CITIZENS COMMUNICATIONS COMPANY
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
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OF THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE YEAR ENDED DECEMBER 31, 2007
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2007
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OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________ to ___________
Commission file number 001-11001
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CITIZENS COMMUNICATIONS COMPANY
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(Exact name of registrant as specified in its charter)
Delaware 06-0619596
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 614-5600
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Common Stock, par value $.25 per share New York Stock Exchange
Guarantee of Convertible Preferred Securities of Citizens Utilities Trust New York Stock Exchange
Series A Participating Preferred Stock Purchase Rights New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes X No
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Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Act. Yes No X
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definition of "accelerated filer", "large accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer [X] Accelerated Filer [ ] Non-Accelerated Filer [ ] Smaller Reporting Company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes No X
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The aggregate market value of common stock held by non-affiliates of the
registrant on June 29, 2007 was approximately $5,195,611,000 based on the
closing price of $15.27 per share on such date.
The number of shares outstanding of the registrant's Common Stock as of January
31, 2008 was 327,762,000.
DOCUMENT INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Company's 2008 Annual Meeting of
Stockholders to be held on May 15, 2008 are incorporated by reference into Part
III of this Form 10-K.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
TABLE OF CONTENTS
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Page
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PART I
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Item 1. Business 2
Item 1A. Risk Factors 8
Item 1B. Unresolved Staff Comments 11
Item 2. Properties 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 12
Executive Officers 13
PART II
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Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities 15
Item 6. Selected Financial Data 18
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 35
Item 8. Financial Statements and Supplementary Data 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 36
Item 9A. Controls and Procedures 37
Item 9B. Other Information 37
PART III
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Item 10. Directors, Executive Officers and Corporate Governance 38
Item 11. Executive Compensation 38
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 38
Item 13. Certain Relationships and Related Transactions, and Director
Independence 38
Item 14. Principal Accountant Fees and Services 38
PART IV
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Item 15. Exhibits and Financial Statement Schedules 38
Index to Consolidated Financial Statements F-1
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
PART I
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Item 1. Business
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Citizens Communications Company (Citizens) and its subsidiaries will be referred
to as the "Company," "we," "us" or "our" throughout this report. Citizens was
incorporated in the State of Delaware in 1935 as Citizens Utilities Company.
We are a communications company providing services to rural areas and small and
medium-sized towns and cities. We offer our services under the "Frontier" name.
Revenue from our Frontier operations was $2.3 billion in 2007. Among the
highlights for 2007:
* Acquisitions
On March 8, 2007, we acquired Commonwealth Telephone Enterprises,
Inc. (Commonwealth or CTE) in a cash and stock taxable
transaction, for a total consideration of approximately $1.1
billion.
On October 31, 2007, we completed the acquisition of Global
Valley Networks, Inc. and GVN Services (together GVN) for a total
consideration of $62.0 million in cash.
* Cash Generation
We continued to generate significant 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. The first quarter
of 2007 included the $37.5 million favorable impact of a cash
settlement of a switched access dispute.
* Stockholder Value
During 2007, we repurchased $250.0 million of our common stock
and we continued to pay an annual dividend of $1.00 per common
share.
* Growth
During 2007, we added approximately 130,700 new high-speed
internet customers and almost 116,100 customers began buying a
bundle or package of our services. At December 31, 2007, we had
approximately 523,800 high-speed data customers and almost
633,800 customers buying a bundle or package of services. During
2005, we also began offering a television product in partnership
with Echostar's DISH Network (DISH), and at the end of 2007 we
had approximately 93,600 DISH customers.
Our objective is to be the leading provider of communication services to homes
and businesses in our service areas. We are committed to delivering innovative
and reliable products and solutions with an emphasis on convenience, service and
customer satisfaction. We offer a variety of voice, data and internet services,
and television that are available as bundled or package solutions or, for some
products, a la carte. We believe that superior customer service and innovative
product positioning will continue to differentiate us from our competitors in
the marketplace.
Telecommunications Services
As of December 31, 2007, we operated as an incumbent local exchange carrier
(ILEC) in 24 states.
The telecommunications industry is undergoing significant changes and
difficulties and our financial results reflect the impact of this challenging
environment. As discussed in more detail in Management's Discussion and Analysis
of Financial Condition and Results of Operations (MD&A), we operate in an
increasingly challenging environment and, accordingly, our Frontier revenues
have decreased slightly in 2007 after excluding the impact of the CTE and GVN
acquisitions.
Our business, under the Frontier name, is primarily with residential customers
and, to a lesser extent, non-residential customers. Our Frontier services
include:
* access services;
* local services;
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* long distance services;
* data and internet services;
* directory services;
* television services; and
* wireless services.
Frontier is typically the leading incumbent carrier in the markets we serve and
provides the "last mile" of telecommunications services to residential and
business customers in these markets.
Access services. Switched access services allow other carriers the use of our
facilities to originate and terminate their long distance voice and data
traffic. These services are generally offered on a month-to-month basis and the
service is billed on a minutes-of-use basis. Access charges are based on access
rates filed with the Federal Communications Commission (FCC) for interstate
services and with the respective state regulatory agency for intrastate
services. In addition, subsidies received from state and federal universal
service funds based on the high cost of providing telephone service to certain
rural areas are a part of our access services revenue.
Revenue is recognized when services are provided to customers or when products
are delivered to customers. Monthly recurring network access service revenue is
billed in advance. The unearned portion of this revenue is initially deferred on
our balance sheet and recognized in revenue over the period that the services
are provided.
Local services. We provide basic telephone wireline services to residential and
non-residential customers in our service areas. Our service areas are largely
residential and are generally less densely populated than the primary service
areas of the largest incumbent local exchange carriers. We also provide enhanced
services to our customers by offering a number of calling features including
call forwarding, conference calling, caller identification, voicemail and call
waiting. All of these local services are billed monthly 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. We also
offer packages of communications services. These packages permit customers to
bundle their basic telephone line with their choice of enhanced, long distance,
television and internet services for a monthly fee and/or usage fee depending on
the plan.
We intend to continue our efforts to increase the penetration of enhanced
services. We believe that increased sales of such services will produce revenue
with higher operating margins due to the relatively low marginal operating costs
necessary to offer such services. We believe that our ability to integrate these
services with other services will provide us with the opportunity to capture an
increased percentage of our customers' communications expenditures.
Long distance services. We offer long distance services in our territories to
our customers. We believe that many customers prefer the convenience of
obtaining their long distance service through their local telephone company and
receiving a single bill. Long distance network service to and from points
outside of our operating territories is provided by interconnection with the
facilities of interexchange carriers (IXCs). Our long distance services are
billed either as unlimited/fixed number of minutes in advance or on a per minute
of use basis, in which case it is billed in arrears. The earned but unbilled
portion of this revenue is recognized in revenue and accrued in accounts
receivable over the period that the services are provided.
Data and internet services. We offer data services including internet access
(via high-speed or dial up internet access), frame relay, Metro ethernet and
asynchronous transfer mode (ATM) switching services. We offer other data
transmission services to other carriers and high-volume commercial customers
with dedicated high-capacity circuits like DS-1's and DS-3's. Such services are
generally offered on a contract basis and the service is billed on a fixed
monthly recurring charge basis. Data and internet services are typically billed
monthly 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.
Directory services. Directory services involves the provision of white and
yellow page directories of residential and business listings. We provide this
service through a third-party contractor and are paid a percentage of revenues
from the sale of advertising in these directories. Our directory service also
includes "Frontier Pages," an internet-based directory service which generates
advertising revenue. We recognize the revenue from these services over the life
of the related white or yellow pages book, which is typically one calendar year.
3
Television services. We offer a television product in partnership with
Echostar's DISH Network. We provide access to all-digital television channels
featuring movies, sports, news, music, and high-definition TV programming. We
offer packages of 100, 200 or 250 channels and include high-definition channels,
family channels and ethnic channels. We also provide access to local channels.
We are in an "agency" relationship with DISH. We bill the customer for the
monthly services and remit those billings to DISH without recognizing any
revenue. We in-turn receive from DISH and recognize as revenue activation fees
and a nominal billing and collection fee.
Wireless services. During 2006, we began offering wireless data services in
certain markets. Our wireless data services utilize technologies that are
relatively new, and we depend to some degree on the representations of equipment
vendors, lab testing and the experiences of others who have been successful at
deploying these new technologies. As of December 31, 2007, we operate wireless
data WIFI networks in 13 municipalities, four colleges and universities and over
50 business establishments with wireless coverage known as hot spots. We earn
revenue from this service from end-user subscribers on a monthly recurring
charge, from colleges, universities and businesses on a monthly recurring charge
for a fixed number of users, and from hourly, daily and weekly casual end-users.
All revenues are billed in advance or by credit card.
The following table sets forth the number of our access lines and high-speed
internet subscribers as of December 31, 2007 and 2006.
Access Lines and High-Speed
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Internet Subscribers at December 31,
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State 2007 2006
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New York............ 897,300 952,500
Pennsylvania ....... 523,500 45,300
Minnesota........... 287,400 296,900
California.......... 205,400 190,200
Arizona............. 199,600 198,700
West Virginia....... 183,700 178,100
Illinois............ 129,000 129,100
Tennessee........... 108,600 111,000
Wisconsin........... 78,800 77,600
Iowa................ 57,100 57,600
Nebraska............ 53,300 54,100
All other states (13)... 231,800 228,700
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Total 2,955,500 2,519,800
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Change in the number of our access lines is important to our revenue and
profitability. We have lost access lines primarily because of competition,
changing consumer behavior, economic conditions, changing technology and by some
customers disconnecting second lines when they add high-speed internet or cable
modem service. Our CTE acquisition in Pennsylvania added 434,600 access lines
and 50,500 high-speed customers at date of closing, March 8, 2007. Excluding the
impact of the CTE and GVN acquisitions, we lost approximately 130,300 access
lines during the year ended December 31, 2007, but added over 66,700 high-speed
internet subscribers during this same period. With respect to the access lines
we lost in 2007, 112,900 were residential customer lines and 17,400 were
non-residential customer lines. The non-residential line losses were principally
in our central and eastern regions and Rochester, New York, while the
residential losses were throughout our markets. Our GVN acquisition in
California added approximately 15,300 access lines and 4,200 high-speed internet
subscribers as of December 31, 2007. We expect to continue to lose access lines
but to increase high-speed internet subscribers during 2008. A continued loss of
access lines, combined with increased competition and the other factors
discussed in MD&A, may cause our revenues, profitability and cash flows to
decrease during 2008.
4
Regulatory Environment
General
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The majority of our operations are regulated by various state regulatory
agencies, often called public service or utility commissions, and the FCC.
Our revenue is subject to regulation by the FCC and various state regulatory
agencies. We expect federal and state lawmakers to continue to review the
statutes governing the level and type of regulation for telecommunications
services.
The Telecommunications Act of 1996, or the 1996 Act, dramatically changed the
telecommunications industry. The main purpose of the 1996 Act was to open local
telecommunications marketplaces to competition. The 1996 Act preempts state and
local laws to the extent that they prevent competition with respect to
communications services. Under the 1996 Act, however, states retain authority to
impose requirements on carriers necessary to preserve universal service, protect
public safety and welfare, ensure quality of service and protect consumers.
States are also responsible for mediating and arbitrating interconnection
agreements between competitive local exchange carriers (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. Incumbent local carriers must interconnect with other
carriers, unbundle some of their services at wholesale rates, permit resale of
some of their services, enable collocation of equipment, provide local telephone
number portability and dialing parity, provide access to poles, ducts, conduits
and rights-of-way, and complete calls originated by competing carriers under
termination arrangements.
At the federal level and in a number of the states in which we operate, we are
subject to price cap or incentive regulation plans under which prices for
regulated services are capped in return for the elimination or relaxation of
earnings oversight. The goal of these plans is to provide incentives to improve
efficiencies and increased pricing flexibility for competitive services while
ensuring that customers receive reasonable rates for basic services. Some of
these plans have limited terms and, as they expire, we may need to renegotiate
with various states. These negotiations could impact rates, service quality
and/or infrastructure requirements which could impact our earnings and capital
expenditures. In other states in which we operate, we are subject to rate of
return regulation that limits levels of earnings and returns on investments. In
some of our states, we have been successful in reducing or eliminating price
regulation on end-user services under state commission jurisdiction. In order to
receive relief from earnings regulation, we have agreed to certain broadband
availability commitments in Pennsylvania. We have been compliant with all of
those regulatory requirements to date and we continue to work toward our
requirement to have 100% broadband availability by the end of 2008. We will be
able to meet customer requests for broadband using various types of technology,
including DSL, T1 and wireless, where appropriate. We continue to advocate our
position of less regulation with various regulatory agencies.
For interstate services regulated by the FCC, we have elected a form of
incentive regulation known as "price caps" for most of our operations. In May
2000, the FCC adopted a methodology for regulating the interstate access rates
of price cap companies through May 2005. The program, known as the Coalition for
Affordable Local and Long Distance Services, or CALLS plan, reduced prices for
interstate-switched access services and phased out many of the implicit
subsidies in interstate access rates. The CALLS program expired in 2005. The FCC
may address future changes in interstate access charges during 2008 and such
changes may adversely affect our revenues and profitability.
Another goal of the 1996 Act was to remove implicit subsidies from the rates
charged by local telecommunications companies. The CALLS plan addressed this
requirement for interstate services. State legislatures and regulatory agencies
are beginning to reduce the implicit subsidies in intrastate rates. The most
common subsidies are in access rates that historically have been priced above
their costs to allow basic local rates to be priced below cost. Legislation has
been considered in several states to require regulators to eliminate these
subsidies and implement state universal service programs where necessary to
maintain reasonable basic local rates. However, not all the reductions in access
charges would be fully offset. We anticipate additional state legislative and
regulatory pressure to lower intrastate access rates.
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.
5
Recent and Potential Regulatory Developments
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Wireline and wireless carriers are required to provide local number portability
(LNP). LNP is the ability of customers to switch from a wireline or wireless
carrier to another wireline or wireless carrier without changing telephone
numbers. We are 100% LNP capable in our largest markets and over 99% of our
exchanges are LNP capable. We will upgrade the remaining exchanges in response
to bona fide requests as required by FCC regulations.
In 1994, Congress passed the Communications Assistance for Law Enforcement Act
(CALEA) to ensure that telecommunication networks can meet law enforcement
wiretapping needs. Our company was fully compliant, for all Time Division
Multiplexing (TDM) voice services, by June 2006. In June 2006, the FCC issued an
order addressing the assistance capabilities required, pursuant to Section 103
of the CALEA law, for facilities-based broadband Internet access providers and
providers of interconnected voice over internet protocol (VOIP). We invested
significant capital in 2007 to take the necessary steps to comply with this
order.
The FCC and Congress may address issues involving inter-carrier compensation,
the universal service fund net neutrality and internet telephony in 2008. 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 could reduce our access
revenues and our profitability. The universal service fund is under pressure as
local exchange companies lose access lines and more entities, such as wireless
companies, seek to receive monies from the fund. The FCC released 3 Notices of
Proposed Rulemakings on January 29, 2008 considering comprehensive reform to how
the high-cost portion of the fund is calculated and distributed to both
incumbent and competitive recipients. Changes in the funding or payout rules of
the universal service fund could further reduce our subsidy revenues and our
profitability. As discussed in MD&A, our access and subsidy revenues are
important to our cash flows and our access and subsidy revenues declined in 2007
compared to 2006. Our access and subsidy revenues are both likely to decline in
2008.
Regulators at both the federal and state levels continue to address whether
internet telephony services (VOIP) are subject to the same or different
regulatory and financial models as traditional telephony. The FCC has concluded
that certain VOIP services are jurisdictionally interstate in nature and are
thereby exempt from state telecommunications regulations. The FCC has not
addressed other related issues, such as: whether or under what terms VOIP
originated traffic may be subject to intercarrier compensation; and whether VOIP
services are subject to general state requirements relating to taxation and
general commercial business requirements. The FCC has stated its intent to
address these open questions in subsequent orders in its ongoing "IP-Enabled
Services Proceeding," which opened in February 2004. Internet telephony may have
an advantage over our traditional services if it remains less regulated.
The FCC has issued rules that became effective on October 11, 2007 requiring the
amount of emergency backup power that we, along with all ILEC's and wireless
carriers, are required to have at its central offices, remote offices, and
digital loop carrier systems (DLCs). We will be required to invest capital in
2008 to meet these requirements in certain of our offices and DLCs. Under the
rules, we must be compliant by October 11, 2008. These FCC rules are currently
being challenged in the courts and a favorable ruling could reduce or eliminate
the capital expenditures needed to comply with the rules.
In January 2008, the FCC released public notices requesting comments on two
petitions that have been filed regarding net neutrality and the application of
the FCC's Internet Policy Statement. It is uncertain whether these petitions
will result in any formal FCC action.
Some state regulators (including New York and Illinois) have in the past
considered imposing on regulated companies (including us) cash management
practices that could limit the ability of a company to transfer cash between its
subsidiaries or to its parent company. None of the existing state requirements
materially affect our cash management but future changes by state regulators
could affect our ability to freely transfer cash within our consolidated
companies.
Competition
Competition in the telecommunications industry is intense and increasing, while
the industry continues to undergo significant changes. We experience competition
from many communication service providers including cable operators, wireless
carriers, VOIP providers, long distance providers, competitive local exchange
carriers, internet providers and other wireline carriers. In addition, consumers
are changing behavior by using wireless in place of wireline services and maybe
using email as a substitute for telephone calls. We believe that competition
will continue to intensify in 2008 across all products and in all of our
markets, and that trends in changing consumer behavior will continue. Our
business experienced erosion in access lines and switched access minutes of use
in 2007 as a result of competition and these trends. Competition in our markets
and these trends may result in reduced revenues in 2008.
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We are responding to this competitive environment with new product offers and by
bundling products and services together and making these services subject to an
end-user contract term commitment (called a Price Protection Plan). Revenues
from data services and packages continue to increase as a percentage of our
total revenues. There will continue to be price and margin pressures in our
business that may result in less revenues and profitability.
In addition, the factors, that could affect our revenues and profitability,
could also result in more bankruptcies in the sector and therefore affect our
ability to collect money owed to us by bankrupt carriers.
Divestiture of Electric Lightwave, LLC
In 2006, we sold our CLEC business, Electric Lightwave, LLC (ELI) for $255.3
million (including the sale of associated real estate) in cash plus the
assumption of approximately $4.0 million in capital lease obligations. We
recognized a pre-tax gain on the sale of ELI of approximately $116.7 million.
Our after-tax gain on the sale was $71.6 million. Our cash liability for taxes
as a result of the sale was approximately $5.0 million due to the utilization of
existing tax net operating losses on both the federal and state level.
Segment Information
With the 2006 sale of our CLEC (ELI), we currently operate in only one
reportable segment.
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 business. We have no
material contracts or subcontracts that may be subject to renegotiation of
profits or termination at the election of the Federal government. We hold no
patents, licenses or concessions that are material. We have applied for a patent
for certain technology used in our "Frontier 1" product.
Employees
As of December 31, 2007, we had approximately 5,900 employees. Approximately
3,100 of our employees are affiliated with a union. The number of union
employees covered by agreements set to expire during 2008 is 650. We consider
our relations with our employees to be good.
Available Information
We are subject to the informational requirements of the Securities Exchange Act
of 1934. Accordingly, we file periodic reports, proxy statements and other
information with the Securities and Exchange Commission (SEC). Such reports,
proxy statements and other information may be obtained by visiting the Public
Reference Room of the SEC at 100 F Street, NE, Washington, D.C. 20549 or by
calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet
site (www.sec.gov) that contains reports, proxy and information statements and
other information regarding the Company and other issuers that file
electronically. Material filed by us can also be inspected at the offices of the
New York Stock Exchange, Inc. (NYSE), 20 Broad Street, New York, NY 10005, on
which our common stock is listed. On June 8, 2007, our Chief Executive Officer
submitted the annual certification required by Section 303A.12(a) of the NYSE
Listed Company Manual. In addition, the certifications of our Chief Executive
Officer and Chief Financial Officer required under Section 302 of the
Sarbanes-Oxley Act of 2002 are included as exhibits to this Form 10-K.
We make available, free of charge on our website, our Annual Report on Form
10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments
to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act, as soon as practicable after we electronically file these
documents with, or furnish them to, the SEC. These documents may be accessed
through our website at www.czn.net under "Investor Relations."
7
We also make available on our website, or in printed form upon request, free of
charge, our Corporate Governance Guidelines, Code of Business Conduct and
Ethics, and the charters for the Audit, Compensation, and Nominating and
Corporate Governance committees of the Board of Directors. Stockholders may
request printed copies of these materials by writing to: 3 High Ridge Park,
Stamford, Connecticut 06905 Attention: Corporate Secretary. Our website address
is www.czn.net.
Item 1A. Risk Factors
------------
Before you make an investment decision with respect to our securities, you
should carefully consider all the information we have included or incorporated
by reference in this Form 10-K and our subsequent periodic filings with the SEC.
In particular, you should carefully consider the risk factors described below
and read the risks and uncertainties related to "forward-looking statements" as
set forth in the "Management's Discussion and Analysis of Financial Condition
and Results of Operations" section of this Form 10-K. The risks and
uncertainties described below are not the only ones facing our company.
Additional risks and uncertainties that are not presently known to us or that we
currently deem immaterial or that are not specific to us, such as general
economic conditions, may also adversely affect our business and operations.
Risks Related to Competition and Our Industry
---------------------------------------------
We face intense competition, which could adversely affect us.
The telecommunications industry is extremely competitive and
competition is increasing. The traditional dividing lines between long distance,
local, wireless, cable and internet services are becoming increasingly blurred.
Through mergers and various service expansion strategies, services providers are
striving to provide integrated solutions both within and across geographic
markets. Our competitors include CLECs and other providers (or potential
providers) of services, such as internet service providers, or ISPs, wireless
companies, neighboring incumbents, VOIP providers and cable companies that may
provide services competitive with ours or services that we intend to introduce.
Competition is intense and increasing and we cannot assure you that we will be
able to compete effectively. For example, excluding the impact of the CTE and
GVN acquisitions, at December 31, 2007, we had 130,300 fewer access lines than
we had at December 31, 2006, and we believe wireless and cable telephony
providers have increased their market share in our markets. We expect to
continue to lose access lines and that competition with respect to all our
products and services will increase.
We expect competition to intensify as a result of the entrance of new
competitors, penetration of existing competitors into new markets, changing
consumer behavior and the development of new technologies, products and
services. We cannot predict which of the many possible future technologies,
products or services will be important to maintain our competitive position or
what expenditures will be required to develop and provide these technologies,
products or services. Our ability to compete successfully will depend on
marketing and on our ability to anticipate and respond to various competitive
factors affecting the industry, including a changing regulatory environment that
may affect our competitors and us differently, new services that may be
introduced, changes in consumer preferences, demographic trends, economic
conditions and pricing strategies by competitors. Increasing competition may
reduce our revenues and increase our costs as well as require us to increase our
capital expenditures and thereby decrease our cash flow.
Some of our competitors have superior resources, which may place us at
a cost and price disadvantage.
Some of our current and potential competitors have market presence,
engineering, technical and marketing capabilities, and financial, personnel and
other resources substantially greater than ours. In addition, some of our
competitors can raise capital at a lower cost than we can. Consequently, some
competitors may be able to develop and expand their communications and network
infrastructures more quickly, adapt more swiftly to new or emerging technologies
and changes in customer requirements, take advantage of acquisition and other
opportunities more readily and devote greater resources to the marketing and
sale of their products and services than we can. Additionally, the greater brand
name recognition of some competitors may require us to price our services at
lower levels in order to retain or obtain customers. Finally, the cost
advantages of some competitors may give them the ability to reduce their prices
for an extended period of time if they so choose.
Risks Related to Our Business
-----------------------------
Decreases in certain types of our revenues will impact our
profitability.
8
Our Frontier business has been experiencing declining access lines,
switched access minutes of use, long distance prices, Federal and state
subsidies and related revenues because of economic conditions, increasing
competition, changing consumer behavior (such as wireless displacement of
wireline use, email use, instant messaging and increasing use of VOIP),
technology changes and regulatory constraints. These factors are likely to cause
our local network service, switched network access, long distance and subsidy
revenues to continue to decline, and these factors, together with the potential
need to increase our capital spending, may cause our cash generated by
operations to decrease.
We may be unable to grow our revenue and cash flow despite the
initiatives we have implemented.
We must produce adequate cash flow that, when combined with funds
available under our revolving credit facility, will be sufficient to service our
debt, fund our capital expenditures, pay our taxes and maintain our current
dividend policy. We expect that our cash taxes, which increased significantly in
2007, will continue to increase in 2008 and 2009 due to our expectations of
continued profitability and the effects of fully utilizing our federal net
operating loss carryforwards and Alternative Minimum Tax (AMT) tax credit
carryforwards that were generated in prior years. We have implemented several
growth initiatives, including increasing our marketing promotion/expenditures
and launching new products and services with a focus on areas that are growing
or demonstrate meaningful demand such as wireline and wireless high-speed
internet, the DISH satellite television product and our Peace of Mind computer
technical support. There is no assurance that these initiatives will result in
an improvement in our financial position or our results of operations.
We may complete a significant business combination or other transaction
that could increase our shares outstanding, affect our debt, result in a change
in control, or all of the above.
From time to time we evaluate potential acquisitions and other
arrangements, such as the Commonwealth and GVN acquisitions, that would extend
our geographic markets, expand our services, enlarge the capacity of our
networks or increase the types of services provided through our networks. If we
complete any acquisition or other arrangement, we may require additional
financing that could result in an increase in our shares outstanding and/or
debt, result in a change in control, or all of the above. There can be no
assurance that we will enter into any transaction.
Our business is sensitive to the creditworthiness of our wholesale
customers.
We have substantial business relationships with other
telecommunications carriers for whom we provide service. During the past few
years, several of our carrier customers have filed for bankruptcy. While these
bankruptcies have not had a material adverse effect on our business to date,
future bankruptcies in our industry could result in our loss of significant
customers, more price competition and uncollectible accounts receivable. As a
result, our revenues and results of operations could be materially and adversely
affected.
Risks Related to Liquidity, Financial Resources, and Capitalization
-------------------------------------------------------------------
Substantial debt and debt service obligations may adversely affect us.
We have a significant amount of indebtedness. We may also obtain
additional long-term debt and working capital lines of credit to meet future
financing needs, subject to certain restrictions under our existing
indebtedness, which would increase our total debt.
The significant negative consequences on our financial condition and
results of operations that could result from our substantial debt include:
* limitations on our ability to obtain additional debt or equity
financing, partially due to the effects of the current credit
environment;
* instances in which we are unable to meet the financial covenants
contained in our debt agreements or to generate cash sufficient
to make required debt payments, which circumstances have the
potential of accelerating the maturity of some or all of our
outstanding indebtedness;
* the allocation of a substantial portion of our cash flow from
operations to service our debt, thus reducing the amount of our
cash flow available for other purposes, including operating
costs, capital expenditures and dividends that could improve our
competitive position or results of operations;
9
* requiring us to sell debt or equity securities or to sell some of
our core assets, possibly on unfavorable terms, to meet payment
obligations;
* compromising our flexibility to plan for, or react to,
competitive challenges in our business and the
communications industry; and
* the possibility of our being put at a competitive disadvantage
with competitors who do not have as much debt as us, and
competitors who may be in a more favorable position to access
additional capital resources.
We will require substantial capital to upgrade and enhance our
operations.
Replacing or upgrading our infrastructure will result in significant
capital expenditures. If this capital is not available when needed, our business
will be adversely affected. Increasing competition, offering new services,
improving the capabilities or reducing the maintenance costs of our plant may
cause our capital expenditures to increase in the future. In addition, our
ongoing annual dividend of $1.00 per share under our current policy utilizes a
significant portion of our cash generated by operations and therefore limits our
operating and financial flexibility and our ability to significantly increase
capital expenditures. While we believe that the amount of our dividend will
allow for adequate amounts of cash flow for capital spending and other purposes,
any material reduction in cash generated by operations and any increases in
capital expenditures, interest expense or cash taxes would reduce the amount of
cash generated by operations and available for payment of dividends. Losses of
access lines, the effects of increased competition, lower subsidy and access
revenues and the other factors described above may reduce our cash generated by
operations and may require us to increase capital expenditures. In addition, we
expect our cash paid for taxes to increase significantly in 2008 and 2009.
Risks Related to Regulation
---------------------------
The access charge revenues we receive may be reduced at any time.
A significant portion of our revenues ($349.4 million, or 15% in 2007)
is derived from access charges paid by IXCs for services we provide in
originating and terminating intrastate and interstate traffic. The amount of
access charge revenues we receive for these services is regulated by the FCC and
state regulatory agencies. Recent rulings regarding access charges have lowered
the amount of revenue we receive from this source. The FCC has an open
proceeding to address reform to access charges and other intercarrier
compensation. Additionally, some of the state commissions in the states where we
operate have proceedings to address intrastate access charges. We have also been
experiencing an increasing number of challenges from CLECs and other ILECs with
respect to our intrastate access charges in a number of states. Certain of those
challenges have led to formal complaints to the state PUCs. A material reduction
in the access revenues we receive would adversely affect our financial results.
We are reliant on support funds provided under federal and state laws.
We receive a portion of our revenue ($130.0 million, or 6% in 2007)
from federal and state subsidies, including the federal high cost fund, federal
local switching support fund, federal universal service fund surcharge and
various state funds. FCC and state regulators are currently considering a number
of proposals for changing the manner in which eligibility for federal subsidies
is determined as well as the amounts of such subsidies. The FCC is also
reviewing the mechanism by which subsidies are funded. We cannot predict when or
how these matters will be decided nor the effect on our subsidy revenue.
The federal high cost fund is our largest source of subsidy revenue
(approximately $33.1 million in 2007). We currently expect that as a result of
both an increase in the national average cost per loop and a decrease in our
cost structure, there is likely to be a decrease in the subsidy revenue earned
in 2008 through the federal high cost support fund.
In addition, approximately $35.9 million, or 1% of our revenue
represents a surcharge to customers (local, long distance and IXC) which is
remitted to the FCC and recorded as an expense in "other operating expenses".
10
Our company and industry are highly regulated, imposing substantial
compliance costs and restricting our ability to compete in our target markets.
As an incumbent, we are subject to significant regulation from Federal,
state and local authorities. This regulation restricts our ability to change our
rates, especially on our basic services, and imposes substantial compliance
costs on us. Regulation restricts our ability to compete and, in some
jurisdictions, it may restrict how we are able to expand our service offerings.
In addition, changes to the regulations that govern us may have an adverse
effect upon our business by reducing the allowable fees that we may charge,
imposing additional compliance costs, or otherwise changing the nature of our
operations and the competition in our industry.
Customers are now permitted to retain their wireline number when
switching to another service provider. This is likely to increase the number of
our customers who decide to disconnect their service from us. Other pending
rulemakings, including those relating to intercarrier compensation, universal
service and VOIP regulations, could have a substantial adverse impact on our
operations.
Risks Related to Technology
---------------------------
In the future as competition intensifies within our markets, we may be
unable to meet the technological needs or expectations of our customers, and may
lose customers as a result.
The telecommunications industry is subject to significant changes in
technology. If we do not replace or upgrade technology and equipment, we will be
unable to compete effectively because we will not be able to meet the needs or
expectations of our customers. Replacing or upgrading our infrastructure could
result in significant capital expenditures.
In addition, rapidly changing technology in the telecommunications
industry may influence our customers to consider other service providers. For
example, we may be unable to retain customers who decide to replace their
wireline telephone service with wireless telephone service. In addition, VOIP
technology, which operates on broadband technology, now provides our competitors
with a low-cost alternative to provide voice services to our customers.
Item 1B. Unresolved Staff Comments
-------------------------
None.
Item 2. Properties
----------
Our principal corporate offices are located in leased premises at 3 High Ridge
Park, Stamford, Connecticut 06905.
Operations support offices are currently located in leased premises at 180 South
Clinton Avenue, Rochester, New York 14646 and at 100 CTE Drive, Dallas,
Pennsylvania 18612. Call center support offices are currently located in leased
premises at 14450 Burnhaven Drive, Burnsville, Minnesota 55306 and 1398 South
Woodland Blvd., DeLand, Florida 32720. In addition, we lease and own space in
our operating markets throughout the United States.
Our telephone properties include: connecting lines between customers' premises
and the central offices; central office switching equipment; fiber-optic and
microwave radio facilities; buildings and land; and customer premise equipment.
The connecting lines, including aerial and underground cable, conduit, poles,
wires and microwave equipment, are located on public streets and highways or on
privately owned land. We have permission to use these lands pursuant to local
governmental consent or lease, permit, franchise, easement or other agreement.
Item 3. Legal Proceedings
-----------------
Ronald A. Katz Technology Licensing LP, filed suit against us for patent
infringement on June 8, 2007 in the U.S. District Court for the District of
Delaware. Katz Technology alleges that, by operating automated telephone
systems, including customer service systems, that allow our customers to utilize
telephone calling cards, order internet, DSL, and dial-up services, and perform
a variety of account related tasks such as billing and payments, we have
infringed thirteen of Katz Technology's patents and continue to infringe three
of Katz Technology's patents. Katz Technology seeks unspecified damages
resulting from our alleged infringement, as well as a permanent injunction
enjoining us from continuing the alleged infringement. Katz Technology
subsequently filed a tag-along notice with the Judicial Panel on Multi-District
Litigation, notifying them of this action and its relatedness to In re Katz
11
Interactive Dial Processing Patent Litigation (MDL No. 1816), pending in the
Central District of California before Judge R. Gary Klausner. The Judicial Panel
on Multi-District Litigation has transferred the case to the Central District of
California. Discovery in the case has commenced. In January 2008, we received
notice of the accused services and 40 asserted claims from Katz Technology. We
intend to vigorously defend against this lawsuit.
We are party to various 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 2007.
12
Executive Officers of the Registrant
Our Executive Officers as of February 1, 2008 were:
Name Age Current Position and Officer
---- --- ----------------------------
Mary Agnes Wilderotter 53 Chairman of the Board, President and Chief Executive Officer
Donald R. Shassian 52 Chief Financial Officer
Hilary E. Glassman 45 Senior Vice President, General Counsel and Secretary
Peter B. Hayes 50 Executive Vice President Sales, Marketing and Business Development
Robert J. Larson 48 Senior Vice President and Chief Accounting Officer
Daniel J. McCarthy 43 Executive Vice President and Chief Operating Officer
Cecilia K. McKenney 45 Senior Vice President, Human Resources
Melinda White 48 Senior Vice President and General Manager, New Business Operations
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 with Citizens since November 2004. She was
elected President and Chief Executive Officer in November 2004 and Chairman of
the Board in December 2005. Prior to joining Citizens, she was Senior Vice
President - Worldwide Public Sector of Microsoft Corp. from February 2004 to
November 2004 and Senior Vice President - Worldwide Business Strategy of
Microsoft Corp. from 2002 to 2004. Before that she was President and Chief
Executive Officer of Wink Communications from 1997 to 2002.
DONALD R. SHASSIAN has been with Citizens since April 2006. Prior to joining
Citizens, Mr. Shassian had been an independent consultant since 2001 primarily
providing M&A advisory services to several organizations in the communications
industry. In his role as independent consultant, Mr. Shassian also served as
Interim Chief Financial Officer of the Northeast region of Health Net, Inc. for
a short period of time, and assisted in the evaluation of acquisition,
disposition and capital raising opportunities for several companies in the
communications industry including AT&T, Consolidated Communications and smaller
companies in the rural local exchange business. Mr. Shassian is a certified
public accountant, and served for 5 years as the Senior Vice President and Chief
Financial Officer of Southern New England Telecommunications Corporation and for
more than 16 years at Arthur Andersen.
HILARY E. GLASSMAN has been with Citizens since July 2005. Prior to joining
Citizens, from February 2003, she was associated with Sandler O'Neill &
Partners, L.P., an investment bank with a specialized financial institutions
practice, first as Managing Director, Associate General Counsel and then as
Managing Director, Deputy General Counsel. From February 2000 through February
2003, Ms. Glassman was Vice President and General Counsel of Newview
Technologies, Inc. (formerly e-Steel Corporation), a privately-held software
company.
PETER B. HAYES has been with Citizens since February 2005. He is currently
Executive Vice President, Sales, Marketing and Business Development. Previously,
he was Senior Vice President, Sales, Marketing and Business Development from
February 2005 to December 2005. Prior to joining Citizens, he was associated
with Microsoft Corp. and served as Vice President, Public Sector, Europe, Middle
East, Africa from 2003 to 2005 and Vice President and General Manager, Microsoft
U.S. Government from 1997 to 2003.
ROBERT J. LARSON has been with Citizens since July 2000. He was elected Senior
Vice President and Chief Accounting Officer of Citizens in December 2002.
Previously, he was Vice President and Chief Accounting Officer from July 2000 to
December 2002. Prior to joining Citizens, he was Vice President and Controller
of Century Communications Corp.
DANIEL J. McCARTHY has been with Citizens since December 1990. He is currently
Executive Vice President and Chief Operating Officer. Previously, he was Senior
Vice President, Field Operations from December 2004 to December 2005. He was
Senior Vice President Broadband Operations from January 2004 to December 2004,
President and Chief Operating Officer of Electric Lightwave from January 2002 to
December 2004, President and Chief Operating Officer, Public Services Sector
from November 2001 to January 2002, Vice President and Chief Operating Officer,
Public Services Sector from March 2001 to November 2001 and Vice President,
Citizens Arizona Energy from April 1998 to March 2001.
13
CECILIA K. McKENNEY has been with Citizens since February 2006. Prior to joining
Citizens, she was the Group Vice President, of Headquarters of Human Resources
of The Pepsi Bottling Group (PBG) from 2004 to 2005. Previously at PBG, Ms.
McKenney was the Vice President, Headquarters Human Resources from 2000 to 2004.
MELINDA WHITE has been with Citizens since January 2005. She is currently Senior
Vice President and General Manager of New Business Operations. Previously, she
was Senior Vice President, Commercial Sales and Marketing from January 2006 to
October 2007. Ms. White was Vice President and General Manager of Electric
Lightwave from January 2005 to July 2006. Prior to joining Citizens, she was
Executive Vice President, National Accounts/Business Development for Wink
Communications from 1996 to 2002. From 2002 to 2005, Ms. White pursued a career
in music.
14
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.
2007 2006
------------------- ------------------
High Low High Low
------- ------- ------- ------
First Quarter $15.58 $13.92 $13.72 $11.97
Second Quarter $16.05 $14.80 $13.76 $12.25
Third Quarter $15.62 $12.50 $14.31 $12.38
Fourth Quarter $14.54 $12.03 $14.95 $13.68
As of January 31, 2008, the approximate number of security holders of record of
our common stock was 24,984. This information was obtained from our transfer
agent, Illinois Stock Transfer Company.
DIVIDENDS
The amount and timing of dividends payable on our common stock are within the
sole discretion of our Board of Directors. Commencing with the third quarter of
2004, we instituted a regular annual cash dividend of $1.00 per share of common
stock to be paid quarterly. Cash dividends paid to shareholders were
approximately $336.0 million, $323.7 million and $338.4 million in 2007, 2006
and 2005, respectively. There are no material restrictions on our ability to pay
dividends. The table below sets forth dividends paid during the periods
indicated.
2007 2006 2005
----------- ----------- ---------
First Quarter $0.25 $0.25 $0.25
Second Quarter $0.25 $0.25 $0.25
Third Quarter $0.25 $0.25 $0.25
Fourth Quarter $0.25 $0.25 $0.25
15
STOCKHOLDER RETURN PERFORMANCE GRAPH
The following performance graph compares the cumulative total return of our
common stock to the S&P 500 Stock Index and to the S&P Telecommunication
Services Index for the five-year period commencing December 31, 2002.
[GRAPH]
The graph assumes that $100 was invested on December 31, 2002 in each of our
common stock, the S&P 500 Stock Index and the S&P Telecommunications Services
Index and that all dividends were reinvested.
INDEXED RETURNS
Base Years Ending
Period
Company / Index 12/02 12/03 12/04 12/05 12/06 12/07
------------------------------------------------------------------------------------------------
Citizens Communications Company 100 117.73 156.79 150.04 189.56 180.03
S&P 500 Index 100 128.68 142.69 149.70 173.34 182.86
S&P Telecommunications Services 100 107.08 128.34 121.12 165.69 185.48
RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM
REGISTERED SECURITIES
Since March 9, 2007, the Company's employees who participate in the Commonwealth
Builder 401(k) Plan (CTE 401(k) Plan), which was taken over by the Company upon
the acquisition of CTE, were inadvertently permitted to purchase in the open
market approximately 149,000 shares of the Company's common stock that were not
registered for purchase by the CTE 401(k) Plan utilizing a Registration
Statement on Form S-8 under the Securities Act of 1933. All such shares were
purchased by the trustee of the CTE 401(k) Plan on behalf of participants
through open market purchases, and the Company received no proceeds from these
transactions. Effective December 31, 2007, the CTE 401(k) Plan was merged into
the Citizens 401(k) Savings Plan and the shares purchased thereunder are
registered under a Form S-8.
16
ISSUER PURCHASES OF EQUITY SECURITIES
(d) Maximum
Approximate
Dollar Value of
(c) Total Number Shares that
of Shares May Yet Be
(a) Total Purchased as Part Purchased
Number of (b) Average of Publicly Under the Plans
Shares Price Paid Announced Plans or Programs (in
Period Purchased Per Share or Programs millions)
------------------------------------------------------------------------------------------------
October 1, 2007 to October 31, 2007
Share Repurchase Program (1) 2,174,901 $ 14.20 2,174,901 $ -
Employee Transactions (2) 447 $ 13.23 N/A N/A
November 1, 2007 to November 30, 2007
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 46,286 $ 12.67 N/A N/A
December 1, 2007 to December 31, 2007
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
Totals October 1, 2007 to December 31,
2007
Share Repurchase Program (1) 2,174,901 $ 14.20 2,174,901 $ -
Employee Transactions (2) 46,733 $ 12.67 N/A N/A
(1) In February 2007, our Board of Directors authorized us to repurchase up to
$250.0 million of our common stock in public or private transactions over
the following twelve month period. This share repurchase program commenced
on March 19, 2007, and was completed on October 15, 2007.
(2) Includes restricted shares withheld (under the terms of grants under
employee stock compensation plans) to offset minimum tax withholding
obligations that occur upon the vesting of restricted shares. The Company's
stock compensation plans provide that the value of shares withheld shall be
the average of the high and low price of the Company's common stock on the
date the relevant transaction occurs.
17
Item 6. Selected Financial Data
-----------------------
The following tables present selected historical consolidated financial
information of Citizens for the periods indicated. The selected historical
consolidated financial information of Citizens as of and for each of the five
fiscal years in the period ended December 31, 2007 has been derived from
Citizens' historical consolidated financial statements. The selected historical
consolidated financial information as of December 31, 2007 and 2006 and for the
three years ended December 31, 2007 is derived from the audited historical
consolidated financial statements of Citizens included elsewhere in this Form
10-K. The selected historical consolidated financial information as of December
31, 2004 and for the years ended December 31, 2004 and 2003 is derived from the
audited historical consolidated financial statements of Citizens not included in
this Form 10-K. The selected historical consolidated financial information as of
December 31, 2003 is derived from the unaudited historical consolidated
financial statements of Citizens not included in this Form 10-K and has been
recast to be comparable to the audited historical consolidated financial
statements.
($ in thousands, except per share amounts) Year Ended December 31,
------------------------------------------ --------------------------------------------------------------
2007 2006 2005 2004 2003
------------ ----------- ------------ ------------ -----------
Revenue (1) $2,288,015 $2,025,367 $2,017,041 $2,022,378 $2,268,561
Income from continuing operations before
cumulative effect of change in accounting
principle (2) $ 214,654 $ 254,008 $ 187,942 $ 57,064 $ 71,879
Net income $ 214,654 $ 344,555 $ 202,375 $ 72,150 $ 187,852
Basic income per share of common stock
from continuing operations before cumulative
effect of change in accounting principle (2) $ 0.65 $ 0.79 $ 0.56 $ 0.19 $ 0.26
Earnings available for common shareholders per
basic share $ 0.65 $ 1.07 $ 0.60 $ 0.24 $ 0.67
Earnings available for common shareholders per
diluted share $ 0.65 $ 1.06 $ 0.60 $ 0.23 $ 0.64
Cash dividends declared (and paid) per common
share $ 1.00 $ 1.00 $ 1.00 $ 2.50 $ -
As of December 31,
--------------------------------------------------------------
2007 2006 2005 2004 2003
------------ ----------- ------------ ------------ -----------
Total assets $7,256,069 $6,797,536 $6,427,567 $6,679,899 $7,457,939
Long-term debt $4,736,897 $4,467,086 $3,995,130 $4,262,658 $4,179,590
Equity units (3) $ - $ - $ - $ - $ 460,000
Company Obligated Mandatorily Redeemable
Convertible Preferred Securities (4) $ - $ - $ - $ - $ 201,250
Shareholders' equity $ 997,899 $1,058,032 $1,041,809 $1,362,240 $1,415,183
(1) Operating results include activities from our Vermont Electric segment for
three months of 2004 and the year ended 2003, and for Commonwealth from the
date of its acquisition on March 8, 2007 and for GVN from the date of its
acquisition on October 31, 2007.
(2) The cumulative effect of change 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.
(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 No. 46R, "Consolidation of Variable Interest
Entities."
18
Item 7. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
Forward-Looking Statements
--------------------------
This annual report on Form 10-K contains forward-looking statements that are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed or implied in the statements. Statements that
are not historical facts are forward-looking statements made pursuant to the
safe harbor provisions of The Private Securities Litigation Reform Act of 1995.
Words such as "believe," "anticipate," "expect" and similar expressions are
intended to identify forward-looking statements. Forward-looking statements
(including oral representations) are only predictions or statements of current
plans, which we review continuously. Forward-looking statements may differ from
actual future results due to, but not limited to, and our future results may be
materially affected by, any of the following possibilities:
* Reductions in the number of our access lines and high-speed internet
subscribers;
* The effects of competition from cable, wireless and other wireline
carriers (through voice over internet protocol (VOIP) or otherwise);
* The effects of greater than anticipated competition requiring new
pricing, marketing strategies or new product offerings and the risk
that we will not respond on a timely or profitable basis;
* The effects of general and local economic, business, industry and
employment conditions on our revenues;
* Our ability to effectively manage service quality;
* Our ability to successfully introduce new product offerings, including
our ability to offer bundled service packages on terms that are both
profitable to us and attractive to our customers;
* Our ability to sell enhanced and data services in order to offset
ongoing declines in revenue from local services, switched access
services and subsidies;
* Changes in accounting policies or practices adopted voluntarily or as
required by generally accepted accounting principles or regulators;
* The effects of ongoing changes in the regulation of the communications
industry as a result of federal and state legislation and regulation,
including potential changes in state rate of return limitations on our
earnings, access charges and subsidy payments, and regulatory network
upgrade and reliability requirements;
* Our ability to effectively manage our operations, operating expenses
and capital expenditures, to pay dividends and to reduce or refinance
our debt;
* Adverse changes in the ratings given to our debt securities by
nationally accredited ratings organizations, which could limit or
restrict the availability and/or increase the cost of financing;
* The effects of bankruptcies in the telecommunications industry, which
could result in potential bad debts;
* The effects of technological changes and competition on our capital
expenditures and product and service offerings, including the lack of
assurance that our ongoing network improvements will be sufficient to
meet or exceed the capabilities and quality of competing networks;
* The effects of increased medical, retiree and pension expenses and
related funding requirements;
* Changes in income tax rates, tax laws, regulations or rulings, and/or
federal or state tax assessments;
* The effects of state regulatory cash management policies on our
ability to transfer cash among our subsidiaries and to the parent
company;
19
* Our ability to successfully renegotiate union contracts expiring in
2008 and thereafter;
* Our ability to pay a $1.00 per common share dividend annually, which
may be affected by our cash flow from operations, amount of capital
expenditures, debt service requirements, cash paid for income taxes
(which will increase in the future) and our liquidity;
* The effects of fully utilizing our federal net operating loss
carryforwards and AMT tax credit carryforwards that were generated in
prior years, which have significantly increased our cash taxes in 2007
and will continue to do so in 2008 and 2009;
* The effects of any future liabilities or compliance costs in
connection with worker health and safety matters; and
* The effects of any unfavorable outcome with respect to any of our
current or future legal, governmental or regulatory proceedings,
audits or disputes.
Any of the foregoing events, or other events, could cause financial information
to vary from management's forward-looking statements included in this report.
You should consider these important factors, as well as the risks set forth
under Item 1A. "Risk Factors" above, in evaluating any statement in this Form
10-K or otherwise made by us or on our behalf. The following information is
unaudited and should be read in conjunction with the consolidated financial
statements and related notes included in this report. We have no obligation to
update or revise these forward-looking statements.
Overview
--------
We are a full-service communications provider and one of the largest exchange
telephone carriers in the country. We offer our incumbent local exchange carrier
(ILEC) services under the "Frontier" name. On July 31, 2006, we sold our
competitive local exchange carrier (CLEC), Electric Lightwave, LLC (ELI). We
accounted for ELI as a discontinued operation in our consolidated statements of
operations. On March 8, 2007, we completed the acquisition of Commonwealth
Telephone Enterprises, Inc., which includes a small CLEC component. This
acquisition expands our presence in Pennsylvania and strengthens our position as
a leading full-service communications provider to rural markets. On October 31,
2007, we completed the acquisition of Global Valley Networks, Inc. and GVN
Services which expands our presence in California and also strengthens our rural
position. As of December 31, 2007, we operated in 24 states with approximately
5,900 employees.
Competition in the telecommunications industry is intense and increasing. We
experience competition from many telecommunications service providers, including
cable operators, wireless carriers, voice over internet protocol (VOIP)
providers, long distance providers, competitive local exchange carriers,
internet providers and other wireline carriers. We believe that as of December
31, 2007, approximately 58% of the households in our territories are able to be
served by alternate phone providers. We also believe that competition will
continue to intensify in 2008 across all of our products and in all of our
markets. Our Frontier business experienced erosion in access lines and switched
access minutes in 2006 and 2007, primarily as a result of competition.
Competition in our markets may result in reduced revenues in 2008.
The communications industry is undergoing significant changes. The market is
extremely competitive, resulting in lower prices. These trends are likely to
continue and result in a challenging revenue environment. These factors could
also result in more bankruptcies in the sector and, therefore, affect our
ability to collect money owed to us by carriers.
Revenues from data and internet services such as high-speed internet continue to
increase as a percentage of our total revenues and revenues from services such
as local line and access charges (including Federal and state subsidies) are
decreasing as a percentage of our revenues. These factors, along with the
potential for increasing operating costs, could cause our profitability and our
cash generated by operations to decrease.
On October 24, 2007, the Federal Communications Commission (FCC) released an
order granting us relief from certain tariff and pricing regulations on our
existing packet-switched and optical transmission services. While this is a
positive regulatory step by the FCC, these services are a small, but growing,
portion of our current total revenues. The impact of this ruling will not have
an immediate material impact on our revenues.
20
(a) Liquidity and Capital Resources
-------------------------------
Cash Flow from Operating Activities
-----------------------------------
As of December 31, 2007, we had cash and cash equivalents aggregating $226.5
million. Our primary source of funds continued to be cash generated from
operations. For the year ended December 31, 2007, we used cash flow from
continuing operations, incremental borrowings, and cash and cash equivalents to
fund a significant portion of the acquisition of Commonwealth, the entire
acquisition of GVN, capital expenditures, dividends, interest payments, debt
repayments and stock repurchases.
We believe our operating cash flows, existing cash balances, and credit facility
will be adequate to finance our working capital requirements, fund capital
expenditures, make required debt payments through 2008, pay taxes, pay dividends
to our stockholders in accordance with our dividend policy and support our
short-term and long-term operating strategies. However, a number of factors,
including but not limited to, increased cash taxes, losses of access lines,
increases in competition and lower subsidy and access revenues are expected to
reduce our cash generated by operations. Our below investment grade credit
ratings may make it more difficult and expensive to refinance our maturing debt,
although we do not have any significant maturities until 2011. We have
approximately $2.4 million and $2.5 million of debt maturing in 2008 and 2009,
respectively.
We have in recent years paid relatively low amounts of cash taxes. We expect
that in 2008 and beyond our cash taxes will increase substantially, as our
federal net operating loss carryforwards and AMT tax credit carryforwards are
estimated to be fully utilized during 2007 and 2008. We paid $54.4 million in
cash taxes during 2007, and expect to pay approximately $130.0 million to $140.0
million in 2008. Our 2008 cash tax estimate does not reflect the impact of the
"Economic Stimulus Act of 2008," which we are currently evaluating.
Cash Flow used by Investing Activities
--------------------------------------
Acquisitions
------------
On March 8, 2007, we acquired Commonwealth in a cash-and-stock taxable
transaction, for a total consideration of approximately $1.1 billion. We paid
$804.1 million in cash ($663.7 million net, after cash acquired) and issued
common stock with a value of approximately $247.4 million.
In connection with the acquisition of Commonwealth, we assumed $35.0 million of
debt under a revolving credit facility and $191.8 million face amount of
Commonwealth convertible notes (fair value of $209.6 million). During March
2007, we paid down the $35.0 million credit facility. We have retired all but
$8.5 million of the $191.8 million face amount of Commonwealth notes as of
December 31, 2007. The notes were retired by the payment of $165.4 million in
cash and the issuance of our common stock valued at approximately $36.7 million.
The premium paid of $18.9 million was recorded as $17.8 million to goodwill and
$1.1 million to other income (loss), net.
On October 31, 2007, we completed the acquisition of Global Valley Networks,
Inc. and GVN Services for a total cash consideration of $62.0 million.
Rural Telephone Bank
--------------------
We received approximately $64.6 million in cash from the dissolution of the
Rural Telephone Bank (RTB) in April 2006, which resulted in the recognition of a
pre-tax gain of approximately $61.4 million during the second quarter of 2006,
as reflected in investment income in the consolidated statements of operations
for the year ended December 31, 2006. Our tax net operating losses were used to
absorb the cash liability for taxes.
Sale of Non-Core Operations and Investments
-------------------------------------------
During 2006, we sold ELI, our CLEC business (including its associated real
estate), for $255.3 million in cash plus the assumption of approximately $4.0
million in capital lease obligations.
During 2005, we executed a strategy of divesting non-core assets, which resulted
in the following transactions:
On February 1, 2005, we sold 20,672 shares of Prudential Financial, Inc. for
approximately $1.1 million.
21
On March 15, 2005, we completed the sale of Conference Call USA, LLC for $43.6
million.
In June 2005, we sold for cash our interests in certain key man life insurance
policies on the lives of Leonard Tow, our former Chairman and Chief Executive
Officer, and his wife, a former director. The cash surrender value of the
policies purchased by Dr. Tow totaled approximately $24.2 million, and we
recognized a gain of approximately $457,000 that is included in other income
(loss), net.
During 2005, we sold 79,828 shares of Global Crossing Limited for $1.1 million.
Capital Expenditures
--------------------
For the year ended December 31, 2007, our capital expenditures were $315.8
million, including $34.3 million related to the Commonwealth and GVN properties
since date of acquisition. We continue to closely scrutinize all of our capital
projects, emphasize return on investment and focus our capital expenditures on
areas and services that have the greatest opportunities with respect to revenue
growth and cost reduction. We anticipate capital expenditures of approximately
$300.0 million to $310.0 million for 2008.
Cash Flow used by Financing Activities
--------------------------------------
Debt Reduction and Debt Exchanges
---------------------------------
For the year ended December 31, 2007, we retired an aggregate principal amount
of $967.2 million of debt, including $3.3 million of 5% Company Obligated
Mandatorily Redeemable Convertible Preferred Securities (EPPICS), and $17.8
million of 3.25% Commonwealth convertible notes that were converted into our
common stock. On April 26, 2007, we redeemed $495.2 million principal amount of
our 7.625% Senior Notes due 2008 at a price of 103.041% plus accrued and unpaid
interest. During the first quarter of 2007, we temporarily borrowed and repaid
$200.0 million utilized to temporarily fund the acquisition of Commonwealth, and
we paid down the $35.0 million Commonwealth credit facility. Through December
31, 2007, we retired $183.3 million face amount of Commonwealth convertible
notes for which we paid $165.4 million in cash and $36.7 million in common stock
(premium paid of $18.9 million was recorded as $17.8 million to goodwill and
$1.1 million to other income (loss), net), resulting in a remaining outstanding
balance of $8.5 million as of December 31, 2007. We also paid down $44.6 million
of industrial development revenue bonds and $4.3 million of rural utilities
service loan contracts.
For the year ended December 31, 2006, we retired an aggregate principal amount
of $251.0 million of debt, including $15.9 million of EPPICS that were converted
into our common stock. During the first quarter of 2006, we entered into two
debt-for-debt exchanges of our debt securities. As a result, $47.5 million of
our 7.625% notes due 2008 were exchanged for approximately $47.4 million of our
9.00% notes due 2031. During the fourth quarter of 2006, we entered into four
debt-for-debt exchanges and exchanged $157.3 million of our 7.625% notes due
2008 for $149.9 million of our 9.00% notes due 2031. The 9.00% notes are
callable on the same general terms and conditions as the 7.625% notes exchanged.
No cash was exchanged in these transactions. However, with respect to the first
quarter debt exchanges, a non-cash pre-tax loss of approximately $2.4 million
was recognized in accordance with EITF No. 96-19, "Debtor's Accounting for a
Modification or Exchange of Debt Instruments," which is included in other income
(loss), net.
On June 1, 2006, we retired at par our entire $175.0 million principal amount of
7.60% Debentures due June 1, 2006. On June 14, 2006, we repurchased $22.7
million of our 6.75% Senior Notes due August 17, 2006 at a price of 100.181% of
par. On August 17, 2006, we retired at par the $29.1 million remaining balance
of the 6.75% Senior Notes.
For the year ended December 31, 2005, we retired an aggregate principal amount
of $36.4 million of debt, including $30.0 million of EPPICS that were converted
into our common stock. During the second quarter of 2005, we entered into two
debt-for-debt exchanges of our debt securities. As a result, $50.0 million of
our 7.625% notes due 2008 were exchanged for approximately $52.2 million of our
9.00% notes due 2031. The 9.00% notes are callable on the same general terms and
conditions as the 7.625% notes exchanged. No cash was exchanged in these
transactions, however a non-cash pre-tax loss of approximately $3.2 million was
recognized in accordance with EITF No. 96-19, "Debtor's Accounting for a
Modification or Exchange of Debt Instruments," which is included in other income
(loss), net.
We may from time to time repurchase our debt in the open market, through tender
offers, exchanges of debt securities, by exercising rights to call or in
privately negotiated transactions. We may also exchange existing debt for newly
issued debt obligations.
22
Issuance of Debt Securities
---------------------------
On March 23, 2007, we issued in a private placement an aggregate $300.0 million
principal amount of 6.625% Senior Notes due 2015 and $450.0 million principal
amount of 7.125% Senior Notes due 2019. Proceeds from the sale were used to pay
down $200.0 million principal amount of indebtedness incurred on March 8, 2007
under a bridge loan facility in connection with the acquisition of Commonwealth
and redeem, on April 26, 2007, $495.2 million principal amount of our 7.625%
Senior Notes due 2008. In the second quarter of 2007, we completed an exchange
offer (to publicly register the debt) on the $750.0 million in total of private
placement notes described above, in addition to the $400.0 million principal
amount of 7.875% Senior Notes issued in a private placement on December 22,
2006, for registered notes.
On December 22, 2006, we issued in a private placement, $400.0 million principal
amount of 7.875% Senior Notes due January 15, 2027. Proceeds from the sale were
used to partially finance our acquisition of Commonwealth.
In December 2006, we borrowed $150.0 million under a senior unsecured term loan
agreement. The loan matures in 2012 and bears interest based on an average prime
rate or London Interbank Offered Rate, or LIBOR, at our election plus a margin
which varies depending on our debt leverage ratio. We used the proceeds to
partially finance our acquisition of Commonwealth.
EPPICS
------
As of December 31, 2007, we have only $4.0 million of EPPICS related debt
outstanding to third parties. The following disclosure provides the history
regarding this issuance.
In 1996, our consolidated wholly owned subsidiary, Citizens Utilities Trust (the
Trust), issued, in an underwritten public offering, 4,025,000 shares of 5%
Company Obligated Mandatorily Redeemable Convertible Preferred Securities due
2036 (Trust Convertible Preferred Securities or EPPICS), representing preferred
undivided interests in the assets of the Trust, with a liquidation preference of
$50 per security (for a total liquidation amount of $201.3 million). These
securities have an adjusted conversion price of $11.46 per share of our common
stock. The conversion price was reduced from $13.30 to $11.46 during the third
quarter of 2004 as a result of the $2.00 per share of common stock special,
non-recurring dividend. The proceeds from the issuance of the Trust Convertible
Preferred Securities and a Company capital contribution were used to purchase
$207.5 million aggregate liquidation amount of 5% Partnership Convertible
Preferred Securities due 2036 from another wholly owned consolidated subsidiary,
Citizens Utilities Capital L.P. (the Partnership). The proceeds from the
issuance of the Partnership Convertible Preferred Securities and a Company
capital contribution were used to purchase from us $211.8 million aggregate
principal amount of 5% Convertible Subordinated Debentures due 2036. The sole
assets of the Trust are the Partnership Convertible Preferred Securities, and
our Convertible Subordinated Debentures are substantially all the assets of the
Partnership. Our obligations under the agreements relating 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 2007, 2006
and 2005. 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, 2007, EPPICS representing a total principal amount of $197.3
million had been converted into 15,918,182 shares of our common stock, and a
total of $4.0 million remains outstanding to third parties. Our long-term debt
footnote indicates $14.5 million of EPPICS outstanding at December 31, 2007, of
which $10.5 million is debt of related parties for which we have an offsetting
receivable.
Interest Rate Management
------------------------
In order to manage our interest expense, we had entered into interest rate swap
agreements. Under the terms of these agreements, we made semi-annual, floating
rate interest payments based on six month LIBOR and received a fixed rate on the
notional amount. The underlying variable rate on these swaps was set either in
advance or in arrears.
The notional amounts of fixed-rate indebtedness hedged as of December 31, 2007
and 2006 were $400.0 million and $550.0 million, respectively. Such contracts
required us to pay variable rates of interest (estimated average pay rates of
approximately 8.54% as of December 31, 2007, and approximately 9.02% as of
December 31, 2006) and receive fixed rates of interest (average receive rate of
8.50% as of December 31, 2007, and 8.26% as of December 31, 2006). All swaps are
accounted for under SFAS No. 133 (as amended) as fair value hedges. For the
years ended December 31, 2007 and 2006, the interest expense resulting from
these interest rate swaps totaled approximately $2.4 million and $4.2 million,
respectively. For the year ended December 31, 2005, our interest expense was
reduced by $2.5 million, as a result of our swaps.
23
On January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with our
Senior Notes due in 2011 and 2013. Cash proceeds on the swap terminations of
approximately $15.5 million were received in January 2008. The related gain will
be deferred on the balance sheet, and amortized into income over the term of the
associated debt.
Credit Facility
---------------
As of December 31, 2007, we had available lines of credit with financial
institutions in the aggregate amount of $250.0 million and there were no
outstanding standby letters of credit issued under the facility. Associated
facility fees vary, depending on our debt leverage ratio, and were 0.225% per
annum as of December 31, 2007. The expiration date for this $250.0 million five
year revolving credit agreement is May 18, 2012. During the term of the credit
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.
Covenants
---------
The terms and conditions contained in our indentures and credit facility
agreements include the timely payment of principal and interest when due, the
maintenance of our corporate existence, keeping proper books and records in
accordance with United States Generally Accepted Accounting Principles (U.S.
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, other than those imposed by the Delaware General Corporate
laws.
Our $200.0 million term loan facility with the Rural Telephone Finance
Cooperative (RTFC) contains a maximum leverage ratio covenant. Under the
leverage ratio covenant, we are required to maintain a ratio of (i) total
indebtedness minus cash and cash equivalents in excess of $50.0 million to (ii)
consolidated adjusted EBITDA (as defined in the agreement) over the last four
quarters no greater than 4.00 to 1.
Our $250.0 million credit facility and our $150.0 million senior unsecured term
loan contain a maximum leverage ratio covenant. Under the leverage ratio
covenant, we are required to maintain a ratio of (i) total indebtedness minus
cash and cash equivalents in excess of $50.0 million to (ii) consolidated
adjusted EBITDA (as defined in the agreements) over the last four quarters no
greater than 4.50 to 1. Although both facilities are unsecured, they 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.
Certain indentures for our senior unsecured debt obligations limit our ability
to create liens or merge or consolidate with other companies and our
subsidiaries' ability to borrow funds, subject to important exceptions and
qualifications.
We are in compliance with all of our debt and credit facility covenants.
Proceeds from the Sale of Equity Securities
-------------------------------------------
We receive proceeds from the issuance of our common stock upon the exercise of
options pursuant to our stock-based compensation plans. For the years ended
December 31, 2007 and 2006, we received approximately $13.8 million and $27.2
million, respectively, upon the exercise of outstanding stock options.
Share Repurchase Programs
-------------------------
In February 2008, our Board of Directors authorized us to repurchase up to
$200.0 million of our common stock in public or private transactions over the
following twelve month period.
In February 2007, our Board of Directors authorized us to repurchase up to
$250.0 million of our common stock in public or private transactions over the
following twelve month period. This share repurchase program commenced on March
19, 2007, and was completed on October 15, 2007. During 2007, we repurchased
17,279,600 shares of our common stock at an aggregate cost of $250.0 million.
In February 2006, our Board of Directors authorized us to repurchase up to
$300.0 million of our common stock in public or private transactions over the
following twelve-month period. This share repurchase program commenced on March
6, 2006. During 2006, we repurchased 10,199,900 shares of our common stock at an
aggregate cost of approximately $135.2 million. No further purchases were made
prior to expiration of this authorization.
24
On May 25, 2005, our Board of Directors authorized us to repurchase up to $250.0
million of our common stock. This share repurchase program commenced on June 13,
2005. During 2005, we completed the repurchase program and had repurchased a
total of 18,775,200 shares of our common stock at an aggregate cost of $250.0
million.
Dividends
---------
We expect to pay regular quarterly dividends. Our ability to fund a regular
quarterly dividend will be impacted by our ability to generate cash from
operations. The declarations and payment of future dividends will be at the
discretion of our Board of Directors, and will depend upon many factors,
including our financial condition, results of operations, growth prospects,
funding requirements, applicable law and other factors our Board of Directors
deems relevant.
Off-Balance Sheet Arrangements
------------------------------
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationships with unconsolidated entities that would be expected to
have a material current or future effect upon our financial statements.
Future Commitments
------------------
A summary of our future contractual obligations and commercial commitments as of
December 31, 2007 is as follows:
Contractual Obligations: Payment due by period
------------------------
----------------------------------------------------------------
($ in thousands) Total 2008 2009-2010 2011-2012 Thereafter
--------------- ------ ---- --------- --------- ----------
Long-term debt obligations,
excluding interest (see Note 11) (1) $4,760,639 $ 2,448 $ 8,393 $1,431,534 $3,318,264
Interest on long-term debt 4,887,086 370,721 740,879 579,081 3,196,405
Operating lease
obligations (see Note 24) 79,052 24,094 23,399 16,025 15,534
Purchase obligations (see Note 24) 55,904 27,813 27,236 360 495
FIN No. 48 liability (see Note 2) 65,959 15,500 26,170 18,175 6,114
---------- -------- -------- ---------- ----------
Total $9,848,640 $440,576 $826,077 $2,045,175 $6,536,812
========== ======== ======== ========== ==========
(1) Includes interest rate swaps for $7.9 million.
At December 31, 2007, we have outstanding performance letters of credit totaling
$22.9 million.
Divestitures
------------
On August 24, 1999, our Board of Directors approved a plan of divestiture for
our public utilities services businesses, which included gas, electric and water
and wastewater businesses. We have sold all of these properties. All of the
agreements relating to the sales provide that we will indemnify the buyer
against certain liabilities (typically liabilities relating to events that
occurred prior to sale), including environmental liabilities, for claims made by
specified dates and that exceed threshold amounts specified in each agreement
(see Note 24).
Discontinued Operations
-----------------------
On July 31, 2006, we sold our CLEC business Electric Lightwave, LLC (ELI) for
$255.3 million (including a later sale of associated real estate) in cash plus
the assumption of approximately $4.0 million in capital lease obligations. We
recognized a pre-tax gain on the sale of ELI of approximately $116.7 million.
Our after-tax gain on the sale was $71.6 million. Our cash liability for taxes
as a result of the sale was approximately $5.0 million due to the utilization of
existing tax net operating losses on both the Federal and state level.
25
On March 15, 2005, we completed the sale of Conference Call USA, LLC (CCUSA) for
$43.6 million in cash. The pre-tax gain on the sale of CCUSA was $14.1 million.
Our after-tax gain was $1.2 million. The book income taxes recorded upon sale
are primarily attributable to a low tax basis in the assets sold.
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, pension and other postretirement benefits, income
taxes, contingencies and purchase price allocations among others.
Management has discussed the development and selection of these critical
accounting estimates with the Audit Committee of our Board of Directors and our
Audit Committee has reviewed our disclosures relating to them.
Telecommunications Bankruptcies
Our estimate of anticipated losses related to telecommunications bankruptcies is
a "critical accounting estimate." We have significant ongoing normal course
business relationships with many telecom providers, some of which (in prior
years) have filed for bankruptcy. We generally reserve approximately 95% of the
net outstanding pre-bankruptcy balances owed to us and believe that our estimate
of the net realizable value of the amounts owed to us by bankrupt entities is
appropriate. In 2007 and 2006, we had no "critical estimates" related to
telecommunications bankruptcies.
Asset Impairment
In 2007 and 2006, we had no "critical estimates" related to asset impairments.
Depreciation and Amortization
The calculation of depreciation and amortization expense is based on the
estimated economic useful lives of the underlying property, plant and equipment
and identifiable intangible assets. An independent study updating the estimated
remaining useful lives of our plant assets is performed annually. We adopted the
lives proposed in the study effective October 1, 2007. Our "composite
depreciation rate" increased from 5.25% to 5.45% as a result of the study. We
anticipate depreciation expense of approximately $350.0 million to $370.0
million for 2008.
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, we aggregate
our reporting units into one ILEC segment. In determining fair value of goodwill
during 2007 we compared the net book value of the reporting units to current
trading multiples of ILEC properties as well as trading values of our publicly
traded common stock. Additionally, we utilized a range of prices to gauge
sensitivity. Our test determined that fair value exceeded book value of
goodwill.
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 noncontributory defined benefit pension plans covering a
significant number of current and former employees and other post retirement
benefit plans that provide medical, dental, life insurance and other benefits
for covered retired employees and their beneficiaries and covered dependents.
The pension plans for the majority of our current employees are frozen. The
accounting results for pension and post retirement benefit costs and obligations
are dependent upon various actuarial assumptions applied in the determination of
such amounts. These actuarial assumptions include the following: discount rates,
expected long-term rate of return on plan assets, future compensation increases,
employee turnover, healthcare cost trend rates, expected retirement age,
optional form of benefit and mortality. We review these assumptions for changes
annually with our independent actuaries. We consider our discount rate and
expected long-term rate of return on plan assets to be our most critical
assumptions.
26
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 pattern of expected future benefit payments and the prevailing rates
available on long-term, high quality corporate bonds that approximate the
benefit obligation. In making this determination we consider, among other
things, the yields on the Citigroup Pension Discount Curve and Bloomberg Finance
and the changes in those rates from one period to the next. This rate can change
from year-to-year based on market conditions that impact corporate bond yields.
Our discount rate increased from 6.00% at year-end 2006 to 6.50% at year-end
2007.
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 35%
to 55% in fixed income securities, 35% to 55% in equity securities and 5% to 15%
in alternative investments. We review our asset allocation at least annually and
make changes when considered appropriate. In 2007, we did not change our
expected long-term rate of return from the 8.25% used in 2006. Our pension plan
assets are valued at actual market value as of the measurement date.
Accounting standards in effect prior to December 31, 2006 required that we
record an additional minimum pension liability when the plan's "accumulated
benefit obligation" exceeded the fair market value of plan assets at the pension
plan measurement (balance sheet) date. In the fourth quarter of 2005, primarily
due to a decrease in the year-end discount rate, we recorded an additional
minimum pension liability in the amount of $36.4 million with a corresponding
charge to shareholders' equity of $22.5 million, net of taxes of $13.9 million.
These adjustments did not impact our net income or cash flows.
We expect that our pension and other postretirement benefit expenses for 2008
will be $5.0 million to $10.0 million (they were $8.8 million in 2007, excluding
a pension curtailment gain of $14.4 million) and that no contribution will be
made by us to our pension plan in 2008. No contribution was made to our pension
plans (which were merged into one plan at year end) during 2007.
Income Taxes
Our effective tax rates in 2006 and 2007 were approximately at the statutory
rates, while in 2005 our effective tax rate was below the statutory rate level
as a result of the completion of audits with federal and state taxing
authorities and changes in the structure of certain of our subsidiaries.
Contingencies
At December 31, 2006, we had a reserve of $8.0 million in connection with a
potential environmental claim in Bangor, Maine. This claim was settled with a
payment of $7.625 million plus additional expenses during the third quarter of
2007.
We currently do not have any contingencies in excess of $5.0 million recorded on
our books.
Purchase Price Allocation - Commonwealth
The allocation of the approximate $1.1 billion paid to the "fair market value"
of the assets and liabilities of Commonwealth is a critical estimate. We have
adjusted our preliminary estimate for the fair values assigned to plant,
customer list, and goodwill to the final values. Additionally, the estimated
expected life of a customer (used to amortize the customer list) is a critical
estimate.
New Accounting Pronouncements
-----------------------------
Accounting for Uncertainty in Income Taxes
------------------------------------------
In July 2006, the FASB issued FASB Interpretation No. (FIN) 48, "Accounting for
Uncertainty in Income Taxes." Among other things, FIN No. 48 requires applying a
"more likely than not" threshold to the recognition and derecognition of
uncertain tax positions either taken or expected to be taken in the Company's
income tax returns. We adopted the provisions of FIN No. 48 in the first quarter
of 2007. The total amount of our gross FIN No. 48 tax liability for tax
positions that may not be sustained under a "more likely than not" threshold as
of the date of adoption was $44.7 million (including $10.4 million acquired from
CTE) and amounts to $66.0 million as of December 31, 2007. This amount includes
an accrual for interest from the date the tax positions were taken in the amount
of $6.2 million as of December 31, 2007. These balances include amounts of $9.0
million and $1.4 million for total FIN No. 48 tax liabilities and accrued
interest, respectively, resulting from positions taken by Commonwealth which we
27
acquired in March 2007. An increase of $14.8 million in the balance since the
date of adoption is attributable to a change made to the estimated useful life
of an intangible asset for income tax purposes. This tax position is temporary
in nature and, therefore, will not impact the Company's results of operations
when ultimately settled in the future. The amount of our total FIN No. 48 tax
liabilities reflected above that would positively impact the calculation of our
effective income tax rate, if our tax positions are sustained, is $21.1 million
as of December 31, 2007.
The Company's policy regarding the classification of interest and penalties is
to include these amounts as a component of income tax expense. This treatment of
interest and penalties is consistent with prior periods. We have recognized in
our consolidated statement of operations for the year ended December 31, 2007,
additional interest in the amount of $1.2 million. We are subject to income tax
examinations generally for the years 2003 forward for both our Federal and state
filing jurisdictions. We maintain uncertain tax positions in various state
jurisdictions. It is reasonably possible that amounts related to previous asset
dispositions and tax credits will change within the next 12 months, due to the
expiration of the relevant statutes of limitations. This could favorably impact
our results of operations by up to $7.0 million and reduce acquired goodwill
balances by up to $3.0 million. Amounts related to all other positions that may
change within the next twelve months are not material.
The following new accounting standards were adopted by the Company without any
financial statement impact. All of these standards are more fully described in
Note 2 to the consolidated financial statements.
* How Taxes Collected from Customers and Remitted to Governmental
----------------------------------------------------------------------
Authorities Should be Presented in the Income Statement (EITF No.
----------------------------------------------------------------------
06-3)
-----
* Accounting for Purchases of Life Insurance (EITF No. 06-5)
----------------------------------------------------------
The following new accounting standards that will be adopted by the Company in
2008 and 2009 are currently being evaluated by the Company, but we do not expect
the adoption to have a material impact on our financial position, results of
operations or cash flows.
* Accounting for Endorsement Split-Dollar Life Insurance Arrangements
----------------------------------------------------------------------
(EITF No. 06-4)
---------------
* Fair Value Measurements (SFAS No. 157), as amended
--------------------------------------------------
* Fair Value Option for Financial Assets and Financial Liabilities (SFAS
----------------------------------------------------------------------
No. 159)
--------
* Accounting for Collateral Assignment Split-Dollar Life Insurance
----------------------------------------------------------------------
Arrangements (EITF No. 06-10)
-----------------------------
* Business Combinations (SFAS No. 141R)
-------------------------------------
28
(b) Results of Operations
---------------------
In the paragraphs below, the Company has shown adjustments to its financial
presentations to exclude the effects of the acquisitions of CTE and GVN because
of the aggregate magnitude of the acquisitions and their impact on the Company's
financial results in 2007. The Company's variance explanations below are based
upon an analysis of 2007 for Citizens (excluding CTE and GVN), except that the
first sentence in each section of revenue or expense shows the revenue, expenses
and/or variances based upon an analysis of Citizens including the acquired
properties.
REVENUE
Revenue is generated primarily through the provision of local, network access,
long distance and data and internet services. Such services are provided through
either a monthly recurring fee or a fee based on usage at a tariffed rate and
revenue recognition is not dependent upon significant judgments by management,
with the exception of a determination of a provision for uncollectible amounts.
Consolidated revenue for the year ended December 31, 2007 increased $262.6
million, or 13%, to $2,288.0 million as compared with the prior year. Excluding
the additional revenue due to the CTE and GVN acquisitions, revenue decreased
$4.0 million during 2007, as compared with the prior year. During the first
quarter of 2007, we had a significant favorable settlement of a dispute with a
carrier that resulted in a favorable one-time impact to our revenues of $38.7
million. Excluding the impact of our acquisitions and the one-time favorable
settlement, our revenues for the year ended December 31, 2007 would have been
$1,982.7 million, a decrease of $42.7 million, or 2%, as compared to the prior
year, primarily from a reduction of $39.9 million in subsidies received from
federal and state funds.
Consolidated revenue increased $8.3 million to $2.025 billion in 2006 from
$2.017 billion in 2005. The increase in 2006 was primarily due to a 24% increase
in high-speed internet subscribers partially offset by a loss of access lines, a
decline in the average rate per minute for long distance customers and an
increase in bad debt expense.
Change in the number of our access lines is important to our revenue and
profitability. We have lost access lines primarily because of competition,
changing consumer behavior, economic conditions, changing technology and by some
customers disconnecting second lines when they add high-speed internet or cable
modem service. Excluding the impact of our acquisitions, we lost approximately
130,300 access lines during 2007, but added approximately 66,700 high-speed
internet subscribers during this same period. Our GVN acquisition represented
approximately 15,300 access lines and 4,200 high-speed internet subscribers as
of December 31, 2007. The loss of access lines during 2007 was primarily among
residential customers. The non-residential line losses were principally in our
central and eastern regions and 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 2008. A continued loss of
access lines, combined with increased competition and the other factors
discussed herein may cause our revenues, profitability and cash flows to
decrease in 2008.
Our historical results include the results of operations of Commonwealth from
the date of its acquisition on March 8, 2007 and of GVN from the date of its
acquisition on October 31, 2007. The financial tables below include a
comparative analysis of our results of operations on a historical basis for
2007, 2006 and 2005. We have also presented an analysis of each category for
2007 for the results of Citizens (excluding CTE and GVN) and the results of our
acquisitions: CTE for the last 23 days of March and the nine months ended
December 31, 2007, and the results of GVN for the last two months of 2007, as
included in the consolidated results of operations.
TELECOMMUNICATIONS REVENUE
2007 2006 2005
----------------------------------------------------- ------------------------------- ----------
Citizens
($ in thousands) As (excluding
---------------- Reported Acquisitions CTE and GVN) $ Change % Change Amount $ Change % Change Amount
---------- ----------------------- ---------- -------------------- -----------------------------
Local services $ 875,762 $ 95,197 $ 780,565 $ (29,019) -4% $ 809,584 $(20,101) -2% $ 829,685
Data and internet services 543,764 58,934 484,830 60,621 14% 424,209 58,596 16% 365,613
Access services 479,462 70,235 409,227 (18,732) -4% 427,959 (3,380) -1% 431,339
Long distance services 180,525 27,070 153,455 183 0% 153,272 (16,224) -10% 169,496
Directory services 114,586 1,264 113,322 (816) -1% 114,138 1,046 1% 113,092
Other 93,916 13,908 80,008 (16,197) -17% 96,205 (11,611) -11% 107,816
---------- ---------- ----------- ---------- ----------- --------- ----------
$2,288,015 $ 266,608 $2,021,407 $ (3,960) 0% $2,025,367 $ 8,326 0% $2,017,041
========== ========== =========== ========== =========== ========= ==========
29
Local Services
Local services revenue for the year ended December 31, 2007 increased $66.2
million, or 8%, to $875.8 million as compared with the prior year. Excluding the
additional local services revenue due to the CTE and GVN acquisitions of $95.2
million, local services revenue for the year ended December 31, 2007 decreased
$29.0 million, or 4%, to $780.6 million as compared with the prior year. The
loss of access lines accounted for $28.7 million of the decline in local
revenue, partially offset by rate increases in Rochester, New York on
residential lines that became effective August of 2006 and 2007.
Local services revenue for the year ended December 31, 2006 decreased $20.1
million, or 2%, as compared with the prior year. Local revenue decreased $25.9
million, primarily due to continued losses of access lines partially offset by a
local rate increase on some of our Rochester residential access lines effective
August 2006. 2005 reflected a reserve of $4.0 million associated with a state
rate of return limitation on earnings. Enhanced services revenue increased $5.8
million, primarily due to sales of additional feature packages.
Economic conditions and/or increasing competition could make it more difficult
to sell our packages and bundles and cause us to lower our prices for those
products and services, which would adversely affect our revenues, profitability
and cash flow.
Data and Internet Services
Data and internet services revenue for the year ended December 31, 2007
increased $119.6 million, or 28%, to $543.8 million as compared to the prior
year. Excluding the additional data and internet services revenue due to the CTE
and GVN acquisitions of $58.9 million, data and internet services revenue for
the years ended December 31, 2007 and 2006 increased $60.6 million, or 14%, and
$58.6 million, or 16%, respectively, as compared with the prior year, primarily
due to growth in data and high-speed internet services. As of December 31, 2007,
the number of the Company's high-speed internet subscribers increased by 66,700,
or 17%, since December 31, 2006. Data and internet services also includes
revenue from data transmission services to other carriers and high-volume
commercial customers with dedicated high-capacity circuits like DS-1's and
DS-3's. Revenue from these dedicated high-capacity circuits increased $19.8
million in 2007 and $9.1 million in 2006, primarily due to growth in the number
of those circuits.
Access Services
Access services revenue for the year ended December 31, 2007 increased $51.5
million, or 12%, to $479.5 million as compared to the prior year. Excluding the
additional access services revenue due to the CTE and GVN acquisitions of $70.2
million, access services revenue for the year ended December 31, 2007 decreased
$18.7 million, or 5%, as compared with the prior year. Switched access revenue
of $284.6 million increased $21.2 million, or 8%, as compared with the prior
year, primarily due to the settlement in the first quarter of a dispute with a
carrier resulting in a favorable impact on our revenue of $38.7 million (a
one-time event), partially offset by the impact of a decline in minutes of use
related to access line losses. Access service revenue includes subsidy payments
we receive from federal and state agencies. Subsidy revenue of $124.7 million
decreased $39.9 million, primarily due to lower receipts under the Federal High
Cost Fund program resulting from our reduced cost structure and an increase in
the program's National Average Cost Per Local Loop (NACPL), along with
reductions in Universal Service Fund (USF) surcharges due to the elimination of
high-speed internet units from the USF calculation.
Access services revenue for the year ended December 31, 2006 decreased $3.4
million, or 1%, as compared with the prior year. Switched access revenue
decreased $13.9 million to $263.4 million. Approximately $24.0 million of the
switched access decline was attributable to a decline in minutes of use related
to access line losses. This decline was offset by approximately $9.3 million of
disputed carrier activity resolved in the Company's favor during the fourth
quarter of 2006. Subsidy revenue increased $10.5 million to $164.6 million in
2006, primarily due to increased receipts from the Federal High Cost Fund due to
higher costs in the base year, as well as increased receipts from state high
cost funds.
Increases in the number of Competitive Eligible Telecommunications Companies
(including wireless companies) receiving federal subsidies, among other factors,
may lead to further increases in the NACPL, thereby resulting in decreases in
our federal subsidy revenue in the future. The FCC and state regulators are
currently considering a number of proposals for changing the manner in which
eligibility for federal subsidies is determined as well as the amounts of such
subsidies. The FCC is also reviewing the mechanism by which subsidies are
funded. Additionally, the FCC has an open proceeding to address reform to access
charges and other intercarrier compensation. We cannot predict when or how these
matters will be decided nor the effect on our subsidy or access revenues. Future
reductions in our subsidy and access revenues will directly affect our
profitability and cash flows as those regulatory revenues do not have associated
variable expenses.
30
Long Distance Services
Long distance services revenue for the year ended December 31, 2007 increased
$27.3 million, or 18%, to $180.5 million as compared to the prior year.
Excluding the additional long distance services revenue due to the CTE and GVN
acquisitions of $27.1 million, long distance services revenue for the year ended
December 31, 2007 was relatively unchanged as compared with the prior year,
despite an increase of 13% in our long distance minutes of use. Long distance
services revenue for the year ended December 31, 2006 decreased $16.2 million,
or 10% from 2005, primarily due to a decline in the average rate per minute. Our
long distance minutes of use increased during 2006. During 2007, we actively
marketed a package of unlimited long distance minutes with our digital phone and
state unlimited bundled service offerings. The sale of our digital phone and
state unlimited products, and its associated unlimited minutes, has resulted in
an increase in long distance customers, and the minutes used by those customers.
This has lowered our overall average rate per minute billed. Our long distance
minutes of use increased during 2007 and 2006, as compared to the prior years
and, as noted below in network access expenses, has increased our cost of
services provided.
Our long distance services revenues have remained relatively unchanged, but may
decrease in the future due to lower rates and/or minutes of use. Competing
services such as wireless, VOIP and cable telephony are resulting in a loss of
customers, minutes of use and further declines in the rates we charge our
customers.
Directory Services
Directory services revenue for the year ended December 31, 2007 increased $0.4
million to $114.6 million as compared to the prior year. Excluding the
additional directory services revenue due to the CTE and GVN acquisitions of
$1.3 million, directory services revenue for the year ended December 31, 2007
decreased $0.8 million, or 1%, as compared with the prior year with slightly
lower revenues from yellow pages advertising, mainly in Rochester, New York.
Directory services revenue for the year ended December 31, 2006 increased $1.0
million, or 1%, as compared with the prior year due to growth in yellow pages
advertising.
Other
Other revenue for the year ended December 31, 2007 decreased $2.3 million, or
2%, to $93.9 million as compared to the prior year. Excluding the additional
other revenue due to the CTE and GVN acquisitions of $13.9 million, other
revenue for the year ended December 31, 2007 decreased $16.2 million, or 17%, as
compared with the prior year, primarily due to a $9.9 million increase in bad
debt expense, the impact of a $3.4 million reduction in revenue for our free
video promotions with a multi-year customer commitment in some of our markets, a
decrease in service activation billing of $2.5 million and a decrease of $1.8
million in wireless revenue from the Mohave Cellular Limited Partnership.
Other revenue for the year ended December 31, 2006 decreased $11.6 million, or
11%, as compared with the prior year, primarily due to an increase in bad debt
expense of $7.5 million and decreases of $2.3 million for promotional credits,
$1.8 million in sales of customer premise equipment (CPE) and $1.6 million in
"bill and collect" fee revenue. The decreases were partially offset by an
increase of $2.5 million in cellular roaming revenue from the Mohave Cellular
Limited Partnership.
OTHER FINANCIAL AND OPERATING DATA
As of December 31, 2007
-----------------------------------------------
As Citizens (excluding % As of %
Reported Acquisitions CTE and GVN) Change December 31, 2006 Change 2005
---------------------------------------------------------------------------------------------
Access lines 2,431,676 435,438 1,996,238 -6% 2,126,574 -5% 2,237,539
High-speed internet (HSI)
subscribers 523,845 63,971 459,874 17% 393,184 24% 318,096
Video subscribers 93,596 9,080 84,516 34% 62,851 94% 32,326
Long distance subscribers 1,569,620 197,632 1,371,988 -1% 1,382,411 0% 1,381,238
For the year ended December 31, 2007
-----------------------------------------------
As Citizens (excluding % For the year ended %
Reported Acquisitions CTE and GVN) Change December 31, 2006 Change 2005
---------------------------------------------------------------------------------------------
Switched access minutes of
use (in millions) 10,592 1,186 9,406 -8% 10,227 -9% 11,226
Average monthly revenue per
average access line N/A N/A $ 81.50 * 6% $ 77.25 5% $ 73.39
* For the year ended December 31, 2007, the calculation includes the $38.7
million favorable impact from the first quarter 2007 settlement of a switched
access dispute. The amount is $79.94 without the $38.7 million favorable impact
from the settlement.
31
NETWORK ACCESS EXPENSES
2007 2006 2005
----------------------------------------------------- ------------------------------- ----------
Citizens
($ in thousands) As (excluding
---------------- Reported Acquisitions CTE and GVN) $ Change % Change Amount $ Change % Change Amount
--------- ------------ ----------- ------------------- ----------- ------------------- ---------
Network access $ 228,242 $ 35,781 $ 192,461 $ 21,214 12% $ 171,247 $ 14,425 9% $ 156,822
Network access
Consolidated network access expenses for the year ended December 31, 2007
increased $57.0 million, or 33%, to $228.2 million as compared to the prior year
($35.8 million of which was attributable to our 2007 acquisitions). Excluding
the additional network access expenses due to the 2007 acquisitions of CTE and
GVN, network access expenses for the years ended December 31, 2007 and 2006
increased $21.2 million and $14.4 million, or 12% and 9%, respectively, as
compared with the prior year. The increases in network costs for 2007 and 2006,
are primarily due to increasing rates and usage related to our long distance
product and our data backbone. Additionally, in the fourth quarters of 2007 and
2006, we expensed $11.4 million and $9.7 million, respectively, of promotional
costs associated with fourth quarter high-speed internet promotions that
subsidized the cost of a new personal computer or a new digital camera in 2007,
and a new personal computer in 2006, provided to customers that entered into a
multi-year commitment for certain bundled services. As we continue to increase
our sales of data products such as high-speed internet and expand the
availability of our unlimited long distance calling plans, our network access
expense is likely to continue to increase. A decline in expenses associated with
access line losses, has offset some of the increase.
OTHER OPERATING EXPENSES
2007 2006 2005
----------------------------------------------------- ------------------------------- ----------
Citizens
($ in thousands) As (excluding
---------------- Reported Acquisitions CTE and GVN) $ Change % Change Amount $ Change % Change Amount
--------- ----------- ----------- ------------------- ----------- ------------------- ---------
Wage and benefit expenses $381,326 $ 28,907 $ 352,419 $ (6,408) -2% $ 358,827 $ (23,841) -6% $ 382,668
Severance and early retirement
costs 13,874 - 13,874 6,681 93% 7,193 212 3% 6,981
Stock based compensation 9,022 - 9,022 (1,318) -13% 10,340 1,913 23% 8,427
All other operating expenses 404,279 72,086 * 332,193 (24,590) -7% 356,783 3,812 1% 352,971
--------- --------- ----------- ---------- ----------- ---------- ---------
$808,501 $100,993 $ 707,508 $ (25,635) -3% $ 733,143 $ (17,904) -2% $ 751,047
========= ========= =========== ========== =========== ========== =========
* Includes $33.0 million of common corporate costs allocated to the CTE
operations during 2007.
Consolidated other operating expenses for the year ended December 31, 2007
increased $75.4 million, or 10%, to $808.5 million as compared to the prior
year, primarily the result of our 2007 acquisitions of CTE and GVN. Other
operating expenses were impacted as follows:
Wage and benefit expenses
Wage and benefit expenses for the year ended December 31, 2007 increased $22.5
million, or 6%, to $381.3 million as compared to the prior year. Excluding the
additional wage and benefit expenses due to the CTE and GVN acquisitions of
$28.9 million, wage and benefit expenses for the year ended December 31, 2007
decreased $6.4 million, or 2%, as compared with the prior year, primarily due to
headcount reductions and associated decreases in compensation and benefit costs.
Wage and benefit expenses for the year ended December 31, 2006 decreased $23.8
million, or 6%, as compared with the prior year, primarily due to headcount
reductions, and associated decreases in compensation and benefits, and improved
expense control in benefit costs.
Included in our "As Reported" wage and benefit expenses is pension and other
postretirement benefit expenses. The amounts for 2007 include the costs for our
recently acquired Commonwealth plans and reflect the positive impact of a
pension curtailment gain of $14.4 million, resulting from the freeze placed on
certain pension benefits of the former Commonwealth non-union employees. Based
on current assumptions and plan asset values, we estimate that our pension and
other postretirement benefit expenses (which were $8.8 million in 2007,
including the costs associated with the Commonwealth plans, except for the
pension curtailment gain of $14.4 million), will be approximately $5.0 million
to $10.0 million in 2008, and that no contribution will be required to be made
by us to the pension plan in 2008. No contribution was made to our pension plans
during 2007. In future periods, if the value of our pension assets decline
and/or projected benefit costs increase, we may have increased pension and/or
postretirement expenses. Also, effective December 31, 2007, the CTE Employees'
Pension Plan was merged into the Citizens Pension Plan.
32
Severance and early retirement costs
Severance and early retirement costs for the year ended December 31, 2007
increased $6.7 million, or 93%, as compared with the prior year, primarily due
to a third quarter charge of approximately $12.1 million related to ongoing
initiatives to enhance customer service, streamline operations and reduce costs.
Approximately 120 positions have been eliminated as part of that initiative,
most of which have been filled by new employees at our remaining call centers.
In addition, approximately 50 field operations employees agreed to participate
in an early retirement program and another 30 employees from a variety of
functions have left the Company.
Severance and early retirement costs for the year ending December 31, 2006
increased slightly from the prior year.
Stock based compensation
Stock based compensation for the year ended December 31, 2007 decreased $1.3
million, or 13%, as compared with the prior year due to reduced costs associated
with stock options, since we have fewer stock option grants that remain unvested
compared to 2006.
Stock based compensation for the year ended December 31, 2006 increased $1.9
million, or 23%, as compared with the prior year due to expensing the cost,
which began in 2006, of the unvested portion of outstanding stock options
pursuant to SFAS No. 123R.
All other operating expenses
All other operating expenses for the year ended December 31, 2007 increased
$47.5 million, or 13%, to $404.3 million as compared to the prior year.
Excluding the additional expenses due to the CTE and GVN acquisitions of $72.1
million, all other operating expenses for the year ended December 31, 2007
decreased $24.6 million, or 7%, as compared with the prior year, primarily due
to the allocation of common corporate costs over a larger base of operations,
which now includes Commonwealth. Our purchase of Commonwealth has enabled us to
realize cost savings by leveraging our centralized back office, customer service
and administrative support functions over a larger customer base. Additionally,
our USF contribution rate and PUC fees decreased from the prior year period,
resulting in a reduction in costs of $13.1 million in 2007. An increase in
consulting and other outside services of $11.7 million for the year ended
December 31, 2007 offset some of the decrease in expenses noted above.
All other operating expenses for the year ended December 31, 2006 increased $3.8
million, or 1%, as compared with the prior year, primarily due to sales and
marketing expenses that increased due to a competitive environment and the
launch of new products.
DEPRECIATION AND AMORTIZATION EXPENSE
2007 2006 2005
------------------------------------------------------ -------------------------------- ---------
Citizens
($ in thousands) As (excluding
---------------- Reported Acquisitions CTE and GVN) $ Change % Change Amount $ Change % Change Amount
---------- ----------- ---------- ------------------- ----------- ------------------- ---------
Depreciation expense $ 374,435 $ 45,289 $ 329,146 $ (20,961) -6% $ 350,107 $ (43,719) -11% $ 393,826
Amortization expense 171,421 45,042 * 126,379 (1) 0% 126,380 2 0% 126,378
---------- ---------- ---------- ---------- ----------- ---------- ---------
$ 545,856 $ 90,331 $ 455,525 $ (20,962) -4% $ 476,487 $ (43,717) -8% $ 520,204
========== ========== ========== ========== =========== ========== =========
* Represents amortization expense related to the customer base acquired in the
CTE and GVN acquisitions, and the Commonwealth trade name. Our assessment of the
value of the customer base and trade name, and associated expected useful life,
are based upon independent appraisal.
Consolidated depreciation and amortization expense for the year ended December
31, 2007 increased $69.4 million, or 15%, to $545.9 million as compared to the
prior year as a result of our 2007 acquisitions of CTE and GVN. Excluding the
impact of our 2007 acquisitions, depreciation expense for the years ended
December 31, 2007 and 2006 decreased $21.0 million, or 6%, and $43.7 million, or
11%, respectively, as compared with the prior years due to a declining net asset
base partially offset by changes in the remaining useful lives of certain
assets. An independent study updating the estimated remaining useful lives of
our plant assets is performed annually. We adopted the lives proposed in the
study effective October 1, 2007. Our "composite depreciation rate" increased
from 5.25% to 5.45% as a result of the study. We anticipate depreciation expense
of approximately $350.0 million to $370.0 million for 2008.
33
INVESTMENT INCOME/OTHER INCOME (LOSS), NET / INTEREST EXPENSE /
INCOME TAX EXPENSE
2007 2006 2005
------------------------------------------------------ -------------------------------- ---------
Citizens
($ in thousands) As (excluding
---------------- Reported Acquisitions CTE and GVN) $ Change % Change Amount $ Change % Change Amount
---------- ------------ ---------- ------------------- ----------- ------------------ ---------
Investment income $ 35,781 $ 402 $ 35,379 $ (44,057) -55% $ 79,436 $ 67,213 550% $ 12,223
Other income (loss), net $ (17,833) $ 4,978 $ (22,811) $ (25,818) -859% $ 3,007 $ 2,251 298% $ 756
Interest expense $ 380,696 $ (260) $ 380,956 $ 44,510 13% $ 336,446 $ (2,289) -1% $ 338,735
Income tax expense $ 128,014 $ 27,013 $ 101,001 $ (35,478) -26% $ 136,479 $ 61,209 81% $ 75,270
Investment Income
Investment income for the year ended December 31, 2007 decreased $43.7 million,
or 55%, to $35.8 million as compared to the prior year. Excluding the investment
income due to the CTE and GVN acquisitions of $0.4 million, investment income
for the year ended December 31, 2007 decreased $44.1 million, as compared with
the prior year, primarily due to the $64.6 million in proceeds received in 2006
from the RTB liquidation and dissolution, partially offset by an increase of
$10.8 million in income from short-term investments of cash and lower minority
interest in joint ventures of $2.3 million.
We borrowed $550.0 million in December 2006 in anticipation of the Commonwealth
acquisition in 2007. Our average cash balance was $594.2 million and $429.5
million for the years ended December 31, 2007 and 2006, respectively.
Investment income for the year ended December 31, 2006 increased $67.2 million,
as compared with the prior year, primarily due to an increase of $6.4 million in
income from higher cash balances during the year arising from the $64.6 million
of cash received from the liquidation and dissolution of the RTB (and gain
recognized of $61.4 million), the $255.3 million in cash received from the sale
of ELI and the postponement of our stock repurchase and debt repurchase programs
during the second half of 2006 in connection with our acquisition of
Commonwealth.
Other Income (Loss), net
Other income (loss), net for the year ended December 31, 2007 decreased $20.8
million to ($17.8) million as compared to the prior year. Excluding the other
income due to the CTE and GVN acquisitions of $5.0 million, other income (loss),
net for the year ended December 31, 2007 decreased $25.8 million to ($22.8)
million as compared to prior year, primarily due to the premium paid of $18.2
million on the early retirement of debt during 2007 and a bridge loan fee of
$4.1 million.
Other income (loss), net for the year ended December 31, 2006 increased $2.3
million, as compared to the prior year. Other income (loss), net for 2006
consists primarily of insurance proceeds of $4.2 million, a loss of $2.4 million
on the exchange of debt, an expense of $1.0 million for legal matters and gains
recognized on the extinguishment of approximately $3.5 million of retained
liabilities of our disposed water properties.
Interest Expense
Interest expense for the year ended December 31, 2007 increased $44.5 million,
or 13%, to $381.0 million as compared with the prior year, primarily due to
$637.6 million of higher average debt resulting from financing the Commonwealth
acquisition. Our composite average borrowing rate for the year ended December
31, 2007, as compared with the prior year was 18 basis points lower, decreasing
from 8.12% to 7.94%.
Interest expense for the year ended December 31, 2006 decreased $2.3 million, or
1%, as compared with the prior year, primarily due to slightly lower average
debt levels, partially offset by higher short term interest rates that we paid
on our swap agreements ($550.0 million in principal amount was swapped to
floating rate at December 31, 2006). Our composite average borrowing rate for
the year ended December 31, 2006, as compared with the prior year was 18 basis
points higher, increasing from 7.94% to 8.12%.
Our average debt outstanding was $4,834.5 million, $4,196.9 million and $4,260.8
million for the years ended December 31, 2007, 2006 and 2005.
Income Tax Expense
Income tax expense for the year ended December 31, 2007 decreased $35.5 million,
or 26%, as compared with the prior year, primarily due to changes in taxable
income. The overall effective tax rate for 2007 was 37.4% as compared with an
effective tax rate of 34.9% for 2006. The Company's overall effective tax rate
increased in 2007 mainly due to changes in permanent difference items and tax
contingencies.
34
We paid $54.4 million in cash taxes during 2007, an increase of $49.0 million
over 2006, reflecting the utilization of our tax loss carryforwards in prior
years. We expect to pay approximately $130.0 million to $140.0 million in 2008.
Our 2008 cash tax estimate does not reflect the impact of the "Economic Stimulus
Act of 2008," which we are currently evaluating.
Income taxes for the year ended December 31, 2006 increased $61.2 million, as
compared with the prior year, primarily due to changes in taxable income. The
effective tax rate for 2006 was 34.9%, as compared with an effective tax rate of
28.6% for 2005. We utilized a substantial amount of tax loss carryforwards as a
result of the sale of ELI and receipt of RTB proceeds in 2006.
DISCONTINUED OPERATIONS
($ in thousands) 2007 2006 2005
---------------- ---------- ---------- -----------
Amount Amount Amount
---------- ---------- -----------
Revenue $ - $ 100,612 $ 163,768
Operating income $ - $ 27,882 $ 22,969
Income taxes $ - $ 11,583 $ 9,519
Net income $ - $ 18,912 $ 13,266
Gain on disposal of ELI and CCUSA,
net of tax $ - $ 71,635 $ 1,167
On July 31, 2006, we sold our CLEC business, Electric Lightwave, LLC (ELI) for
$255.3 million (including the sale of associated real estate) in cash plus the
assumption of approximately $4.0 million in capital lease obligations. We
recognized a pre-tax gain on the sale of ELI of approximately $116.7 million.
Our after-tax gain on the sale was $71.6 million. Our cash liability for taxes
as a result of the sale was approximately $5.0 million due to the utilization of
existing tax net operating losses on both the Federal and state level.
On March 15, 2005, we completed the sale of CCUSA for $43.6 million in cash. The
pre-tax gain on the sale of CCUSA was $14.1 million. Our after-tax gain was $1.2
million. The book income taxes recorded upon sale are primarily attributable to
a low tax basis in assets sold.
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
prices. We do not hold or issue derivative instruments, derivative commodity
instruments or other financial instruments for trading purposes. As a result, we
do not undertake any specific actions to cover our exposure to market risks and
we are not party to any market risk management agreements other than in the
normal course of business or to hedge long-term interest rate risk. Our primary
market risk exposures are interest rate risk and equity price risk as follows:
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest-bearing portion of our investment portfolio and interest on our
long-term debt. The long-term debt includes 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, all but $148.5 million 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. 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, 2007, a near-term change in
interest rates would not materially affect our consolidated financial position,
results of operations or cash flows.
In order to manage our interest expense, we entered into interest rate swap
agreements. Under the terms of the agreements, which qualify for hedge
accounting, we made semi-annual, floating interest rate payments based on six
month LIBOR and received a fixed rate on the notional amount. The underlying
variable rate for these interest rate swaps is set in arrears. For the years
ended December 31, 2007 and 2006, the net cash interest payment resulting from
these interest rate swaps totaled approximately $2.4 million and $4.2 million,
respectively.
35
On January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with our
Senior Notes due in 2011 and 2013. We received cash proceeds on the swap
terminations of approximately $15.5 million in January 2008.
Sensitivity analysis of interest rate exposure
At December 31, 2007, the fair value of our long-term debt was estimated to be
approximately $4.8 billion, based on our overall weighted average borrowing rate
of 7.94% and our overall weighted average maturity of approximately 13 years.
There has been no material change in the weighted average maturity applicable to
our obligations since December 31, 2006.
Our long-term debt as of December 31, 2007 was approximately 97% fixed rate debt
with minimal exposure to interest rate changes after the termination of our
remaining interest rate swap agreements on January 15, 2008.
Equity Price Exposure
Our exposure to market risks for changes in security prices as of December 31,
2007 is limited to our pension assets of $822.2 million. We have no other
security investments of any material amount.
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.
36
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, and taking into account a failure to file one interim report on
Form 8-K (for execution of a credit agreement that was described in the
immediately succeeding Form 10-Q) as well as to report in our periodic
reports on Form 10-Q the unregistered sales of shares to participants in
the Commonwealth Builder 401(k) Plan as described in Item 5(a) of this
Report, our principal executive officer and principal financial officer
concluded, as of the end of the period covered by this report, December 31,
2007, that our disclosure controls and procedures were not effective. We
have taken steps to improve these controls and believe that as of the date
of this report, 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.
(b) Report of registered public accounting firm
The report of KPMG LLP, our independent registered public accounting firm,
on internal control over financial reporting appears on page F-4.
(c) Changes in internal control over financial reporting
We reviewed our internal control over financial reporting at December 31,
2007. There has been no change in our internal control over financial
reporting identified in an evaluation thereof that occurred during the last
fiscal quarter of 2007 that materially affected or is reasonably likely to
materially affect our internal control over financial reporting.
Item 9B. Other Information
-----------------
None.
37
PART III
--------
Item 10. Directors, Executive Officers and Corporate Governance
------------------------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2008 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2007. See "Executive Officers of the Registrant" in Part I of this Report
following Item 4 for information relating to executive officers.
Item 11. Executive Compensation
----------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2008 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2007.
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 2008 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2007.
Item 13. Certain Relationships and Related Transactions, and Director
------------------------------------------------------------
Independence
------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2008 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2007.
Item 14. Principal Accountant Fees and Services
--------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2008 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2007.
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:
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2007 and 2006
Consolidated Statements of Operations for the years ended
December 31, 2007, 2006 and 2005
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2007, 2006 and 2005
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2007, 2006 and 2005
Consolidated Statements of Cash Flows for the years ended
December 31, 2007, 2006 and 2005
Notes to Consolidated Financial Statements
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.
38
(2) Index to Exhibits:
All documents referenced below were filed pursuant to the Securities Exchange
Act of 1934 by Citizens Communications Company, file number 001-11001, unless
otherwise indicated.
Exhibit
No. Description
------- -----------
3.1 Restated Certificate of Incorporation of Citizens Communications
Company, (filed as Exhibit 3.200.1 to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended June 30, 2000).*
3.2 By-laws of Citizens Communications Company, as amended (filed
as Exhibit 99.2 to the Company's Current Report on Form 8-K filed
on May 31, 2006).*
4.1 Rights Agreement, dated as of March 6, 2002, between Citizens
Communications Company and Mellon Investor Services, LLC, as
Rights Agent (filed as Exhibit 1 to the Company's
Registration Statement on Form 8-A filed on March 22, 2002).*
4.2 Amendment No. 1 to Rights Agreement, dated as of January 16,
2003, between Citizens Communications Company and Mellon
Investor Services LLC, as Rights Agent (filed as Exhibit
1.1 to the Company's Registration Statement on Form 8-A/A, dated
January 16, 2003).*
4.3 Indenture of Securities, dated as of August 15, 1991, between
Citizens Communications Company (f/k/a Citizens Utilities
Company) and JPMorgan Chase Bank, N.A. (as successor to Chemical
Bank), as Trustee (the "August 1991 Indenture") (filed as Exhibit
4.100.1 to the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended September 30, 1991).*
4.4 Fourth Supplemental Indenture to the August 1991 Indenture, dated
October 1, 1994, between Citizens Communications Company (f/k/a
Citizens Utilities Company) and JPMorgan Chase Bank, N.A. (as
successor to Chemical Bank), as Trustee (filed as Exhibit 4.100.7
to the Company Current Report on Form 8-K filed on January 3,
1995).*
4.5 Fifth Supplemental Indenture to the August 1991 Indenture,
dated as of June 15, 1995, between Citizens Communications
Company (f/k/a Citizens Utilities Company) and JPMorgan
Chase Bank, N.A. (as successor to Chemical Bank), as Trustee
(filed as Exhibit 4.100.8 to the Company's Current Report on
Form 8-K filed on March 29, 1996 (the "March 29, 1996
8-K")).*
4.6 Sixth Supplemental Indenture to the August 1991 Indenture,
dated as of October 15, 1995, between Citizens Communications
Company (f/k/a Citizens Utilities Company) and JPMorgan
Chase Bank, N.A. (as successor to Chemical Bank), as Trustee
(filed as Exhibit 4.100.9 to the March 29, 1996 8-K).*
4.7 Seventh Supplemental Indenture to the August 1991 Indenture,
dated as of June 1, 1996, between Citizens Communications Company
(f/k/a Citizens Utilities Company) and JPMorgan Chase Bank, N.A.
(as successor to Chemical Bank), as Trustee (filed as Exhibit
4.100.11 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1996 (the "1996 10-K")).*
4.8 Eighth Supplemental Indenture to the August 1991 Indenture,
dated as of December 1, 1996, between Citizens Communications
Company (f/k/a Citizens Utilities Company) and JPMorgan
Chase Bank, N.A. (as successor to Chemical Bank), as Trustee
(filed as Exhibit 4.100.12 to the 1996 10-K).*
4.9 Amended and Restated Declaration of Trust dated as of January
15, 1996, of Citizens Utilities Trust (filed as Exhibit
4.200.4 to the Company's Form 8-K Current Report filed on
May 28, 1996 (the "May 28, 1996 8-K")).*
4.10 Convertible Preferred Security Certificate (filed as Exhibit
A-1 to Exhibit 4.200.4 to the May 28, 1996 8-K).*
4.11 Amended and Restated Limited Partnership Agreement dated as of
January 15, 1996 of Citizens Utilities Capital L.P. (filed as
Exhibit 4.200.6 to the May 28, 1996 8-K).*
4.12 Partnership Preferred Security Certificate (filed as Annex A
to Exhibit 4.200.6 to the May 28, 1996 8-K).*
4.13 Convertible Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Communications Company (f/k/a
Citizens Utilities Company) and JPMorgan Chase Bank, N.A. (as
successor to Chemical Bank), as guarantee trustee (filed as
Exhibit 4.200.8 to the May 28, 1996 8-K).*
4.14 Partnership Preferred Securities Guarantee Agreement dated as of
January 15, 1996 between Citizens Communications Company (f/k/a
Citizens Utilities Company) and JPMorgan Chase Bank, N.A. (as
successor to Chemical Bank), as guarantee trustee (filed as
Exhibit 4.200.9 to the May 28, 1996 8-K).*
4.15 Letter of Representations dated January 18, 1996, from Citizens
Communications Company (f/k/a Citizens Utilities Company) and
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), as
trustee, to DTC, for deposit of Convertible Preferred Securities
with DTC (filed as Exhibit 4.200.10 to the May 28, 1996 8-K).*
----------------------
*Incorporated by reference.
39
4.16 Indenture, dated as of January 15, 1996, between Citizens
Communications Company (f/k/a Citizens Utilities Company) and
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank),
as indenture trustee (the "January 1996 Indenture") (filed as
Exhibit 4.200.1 to the May 28, 1996 8-K ).*
4.17 First Supplemental Indenture to the January 1996 Indenture,
dated as of January 15, 1996, between Citizens Communications
Company (f/k/a Citizens Utilities Company) and JPMorgan
Chase Bank, N.A. (as successor to Chemical Bank), as indenture
trustee (including the form of note attached thereto) (filed as
Exhibit 4.200.2 to the May 28, 1996 8-K).*
4.18 Senior Indenture, dated as of May 23, 2001, between Citizens
Communications Company and JPMorgan Chase Bank, N.A.(as successor
to The Chase Manhattan Bank), as trustee (the "May
2001 Indenture") (filed as Exhibit 4.1 to the Company's Current
Report on Form 8-K filed on May 24, 2001 8-K (the "May 24, 2001
8-K")).*
4.19 Form of Senior Note due 2011 (filed as Exhibit 4.4 to the May 24,
2001 8-K).*
4.20 Third Supplemental Indenture to the May 2001 Indenture, dated
as of November 12, 2004, between Citizens Communications and
JPMorgan Chase Bank, N.A.(filed as Exhibit 4.1 to the Company's
Current Report on Form 8-K filed on November 12, 2004 (the
"November 12, 2004 8-K")).*
4.21 Form of Senior Note due 2013 (filed as Exhibit A to Exhibit
4.1 to the November 12, 2004 8-K).*
4.22 Indenture, dated as of August 16, 2001, between Citizens
Communications Company and JPMorgan Chase Bank, N.A. (as
successor to The Chase Manhattan Bank), as Trustee (including
the form of note attached thereto) (filed as Exhibit 4.1 of the
Company's Current Report on Form 8-K filed on August 22, 2001).*
4.23 Indenture, dated as of December 22, 2006, between Citizens
Communications Company and The Bank of New York, as Trustee
(filed as Exhibit 4.1 to the Company's Current Report on Form
8-K filed on December 29, 2006).*
4.24 First Supplemental Indenture, dated March 8, 2007, among
Commonwealth Telephone Enterprises, Inc., Citizens Communications
Company and The Bank of New York, as Trustee. (filed as Exhibit
10.1 to the Company's Current Report on Form 8-K filed on March
9, 2007 (the "March 9, 2007 8-K")).*
4.25 First Supplemental Indenture, dated March 8, 2007, among
Commonwealth Telephone Enterprises, Inc., Citizens Communications
Company and The Bank of New York, as Trustee. (filed as
Exhibit 10.2 to the March 9, 2007 8-K).*
4.26 Indenture dated as of March 23, 2007 by and between Citizens
Communications Company and The Bank of New York with respect to
the 6.625% Senior Notes due 2015 (including the form of
such note attached thereto) (filed as Exhibit 4.1 to the
Company's Current Report on Form 8-K filed on March 27, 2007
(the "March 27, 2007 8-K")).*
4.27 Indenture dated as of March 23, 2007 by and between Citizens
Communications Company and The Bank of New York with respect
to the 7.125% Senior Notes due 2019 (including the form of
such note attached thereto) (filed as Exhibit 4.2 to the March
27, 2007 8-K).*
10.1 Loan Agreement between Citizens Communications Company
and Rural Telephone Finance Cooperative for $200,000,000
dated October 24, 2001 (filed as Exhibit 10.39 to the Company's
Quarterly Report on Form 10-Q for the fiscal quarter ended
September 30, 2001).*
10.2 Amendment No. 1, dated as of March 31, 2003, to Loan
Agreement between Citizens Communications Company and Rural
Telephone Finance Cooperative (filed as Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the fiscal quarter
ended March 31, 2003).*
10.3 Credit Agreement, dated as of December 6, 2006, among Citizens
Communications Company, as the Borrower, and CoBank, ACB, as the
Administrative Agent, the Lead Arranger and a Lender, and the
other Lenders referred to therein (filed as Exhibit 10.1 to the
Company's Current Report on Form 8-K filed on December 7, 2006).*
10.4 Loan Agreement, dated as of March 8, 2007, among Citizens
Communications Company, as borrower, the Lenders listed therein,
Citicorp North America, Inc., as Administrative Agent, and
Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC
and J.P. Morgan Securities Inc. as Joint-Lead Arrangers and Joint
Book-Running Managers. (filed as Exhibit 10.3 to the March 9,
2007 8-K).*
10.5 Credit Agreement, dated as of May 18, 2007, among Citizens
Communications Company, the lenders party thereto and Deutsche
Bank AG New York Branch, as Administrative Agent, and
Deutsche Bank Securities Inc., as Sole Lead Arranger and
Bookrunner.
10.6 Amended and Restated Non-Employee Directors' Deferred Fee
Equity Plan dated as of May 18, 2004 (filed as Exhibit 10.1.2 to
the Company's Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 2004 (the "2nd Quarter 2004 10-Q")).*
10.7 Amendment No. 1 to the Amended and Restated Non-Employee
Directors' Deferred Fee Equity Plan (filed as Exhibit 10.2 to
the Company's Current Report on Form 8-K filed on December 20,
2005).*
40
10.8 Non-Employee Directors' Equity Incentive Plan (filed as
Appendix B to the Company's Proxy Statement dated April 17,
2006).*
10.9 Separation Agreement between Citizens Communications Company and
Leonard Tow effective July 10, 2004 (filed as Exhibit 10.2.4 of
the 2nd Quarter 2004 10-Q).*
10.10 Citizens Executive Deferred Savings Plan dated January 1,
1996 (filed as Exhibit 10.19 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1999 (the "1999
10-K")).*
10.11 1996 Equity Incentive Plan (filed as Appendix A to the Company's
Proxy Statement dated March 29, 1996).*
10.12 Amendment to 1996 Equity Incentive Plan (filed as Exhibit B to
the Company's Proxy Statement dated March 28, 1997).*
10.13 Amendment to 1996 Equity Incentive Plan (effective March 4, 2005)
(filed as Exhibit 10.1 to the Company's Quarterly Report on Form
10-Q for the fiscal quarter ended March 31, 2005). *
10.14 2008 Citizens Incentive Plan (filed as Appendix A to the
Company's Proxy Statement dated April 10, 2007).*
10.15 Amended and Restated 2000 Citizens Communications Company Equity
Incentive Plan, as amended May 18, 2007 (filed as Appendix B to
the Company's Proxy Statement dated April 10, 2007).*
10.16 Employment Agreement between Citizens Communications Company and
Mary Agnes Wilderotter, effective November 1, 2004 (filed as
Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for
the fiscal quarter ended September 30, 2004 (the "3rd Quarter
2004 10-Q")).*
10.17 Employment Agreement between Citizens Communications Company and
Robert Larson, effective September 1, 2004 (filed as Exhibit
10.18 to the 3rd Quarter 2004 10-Q).*
10.18 Employment Agreement between Citizens Communications Company
and John H. Casey, III, effective February 15, 2005 (filed as
Exhibit 10.20 to the Company's Annual Report on Form
10-K for the year ended December 31, 2004 (the "2004 10-K")).*
10.19 Offer of Employment Letter between Citizens Communications
Company and Peter B. Hayes, effective February 1, 2005 (filed as
Exhibit 10.23 to the 2004 10-K).*
10.20 Offer of Employment Letter between Citizens Communications
Company and Donald R. Shassian, effective March 8, 2006 (filed
as Exhibit 10.1 to the Company's Quarterly Report on Form
10-Q for the fiscal quarter ended March 31, 2006).*
10.21 Separation Agreement between Citizens Communications Company
and John H. Casey III dated November 15, 2007.
10.22 Form of arrangement with named executive officers (other than
CEO) with respect to vesting of restricted stock upon a change-in
-control.
10.23 Form of Restricted Stock Agreement for CEO.
10.24 Form of Restricted Stock Agreement for named executive officers
other than CEO.
10.25 Summary of Compensation Arrangements for Named Executive
Officers Outside of Employment Agreements (filed as Exhibit
10.1 to the Company's Current Report on Form 8-K filed February
27, 2008).*
10.26 Summary of Non-Employee Directors' Compensation Arrangements
Outside of Formal Plans.
10.27 Membership Interest Purchase Agreement between Citizens
Communications Company and Integra Telecom Holdings, Inc.
dated February 6, 2006 (filed as Exhibit 10.1 to the
Company's Current Report on Form 8-K filed on February 9, 2006).*
10.28 Agreement and Plan of Merger dated as of September 17, 2006
among Commonwealth Telephone Enterprises, Inc., Citizens
Communications Company and CF Merger Corp. (filed as Exhibit 2.1
to the Company's Current Report on Form 8-K filed on September
18, 2006).*
10.29 Stock Purchase Agreement, dated as of July 3, 2007, between
Citizens Communications Company and Country Road Communications
LLC (filed as Exhibit 2.1 to the Company's Current Report on Form
8-K filed on July 9, 2007).*
12.1 Computation of ratio of earnings to fixed charges (this item is
included herein for the sole purpose of incorporation by
reference).
21.1 Subsidiaries of the Registrant.
23.1 Auditors' Consent.
31.1 Certification of Principal Executive Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934 (the "1934
Act").
31.2 Certification of Principal Financial Officer pursuant to Rule
13a-14(a) under the 1934 Act.
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 ("SOXA").
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of SOXA .
Exhibits 10.6 through 10.26 are management contracts or compensatory plans or
arrangements.
41
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Mary Agnes Wilderotter
----------------------------
Mary Agnes Wilderotter
Chairman of the Board, President and Chief Executive
Officer
February 27, 2008
42
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 27th day of February 2008.
Signature Title
--------- -----
/s/ Kathleen Q. Abernathy Director
--------------------------------------------
(Kathleen Q. Abernathy)
/s/ Leroy T. Barnes, Jr. Director
--------------------------------------------
(Leroy T. Barnes, Jr.)
/s/ Peter Bynoe Director
--------------------------------------------
(Peter Bynoe)
/s/ Michael T. Dugan Director
--------------------------------------------
(Michael T. Dugan)
/s/ Jeri B. Finard Director
--------------------------------------------
(Jeri B. Finard)
/s/ Lawton Fitt Director
--------------------------------------------
(Lawton Fitt)
/s/ William Kraus
-------------------------------------------- Director
(William Kraus)
/s/ Robert J. Larson Senior Vice President and
-------------------------------------------- Chief Accounting Officer
(Robert J. Larson)
/s/ Howard L. Schrott Director
--------------------------------------------
(Howard L. Schrott)
/s/ Larraine D. Segil Director
--------------------------------------------
(Larraine D. Segil)
/s/ Donald R. Shassian Chief Financial Officer
--------------------------------------------
(Donald R. Shassian)
/s/ Bradley E. Singer Director
--------------------------------------------
(Bradley E. Singer)
/s/ David H. Ward Director
--------------------------------------------
(David H. Ward)
/s/ Myron A. Wick III Director
--------------------------------------------
(Myron A. Wick III)
/s/ Mary Agnes Wilderotter Chairman of the Board,
-------------------------------------------- President and Chief
(Mary Agnes Wilderotter) Executive Officer
43
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index to Consolidated Financial Statements
Item Page
---- ----
Management's Report on Internal Control Over Financial Reporting F-2
Reports of Independent Registered Public Accounting Firm F-3 and F-4
Consolidated Balance Sheets as of December 31, 2007 and 2006 F-5
Consolidated Statements of Operations for the years ended
December 31, 2007, 2006 and 2005 F-6
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2007, 2006 and 2005 F-7
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2007, 2006 and 2005 F-7
Consolidated Statements of Cash Flows for the years ended
December 31, 2007, 2006 and 2005 F-8
Notes to Consolidated Financial Statements F-9
F-1
Management's Report on Internal Control Over Financial Reporting
----------------------------------------------------------------
The Board of Directors and Shareholders
Citizens Communications Company:
The management of Citizens Communications Company and subsidiaries is
responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and
15d-15(f).
Under the supervision and with the participation of our management, we conducted
an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal Control-Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission. Based
on our evaluation our management concluded that our internal control over
financial reporting was effective as of December 31, 2007 and for the period
then ended.
Our independent registered public accounting firm, KPMG LLP, has audited the
consolidated financial statements included in this report and, as part of their
audit, has issued their report, included herein, on the effectiveness of our
internal control over financial reporting.
Stamford, Connecticut
February 27, 2008
F-2
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, 2007 and 2006, and
the related consolidated statements of operations, shareholders' equity,
comprehensive income and cash flows for each of the years in the three-year
period ended December 31, 2007. 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, 2007 and 2006 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2007, in conformity with U.S. generally
accepted accounting principles.
As discussed in Note 2 to the accompanying consolidated financial statements,
the Company adopted the recognition and disclosure provisions of FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" as of
January 1, 2007. As discussed in Notes 1 and 2, effective January 1, 2006, the
Company adopted the fair value method of accounting for stock-based compensation
as required by Statement of Financial Accounting Standards No. 123(R),
"Share-Based Payment" and Staff Accounting Bulletin No. 108, "Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements". Also, as discussed in Note 23, the Company adopted
the recognition and disclosure provisions of Statement of Financial Accounting
Standards No. 158, "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans" as of December 31, 2006.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Citizens Communications Company's
internal control over financial reporting as of December 31, 2007, 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 February 27, 2008 expressed an unqualified opinion on the
effectiveness of the Company's internal control over financial reporting.
/s/ KPMG LLP
Stamford, Connecticut
February 27, 2008
F-3
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
Citizens Communications Company:
We have audited Citizens Communications Company's internal control over
financial reporting as of December 31, 2007, 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, included in the accompanying Management's
Report on Internal Control Over Financial Reporting. Our responsibility is to
express an opinion on 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, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control, based on the assessed risk. Our audit also included 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, Citizens Communications Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2007, 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, 2007 and
2006, and the related consolidated statements of operations, shareholders'
equity, comprehensive income and cash flows for each of the years in the
three-year period ended December 31, 2007, and our report dated February 27,
2008 expressed an unqualified opinion on those consolidated financial
statements.
/s/ KPMG LLP
Stamford, Connecticut
February 27, 2008
F-4
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2007 AND 2006
($ in thousands)
2007 2006
-------------- --------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 226,466 $ 1,041,106
Accounts receivable, less allowances of $32,748 and $108,537, respectively 234,762 187,737
Prepaid expenses 29,437 30,377
Other current assets 33,489 13,773
-------------- --------------
Total current assets 524,154 1,272,993
Property, plant and equipment, net 3,335,244 2,983,504
Goodwill, net 2,634,559 1,917,751
Other intangibles, net 547,735 432,353
Investments 21,191 16,474
Other assets 193,186 174,461
-------------- --------------
Total assets $ 7,256,069 $ 6,797,536
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Long-term debt due within one year $ 2,448 $ 39,271
Accounts payable 179,402 153,890
Advanced billings 44,722 39,417
Income taxes accrued - 9,897
Other taxes accrued 21,400 21,434
Interest accrued 116,923 103,342
Other current liabilities 80,996 58,392
-------------- --------------
Total current liabilities 445,891 425,643
Deferred income taxes 711,645 514,130
Other liabilities 363,737 332,645
Long-term debt 4,736,897 4,467,086
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares; 327,749,000 and 322,265,000
outstanding, respectively, and 349,456,000 and 343,956,000 issued at December 31, 2007
and 2006, respectively) 87,364 85,989
Additional paid-in capital 1,280,508 1,207,399
Retained earnings 14,001 134,705
Accumulated other comprehensive loss, net of tax (77,995) (81,899)
Treasury stock (305,979) (288,162)
-------------- --------------
Total shareholders' equity 997,899 1,058,032
-------------- --------------
Total liabilities and shareholders' equity $ 7,256,069 $ 6,797,536
============== ==============
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, 2007, 2006 and 2005
($ in thousands, except for per-share amounts)
2007 2006 2005
--------------- -------------- --------------
Revenue $ 2,288,015 $ 2,025,367 $ 2,017,041
Operating expenses:
Network access expenses 228,242 171,247 156,822
Other operating expenses 808,501 733,143 751,047
Depreciation and amortization 545,856 476,487 520,204
--------------- -------------- --------------
Total operating expenses 1,582,599 1,380,877 1,428,073
--------------- -------------- --------------
Operating income 705,416 644,490 588,968
Investment income 35,781 79,436 12,223
Other income (loss), net (17,833) 3,007 756
Interest expense 380,696 336,446 338,735
--------------- -------------- --------------
Income from continuing operations before income taxes 342,668 390,487 263,212
Income tax expense 128,014 136,479 75,270
--------------- -------------- --------------
Income from continuing operations 214,654 254,008 187,942
Discontinued operations (see Note 8):
Income from discontinued operations before income taxes - 147,136 36,844
Income tax expense - 56,589 22,411
--------------- -------------- --------------
Income from discontinued operations - 90,547 14,433
--------------- -------------- --------------
Net income available for common shareholders $ 214,654 $ 344,555 $ 202,375
=============== ============== ==============
Basic income per common share:
Income from continuing operations $ 0.65 $ 0.79 $ 0.56
Income from discontinued operations - 0.28 0.04
--------------- -------------- --------------
Net income per common share $ 0.65 $ 1.07 $ 0.60
=============== ============== ==============
Diluted income per common share:
Income from continuing operations $ 0.65 $ 0.78 $ 0.56
Income from discontinued operations - 0.28 0.04
--------------- -------------- --------------
Net income per common share $ 0.65 $ 1.06 $ 0.60
=============== ============== ==============
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, 2007, 2006 and 2005
(dollars and shares 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) Loss Shares Amount Equity
--------- --------- ----------- -------------- -------------- --------- ---------- ------------
Balance December 31, 2004 339,635 $ 84,909 $1,664,627 $ (287,719) $ (99,569) (2) $ (8) $1,362,240
Stock plans 2,096 524 24,039 - - 2,598 34,689 59,252
Conversion of EPPICS 2,225 556 24,308 - - 391 5,115 29,979
Dividends on common stock of
$1.00 per share - - (338,364) - - - - (338,364)
Shares repurchased - - - - - (18,775) (250,000) (250,000)
Net income - - - 202,375 - - - 202,375
Other comprehensive loss, net
of tax and reclassifications
adjustments - - - - (23,673) - - (23,673)
--------- --------- ----------- -------------- -------------- --------- ---------- ------------
Balance December 31, 2005 343,956 85,989 1,374,610 (85,344) (123,242) (15,788) (210,204) 1,041,809
Cumulative Effect Adjustment (see
Note 5) - - - 36,392 - - - 36,392
Stock plans - - (1,875) - - 2,908 38,793 36,918
Conversion of EPPICS - - (2,563) - - 1,389 18,488 15,925
Dividends on common stock of
$1.00 per share - - (162,773) (160,898) - - - (323,671)
Shares repurchased - - - - - (10,200) (135,239) (135,239)
Net income - - - 344,555 - - - 344,555
Pension Liability Adjustment,
after adoption of SFAS No. 158,
net of taxes - - - - (83,634) - - (83,634)
Other comprehensive income, net
of tax and reclassifications
adjustments - - - - 124,977 - - 124,977
--------- --------- ----------- -------------- -------------- --------- ------------ ----------
Balance December 31, 2006 343,956 85,989 1,207,399 134,705 (81,899) (21,691) (288,162) 1,058,032
Stock plans - - (6,237) 667 - 1,824 25,399 19,829
Acquisition of Commonwealth 5,500 1,375 77,939 - - 12,640 168,121 247,435
Conversion of EPPICS - - (549) - - 291 3,888 3,339
Conversion of Commonwealth notes - - 1,956 - - 2,508 34,775 36,731
Dividends on common stock of
$1.00 per share - - - (336,025) - - - (336,025)
Shares repurchased - - - - - (17,279) (250,000) (250,000)
Net income - - - 214,654 - - - 214,654
Other comprehensive income, net
of tax and reclassifications
adjustments - - - - 3,904 - - 3,904
--------- --------- ----------- -------------- -------------- --------- ------------ -----------
Balance December 31, 2007 349,456 $ 87,364 $1,280,508 $ 14,001 $ (77,995) (21,707) $(305,979) $ 997,899
========= ========= =========== ============== ============== ========= ============ ===========
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2007, 2006 and 2005
($ in thousands)
2007 2006 2005
-------------- -------------- -------------
Net income $ 214,654 $ 344,555 $ 202,375
Other comprehensive income (loss), net of tax
and reclassifications adjustments* 3,904 124,977 (23,673)
-------------- -------------- -------------
Total comprehensive income $ 218,558 $ 469,532 $ 178,702
============== ============== =============
* Consists of amortization of pension and post retirement costs, unrealized
holding (losses)/gains of marketable securities, realized gains taken to
income as a result of the sale of securities and minimum pension and other
post retirement liabilities (see Note 20).
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, 2007, 2006 and 2005
($ in thousands)
2007 2006 2005
--------------- --------------- ----------------
Cash flows provided by (used in) operating activities:
Net income $ 214,654 $ 344,555 $ 202,375
Deduct: Gain on sale of discontinued operations, net of tax - (71,635) (1,167)
Income from discontinued operations, net of tax - (18,912) (13,266)
Adjustments to reconcile income to net cash provided by
operating activities:
Depreciation and amortization expense 545,856 476,487 520,204
Stock based compensation expense 9,022 10,340 8,427
Loss on debt exchange - 2,433 3,175
Loss on extinguishment of debt 20,186 - -
Investment gain - (61,428) (492)
Other non-cash adjustments (7,598) 5,191 22,438
Deferred income taxes 81,011 132,031 100,636
Legal settlement (7,905) - -
Change in accounts receivable (4,714) 15,333 8,782
Change in accounts payable and other liabilities (36,257) (3,064) (37,257)
Change in other current assets 7,428 (2,148) 1,609
--------------- --------------- ----------------
Net cash provided by continuing operating activities 821,683 829,183 815,464
Cash flows provided from (used by) investing activities:
Capital expenditures (315,793) (268,806) (259,448)
Cash paid for acquisitions (net of cash acquired) (725,548) - -
Proceeds from sales of assets, net of selling expenses - - 24,195
Proceeds from sale of discontinued operations - 255,305 43,565
Other assets (purchased) distributions received, net 6,629 67,050 973
--------------- --------------- ----------------
Net cash (used by) provided from investing activities (1,034,712) 53,549 (190,715)
Cash flows provided from (used by) financing activities:
Repayment of customer advances for construction
and contributions in aid of construction (942) (264) (1,662)
Long-term debt borrowings 950,000 550,000 -
Debt issuance costs (12,196) (6,948) -
Long-term debt payments (946,070) (227,693) (6,299)
Premium paid to retire debt (20,186) - -
Issuance of common stock 13,808 27,200 47,550
Common stock repurchased (250,000) (135,239) (250,000)
Dividends paid (336,025) (323,671) (338,364)
--------------- --------------- ----------------
Net cash used by financing activities (601,611) (116,615) (548,775)
Cash flows of discontinued operations:
Operating cash flows - 17,833 27,500
Investing cash flows - (6,593) (11,388)
Financing cash flows - - (134)
--------------- --------------- ----------------
Net cash provided by discontinued operations - 11,240 15,978
(Decrease) increase in cash and cash equivalents (814,640) 777,357 91,952
Cash and cash equivalents at January 1, 1,041,106 263,749 171,797
--------------- --------------- ----------------
Cash and cash equivalents at December 31, $ 226,466 $1,041,106 $ 263,749
=============== =============== ================
Cash paid during the period for:
Interest $ 364,381 $ 332,204 $ 318,638
Income taxes $ 54,407 $ 5,365 $ 4,711
Non-cash investing and financing activities:
Change in fair value of interest rate swaps $ 18,198 $ (1,562) $ (13,193)
Conversion of EPPICS $ 3,339 $ 15,925 $ 29,979
Conversion of Commonwealth notes $ 36,731 $ - $ -
Debt-for-debt exchange $ - $ 2,433 $ 3,175
Shares issued for Commonwealth acquisition $ 247,435 $ - $ -
Acquired debt $ 244,570 $ - $ -
Other acquired liabilities $ 112,194 $ - $ -
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," "our," or the "Company" 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.
(b) Basis of Presentation and Use of Estimates:
-------------------------------------------
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (U.S. 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 U.S. 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 and
amortization rates, pension assumptions, calculations of impairment
amounts, reserves established for receivables, income taxes,
contingencies and purchase price allocations.
(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:
--------------------
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 consolidated statements 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.
The Company collects various taxes from its customers and subsequently
remits such funds to governmental authorities. Substantially all of
these taxes are recorded through the consolidated balance sheet and
presented on a net basis in our consolidated statements of operations.
We also collect Universal Service Fund ("USF") surcharges from
customers (primarily federal USF) which have been recorded on a gross
basis in our consolidated statements of operations and have been
included in revenue and other operating expenses at $35.9 million,
$37.1 million and $39.1 million for the years ended December 31, 2007,
2006 and 2005, respectively.
(e) Property, Plant and Equipment:
------------------------------
Property, plant and equipment are stated at original cost or fair
market value for our acquired properties, including capitalized
interest. Maintenance and repairs are charged to operating expenses as
incurred. The gross book value of routine property, plant and
equipment retired is charged against accumulated depreciation.
(f) Goodwill and Other Intangibles:
-------------------------------
Intangibles represent the excess of purchase price over the fair value
of identifiable tangible net assets acquired. We undertake studies to
determine the fair values of assets and liabilities acquired and
allocate purchase prices to assets and liabilities, including
property, plant and equipment, goodwill and other identifiable
intangibles. We annually (during the fourth quarter) examine the
carrying value of our goodwill and trade name to determine whether
there are any impairment losses and have determined for the year ended
December 31, 2007 that there was no impairment.
F-9
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill
and Other Intangible Assets," 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 to determine whether any changes
to those lives are required.
(g) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
----------------------------------------------------------------------
Of:
---
We review long-lived assets to be held and used and long-lived assets
to be disposed of, including intangible assets with estimated useful
lives, for impairment whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be
recoverable. Recoverability of assets to be held and used is measured
by comparing the carrying amount of the asset to the future
undiscounted net cash flows expected to be generated by the asset.
Recoverability of assets held for sale is measured by comparing the
carrying amount of the assets to their estimated fair market value. If
any assets are considered to be impaired, the impairment is measured
by the amount by which the carrying amount of the assets exceeds the
estimated fair value.
(h) Derivative Instruments and Hedging Activities:
----------------------------------------------
We account for derivative instruments and hedging activities in
accordance with SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended. SFAS No. 133, as amended,
requires that all derivative instruments, such as interest rate swaps,
be recognized in the financial statements and measured at fair value
regardless of the purpose or intent of holding them.
On the date we enter into a derivative contract that qualifies for
hedge accounting, we designate the derivative as either a fair value
or cash flow hedge. A hedge of the fair value of a recognized asset or
liability or of an unrecognized firm commitment is a fair value hedge.
A hedge of a forecasted transaction or the variability of cash flows
to be received or paid related to a recognized asset or liability is a
cash flow hedge. We formally document all relationships between
hedging instruments and hedged items, as well as our risk-management
objective and strategy for undertaking the hedge transaction. This
process includes linking all derivatives that are designated as fair
value or cash flow hedges to specific assets and liabilities on the
balance sheet or to specific firm commitments or forecasted
transactions.
We also formally assess, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. If it is determined that a derivative
is not highly effective as a hedge or that it has ceased to be a
highly effective hedge, we would discontinue hedge accounting
prospectively.
All derivatives are recognized on the balance sheet at their fair
value. Changes in the fair value of derivative financial instruments
are either recognized in income or shareholders' 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.
As of December 31, 2007, we had interest rate swap arrangements
related to a portion of our fixed rate debt. These hedge strategies
satisfied the fair value hedging requirements of SFAS No. 133, as
amended. As a result, the fair value of the swaps is carried on the
consolidated balance sheets in other liabilities and the related
hedged 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. Our marketable securities are
insignificant (see Note 9).
F-10
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 (see
Note 9).
(j) Income Taxes and Deferred Income Taxes:
---------------------------------------
We file a consolidated federal income tax return. We utilize the asset
and liability method of accounting for income taxes. Under the asset
and liability method, deferred income taxes are recorded for the tax
effect of temporary differences between the financial statement basis
and the tax basis of assets and liabilities using tax rates expected
to be in effect when the temporary differences are expected to
reverse.
(k) Stock Plans:
------------
We have various stock-based compensation plans. Awards under these
plans are granted to eligible officers, management employees,
non-management employees and non-employee directors. Awards may be
made in the form of incentive stock options, non-qualified stock
options, stock appreciation rights, restricted stock, restricted stock
units or other stock-based awards. We have no awards with market or
performance conditions. Our general policy is to issue shares upon the
grant of restricted shares and exercise of options from treasury.
On January 1, 2006, we adopted the provisions of SFAS No. 123 (revised
2004), "Share-Based Payment" (SFAS No. 123R) and elected to use the
modified prospective transition method. The modified prospective
transition method requires that compensation cost be recognized in the
financial statements for all awards granted after the date of adoption
as well as for existing awards for which the requisite service had not
been rendered as of the date of adoption. Compensation cost for awards
that were outstanding at the effective date are recognized over the
remaining service period using the compensation cost calculated for
pro forma disclosure purposes. Prior periods have not been restated.
On November 10, 2005, the Financial Accounting Standards Board (FASB)
issued FASB Staff Position SFAS No. 123R-3, "Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards."
We elected to adopt the alternative transition method provided for
calculating the tax effects of share-based compensation pursuant to
SFAS No. 123R. The alternative transition method includes a simplified
method to establish the beginning balance of the additional paid-in
capital pool (APIC pool) related to the tax effects of employee
share-based compensation, which is available to absorb tax
deficiencies recognized subsequent to the adoption of SFAS No. 123R.
In accordance with the adoption of SFAS No. 123R, we recorded
stock-based compensation expense for the cost of stock options,
restricted shares and stock units issued under our stock plans
(together, Stock-Based Awards). Stock-based compensation expense for
the years ended December 31, 2007 and 2006 was $9.0 million and $10.3
million, respectively, ($5.6 million and $6.7 million after tax,
respectively).
The compensation cost recognized is based on awards ultimately
expected to vest. SFAS No. 123R requires forfeitures to be estimated
and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates.
Prior to the adoption of SFAS No. 123R, we applied Accounting
Principles Board Opinion (APB) No. 25 and related interpretations to
account for our stock plans resulting in the use of the
intrinsic-value based method to value the stock. Under APB No. 25, we
were not required to recognize compensation expense for the cost of
stock options issued under our stock plans.
Prior to 2006, we provided pro forma net income and pro forma net
income per common share disclosures for employee and non-employee
director stock option grants based on the fair value of the options at
the date of grant (see Note 17). For purposes of presenting pro forma
information, the fair value of options granted is computed using the
Black Scholes option-pricing model.
F-11
Had we determined compensation cost based on the fair value at the
grant date for the Management Equity Incentive Plan (MEIP), Equity
Incentive Plan (EIP), Employee Stock Purchase Plan (ESPP) and
Non-Employee Directors' Deferred Fee Equity Plan, our pro forma net
income and net income per common share available for common
shareholders would have been as follows for the year ended December
31, 2005:
($ in thousands) 2005
---------------- ---------------
Net income available for common shareholders As reported $ 202,375
Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects 5,267
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (8,165)
---------------
Pro forma $ 199,477
===============
Net income per common share available As reported:
for common shareholders Basic $ 0.60
Diluted $ 0.60
Pro forma:
Basic $ 0.59
Diluted $ 0.59
(l) Net Income Per Common Share Available for Common Shareholders:
--------------------------------------------------------------
Basic net income per common share is computed using the weighted
average number of common shares outstanding during the period being
reported on. Except when the effect would be antidilutive, diluted net
income per common share reflects the dilutive effect of the assumed
exercise of stock options using the treasury stock method at the
beginning of the period being reported on as well as common shares
that would result from the conversion of convertible preferred stock
(EPPICS) and convertible notes. In addition, the related interest on
debt (net of tax) is added back to income since it would not be paid
if the debt was converted to common stock.
(2) Recent Accounting Literature and Changes in Accounting Principles:
------------------------------------------------------------------
New Accounting Pronouncements
------------------------------
Accounting for Uncertainty in Income Taxes
------------------------------------------
In July 2006, the FASB issued FASB Interpretation No. (FIN) 48,
"Accounting for Uncertainty in Income Taxes." Among other things, FIN
No. 48 requires applying a "more likely than not" threshold to the
recognition and derecognition of uncertain tax positions either taken
or expected to be taken in the Company's income tax returns. We
adopted the provisions of FIN No. 48 in the first quarter of 2007. The
total amount of our gross FIN No. 48 tax liability for tax positions
that may not be sustained under a "more likely than not" threshold as
of the date of adoption was $44.7 million (including $10.4 million
acquired from CTE) and amounts to $66.0 million as of December 31,
2007. This amount includes an accrual for interest from the date the
tax positions were taken in the amount of $6.2 million as of December
31, 2007. These balances include amounts of $9.0 million and $1.4
million for total FIN No. 48 tax liabilities and accrued interest,
respectively, resulting from positions taken by Commonwealth Telephone
Enterprises, Inc., which we acquired in March 2007. An increase of
$14.8 million in the balance since the date of adoption is
attributable to a change made to the estimated useful life of an
intangible asset for income tax purposes. This tax position is
temporary in nature and, therefore, will not impact the Company's
results of operations when ultimately settled in the future. The
amount of our total FIN No. 48 tax liabilities reflected above that
would positively impact the calculation of our effective income tax
rate, if our tax positions are sustained, is $21.1 million as of
December 31, 2007.
F-12
The Company's policy regarding the classification of interest and
penalties is to include these amounts as a component of income tax
expense. This treatment of interest and penalties is consistent with
prior periods. We have recognized in our consolidated statement of
operations for the year ended December 31, 2007, additional interest
in the amount of $1.2 million. We are subject to income tax
examinations generally for the years 2003 forward for both our Federal
and state filing jurisdictions. We maintain uncertain tax positions in
various state jurisdictions. It is reasonably possible that amounts
related to previous asset dispositions and tax credits will change
within the next 12 months, due to the expiration of the relevant
statutes of limitations. This could favorably impact our results of
operations by up to $7.0 million and reduce acquired goodwill balances
by up to $3.0 million. Amounts related to all other positions that may
change within the next twelve months are not material.
How Taxes Collected from Customers and Remitted to Governmental
----------------------------------------------------------------------
Authorities Should be Presented in the Income Statement
-------------------------------------------------------
In June 2006, the FASB issued EITF Issue No. 06-3, "How Taxes
Collected from Customers and Remitted to Governmental Authorities
Should be Presented in the Income Statement," which requires
disclosure of the accounting policy for any tax assessed by a
governmental authority that is directly imposed on a revenue-producing
transaction, that is Gross versus Net presentation. EITF No. 06-3 is
effective for periods beginning after December 15, 2006. We adopted
the disclosure requirements of EITF No. 06-3 commencing January 1,
2007. See Note 1(d).
Accounting for Purchases of Life Insurance
------------------------------------------
In September 2006, the FASB reached consensus on the guidance provided
by EITF No. 06-5, "Accounting for Purchases of Life
Insurance-Determining the Amount That Could Be Realized in Accordance
with FASB Technical Bulletin No. 85-4, Accounting for Purchases of
Life Insurance." EITF No. 06-5 states that a policyholder should
consider any additional amounts included in the contractual terms of
the insurance policy other than the cash surrender value in
determining the amount that could be realized under the insurance
contract. EITF No. 06-5 also states that a policyholder should
determine the amount that could be realized under the life insurance
contract assuming the surrender of an individual-life by
individual-life policy (or certificate by certificate in a group
policy). EITF No. 06-5 was effective for fiscal years beginning after
December 15, 2006. The adoption of the accounting requirements of EITF
No. 06-5 in the first quarter of 2007 had no material impact on our
financial position, results of operation or cash flows.
Accounting for Endorsement Split-Dollar Life Insurance Arrangements
-------------------------------------------------------------------
In September 2006, the FASB reached consensus on the guidance provided
by EITF No. 06-4, "Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life
Insurance Arrangements." The guidance is applicable to endorsement
split-dollar life insurance arrangements, whereby the employer owns
and controls the insurance policy, that are associated with a
postretirement benefit. EITF No. 06-4 requires that for a split-dollar
life insurance arrangement within the scope of the issue, an employer
should recognize a liability for future benefits in accordance with
SFAS No. 106 (if, in substance, a postretirement benefit plan exists)
or Accounting Principles Board Opinion No. 12 (if the arrangement is,
in substance, an individual deferred compensation contract) based on
the substantive agreement with the employee. EITF No. 06-4 is
effective for fiscal years beginning after December 15, 2007. We do
not expect the adoption of EITF No. 06-4 in the first quarter of 2008
to have a material impact on our financial position, results of
operations or cash flows.
Fair Value Measurements
-----------------------
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements," which defines fair value, establishes a framework for
measuring fair value, and expands disclosures about fair value
measurements. The provisions of SFAS No. 157 are effective as of the
beginning of our 2008 fiscal year. We do not expect the adoption of
SFAS No. 157, as amended, to have a material impact on our financial
position, results of operations or cash flows.
F-13
Fair Value Option for Financial Assets and Financial Liabilities
----------------------------------------------------------------
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities Including an amendment
of FASB Statement No. 115," which permits entities to choose to
measure many financial instruments and certain other items at fair
value. The provisions of SFAS No. 159 are effective as of the
beginning of our 2008 fiscal year. We do not expect the adoption of
SFAS No. 159 to have a material impact on our financial position,
results of operations or cash flows.
Accounting for Collateral Assignment Split-Dollar Life Insurance
----------------------------------------------------------------
Arrangements
------------
In March 2007, the FASB ratified the consensus reached by the EITF on
Issue No. 06-10, "Accounting for Collateral Assignment Split-Dollar
Life Insurance Arrangements." EITF No. 06-10 provides guidance on an
employers' recognition of a liability and related compensation costs
for collateral assignment split-dollar life insurance arrangements
that provide a benefit to an employee that extends into postretirement
periods and the asset in collateral assignment split-dollar life
insurance arrangements. The effective date of EITF No. 06-10 is for
fiscal years beginning after December 15, 2007. We do not expect the
adoption of EITF No. 06-4 in the first quarter of 2008 to have a
material impact on our financial position, results of operations or
cash flows.
Business Combinations
---------------------
In December 2007, the FASB revised SFAS Statement No. 141, "Business
Combinations". The revised statement, SFAS No. 141R, requires an
acquiring entity to recognize all the assets acquired and liabilities
assumed in a transaction at the acquisition date at fair value, to
remeasure liabilities related to contingent consideration at fair
value in each subsequent reporting period and to expense all
acquisition related costs. The effective date of SFAS No. 141R is for
business combinations for which the acquisition date is on or after
the beginning of the first annual reporting period beginning on or
after December 15, 2008. This standard does not impact our currently
reported results. The Company is currently evaluating the impact that
the adoption of the standard will have on the Company's future results
of operations or financial condition.
(3) Acquisition of Commonwealth Telephone and Global Valley Networks:
-----------------------------------------------------------------
On March 8, 2007, we acquired Commonwealth Telephone Enterprises, Inc.
("Commonwealth" or "CTE") in a cash-and-stock taxable transaction, for a
total consideration of approximately $1.1 billion. We paid $804.1 million
in cash ($663.7 million net, after cash acquired) and issued common stock
with a value of $247.4 million.
In connection with the acquisition of Commonwealth, we assumed $35.0
million of debt under a revolving credit facility and $191.8 million face
amount of Commonwealth convertible notes (fair value of $209.6 million).
During March 2007, we paid down the $35.0 million credit facility. We have
retired all but $8.5 million of the $191.8 million face amount of
Commonwealth convertible notes as of December 31, 2007. The notes were
retired by the payment of $165.4 million in cash and the issuance of our
common stock valued at $36.7 million. The premium paid of $18.9 million was
recorded as $17.8 million to goodwill and $1.1 million to other income
(loss), net.
We entered into an agreement on July 5, 2007 with Country Road
Communications LLC ("Country Road") to acquire Global Valley Networks, Inc.
("GVN") and GVN Services ("GVS") through the purchase from Country Road of
100% of the outstanding common stock of Evans Telephone Holdings, Inc., the
parent company of GVN and GVS. We closed on this acquisition on October 31,
2007. The purchase price of $62.0 million was paid with cash on hand.
We have accounted for the acquisitions of Commonwealth and GVN as purchases
under U.S. generally accepted accounting principles. Under the purchase
method of accounting, the assets and liabilities of Commonwealth and GVN
are recorded as of the acquisition date, at their respective fair values,
and consolidated with those of Citizens. The reported consolidated
financial condition of Citizens as of December 31, 2007, reflects the final
allocation of these fair values. The final allocation reflects a decrease
of $236.5 million in the value of the Commonwealth customer base, as
compared to our preliminary estimate.
F-14
The following schedule provides a summary of the purchase price paid by
Citizens in the acquisitions of Commonwealth and GVN as of December 31,
2007:
($ in thousands)
---------------- Commonwealth GVN
------------------ ---------------
Cash paid $ 804,085 $ 62,001
Value of Citizens common stock issued 247,435 -
Accrued closing costs 2,838 -
------------------ ---------------
Total Purchase Price $ 1,054,358 $ 62,001
================== ===============
With respect to our acquisition of Commonwealth, the purchase price has
been allocated based on fair values to the net tangible and intangible
assets acquired and liabilities assumed. Our GVN purchase price allocation
is preliminary. The allocations are as follows:
($ in thousands)
---------------- Commonwealth GVN
(Final) (Preliminary)
------------------ ---------------
Allocation of purchase price:
Current assets (1) $ 190,106 $ 1,945
Property, plant and equipment 387,343 25,712
Goodwill 690,035 26,774
Other intangibles 273,800 13,000
Other assets 11,234 386
Current portion of debt (35,000) (17)
Accounts payable and other current liabilities (81,767) (911)
Deferred income taxes (143,472) (3,740)
Convertible notes (209,553) -
Other liabilities (28,368) (1,148)
------------------ ---------------
Total Purchase Price $ 1,054,358 $ 62,001
================== ===============
(1) Includes $140.6 million of total acquired cash.
The following unaudited pro forma financial information presents the
combined results of operations of Citizens, Commonwealth and GVN as if the
acquisitions had occurred at the beginning of each period presented. The
historical results of the Company include the results of Commonwealth from
the date of acquisition on March 8, 2007, and GVN from November 1, 2007.
The pro forma information is not necessarily indicative of what the
financial position or results of operations actually would have been had
the acquisitions been completed at the dates indicated. In addition, the
unaudited pro forma financial information does not purport to project the
future financial position or operating results of Citizens after completion
of the acquisitions.
F-15
2007 2006
-------------- ---------------
($ in thousands, except per share amounts)
-----------------------------------------
Revenue $ 2,362,695 $ 2,371,143
Operating income $ 719,518 $ 716,162
Income from continuing operations $ 216,266 $ 284,707
Income from discontinued operations $ - $ 90,547
Net income available for common shareholders $ 216,266 $ 375,254
Basic income per common share:
Income from continuing operations $ 0.65 $ 0.83
Income from discontinued operations - 0.26
-------------- ---------------
Net income per common share $ 0.65 $ 1.09
============== ===============
Diluted income per common share:
Income from continuing operations $ 0.65 $ 0.83
Income from discontinued operations - 0.26
-------------- ---------------
Net income per common share $ 0.65 $ 1.09
============== ===============
(4) Property, Plant and Equipment:
------------------------------
The components of property, plant and equipment at December 31, 2007 and
2006 are as follows:
Estimated
($ in thousands) Useful Lives 2007 2006
---------------- ------------------- ----------------- ------------------
Land N/A $ 23,347 $ 17,944
Buildings and leasehold improvements 41 years 343,826 324,230
General support 5 to 17 years 492,771 425,952
Central office/electronic circuit equipment 5 to 11 years 2,855,645 2,602,168
Cable and wire 15 to 60 years 3,484,838 3,171,421
Other 20 to 30 years 46,620 11,800
Construction work in progress 128,250 131,951
----------------- ------------------
7,375,297 6,685,466
Less: Accumulated depreciation (4,040,053) (3,701,962)
----------------- ------------------
Property, plant and equipment, net $ 3,335,244 $ 2,983,504
================= ==================
Depreciation expense is principally based on the composite group method.
Depreciation expense was $374.4 million, $350.1 million and $393.8 million
for the years ended December 31, 2007, 2006 and 2005, respectively.
Effective with the completion of an independent study of the estimated
useful lives of our plant assets we adopted new lives beginning October 1,
2007.
(5) Retained Earnings - Cumulative Effect Adjustment:
-------------------------------------------------
In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB)
Topic 1N (SAB No. 108), "Financial Statements - Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements". SAB No. 108 provides guidance on how prior year
misstatements should be taken into consideration when quantifying
misstatements in current year financial statements for purposes of
determining whether the financial statements are materially misstated.
Under this guidance, companies should take into account both the effect of
a misstatement on the current year balance sheet as well as the impact upon
the current year income statement in assessing the materiality of a current
year misstatement. Once a current year misstatement has been quantified,
the guidance in SAB Topic 1M, "Financial Statements Materiality," (SAB No.
99) will be applied to determine whether the misstatement is material.
F-16
SAB No. 108 allowed for a one-time transitional cumulative effect
adjustment to retained earnings as of January 1, 2006 for errors that were
not previously deemed material as they were being evaluated under a single
method but were material when evaluated under the dual approach prescribed
by SAB No. 108. The Company adopted SAB No. 108 in connection with the
preparation of its financial statements for the year ended December 31,
2006. The adoption did not have any impact on the Company's cash flow or
prior year financial statements. As a result of adopting SAB No. 108 in the
fourth quarter of 2006 and electing to use the one-time transitional
cumulative effect adjustment, the Company made adjustments to the beginning
balance of retained earnings as of January 1, 2006 in the fourth quarter of
2006 for the following errors (all of which were determined to be
immaterial under the Company's previous methodology):
Summary SAB No. 108 entry recorded January 1, 2006:
Increase/
($ in thousands) (Decrease)
---------------- --------------
Property, Plant & Equipment $ 1,990
Goodwill (3,716)
Other Assets (20,081)
--------------
$ (21,807)
==============
Current Liabilities $ (2,922)
Deferred Taxes (17,339)
Other Long-Term Liabilities (13,037)
Long-Term Debt (24,901)
Retained Earnings 36,392
--------------
$ (21,807)
==============
Deferred Tax Accounting. As a result of adopting SAB No. 108 in the fourth
quarter of 2006 we recorded a decrease in deferred income tax liabilities
in the amount of approximately $23.5 million and an increase in retained
earnings of approximately $23.5 million as of January 1, 2006. The change
in deferred tax and retained earnings is a result of excess deferred tax
liabilities that built up in periods prior to 2004 (approximately $4
million in 2003, $5.4 million in 2002 and $14.1 million in 2001 and prior),
resulting primarily from differences between actual state income tax rates
and the effective composite state rate utilized for estimating the
Company's book state tax provisions.
Goodwill. During 2002, we estimated and booked impairment charges (pre-tax)
of $1.07 billion. We subsequently discovered that the impairment charge
recorded was overstated as it exceeded the underlying book value by
approximately $8.1 million. The result was an understatement of goodwill.
We corrected this error by reversing the negative goodwill balance of $8.1
million with an offset to increase retained earnings.
Unrecorded Liabilities. The Company changed its accounting policies
associated with the accrual of utilities and vacation expense.
Historically, the Company's practice was to expense utility and vacation
costs in the period these items were paid, which generally resulted in a
full year of utilities and vacation expense in the consolidated statements
of income. The utility costs are now accrued in the period used and
vacation costs are accrued in the period earned. The cumulative amount of
these changes as of the beginning of fiscal 2006 was approximately $3.0
million and, as provided in SAB No. 108, the impact was recorded as a
reduction of retained earnings as of the beginning of fiscal 2006.
We established an accrual of $4.5 million for advance billings associated
with certain revenue at two telephone properties that the Company operated
since the 1930's. For these two properties, the Company's records have not
reflected the liability. This had no impact on the revenue reported for any
of the five years reported in this 10-K.
F-17
We recorded a long-term liability of $2.5 million to recognize a post
retirement annuity payment obligation for two former executives of the
Company. The liability should have been established in 1999 at the time the
two employees elected to exchange their death benefit rights for an annuity
payout in accordance with the terms of their respective split dollar life
insurance agreements. We established the liability effective January 1,
2006 in accordance with SAB No. 108 by reducing retained earnings by a like
amount.
Long-Term Debt. We recorded a reclassification of $20.1 million from other
assets to long-term debt. The amount represents debt discounts which the
company historically accounted for as a deferred asset. For certain debt
issuances the Company amortized the debt discount using the straight line
method instead of the effective interest method. We corrected this error by
increasing the debt discount by $4.8 million and increasing retained
earnings by a like amount.
Customer Advances for Construction. Amounts associated with "construction
advances" remaining on the Company's balance sheet ($92.4 million at
December 31, 2005) included approximately $7.3 million of such contract
advances that were transferred to the purchaser of our water and wastewater
operations on January 15, 2002 and accordingly should have been included in
the gain recognized upon sale during that period. Upon the adoption of SAB
No. 108 in the fourth quarter of 2006, this error was corrected as of
January 1, 2006 through a decrease in other long-term liabilities and an
increase in retained earnings.
Purchase Accounting. During the period 1991 to 2001, Citizens acquired a
number of telecommunications businesses, growing its asset base from
approximately $400.0 million in 1991 to approximately $6.0 billion by the
end of 2001. As a result of these acquisitions, we recorded in accordance
with purchase accounting standards, all of the assets and liabilities
associated with these properties. We have determined that approximately
$18.8 million (net) of liabilities were established in error. Approximately
$18.0 million of the liabilities should have been recorded as a decrease to
goodwill and $4.2 million should have been an increase to property, plant
and equipment ($1.99 million after amortization of $2.21 million). In
addition, $4.964 million of liabilities should have been reversed in 2001.
We corrected this error by reversing the liability to retained earnings.
As permitted by the adoption of SAB No. 108 we have adjusted our previously
recorded acquisition entries as follows:
Increase/
($ in thousands) (Decrease)
---------------- --------------
Property, Plant & Equipment $ 1,990
Goodwill (18,049)
--------------
$ (16,059)
==============
Current Liabilities $ (10,468)
Other Long-Term Liabilities (8,345)
Retained Earnings 2,754
--------------
$ (16,059)
==============
Tax Effect. The net effect on taxes (excluding the $23.5 million entry
described above) resulting from the GRAPHIC OMITTED][GRAPHIC OMITTED]
adoption of SAB No. 108 was an increase to deferred tax liabilities of $6.2
million and an increase to goodwill of $6.2 million.
F-18
(6) Accounts Receivable:
--------------------
The components of accounts receivable at December 31, 2007 and 2006 are as
follows:
($ in thousands) 2007 2006
---------------- -------------- ---------------
End user $ 244,592 $ 273,828
Other 22,918 22,446
Less: Allowance for doubtful accounts (32,748) (108,537)
-------------- ---------------
Accounts receivable, net $ 234,762 $ 187,737
============== ===============
An analysis of the activity in the allowance for doubtful accounts for the
years ended December 31, 2007, 2006, and 2005 is as follows:
Additions
------------------------------------------
Balance at Balance of Charged to Charged to other Balance at
beginning of acquired bad debt accounts - end of
Allowance for doubtful accounts Period properties expense* Revenue Deductions Period
------------------------------- ------------- ----------- ------------ --------------- ------------ -----------
2005 $ 35,080 $ - $ 12,797 $ 1,080 $ 17,572 $ 31,385
2006 31,385 - 20,257 80,003 23,108 108,537
2007 108,537 1,499 31,131 (77,898) 30,521 32,748
* Such amounts are included in bad debt expense and for financial reporting
purposes are classified as contra-revenue.
We maintain an allowance for estimated bad debts based on our estimate of
collectability of our accounts receivable. Bad debt expense is recorded as
a reduction to revenue.
Our allowance for doubtful accounts increased by approximately $78.3
million in 2006 as a result of carrier activity that was in dispute. Our
allowance for doubtful accounts (and "end user" receivables) declined from
December 31, 2006, primarily as a result of the resolution of our principal
carrier dispute. On March 12, 2007, we entered into a settlement agreement
with a carrier pursuant to which we were paid $37.5 million, resulting in a
favorable impact on our revenue in the first quarter of 2007 of $38.7
million.
(7) Other Intangibles:
------------------
Other intangibles at December 31, 2007 and 2006 are as follows:
($ in thousands) 2007 2006
---------------- --------------- ----------------
Customer base $ 1,271,085 $ 994,605
Trade name 132,381 122,058
--------------- ----------------
Other intangibles 1,403,466 1,116,663
Less: Accumulated amortization (855,731) (684,310)
--------------- ----------------
Total other intangibles, net $ 547,735 $ 432,353
=============== ================
Amortization expense was $171.4 million, $126.4 million and $126.4 million
for the years ended December 31, 2007, 2006 and 2005, respectively.
Amortization expense for 2007 is comprised of $126.4 million for
amortization associated with our "legacy" properties and $45.0 million for
intangible assets (customer base and trade name) acquired in the
Commonwealth and Global Valley acquisitions. As of December 31, 2007,
$263.5 million has been allocated to the customer base (five year life) and
$10.3 million to the trade name (five year life) acquired in the
Commonwealth acquisition, and $13.0 million on a preliminary basis to the
customer base (five year life) acquired in the Global Valley acquisition.
Amortization expense, based on our estimate of useful lives, is estimated
to be $183.7 million in 2008, $115.0 million in 2009, and $57.4 million
annually thereafter through 2012.
F-19
(8) Discontinued Operations:
------------------------
(a) Electric Lightwave
------------------
On July 31, 2006, we sold our CLEC business, Electric Lightwave, LLC
(ELI), for $255.3 million (including the sale of associated real
estate) in cash plus the assumption of approximately $4.0 million in
capital lease obligations. We recognized a pre-tax gain on the sale of
ELI of approximately $116.7 million. Our after-tax gain on the sale
was $71.6 million. Our cash liability for taxes as a result of the
sale was approximately $5.0 million due to the utilization of existing
tax net operating losses on both the Federal and state level.
In accordance with SFAS No. 144, any component of our business that we
dispose of, or classify as held for sale, that has operations and cash
flows clearly distinguishable from continuing operations for financial
reporting purposes, and that will be eliminated from the ongoing
operations, should be classified as discontinued operations.
Accordingly, we have classified the results of operations of ELI as
discontinued operations in our consolidated statements of operations.
We ceased to record depreciation expense for ELI effective February
2006.
Summarized financial information for ELI is set forth below:
For the years
($ in thousands) ended December 31,
---------------- -------------------------------------
2006 2005
----------------- ----------------
Revenue $ 100,612 $ 159,161
Operating income $ 27,882 $ 21,480
Income taxes $ 11,583 $ 9,070
Net income $ 18,912 $ 12,226
Gain on disposal of ELI, net of tax $ 71,635 $ -
(b) Conference Call USA
-------------------
In February 2005, we entered into a definitive agreement to sell
Conference-Call USA, LLC (CCUSA), our conferencing services business.
On March 15, 2005, we completed the sale for $43.6 million in cash.
The pre-tax gain on the sale of CCUSA was $14.1 million. Our after-tax
gain was approximately $1.2 million. The book income taxes recorded
upon sale are primarily attributable to a low tax basis in the assets
sold.
In accordance with SFAS No. 144, any component of our business that we
dispose of, or classify as held for sale, that has operations and cash
flows clearly distinguishable from continuing operations for financial
reporting purposes, and that will be eliminated from the ongoing
operations, should be classified as discontinued operations.
Accordingly, we have classified the results of operations of CCUSA as
discontinued operations in our consolidated statements of operations.
The Company had no outstanding debt specifically identified with CCUSA
and therefore no interest expense was allocated to discontinued
operations. In addition, we ceased to record depreciation expense
effective February 16, 2005.
F-20
Summarized financial information for CCUSA is set forth below:
($ in thousands)
---------------- For the year
ended December 31,
2005
-----------------
Revenue $ 4,607
Operating income $ 1,489
Income taxes $ 449
Net income $ 1,040
Gain on disposal of CCUSA, net of tax $ 1,167
(9) Investments:
------------
The components of investments at December 31, 2007 and 2006 are as follows:
($ in thousands) 2007 2006
---------------- ---------------- ----------------
Marketable equity securities $ - $ 30
Equity method investments 21,191 16,444
---------------- ----------------
$ 21,191 $ 16,474
================ ================
Equity Method Investments
Our investments in entities that are accounted for under the equity method
of accounting consist of the following: (1) a 50% interest in the C-Don
Partnership, acquired in the purchase of Commonwealth, which publishes,
manufactures and distributes classified telephone directories in the
Commonwealth service territory; (2) a 16.8% interest in the Fairmount
Cellular Limited Partnership which is engaged in cellular mobile telephone
service in the Rural Service Area (RSA) designated by the FCC as Georgia
RSA No. 3; and (3) our investments in CU Capital and CU Trust with relation
to our convertible preferred securities.
(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, 2007 and
2006. 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. Other equity method
investments for which market values are not readily available are carried
at cost, which approximates fair value.
The fair value of our long-term debt is estimated based on quoted market
prices at the reporting date for those financial instruments.
($ in thousands) 2007 2006
---------------- ----------------------------------- ---------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------------- ------------------ ---------------- ----------------
Long-term debt (1) $ 4,736,897 $ 4,760,639 $ 4,467,086 $ 4,620,921
(1) 2007 and 2006 include interest rate swaps of $7.9 million and ($10.3
million), respectively. 2007 and 2006 include EPPICS of $14.5 million and
$17.9 million, respectively.
F-21
(11) Long-Term Debt:
---------------
The activity in our long-term debt from December 31, 2006 to December 31,
2007 is summarized as follows:
Year Ended December 31, 2007
----------------------------------------------------------------
Assumed Interest
from Interest Rate* at
December 31, New Commonwealth Rate Conversion to December 31, December 31,
($ in thousands) 2006 Payments Borrowings Acquisition Swap Common Stock 2007 2007
---------------- ------------- ----------- ------------ ------------- --------- ---------------- ------------ -----------
Rural Utilities Service
Loan Contracts $ 21,886 $ (4,331) $ - $ - $ - $ - $ 17,555 6.07%
Senior Unsecured Debt 4,435,018 (897,149) 950,000 226,779 18,198 (17,833) 4,715,013 7.96%
EPPICS (see Note 15) 17,860 - - - - (3,339) 14,521 5.00%
Industrial Development
Revenue Bonds 58,140 (44,590) - - - - 13,550 6.31%
------------- ------------ ---------- ------------- --------- --------------- -------------
TOTAL LONG-TERM DEBT $ 4,532,904 $ (946,070) $950,000 $ 226,779 $ 18,198 $ (21,172) $ 4,760,639 7.94%
============= ============ ========== ============= ========= =============== =============
Less: Debt Discount (26,547) (21,294)
Less: Current Portion (39,271) (2,448)
------------- -------------
$ 4,467,086 $ 4,736,897
============= =============
* Interest rate includes amortization of debt issuance costs, debt premiums
or discounts. The interest rate for Rural Utilities Service Loan Contracts,
Senior Unsecured Debt, and Industrial Development Revenue Bonds represent a
weighted average of multiple issuances.
Additional information regarding our Senior Unsecured Debt at December 31:
2007 2006
--------------------------------- -----------------------------------
Principal Interest Principal Interest
($ in thousands) Outstanding Rate Outstanding Rate
---------------- ---------------- ------------- ----------------- --------------
Senior Notes:
Due 8/15/2008 $ - - $ 495,240 7.625%
Due 5/15/2011 1,050,000 9.250% 1,050,000 9.250%
Due 10/24/2011 200,000 6.270% 200,000 6.270%
Due 12/31/2012 148,500 6.44% (Variable) 150,000 6.75% (Variable)
Due 1/15/2013 700,000 6.250% 700,000 6.250%
Due 3/15/2015 300,000 6.625% - -
Due 3/15/2019 450,000 7.125% - -
Due 1/15/2027 400,000 7.875% 400,000 7.875%
Due 8/15/2031 945,325 9.000% 945,325 9.000%
---------------- -----------------
4,193,825 3,940,565
Debentures due 2025 - 2046 468,742 7.136% 468,742 7.136%
Subsidiary Senior
Notes due 12/1/2012 36,000 8.050% 36,000 8.050%
CTE Convertible Notes due 7/23/2023 8,537 3.250% - -
Fair value of interest rate swaps 7,909 (10,289)
---------------- -----------------
Total $ 4,715,013 $ 4,435,018
================ =================
During 2007, we retired an aggregate principal amount of $967.2 million of
debt, including $3.3 million of 5% Company Obligated Mandatorily Redeemable
Convertible Preferred Securities due 2036 (EPPICS) and $17.8 million of
3.25% Commonwealth convertible notes that were converted into our common
stock. As further described below, we temporarily borrowed and repaid
$200.0 million during the month of March 2007, utilized to temporarily fund
our acquisition of Commonwealth. Although this borrowing does not appear in
our December 31, 2006 or 2007 balance sheet, the borrowing and repayment
are shown gross in the above table.
F-22
In connection with the acquisition of Commonwealth, we assumed $35.0
million of debt under a revolving credit facility and approximately $191.8
million face amount of Commonwealth convertible notes (fair value of
approximately $209.6 million). During March 2007, we paid down the $35.0
million credit facility, and through December 31, 2007, we have retired
approximately $183.3 million face amount (for which we paid $165.4 million
in cash and $36.7 million in common stock) of the convertible notes
(premium paid of $18.9 million was recorded as $17.8 million to goodwill
and $1.1 million to other income (loss), net), resulting in a remaining
outstanding balance of $8.5 million as of December 31, 2007.
On March 23, 2007, we issued in a private placement an aggregate $300.0
million principal amount of 6.625% Senior Notes due 2015 and $450.0 million
principal amount of 7.125% Senior Notes due 2019. Proceeds from the sale
were used to pay down $200.0 million principal amount of indebtedness
borrowed on March 8, 2007 under a bridge loan facility in connection with
the acquisition of Commonwealth, and redeem, on April 26, 2007, $495.2
million principal amount of our 7.625% Senior Notes due 2008.
During the first quarter of 2007, we incurred and expensed approximately
$4.1 million of fees associated with the bridge loan facility. In the
second quarter of 2007, we completed an exchange offer (to publicly
register the debt) on the $750.0 million in total of private placement
notes described above, in addition to the $400.0 million principal amount
of 7.875% Senior Notes issued in a private placement on December 22, 2006,
for registered Senior Notes due 2027. On April 26, 2007, we redeemed $495.2
million principal amount of our 7.625% Senior Notes due 2008 at a price of
103.041% plus accrued and unpaid interest. The debt retirement generated a
pre-tax loss on the early extinguishment of debt at a premium of
approximately $16.3 million in the second quarter of 2007 and is included
in other income (loss), net. As a result of this debt redemption, we also
terminated three interest rate swap agreements hedging an aggregate $150.0
million notional amount of indebtedness. Payments on the swap terminations
of approximately $1.0 million were made in the second quarter of 2007.
On January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with
our Senior Notes due in 2011 and 2013. Cash proceeds on the swap
terminations of approximately $15.5 million were received in January 2008.
The related gain will be deferred on the balance sheet, and amortized into
income over the term of the associated debt.
As of December 31, 2007, EPPICS representing a total principal amount of
$197.3 million have been converted into 15,918,182 shares of our common
stock. Approximately $4.0 million of EPPICS, which are convertible into
350,259 shares of our common stock, were outstanding at December 31, 2007.
Our long-term debt footnote indicates $14.5 million of EPPICS outstanding
at December 31, 2007, of which $10.5 million is debt of related parties for
which the Company has an offsetting receivable.
As of December 31, 2007, we had available lines of credit with financial
institutions in the aggregate amount of $250.0 million and there were no
outstanding standby letters of credit issued under the facility. Associated
facility fees vary, depending on our debt leverage ratio, and were 0.225%
per annum as of December 31, 2007. The expiration date for this $250.0
million five year revolving credit agreement is May 18, 2012. During the
term of the credit 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.
For the year ended December 31, 2006, we retired an aggregate principal
amount of $251.0 million of debt, including $15.9 million of 5% Company
Obligated Mandatorily Redeemable Convertible Preferred Securities due 2006
(EPPICS) that were converted into our common stock.
F-23
During the first quarter of 2006, we entered into two debt-for-debt
exchanges of our debt securities. As a result, $47.5 million of our 7.625%
notes due 2008 were exchanged for approximately $47.4 million of our 9.00%
notes due 2031. During the fourth quarter of 2006, we entered into four
debt-for-debt exchanges and exchanged $157.3 million of our 7.625% notes
due 2008 for $149.9 million of our 9.00% notes due 2031. The 9.00% notes
are callable on the same general terms and conditions as the 7.625% notes
exchanged. No cash was exchanged in these transactions. However, with
respect to the first quarter debt exchanges, a non-cash pre-tax loss of
approximately $2.4 million was recognized in accordance with EITF No.
96-19, "Debtor's Accounting for a Modification or Exchange of Debt
Instruments," which is included in other income (loss), net, for the year
ended December 31, 2006.
On June 1, 2006, we retired at par our entire $175.0 million principal
amount of 7.60% Debentures due June 1, 2006.
On June 14, 2006, we repurchased $22.7 million of our 6.75% Senior Notes
due August 17, 2006 at a price of 100.181% of par.
On August 17, 2006, we retired at par the $29.1 million remaining balance
of the 6.75% Senior Notes.
On December 22, 2006, we issued in a private placement, an aggregate $400.0
million principal amount of 7.875% Senior Notes due January 15, 2027.
Proceeds from the sale were used to partially finance the Commonwealth
acquisition.
In December 2006, we borrowed $150.0 million under a senior unsecured term
loan agreement. The loan matures in 2012 and bears interest based on an
average prime rate or London Interbank Offered Rate or LIBOR plus 1 3/8%,
at our election. Proceeds were used to partially finance the Commonwealth
acquisition.
For the year ended December 31, 2005, we retired an aggregate principal
amount of $36.4 million of debt, including $30.0 million of EPPICS that
were converted into our common stock. During the second quarter of 2005, we
entered into two debt-for-debt exchanges of our debt securities. As a
result, $50.0 million of our 7.625% notes due 2008 were exchanged for
approximately $52.2 million of our 9.00% notes due 2031. The 9.00% notes
are callable on the same general terms and conditions as the 7.625% notes
exchanged. No cash was exchanged in these transactions, however a non-cash
pre-tax loss of approximately $3.2 million was recognized in accordance
with EITF No. 96-19, "Debtor's Accounting for a Modification or Exchange of
Debt Instruments," which is included in other income (loss), net.
We are in compliance with all of our debt and credit facility covenants.
Our principal payments for the next five years are as follows:
Principal
($ in thousands) Payments
---------------- ---------------
2008 $ 2,448
2009 2,507
2010 5,886
2011 1,252,517
2012 179,017
(12) Derivative Instruments and Hedging Activities:
----------------------------------------------
Interest rate swap agreements were 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.
On January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with
our Senior Notes due in 2011 and 2013. Cash proceeds on the swap
terminations of approximately $15.5 million were received in January 2008.
The related gain will be deferred on the balance sheet, and amortized into
income over the term of the associated debt.
F-24
As of January 16, 2008, we no longer have any derivative instruments. The
following disclosure is necessary to understand our historical financial
statements.
The interest rate swap contracts are reflected at fair value in our
consolidated balance sheets and the related portion of fixed-rate debt
being hedged is reflected at an amount equal to the sum of its book value
and an amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. Changes in the fair
value of interest rate swap contracts, and the offsetting changes in the
adjusted carrying value of the related portion of the fixed-rate debt being
hedged, are recognized in the consolidated statements of operations in
interest expense. The notional amounts of interest rate swap contracts
hedging fixed-rate indebtedness as of December 31, 2007 and 2006 were
$400.0 million and $550.0 million, respectively. Such contracts require us
to pay variable rates of interest (average pay rates of approximately 8.54%
and 9.02% as of December 31, 2007 and 2006, respectively) and receive fixed
rates of interest (average receive rates of 8.50% and 8.26% as of December
31, 2007 and 2006, respectively). The fair value of these derivatives is
reflected in other assets as of December 31, 2007 and other liabilities as
of December 31, 2006, in the amount of $7.9 million and ($10.3 million),
respectively. The related underlying debt has been increased in 2007 and
decreased in 2006 by a like amount. For the years ended December 31, 2007
and 2006, the interest expense resulting from these interest rate swaps
totaled approximately $2.4 million and $4.2 million, respectively. For the
year ended December 31, 2005, our interest expense was reduced by $2.5
million.
(13) Investment Income:
------------------
The components of investment income for the years ended December 31, 2007,
2006 and 2005 are as follows:
($ in thousands) 2007 2006 2005
---------------- ---------------- ---------------- ----------------
Interest and dividend income $ 32,986 $ 22,172 $ 15,822
Gain from Rural Telephone Bank
dissolution - 61,428 -
Equity earnings/minority interest
in joint ventures, net 2,795 (4,164) (3,599)
---------------- ---------------- ----------------
Total investment income $ 35,781 $ 79,436 $ 12,223
================ ================ ================
(14) Other Income(Loss) net:
-----------------------
The components of other income (loss), net for the years ended December
31, 2007, 2006 and 2005 are as follows:
($ in thousands) 2007 2006 2005
---------------- ----------------- ----------------- -----------------
Bridge loan fee $ (4,069) $ - $ -
Premium on debt repurchases (18,217) - -
Legal contingency - (1,000) (7,000)
Gain on expiration/settlement of customer advances 2,031 3,539 681
Loss on exchange of debt - (2,433) (3,175)
Gain on forward rate agreements - 430 1,851
Other, net 2,422 2,471 8,399
----------------- ----------------- -----------------
Total other income (loss), net $ (17,833) $ 3,007 $ 756
================= ================= =================
During the first quarter of 2007, we incurred $4.1 million of fees
associated with a bridge loan facility. In 2007, we retired certain debt
and recognized a pre-tax loss of $18.2 million on the early extinguishment
of debt at a premium, mainly for the 7.625% Senior Notes due 2008. During
2006 and 2005, we recorded expense in connection with the Bangor, Maine
legal matter. During 2007, 2006 and 2005, we recognized income in
connection with certain retained liabilities, that have terminated,
associated with customer advances for construction from our disposed water
properties. In connection with our exchange of debt during the first
quarter of 2006 and second quarter of 2005, we recognized a non-cash,
pre-tax loss. 2006 and 2005 also include a gain for the changes in fair
value of our forward rate agreements.
F-25
Pre-tax gains (losses) in connection with the following transactions were
also recorded in other income (loss), net during 2005:
On February 1, 2005, we sold shares of Prudential Financial, Inc. for
approximately $1.1 million in cash, and we recognized a pre-tax gain of
approximately $493,000.
In June 2005, we sold for cash our interests in certain key man life
insurance policies on the lives of Leonard Tow, our former Chairman and
Chief Executive Officer, and his wife, a former director. The cash
surrender value of the policies purchased by Dr. Tow totaled approximately
$24.2 million, and we recognized a pre-tax gain of approximately $457,000.
During 2005, we sold shares of Global Crossing Limited for approximately
$1.1 million in cash, and we recognized a pre-tax gain for the same amount.
(15) Company Obligated Mandatorily Redeemable Convertible Preferred Securities:
--------------------------------------------------------------------------
As of December 31, 2007, we have only $4.0 million of EPPICS related debt
outstanding to third parties. The following disclosure provides the history
regarding this issue.
In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust
(the Trust), issued, in an underwritten public offering, 4,025,000 shares
of EPPICS, representing preferred undivided interests in the assets of the
Trust, with a liquidation preference of $50 per security (for a total
liquidation amount of $201.3 million). These securities have an adjusted
conversion price of $11.46 per share of our common stock. The conversion
price was reduced from $13.30 to $11.46 during the third quarter of 2004 as
a result of the $2.00 per share of common stock special, non-recurring
dividend. The proceeds from the issuance of the Trust Convertible Preferred
Securities and a Company capital contribution were used to purchase $207.5
million aggregate liquidation amount of 5% Partnership Convertible
Preferred Securities due 2036 from another wholly-owned 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 2007, 2006 and 2005. 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, 2007, EPPICS representing a total principal amount of
$197.3 million have been converted into 15,918,182 shares of our common
stock. A total of $4.0 million of EPPICS was outstanding as of December 31,
2007, and if all outstanding EPPICS were converted, 350,259 shares of our
common stock would be issued upon such conversion. Our long-term debt
footnote indicates $14.5 million of EPPICS outstanding at December 31,
2007, of which $10.5 million is debt of related parties for which the
Company has an offsetting receivable.
We adopted the provisions of FIN No. 46R (revised December 2003) (FIN No.
46R), "Consolidation of Variable Interest Entities," effective January 1,
2004. Accordingly, the Trust holding the EPPICS and the related Citizens
Utilities Capital L.P. are deconsolidated.
(16) Capital Stock:
--------------
We are authorized to issue up to 600,000,000 shares of common stock. The
amount and timing of dividends payable on common stock are, subject to
applicable law, within the sole discretion of our Board of Directors.
F-26
(17) Stock Plans:
------------
At December 31, 2007, we had five stock-based compensation plans under
which grants have been made and awards remained outstanding. These plans,
which are described below, are the Management Equity Incentive Plan (MEIP),
the 1996 Equity Incentive Plan (1996 EIP), the Amended and Restated 2000
Equity Incentive Plan (2000 EIP), the Non-Employee Directors' Deferred Fee
Plan (Deferred Fee Plan) and the Non-Employee Directors' Equity Incentive
Plan (Director's Equity Plan, and together with the Deferred Fee Plan, the
Director Plans).
Prior to the adoption of SFAS No. 123R, we applied APB No. 25 and related
interpretations to account for our stock plans resulting in the use of the
intrinsic value to value the stock and determine compensation expense.
Under APB No. 25, we were not required to recognize compensation expense
for the cost of stock options. In accordance with the adoption of SFAS No.
123R as of January 1, 2006, we recorded stock-based compensation expense
for the cost of our stock options. Compensation expense, recognized in
other operating expenses, of $0.8 million and $2.2 million in 2007 and
2006, respectively, has been recorded for the cost of our stock options.
Our general policy is to issue shares upon the grant of restricted shares
and exercise of options from treasury. At December 31, 2007, there were
16,058,182 shares authorized for grant under these plans and 5,242,717
shares available for grant. No further awards may be granted under the
MEIP, the 1996 EIP and the Deferred Fee Plan.
In connection with the Director Plans, compensation costs associated with
the issuance of stock units was $1.6 million, $2.0 million and $1.1 million
in 2007, 2006 and 2005, respectively. Cash compensation associated with the
Director Plans was $0.5 million, $0.5 million and $0.4 million in 2007,
2006 and 2005, respectively. These costs are recognized in other operating
expenses.
We have granted restricted stock awards to key employees in the form of our
common stock. The number of shares issued as restricted stock awards during
2007, 2006 and 2005 were 722,000, 732,000 and 352,000, 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, subject to limited exceptions. The restrictions are
time based. At December 31, 2007, 1,210,000 shares of restricted stock were
outstanding. Compensation expense, recognized in other operating expenses,
of $6.6 million, $6.0 million and $7.4 million, for the years ended
December 31, 2007, 2006 and 2005, respectively, has been recorded in
connection with these grants.
Management Equity Incentive Plan
--------------------------------
Prior to its expiration on June 21, 2000, awards of our common stock could
have been granted under the MEIP to eligible officers, management employees
and non-management employees in the form of incentive stock options,
non-qualified stock options, stock appreciation rights (SARs), restricted
stock or other stock-based awards.
Since the expiration of the MEIP, no awards have been or may 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 were not ordinarily exercisable on the date of
grant but vest over a period of time (generally four years). Under the
terms of the MEIP, subsequent stock dividends and stock splits have the
effect of increasing the option shares outstanding, which correspondingly
decreases the average exercise price of outstanding options.
1996 and 2000 Equity Incentive Plans
------------------------------------
Since the expiration date of the 1996 EIP on May 22, 2006, no awards have
been or may be granted under the 1996 EIP. Under the 2000 EIP, awards of
our common stock may be granted to eligible officers, management employees
and non-management employees in the form of incentive stock options,
non-qualified stock options, SAR's, restricted stock or other stock-based
awards. As discussed under the Non-Employee Directors' Compensation Plans
below, prior to May 25, 2006 non-employee directors received an award of
stock options under the 2000 EIP upon commencement of service.
At December 31, 2007, there were 13,517,421 shares authorized for grant
under the 2000 EIP and 2,871,999 shares available for grant, as adjusted to
reflect stock dividends. No awards will be granted more than 10 years after
the effective date (May 18, 2000) of the 2000 EIP plan. The exercise price
of stock options and SARs under the 2000 and 1996 EIP generally shall be
equal to or greater than the fair market value of the underlying common
stock on the date of grant. Stock options are not ordinarily exercisable on
the date of grant but vest over a period of time (generally four years).
Under the terms of the EIPs, 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.
F-27
The following summary presents information regarding outstanding stock
options and changes with regard to options under the MEIP and EIP plans:
Weighted Weighted
Shares Average Average Aggregate
Subject to Option Price Remaining Intrinsic
Option Per Share Life in Years Value
--------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2005 12,411,000 $ 11.15 6.11 $ 38,162,000
Options granted 183,000 $ 11.58
Options exercised (4,317,000) $ 10.52 $ 12,730,000
Options canceled, forfeited or lapsed (292,000) $ 10.48
--------------------------------------------------------------------
Balance at December 31, 2005 7,985,000 $ 11.52 5.32 $ 13,980,000
Options granted 22,000 $ 12.55
Options exercised (2,695,000) $ 9.85 $ 9,606,000
Options canceled, forfeited or lapsed (70,000) $ 10.13
--------------------------------------------------------------------
Balance at December 31, 2006 5,242,000 $ 12.41 4.36 $ 14,490,000
Options granted - $ -
Options exercised (1,254,000) $ 10.19 $ 6,033,000
Options canceled, forfeited or lapsed (33,000) $ 10.79
--------------------------------------------------------------------
Balance at December 31, 2007 3,955,000 $ 13.13 3.4 $ 5,727,000
====================================================================
The following table summarizes information about shares subject to options
under the MEIP and EIP plans at December 31, 2007:
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
----------------------------------------------------------------------------------------------------------------------------------
254,000 $ 6.45 - 6.67 $ 6.51 0.98 254,000 $ 6.51
433,000 8.19 - 8.19 8.19 4.37 433,000 8.19
17,000 8.80 - 9.68 9.11 0.78 17,000 9.11
570,000 10.44 - 10.44 10.44 5.41 570,000 10.44
213,000 11.15 - 11.15 11.15 2.80 213,000 11.15
489,000 11.79 - 11.79 11.79 3.38 489,000 11.79
175,000 11.90 - 14.27 13.41 5.86 158,000 13.45
582,000 15.02 - 15.02 15.02 2.75 582,000 15.02
640,000 15.94 - 16.74 16.67 2.73 640,000 16.67
582,000 18.46 - 18.46 18.46 2.75 582,000 18.46
------------ ------------
3,955,000 $ 6.45 - 18.46 $ 13.13 3.40 3,938,000 $ 13.13
============ ============
The number of options exercisable at December 31, 2006 and 2005 were
4,791,000 and 6,548,000, with a weighted average exercise price of $12.58
and $11.92, respectively.
Cash received upon the exercise of options during 2007, 2006 and 2005 was
$13.8 million, $27.2 million and $47.6 million, respectively. Total
remaining unrecognized compensation cost associated with unvested stock
options at December 31, 2007 was $0.1 million and the weighted average
period over which this cost is expected to be recognized is approximately
one year.
For purposes of determining compensation expense, the fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model which requires the use of various assumptions
including expected life of the option, expected dividend rate, expected
volatility, and risk-free interest rate. The expected life (estimated
period of time outstanding) of stock options granted was estimated using
the historical exercise behavior of employees. The risk free interest rate
is based on the U.S. Treasury yield curve in effect at the time of the
grant. Expected volatility is based on historical volatility for a period
equal to the stock option's expected life, calculated on a monthly basis.
F-28
The following table presents the weighted average assumptions used for
stock option grants in 2006 and 2005. No stock option grants were issued in
2007.
2006 2005
--------------------------- --------------- --------------
Dividend yield 7.55% 7.72%
Expected volatility 44% 46%
Risk-free interest rate 4.89% 4.16%
Expected life 5 years 6 years
--------------------------- --------------- --------------
The following summary presents information regarding unvested restricted
stock and changes with regard to restricted stock under the MEIP and the
EIPs:
Weighted
Average
Number of Grant Date Aggregate
Shares Fair Value Fair Value
---------------------------------------------------------------------------------------------------------
Balance at January 1, 2005 1,686,000 $ 12.29 $ 23,253,000
Restricted stock granted 352,000 $ 13.11 $ 4,305,000
Restricted stock vested (491,000) $ 12.27 $ 6,000,000
Restricted stock forfeited (91,000) $ 12.58
---------------------------------------------------------------
Balance at December 31, 2005 1,456,000 $ 12.47 $ 17,808,000
Restricted stock granted 732,000 $ 12.87 $ 10,494,000
Restricted stock vested (642,000) $ 12.08 $ 9,226,000
Restricted stock forfeited (372,000) $ 12.60
---------------------------------------------------------------
Balance at December 31, 2006 1,174,000 $ 12.89 $ 16,864,000
Restricted stock granted 722,000 $ 15.04 $ 9,187,000
Restricted stock vested (587,000) $ 12.94 $ 7,465,000
Restricted stock forfeited (100,000) $ 13.95
---------------------------------------------------------------
Balance at December 31, 2007 1,209,000 $ 14.06 $ 15,390,000
===============================================================
For purposes of determining compensation expense, the fair value of each
restricted stock grant is estimated based on the average of the high and
low market price of a share of our common stock on the date of grant. Total
remaining unrecognized compensation cost associated with unvested
restricted stock awards at December 31, 2007 was $12.7 million and the
weighted average period over which this cost is expected to be recognized
is approximately two to three years.
Non-Employee Directors' Compensation Plans
------------------------------------------
Upon commencement of his or her service on the Board of Directors, each
non-employee director receives a grant of 10,000 stock options. These
options are currently awarded under the Directors' Equity Plan. Prior to
effectiveness of the Directors' Equity Plan on May 25, 2006, these options
were awarded under the 2000 EIP. The exercise price of these options, which
become exercisable six months after the grant date, is the fair market
value (as defined in the relevant plan) of our common stock on the date of
grant. Options granted under the Directors' Equity Plan expire on the
earlier of the tenth anniversary of the grant date or the first anniversary
of termination of service as a director. Options granted to non-employee
directors under the 2000 EIP expire on the tenth anniversary of the grant
date.
Each non-employee director also receives an annual grant of 3,500 stock
units. These units are currently awarded under the Directors' Equity Plan
and prior to effectiveness of that plan, were awarded under the Deferred
Fee Plan. Since the effectiveness of the Director's Equity Plan, no further
grants have been made under the Deferred Fee Plan. Prior to April 20, 2004,
each non-employee director received an award of 5,000 stock options. The
exercise price of such options was set at 100% of the fair market value on
the date the options were granted. The options were exercisable six months
after the grant date and remain exercisable for ten years after the grant
date.
In addition, each year, each non-employee director is also entitled to
receive a retainer, meeting fees, and, when applicable, fees for serving as
a committee chair or as Lead Director. For 2007, each non-employee director
had to elect, by December 31 of the preceding year, to receive $40,000 cash
or 5,760 stock units as an annual retainer and to receive meeting fees and
Lead Director and committee chair stipends in the form of cash or stock
units. Stock units are awarded under the Directors' Equity Plan. Directors
making a stock unit election must also elect to convert the units to either
common stock (convertible on a one-to-one basis) or cash upon retirement or
death.
F-29
The number of shares of common stock authorized for issuance under the
Directors' Equity Plan is 2,540,761, which includes 540,761 shares that
were available for grant under the Deferred Fee Plan on the effective date
of the Directors' Equity Plan. In addition, if and to the extent that any
"plan units" outstanding on May 25, 2006 under the Deferred Fee Plan are
forfeited or if any option granted under the Deferred Fee Plan terminates,
expires, or is cancelled or forfeited, without having been fully exercised,
shares of common stock subject to such "plan units" or options cancelled
shall become available under the Directors' Equity Plan. At December 31,
2007, there were 2,370,718 shares available for grant. There were 13
directors participating in the Directors' Plans during all or part of 2007.
In 2007, the total options, plan units, and stock earned were 10,000,
98,070, and 0, respectively. In 2006, the total options, plan units, and
stock earned were 20,000, 81,000 and 0, respectively. In 2005, the total
options, plan units, and stock earned were 70,000, 64,000 and 0,
respectively. Options granted prior to the adoption of the Directors'
Equity Plan were granted under the 2000 EIP. At December 31, 2007, 177,952
options were outstanding and 172,952 options were exercisable under the
Director Plans at a weighted average exercise price of $12.59.
For 2007, each non-employee director received fees of $2,000 for each
in-person Board of Directors and committee meeting attended and $1,000 for
each telephone Board and committee meeting attended. The chairs of the
Audit, Compensation, Nominating and Corporate Governance and Retirement
Plan Committees were paid an additional annual fee of $25,000, $15,000,
$7,500 and $5,000, respectively. In addition, the Lead Director, who heads
the ad hoc committee of non-employee directors, received an additional
annual fee of $15,000. A director must elect, by December 31 of the
preceding year, to receive meeting and other fees in cash, stock units, or
a combination of both. All fees paid to the non-employee directors in 2007
were 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 closing prices of our common stock on the last business day of the
calendar quarter in which the fees or stipends were earned. Units are
credited to the director's account quarterly.
We account for the Deferred Fee Plan and Directors' Equity Plan in
accordance with SFAS No. 123R. To the extent directors elect to receive the
distribution of their stock unit account in cash, they are considered
liability-based awards. To the extent directors elect to receive the
distribution of their stock unit accounts in common stock, they are
considered equity-based awards. Compensation expense for stock units that
are considered equity-based awards is based on the market value of our
common stock at the date of grant. Compensation expense for stock units
that are considered liability-based awards is based on the market value of
our common stock at the end of each period. For awards granted prior to
1999, a director could elect to be paid in stock options. Generally,
compensation cost was not recorded because the options were granted at the
fair market value of our common stock on the grant date under APB No. 25
and related interpretations.
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. As
of December 31, 2007, the liability for such payments was reduced to $0 as
the obligation was fully settled during the second quarter of 2007.
F-30
(18) Income Taxes:
-------------
The following is a reconciliation of the provision for income taxes for
continuing operations computed at Federal statutory rates to the effective
rates for the years ended December 31, 2007, 2006 and 2005:
2007 2006 2005
------------ ----------- -----------
Consolidated tax provision at federal statutory rate 35.0 % 35.0 % 35.0 %
State income tax provisions, net of federal income tax benefit 1.8 % 2.1 % 1.6 %
Tax reserve adjustment 1.0 % 0.2 % (8.2)%
All other, net (0.4)% (2.4)% 0.2 %
------------ ----------- -----------
37.4 % 34.9 % 28.6 %
============ =========== ===========
The components of the net deferred income tax liability (asset) at December
31 are as follows:
($ in thousands) 2007 2006
---------------- ------------ -----------
Deferred income tax liabilities:
--------------------------------
Property, plant and equipment basis differences $ 624,426 $ 547,726
Intangibles 275,102 175,991
Other, net 10,431 9,675
------------ -----------
909,959 733,392
------------ -----------
Deferred income tax assets:
---------------------------
SFAS No. 158 pension/OPEB liability 58,540 51,660
Tax operating loss carryforward 83,203 81,515
Alternate minimum tax credit carryforward 26,658 54,834
Employee benefits 67,813 70,013
State tax liability 10,361 -
Other, net 33,514 24,039
------------ -----------
280,089 282,061
Less: Valuation allowance (59,566) (49,679)
------------ -----------
Net deferred income tax asset 220,523 232,382
------------ -----------
Net deferred income tax liability $ 689,436 $ 501,010
============ ===========
Deferred tax assets and liabilities are reflected in the following
------------------------------------------------------------------
captions on the balance sheet:
------------------------------
Deferred income taxes $ 711,645 $ 514,130
Other current assets (22,209) (13,120)
------------ -----------
Net deferred income tax liability $ 689,436 $ 501,010
============ ===========
Our Federal and state tax operating loss carryforwards as of December 31,
2007 are estimated at $11.3 million and $1,563.0 million, respectively. Our
Federal loss carryforward will expire in the year 2026. A portion of our
state loss carryforward begins to expire in 2008. Our alternative minimum
tax credit as of December 31, 2007 can be carried forward indefinitely to
reduce future regular tax liability.
F-31
The provision (benefit) for Federal and state income taxes, as well as the
taxes charged or credited to shareholders' equity, includes amounts both
payable currently and deferred for payment in future periods as indicated
below:
($ in thousands) 2007 2006 2005
---------------- ------------ ----------- -----------
Income taxes charged (credited) to the income statement for
continuing operations:
Current:
Federal $ 37,815 $ 772 $ 16,708
State 9,188 3,676 (33,006)
------------ ----------- -----------
Total current 47,003 4,448 (16,298)
------------ ----------- -----------
Deferred:
Federal 75,495 128,534 89,446
Federal tax credits - - (18)
State 5,516 3,497 2,140
------------ ----------- -----------
Total deferred 81,011 132,031 91,568
------------ ----------- -----------
Subtotal income taxes for continuing operations 128,014 136,479 75,270
------------ ----------- -----------
Income taxes charged to the income statement for
discontinued operations:
Current:
Federal - 3,018 -
State - 2,004 2
------------ ----------- -----------
Total current - 5,022 2
------------ ----------- -----------
Deferred:
Federal - 47,732 18,871
State - 3,835 3,538
------------ ----------- -----------
Total deferred - 51,567 22,409
------------ ----------- -----------
Subtotal income taxes for discontinued operations - 56,589 22,411
------------ ----------- -----------
Total income taxes charged to the income statement (a) 128,014 193,068 97,681
------------ ----------- -----------
Income taxes charged (credited) to shareholders' equity:
Deferred income tax benefits on unrealized/realized gains or
losses on securities classified as available-for-sale (11) (35) (411)
Current benefit arising from stock options exercised and
restricted stock (552) (3,777) (5,976)
Deferred income taxes (benefits) arising from the recognition
of additional pension/OPEB liability (6,880) 24,707 (13,933)
Deferred tax benefit from recording adjustments from the adoption
of SAB No. 108 - (17,339) -
------------ ----------- -----------
Income taxes charged (credited) to shareholders'
equity (b) (7,443) 3,556 (20,320)
------------ ----------- -----------
Total income taxes: (a) plus (b) $ 120,571 $ 196,624 $ 77,361
============ =========== ===========
The following table sets forth the changes in the Company's balance of
unrecognized tax benefits for the year in accordance with FIN No. 48:
($ in thousands)
---------------- 2007
------------
Unrecognized tax benefits - beginning of year $ 30,332
Gross increases - unrecognized tax benefits acquired
via acquisitions 8,977
Gross increases - current year tax positions 20,408
------------
Unrecognized tax benefits - end of year $ 59,717
============
The amounts above exclude $6.2 million of accrued interest that we have
recorded and would be payable should the Company's tax positions not be
sustained.
F-32
(19) Net Income Per Common Share:
----------------------------
The reconciliation of the net income per common share calculation for the
years ended December 31, 2007, 2006 and 2005 is as follows:
($ in thousands, except per-share amounts)
------------------------------------------ 2007 2006 2005
------------------ ------------------ ------------------
Net income used for basic and diluted
-------------------------------------
earnings per common share:
--------------------------
Income from continuing operations $ 214,654 $ 254,008 $ 187,942
Income from discontinued operations - 90,547 14,433
------------------ ------------------ ------------------
Total basic net income available for common shareholders $ 214,654 $ 344,555 $ 202,375
Effect of conversion of preferred securities - EPPICS 152 401 1,255
------------------ ------------------ ------------------
Total diluted net income available for common shareholders $ 214,806 $ 344,956 $ 203,630
================== ================== ==================
Basic earnings per common share:
--------------------------------
Weighted-average shares outstanding - basic 331,037 322,641 337,065
================== ================== ==================
Income from continuing operations $ 0.65 $ 0.79 $ 0.56
Income from discontinued operations - 0.28 0.04
------------------ ------------------ ------------------
Net income per share available for common shareholders $ 0.65 $ 1.07 $ 0.60
================== ================== ==================
Diluted earnings per common share:
----------------------------------
Weighted-average shares outstanding - basic 331,037 322,641 337,065
Effect of dilutive shares 940 931 1,417
Effect of conversion of preferred securities - EPPICS 401 973 3,193
------------------ ------------------ ------------------
Weighted-average shares outstanding - diluted 332,378 324,545 341,675
================== ================== ==================
Income from continuing operations $ 0.65 $ 0.78 $ 0.56
Income from discontinued operations - 0.28 0.04
------------------ ------------------ ------------------
Net income per share available for common shareholders $ 0.65 $ 1.06 $ 0.60
================== ================== ==================
Stock Options
-------------
For the years ended December 31, 2007, 2006 and 2005, options to purchase
shares of 1,804,000 (at exercise prices ranging from $15.02 to $18.46),
1,917,000 (at exercise prices ranging from $13.45 to $18.46), and 1,930,000
(at exercise prices ranging from $13.09 to $18.46), respectively, issuable
under employee compensation plans were excluded from the computation of
diluted earnings per share (EPS) for those periods because the exercise
prices were greater than the average market price of our common stock and,
therefore, the effect would be antidilutive. In calculating diluted EPS we
apply the treasury stock method and include future unearned compensation as
part of the assumed proceeds.
In addition, for the years ended December 31, 2007, 2006 and 2005,
restricted stock awards of 1,209,000, 1,174,000 and 1,456,000 shares,
respectively, are excluded from our basic weighted average shares
outstanding and included in our dilutive shares until the shares are no
longer subject to restriction after the satisfaction of all specified
conditions.
EPPICS
------
At December 31, 2007 and 2006, we had 80,307 and 147,079 shares,
respectively, of potentially dilutive EPPICS, which were convertible into
our common stock at a 4.3615 to 1 ratio at an exercise price of $11.46 per
share. If all EPPICS that remain outstanding as of December 31, 2007 are
converted, we would issue approximately 350,259 shares of our common stock.
As a result of the September 2004 special, non-recurring dividend, the
EPPICS exercise price for conversion into common stock was reduced from
$13.30 to $11.46. These securities have been included in the diluted income
per common share calculation for the periods ended December 31, 2007, 2006
and 2005.
F-33
Stock Units
-----------
At December 31, 2007, 2006 and 2005, we had 225,427, 319,423, and 206,630
stock units, respectively, issued under the Director Plans and the
Non-Employee Directors' Retirement Plan. These securities have not been
included in the diluted income per share of common stock calculation
because their inclusion would have had an antidilutive effect.
Share Repurchase Programs
-------------------------
In February 2007, our Board of Directors authorized us to repurchase up to
$250.0 million of our common stock in public or private transactions over
the following twelve-month period. This share repurchase program commenced
on March 19, 2007. During 2007, we repurchased approximately 17.3 million
shares of our common stock at an aggregate cost of approximately $250.0
million. The repurchase program was completed on October 15, 2007.
In February 2006, our Board of Directors authorized us to repurchase up to
$300.0 million of our common stock in public or private transactions over
the following twelve-month period. This share repurchase program commenced
on March 6, 2006. During 2006, we repurchased approximately 10.2 million
shares of our common stock at an aggregate cost of approximately $135.2
million.
(20) Comprehensive Income:
---------------------
Comprehensive income consists of net income and other gains and losses
affecting shareholders' investment and SFAS No. 158 pension/OPEB
liabilities that, under GAAP, are excluded from net income.
Our other comprehensive income (loss) for the years ended December 31,
2007, 2006 and 2005 is as follows:
2007
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- -------------- --------------- -------------
Amortization of pension and post retirement costs $ (3,023) $ (6,880) $ 3,857
All other 35 (12) 47
-------------- --------------- -------------
Other comprehensive income $ (2,988) $ (6,892) $ 3,904
============== =============== =============
2006
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- -------------- --------------- -------------
Net unrealized holding losses on securities
arising during period $ (92) $ (35) $ (57)
SFAS No. 158 pension/OPEB liability 199,653 74,619 125,034
-------------- --------------- -------------
Other comprehensive income $199,561 $ 74,584 $ 124,977
============== =============== =============
2005
--------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- -------------- --------------- -------------
Net unrealized holding losses on securities
arising during period $ (1,055) $ (395) $ (660)
Minimum pension liability (36,416) (13,933) (22,483)
Less: Reclassification adjustments for net gains
on securities realized in net income (537) (7) (530)
-------------- --------------- -------------
Other comprehensive (loss) $(38,008) $(14,335) $ (23,673)
============== =============== =============
F-34
(21) Segment Information:
--------------------
We operate in one reportable segment, Frontier. Frontier provides both
regulated and unregulated communications services to residential, business
and wholesale customers and is typically the incumbent provider in its
service areas.
As permitted by SFAS No. 131, we have utilized the aggregation criteria in
combining our markets because all of our Frontier properties share similar
economic characteristics, in that they provide the same products and
services to similar customers using comparable technologies in all of the
states in which we operate. The regulatory structure is generally similar.
Differences in the regulatory regime of a particular state do not
materially impact the economic characteristics or operating results of a
particular property.
(22) Quarterly Financial Data (Unaudited):
-------------------------------------
($ in thousands, except per share amounts)
------------------------------------------ First Second Third Fourth Year ended
2007 quarter quarter quarter quarter December 31,
---- ------------ ---------- ---------- ----------- -------------
Revenue $ 556,147 $ 578,826 $ 575,814 $ 577,228 $ 2,288,015
Operating income 193,302 171,298 165,925 174,891 705,416
Net income 67,667 40,559 47,415 59,013 214,654
Net income available for common shareholders per
basic share $ 0.21 $ 0.12 $ 0.14 $ 0.18 $ 0.65
Net income available for common shareholders per
diluted share $ 0.21 $ 0.12 $ 0.14 $ 0.18 $ 0.65
2006
----
Revenue $ 506,861 $ 506,912 $ 507,198 $ 504,396 $ 2,025,367
Operating income 157,338 169,458 160,721 156,973 644,490
Net income 50,483 101,702 128,459 63,911 344,555
Net income available for common shareholders per
basic share $ 0.15 $ 0.32 $ 0.40 $ 0.20 $ 1.07
Net income available for common shareholders per
diluted share $ 0.15 $ 0.31 $ 0.40 $ 0.20 $ 1.06
The quarterly net income per common share amounts are rounded to the
nearest cent. Annual net income per common share may vary depending on the
effect of such rounding. Our quarterly results include the results of
operations of Commonwealth from the date of its acquisition on March 8,
2007 and of GVN from the date of its acquisition on October 31, 2007.
During the second quarter of 2006, we recorded a gain in investment income
of $61.4 million resulting from the dissolution and liquidation of the
Rural Telephone Bank. In the third quarter of 2006 we sold ELI (see Note
8). See Notes 13 and 14 for a description of other miscellaneous
transactions impacting our quarterly results.
(23) Retirement Plans:
-----------------
We sponsor a noncontributory defined benefit pension plan covering a
significant number of our former and current employees and other
postretirement benefit plans that provide medical, dental, life insurance
and other benefits for covered retired employees and their beneficiaries
and covered dependents. The benefits are based on years of service and
final average pay or career average pay. Contributions are made in amounts
sufficient to meet ERISA funding requirements while considering tax
deductibility. Plan assets are invested in a diversified portfolio of
equity and fixed-income securities and alternative investments.
The accounting results for pension and postretirement benefit costs and
obligations are dependent upon various actuarial assumptions applied in the
determination of such amounts. These actuarial assumptions include the
following: discount rates, expected long-term rate of return on plan
assets, future compensation increases, employee turnover, healthcare cost
trend rates, expected retirement age, optional form of benefit and
mortality. We review these assumptions for changes annually with our
independent actuaries. We consider our discount rate and expected long-term
rate of return on plan assets to be our most critical assumptions.
F-35
The discount rate is used to value, on a present value basis, our pension
and postretirement benefit obligations 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 pattern of expected future
benefit payments and the prevailing rates available on long-term, high
quality corporate bonds that approximate the benefit obligation. In making
this determination we consider, among other things, the yields on the
Citigroup Pension Discount Curve and Bloomberg Finance and the changes in
those rates from one period to the next. This rate can change from
year-to-year based on market conditions that impact corporate bond yields.
Our discount rate increased from 6.00% at year-end 2006 to 6.50% at
year-end 2007.
The expected long-term rate of return on plan assets is applied in the
determination of periodic pension and postretirement benefit cost as a
reduction in the computation of the expense. In developing the expected
long-term rate of return assumption, we considered published surveys of
expected market returns, 10 and 20 year actual returns of various major
indices, and our own historical 5-year and 10-year investment returns. The
expected long-term rate of return on plan assets is based on an asset
allocation assumption of 35% to 55% in fixed income securities, 35% to 55%
in equity securities and 5% to 15% in alternative investments. We review
our asset allocation at least annually and make changes when considered
appropriate. In 2007, we did not change our expected long-term rate of
return from the 8.25% used in 2006. 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.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans" (SFAS No. 158). We
adopted SFAS No. 158 prospectively on December 31, 2006. SFAS No. 158
requires that we recognize all obligations related to defined benefit
pensions and other postretirement benefits. This statement requires that we
quantify the plans' funded status as an asset or a liability on our
consolidated balance sheets. In accordance with SFAS No. 158, our 2005
accounting and related disclosures were not affected by the adoption of the
new standard. The table below summarizes the incremental effects of SFAS
No. 158 adoption on the individual line items in our consolidated balance
sheet at December 31, 2006:
Pre SFAS SFAS Post SFAS
No. 158 No. 158 No. 158
($ in thousands) Adoption Adjustment Adoption
---------------- ------------- ------------- -------------
Liabilities:
Deferred income taxes $ 564,041 $ (49,911) $ 514,130
Other liabilities 199,100 133,545 332,645
Shareholders' Equity:
Accumulated other comprehensive loss 1,735 (83,634) (81,899)
SFAS No. 158 requires that we measure the plan's assets and obligations
that determine our funded status as of the end of the fiscal year. We are
also required to recognize as a component of Other Comprehensive Income
"OCI" the changes in funded status that occurred during the year that are
not recognized as part of net periodic benefit cost as explained in SFAS
No. 87, "Employers' Accounting for Pensions," or SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions."
Based on the funded status of our defined benefit pension and
postretirement benefit plans as of December 31, 2006, we reported a gain
(net of tax) to our AOCI of $41.4 million, a decrease of $66.1 million to
accrued pension obligations and an increase of $24.7 million to accumulated
deferred income taxes. Our adoption of SFAS No. 158 on December 31, 2006,
had no impact on our earnings. The following tables present details about
our pension plans.
F-36
Pension Benefits
----------------
The following tables set forth the plan's projected benefit obligations and
fair values of plan assets as of December 31, 2007 and 2006 and net
periodic benefit cost for the years ended December 31, 2007, 2006 and 2005:
($ in thousands) 2007 2006
---------------- ------------- --------------
Change in projected benefit obligation
--------------------------------------
Projected benefit obligation at beginning of year $ 780,719 $ 842,602
Commonwealth plan as of acquisition date 107,047 -
Service cost 9,175 6,811
Interest cost 50,948 45,215
Actuarial gain (26,524) (46,597)
Benefits paid (87,049) (69,005)
Curtailment (14,379) -
Special termination benefits 467 1,809
Plan change - (116)
------------- --------------
Projected benefit obligation at end of year $ 820,404 $ 780,719
------------- --------------
Change in plan assets
---------------------
Fair value of plan assets at beginning of year $ 770,182 $ 762,225
Commonwealth plan as of acquisition date 92,175 -
Actual return on plan assets 46,857 76,962
Benefits paid (87,049) (69,005)
------------- --------------
Fair value of plan assets at end of year $ 822,165 $ 770,182
------------- --------------
(Accrued)/Prepaid benefit cost
------------------------------
Funded status $ 1,761 $ (10,537)
============= ==============
Amounts recognized in the consolidated balance sheet
----------------------------------------------------
Other assets/(other long-term liabilities) $ 1,761 $ (10,537)
============= ==============
Accumulated other comprehensive income $ 134,276 $ 147,248
============= ==============
Expected
($ in thousands) 2008 2007 2006 2005
---------------- ------------- -------------- --------------- ----------------
Components of net periodic benefit cost
---------------------------------------
Service cost $ 9,175 $ 6,811 $ 6,117
Interest cost on projected benefit obligation 50,948 45,215 46,416
Expected return on plan assets (67,467) (60,759) (60,371)
Amortization of prior service cost and unrecognized
net obligation $ (255) (255) (255) (244)
Amortization of unrecognized loss 5,075 7,313 11,871 9,882
-------------- --------------- ----------------
Net periodic benefit cost/(income) (286) 2,883 1,800
Plan curtailment gain (14,379) - -
Special termination charge 467 1,809 -
-------------- --------------- ----------------
Total periodic benefit cost/(income) $ (14,198) $ 4,692 $ 1,800
============== =============== ================
F-37
Effective December 30, 2007, the CTE Employees' Pension Plan was frozen for
all non-union Commonwealth employees. No additional benefit accruals for
service rendered subsequent to December 30, 2007 will occur for those
participants. As a result of this plan change and in accordance with SFAS
No. 88, "Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits," a gain on pension
curtailment of $14.4 million was recorded in 2007 and included in other
operating expenses in the consolidated statement of operations. Also,
effective December 31, 2007, the CTE Employees' Pension Plan was merged
into the Citizens Pension Plan.
The plan's weighted average asset allocations at December 31, 2007 and 2006
by asset category are as follows:
2007 2006
------------- --------------
Asset category:
---------------
Equity securities 51% 53%
Debt securities 38% 34%
Alternative investments 9% 12%
Cash and other 2% 1%
------------- --------------
Total 100% 100%
============= ==============
The plan's expected benefit payments over the next 10 years are as follows:
($ in thousands)
----------------
Year Amount
---------------- --------------
2008 $ 58,423
2009 61,277
2010 62,645
2011 64,540
2012 68,968
2013 - 2017 347,027
--------------
Total $ 662,880
==============
We expect that no contribution will be made by us to the pension plan in
2008.
The accumulated benefit obligation for the plan was $805.0 million and
$762.1 million at December 31, 2007 and 2006, respectively.
Assumptions used in the computation of annual pension costs and valuation
of the year-end obligations were as follows:
2007 2006 2005
----- ------ ------
Discount rate - used at year end to value obligation 6.50% 6.00% 5.625%
Discount rate - used to compute annual cost 6.00% 5.625% 6.00%
Expected long-term rate of return on plan assets 8.25% 8.25% 8.25%
Rate of increase in compensation levels 3.50% 4.00% 4.00%
F-38
Postretirement Benefits Other Than Pensions - "OPEB"
----------------------------------------------------
The following table sets forth the plans' benefit obligations, fair values
of plan assets and the postretirement benefit liability recognized on our
balance sheets at December 31, 2007 and 2006 and net periodic
postretirement benefit costs for the years ended December 31, 2007, 2006
and 2005.
($ in thousands) 2007 2006
---------------- ------------- --------------
Change in benefit obligation
----------------------------
Benefit obligation at beginning of year $ 159,931 $ 160,922
Commonwealth plan as of date of acquisition 996 -
Service cost 533 664
Interest cost 10,241 8,974
Plan participants' contributions 3,370 1,558
Actuarial loss 15,620 1,778
Benefits paid (15,064) (13,965)
Plan change (1,025) -
------------- --------------
Benefit obligation at end of year $ 174,602 $ 159,931
------------- --------------
Change in plan assets
---------------------
Fair value of plan assets at beginning of year $ 11,869 $ 11,424
Actual return on plan assets 815 445
Benefits paid (11,695) (12,407)
Employer contribution 8,380 12,407
------------- --------------
Fair value of plan assets at end of year $ 9,369 $ 11,869
------------- --------------
Accrued benefit cost
--------------------
Funded status $(165,233) $(148,062)
============= ==============
Amounts recognized in the consolidated balance sheet
----------------------------------------------------
Current liabilities $ (8,498) $ (7,238)
============= ==============
Other long-term liabilities $(156,735) $(140,824)
============= ==============
Accumulated other comprehensive income $ 2,292 $ (13,703)
============= ==============
($ in thousands) Expected
---------------- 2008 2007 2006 2005
------------- -------------- --------------- ----------------
Components of net periodic postretirement benefit cost
------------------------------------------------------
Service cost $ 533 $ 664 $ 1,046
Interest cost on projected benefit obligation 10,241 8,974 12,055
Expected return on plan assets (578) (889) (1,248)
Amortization of prior service cost and transition obligation $ (7,735) (7,735) (7,589) (1,255)
Amortization of unrecognized loss 5,617 6,099 4,678 6,615
-------------- --------------- ----------------
Net periodic postretirement benefit cost $ 8,560 $ 5,838 $ 17,213
============== =============== ================
Assumptions used in the computation of annual OPEB costs and valuation of
the year-end OPEB obligations were as follows:
2007 2006 2005
------- ------- -------
Discount rate - used at year end to value obligation 6.50% 6.00% 5.625%
Discount rate - used to compute annual cost 6.00% 5.625% 6.00%
Expected long-term rate of return on plan assets 6.00% 8.25% 8.25%
F-39
The plans' weighted average asset allocations at December 31, 2007 and 2006
by asset category are as follows:
2007 2006
------------- --------------
Asset category:
---------------
Equity securities 0% 0%
Debt securities 100% 100%
Cash and other 0% 0%
------------- --------------
Total 100% 100%
============= ==============
The plans' expected benefit payments over the next 10 years are as follows:
($ in thousands)
----------------
Gross Medicare D
Year Benefits Subsidy Total
--------------- -------------- ------------- --------------
2008 $ 12,123 $ 447 $ 11,676
2009 12,697 526 12,171
2010 13,212 607 12,605
2011 13,857 699 13,158
2012 14,128 842 13,286
2013 - 2017 74,918 6,244 68,674
-------------- ------------- --------------
Total $ 140,935 $ 9,365 $ 131,570
============== ============= ==============
Our expected contribution to the plans in 2008 is $11.7 million.
For purposes of measuring year-end benefit obligations, we used, depending
on medical plan coverage for different retiree groups, a 9.50% annual rate
of increase in the per-capita cost of covered medical benefits, gradually
decreasing to 5% in the year 2017 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 $0.6 million
and the effect on the accumulated postretirement benefit obligation for
health benefits would be $8.9 million. 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 $(0.5) million and the effect on the accumulated
postretirement benefit obligation for health benefits would be $(7.8)
million.
In December 2003, the Medicare Prescription Drug Improvement and
Modernization Act of 2003 (the Act) became law. The Act introduces a
prescription drug benefit under Medicare. It includes a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that
is at least actuarially equivalent to the Medicare Part D benefit. The
amount of the federal subsidy is based on 28% of an individual
beneficiary's annual eligible prescription drug costs ranging between $250
and $5,000. We have determined that the Company-sponsored postretirement
healthcare plans that provide prescription drug benefits are actuarially
equivalent to the Medicare Prescription Drug benefit. The impact of the
federal subsidy has been incorporated into the calculation.
The amounts in accumulated other comprehensive income that have not yet
been recognized as components of net periodic benefit cost at December 31,
2007 are as follows:
($ in thousands) Pension Plan OPEB
---------------- ------------------ ----------------
Net actuarial loss $ 135,627 $ 49,154
Prior service cost (1,351) (46,862)
------------------ ----------------
Total $ 134,276 $ 2,292
================== ================
F-40
The amounts recognized as a component of accumulated comprehensive income
for the years ended December 31, 2007 and 2006 are as follows:
Pension Plan OPEB
---------------------------- -----------------------------
($ in thousands) 2007 2006 2007 2006
---------------- ------------- ------------- ------------- --------------
Accumulated other comprehensive income at
beginning of year $ 147,248 $ 199,652 $ (13,703) $ -
------------- ------------- ------------- --------------
Net actuarial loss recognized during year (7,312) (11,871) (6,099) (4,678)
Prior service cost recognized during year 255 255 7,735 7,589
Net actuarial loss (gain) occurring during year (5,915) (62,800) 15,384 2,222
Prior service cost (credit) occurring during year - (116) (1,025) -
Other adjustments - 22,128 - (18,836)
------------- ------------- ------------- --------------
Net amount recognized in comprehensive income
for the year (12,972) (52,404) 15,995 (13,703)
------------- ------------- ------------- --------------
Accumulated other comprehensive income at end
of year $ 134,276 $ 147,248 $ 2,292 $ (13,703)
============= ============= ============= ==============
401(k) Savings Plans
--------------------
We sponsor employee retirement savings plans under section 401(k) of the
Internal Revenue Code. The plans cover substantially all full-time
employees. Under the plans, we provide matching contributions and also
provide certain profit-sharing contributions to certain employees upon the
attainment of pre-established financial criteria. Employer contributions
were $4.9 million, $4.7 million and $6.7 million for 2007, 2006 and 2005,
respectively. The amount for 2007 includes employer contributions of $0.4
million for CTE employees under a separate Commonwealth plan. Also,
effective December 31, 2007, the Commonwealth Builder 401(k) Plan was
merged into the Citizens 401(k) Savings Plan.
(24) Commitments and Contingencies:
------------------------------
Ronald A. Katz Technology Licensing LP, filed suit against us for patent
infringement on June 8, 2007 in the U.S. District Court for the District of
Delaware. Katz Technology alleges that, by operating automated telephone
systems, including customer service systems, that allow our customers to
utilize telephone calling cards, order internet, DSL, and dial-up services,
and perform a variety of account related tasks such as billing and
payments, we have infringed thirteen of Katz Technology's patents and
continue to infringe three of Katz Technology's patents. Katz Technology
seeks unspecified damages resulting from our alleged infringement, as well
as a permanent injunction enjoining us from continuing the alleged
infringement. Katz Technology subsequently filed a tag-along notice with
the Judicial Panel on Multi-District Litigation, notifying them of this
action and its relatedness to In re Katz Interactive Dial Processing Patent
Litigation (MDL No. 1816), pending in the Central District of California
before Judge R. Gary Klausner. The Judicial Panel on Multi-District
Litigation has transferred the case to the Central District of California.
Discovery in the case has commenced. In January 2008, we received notice of
the accused services and 40 asserted claims from Katz Technology. We intend
to vigorously defend against this lawsuit.
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 $1.0 billion. In August 2004, we notified Citibank by letter that we
believe its claims for indemnification are invalid and are not supported by
applicable law. In 2005, Citibank moved to dismiss the underlying complaint
against it. That motion is currently pending. We have received no further
communications from Citibank since our August 2004 letter.
F-41
We are party to various other legal proceedings arising in the normal
course of our business. The outcome of individual matters is not
predictable. However, we believe that the ultimate resolution of all such
matters, after considering insurance coverage, will not have a material
adverse effect on our financial position, results of operations, or our
cash flows.
Although we from time to time make short-term purchasing commitments to
vendors with respect to these expenditures, we generally do not enter into
firm, written contracts for such activities.
We conduct certain of our operations in leased premises and also lease
certain equipment and other assets pursuant to operating leases. The lease
arrangements have terms ranging from 1 to 99 years and several contain rent
escalation clauses providing for increases in monthly rent at specific
intervals. When rent escalation clauses exist, we record total expected
rent payments on a straight-line basis over the lease term. Certain leases
also have renewal options. Renewal options that are reasonably assured are
included in determining the lease term. Future minimum rental commitments
for all long-term noncancelable operating leases and future minimum capital
lease payments for continuing operations as of December 31, 2007 are as
follows:
($ in thousands) Operating
---------------- Leases
--------------
Year ending December 31:
2008 $ 24,094
2009 12,436
2010 10,963
2011 9,604
2012 6,421
Thereafter 15,534
-------------
Total minimum lease payments $ 79,052
=============
Total rental expense included in our results of operations for the years
ended December 31, 2007, 2006 and 2005 was $23.6 million, $16.3 million and
$16.9 million, respectively.
We are a party to contracts with several unrelated long distance carriers.
The contracts provide fees based on traffic they carry for us subject to
minimum monthly fees.
At December 31, 2007, the estimated future payments for obligations under
our noncancelable long distance contracts and service agreements are as
follows:
($ in thousands)
----------------
Year Amount
--------------- ---------------
2008 $ 27,813
2009 19,825
2010 7,411
2011 195
2012 165
Thereafter 495
---------------
Total $ 55,904
===============
F-42
We sold all of our utility businesses as of April 1, 2004. However, we have
retained a potential payment obligation associated with our previous
electric utility activities in the state of Vermont. The Vermont Joint
Owners (VJO), a consortium of 14 Vermont utilities, including us, entered
into a purchase power agreement with Hydro-Quebec in 1987. The agreement
contains "step-up" provisions that state that if any VJO member defaults on
its purchase obligation under the contract to purchase power from
Hydro-Quebec the other VJO participants will assume responsibility for the
defaulting party's share on a pro-rata basis. Our pro-rata share of the
purchase power obligation is 10%. If any member of the VJO defaults on its
obligations under the Hydro-Quebec agreement, then the remaining members of
the VJO, including us, may be required to pay for a substantially larger
share of the VJO's total power purchase obligation for the remainder of the
agreement (which runs through 2015). Paragraph 13 of FIN No. 45 requires
that we disclose "the maximum potential amount of future payments
(undiscounted) the guarantor could be required to make under the
guarantee." Paragraph 13 also states that we must make such disclosure "...
even if the likelihood of the guarantor's having to make any payments under
the guarantee is remote..." As noted above, our obligation only arises as a
result of default by another VJO member, such as upon bankruptcy.
Therefore, to satisfy the "maximum potential amount" disclosure requirement
we must assume that all members of the VJO simultaneously default, a highly
unlikely scenario given that the two members of the VJO that have the
largest potential payment obligations are publicly traded with credit
ratings equal to or superior to ours, and that all VJO members are
regulated utility providers with regulated cost recovery. Regardless,
despite the remote chance that such an event could occur, or that the State
of Vermont could or would allow such an event, assuming that all the
members of the VJO defaulted on January 1, 2008 and remained in default for
the duration of the contract (another 8 years), we estimate that our
undiscounted purchase obligation for 2008 through 2015 would be
approximately $1.1 billion. In such a scenario the Company would then own
the power and could seek to recover its costs. We would do this by seeking
to recover our costs from the defaulting members and/or reselling the power
to other utility providers or the northeast power grid. There is an active
market for the sale of power. We could potentially lose money if we were
unable to sell the power at cost. We caution that we cannot predict with
any degree of certainty any potential outcome.
At December 31, 2007, we have outstanding performance letters of credit as
follows:
($ in thousands)
----------------
CNA $ 19,948
State of New York 2,993
--------------
Total $ 22,941
==============
CNA serves as our agent with respect to general liability claims (auto,
workers compensation and other insured perils of the Company). As our
agent, they administer all claims and make payments for claims on our
behalf. We reimburse CNA for such services upon presentation of their
invoice. To serve as our agent and make payments on our behalf, CNA
requires that we establish a letter of credit in their favor. CNA could
potentially draw against this letter of credit if we failed to reimburse
CNA in accordance with the terms of our agreement. The value of the letter
of credit is reviewed annually and adjusted based on claims history.
None of the above letters of credit restrict our cash balances.
F-43