we issued an aggregate $700,000,000 principal amount of 6.25% senior notes due January 15, 2013 through a registered underwritten public offering. Proceeds from the sale were used to redeem our outstanding $700,000,000 of 8.50% Notes due 2006, which is discussed below. F-21 On November 12, 2004, we called for redemption on December 13, 2004 the entire $700,000,000 of our 8.50% Notes due 2006 at a price of 107.182% of the principal amount called, plus accrued interest, at a premium of approximately $50,300,000. As of December 31, 2004, EPPICS representing a total principal amount of $147,991,000 had been converted into 11,622,749 shares of Citizens common stock. Total future minimum cash payment commitments under ELI's long-term capital leases amounted to $10,017,000 as of December 31, 2004. The total outstanding principal amounts of industrial development revenue bonds were $58,140,000 and $70,440,000 at December 31, 2004 and 2003, respectively. The earliest maturity date for these bonds is in August 2015. Holders of certain industrial development revenue bonds may tender such bonds to us at par prior to maturity. The next tender date is August 1, 2007 for $30,350,000 principal amount of bonds. We expect to retire all such bonds that are tendered. As of December 31, 2004 we had available lines of credit with financial institutions in the aggregate amount of $250,000,000 with a maturity date of October 29, 2009. Associated facility fees vary depending on our leverage ratio and were 0.375% as of December 31, 2004. During the term of the credit facility we may borrow, repay and re-borrow funds. The credit facility is available for general corporate purposes but may not be used to fund dividend payments. There are no outstanding borrowings under the facility. During the twelve months ended December 31, 2003, we executed a series of purchases in the open market of our outstanding debt securities. The aggregate principal amount of debt securities purchased was $94,895,000 and they generated a pre-tax loss on the early extinguishment of debt at a premium of approximately $3,117,000 recorded in other income (loss), net. During December 2002, we completed a tender offer with respect to our 6.80% Debentures due 2026 (puttable at par in 2003) and ELI's 6.05% Guaranteed Notes due 2004. As a result of the tender, $82,286,000 and $259,389,000, respectively, of these securities were purchased and retired at a pre-tax cost of $12,800,000 (recorded in other income (loss), net) in excess of the principal amount of the securities purchased. For the year ended December 31, 2004, we retired an aggregate $1,362,012,000 of debt (including $147,991,000 of EPPICS conversions), representing approximately 28% of total debt outstanding at December 31, 2003. Our principal payments and capital lease payments (principal only) for the next five years are as follows: ($ in thousands) ---------------- Principal Capital --------- ------- Payments Lease Payments --------- -------------- 2005 $ 6,302 $ 81 2006 227,693 94 2007 37,771 110 2008 750,938 126 2009 1,000 145 (12) Derivative Instruments and Hedging Activities: --------------------------------------------- Interest rate swap agreements are used to hedge a portion of our debt that is subject to fixed interest rates. Under our interest rate swap agreements, we agree to pay an amount equal to a specified variable rate of interest times a notional principal amount, and to receive in return an amount equal to a specified fixed rate of interest times the same notional principal amount. The notional amounts of the contracts are not exchanged. No other cash payments are made unless the agreement is terminated prior to maturity, in which case the amount paid or received in settlement is established by agreement at the time of termination and represents the market value, at the then current rate of interest, of the remaining obligations to exchange payments under the terms of the contracts. F-22 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 December 31, 2004 and December 31, 2003 was $300,000,000 and $400,000,000, respectively. Such contracts require us to pay variable rates of interest (average pay rate of approximately 6.12% as of December 31, 2004) and receive fixed rates of interest (average receive rate of 8.44% as of December 31, 2004). The fair value of these derivatives is reflected in other assets as of December 31, 2004, in the amount of $4,466,000 and the related underlying debt has been increased by a like amount. The amounts received during the year ended December 31, 2004 as a result of these contracts amounted to $9,363,000 and are included as a reduction of interest expense. As the result of our call of all of our 8.50% Notes due 2006 in November 2004, we terminated five interest rate swaps involving an aggregate $250,000,000 notional amount of indebtedness. Proceeds from the swap terminations of approximately $3,026,000 and U.S. Treasury rate lock agreements of approximately $971,000 were applied against the cost to retire the debt, resulting in a net premium of approximately $46,277,000 recorded in other income (loss), net. We do not anticipate any nonperformance by counter parties to our derivative contracts as all counter parties have investment grade credit ratings. (13) Management Succession and Strategic Alternatives Expenses: --------------------------------------------------------- On July 11, 2004, our Board of Directors announced that it had completed its review of the Company's financial and strategic alternatives and on September 2, 2004 the Company paid a special, non-recurring 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 resigned his position as Chairman of the board on September 27, 2004. The Board of Directors named Mary Agnes Wilderotter president and chief executive officer, and Rudy J. Graf was elected Chairman of the board, on September 30, 2004. In 2004, we expensed approximately $90,632,000 of costs related to management succession and our exploration of financial and strategic alternatives. Included are $36,618,000 of non-cash expenses for the acceleration of stock benefits, cash expenses of $19,229,000 for advisory fees, $19,339,000 for severance and retention arrangements and $15,446,000 primarily for tax reimbursements. (14) Shareholder Rights Plan: ----------------------- On March 6, 2002, our Board of Directors adopted a Shareholder Rights Plan. The purpose of the Shareholder Rights Plan is to deter coercive takeover tactics and to encourage third parties interested in acquiring us to negotiate with our Board of Directors. It is intended to strengthen the ability of our Board of Directors to fulfill its fiduciary duties to take actions, which are in the best interest of our shareholders. The rights were distributed to shareholders as a dividend at the rate of one right for each share of our common stock held by shareholders of record as of the close of business on March 26, 2002. Initially, the rights generally were exercisable only if a person or group acquired beneficial ownership of 15 percent or more of our common stock (the "Acquiror") without the consent of our independent directors. On January 21, 2003, our Board of Directors amended the terms of our Rights agreement increasing the level at which these rights will become exercisable to 20 percent of our common stock. Each right not owned by an Acquiror becomes the right to purchase our common stock at a 50 percent discount. F-23 (15) Other Income (Loss), net: ------------------------ The components of other income (loss), net for the years ended December 31, 2004, 2003 and 2002 are as follows:
($ in thousands) 2004 2003 2002 - ---------------- ----------------- ---------------- ----------------- Gain on capital lease termination/restructuring - 69,512 - Gain on expiration/settlement of customer advances 25,345 6,165 26,330 (Premium) discount on debt repurchases (66,480) (10,851) 5,550 Gain (loss) on sale of assets (1,945) (20,492) 9,798 Other, net (10,279) (345) (19,141) ----------------- ---------------- ----------------- Total other income (loss), net $ (53,359) $ 43,989 $ 22,537 ================= ================ =================
During 2004, 2003 and 2002, we recognized income in connection with certain retained liabilities associated with customer advances for construction from our disposed water properties, as a result of some of these liabilities terminating. During 2003, we recognized gains in connection with the termination/restructuring of capital leases at ELI. Gain (loss) on sale of assets in 2004 is primarily attributable to the loss on the sale of our corporate aircraft during the third quarter. In 2003, the amount represents the sales of The Gas Company in Hawaii and our Arizona gas and electric divisions, access lines in North Dakota and our wireless partnership interest in Wisconsin, and our Plano, Texas office building. Other, net for 2002 includes a $12,800,000 loss related to a tender offer completed in 2002 with respect to our 6.80% Debentures due 2026 (puttable at par in 2003) and ELI's 6.05% Guaranteed Notes due 2004. (16) Company Obligated Mandatorily Redeemable Convertible Preferred Securities: ------------------------------------------------------------------------- In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust (the Trust), issued, in an underwritten public offering, 4,025,000 shares of 5% Company Obligated Mandatorily Redeemable Convertible Preferred Securities due 2036 (EPPICS), representing preferred undivided interests in the assets of the Trust, with a liquidation preference of $50 per security (for a total liquidation amount of $201,250,000). These securities have an adjusted conversion price of $11.46 per Citizens common share. The conversion price was reduced from $13.30 to $11.46 during the third quarter of 2004 as a result of the $2.00 per share special, non-recurring dividend. The proceeds from the issuance of the Trust Convertible Preferred Securities and a Company capital contribution were used to purchase $207,475,000 aggregate liquidation amount of 5% Partnership Convertible Preferred Securities due 2036 from another wholly-owned subsidiary, Citizens Utilities Capital L.P. (the Partnership). The proceeds from the issuance of the Partnership Convertible Preferred Securities and a Company capital contribution were used to purchase from us $211,756,000 aggregate principal amount of 5% Convertible Subordinated Debentures due 2036. The sole assets of the Trust are the Partnership Convertible Preferred Securities, and our Convertible Subordinated Debentures are substantially all the assets of the Partnership. Our obligations under the agreements related to the issuances of such securities, taken together, constitute a full and unconditional guarantee by us of the Trust's obligations relating to the Trust Convertible Preferred Securities and the Partnership's obligations relating to the Partnership Convertible Preferred Securities. In accordance with the terms of the issuances, we paid the annual 5% interest in quarterly installments on the Convertible Subordinated Debentures in the four quarters of 2004, 2003 and 2002. Only cash was paid (net of investment returns) to the Partnership in payment of the interest on the Convertible Subordinated Debentures. The cash was then distributed by the Partnership to the Trust and then by the Trust to the holders of the EPPICS. As of December 31, 2004, EPPICS representing a total principal amount of $147,991,000 had been converted into 11,622,749 shares of Citizens common stock. We have adopted the provisions of FIN 46R (revised December 2003) ("FIN 46R"), "Consolidation of Variable Interest Entities," effective January 1, 2004. We have not restated prior periods. F-24 We have included the following description to provide readers a comparative analysis of the accounting impact of this standard. Both the Trust and the Partnership have been consolidated from the date of their creation through December 31, 2003. As a result of the new consolidation standards established by FIN 46R, the Company, effective January 1, 2004, deconsolidated the activities of the Trust and the Partnership. We have highlighted the comparative effect of this change in the following table:
Balance Sheet - ------------- As of ------------------------------------------------------------- ($ in thousands) December 31, 2003 December 31, 2004 Change - ---------------- --------------------- -------------------- -------------- Assets: Cash $ 2,103 $ - $ (2,103) (1) Investments - 12,645 12,645 (2) Liabilities: Long-term debt - 63,765 (3) (137,485) (3) EPPICS 201,250 - (3) Statement of Operations - ----------------------- As reported for the year ended ------------------------------------------------------------- ($ in thousands) December 31, 2003 December 31, 2004 Change - ---------------- --------------------- -------------------- -------------- Investment income $ - $ 632 $ 632 (4) Interest expense - 8,082 8,082 (5) Dividends on EPPICS (before tax) 10,063 - (10,063) (6) --------------------- -------------------- -------------- Net $ 10,063 $ 7,450 $ (2,613) ===================== ==================== ==============
(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 were 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." As of December 31, 2004, Citizens has $53,259,000 ($63,765,000 less $10,506,000 of intercompany debt) 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. 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. (17) Capital Stock: ------------- We are authorized to issue up to 600,000,000 shares of Common Stock. The amount and timing of dividends payable on Common Stock are within the sole discretion of our Board of Directors. F-25 (18) Stock Plans: ----------- At December 31, 2004, we have five stock based compensation plans, which are described below. We apply APB Opinion No. 25 and related interpretations in accounting for the employee stock plans resulting in the use of the intrinsic value to value the stock option. Compensation cost has not generally been recognized in the financial statements for options issued pursuant to the Management Equity Incentive Plan (MEIP), the 1996 Equity Incentive Plan (1996 EIP) or the Amended and Restated 2000 Equity Incentive Plan (2000 EIP), as the exercise price for such options was equal to the market price of the stock at the time of grant. However, during 2002 the expiration date of approximately 79,000 options was extended and compensation cost of approximately $220,000 was recognized. No compensation cost has been recognized in the financial statements related to the Employee Stock Purchase Plan (ESPP) because the purchase price is 85% of the fair value. In connection with our Directors' Deferred Fee Equity Plan, compensation cost associated with the issuance of stock units was $2,222,000, $607,000 and $359,000 in 2004, 2003 and 2002, respectively. Cash compensation associated with this plan was $642,000, $374,000 and $236,000 in 2004, 2003 and 2002, respectively. These costs are recognized in operating expense. We have granted restricted stock awards to key employees in the form of our Common Stock. The number of shares issued as restricted stock awards during 2004, 2003 and 2002 were 2,172,085, 312,000 and 538,000, respectively. None of the restricted stock awards may be sold, assigned, pledged or otherwise transferred, voluntarily or involuntarily, by the employees until the restrictions lapse. The restrictions are time based. At December 31, 2004, 1,686,248 shares of restricted stock were outstanding. Compensation expense, recognized in operating expense, of $45,313,000, $8,552,000, and $7,029,000 for the years ended December 31, 2004, 2003 and 2002, respectively, has been recorded in connection with these grants. Management Equity Incentive Plan -------------------------------- Under the MEIP, awards of our Common Stock may be granted to eligible officers, management employees and non-management employees in the form of incentive stock options, non-qualified stock options, stock appreciation rights (SARs), restricted stock or other stock-based awards. The Compensation Committee of the Board of Directors administers the MEIP. Since the expiration date of the MEIP plan on June 21, 2000, no awards can be granted under the MEIP. The exercise price of stock options issued was equal to or greater than the fair market value of the underlying common stock on the date of grant. Stock options are generally not exercisable on the date of grant but vest over a period of time. Under the terms of the MEIP, subsequent stock dividends and stock splits have the effect of increasing the option shares outstanding, which correspondingly decreases the average exercise price of outstanding options. Equity Incentive Plans ---------------------- In May 1996, our shareholders approved the 1996 EIP and in May 2001, our shareholders approved the 2000 EIP. Under the EIP plans, awards of our Common Stock may be granted to eligible officers, management employees and non-management employees in the form of incentive stock options, non-qualified stock options, SARs, restricted stock or other stock-based awards. Directors may receive awards under the 2000 EIP (other than options for annual retainer fees). SARs may be granted under the 1996 EIP. The Compensation Committee of the Board of Directors administers the EIP plans. The maximum number of shares of common stock, which may be issued pursuant to awards at any time for both plans, is 25,358,000 shares, which has been adjusted for subsequent stock dividends. No awards will be granted more than 10 years after the effective dates (May 23, 1996 and May 18, 2000) of the EIP plans. The exercise price of stock options and SARs generally shall be equal to or greater than the fair market value of the underlying common stock on the date of grant. Stock options are generally not exercisable on the date of grant but vest over a period of time. Under the terms of the EIP plans, subsequent stock dividends and stock splits have the effect of increasing the option shares outstanding, which correspondingly decrease the average exercise price of outstanding options. In connection with the payment of the special, non-recurring dividend of $2 per common share on September 2, 2004, the exercise price and number of all outstanding options was adjusted such that each option had the same value to the holder after the dividend as it had before the dividend. In accordance with FASB Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation" and EITF 00-23, "Issues Related to the Accounting for Stock Compensation under APB No. 25 and FIN 44", there is no accounting consequence for changes made to the exercise price and the number of shares of a fixed stock option or award as a direct result of the special, non-recurring dividend. F-26 The following is a summary of share activity subject to option under the MEIP and EIP plans.
Weighted Shares Average Subject to Option Price Option Per Share --------------------------------------------------------------------------------------------------------- Balance at January 1, 2002 19,057,000 $11.87 Options granted 3,065,000 9.53 Options exercised (812,000) 7.90 Options canceled, forfeited or lapsed (2,178,000) 11.94 --------------------------------------------------------------------------------------- Balance at December 31, 2002 19,132,000 11.66 Options granted 2,017,000 12.14 Options exercised (1,612,000) 7.97 Options canceled, forfeited or lapsed (1,572,000) 12.92 --------------------------------------------------------------------------------------- Balance at December 31, 2003 17,965,000 11.94 Options granted - - Options exercised (7,411,000) 9.69 Options canceled, forfeited or lapsed (355,000) 12.14 Effect of special, non-recurring dividend 2,212,000 - --------------------------------------------------------------------------------------- Balance at December 31, 2004 12,411,000 $11.15 ======================================================================================= The following table summarizes information about shares subject to options under the MEIP and EIP at December 31, 2004. Options Outstanding Options Exercisable --------------------------------------------------------------------------------- --------------------------------- Weighted Average Weighted Number Range of Weighted Average Remaining Number Average Outstanding Exercise Prices Exercise Price Life in Years Exercisable Exercise Price ------------------ -------------------- -------------------- -------------------- -- ----------------- --------------- 569,000 $ 6.45 - 6.64 $ 6.48 4.23 569,000 $ 6.48 764,000 6.67 - 7.33 7.06 2.70 764,000 7.06 50,000 7.89 - 8.06 7.96 4.37 27,000 8.01 1,685,000 8.19 - 8.19 8.19 7.38 612,000 8.19 391,000 8.80 - 9.68 9.05 2.67 391,000 9.05 1,937,000 9.80 - 10.44 10.40 8.15 456,000 10.28 656,000 10.64 - 11.09 10.88 5.50 656,000 10.88 1,091,000 11.15 - 11.15 11.15 7.38 1,091,000 11.15 586,000 11.51 - 11.58 11.58 6.45 582,000 11.58 2,013,000 11.79 - 11.79 11.79 6.38 1,418,000 11.79 2,669,000 11.83 - 18.46 15.57 5.72 2,669,000 15.57 ------------------ ------------- 12,411,000 $ 6.45 - 18.46 $ 11.15 6.24 9,235,000 $ 11.57 ================== =============
The number of options exercisable at December 31, 2003 and 2002 were 11,690,000 and 12,198,000, respectively. There were no option grants made during 2004. The weighted average fair value of options granted during 2003 and 2002 were $6.04 and $4.98, respectively. For purposes of the pro forma calculation, the fair value of each option grant is estimated on the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions used for grants in 2003 and 2002: 2003 2002 --------------------------- --------------- -------------- Dividend yield - - Expected volatility 44% 44% Risk-free interest rate 2.94% 4.94% Expected life 7 years 7 years --------------------------- --------------- -------------- F-27 Employee Stock Purchase Plan ---------------------------- Our ESPP was approved by shareholders on June 12, 1992 and amended on May 22, 1997. Under the ESPP, eligible employees have the right to subscribe to purchase shares of our Common Stock at 85% of the average of the high and low market prices on the last day of the purchase period. An employee may elect to have up to 50% of annual base pay withheld in equal installments throughout the designated payroll-deduction period for the purchase of shares. The value of an employee's subscription may not exceed $25,000 in any one calendar year and the minimum contribution each purchase period is $50.00. Active employees are required to hold their shares for three years from the date of each purchase period. An employee may not participate in the ESPP if such employee owns stock possessing 5% or more of the total combined voting power or value of our capital stock. As of December 31, 2002, there were 6,407,000 shares of Common Stock reserved for issuance under the ESPP. These shares may be adjusted for any future stock dividends or stock splits. The ESPP will terminate when all shares reserved have been subscribed for and purchased, unless terminated earlier or extended by the Board of Directors. The Compensation Committee of the Board of Directors administers the ESPP. Effective November 30, 2002, the employee stock purchase plan was temporarily suspended for future purchase periods. In 2002, 146,406 shares were purchased under the ESPP and 4,072,647 shares were purchased under the plan as of date of suspension. For purposes of the pro forma calculation, compensation cost is recognized for the fair value of the employees' purchase rights, which was estimated using the Black Scholes option pricing model with the following assumptions for subscription periods beginning in 2002: 2002 ------------- Dividend yield - Expected volatility 44% Risk-free interest rate 1.93% Expected life 6 months The weighted average fair value of those purchase rights granted in 2002 was $2.57. Non-Employee Directors' Compensation Plan ----------------------------------------- Upon commencement of his or her service on the Board of Directors, each non-employee director receives a grant of 10,000 stock options, which is awarded under our 2000 Equity Incentive Plan. The price of these options, which are immediately exercisable, is set at the average of the high and low market prices of the Company's common stock on the effective date of the director's initial election to the board. Annually, each non-employee director also receives a grant of 3,500 stock units under the Company's Formula Plan, which commenced in 1997 and continues through May 22, 2007. Prior to April 20, 2004, each non-employee director received an award of 5,000 stock options. The exercise price of the options granted under the Formula Plan was set at 100% of the average of the high and low market prices of the Company's common stock on the third, fourth, fifth, and sixth trading days of the year in which the options were granted. The options are exercisable six months after the grant date and remain exercisable for ten years after the grant date. In addition, on September 1, 1996, each non-employee director received a grant, under the Formula Plan, of options to purchase 2,500 shares of common stock. These options granted under the Formula Plan became exercisable six months after the grant date and remain exercisable for ten years after the grant date. Effective April 2004, the Formula Plan was amended to replace the annual grant of stock options with an annual grant of 3,500 stock units. The stock units are awarded on the first business day of each calendar year. Each non-employee director must elect, by December 31 of the preceding year, whether the stock units awarded under the Formula Plan will be redeemed in cash or stock upon the director's retirement or death, whichever occurs first. In addition, each non-employee director is also entitled to annually receive a retainer, meeting fees, and, when applicable, fees for serving as a committee chair or as Lead Director, which are awarded under the Non-Employee Directors' Deferred Fee Equity Plan. Each non-employee director must elect, by December 31 of the preceding year, to receive $30,000 cash or 5,000 stock units as an annual retainer. Directors making a stock unit election must also elect to convert the units to either stock (convertible on a one-to-one basis) or cash upon retirement or death. Prior to June 30, 2003, a director could elect to receive 20,000 stock options as an annual retainer in lieu of cash or stock units. The exercise price of the stock options was set at the average of the high and low market prices of the Company's common stock on the date of grant. The options were exercisable six months after the date of grant and had a 10-year term. F-28 As of any date, the maximum number of shares of common stock which the Non-Employee Directors' Deferred Fee Equity Plan is obligated to deliver shall not be more than one percent (1%) of the total outstanding shares of the Company's common stock as of June 30, 2003, subject to adjustment in the event of changes in our corporate structure affecting capital stock. There were 11 directors participating in the Directors' Plan during all or part of 2004. In 2004, the total options, plan units, and stock earned were 50,000, 57,226 and 0, respectively. In 2003, the total options, plan units, and stock earned were 83,125, 46,034 and 0, respectively. In 2002, the total options, plan units, and stock earned were 99,583, 43,031 and 1,514, respectively. At December 31, 2004, 699,979 options were exercisable at a weighted average exercise price of $9.36. For 2004, each non-employee director received fees of $2,000 for each Board of Directors and committee meeting attended. In addition, committee chairs (except the chairs of the Audit and Compensation Committees) received an additional annual fee of $5,000. The chairs of the Audit and Compensation Committees were each paid an additional annual fee of $50,000 and $30,000, respectively. In addition, the Lead Director, who heads the ad hoc committee of non-employee directors, received an additional annual fee of $30,000. A director must elect, by December 31 of the preceding year, to receive his meeting and other fees in cash, stock units, or a combination of both. All fees paid to the non-employee directors are paid quarterly. If the director elects stock units, the number of units credited to the director's account is determined as follows: the total cash value of the fees payable to the director are divided by 85% of the average of the high and low market prices of the Company's common stock on the first trading day of the year the election is in effect. Units are credited to the director's account quarterly. The number of stock units awarded during a given year as fees will be increased if the average of the high and low market prices of the Company's common stock on the last trading day of November is less than the average market price used to initially value the stock units. If an increase in the number of units is required, the additional units are credited to the director's account in December. The Company accounts for the Directors' Deferred Fee Equity Plan in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Compensation expense is recorded if cash or stock units are elected. If stock units are elected, the compensation expense is based on the market value of our common stock at the date of grant. If the stock option election is chosen, compensation expense is not recorded because the options are granted at the fair market value of our common stock on the grant date. We had also maintained a Non-Employee Directors' Retirement Plan providing for the payment of specified sums annually to our non-employee directors, or their designated beneficiaries, starting at the director's retirement, death or termination of directorship. In 1999, we terminated this Plan. The vested benefit of each non-employee director, as of May 31, 1999, was credited to the director's account in the form of stock units. Such benefit will be payable to each director upon retirement, death or termination of directorship. Each participant had until July 15, 1999 to elect whether the value of the stock units awarded would be payable in the Company's common stock (convertible on a one for one basis) or in cash. As of December 31, 2004, the liability for such payments was $2,155,000 of which $1,411,000 will be payable in stock (based on the July 15, 1999 stock price) and $744,000 will be payable in cash. While the number of shares of stock payable to those directors electing to be paid in stock is fixed, the amount of cash payable to those directors electing to be paid in cash will be based on the number of stock units awarded multiplied by the stock price on the payment date. (19) Restructuring and Other Expenses: -------------------------------- 2003 ---- Restructuring and other expenses primarily consist of expenses related to reductions in personnel at our telecommunications operations and the write-off of software no longer useful. We continue to review our operations, personnel and facilities to achieve greater efficiency. 2002 ---- Restructuring and other expenses primarily consist of expenses related to our various restructurings, $32,985,000 related to reductions in personnel at our telecommunications operations, costs that were spent at our Plano, Texas facility and at other locations as a result of transitioning functions and jobs, and $6,800,000 related to our tender offer in June 2002 for all of the publicly held ELI common shares that we did not already own. These costs were partially offset by a $2,825,000 reversal of a 2001 ELI accrual. F-29 (20) Income Taxes: ------------ The following is a reconciliation of the provision (benefit) for income taxes for continuing operations computed at federal statutory rates to the effective rates for the years ended December 31, 2004, 2003 and 2002:
2004 2003 2002 ------------ ------------ ------------ Consolidated tax provision (benefit) at federal statutory rate 35.0 % 35.0 % (35.0)% State income tax provisions (benefit), net of federal income tax benefit 1.7 % 6.4 % (1.3)% Write-off of regulatory assets 0.0 % 0.0 % 2.6 % Tax reserve adjustment (17.5)% (8.0)% 0.0 % All other, net (3.6)% 1.0 % 0.0 % ------------ ------------ ----------- 15.6 % 34.4 % (33.7)% ============ ============ ============
The components of the net deferred income tax liability (asset) at December 31 are as follows:
($ in thousands) 2004 2003 - ---------------- ------------ ------------ Deferred income tax liabilities: - -------------------------------- Property, plant and equipment basis differences $ 578,501 $ 412,795 Intangibles 161,955 152,226 Unrealized securities gain 458 11,432 Other, net 8,546 15,042 ------------ ------------ 749,460 591,495 ------------ ------------ Deferred income tax assets: - --------------------------- Minimum pension liability 62,435 55,837 Tax operating loss carryforward 394,797 253,215 Alternate minimum tax credit carryforward 37,796 49,864 Employee benefits 55,566 47,856 Other, net 23,095 40,745 ------------ ------------ 573,689 447,517 Less: Valuation allowance (43,503) (44,236) ------------ ------------ Net deferred income tax asset 530,186 403,281 ------------ ------------ Net deferred income tax liability $ 219,274 $ 188,214 ============ ============ Deferred tax assets and liabilities are reflected in the following captions on the balance sheet: Deferred income taxes $ 232,766 $ 198,312 Other current assets (13,492) (10,098) ------------ ------------ Net deferred income tax liability $ 219,274 $ 188,214 ============ ============
Our federal and state tax operating loss carryforwards as of December 31, 2004 are estimated at $933,722,000 and $1,302,736,000, respectively. Our federal loss carryforward will begin to expire in the year 2020. A portion of our state loss carryforward will begin to expire in 2005. Our alternative minimum tax credit as of December 31, 2004 can be carried forward indefinitely to reduce future regular tax liability. F-30 The provision (benefit) for federal and state income taxes, as well as the taxes charged or credited to shareholders' equity, includes amounts both payable currently and deferred for payment in future periods as indicated below:
($ in thousands) 2004 2003 2002 - ---------------- ------------ ------------ ------------ Income taxes charged (credited) to the income statement for continuing operations: Current: Federal $ - $ (12,632) $ (159,844) State 772 2,900 (2,562) ------------ ------------ ------------ Total current 772 (9,732) (162,406) Deferred: Federal 19,451 80,152 (230,388) Federal tax credits (40) (3,128) (352) State (6,804) (76) (21,728) ------------ ------------ ------------ Total deferred 12,607 76,948 (252,468) ------------ ------------ ------------ Subtotal 13,379 67,216 (414,874) Income taxes charged (credited) to the income statement for discontinued operations: Current: Federal - - 169,246 State - - 11,328 ------------ ------------ ------------ Total current - - 180,574 Deferred: Federal - - (39,904) Investment tax credits - - - State - - (5,921) ------------ ------------ ------------ Total deferred - - (45,825) ------------ ------------ ------------ Subtotal - - 134,749 Income tax benefit on dividends on convertible preferred securities: Current: Federal - (3,344) (3,344) State - (508) (508) ------------ ------------ ------------ Subtotal - (3,852) (3,852) Income taxes charged to the income statement for cumulative effect of change in accounting principle: Deferred: Federal - 35,414 - State - 6,177 - ------------ ------------ ------------ Subtotal - 41,591 - ------------ ------------ ------------ Total income taxes charged (credited) to the income statement (a) 13,379 104,955 (283,977) Income taxes charged (credited) to shareholders' equity: Deferred income taxes (benefits) on unrealized/realized gains or losses on securities classified as available-for-sale (10,982) 5,539 2,726 Current benefit arising from stock options exercised and restricted stock (13,765) (2,535) (720) Deferred income taxes (benefits) arising from recognition of a minimum pension liability (6,645) 13,373 (69,209) ------------ ------------ ------------ Income taxes charged (credited) to shareholders' equity (b) (31,392) 16,377 (67,203) ------------ ------------ ------------ Total income taxes: (a) plus (b) $ (18,013) $ 121,332 $ (351,180) ============ ============ ============
F-31 (21) Net Income (Loss) Per Common Share: ---------------------------------- The reconciliation of the net income (loss) per common share calculation for the years ended December 31, 2004, 2003 and 2002 is as follows:
($ in thousands, except per-share amounts) - ------------------------------------------ 2004 2003 2002 ------------------ ------------------ ------------------ Net income (loss) used for basic and diluted earnings per common share: Income (loss) from continuing operations before cumulative effect of change in accounting principle $ 72,150 $ 122,083 $ (822,976) Income from discontinued operations - - 179,891 ------------------ ------------------ ------------------ Income (loss) before cumulative effect of change in accounting principle 72,150 122,083 # (643,085) Income (loss) from cumulative effect of change in accounting principle - 65,769 (39,812) ------------------ ------------------ ------------------ Total basic net income (loss) available for common shareholders $ 72,150 $ 187,852 $ (682,897) ================== ================== ================== Effect of conversion of preferred securities - 6,210 - ------------------ ------------------ ------------------ Total diluted net income (loss) available for common shareholders $ 72,150 $ 194,062 $ (682,897) ================== ================== ================== Basic earnings (loss) per common share: Weighted-average shares outstanding - basic 303,989 282,434 280,686 ------------------ ------------------ ------------------ Income (loss) from continuing operations before cumulative effect of change in accounting principle $ 0.24 $ 0.44 $ (2.93) Income from discontinued operations - - 0.64 ------------------ ------------------ ------------------ Income (loss) before cumulative effect of change in accounting principle 0.24 0.44 (2.29) Income (loss) from cumulative effect of change in accounting principle - 0.23 (0.14) ------------------ ------------------ ------------------ Net income (loss) per share available for common shareholders $ 0.24 $ 0.67 $ (2.43) ================== ================== ================== Diluted earnings (loss) per common share: Weighted-average shares outstanding 303,989 282,434 280,686 Effect of dilutive shares 5,194 4,868 3,887 Effect of conversion of preferred securities - 15,134 - ------------------ ------------------ ------------------ Weighted-average shares outstanding - diluted 309,183 302,436 284,573 ================== ================== ================== Income (loss) from continuing operations before cumulative effect of change in accounting principle $ 0.23 $ 0.42 $ (2.93) Income from discontinued operations - - 0.64 ------------------ ------------------ ------------------ Income (loss) before cumulative effect of change in accounting principle 0.23 0.42 (2.29) Income (loss) from cumulative effect of change in accounting principle - 0.22 (0.14) ------------------ ------------------ ------------------ Net income (loss) per share available for common shareholders $ 0.23 $ 0.64 $ (2.43) ================== ================== ==================
Stock Options ------------- For the year ended December 31, 2004, 2003 and 2002 options of 2,494,634 (at exercise prices ranging from $13.30 to $18.46), and 10,190,000 and 14,391,000 (at exercise prices ranging from $9.18 to $21.47), respectively, issuable under employee compensation plans were excluded from the computation of diluted EPS for those periods because the exercise prices were greater than the average market price of common shares and, therefore, the effect would be antidilutive. In connection with the payment of the special, non-recurring dividend of $2 per common share on September 2, 2004, the exercise price and number of all outstanding options was adjusted such that each option had the same value to the holder after the dividend as it had before the dividend. In accordance with FASB Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions involving Stock Compensation" and EITF 00-23, "Issues Related to the Accounting for Stock Compensation under APB No. 25 and FIN 44", there is no accounting consequence for changes made to the exercise price and the number of shares of a fixed stock option or award as a direct result of the special, non-recurring dividend. F-32 As a result of our loss from continuing operations for the year ended December 31, 2002 dilutive securities of 3,373,846 issuable under employee compensation plans were excluded from the computation of diluted EPS because their inclusion would have had an antidilutive effect. In addition, for the years ended December 31, 2004, 2003 and 2002, restricted stock awards of 1,686,000, 1,249,000, and 1,004,000 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. Equity Units and EPPICS ----------------------- On August 17, 2004 we issued 32,073,633 shares of common stock, including 3,591,000 treasury shares, to our equity unit holders in settlement of the equity purchase contract component of the equity units. With respect to the $460,000,000 Senior Note component of the equity units, we repurchased $300,000,000 principal amount of these Notes in July 2004. The remaining $160,000,000 of the Senior Notes were repriced and a portion was remarketed on August 12, 2004 as the 6.75% Notes due August 17, 2006. During 2004, we repurchased an additional $108,230,000 of the 6.75% Notes which, in addition to the $300,000,000 purchased in July, resulted in a pre-tax charge of approximately $20,080,000 during the third quarter of 2004, but will result in an annual reduction in interest expense of about $27,555,000 per year. As a result of our July dividend announcement with respect to our common shares, our 5% Company Obligated Mandatorily Redeemable Convertible Preferred Securities due 2036 (EPPICS) began to convert to Citizens common shares. As of December 31, 2004, approximately 74% of the EPPICS outstanding, or about $147,991,000 aggregate principal amount of units, have converted to 11,622,749 Citizens common shares, including 725,000 issued from treasury. At December 31, 2004, we had 1,065,171 shares of potentially dilutive EPPICS, which were convertible into common stock at a 4.36 to 1 ratio at an exercise price of $11.46 per share. As a result of the September 2004 special, non-recurring dividend, the EPPICS exercise price for conversion into common stock was reduced from $13.30 to $11.46. These securities have not been included in the diluted income per share calculation because their inclusion would have had an antidilutive effect. At December 31, 2003 and 2002, we had 4,025,000 shares of potentially dilutive EPPICS that have been included in the diluted income (loss) per common share calculation for the period ended December 31, 2003. Stock Units ----------- At December 31, 2004, 2003 and 2002, we had 432,872, 427,475 and 416,305 stock units, respectively, issuable under our Directors' Deferred Fee Equity Plan and Non-Employee Directors' Retirement Plan. These securities have not been included in the diluted income per share calculation because their inclusion would have had an antidilutive effect. F-33 (22) Comprehensive Income (Loss): --------------------------- Comprehensive income consists of net income (loss) and other gains and losses affecting shareowners' investment and minimum pension liability that, under GAAP, are excluded from net income (loss). Our other comprehensive income (loss) for the years ended December 31, 2004, 2003 and 2002 is as follows:
2004 --------------------------------------------- Before-Tax Tax Expense/ Net-of-Tax ($ in thousands) Amount (Benefit) Amount - ---------------- -------------- --------------- ------------- Net unrealized losses on securities: Net unrealized holding losses arising during period $ (1,901) $ (742) $ (1,159) Minimum pension liability (17,372) (6,645) (10,727) Less: Reclassification adjustments for net gains realized in net income (26,247) (10,240) (16,007) -------------- --------------- ------------- Other comprehensive loss $ (45,520) $ (17,627) $ (27,893) ============== =============== ============= 2003 --------------------------------------------- Before-Tax Tax Expense/ Net-of-Tax ($ in thousands) Amount (Benefit) Amount - ---------------- -------------- --------------- ------------- Net unrealized gains on securities: Net unrealized holding gains arising during period $ 14,470 $ 5,539 $ 8,931 Minimum pension liability 34,935 13,373 21,562 -------------- --------------- ------------- Other comprehensive income $ 49,405 $ 18,912 $ 30,493 ============== =============== ============= 2002 --------------------------------------------- Before-Tax Tax Expense/ Net-of-Tax ($ in thousands) Amount (Benefit) Amount - ---------------- -------------- --------------- ------------- Net unrealized losses on securities: Net unrealized holding losses arising during period $ (101,137) $ (38,078) $ (63,059) Minimum pension liability (180,798) (69,209) (111,589) Add: Reclassification adjustments for net losses realized in net loss 108,376 40,804 67,572 -------------- --------------- ------------- Other comprehensive loss $ (173,559) $ (66,483) $(107,076) ============== =============== =============
(23) Segment Information: ------------------- As of April 1, 2004, we operate in two segments, ILEC and ELI (a CLEC). The ILEC segment provides both regulated and unregulated communications services to residential, business and wholesale customers and is typically the incumbent provider in its service areas. As an ILEC, we compete with CLECs that may operate in our markets. As a CLEC, we provide telecommunications services, principally to businesses, in competition with the ILEC. As a CLEC, we frequently obtain the "last mile" access to customers through arrangements with the applicable ILEC. ILECs and CLECs are subject to different regulatory frameworks of the Federal Communications Commission (FCC). Our ILEC operations and ELI do not compete with each other. As permitted by SFAS No. 131, we have utilized the aggregation criteria in combining our markets because all of the Company's ILEC properties share similar economic characteristics: they provide the same products and services to similar customers using comparable technologies in all of the states that we operate in. The regulatory structure is generally similar. Differences in the regulatory regime of a particular state do not impact the economic characteristics or operating results of a particular property. F-34
($ in thousands) For the year ended December 31, 2004 - ---------------- ---------------------------------------------------------- Total ILEC ELI Electric (1) Segments ------------- -------------- ------------- ----------- Revenue $ 2,027,215 $ 156,030 $ 9,735 $2,192,980 Depreciation and Amortization 548,649 24,061 - 572,710 Management succession and strategic alternatives expenses 87,279 3,353 - 90,632 Operating Income (Loss) 477,070 10,350 (3,134) 484,286 Capital Expenditures 264,337 11,644 - 275,981 Assets 6,101,546 173,369 - 6,274,915 ($ in thousands) For the year ended December 31, 2003 - ---------------- ------------------------------------------------------------------------- Total ILEC ELI Gas Electric Segments ------------- -------------- ------------- ----------- ------------- Revenue $ 2,040,935 $ 165,389 $ 137,686 $ 100,928 $ 2,444,938 Depreciation and Amortization 571,766 23,510 - - 595,276 Reserve for Telecommunications Bankruptcies (5,524) 1,147 - - (4,377) Restructuring and Other Expenses 9,373 314 - - 9,687 Loss on Impairment - - - 15,300 15,300 Operating Income (Loss) 537,248 9,710 14,013 (3,359) 557,612 Capital Expenditures 244,089 9,496 9,877 13,984 277,446 Assets 6,425,383 184,559 - 23,130 6,633,072 ($ in thousands) For the year ended December 31, 2002 - ---------------- ------------------------------------------------------------------------- Total ILEC ELI Gas Electric Segments ------------- -------------- ------------- ----------- ------------- Revenue $ 2,062,905 $ 175,079 $ 216,517 $ 214,831 $ 2,669,332 Depreciation and Amortization 643,123 112,035 148 216 755,522 Reserve for Telecommunications Bankruptcies 10,446 434 - - 10,880 Restructuring and Other Expenses 30,054 7,132 - - 37,186 Loss on Impairment - 656,658 152,300 265,100 1,074,058 Operating Income (Loss) 413,241 (759,161) (119,579) (222,090) (687,589) Capital Expenditures 288,823 122,003 (2) 21,035 18,625 (3) 450,486 Assets 6,681,448 214,252 389,737 58,027 7,343,464
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. 2 Includes $110,000,000 of previously leased facilities purchased by ELI in April 2002. 3 Does not include approximately $38,000,000 of non-cash capital lease additions. F-35 The following tables are reconciliations of certain sector items to the total consolidated amount.
($ in thousands) - ---------------- For the years ended December 31, Capital Expenditures 2004 2003 2002 -------------- ------------- ----------- Total segment capital expenditures $ 275,981 $ 277,446 $ 450,486 General capital expenditures 367 569 18,256 -------------- ------------- ----------- Consolidated reported capital expenditures $ 276,348 $ 278,015 $ 468,742 ============== ============= =========== Assets 2004 2003 -------------- ------------- Total segment assets $ 6,274,915 $ 6,633,072 General assets 393,504 812,473 -------------- ------------- Consolidated reported assets $ 6,668,419 $ 7,445,545 ============== =============
(24) Quarterly Financial Data (Unaudited): ------------------------------------
($ in thousands, except per share amounts) - ------------------------------------------- First quarter Second quarter Third quarter Fourth quarter ------------- -------------- ------------- -------------- 2004 - ---- Revenue $558,468 $ 544,091 $ 545,393 $ 545,028 Operating income 139,806 128,175 71,954 144,351 Net income (loss) 42,868 23,792 (11,290) 16,780 Net income (loss) available for common shareholders per basic share $ 0.15 $ 0.08 $ (0.04) $ 0.05 Net income (loss) available for common shareholders per diluted share $ 0.15 $ 0.08 $ (0.04) $ 0.05 2003 - ---- Revenue $651,862 $ 643,954 $ 595,037 $ 554,085 Operating income 164,295 135,192 133,156 124,969 Income before cumulative effect of change in accounting principle 61,662 34,057 11,412 14,952 Net income 127,431 34,057 11,412 14,952 Income before cumulative effect of change in accounting principle available for common shareholders per basic share $ 0.22 $ 0.12 $ 0.04 $ 0.05 Income before cumulative effect of change in accounting principle available for common shareholders per diluted share $ 0.22 $ 0.12 $ 0.04 $ 0.05 Net income available for common shareholders per basic share $ 0.45 $ 0.12 $ 0.04 $ 0.05 Net income available for common shareholders per diluted share $ 0.43 $ 0.12 $ 0.04 $ 0.05
The quarterly net income (loss) per common share amounts are rounded to the nearest cent. Annual net income (loss) per common share may vary depending on the effect of such rounding. 2004 Transactions ----------------- On April 1, 2004, we completed the sale of our Vermont electric distribution operations for approximately $13,992,000 in cash, net of selling expenses. During the third quarter of 2004, we sold our corporate aircraft for approximately $15,298,000 in cash. The pre-tax loss on the sale was $1,087,000. In October 2004, we sold cable assets in California, Arizona, Indiana, and Wisconsin for approximately $2,263,000 in cash. The pre-tax gain on these sales was $40,000. 2003 Transactions ----------------- 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. F-36 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. 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 initial pre-tax loss on the sale was $18,480,000 recognized in the third quarter of 2003. We recognized an additional loss on the sale of $700,000 in the fourth quarter of 2003 due to customary sale price adjustments. On August 11, 2003, we completed the sale of our Arizona gas and electric divisions for $224,100,000 in cash. The initial pre-tax loss on the sale was $12,791,000 recognized in the third quarter of 2003. We recognized an additional loss on the sale of $5,700,000 in the fourth quarter of 2003 due to customary sale price adjustments. In the third quarter 2003, we recognized a non-cash pre-tax impairment loss of $4,000,000 related to the electric sector assets held for sale, in accordance with the provisions of SFAS No. 144. In the fourth quarter 2003, we recognized an additional non-cash pre-tax impairment loss of $11,300,000 related to the electric sector assets held for sale, in accordance with the provisions of SFAS No. 144. 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 per an order by the Vermont Public Service Board). In the fourth quarter 2003, we reduced our reserve for telecommunications bankruptcies by approximately $6,600,000 as a result of a settlement with WorldCom/MCI. Restructuring and other expenses in 2003 primarily consist of severance expenses related to reductions in personnel at our telecommunications operations and the write-off of software no longer useful. (25) Retirement Plans: ---------------- We sponsor a noncontributory defined benefit pension plan covering a significant number of our employees and other postretirement benefit plans that provide medical, dental, life insurance benefits and other benefits for covered retired employees and their beneficiaries and covered dependents. The benefits are based on years of service and final average pay or career average pay. Contributions are made in amounts sufficient to meet ERISA funding requirements while considering tax deductibility. Plan assets are invested in a diversified portfolio of equity and fixed-income securities. The accounting results for pension and postretirement benefit costs and obligations are dependent upon various actuarial assumptions applied in the determination of such amounts. These actuarial assumptions include the following: discount rates, expected long-term rate of return on plan assets, future compensation increases, employee turnover, healthcare cost trend rates, expected retirement age, optional form of benefit and mortality. The Company reviews these assumptions for changes annually with its outside actuaries. We consider our discount rate and expected long-term rate of return on plan assets to be our most critical assumptions. The discount rate is used to value, on a present basis, our pension and postretirement benefit obligation as of the balance sheet date. The same rate is also used in the interest cost component of the pension and postretirement benefit cost determination for the following year. The measurement date used in the selection of our discount rate is the balance sheet date. Our discount rate assumption is determined annually with assistance from our actuaries based on the interest rates for long-term high quality corporate bonds. This rate can change from year-to-year based on market conditions that impact corporate bond yields. The expected long-term rate of return on plan assets is applied in the determination of periodic pension and postretirement benefit cost as a reduction in the computation of the expense. In developing the expected long-term rate of return assumption, we considered published surveys of expected market returns, 10 and 20 year actual returns of various major indices, and our own historical 5-year and 10-year investment returns. F-37 The expected long-term rate of return on plan assets is based on an asset allocation assumption of 30% to 45% in fixed income securities and 55% to 70% in equity securities. We review our asset allocation at least annually and make changes when considered appropriate. In 2004, we did not change our expected long-term rate of return from the 8.25% used in 2003. Our pension plan assets are valued at actual market value as of the measurement date. The measurement date used to determine pension and other postretirement benefit measures for the pension plan and the postretirement benefit plan is December 31. Accounting standards require that Citizens record an additional minimum pension liability when the plan's "accumulated benefit obligation" exceeds the fair market value of plan assets at the pension plan measurement (balance sheet) date. In the fourth quarter of 2003, due to strong performance in the equity markets during 2003, partially offset by a decrease in the year-end discount rate, the Company recorded a reduction to its minimum pension liability in the amount of $34,935,000 with a corresponding credit to shareholders' equity of $21,562,000, net of taxes of $13,373,000. In the fourth quarter of 2004, mainly due to a decrease in the year-end discount rate, the Company recorded an additional minimum pension liability in the amount of $17,372,000 with a corresponding charge to shareholders' equity of $10,727,000, net of taxes of $6,645,000. These adjustments did not impact our earnings or cash flows for either year. If discount rates and the equity markets performance decline, the Company would be required to increase its minimum pension liabilities and record additional charges to shareholder's equity in the future. Actual results that differ from our assumptions are added or subtracted to our balance of unrecognized actuarial gains and losses. For example, if the year-end discount rate used to value the plan's projected benefit obligation decreases from the prior year-end, then the plan's actuarial loss will increase. If the discount rate increases from the prior year-end then the plan's actuarial loss will decrease. Similarly, the difference generated from the plan's actual asset performance as compared to expected performance would be included in the balance of unrecognized gains and losses. The impact of the balance of accumulated actuarial gains and losses are recognized in the computation of pension cost only to the extent this balance exceeds 10% of the greater of the plan's projected benefit obligation or market value of plan assets. If this occurs, that portion of gain or loss that is in excess of 10% is amortized over the estimated future service period of plan participants as a component of pension cost. The level of amortization is affected each year by the change in actuarial gains and losses and could potentially be eliminated if the gain/loss activity reduces the net accumulated gain/loss balance to a level below the 10% threshold. Effective February 1, 2003, the pension plan was frozen for all non-union plan participants. The vested benefit earned through that date is protected by law and will be available upon retirement. No additional benefit accruals for service will occur after February 1, 2003 for those participants. F-38 Pension Plan ------------ The following tables set forth the plan's benefit obligations and fair values of plan assets as of December 31, 2004 and 2003 and net periodic benefit cost for the years ended December 31, 2004, 2003 and 2002.
($ in thousands) 2004 2003 - ---------------- ------------- -------------- Change in benefit obligation - ---------------------------- Benefit obligation at beginning of year $ 761,683 $ 780,237 Service cost 5,748 6,479 Interest cost 46,468 49,103 Amendments - (22,164) Actuarial loss 44,350 43,146 Settlement due to transfer of plan - (22,475) Plant closings/Reduction in force - (1,198) Benefits paid (58,791) (71,445) ------------- -------------- Benefit obligation at end of year $ 799,458 $ 761,683 ============= ============== Change in plan assets - --------------------- Fair value of plan assets at beginning of year $ 719,622 $ 692,361 Actual return on plan assets 80,337 121,821 Settlement due to transfer of plan - (23,115) Employer contribution 20,000 - Benefits paid (58,791) (71,445) ------------- -------------- Fair value of plan assets at end of year $ 761,168 $ 719,622 ============= ============== (Accrued)/Prepaid benefit cost - ------------------------------ Funded status $ (38,290) $ (42,061) Unrecognized net liability - - Unrecognized prior service cost (1,988) (2,232) Unrecognized net actuarial loss 183,481 171,071 ------------- -------------- Prepaid benefit cost $ 143,203 $ 126,778 ============= ============== Amounts recognized in the statement of financial position - --------------------------------------------------------- Accrued benefit liability $ (20,034) $ (19,086) Other comprehensive income 163,237 145,864 ------------- -------------- Net amount recognized $ 143,203 $ 126,778 ============= ============== ($ in thousands) 2004 2003 2002 - ---------------- ------------- -------------- --------------- Components of net periodic benefit cost - --------------------------------------- Service cost $ 5,748 $ 6,479 $ 12,159 Interest cost on projected benefit obligation 46,468 49,103 53,320 Return on plan assets (57,203) (53,999) (63,258) Amortization of prior service cost and unrecognized net obligation (244) (172) (106) Amortization of unrecognized loss 8,806 11,026 2,137 ------------- -------------- --------------- Net periodic benefit cost 3,575 12,437 4,252 Curtailment/settlement charge - 6,585 - ------------- -------------- --------------- Total periodic benefit cost $ 3,575 $ 19,022 $ 4,252 ============= ============== ===============
F-39 The plan's weighted average asset allocations at December 31, 2004 and 2003 by asset category are as follows: 2004 2003 ---- ---- Asset category: - -------------- Equity securities 65% 62% Debt securities 32% 36% Cash and other 3% 2% ------ ------ Total 100% 100% ====== ====== The Plan's expected benefit payments by year are as follows: ($ in thousands) - ----------------- Year Amount --------------- ------------- 2005 $ 51,878 2006 53,072 2007 54,267 2008 55,187 2009 57,357 2010 - 2014 290,983 ------------- Total $ 562,744 ============= The Company's required contribution to the plan in 2005 is $0. The accumulated benefit obligation for the plan was $781,202,000 and $738,709,000 at December 31, 2004 and 2003, respectively. Assumptions used in the computation of pension and postretirement benefits other than pension costs/year-end benefit obligations were as follows: 2004 2003 ---- ---- Discount rate 6.25/6.00% 6.75/6.25% Expected long-term rate of return on plan assets 8.25%/N/A 8.25%/N/A Rate of increase in compensation levels 4.0%/4.0% 4.0%/4.0% As part of the Frontier acquisition, Global Crossing and we agreed to the transfer of pension liabilities and assets related to substantially all Frontier employees. The liabilities associated with the Frontier employees retained by Global Crossing were valued following the Pension Benefit Guaranty Corporation's "safe harbor" rules. Prior to Global Crossing's bankruptcy filing, Global Crossing and we reached an agreement on the value of the pension assets and liabilities to be retained by Global Crossing as well as the time frame and procedures by which the remainder of the assets were to be transferred to a pension trust held by Citizens. Global Crossing failed to execute and deliver an authorization letter to the Frontier plan trustee directing the trustee to transfer to our pension plan record ownership of the transferred assets. We initiated an adversary proceeding with the Bankruptcy Court supervising Global Crossing's bankruptcy proceeding, to determine and declare that Global Crossing's obligation was not "executory", and to compel Global Crossing to execute and deliver such authorization letter. On December 18, 2002 we entered into a stipulation with Global Crossing and other parties, "so ordered" by the bankruptcy court, fully and finally settling the adversary proceeding. Pursuant to the stipulation and order, on February 3, 2003 Global Crossing instructed the Frontier Plan Trustee to transfer record ownership of the transferred assets with a market value of $447,800,000 to our pension plan, and the transfer in fact took place on that date. F-40 Postretirement Benefits Other Than Pensions ------------------------------------------- The following table sets forth the plan's benefit obligations, fair values of plan assets and the postretirement benefit liability recognized on our balance sheets at December 31, 2004 and 2003 and net periodic postretirement benefit costs for the years ended December 31, 2004, 2003 and 2002:
($ in thousands) 2004 2003 - ---------------- ------------- -------------- Change in benefit obligation - ---------------------------- Benefit obligation at beginning of year $ 223,337 $ 210,683 Service cost 1,128 1,387 Interest cost 12,698 13,606 Plan participants' contributions 4,118 3,723 Actuarial (gain) loss (1,706) 16,835 Amendments (3,045) - Benefits paid (19,150) (22,897) ------------- -------------- Benefit obligation at end of year $ 217,380 $ 223,337 ============= ============== Change in plan assets - --------------------- Fair value of plan assets at beginning of year $ 27,493 $ 27,050 Actual return on plan assets 987 1,624 Benefits paid (15,032) (19,173) Employer contribution 1,678 19,568 Acquisitions/Divestitures - (1,576) ------------- -------------- Fair value of plan assets at end of year $ 15,126 $ 27,493 ============= ============== Accrued benefit cost - -------------------- Funded status $(202,254) $(195,844) Unrecognized transition obligation - 211 Unrecognized prior service cost (2,617) 13 Unrecognized loss 44,319 49,982 ------------- -------------- Accrued benefit cost $(160,552) $(145,638) ============= ============== ($ in thousands) 2004 2003 2002 - ---------------- ------------- -------------- --------------- Components of net periodic postretirement benefit cost - ------------------------------------------------------ Service cost $ 1,128 $ 1,387 $ 1,350 Interest cost on projected benefit obligation 12,698 13,606 13,753 Return on plan assets (2,268) (2,133) (2,438) Amortization of prior service cost and transition obligation (204) 26 26 Amortization of unrecognized (gain)/loss 5,238 3,985 2,383 ------------- -------------- --------------- Net periodic postretirement benefit cost $ 16,592 $ 16,871 $ 15,074 ============= ============== ===============
The plan's weighted average asset allocations at December 31, 2004 and 2003 by asset category are as follows: 2004 2003 ---- ---- Asset category: - -------------- Equity securities 0% 16% Debt securities 100% 63% Cash and other 0% 21% ------ ------- Total 100% 100% ====== ======= F-41 The Plan's expected benefit payments by year are as follows: ($ in thousands) - ---------------- Year Amount --------------- ------------- 2005 $ 14,477 2006 15,172 2007 15,846 2008 16,401 2009 16,921 2010 - 2014 89,998 ------------- Total $ 168,815 ============= The Company's expected contribution to the plan in 2005 is $14,477,000. For purposes of measuring year-end benefit obligations, we used, depending on medical plan coverage for different retiree groups, a 7 - 10% annual rate of increase in the per-capita cost of covered medical benefits, gradually decreasing to 5% in the year 2010 and remaining at that level thereafter. The effect of a 1% increase in the assumed medical cost trend rates for each future year on the aggregate of the service and interest cost components of the total postretirement benefit cost would be $1,397,000 and the effect on the accumulated postretirement benefit obligation for health benefits would be $21,428,000. The effect of a 1% decrease in the assumed medical cost trend rates for each future year on the aggregate of the service and interest cost components of the total postretirement benefit cost would be $(1,145,000) and the effect on the accumulated postretirement benefit obligation for health benefits would be $(17,711,000). In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) became law. The Act introduces a prescription drug benefit under Medicare 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 has not yet been able to conclude whether the benefits provided by its postretirement medical plan are actuarially equivalent to Medicare Part D under the Act. Therefore, the Company cannot quantify the effects, if any, that the Act will have on its future benefit costs or accumulated postretirement benefit obligation and accordingly, the effects of the Act have not been reflected in the accompanying consolidated financial statements. In August 1999, our Board of Directors approved a plan of divestiture for the public services properties. Any pension and/or postretirement gain or loss associated with the divestiture of these properties will be recognized when realized. During 2002, we sold our entire water distribution and wastewater treatment business and one of our three electric businesses. The pension plan has been frozen from the date of sale and we have retained those liabilities. During 2003, we sold our remaining gas businesses in Hawaii and Arizona as well as our electric business in Arizona. The pension plan covering union employees for the Hawaiian gas property was transferred in its entirety to the buyer. The pension plan liabilities covering the remaining employees transferred have been retained by us. In all transactions, the buyer assumed the retiree medical liabilities for those properties. 401(k) Savings Plans -------------------- We sponsor an employee retirement savings plan under section 401(k) of the Internal Revenue Code. The Plan covers substantially all full-time employees. Under the Plan, we provide matching and certain profit-sharing contributions. Effective May 1, 2002, the Plan was amended to provide for employer contributions to be made in cash rather than Company stock, impacting all non-union employees and most union employees. Employer contributions were $8,403,000, $9,724,000 and $10,331,000 for 2004, 2003 and 2002, respectively. F-42 (26) 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. The Court has dismissed all but two of the City's claims including its CERCLA claims and the claim against us for punitive damages. We are currently pursuing settlement discussions with the other parties, but if those efforts fail a trial of the City's remaining claims could begin as early as May 2005. 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 part of the Global Crossing bankruptcy proceeding. Citibank bases its claim for indemnity on the provisions of a credit agreement that was entered into in October 2000 between Citibank and our subsidiary. We purchased Frontier Subsidiary Telco, Inc., in June 2001 as part of our acquisition of the Frontier telephone companies. The complaint against Citibank, for which it seeks indemnification, alleges that the seller improperly used a portion of the proceeds from the Frontier transaction to pay off the Citibank credit agreement, thereby defrauding certain debt holders of Global Crossing North America Inc. Although the credit agreement was paid off at the closing of the Frontier transaction, Citibank claims the indemnification obligation survives. Damages sought against Citibank and its co-defendants could exceed $1,000,000,000. In August 2004 we notified Citibank by letter that we believe its claims for indemnification are invalid and are not supported by applicable law. We have received no further communications from Citibank since our August letter. We are party to other legal proceedings arising in the normal course of our business. The outcome of individual matters is not predictable. However, we believe that the ultimate resolution of all such matters, after considering insurance coverage, will not have a material adverse effect on our financial position, results of operations, or our cash flows. We have budgeted capital expenditures in 2005 of approximately $270,000,000, including $255,000,000 for ILEC and $15,000,000 for ELI. Although we from time to time make short-term purchasing commitments to vendors with respect to these expenditures, we generally do not enter into firm, written contracts for such activities. F-43 We conduct certain of our operations in leased premises and also lease certain equipment and other assets pursuant to operating leases. Future minimum rental commitments for all long-term noncancelable operating leases and future minimum capital lease payments for continuing operations as of December 31, 2004 are as follows:
($ in thousands) Capital Operating ---------------- Leases Leases Year ending December 31: 2005 $ 539 $ 21,198 2006 544 14,228 2007 549 12,537 2008 555 11,517 2009 561 10,018 Thereafter 7,269 35,494 ---------- ----------- Total minimum lease payments 10,017 $104,992 =========== Less amount representing interest (rates range from 9.25% to 10.65%) (5,596) ---------- Present value of net minimum capital lease payments 4,421 Less current installments of obligations under capital leases (81) ---------- Obligations under capital leases, excluding current installments $ 4,340 ==========
Total rental expense included in our results of operations for the years ended December 31, 2004, 2003 and 2002 was $26,349,000, $33,801,000 and $37,480,000, respectively. Until March 1, 2005, we sublet certain office space in our corporate office to a charitable foundation formed by our ex-Chairman. We are a party to contracts with several unrelated long distance carriers. The contracts provide fees based on traffic they carry for us subject to minimum monthly fees. At December 31, 2004, the estimated future payments for obligations under our long distance contracts and service agreements are as follows: ($ in thousands) Year ILEC / ELI - ---------------- -------------- -------------- 2005 $ 35,831 2006 26,363 2007 6,796 2008 735 2009 165 thereafter 990 ------------- Total $ 70,880 ============= F-44 The Company sold all of its utility businesses as of April 1, 2004. However, we have retained a potential payment obligation associated with our previous electric utility activities in the state of Vermont. The Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities, including us, entered into a purchase power agreement with Hydro-Quebec in 1987. The agreement contains "step-up" provisions that state that if any VJO member defaults on its purchase obligation under the contract to purchase power from Hydro-Quebec the other VJO participants will assume responsibility for the defaulting party's share on a pro-rata basis. Our pro-rata share of the purchase power obligation is 10%. If any member of the VJO defaults on its obligations under the Hydro-Quebec agreement, then the remaining members of the VJO, including us, may be required to pay for a substantially larger share of the VJO's total power purchase obligation for the remainder of the agreement (which runs through 2015). Paragraph 13 of FIN 45 requires that we disclose "the maximum potential amount of future payments (undiscounted) the guarantor could be required to make under the guarantee." Paragraph 13 also states that we must make such disclosure "... even if the likelihood of the guarantor's having to make any payments under the guarantee is remote..." As noted above, our obligation only arises as a result of default by another VJO member such as upon bankruptcy. Therefore, to satisfy the "maximum potential amount" disclosure requirement we must assume that all members of the VJO simultaneously default, a highly unlikely scenario given that the two members of the VJO that have the largest potential payment obligations are publicly traded with investment grade credit ratings, and that all VJO members are regulated utility providers with regulated cost recovery. Regardless, despite the remote chance that such an event could occur, or that the State of Vermont could or would allow such an event, assuming that all the members of the VJO defaulted on January 1, 2006 and remained in default for the duration of the contract (another 10 years), we estimate that our undiscounted purchase obligation for 2006 through 2015 would be approximately $1,400,000,000. In such a scenario the Company would then own the power and could seek to recover its costs. We would do this by seeking to recover our costs from the defaulting members and/or reselling the power to other utility providers or the northeast power grid. There is an active market for the sale of power. We could potentially lose money if we were unable to sell the power at cost. We caution that we cannot predict with any degree of certainty any potential outcome. At December 31, 2004, we have outstanding performance letters of credit as follows: ($ in thousands) ---------------- CNA $ 19,404 State of New York 2,993 ELI projects 50 ----------- Total $ 22,447 =========== In 2004, we assumed a letter of credit with the State of New York (related to workers compensation claims) from Global Crossing, Inc. CNA serves as our agent with respect to general liability claims (auto, workers compensation and other insured perils of the Company). As our agent, they administer all claims and make payments for claims on our behalf. The Company reimburses CNA for such services upon presentation of their invoice. To serve as our agent and make payments on our behalf, CNA requires that we establish a letter of credit in their favor. CNA could potentially draw against this letter of credit if we failed to reimburse CNA in accordance with the terms of our agreement. The value of the letter of credit is reviewed annually and adjusted based on claims history. None of the above letters of credit restrict our cash balances. (27) Subsequent Events: ----------------- In February 2005, we entered into a definitive agreement to sell Conference-Call USA, LLC, our conferencing services business, to Premiere Global Services, Inc. for $41,000,000 in cash, subject to adjustments under the terms of the agreement. This transaction is expected to close by March 31, 2005. F-45 CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders Citizens Communications Company: Under date of March 11, 2005, we reported separately on the consolidated balance sheets of Citizens Communications Company and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders' equity, comprehensive income (loss) and cash flows for each of the years in the three-year period ended December 31, 2004. In connection with our audits of the aforementioned consolidated financial statements, we have also audited the related financial statement schedule. The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Our report refers to the adoption of Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" as of January 1, 2003. /s/ KPMG LLP New York, New York March 11, 2005 F-46 Schedule II CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES Valuation and Qualifying Accounts ($ In thousands)
Additions ------------------------------ Balance at Charged to Charged to other Balance at beginning of costs and accounts - End of Accounts period expenses Revenue Deductions Period - ------------------------------ -------------- ------------------------------ ------------- --------- Allowance for doubtful accounts 2002 67,601 24,249 42,686 (95,590)(1) 38,946 2003 38,946 21,525 32,240 (45,379) 47,332 2004 47,332 17,859 13,586 (42,735) 36,042
(1) Net of recoveries of amounts previously written off. F-47 EX-10.19 2 exhibit10-19.txt COMPENSATION AGREEMENTS Exhibit 10.19 Summary of Compensation Arrangements for Named Executive Officers ----------------------------------------------------------------- Outside of Employment Agreements -------------------------------- The following executive officers, expected to be named executive officers in the Company's proxy statement for its 2005 annual meeting, are at will employees with whom the Company does not have written employment agreements. Their compensation arrangements are as follows: Name Salary Target Bonus - ----- ------ ------------ Daniel McCarthy $ 265,000 75% $198,800 L. Russell Mitten $ 201,800 50% $100,900 In addition, such executive officers are eligible to participate in benefit programs open to our employees generally, including equity awards at the discretion of the Compensation Committee of the board of directors. Summary of Non-Employee Directors' Compensation Arrangements ------------------------------------------------------------ Outside of Formal Plans ----------------------- ANNUAL RETAINER FEE On January 1 of each year he or she serves on the board, each non-employee director will receive an annual retainer fee of $30,000 cash of 5,000 stock units. Each non-employee director must irrevocable elect by December 31 of the prior year whether to receive his or her retainer in cash or units. MEETING FEES Each non-employee director will receive $2,000 for his or her participation in each board and committee meeting. Each Committee Chair and the Lead Director will receive an additional annual stipend, payable in equal quarterly installments on the first business day of the succeeding quarter, in the following amounts: Lead Director $20,000 Audit Committee Chair $25,000 Compensation Committee Chair $15,000 Nominating and Corporate Governance Committee Chair $ 7,500 Retirement Plan Committee $ 5,000 Each non-employee director must elect by December 31 of the prior year whether to receive his or her meeting fees and chairmanship stipend, when applicable, in cash or stock units, or a combination of the two forms of compensation. EX-10.19.1 3 exhibit10-191.txt MITTEN AGREEMENT SPLIT DOLLAR CITIZENS UTILITIES COMPANY SPLIT DOLLAR LIFE INSURANCE AGREEMENT THIS AGREEMENT, made as of the 28th day of April, 1994, by and between Citizens Utilities Company, (hereinafter called the Employer), and Lyman Russell Mitten (hereinafter called the Employee). WHEREAS, Employee is a valued and trusted employee and has been employed by Employer for a number of years and has discharged all duties in a most capable manner, and WHEREAS, Employer wishes to encourage Employee to continue employment by establishing this Split Dollar Life Insurance Agreement, and WHEREAS, Employer has applied for and acquired Policy #1529754 issued on November 19, 1993 by Security Life of Denver Insurance Company (hereinafter called the Carrier) insuring the life of the Employee (hereinafter with any additions or modifications called the Policy), and WHEREAS, Employer wishes to help Employee maintain a portion of said life insurance Policy for the benefit and protection of the Employee's family by the establishment of this Split Dollar Life Insurance Agreement, to provide an amount of life insurance payable to the Employee's beneficiary equal to four times the Employee's Base Salary, subject to adjustment, and WHEREAS, it is the intent of the parties that the Policy be designed in a manner to provide that life insurance benefits under this Agreement may continue after the Employee's termination of employment, and WHEREAS, it is the intent of the parties to continue this Slit Dollar Agreement in force until the earlier of the Employee's Normal Retirement Date or death, and WHEREAS, the parties intend that the split dollar arrangement provided in this Agreement will be taxed in accordance with the principles of split dollar set forth in Rev. Rul. 64-328, 1964-2 CB 11, NOW THEREFORE, for acknowledged mutual consideration between the parties hereto it is agreed that: 1. POLICY OWNERSHIP The Employee shall continue to own the Policy. 2. NORMAL RETIREMENT DATE DEFINED For the purposes of this Agreement NORMAL RETIREMENT DATE shall mean the January 1st following the Employee's 65th birthday. 3. DEATH BENEFIT AMOUNT FOR EMPLOYEE'S BENEFICIARY The Employee's designated beneficiary shall be entitled to a life insurance death benefit equal to four times the Employee's annualized Base Salary (a) on the date of death, if death occurs before NORMAL RETIREMENT DATE, and (b) for the year immediately before the Employee's NORMAL RETIREMENT DATE, if death occurs on or after the Employee's NORMAL RETIREMENT DATE. Base Salary shall have the same meaning as "earnings" as defined in Citizens Utilities Company's group term life insurance plan as of January 1, 1994 and set-out in Exhibit A to this Agreement provided, however, that for purpose of determining the amount of the death benefit under this Agreement there shall be the following adjustments. (a) For purposes of this Agreement, during 1994, the Base Salary for the period from January 1, 1994 to the effective date of the annual performance review shall be the actual Base Salary. For purpose of determining Base Salary for the period from the effective date of the annual performance review until December 31, 1994 the Bass Salary as of the date immediately proceeding the effective date of the review shall be increased by the greater of the actual percentage increase times that Base Salary or 5.5% times that Base Salary. (b) For each year after 1994, Base Salary as of January 1 of such year shall be the Base Salary as of December 31, of the preceding year (computed in the manner as set-out in clause (a) above). For the period from the annual performance review date until December 31 of such year, the Base Salary as of the date immediately preceding the review date shall be increased by the greater of the actual percentage increase times that Base Salary or 5.5% times that Base Salary. (c) If any increase in actual Base Salary shall be effective on any date other than an annual performance review date (by reason of a promotion or otherwise) the then Base Salary shall be the greater of actual Base Salary or Base Salary computed in accordance with clauses (a) and (b) above. Provided further that the amount of life insurance death benefit to which the beneficiary of a terminated Employee is entitled is subject to the provisions of Section 6 hereof. 4. PAYMENT OF PREMIUMS The Employee shall pay to the Employer that part of each annual SCHEDULED premium equal to the value of the "reportable economic benefit" of the life insurance amount to which the Employee's beneficiary is entitled under this Agreement, calculated in accordance with U.S. Treasury Department rules. It is the intent of the parties that this amount be calculated in accordance with U.S. Treasury Department rules in a manner which will result in the lowest possible amount being paid by the Employee. Such amount may hereinafter also may be referred to as "the cost of the pure term insurance." October 15th of each calendar year, the Employer shall give written notice to the Employee (whether terminated or not) of the annual cost of the pure term insurance for the current year. Within 30 days after receiving such notice, the Employee shall pay to the Employer an amount equal to the cost of the pure term insurance as set forth in such notice. In the event of the Employee's death at any time, not having paid all or any portion of the cost of the pure term insurance for the year of such death, such unpaid amount shall be a charge against the Employee's benefit under the policy, thereby reducing the death benefit on a dollar for dollar basis. The Employer shall pay the annual SCHEDULED PREMIUM in the amount set for the in the Policy on a timely basis. The cumulative total paid by the Employer, less the cumulative amounts paid by the Employee as the cost of the pure term insurance, shall be known as "PREMIUM ADVANCES". The Employer shall remit each premium due (including the Employee's amount) on an annual basis on or before the due date and agrees not to change the premium payment mode from the annual basis. Provided further, however, that if an Employee has voluntarily terminated employment with Employer, the Employer's premium payment obligation is hereby modified to allow a reduction in the amount of the premium payments so that, based on the Carrier's current assumptions, such modified premium payment schedule will provide the projected, vested death benefit both pre- and post-retirement. 5. COLLATERAL ASSIGNMENT The total amount of all PREMIUM ADVANCES applied to the policy by the Employer shall constitute and be known as the "EMPLOYER'S INTEREST IN THE POLICY" during the Employee's lifetime. Additionally, if Employee voluntarily terminates employment with the employer, the EMPLOYER'S INTEREST IN THE POLICY shall also include the excess of the amount of policy cash value over that needed at any time to provide the death benefit to which Employee will be entitled under this Agreement. As security for the repayment of the EMPLOYER'S INTEREST IN THE POLICY, as it may exist from time to time during the Employee's lifetime, and also as security for the payment of death benefits to the Employer pursuant to Section 10, the Employee shall executive and deliver to the Employer, as of the time of the first Premium Advance hereunder, a Collateral Assignment of said policy. At or about the time of Employee's NORMAL RETIREMENT DATE, the Employer shall withdraw the EMPLOYER'S INTERST IN THE POLICY (decreased by the amounts previously borrowed or withdrawn by the Employer under Section 8 below) from the then policy values and shall release its Collateral Assignment to the Employee. 6. TERMINATION OF EMPLOYEMENT A. Voluntary Termination If employee voluntarily terminates employment with Employer, Employee will e deemed to have become entitled to a continuing death benefit under this Agreement in an amount equal to the product of multiplying Employee's then Vested Percentage times the death benefit to which the Employee's beneficiary had been entitled under this Agreement at the time of the Employee's termination, based on the then Base Salary. The Employee shall continue to be obliged to continue paying the cost of the pure term insurance pursuant to Section 4 hereof until Normal Retirement Date. Employee's Vested Percentage is determined under the following schedule: Years of Service Vested After 1993 Percentage ---------- ---------- 1 20 2 40 3 60 4 80 5 100 A Year of Service is any calendar year in which the Employee is employed for six full months. Employee's voluntary termination will result in the increase of the EMPLOYER'S INTEREST IN THE POLICY set forth in Section 5. Provided, however that if the terminated Employee fails to contribute such cost of the pure term insurance on the continuing, level death benefit, then such failure will result in a charge against the Employee's interest in the policy equal to the sum of the unpaid annual amounts calculated pursuant to Section 4 hereof and further increased by an additional charge for the use of money resulting from such charge at the annually compounding rate of 5.5%. The parties intend and agree that such charges shall be treated as "PREMIUM ADVANCES" made by the Employer, and that such charges will be included as part of the EMPLOYER'S INTEREST IN THE POLICY. It is further intended and agreed that such charges will be secured by the Collateral Assignment pursuant to Section 5 hereof. The effect of such charges will be to reduce the Employee's pre- and post-retirement death benefit and cash surrender value benefit level on a dollar for dollar basis. Any reference to benefit levels or death benefit(s) in this Agreement shall be deemed to mean "as the same may be reduced for failure to contribute the cost of the pure term insurance. The failure of the Employee to be elected or retained in the Employee's present position or in another position of equal or greater responsibility, or a material reduction in the Employee's authority, functions, duties or responsibilities (whether or not followed by termination of employment), shall be deemed to be an "involuntary termination (other than for `good cause')." Upon the occurrence of any event or condition specified in the immediately preceding sentence, the Employee's Vested Percentage shall be fixed at 100%, regardless of the years of service, and, until termination of the Employee's employment, the Employee's Base Salary (and consequently the Employee's death benefit) shall be determined as provided in Section 3. If an event or condition specified in the second preceding sentence occurs and is followed by termination of Employee's employment at any time prior to the Employee's Normal Retirement Date, such termination of employment shall be an "involuntary termination (other than for `good cause')", as stated aforesaid and, following such termination, the Employee's Base Salary (and consequently the Employee's death benefit) shall be determined as provided in the first paragraph of section 6B. B. Involuntary Termination If an Employee is involuntarily terminated (other than for "good cause"), the Employee will thereupon become 100% vested in the right to receive the benefit to which the Employee would be entitled under this Agreement. If the Employee is involuntarily terminated the benefit shall be based on the Employee's Base Salary in the year of termination, adjusted, if necessary, to reflect a minimum annual 5 1/2% increase in Base Salary determined in accordance with paragraph 3 of this Agreement for years after the year of termination up through the year immediately before the Employee's NORMAL RETIREMENT DATE, provided that the Employee shall remain obligated to continue to pay the cost of the pure term insurance until Normal Retirement Date. Provided, however, that if the involuntarily terminated Employee fails to contribute such cost of the pure term insurance, then such failure will result in a charge against the Employee's interest in the policy equal to the sum of the unpaid annual amounts calculated pursuant to Section 4 hereof, and further increased by an additional charge for the use of money resulting from such charge at the annually-compounding rate of 5.5%. The parties intend and agree that such charges shall be treated as "PREMIUM ADVANCES" made by the Employer, and that such charges will be included as part of the EMPLOYER'S INTERST IN THE POLICY. It is further intended and agreed that such charges will be secured by the Collateral Assignment pursuant to Section 5 hereof. The effect of such charges will be to reduce the Employee's post-retirement death benefit level and the cash surrender benefit level on a dollar for dollar basis. Any reference to benefit levels or death benefit(s) in the Agreement shall be deemed to mean "as the same may be reduced for failure to contribute the cost of the pure term insurance." Termination by Employer of Employee's employment for "good cause" as used in this Agreement shall be limited to willful malfeasance by Employee in the performance of employment duties which is demonstrated to have a materially injurious effect on the Employer's business, or by reason of Employee's conviction of a felony related directly to the conduce of Employee's office (which through lapse of time or otherwise, is not subject to appeal) or, while in the employ of the Employer, knowingly engaging in and not thereafter refraining from competition; provided, however, that such termination shall be effected only by written notice thereof delivered by the Employer to the Employee specifying in detail the basis for termination, and shall be effective as of the date which is 30 business days after receipt of such notice by the Employee; provided further, however, that if (i) such termination is by reason of Employee's willful malfeasance without proper cause to perform the Employee's particular obligations which has a materially injurious effect on the Employer's business, or by reason of the Employee knowingly engaging in competition, and (ii) within 30 days following the date of receipt of such notice Employee shall cease such refusal and shall make best efforts to perform such obligations, the termination shall not be effective. Without limitation, Employee shall have the right to contest in appropriate forums any termination for "good cause." If employment is terminated for "good cause" (and, if the Employee has brought a proceeding to contest such termination for "good cause", the Company has prevailed in such proceeding and any time to appeal or seek review has expired), the Employee's and Employee's beneficiary's interest in the Policy and in any death benefits shall cease, and the Company may cancel the Policy and receive the full cash surrender value from the Carrier. If the Employee should die after the date of such termination for cause but before the cancellation of the Policy and the Employee or the Employee's representative shall not have successfully contested such termination for cause, then the Employer shall receive all death benefits and other value and the Employee's beneficiary shall be entitle to nothing. 7. DISABILITY If the Employee or Employer terminates employment as a result of "total disability", which has had a duration of at least 12 months, the Employee will have the same rights and responsibilities under this Agreement as if there had been an involuntary termination, not for "good cause", under Section 6B above. For purposes of this Agreement, the term "total disability" shall have the same meaning as the term "total disability" as defined in the Employer's group long term disability policy in force at the time and in which the Employee is a participant. If the Employer sponsors a non-cancelable individual disability policy for the Employee as a supplement or replacement for the group disability policy, then the term "total disability" shall have the same meaning as in the individual policy. 8. POLICY LOANS After 4 years of employment with Employer beginning January 1, 1994, the Employee will have a right to borrow from the policy for any educational cost requirements of the Employee and/or the Employee's immediate family, provided that the Employee may borrow only from the bash value of the policy which exceeds the EMPLOYER'S INTEREST IN THE POLICY. And further provided that a voluntarily terminated Employee will not have the right to borrow from the policy. Any loans from the policy will reduce the Employee's pre- and post-retirement benefit level on a dollar for dollar basis. Except as provided in this paragraph, the Employer shall have no rights to borrow or withdraw any amounts from the policy prior to the Employee's Normal Retirement Date. At Normal Retirement Date, the Employer's right to borrow or withdraw from the policy shall be limited to its INTEREST IN THE POLICY. Provided that if the Employee has voluntarily terminated, the Employer shall have the right at any time to borrow or withdraw from the Policy any excess cash value not required under the Carrier's then current projections to provide the death benefit to which Employee would be entitle under this Agreement. 9. SATISFACTION OF EMPLOYER'S INTEREST DURING EMPLOYEE'S LIFE Except in the base of termination for "good cause," the Employer shall withdraw the EMPLOYER'S INTERESET IN THE POLICY (as increased under Section 5 if Employee has voluntarily terminated but decreased by any amounts previously borrowed or withdrawn by the Employer under Section 8 above) from the then policy values on the Employee's Normal Retirement Date but in no event before, the Employee's Normal Retirement Date and, upon receipt thereof, shall release and cancel the Collateral Assignment. Such release and cancellation shall terminate this Agreement and all obligations, right and interest of the Employer hereunder. Upon the release and cancellation of the Collateral Assignment by the Employer, the Employee will have no further rights or claim against the Employer in connection with this Agreement and will rely only on the then values in the Policy post retirement even though the then policy values might be insufficient to pay the death benefits specified in this Agreement. 10. PAYOUT OF INSURANCE PROCEEDS In the event of the death of the Employee, while this Agreement is in force, the Carrier shall pay out policy proceeds in the following order of sequence: 1. To the Employer: The EMPLOYER'S INTEREST IN THE POLICY. 2. To the Employee: The amount to which the Employee's designated beneficiary is entitled under this Agreement. 3. To the Employer: Any remaining balance. No beneficiary or representative of the Employee shall have any interest in such balance. 11. BENEFICIARY DESIGNATION The Employee shall have the right to name and change the beneficiary under the policy to the extent of the amount of the death benefit to which the Employee's beneficiary may be entitled under this Agreement. The Employee's beneficiary for the amount set forth in this agreement shall be the beneficiary named in the most recently executed beneficiary designation form filed with the carrier as of the date of employee's death. The Employer will cooperate fully in order to effectuate any change in the beneficiary designation which the Employee may desire to make, subject to the rights of the Employer as defined in this Agreement. The Employer will be the beneficiary of any death benefits in excess of the amounts to which the Employee's beneficiary may be entitled under this Agreement and no beneficiary or representative of the Employee shall have any interest in such excess. 12. AGREEMENT BINDING This agreement shall be binding upon the parties hereto, their heirs, legal representatives or successors. 13. AMENDMENT This Agreement shall not be modified or amended except by a written Agreement signed by the Emp0loyer and the Employee. 14. STATE LAW This Agreement shall be subject to and governed by the laws of the State of Connecticut. 15. NAMED FIDUCIARY AND PLAN ADMINISTRATOR Citizens Utilities Company is hereby designated the "Named Fiduciary", and it shall be responsible for the management, control and administration of the Split Dollar Plan as established herein. It may allocate to others certain aspects of the management and operational responsibilities of the plan, including the employment of advisors and the delegation of any ministerial duties to qualified individuals. 16. CLAIMS PROCEDURE A. Filing of Benefit Claims 1. When an Employee, beneficiary or his or her duly authorized representative (hereinafter referred to as the "Claimant") have a claim which may be covered under the provisions of the Policy, he or she should contact the Named Fiduciary. 2. Claim forms and claim information can be obtained from the above Named Fiduciary. 3. The claim must be in writing and delivered, along with a certified copy of the death certificate, to the above Named Fiduciary either in person or by mail, postage paid. The above Named Fiduciary will forward the claim form, within 14 days of its receipt, to the authorized representative of the Carrier. B. Initial Disposition of Benefit Claims 1. Within thirty (30) days after receipt of a claim, said Carrier shall send to the Claimant, by mail, postage prepaid, a notice granting or denying, in whole or in part, a claim for benefits. 2. If a claim for benefits is denied, the Carrier shall provide to the Claimant written notice setting forth in a manner calculated to be understood by the Claimant. (a) The specific reasons for denial; (b) Specific reference to pertinent policy provisions on which the denial is based; (c) A description of any additional material or information necessary for the Claimant to perfect the claim and an explanation of why such material or information is necessary; and (d) Appropriate information as to the steps to be taken if the Claimant wishes to submit his or her claim for review. 3. If the claim is payable, a benefit check will be issued to the Claimant. 4. If a notice of denial is not received within 30 days of the claim being filed, the claim shall be deemed denied and the Claimant shall be permitted to proceed to the review stage. C. Review Procedure 1. Within thirty (30) days of: (a) The receipt by the Claimant of written notification denying, in whole or in part, his or her claim, or (b) A deemed denial resulting from the Carrier's failure to provide the Claimant with written notice of denial within 30 days of the claim being filed, the Claimant upon written application to the Carrier, delivered in person or by certified mail, postage prepaid, may request an opportunity to appeal a denied claim to the Carrier or a person designated by the Carrier. 2. The Claimant may: (a) Request a review upon written application to Carrier, (b) Review pertinent documents; and (c) Submit issues and comments in writing. 3. The decision on review shall be made within thirty (30) days of the Carrier receipt of a request for review. 4. The decision on review shall be in writing and shall include specific reasons for the decision, written in a manner calculated to be understood by the Claimant, as well as specific references to the policy provision on which the decision is based. 5. If the decision on review is not rendered within 30 days, then the claim shall be deemed denied on review. D. Other Remedies 1. After exhaustion of the claims procedures, nothing shall prevent any person from pursuing any other legal or equitable remedy otherwise available. 17. NOTICES All notices or communications provided for herein shall be in writing and shall be delivered to Employer, Employee or the Carrier in person or by United States mail, via certified mail return receipt requested, postage prepaid, addressed to Employee as follows: Lyman Russell Mitten 10 Banks Drive Wilton, CT 06897 - 3202 or addressed to Employer as follows: Citizens Utilities Company Three High Ridge Park Stamford, CT 06905 Attn: Vice President, Tax or addressed to the Carrier as follows: Security Life of Denver 1290 Broadway Denver, CO 80203 ATTN: Claims Department Until and unless other addresses are specified by written notice. 18. ENTIRE AGREEMENT This Agreement sets forth the entire agreement of the parties with respect to the subject matter hereof. Any and all prior agreements or understandings will respect to such matters are hereby superseded. CORPORATE SEAL Citizens Utilities Company Attest: Employer /s/ Charles J. Weiss By: /s/ Daryl A. Ferguson - ------------------------------- -------------------------- Charles J. Weiss Daryl A. Ferguson Attest: By: /s/ L. Russell Mitten - ------------------------------- -------------------------- L. Russell Mitten Dated: April 28, 1994 ------------------------- Filed at the Home Office of the Insurer this 5th Day of July 1994. The Insurer assumes no responsibility for the Validity of this document. Security of Denver /s/ Jean C. Gallagher ----------------------------------------- Jean C. Gallagher, Sr. Vice President CITIZENS UTILITIES COMPANY SPLIT DOLLAR LIFE INSURANCE AGREEMENT EXHIBIT A DEFINITION OF EARNINGS "Earnings" means only that annual, monthly, bi-weekly, or weekly pay, as the case may be, received by the employee from the employer excluding commissions, bonuses, overtime pay or other additional compensation. EX-10.20 4 caseyagree.txt CASEY AGREEMENT EXHIBIT 10.20 EMPLOYMENT AGREEMENT John H. Casey, III This EMPLOYMENT AGREEMENT (the "Agreement") is dated as of February 15, 2005 (the "Effective Date") by and between Citizens Communications Company (the "Company") and John H. Casey, III ("Executive"). WHEREAS, Executive is currently employed with the Company as an Executive Vice President; and WHEREAS, as of the Effective Date, the Company desires to enter into an agreement with Executive embodying the terms of Executive's employment and pursuant to which Executive will serve as an Executive Vice President, and Executive desires to enter into such an agreement. NOW, THEREFORE, in consideration of the premises and mutual covenants herein and for other good and valuable consideration, the parties agree as follows: 1. Term of Employment. Subject to the provisions of Section 8 of this Agreement, Executive shall be employed by the Company, and any of its subsidiaries that the Chief Executive Officer (the "CEO") or the Board of Directors of the Company (the "Board") shall designate for a period commencing on the Effective Date and ending on the fifth anniversary thereof (the "Initial Term"), on the terms and subject to the conditions set forth in this Agreement. Following the Initial Term, the Agreement shall automatically be renewed for additional terms of one year on each anniversary of the last day of the Initial Term (the Initial Term and any annual extensions of the term of this Agreement, together, the "Employment Term"), subject to Section 7 of this Agreement, unless the Company or the Executive gives the other party written notice of non-renewal at least ninety (90) days prior to such anniversary. A written notice of non-renewal given by the Company to the Executive shall be considered a Notice of Termination (pursuant to Section 7(e) of this Agreement) of a termination without Cause by the Company and shall constitute a termination without Cause under Section 7(c) of this Agreement at the expiration of such Employment Term for all purposes hereunder. 2. Position. a. During the Employment Term, Executive shall serve as an Executive Vice President of the Company and shall report directly to the Chief Executive Officer of the Company. b. During the Employment Term, Executive will devote Executive's full business time and best efforts (excluding any periods of vacation or sick leave) to the performance of Executive's duties hereunder and will not engage in any other business, profession or occupation for compensation or otherwise which would conflict or interfere with the rendition of such services either directly or indirectly, without the prior written consent of the Board; provided that nothing herein shall preclude Executive, subject to the prior approval of the Board, from accepting appointment to or continue to serve on any board of directors or trustees of any business corporation or any charitable organization; provided in each case in the aggregate, that such activities do not conflict or interfere with the performance of Executive's duties hereunder or conflict with Section 9 of this Agreement. 3. Base Salary. During the Employment Term, the Company shall pay Executive a base salary at the annual rate of $400,000, payable in substantially equal periodic payments in accordance with the Company's practices for other executive employees, as such practices may be determined from time to time. Executive shall be entitled to such increases in Executive's base salary, if any, as may be determined from time to time in the sole discretion of the CEO and the Board. Executive's annual base salary, as in effect from time to time, is hereinafter referred to as the "Base Salary." 4. Annual Bonus. During the Employment Term, Executive shall be eligible to earn an annual bonus award (an "Annual Bonus"), with a target bonus amount equal to 100% of the Base Salary (the "Target Bonus"), with adjustments based on the schedules set forth in the Citizens Incentive Plan, as amended from time to time. In no instance will the adjustments to the Plan result in a reduction in the target bonus to less than 100% of base salary. 5. Long-Term Incentive. Each fiscal year during the Employment Term, Executive shall be eligible to receive a grant of restricted shares of common stock (the "Restricted Shares") in an amount to be determined by the Compensation Committee of the Board (the "Compensation Committee") commensurate with Executive's performance; provided, however, that during the term of this Agreement the Compensation Committee is not required to make a grant of Restricted Shares to Executive in any fiscal year other than 2005 during which, in accordance with the schedule to be adopted by the Compensation Committee, Executive will be granted 50,000 restricted shares for his performance during 2004. Subject to Section 7(b)(ii)(D) and Section 7(c)(iii)(D), below, each annual grant of Restricted Shares shall vest and become non-forfeitable as to one third of the shares initially granted on each anniversary of the date of grant and shall be fully vested and 100 percent non-forfeitable upon the fourth anniversary of the date of grant. 6. Employee Benefits; Business Expenses. a. Employee Benefits. During the Employment Term, Executive (and his eligible dependents) shall be entitled to participate in the Company's pension, profit sharing, medical, dental, life insurance and other employee benefit plans (other than severance plans) (the "Company Plans"), as in effect from time to time (collectively the "Employee Benefits") on the same basis as those benefits are generally made available to other senior executives of the Company. b. Business Expenses and Perquisites. (i) Expenses. During the Employment Term, reasonable business expenses incurred by Executive in the performance of Executive's duties hereunder shall be reimbursed by the Company in accordance with the Company's policies. (ii) Perquisites. During the Employment Term, Executive shall be entitled to receive such perquisites as are generally made available to other senior executives of the Company at a level that is commensurate with his position. 7. Termination. Executive's employment hereunder may be terminated by either party at any time and for any reason; provided that Executive will be required to give the Company at least 60 days advance written notice of any resignation of Executive's employment. Notwithstanding any other provision of this Agreement, the provisions of this Section 7 shall exclusively govern Executive's rights upon termination of employment with the Company. a. By the Company For Cause or By Executive Resignation Without Good Reason. (i) The Employment Term and Executive's employment hereunder may be terminated by the Company for Cause (as defined below) and shall terminate automatically upon Executive's resignation without Good Reason; provided that Executive will be required to give the Company at least 60 days advance written notice of such resignation. (ii) For purposes of this Agreement, "Cause" shall mean Executive's (A) willful and continued failure (other than as a result of physical or mental illness or injury) to perform his material duties (provided such duties are as described in Section 2) to the Company or its subsidiaries which continues beyond 10 days after a written demand for substantial performance is delivered to Executive by the Company (the "Cure Period"), which demand shall identify and describe such failure with sufficient specificity to allow Executive to respond; (B) willful or intentional conduct that causes material and demonstrable injury, monetarily or otherwise, to the Company; (C) conviction of, or a plea of nolo contendere to, a crime constituting (x) a felony under the laws of the United States or any state thereof or (y) a misdemeanor involving moral turpitude; or (D) material breach of a material provision of this Agreement, including, without limitation, engaging in any action in breach of Section 8 or Section 9 of this Agreement, which continues beyond the Cure Period (to the extent that, in the Board's reasonable judgment, such breach can be cured). For purposes of this Section 7(a)(ii), no act, or failure to act, on the part of Executive shall be considered "willful" unless it is done, or omitted to be done, by Executive in bad faith and without reasonable belief that Executive's action or inaction was in the best interests of the Company. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or upon the instructions of the Chief Executive Officer of the Company or other senior officer of the Company or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by Executive in good faith and in the best interests of the Company. (iii) If Executive's employment is terminated by the Company for Cause, or if Executive resigns without Good Reason, Executive shall be entitled to receive: (A) the Base Salary through the date of termination; (B) any Annual Bonus earned but unpaid as of the date of termination for any previously completed fiscal year; (C) reimbursement for any unreimbursed business expenses properly incurred by Executive in accordance with Company policy prior to the date of Executive's termination; (D) any accrued but unpaid vacation; and (E) such Employee Benefits, if any, to which Executive may be entitled under the applicable Company Plans upon termination of employment hereunder, (the payments and benefits described clauses (A) through (E) hereof being referred to, collectively, as the "Accrued Rights"). Following such termination of Executive's employment by the Company for Cause or resignation by Executive, except as set forth in this Section 7(a)(iii), Executive shall have no further rights to any compensation or any other benefits under this Agreement. b. Disability or Death. (i) Executive's employment hereunder shall terminate upon Executive's death and may be terminated by the Company if Executive becomes physically or mentally incapacitated and is therefore unable for a period of six (6) consecutive months or for an aggregate of nine (9) months in any twelve (12) consecutive month period to perform Executive's duties (such incapacity is hereinafter referred to as "Disability"). Any question as to the existence of the Disability of Executive as to which Executive and the Company cannot agree shall be determined in writing by a qualified independent physician mutually acceptable to Executive and the Company. If Executive and the Company cannot agree as to a qualified independent physician, each shall appoint such a physician and those two physicians shall select a third who shall make such determination in writing. The determination of Disability made in writing to the Company and Executive shall be final and conclusive for all purposes of the Agreement. (ii) Upon termination of Executive's employment hereunder for either Disability or death, Executive or Executive's estate (as the case may be), shall be entitled to receive: (A) the Accrued Rights; (B) continued payment of Executive's Base Salary during the period commencing on the termination date and ending on the date that is six months after the termination date; (C) a pro rata portion of the Annual Bonus, if any, that Executive would have been entitled to receive pursuant to the Citizens Incentive Plan in the year of termination, based on actual performance through the date of termination; and (D) all Restricted Shares that have been granted as of the date of termination shall be fully vested and non-forfeitable as of such date, all other restricted shares and options previously granted to Executive that are not vested as of such date shall become vested and non-forfeitable or, in the case of options, fully exercisable, and Executive shall not be entitled to any further annual grants of Restricted Shares under Section 5 of this Agreement. (iii) Upon termination of Executive's employment hereunder due to Executive's death or Disability, in addition to the benefits described in Section 7(b)(ii) above, the Company shall provide Executive (in the event of his Disability) and Executive's spouse with medical, dental, life insurance and other health benefits (pursuant to the same Company Plans that are medical, dental, life insurance and other health benefit plans and that are in effect for active employees of the Company), at the sole cost of the Company, until the second anniversary of the date of Executive's death or Disability. Following Executive's termination of employment due to death or Disability, except as set forth in this Section 7(b), Executive shall have no further rights to any compensation or any other benefits under this Agreement. c. By the Company Without Cause or by Executive Resignation for Good Reason. (i) Executive's employment hereunder may be terminated (A) by the Company without Cause (which shall not include Executive's termination of employment due to his Disability) or (B) by Executive for Good Reason (as defined below). (ii) For purposes of this Agreement, "Good Reason" shall mean (A) the failure of the Company to pay or cause to be paid Executive's Base Salary or Annual Bonus earned if any, or a Board approved grant the Restricted Shares when due hereunder, (B) any relocation of Executive's principal office location more than 25 miles outside of the Stamford, Connecticut metropolitan area, or (C) any other material breach of a material provision of this Agreement; provided that any of the events described in clauses (A), (B), or (C) of this Section 7(c)(ii) shall constitute Good Reason only if the Company fails to cure such event within 30 days after receipt from Executive of written notice of the event which constitutes Good Reason (with sufficient specificity from Executive for the Company to respond to such claim). (iii) If Executive's employment is terminated by the Company without Cause (other than by reason of death or Disability) or by Executive for Good Reason, subject to Executive's execution of a release of all then existing claims against the Company and its subsidiaries, affiliates, shareholders, officers, directors, employees and agents, Executive shall be entitled to receive: (A) the Accrued Rights; (B) subject to Executive's continued compliance with the provisions of Section 8 and Section 9 of this Agreement, an amount equal to one year of the then current Base Salary and Target Bonus, payable on the date of termination (C) continuation of medical, dental, life insurance and other health benefits (pursuant to the same Company Plans that are medical, dental, life insurance and other health benefit plans and that are in effect for active employees of the Company) for one year from the date of Termination or until the date on which Executive becomes eligible to receive comparable benefits from any subsequent employer; and (D) all Restricted Shares shall be vested and non-forfeitable as of the date of termination, all other restricted shares and options previously granted to Executive that are not vested as of such date shall become vested and nonforfeitable or, in the case of options, fully exercisable and Executive shall not be entitled to any further annual grants of Restricted Shares under Section 5 of this Agreement. Following Executive's termination of employment by the Company without Cause (other than by reason of Executive's death or Disability) or Executive for Good Reason, except as set forth in this Section 7(c)(iii), Executive shall have no further rights to any compensation or any other benefits under this Agreement. d. Change in Control. (i) Executive shall also be entitled to the benefits set forth in Section 7(c)(iii) above if, within one year following a Change in Control (defined below), Executive terminates his employment as a result of: (i) any decrease by the Company of the Base Salary or Target Bonus percentage; (ii) any decrease in Executive's pension benefit opportunities or any material diminution in the aggregate employee benefits; or (iii) any material diminution in Executive's title or reporting relationships, or duties or responsibilities (each, a "Constructive Termination Event"); provided that either of the events described in clauses (i) and (ii) of this Section 7(d) shall constitute a Constructive Termination Event only if the Company fails to cure such event within 30 days after receipt from Executive of written notice of the event which constitutes a Constructive Termination Event. (ii) For purposes of this Agreement, a "Change in Control" shall be deemed to have occurred: (A) When any "person" as defined in Section 3(a)(9) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and as used in Section 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) of the Exchange Act (but excluding the Company and any subsidiary and any employee benefit plan sponsored or maintained by the Company or any subsidiary (including any trustee of such plan acting as trustee)), directly or indirectly, becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), of securities of the Company representing 50% or more of the combined voting power of the Company's then outstanding securities; or (B) Upon the consummation of any merger or other business combination involving the Company, a sale of substantially all of the Company's assets, liquidation or dissolution of the Company or a combination of the foregoing transactions (the "Transactions") other than a Transaction immediately following which the shareholders of the Company immediately prior to the Transaction own, in the same proportion, at least 51% of the voting power, directly or indirectly, of (i) the surviving corporation in any such merger or other business combination; (ii) the purchaser of or successor to the Company's assets; (iii) both the surviving corporation and the purchaser in the event of any combination of Transactions; or (iv) the parent company owning 100% of such surviving corporation, purchaser or both the surviving corporation and the purchaser, as the case may be. (iii) Excess Parachute Payments. (A) If it is determined (as hereafter provided) that any payment or distribution by the Company to or for the benefit of Executive, whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise pursuant to or by reason of any other agreement, policy, plan, program or arrangement, including without limitation any stock option, restricted stock award, stock appreciation right or similar right, or the lapse or termination of any restriction on or the vesting or exercisability of any of the foregoing (a "Severance Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code") (or any successor provision thereto) by reason of being "contingent on a change in ownership or control" of the Company, within the meaning of Section 280G of the Code (or any successor provision thereto) or to any similar tax imposed by state or local law, or any interest or penalties with respect to such excise tax (such tax or taxes, together with any such interest and penalties, are hereafter collectively referred to as the "Excise Tax"), then Executive shall receive the greater of (x) the Severance Payment, after payment by Executive of the Excise Tax imposed on the Severance Payment and (y) the amount of the Severance Payment (calculated on a net after-tax basis) which could be paid to Executive under Section 280G of the Code without causing any loss of deduction to the Company under such Section (the "Capped Payment"). (B) Subject to the provisions of Section 7(d)(iii)(A) hereof, all determinations required to be made under this Section 7(d), including whether an Excise Tax is payable by Executive and the amount of such Excise Tax, shall be made by the nationally recognized firm of certified public accountants (the "Accounting Firm") used by the Company prior to the Change in Control (or, if such Accounting Firm declines to serve, the Accounting Firm shall be a nationally recognized firm of certified public accountants selected by Executive). The Accounting Firm shall be directed by the Company or Executive to submit its preliminary determination and detailed supporting calculations to both the Company and Executive within 15 calendar days after the date of Executive's termination of employment, if applicable, and any other such time or times as may be requested by the Company or Executive. If the Accounting Firm determines that any Excise Tax is payable by Executive, the Company shall either (x) make payment of the Severance Payment, less all amounts withheld in respect of the Excise Tax, as required by applicable law, or (y) reduce the Severance Payment by the amount which, based on the Accounting Firm's determination and calculations, would provide Executive with the Capped Payment, and pay to Executive such reduced amount. If the Accounting Firm determines that no Excise Tax is payable by Executive, it shall, at the same time as it makes such determination, furnish Executive with an opinion that he has substantial authority not to report any Excise Tax on his federal, state, local income or other tax return. All fees and expenses of the Accounting Firm shall be paid by the Company in connection with the calculations required by this section. (C) The federal, state and local income or other tax returns filed by Executive (or any filing made by a consolidated tax group which includes the Company) shall be prepared and filed on a consistent basis with the determination of the Accounting Firm with respect to the Excise Tax payable by Executive. Executive shall make proper payment of the amount of any Excise Tax, and at the request of the Company, provide to the Company true and correct copies (with any amendments) of his federal income tax return as filed with the Internal Revenue Service and corresponding state and local tax returns, if relevant, as filed with the applicable taxing authority, and such other documents reasonably requested by the Company, evidencing such payment. e. Notice of Termination. Any purported termination of employment by the Company or by Executive (other than due to Executive's death) shall be communicated by written Notice of Termination to the other party hereto in accordance with Section 12(h) hereof. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of employment under the provision so indicated. f. Execution of Release of All Claims. Upon termination of Executive's employment for any reason, Executive agrees to execute a release of all then existing claims against the Company, its subsidiaries, affiliates, shareholders, directors, officers, employees and agents. Notwithstanding anything set forth in this Agreement to the contrary, upon termination of Executive's employment for any reason, Executive shall not receive any payments or benefits to which he may be entitled hereunder (other than those which by law cannot be subject to the execution of a release) (A) if Executive revokes such release or (B) until eight (8) days after the date Executive signs such release (or until such other date as applicable law may provide that Executive cannot revoke such release). 8. Non-Competition/Non-Solicitation/Non-Disparagement. a. Executive acknowledges and recognizes the highly competitive nature of the businesses of the Employer and its affiliates and accordingly agrees that, during the Employment Term and, for a period of one year following any termination of Executive's employment with the Company (the "Restricted Period"), Executive will not, whether on Executive's own behalf or on behalf of or in conjunction with any person, firm, partnership, joint venture, association, corporation or other business organization, entity or enterprise whatsoever ("Person"), directly or indirectly engage in any business that directly or indirectly competes in any material way with the primary business of the Company, or otherwise engage in competition with the Company which is materially detrimental to the Company; (i) During the Restricted Period, Executive will not, whether on Executive's own behalf or on behalf of or in conjunction with any Person, directly or indirectly: (A) solicit or encourage any employee of the Company or its affiliates to leave the employment of the Company or its affiliates; or (B) hire any such employee who was employed by the Company or its affiliates as of the date of Executive's termination of employment with the Company or who left the employment of the Company or its affiliates coincident with, or within one year prior to or after, the termination of Executive's employment with the Company. b. Executive shall not at any time issue any press release or make any public statement about the Company or any director, officer, employee, successor, parent, subsidiary or agent or representative of, or attorney to the Company (any of the foregoing, a "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 and, the Company shall not at any time issue any press release or make any public statement about Executive or his spouse that is intended or reasonably likely to disparage Executive's reputation in the business, industry or legal community or otherwise degrade his or her reputation or standing in their community; provided, that, Executive and the Company 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 other thereof, and (b) defend himself or itself against any statement made by the other party that is intended or reasonably likely to disparage or otherwise degrade that party's reputation, only if there is a reasonable belief that the statements made in such defense are not false statements and (c) provide truthful testimony in any legal proceeding. c. It is expressly understood and agreed that although Executive and the Company consider the restrictions contained in this Section 8 to be reasonable, if a final judicial determination is made by a court of competent jurisdiction that the time or territory or any other restriction contained in this Agreement is an unenforceable restriction against Executive, the provisions of this Agreement shall not be rendered void but shall be deemed amended to apply as to such maximum time and territory and to such maximum extent as such court may judicially determine or indicate to be enforceable. Alternatively, if any court of competent jurisdiction finds that any restriction contained in this Agreement is unenforceable, and such restriction cannot be amended so as to make it enforceable, such finding shall not affect the enforceability of any of the other restrictions contained herein. 9. Confidentiality. a. Executive will not at any time (whether during or after Executive's employment with the Company) (x) retain or use for the benefit, purposes or account of Executive or any other Person; or (y) disclose, divulge, reveal, communicate, share, transfer or provide access to any Person outside the Company (other than its professional advisers who are bound by confidentiality obligations), any non-public, proprietary or confidential information -- including without limitation rates, trade secrets, know-how, research and development, software, databases, inventions, processes, formulae, technology, designs and other intellectual property, information concerning finances, investments, profits, pricing, costs, products, services, vendors, customers, clients, partners, investors, personnel, compensation, recruiting, training, advertising, sales, marketing, promotions, government and regulatory activities and approvals -- concerning the past, current or future business, activities and operations of the Company, its subsidiaries or affiliates and/or any third party that has disclosed or provided any of same to the Company on a confidential basis ("Confidential Information") without the prior written authorization of the Board. b. "Confidential Information" shall not include any information that is (a) generally known to the industry or the public other than as a result of Executive's breach of this covenant or any breach of other confidentiality obligations by third parties; (b) made legitimately available to Executive by a third party without breach of any confidentiality obligation; or (c) required by law to be disclosed; provided that Executive shall give prompt written notice to the Company of such requirement, disclose no more information than is so required, and cooperate with any attempts by the Company to obtain a protective order or similar treatment. c. Except as required by law, Executive will not disclose to anyone, other than Executive's immediate family and legal or financial advisors, the existence or contents of this Agreement; provided that Executive may disclose to any prospective future employer the provisions of Section 8 and 9 of this Agreement provided that such potential employer agrees to maintain the confidentiality of such terms. d. Upon termination of Executive's employment with the Company for any reason, Executive shall immediately destroy, delete, or return to the Company, at the Company's option, all originals and copies in any form or medium (including memoranda, books, papers, plans, computer files, letters and other data) in Executive's possession or control (including any of the foregoing stored or located in Executive's office, home, laptop or other computer, whether or not Company property) that contain Confidential Information or otherwise relate to the business of the Company, its affiliates and subsidiaries, except that Executive may retain only those portions of any personal notes, notebooks and diaries that do not contain any Confidential Information. e. The provisions of this Section 9 shall survive the termination of Executive's employment for any reason. 10. Specific Performance. Executive acknowledges and agrees that the Employer's remedies at law for a breach or threatened breach of any of the provisions of Section 8 or Section 9 of this Agreement would be inadequate and the Company would suffer irreparable damages as a result of such breach or threatened breach. In recognition of this fact, Executive agrees that, in the event of such a breach or threatened breach, in addition to any remedies at law, the Company, without posting any bond, shall be entitled to cease making any payments or providing any benefit otherwise required by this Agreement and obtain equitable relief in the form of specific performance, temporary restraining order, temporary or permanent injunction or any other equitable remedy which may then be available. 11. Arbitration. Except as provided in Section 10, any other dispute arising out of or asserting breach of this Agreement, or any statutory or common law claim by Executive relating to his employment under this Agreement or the termination thereof (including any tort or discrimination claim), shall be exclusively resolved by binding statutory arbitration in accordance with the Employment Dispute Resolution Rules of the American Arbitration Association. Such arbitration process shall take place in New York, New York. A court of competent jurisdiction may enter judgment upon the arbitrator's award. All costs and expenses of arbitration (including fees and disbursements of counsel) shall be borne by the respective party incurring such costs and expenses. 12. Miscellaneous. a. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Connecticut, without regard to conflicts of laws principles thereof. b. Entire Agreement/Amendments. This Agreement contains the entire understanding of the parties with respect to the employment of Executive by the Company. There are no restrictions, agreements, promises, warranties, covenants or undertakings between the parties with respect to the subject matter herein other than those expressly set forth herein. This Agreement may not be altered, modified or amended except by written instrument signed by the parties hereto. c. No Waiver. The failure of a party to insist upon strict adherence to any term of this Agreement on any occasion shall not be considered a waiver of such party's rights or deprive such party of the right thereafter to insist upon strict adherence to that term or any other term of this Agreement. d. Severability. In the event that any one or more of the provisions of this Agreement shall be or become invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions of this Agreement shall not be affected thereby. e. Assignment. This Agreement, and all of Executive's rights and duties hereunder, shall not be assignable or delegable by Executive. Any purported assignment or delegation by Executive in violation of the foregoing shall be null and void ab initio and of no force and effect. This Agreement may be assigned by the Company to a person or entity which is an affiliate or a successor in interest to substantially all of the business operations of the Company. Upon such assignment, the rights and obligations of the Company hereunder shall become the rights and obligations of such affiliate or successor person or entity. f. Set Off; Mitigation. The Company's obligation to pay Executive the amounts provided and to make the arrangements provided hereunder shall be subject to set-off, counterclaim or recoupment of amounts owed by Executive to the Company or its affiliates. Executive shall not be required to mitigate the amount of any payment provided for pursuant to this Agreement by seeking other employment or otherwise and the amount of any payment provided for pursuant to this Agreement shall not be reduced by any compensation earned as a result of Executive's other employment or otherwise. g. Successors; Binding Agreement. This Agreement shall inure to the benefit of and be binding upon the Company and its subsidiaries and Executive and any personal or legal representatives, executors, administrators, successors, assigns, heirs, distributees, devisees and legatees. Further, the Company will require any successor (whether, direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. As used in this Agreement, "Company" shall mean the Company and any successor to its business and/or assets which is required by this Section 12(g) to assume and agree to perform this Agreement or which otherwise assumes and agrees to perform this Agreement; provided, however, in the event that any successor, as described above, agrees to assume this Agreement in accordance with the preceding sentence, as of the date such successor so assumes this Agreement, the Company shall cease to be liable for any of the obligations contained in this Agreement. h. Notice. For the purpose of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered by hand or overnight courier or three days after it has been mailed by United States registered mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth below in this Agreement, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt. If to the Company: Citizens Communications Company Three High Ridge Park Stamford, Connecticut 06905 Attention: L. Russell Mitten, Esq. If to Executive: To the most recent address of Executive set forth in the personnel records of the Company. i. Executive Representation. Executive hereby represents to the Company that the execution and delivery of this Agreement by Executive and the Company and the performance by Executive of Executive's duties hereunder shall not constitute a breach of, or otherwise contravene, the terms of any employment agreement or other agreement or policy to which Executive is a party or otherwise bound. j. Prior Agreements. This Agreement supercedes all prior agreements and understandings (including verbal agreements) between Executive and the Company and/or its affiliates regarding the terms and conditions of Executive's employment with the Company and/or its affiliates. The provisions of Sections 7(b)(ii)(D) and 7(c)(iii)(D) shall also supersede any provision of any restricted stock or option agreement or plan which is less favorable to Executive in the treatment of restricted shares or options previously granted to him thereunder upon his termination of employment upon death or Disability or without Cause or for Good Reason. k. Cooperation. Executive shall provide Executive's reasonable cooperation in connection with any action or proceeding (or any appeal from any action or proceeding) which relates to events occurring during Executive's employment hereunder. This provision shall survive any termination of this Agreement. l. Withholding Taxes. The Company may withhold from any amounts payable under this Agreement such Federal, state and local taxes as may be required to be withheld pursuant to any applicable law or regulation. m. Counterparts. This Agreement may be signed in counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the day and year first above written. CITIZENS COMMUNICATIONS COMPANY: EXECUTIVE: /s/ Mary Agnes Wilderotter /s/ John H. Casey, III - ------------------------------------------ ------------------------- John H. Casey, III By: Mary Agnes Wilderotter ------------------------------------- EX-10.23 5 exhibit10-23.txt HAYES AGREEMENT Exhibit 10.23 December 31, 2004 Mr. Pete Hayes Foresters, 4 Keepers Walk Virginia Water, Surrey, UK GU25 4RU Dear Pete: It is my pleasure to confirm our offer of employment for the position of Senior Vice President, Sales, Marketing & Business Development for Citizens Communications Company. The work location for this position is in Stamford, CT. As agreed, the start date for your employment with Citizens is February 1, 2005. The cash compensation is based upon two components: an annual base salary of $275,000 and an annual incentive target of 75% or $206,300. The base salary is paid on a semi-monthly basis. The incentive compensation is earned based upon achieving the goals of Citizens Incentive Plan, which is paid on an annual basis, generally toward the end of the first quarter following the completion of the operating year-end. The incentive compensation for 2005 will be pro-rated monthly for active months of service in 2005. You will also receive 50,000 restricted shares on your hire date that will vest equally over a three-year period. This stock grant has been approved by the Compensation Committee of the Board of Directors. You will also receive a one-time cash sign-on bonus of $25,000 payable within 60 days of your start date. If for any reason you were to leave Citizens during the first year of employment, this bonus would need to be paid back in full to the Company. You will be eligible for relocation assistance for your move from London. This relocation benefit will include movement of household goods from London to New Canaan, temporary housing and the cost of travel back to the states. In addition, we will pay you an allowance of $4,000 per month for the first year for the difference between your rent in New Canaan and Mortgage in Virginia. If after the first year of employment you decide to keep your home in Virginia and not relocate permanently to Stamford, we will provide you with a monthly allowance of $4,000 for your living and travel expenses. If at a later date you decide to relocate to Stamford, the relocation benefit would be reduced by the amount of the monthly allowance paid to you through the date of your relocation and by the amount paid for movement of household goods from London to New Canaan. Upon acceptance of this offer of employment, a counselor from our relocation partner, Sirva, will contact you within 48 hours to initiate you in to the program. You will be required to reimburse the Company for a pro-rated portion of your relocation expenses in the event you leave the Company within (2) years of your hire date. If Citizens Communications has a change in control (defined as 51% of the Company being sold) and the new owners decrease your responsibility, title, base pay or target incentive opportunity (as a percent of your base pay) or relocates your work location more than 25 miles from Stamford, CT, you would be eligible to receive one-year of base pay, 100% of your bonus pro-rated for the plan year and one year of continued medical benefits. Enclosed is a New Hire Kit including an Employment Application which you need to complete and fax back to me at (203) 614-4640. Also included in the New Hire Kit will be Citizens Employee Handbook, Code of Conduct, Electronic Communications Policy and benefit plan information. Please be advised that your health and welfare benefits will begin on your 30th day of employment and as a Citizens Communications employee, you will be eligible to participate in a, full range of benefits. Please bring all of the original paperwork with you on first day of work. Federal law requires that you provide documentation confirming your eligibility to work in the United States. You will receive a list of documents that you may use to establish your identity and employment eligibility in your New Hire Kit. Please bring the appropriate documents with you when you report to work on your first day. This offer is not an express or implied contract, promise or guarantee of employment, of any particular position, or of any particular term or condition of employment. Your employment by the Company is at will and is subject to the conditions set forth in the Code of Conduct as well as Company policies and applicable to Federal, State and local laws. Pete, we are very excited about the opportunity of working with you. On behalf of Citizens Communications, I welcome you to our team and eagerly anticipate the benefits of your leadership. Please do not hesitate to call me with any questions regarding this offer. To acknowledge your acceptance of this offer, please e-mail me directly a confirmation of your acceptance of this offer. In addition, please sign the bottom of this offer letter and return the original to me directly on your first day of employment. Sincerely, /s/ Jeanne DiSturco - -------------------------------------- Jeanne DiSturco Senior Vice President, Human Resources Cc: Maggie Wilderotter By signing below, I hereby accept the Citizens Communications Company's contingent offer of employment. I understand that I will not have a contract of employment with Citizens for a specified period of time. I further agree to abide by the employment policies and procedures established by Citizens. /s/ Peter B. Hayes 12/31/04 - ------------------------------------------------------------------ Peter B. Hayes Date Signature (please include middle initial) EX-12 6 exhibit12.txt RATIO OF EARNING
Exhibit 12 Page 1 Citizens Communications Company Statements of the Ratio of Earnings to Fixed Charges (a) (Dollars in Thousands) (Unaudited) Years Ended December 31, ------------------------------------------------------------- 2004 2003 2002 2001 2000 ----------- ----------- ------------- ---------- ---------- Pre-tax income (loss) from continuing operations before dividends on convertible preferred securities, extraordinary expense and cumulative effect of changes in accounting principle $ 85,529 $ 195,509 $ (1,231,640) $ (72,521) $ (49,993) (Income) or loss from equity investees (1,612) (794) (1,687) (2,936) (1,935) Minority interest - - - - (12,222) ----------- ----------- ------------- ---------- ---------- Pre-tax income (loss) from continuing operations before adjustment for minority interest in consolidated subsidiaries or (income) or loss from equity investees 83,917 194,715 (1,233,327) (75,457) (64,150) Fixed charges 390,085 430,659 489,124 399,752 206,650 Distributed income of equity investees 558 98 2,609 3,089 800 Interest capitalized (2,278) (2,993) (7,390) (5,675) (4,766) Preference security dividend requirements of consolidated subsidiaries (8,718) (10,063) (10,063) (10,063) (10,063) Carrying cost of equity forward contracts - - - (13,650) - ----------- ----------- ------------- ---------- ---------- Total earnings 463,564 612,416 (759,047) 297,996 128,471 ----------- ----------- ------------- ---------- ---------- Ratio of earnings to fixed charges 1.19 1.42 (1.55) 0.75 0.62 =========== =========== ============= ========== ==========
Note : The above calculation was performed in accordance with Regulation S-K 229.503(d) Ratio of earnings to fixed charges. (a) For the years ended December 31, 2002, 2001 and 2000, earnings were insufficient to cover fixed charges by $1.25 billion, $101.8 million and $78.2 million, respectively.
Exhibit 12 Page 2 Citizens Communications Company Statements of the Ratio of Earnings to Combined Fixed Charges and Preferred Dividends (a) (Dollars in Thousands) (Unaudited) Years Ended December 31, --------------------------------------------------------------- 2004 2003 2002 2001 2000 ----------- ----------- ------------ ----------- ----------- Pre-tax income (loss) from continuing operations before dividends on convertible preferred securities, extraordinary expense and cumulative effect of changes in principle $ 85,529 $ 195,509 $(1,231,640) $ (72,521) $ (49,993) (Income) or loss from equity investees (1,612) (794) (1,687) (2,936) (1,935) Minority interest - - - - (12,222) ----------- ----------- ------------ ----------- ----------- Pre-tax income (loss) from continuing operations before adjustment for minority interest in consolidated subsidiaries or (income) or loss from equity investees 83,917 194,715 (1,233,327) (75,457) (64,150) Fixed charges 390,085 440,722 499,187 423,465 216,713 Distributed income of equity investees 558 98 2,609 3,089 800 Interest capitalized (2,278) (2,993) (7,390) (5,675) (4,766) Preference security dividend requirements of consolidated subsidiaries (8,718) (10,063) (10,063) (10,063) (10,063) Carrying cost of equity forward contracts - - - (13,650) - ----------- ----------- ------------ ----------- ----------- Total earnings $ 463,564 $ 622,479 $ (748,984) $ 321,709 $ 138,534 ----------- ----------- ------------ ----------- ----------- Ratio of earnings to combined fixed charges 1.19 1.41 (1.50) 0.76 0.64 =========== =========== ============ =========== ===========
Note : The above calculation was performed in accordance with Regulation S-K 229.503(d) Ratio of earnings to fixed charges. (a) For the years ended December 31, 2002, 2001 and 2000, earnings were insufficient to cover combined fixed charges by $1.25 billion, $101.8 million and $78.2 million, respectively. EX-21 7 exhib21.txt SUBSIDIARY LIST EXHIBIT 21 Citizens Communications Company Subsidiary List Citizens Cable Company NCC Systems, Inc. Citizens Capital Ventures Corp. Citizens Directory Services Company L.L.C. (i) Citizens International Management Services Company Citizens Louisiana Accounting Company Citizens Mohave Cellular Company Citizens NEWCOM Company Citizens NEWTEL, LLC Citizens Telecommunications Company of Minnesota, LLC Citizens Telecommunications Company of Tennessee L.L.C. Citizens Telecommunications Company of the Volunteer State LLC Citizens Telecom Services Company LLC Citizens Pennsylvania Company LLC Citizens SERP Administration Company Citizens Solutions Company Citizens Southwestern Capital Corporation Citizens Telecommunications Company of California Inc. Citizens Telecommunications Company of Colorado Citizens Telecommunications Company of Idaho Citizens Telecommunications Company of Illinois Citizens Telecommunications Company of Iowa Citizens Telecommunications Company of Montana Citizens Telecommunications Company of Nebraska Citizens Telecommunications Company of Nebraska LLC Citizens Telecommunications Company of Nevada Citizens Telecommunications Company of New York, Inc. Citizens Telecommunications Company of North Dakota Citizens Telecommunications Company of Oregon Citizens Telecommunications Company of the Golden State Citizens Telecommunications Company of the White Mountains, Inc. Citizens Telecommunications Company of Tuolumne Citizens Telecommunications Company of Utah Citizens Telecommunications Company of Virginia Citizens Telecommunications Company of West Virginia Citizens Telecommunications Company of Wyoming Citizens Telecommunications Company of Wyoming LLC Citizens Utilities Company of California Citizens Utilities Rural Company, Inc. Citizens Water Resources Company of Arizona Citizens Water Services Company of Arizona CTC of Colorado LLC CTC Green Company, Inc. CU Capital LLC Electric Lightwave, LLC Electric Lightwave NY, LLC. CU Wireless Company LLC (i) Flowing Wells, Inc. Frontier Communications of America, Inc. Frontier Communications of AuSable Valley, Inc. Frontier Communications of New York, Inc. Frontier Communications of Rochester, Inc. Conference-Call USA, LLC Frontier Directory Services Company, LLC Frontier Communications of Seneca-Gorham, Inc. Frontier Communications of Sylvan Lake, Inc. Frontier Subsidiary Telco LLC Frontier Cable of Mississippi, Inc. Frontier Communications - Midland, Inc Frontier Communications - Prairie, Inc. Frontier Communications - Schuyler, Inc. Frontier Communications - St. Croix, LLC Frontier Cable of Wisconsin LLC Frontier Communications of Alabama, LLC Frontier Communications of Breezewood, LLC Frontier Communications of Canton, LLC Frontier Communications of DePue, Inc. DePue Communications, Inc. Frontier Communications of Fairmount, LLC Fairmount Cellular, LLC Frontier Communications of Georgia, LLC Frontier Communications of Illinois, Inc. Frontier Communications of Indiana, Inc. Frontier Communications of Iowa, Inc. Frontier Communications of Lakeside, Inc. Frontier Communications of Lakewood, LLC Frontier Communications of Lamar County, LLC Frontier Communications of Michigan, Inc. Frontier Communications of Minnesota, Inc. Frontier Communications of Mississippi, Inc. Frontier Communications of Mondovi LLC Frontier Communications of Mt. Pulaski, Inc. Frontier Communications of Orion, Inc. Frontier Communications of Oswayo River, LLC Frontier Communications of Pennsylvania, LLC Frontier Communications of the South, LLC Frontier Communications of Thorntown, Inc. Frontier Cable of Indiana, Inc. Frontier Communications of Viroqua LLC Frontier Communications of Wisconsin LLC Frontier InfoServices, Inc. Frontier TechServ, Inc. Frontier Telephone of Rochester, Inc. Havasu Water Company, Inc. Navajo Communications Company, Inc. Ogden Telephone Company Phone Trends, Inc. Rhinelander Telecommunications, LLC Rhinelander Telephone LLC Rib Lake Cellular for Wisconsin RSA #3, Inc. Rib Lake Telecom, Inc. Sun City Sewer Company Sun City Water Company Sun City West Utilities Company Tubac Valley Water Company, Inc. Citizens Communications Company is a Partner in the following partnerships: Citizens Utilities Capital L.P. (EPPICS) Mohave Cellular Limited Partnership (i) Frontier Communications of America, Inc. is also an LLC member. - -------- EX-23 8 exhibit23consent.txt KPMG CONSENT Exhibit 23 Consent of Independent Registered Public Accounting Firm -------------------------------------------------------- To the Board of Directors and Shareholders Citizens Communications Company: We consent to the incorporation by reference in the Registration Statement (No. 33-52873) on Form S-3, in the Registration Statement (No. 33-63615) on Form S-3, in the Registration Statement (No. 333-58044) on Form S-3, in the Registration Statement (No. 333-91054) on Form S-8, in the Registration Statement (No. 333-61432) on Form S-8, in the Registration Statement (No. 333-71821) on Form S-8, in the Registration Statement (No. 333-71597) on Form S-8, in the Registration Statement (No. 333-71029) on Form S-8, in the Registration Statement (No. 33-42972) on Form S-8, in the Registration Statement (No. 33-48683) on Form S-8, in the Registration Statement (No. 333-69740) on Form S-4 of Citizens Communications Company and subsidiaries of our reports dated March 11, 2005, with respect to the consolidated balance sheets of Citizens Communications Company and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders' equity, comprehensive income (loss) and cash flows for each of the years in the three-year period ended December 31, 2004, management's assessment of effectiveness of internal control over financial reporting as of December 31, 2004 and the effectiveness of internal control over financial reporting as of December 31, 2004, and the related consolidated financial statement schedule, which reports appear in the December 31, 2004, annual report on Form 10-K of Citizens Communications Company and subsidiaries. Our reports refer to the adoption of Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" as of January 1, 2003. /s/ KPMG LLP New York, New York March 11, 2005 EX-31.1 9 exhibit31-1.txt WILDEROTTER CERT. EXHIBIT 31.1 CERTIFICATIONS I, Mary Agnes Wilderotter, certify that: 1. I have reviewed this annual report on Form 10-K 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 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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 d) 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 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: March 11, 2005 /s/ Mary Agnes Wilderotter ------------------------------------- Mary Agnes Wilderotter President and Chief Executive Officer EX-31.2 10 exhibit31-2.txt ELLIOT CERT. EXHIBIT 31.2 CERTIFICATIONS I, Jerry Elliott, certify that: 1. I have reviewed this annual report on Form 10-K 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 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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 d) 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 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: March 11, 2005 /s/ Jerry Elliott --------------------------------- Jerry Elliott Executive Vice President and Chief Financial Officer EX-32.1 11 exhibit32-1.txt WILDEROTTER 906 CERT. 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 Annual Report of Citizens Communications Company (the "Company") on Form 10-K for the year ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Mary Agnes Wilderotter, President and 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/ Mary Agnes Wilderotter - ------------------------------------ Mary Agnes Wilderotter President and Chief Executive Officer March 11, 2005 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 12 exhibit32-2.txt ELLIOTT 906 CERT. 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 Annual Report of Citizens Communications Company (the "Company") on Form 10-K for the year ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Jerry Elliott, Executive Vice President and 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 Executive Vice President and Chief Financial Officer March 11, 2005 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-----