CITIZENS COMMUNICATIONS COMPANY
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2008
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2008
--------------
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
-------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-0619596
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 High Ridge Park
Stamford, Connecticut 06905
---------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
(203) 614-5600
----------------------------------------------------
(Registrant's telephone number, including area code)
N/A
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is 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 Exchange Act).
Yes No X
--- ---
The number of shares outstanding of the registrant's Common Stock as of April
25, 2008 was 324,241,946.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
Index
Page No.
--------
Part I. Financial Information (Unaudited)
Financial Statements
Consolidated Balance Sheets as of March 31, 2008 and December 31, 2007 2
Consolidated Statements of Operations for the three months ended March 31, 2008 and 2007 3
Consolidated Statements of Shareholders' Equity for the year ended
December 31, 2007 and the three months ended March 31, 2008 4
Consolidated Statements of Comprehensive Income for
the three months ended March 31, 2008 and 2007 4
Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2007 5
Notes to Consolidated Financial Statements 6
Management's Discussion and Analysis of Financial Condition and Results of Operations 16
Quantitative and Qualitative Disclosures about Market Risk 28
Controls and Procedures 28
Part II. Other Information
Legal Proceedings 29
Risk Factors 29
Unregistered Sales of Equity Securities and Use of Proceeds 29
Exhibits 31
Signature 32
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)
(Unaudited)
March 31, 2008 December 31, 2007
------------------ -------------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 227,634 $ 226,466
Accounts receivable, less allowances of $34,111 and $32,748, respectively 213,585 234,762
Other current assets 53,308 62,926
------------------ -------------------
Total current assets 494,527 524,154
Property, plant and equipment, net 3,288,135 3,335,244
Goodwill, net 2,636,159 2,634,559
Other intangibles, net 501,800 547,735
Investments 20,530 21,191
Other assets 187,450 193,186
------------------ -------------------
Total assets $ 7,128,601 $ 7,256,069
================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Long-term debt due within one year $ 3,814 $ 2,448
Accounts payable and other current liabilities 364,954 443,443
------------------ -------------------
Total current liabilities 368,768 445,891
Deferred income taxes 712,234 711,645
Other liabilities 360,546 363,737
Long-term debt 4,747,265 4,736,897
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares; 326,434,000
and 327,749,000 outstanding, respectively, and 349,456,000
issued at March 31, 2008 and December 31, 2007) 87,364 87,364
Additional paid-in capital 1,186,851 1,280,508
Retained earnings 59,590 14,001
Accumulated other comprehensive loss, net of tax (77,578) (77,995)
Treasury stock (316,439) (305,979)
------------------ -------------------
Total shareholders' equity 939,788 997,899
------------------ -------------------
Total liabilities and shareholders' equity $ 7,128,601 $ 7,256,069
================== ===================
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
2
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
($ in thousands, except for per-share amounts)
(Unaudited)
2008 2007
--------------- --------------
Revenue $ 569,205 $ 556,147
Operating expenses:
Network access expenses 60,549 51,397
Other operating expenses 203,264 189,267
Depreciation and amortization 141,080 122,181
--------------- --------------
Total operating expenses 404,893 362,845
--------------- --------------
Operating income 164,312 193,302
Investment and other (loss) income, net (1,235) 10,017
Interest expense 90,860 93,964
--------------- --------------
Income before income taxes 72,217 109,355
Income tax expense 26,628 41,688
--------------- --------------
Net income available for common shareholders $ 45,589 $ 67,667
=============== ==============
Basic income per common share $ 0.14 $ 0.21
=============== ==============
Diluted income per common share $ 0.14 $ 0.21
=============== ==============
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
3
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2007 AND THE THREE MONTHS ENDED MARCH 31, 2008
($ and shares in thousands, except for per-share amounts)
(Unaudited)
Accumulated
Common Stock Additional Other Treasury Stock Total
------------------ Paid-In Retained Comprehensive -------------------- Shareholders'
Shares Amount Capital Earnings Loss Shares Amount Equity
-------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balance January 1, 2007 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 adjustment - - - - 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
Stock plans - - (11,547) - - 999 14,277 2,730
Conversion of EPPICS - - (7) - - 2 37 30
Acquisition of Commonwealth - - - - - 1 10 10
Dividends on common stock of
$0.25 per share - - (82,103) - - - - (82,103)
Shares repurchased - - - - - (2,317) (24,784) (24,784)
Net income - - - 45,589 - - - 45,589
Other comprehensive income,
net of tax and
reclassifications adjustment - - - - 417 - - 417
-------- --------- ----------- ------------ ------------ -------- ----------- -----------
Balance March 31, 2008 349,456 $87,364 $1,186,851 $ 59,590 $ (77,578) (23,022) $ (316,439) $ 939,788
======== ========= =========== ============ ============ ======== =========== ===========
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
($ in thousands)
(Unaudited)
2008 2007
------------------ -------------------
Net income $ 45,589 $ 67,667
Other comprehensive income (loss),
net of tax and reclassifications
adjustments 417 (20)
------------------ -------------------
Total comprehensive income $ 46,006 $ 67,647
================== ===================
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
4
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
($ in thousands)
(Unaudited)
2008 2007
---------------- ----------------
Cash flows provided by (used in) operating activities:
Net income $ 45,589 $ 67,667
Adjustments to reconcile income to net cash provided by
operating activities:
Depreciation and amortization expense 141,080 122,181
Stock based compensation expense 3,019 3,407
Loss on extinguishment of debt 6,290 4,026
Other non-cash adjustments (1,413) 2,982
Deferred income taxes (282) 23,614
Change in accounts receivable 19,057 10,366
Change in accounts payable and other liabilities (70,261) (57,242)
Change in other current assets (1,568) (1,714)
---------------- ----------------
Net cash provided by operating activities 141,511 175,287
Cash flows provided from (used by) investing activities:
Capital expenditures (47,986) (45,111)
Cash paid for Commonwealth (net of cash acquired) - (649,507)
Other assets (purchased) distributions received, net 654 571
---------------- ----------------
Net cash used by investing activities (47,332) (694,047)
Cash flows provided from (used by) financing activities:
Long-term debt borrowings 135,000 950,000
Long-term debt payments (129,332) (327,815)
Settlement of interest rate swaps 15,521 -
Financing costs paid (857) (13,841)
Premium paid to retire debt (6,290) -
Issuance of common stock 591 5,119
Common stock repurchased (24,784) (12,016)
Dividends paid (82,103) (85,462)
Repayment of customer advances for construction (757) (602)
---------------- ----------------
Net cash (used by) provided from financing activities (93,011) 515,383
Increase (decrease) in cash and cash equivalents 1,168 (3,377)
Cash and cash equivalents at January 1, 226,466 1,041,106
---------------- ----------------
Cash and cash equivalents at March 31, $ 227,634 $ 1,037,729
================ ================
Cash paid during the period for:
Interest $ 121,396 $ 97,416
Income taxes $ 1,859 $ 6,786
Non-cash investing and financing activities:
Change in fair value of interest rate swaps $ 7,909 $ 2,349
Conversion of EPPICS $ 30 $ 3,205
Conversion of Commonwealth Notes $ - $ 33,553
Shares issued for Commonwealth acquisition $ 10 $ 246,225
Acquired debt $ - $ 245,749
Other acquired liabilities $ - $ 110,648
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
5
PART II. OTHER INFORMATION
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
(1) Summary of Significant Accounting Policies:
-------------------------------------------
(a) Basis of Presentation and Use of Estimates:
-------------------------------------------
Citizens Communications Company and its subsidiaries are referred to
as "we," "us," "our," or the "Company" in this report. Our unaudited
consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (U.S. GAAP) and should be read in conjunction with the
consolidated financial statements and notes included in our Annual
Report on Form 10-K for the year ended December 31, 2007. 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. These
unaudited consolidated financial statements include all adjustments
(consisting of normal recurring accruals) considered necessary to
present fairly the results for the interim periods shown.
The preparation of financial statements in conformity with U.S. GAAP
requires management to make estimates and assumptions which affect the
reported amounts of assets and liabilities at the date of the
financial statements, the disclosure of contingent assets and
liabilities and the reported amounts of revenue and expenses during
the reporting period. Actual results may differ from those estimates.
Estimates and judgments are used when accounting for allowance for
doubtful accounts, impairment of long-lived assets, intangible assets,
depreciation and amortization, employee benefit plans, income taxes,
purchase price allocations, contingencies, long-term incentive program
and pension and postretirement benefits expenses, among others.
Certain information and footnote disclosures have been excluded and/or
condensed pursuant to Securities and Exchange Commission rules and
regulations. The results of the interim periods are not necessarily
indicative of the results for the full year.
(b) 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 $8.5 million and $7.1 million
for the three months ended March 31, 2008 and 2007, respectively.
(c) 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.
As of December 31, 2007, we had interest rate swap arrangements
related to a portion of our fixed rate debt. These arrangements were
all terminated on January 15, 2008. These hedge strategies satisfied
the fair value hedging requirements of SFAS No. 133, as amended. As a
result, the appreciation in value of the swaps through the time of
termination is included in the consolidated balance sheet and is
recognized as lower interest expense over the duration of the
remaining life of the underlying debt.
6
(2) Recent Accounting Literature and Changes in Accounting Principles:
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Accounting for Endorsement Split-Dollar Life Insurance Arrangements
-------------------------------------------------------------------
In September 2006, the FASB reached consensus on the guidance provided by
Emerging Issues Task Force (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 policies, 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 (APB) 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. Our adoption of the accounting
requirements of EITF No. 06-4 in the first quarter of 2008 had no 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. In February 2008,
the FASB amended SFAS No. 157 to defer the application of this standard to
nonfinancial assets and liabilities until 2009. The provisions of SFAS No.
157 related to financial assets and liabilities were effective as of the
beginning of our 2008 fiscal year. Our adoption of SFAS No. 157, as
amended, in the first quarter of 2008 had no impact on our financial
position, results of operations or cash flows. We are still in the process
of evaluating this standard with respect to its effect on nonfinancial
assets and liabilities and therefore have not yet determined the impact
that it will have on our financial statements upon full adoption in 2009.
Nonfinancial assets and liabilities for which we have not applied the
provisions of SFAS No. 157 include those measured at fair value in
impairment testing and those initially measured at fair value in a business
combination.
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.
Our adoption of SFAS No. 159 in the first quarter of 2008 had no 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. Our adoption of the accounting requirements of EITF No.
06-10 in the first quarter of 2008 had no 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.
7
Noncontrolling Interests in Consolidated Financial Statements
-------------------------------------------------------------
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests
in Consolidated Financial Statements." SFAS No. 160 establishes
requirements for ownership interest in subsidiaries held by parties other
than the Company (sometimes called "minority interest") be clearly
identified, presented and disclosed in the consolidated statement of
financial position within shareholder equity, but separate from the
parent's equity. All changes in the parent's ownership interest are
required to be accounted for consistently as equity transactions and any
noncontrolling equity investments in unconsolidated subsidiaries must be
measured initially at fair value. SFAS No. 160 is effective, on a
prospective basis, for fiscal years beginning after December 15, 2008.
However, presentation and disclosure requirements must be retrospectively
applied to comparative financial statements. The Company is currently
assessing the impact of SFAS No. 160 on its financial position, results of
operations and cash flows.
Accounting for the Income Tax Benefits of Dividends on Share-Based Payment
---------------------------------------------------------------------------
Awards
------
In June 2007, the FASB ratified EITF No. 06-11 "Accounting for the Income
Tax Benefits of Dividends on Share-Based Payment Awards." EITF No. 06-11
provides that tax benefits associated with dividends on share-based payment
awards be recorded as a component of additional paid-in capital. EITF No.
06-11 is effective, on a prospective basis, for fiscal years beginning
after December 15, 2007. The implementation of this standard had no
material impact on our financial position, results of operations or cash
flows.
(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.
On October 31, 2007, we acquired Global Valley Networks, Inc. (GVN) and GVN
Services (GVS) through the purchase from Country Road Communications, LLC
of 100% of the outstanding common stock of Evans Telephone Holdings, Inc.,
the parent Company of GVN and GVS. The purchase price of $62.0 million was
paid with cash on hand.
We have accounted for the acquisitions of Commonwealth and GVN as purchases
under U.S. GAAP. Under the purchase method of accounting, the assets and
liabilities of Commonwealth and GVN are recorded as of their respective
acquisition dates, at their respective fair values, and consolidated with
those of Citizens. The reported consolidated financial condition of
Citizens as of March 31, 2008 reflects the final allocation of these fair
values for Commonwealth and a preliminary allocation of these fair values
for GVN.
The following unaudited pro forma financial information presents the
combined results of operations of Citizens, Commonwealth and GVN as if the
acquisitions had occurred at the beginning of 2007. The historical results
of the Company include the results of Commonwealth from the date of
acquisition on March 8, 2007, and GVN from the date of its acquisition on
October 31, 2007. The pro forma information is not necessarily indicative
of what the financial position or results of operations actually would have
been had the acquisitions been completed at the dates indicated. In
addition, the unaudited pro forma financial information does not purport to
project the future financial position or operating results of Citizens
after completion of the acquisitions.
For the three
months ended
March 31, 2007
------------------
($ in thousands, except per share amounts)
------------------------------------------
Revenue $ 622,077
Operating income $ 207,193
Net income available for common shareholders $ 77,012
Basic income per common share: $ 0.23
Diluted income per common share: $ 0.22
8
(4) Accounts Receivable:
--------------------
The components of accounts receivable, net at March 31, 2008 and December
31, 2007 are as follows:
($ in thousands) March 31, 2008 December 31, 2007
---------------- --------------------- --------------------
End user $ 229,942 $ 244,592
Other 17,754 22,918
Less: Allowance for doubtful accounts (34,111) (32,748)
--------------------- --------------------
Accounts receivable, net $ 213,585 $ 234,762
===================== ====================
The Company maintains an allowance for estimated bad debts based on its
estimate of collectibility of its accounts receivable. Bad debt expense,
which is recorded as a reduction of revenue, was $7.2 million and $4.9
million for the three months ended March 31, 2008 and 2007, respectively.
(5) Property, Plant and Equipment, Net:
-----------------------------------
Property, plant and equipment at March 31, 2008 and December 31, 2007 are
as follows:
($ in thousands) March 31, 2008 December 31, 2007
---------------- --------------------- ---------------------
Property, plant and equipment $ 7,412,773 $ 7,375,297
Less: Accumulated depreciation (4,124,638) (4,040,053)
--------------------- ---------------------
Property, plant and equipment, net $ 3,288,135 $ 3,335,244
===================== =====================
Depreciation expense is principally based on the composite group method.
Depreciation expense was $95.1 million and $86.6 million for the three
months ended March 31, 2008 and 2007, respectively.
(6) Other Intangibles:
------------------
Other intangibles at March 31, 2008 and December 31, 2007 are as follows:
($ in thousands) March 31, 2008 December 31, 2007
---------------- ------------------------ ---------------------
Customer base $ 1,271,085 $ 1,271,085
Trade name 132,381 132,381
------------------------ ---------------------
Other intangibles 1,403,466 1,403,466
Less: Accumulated amortization (901,666) (855,731)
------------------------ ---------------------
Total other intangibles, net $ 501,800 $ 547,735
======================== =====================
Amortization expense was $45.9 million and $35.5 million for the three
months ended March 31, 2008 and 2007, respectively. Amortization expense
for the three months ended March 31, 2008 is comprised of $31.6 million for
amortization associated with our "legacy" properties and $14.3 million for
intangible assets (customer base and trade name), acquired in the
Commonwealth and GVN acquisitions.
9
(7) Long-Term Debt:
---------------
The activity in our long-term debt from December 31, 2007 to March 31, 2008
is as follows:
Three months ended March 31, 2008
-------------------------------------------------------------------
Interest
Interest Rate* at
December 31, New Rate Conversion to March 31, March 31,
($ in thousands) 2007 Payments Borrowings Swap Common Stock 2008 2008
---------------- --------------- --------------- ------------- ------------ ----------------- -------------- ----------
Rural Utilities Service
Loan Contracts $ 17,555 $ (233) $ - $ - $ - $ 17,322 6.07%
Senior Unsecured Debt 4,715,013 (129,099) 135,000 (7,909) - 4,713,005 7.67%
EPPICS (see Note 13) 14,521 - - - (30) 14,491 5.00%
Industrial Development
Revenue Bonds 13,550 - - - - 13,550 6.31%
--------------- --------------- ------------- ------------ ----------------- ---------------
TOTAL LONG-TERM DEBT $ 4,760,639 $ (129,332) $ 135,000 $ (7,909) $ (30) $ 4,758,368 7.65%
=============== =============== ============= ============ ================= ===============
Less: Debt Discount (21,294) (7,289)
Less: Current Portion (2,448) (3,814)
--------------- ---------------
$ 4,736,897 $ 4,747,265
=============== ===============
* Interest rate includes amortization of debt issuance costs, debt premiums
or discounts, and deferred gain on interest rate swap terminations. The
interest rates for Rural Utilities Service Loan Contracts, Senior Unsecured
Debt, and Industrial Development Revenue Bonds represent a weighted average
of multiple issuances.
During the first quarter of 2008, we retired an aggregate principal amount
of $129.4 million of debt, including $128.7 million of 9.25% Senior Notes
due 2011, $0.6 million of other senior unsecured debt and rural utilities
service loan contracts, and $0.1 million of 5% Company Obligated
Mandatorily Redeemable Convertible Preferred Securities due 2036 (EPPICS).
On March 28, 2008, we borrowed $135.0 million under a senior unsecured term
loan facility that was established on March 10, 2008. The loan matures in
2013 and bears interest of 4.56% as of March 31, 2008 based on the prime
rate or LIBOR, at our election, plus a margin which varies depending on our
debt leverage ratio. We used the proceeds to repurchase, during the first
quarter of 2008, $128.7 million principal amount of our 9.25% Senior Notes
due 2011 and to pay for the $6.3 million of premium on early retirement of
these notes.
As of March 31, 2008, EPPICS representing a total principal amount of
$197.3 million have been converted into 15,920,799 shares of our common
stock. Approximately $4.0 million of EPPICS, which are convertible into
347,642 shares of our common stock, were outstanding at March 31, 2008. The
above table indicates $14.5 million of EPPICS outstanding at March 31,
2008, of which $10.5 million is debt of related parties for which the
Company has an offsetting receivable.
As of March 31, 2008, we had an available line 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 March 31, 2008. The expiration date for this $250.0 million
five year revolving credit agreement is May 18, 2012. During the term of
the credit facility we may borrow, repay and reborrow funds. The credit
facility is available for general corporate purposes but may not be used to
fund dividend payments.
We are in compliance with all of our debt and credit facility covenants.
10
(8) Net Income Per Common Share:
----------------------------
The reconciliation of the net income per common share calculation for the
three months ended March 31, 2008 and 2007, respectively, is as follows:
($ in thousands, except per share amounts) For the three months ended March 31,
------------------------------------------ ----------------------------------
2008 2007
---------------- ----------------
Net income used for basic and diluted earnings
----------------------------------------------
per common share:
-----------------
Total basic net income available for common
shareholders $ 45,589 $ 67,667
Effect of conversion of preferred securities -
EPPICS 31 58
---------------- ----------------
Total diluted net income available for common
shareholders $ 45,620 $ 67,725
================ ================
Basic earnings per common share:
--------------------------------
Weighted average shares outstanding - basic 326,173 326,542
---------------- ----------------
Net income per share available for common
shareholders $ 0.14 $ 0.21
================ ================
Diluted earnings per common share:
----------------------------------
Weighted average shares outstanding - basic 326,173 326,542
Effect of dilutive shares 139 832
Effect of conversion of preferred securities -
EPPICS 348 503
---------------- ----------------
Weighted average shares outstanding - diluted 326,660 327,877
================ ================
Net income per share available for common
sharesholders $ 0.14 $ 0.21
================ ================
Stock Options
-------------
For the three months ended March 31, 2008 and 2007, options to purchase
2,658,000 and 1,803,000 shares, respectively, (at exercise prices ranging
from $11.15 to $18.46) 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 three months ended March 31, 2008 and 2007, restricted
stock awards of 1,764,000 and 1,404,000 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
------
As a result of our July 2004 dividend announcement with respect to our
common stock, our EPPICS began to convert into shares of our common stock.
As of March 31, 2008, approximately 99% of the EPPICS outstanding, or about
$197.3 million aggregate principal amount of EPPICS, have converted into
15,920,799 shares of our common stock, including shares issued from
treasury.
We had 79,707 and 82,977 shares of potentially dilutive EPPICS at March 31,
2008 and 2007, respectively, 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
remaining EPPICS had been converted, we would have issued approximately
347,642 and 361,904 shares of our common stock as of March 31, 2008 and
2007, respectively. These securities have been included in the diluted
income per common share calculation for the three months ended March 31,
2008 and 2007.
11
Stock Units
-----------
At March 31, 2008 and 2007, we had 290,724 and 385,178 stock units,
respectively, issued under our Non-Employee Directors' Deferred Fee Equity
Plan (Deferred Fee Plan), Non-Employee Directors' Equity Incentive Plan
(Directors' Equity Plan) and 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 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. This share repurchase program commenced
on March 4, 2008. As of March 31, 2008, we had repurchased approximately
2,317,000 shares of our common stock at an aggregate cost of approximately
$24.8 million.
(9) Stock Plans:
------------
At March 31, 2008, we had five stock-based compensation plans under which
grants have been made and awards remained outstanding. At March 31, 2008,
there were 16,058,182 shares authorized for grant under these plans and
4,240,518 shares available for grant. No further awards may be granted
under the MEIP, the 1996 EIP or the Deferred Fee Plan.
On March 17, 2008, the Company adopted the Citizens Long-Term Incentive
Program (LTIP). The LTIP will be offered under the Company's Amended and
Restated 2000 Equity Incentive Plan and covers the named executive officers
and certain other officers. The LTIP is designed to incent and reward the
Company's senior executives in the form of common stock if they achieve
aggressive growth goals for revenue and free cash flow over a three-year
period (the Measurement Period). For purposes of the LTIP, revenue is
defined as the Company's total revenues less regulatory revenues, and free
cash flow is defined as the Company's publicly reported free cash flow,
adjusted to reflect the Company as a full cash taxpayer during the
Measurement Period. The growth in these numbers will be measured from a
2007 base, which in the case of free cash flow was also adjusted to reflect
the Company as a full cash taxpayer and for certain other items.
The following summary presents information regarding outstanding stock
options as of March 31, 2008 and changes during the three months then ended
with regard to options under the MEIP and the EIPs:
Weighted Weighted
Shares Average Average Aggregate
Subject to Option Price Remaining Intrinsic
Option Per Share Life in Years Value
---------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2008 3,955,000 $ 13.13 3.4 $ 5,727,000
Options granted - $ -
Options exercised (80,000) $ 6.72 $ 277,000
Options canceled, forfeited or lapsed (23,000) $ 11.37
----------------------------------------------------------------------------
Balance at March 31, 2008 3,852,000 $ 13.05 3.2 $ 1,601,000
============================================================================
Exercisable at March 31, 2008 3,835,000 $ 13.05 3.2 $ 1,601,000
============================================================================
There were no options granted during the first three months of 2008. Cash
received upon the exercise of options during the first three months of 2008
totaled $0.6 million.
The total intrinsic value of stock options exercised during the first three
months of 2007 was $2.3 million. The total intrinsic value of stock options
outstanding and exercisable at March 31, 2007 was $14.0 million and $12.0
million, respectively. There were no options granted during the first three
months of 2007. Cash received upon the exercise of options during the first
three months of 2007 totaled $5.1 million.
12
The following summary presents information regarding unvested restricted
stock as of March 31, 2008 and changes during the three months then ended
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, 2008 1,209,000 $ 14.06 $ 15,390,000
Restricted stock granted 879,000 $ 11.02 $ 9,226,000
Restricted stock vested (313,000) $ 13.98 $ 3,282,000
Restricted stock forfeited (11,000) $ 13.76 $ 121,000
----------------------------------------------------------------------------
Balance at March 31, 2008 1,764,000 $ 12.56 $ 18,505,000
============================================================================
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 March 31, 2008 was $20.7 million and the
weighted average period over which this cost is expected to be recognized
is approximately three years.
The total fair value of shares granted and vested during the three months
ended March 31, 2007 was approximately $10.3 million and $6.8 million,
respectively. The total fair value of unvested restricted stock at March
31, 2007 was $21.1 million. The weighted average grant date fair value of
restricted shares granted during the three months ended March 31, 2007 was
$15.08. Shares granted during the first three months of 2007 totaled
691,000.
(10) Segment Information:
--------------------
We operate in one reportable segment, Frontier. Frontier provides both
regulated and unregulated voice, data and video 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.
(11) Derivative Instruments and Hedging Activities:
----------------------------------------------
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 has been deferred on the balance sheet and is being
amortized into interest expense over the term of the associated debt.
As of January 16, 2008, we no longer have any derivative instruments. For
the three months ended March 31, 2007, the interest expense resulting from
these interest rate swaps totaled approximately $1.3 million.
13
(12) Investment and Other (Loss) Income, Net:
----------------------------------------
The components of investment and other (loss) income, net are as follows:
For the three months ended March 31,
---------------------------------
($ in thousands) 2008 2007
---------------- --------------- ----------------
Interest and dividend income $ 5,104 $ 14,526
Bridge loan fee - (4,026)
Premium on debt repurchases (6,290) -
Equity earnings/minority interest in joint
ventures, net (297) (998)
Other, net 248 515
--------------- ----------------
Total investment and other (loss)
income, net $(1,235) $ 10,017
=============== ================
(13) Company Obligated Mandatorily Redeemable Convertible Preferred Securities:
--------------------------------------------------------------------------
As of March 31, 2008, EPPICS representing a total principal amount of
$197.3 million have been converted into 15,920,798 shares of our common
stock. A total of approximately $4.0 million of EPPICS was outstanding as
of March 31, 2008 and if all outstanding EPPICS were converted, 347,642
shares of our common stock would be issued upon such conversion. Our
long-term debt footnote indicates $14.5 million of EPPICS outstanding at
March 31, 2008, of which $10.5 million is debt of related parties for which
the Company has an offsetting receivable.
(14) Retirement Plans:
-----------------
The following tables provide the components of net periodic benefit cost:
Pension Benefits
----------------------------
For the three months ended
March 31,
---------------------------
2008 2007
------------- ------------
($ in thousands)
----------------
Components of net periodic benefit cost
---------------------------------------
Service cost $ 1,619 $ 2,009
Interest cost on projected benefit obligation 12,875 11,930
Expected return on plan assets (16,354) (15,676)
Amortization of prior service cost and unrecognized
net obligation (64) (27)
Amortization of unrecognized loss 1,272 2,900
------------- ------------
Net periodic benefit cost/(income) $ (652) $ 1,136
============= ============
Other Postretirement Benefits
----------------------------
For the three months ended
March 31,
---------------------------
2008 2007
------------- ------------
($ in thousands)
----------------
Components of net periodic benefit cost
---------------------------------------
Service cost $ 149 $ 175
Interest cost on projected benefit obligation 2,742 2,208
Expected return on plan assets (122) (254)
Amortization of prior service cost and transition
obligation (1,934) (1,447)
Amortization of unrecognized loss 1,404 1,190
------------- ------------
Net periodic benefit cost $ 2,239 $ 1,872
============= ============
We expect that our 2008 pension and other postretirement benefit expenses
will be between $5.0 million and $10.0 million, and that no contribution
will be required to be made by us to the pension plan in 2008.
14
(15) Commitments and Contingencies:
------------------------------
We anticipate capital expenditures of approximately $300.0 million - $310.0
million for 2008. 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.
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.
In January 2008, we received notice of the accused services and 40 asserted
claims from Katz Technology. The case is now in the discovery phase and
interrogatories have been served and answered. The parties have engaged in
settlement discussions but have not reached agreement. In the event that we
are not able to settle, 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.
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, then the other VJO participants will assume responsibility
for the defaulting party's share on a pro-rata basis. Our pro-rata share of
the purchase power obligation is 10%. If any member of the VJO defaults on
its obligations under the Hydro-Quebec agreement, 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. 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.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
Forward-Looking Statements
--------------------------
This quarterly report on Form 10-Q 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 credit markets and/or 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;
16
* The effects of state regulatory cash management policies on our
ability to transfer cash among our subsidiaries and to the parent
company;
* Our ability to successfully renegotiate 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 alternative minimum tax (AMT) credit carryforwards,
that were generated in prior years, 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," in our Annual Report on Form 10-K for the year
ended December 31, 2007, in evaluating any statement in this report on Form 10-Q
or otherwise made by us or on our behalf. The following information is unaudited
and should be read in conjunction with the consolidated financial statements and
related notes included in this report. 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 March 8, 2007, we completed the
acquisition of Commonwealth Telephone Enterprises, Inc., which includes a small
competitive local exchange carrier (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 March 31, 2008, we operated in 24 states with approximately 5,800 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 March 31,
2008, 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 and 2009 across all of our products and in all of
our markets. Our Frontier business experienced erosion in access lines and
switched access minutes in 2007 and the first three months of 2008 primarily as
a result of competition. Competition in our markets may result in reduced
revenues in 2008 and 2009.
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.
We employ a number of strategies to combat the competitive pressures noted
above. Our strategies are focused in three areas; customer retention, upgrading
and up-selling services to our existing customer base, and new product
deployment.
17
We hope to achieve our customer retention goals by bundling services around the
local access line and providing exemplary customer service. Bundled services
include high-speed internet, unlimited long distance calling, enhanced telephone
features and video offerings. We tailor these services to the needs of our
residential and business customers in the markets we serve and continually
evaluate the introduction of new and complementary products and services, which
can also be purchased separately. Customer retention is also enhanced by
offering 1, 2 and 3 year price protection plans where customers commit to a term
in exchange for predictable pricing. Additionally, we are focused on enhancing
the customer experience as we believe exceptional customer service will
differentiate us from our competition. Our commitment to providing exemplary
customer service is demonstrated by the expansion of our customer services
hours, shorter scheduling windows for in-home appointments and the
implementation of call reminders and follow-up calls for service appointments.
In addition, due to a recent realignment and restructuring of approximately 65
local area markets, those markets are now operated by local managers with
responsibility for the customer experience in those markets as well as the
financial results.
We utilize targeted and innovative promotions to upgrade and up-sell a variety
of service offerings including high-speed internet, video, and enhanced long
distance and feature packages in order to maximize the average revenue per
access line (wallet share) paid to Citizens. We intend to continue to evaluate
the need and effectiveness of offering such promotions to drive sales and may
offer additional promotions during 2008.
Lastly, we are focused on introducing a number of new products that our
customers desire including wireless data, internet portal advertising and
"Frontier Peace of Mind" product suite. This last category is a suite of
products aimed at managing our customers' computer environment and protecting
residential and business customers against catastrophic computer meltdowns. It
includes one or a combination of hard drive back-up, access to an enhanced level
of help desk support and inside wire maintenance. We intend to offer our Peace
of Mind services both to our customers and to other users inside and outside of
our service territories. Although we are optimistic about the opportunities
provided by each of these initiatives, we can provide no assurance about their
long term profitability or impact on revenue.
We believe that the combination of offering multiple products and services to
our customers pursuant to price protection programs, billing them on a single
bill and providing superior customer service will make our customers more loyal
to us, and will help us generate new, and retain existing, customer revenue.
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 total revenues. The decreasing revenue from
historical sources, along with the potential for increasing operating costs,
could cause our profitability and our cash generated by operations to decrease.
18
a) Liquidity and Capital Resources
-------------------------------
As of March 31, 2008, we had cash and cash equivalents aggregating $227.6
million. Our primary sources of funds continued to be cash generated from
operations and incremental borrowings. For the three months ended March 31,
2008, we used cash flow from operations, incremental borrowing and cash and cash
equivalents to fund capital expenditures, dividends, interest payments, debt
repayments and stock repurchases.
Cash Flow from Operating Activities
-----------------------------------
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 2009, 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 $2.9 million of debt maturing during the last nine months of 2008
and approximately $3.9 million and $7.2 million of debt maturing in 2009 and
2010, 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 $1.9 million in
cash taxes during the first three months of 2008 and expect to pay approximately
$110.0 million to $120.0 million for the full year of 2008. Our cash tax
estimate reflects the currently estimated impact of the "Economic Stimulus Act
of 2008."
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 $247.4 million.
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.
Capital Expenditures
--------------------
For the three months ended March 31, 2008, our capital expenditures were $48.0
million. 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 three months ended March 31, 2008, we retired an aggregate principal
amount of $129.4 million of debt, including $128.7 million principal amount of
our 9.25% Senior Notes due 2011, $0.6 million of other senior unsecured debt and
rural utilities service loan contracts, and $0.1 million of 5% Company Obligated
Mandatorily Redeemable Convertible Preferred Securities (EPPICS) that were
converted into our common stock.
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 March 31, 2007
we retired $114.6 million face amount of Commonwealth convertible notes for
which we paid $92.2 million in cash and $22.4 million in common stock. No
additional amounts have been retired since that time.
19
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.
Issuance of Debt Securities
---------------------------
On March 28, 2008, we borrowed $135.0 million under a senior unsecured term loan
facility that was established on March 10, 2008. The loan matures in 2013 and
bears interest based on the prime rate or LIBOR, at our election, plus a margin
which varies depending on our debt leverage ratio. We used the proceeds to
repurchase, during the first quarter of 2008, $128.7 million principal amount of
our 9.25% Senior Notes due 2011 and to pay for the $6.3 million of premium on
early retirement of these notes.
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 at a price of 103.041% plus accrued and unpaid interest.
In the second quarter of 2007, we completed an exchange offer (to publicly
register the debt) for 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 due 2027 issued in a private placement on December 22, 2006, for
registered notes.
EPPICS
------
As of March 31, 2008, EPPICS representing a total principal amount of $197.3
million have been converted into 15,920,799 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 March 31, 2008, 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
were $400.0 million. Such contracts required us to pay variable rates of
interest (estimated average pay rates of approximately 8.54% as of December 31,
2007) and receive fixed rates of interest (average receive rate of 8.50% as of
December 31, 2007). All swaps are accounted for under SFAS No. 133 (as amended)
as fair value hedges. For the three months ended March 31, 2007, the interest
expense resulting from these interest rate swaps totaled approximately $1.3
million.
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 has
been deferred on the balance sheet and is being amortized into interest expense
over the term of the associated debt.
Credit Facilities
-----------------
As of March 31, 2008, 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 March 31, 2008. 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 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. However, we would be restricted under our credit
facilities from declaring dividends if an event of default has occurred and is
continuing at the time or will result from the dividend declaration.
20
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 and $135.0 million
senior unsecured term loans, each 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 all of these 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.
Our credit facilities and 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 three months
ended March 31, 2008 and 2007, we received approximately $0.6 million and $5.1
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. This share repurchase program commenced on March
4, 2008. As of March 31, 2008, we had repurchased approximately 2,317,000 shares
of our common stock at an aggregate cost of approximately $24.8 million.
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.
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, restrictions in our credit facilities 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.
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 at
the date of the financial statements, the disclosure of the contingent assets
and liabilities 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,
long-term incentive program, income taxes, contingencies and purchase price
allocations, among others.
21
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 such estimates.
There have been no material changes to our critical accounting policies and
estimates from the information provided in "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in our
Annual Report on Form 10-K for the year ended December 31, 2007.
New Accounting Pronouncements
-----------------------------
The following new accounting standards were adopted by the Company in the first
quarter of 2008 without any material financial statement impact. All of these
standards are more fully described in Note 2 to the consolidated financial
statements.
* Accounting for Endorsement Split-Dollar Life Insurance Arrangements
----------------------------------------------------------------------
(EITF No. 06-4)
---------------
* Fair Value Measurement (SFAS No. 157), as amended
-------------------------------------------------
* The Fair Value Option for Financial Assets and Financial Liabilities -
----------------------------------------------------------------------
Including an Amendment of FASB Statement No. 115 (SFAS No. 159)
---------------------------------------------------------------
* Accounting for Collateral Assignment Split-Dollar Life Insurance
----------------------------------------------------------------------
Arrangements (EITF No. 06-10)
-----------------------------
* Accounting for the Income Tax Benefits of Dividends on Share-Based
----------------------------------------------------------------------
Payment Awards (EITF No. 06-11)
-------------------------------
The following new accounting standards that will be adopted by the Company in
2008 and 2009 are currently being evaluated by the Company.
* Business Combinations (SFAS No. 141R)
-------------------------------------
* Noncontrolling Interests in Consolidated Financial Statements (SFAS
----------------------------------------------------------------------
No. 160)
--------
22
(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 and 2008. The Company's variance explanations below
are based upon an analysis of 2007 and 2008 for Citizens (excluding CTE and
GVN), except that the first sentence in each section of revenue or expenses
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 three months ended March 31, 2008 increased $13.1
million, or 2%, as compared with the prior year period. Excluding the additional
revenue due to the CTE and GVN acquisitions, revenue decreased $48.9 million
during the first three months of 2008 as compared with the prior year period.
During the first quarter of 2007, we had a significant favorable settlement of a
carrier dispute that resulted in a favorable one-time impact to our revenues of
$38.7 million. Excluding the additional revenue due to the Commonwealth and
Global Valley acquisitions and the one-time favorable settlement in the first
quarter of 2007, our revenue for the three months ended March 31, 2008 would
have declined $10.2 million, or 2%, as compared to the first quarter of 2007.
This decline is a result of lower access lines, subsidy revenue and switched
access revenue, partially offset by a $12.7 million increase in data and
internet services revenue.
Change in the number of our access lines is important to our revenue and
profitability. We have lost access lines primarily because of competition,
changing consumer behavior, economic conditions, changing technology and by some
customers disconnecting second lines when they add high-speed internet or cable
modem service. We lost approximately 43,100 access lines during the three months
ended March 31, 2008, but added approximately 20,200 high-speed internet
subscribers during this same period. The loss of lines during the first three
months of 2008 was primarily among residential customers throughout our markets.
The non-residential line losses were principally in our central and eastern
regions and Rochester, New York. We expect to continue to lose access lines but
to increase high-speed internet subscribers during the remainder of 2008. A
continued loss of access lines, combined with increased competition and the
other factors discussed herein may cause our revenues, profitability and cash
flows to decrease in 2008.
Our historical results include the results of operations of Commonwealth from
the date of its acquisition on March 8, 2007 and of GVN from the date of its
acquisition on October 31, 2007. The financial tables below include a
comparative analysis of our results of operations on a historical basis for the
three months ended March 31, 2008 and 2007. We have also presented an analysis
of each category for the three months ended March 31, 2008 and 2007 for the
results of Citizens (excluding CTE and GVN) and the results of our acquisitions,
as included in the consolidated results of operations.
REVENUE
For the three months For the three months
ended March 31, 2008 ended March 31, 2007
-------------------------------------- -----------------------------------
Citizens Citizens
($ in thousands) As (excluding As (excluding
---------------- Reported Acquisitions CTE and GVN) Reported Acquisition CTE) $ Change % Change
----------- ------------ ------------ ----------- ----------- ----------- --------- ---------
Local services $ 217,158 $ 29,498 $ 187,660 $ 204,444 $ 7,075 $ 197,369 $ (9,709) -5%
Data and internet services 145,982 19,370 126,612 118,024 4,155 113,869 12,743 11%
Access services 107,818 20,548 87,270 139,024 5,695 133,329 (46,059) -35%
Long distance services 46,453 8,409 38,044 40,428 2,047 38,381 (337) -1%
Directory services 28,628 597 28,031 28,670 68 28,602 (571) -2%
Other 23,166 4,215 18,951 25,557 1,626 23,931 (4,980) -21%
----------- ------------ ------------ ----------- ----------- ----------- ---------
$ 569,205 $ 82,637 $ 486,568 $ 556,147 $ 20,666 $ 535,481 $(48,913) -9%
=========== ============ ============ =========== =========== =========== =========
23
Local Services
Local services revenue for the three months ended March 31, 2008 increased $12.7
million, or 6%, as compared with the prior year period. Excluding the additional
local services revenue due to the CTE and GVN acquisitions of $29.5 million and
$7.1 million for the three months ended March 31, 2008 and 2007, respectively,
local services revenue decreased $9.7 million, or 5%, as compared with the prior
year period. The loss of access lines accounted for $7.3 million of the decline
in local services revenue. Enhanced services revenue decreased $1.2 million, as
compared with the prior year period, primarily due to a decline in local access
lines and a shift in customers purchasing individual features versus our
unlimited voice communications packages.
Economic conditions and/or increasing competition could make it more difficult
to sell our packages and bundles and cause us to increase our promotions and/or
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 three months ended March 31, 2008
increased $28.0 million, or 24%, as compared with the prior year period.
Excluding the additional data and internet services revenue due to the CTE and
GVN acquisitions of $19.4 million and $4.2 million for the three months ended
March 31, 2008 and 2007, respectively, data and internet services revenue for
the three months ended March 31, 2008 increased $12.7 million, or 11%, as
compared with the prior year period, primarily due to growth in data and
high-speed internet customers. The number of the Company's high-speed internet
subscribers has increased by more than 62,100, or 15%, since March 31, 2007,
excluding the acquired properties. 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 $4.8
million, or 9%, as compared with the prior year period, primarily due to growth
in the number of those circuits.
Access Services
Access services revenue for the three months ended March 31, 2008 decreased
$31.2 million, or 22%, as compared with the prior year period. Excluding the
additional access services revenue due to the CTE and GVN acquisitions of $20.5
million and $5.7 million for the three months ended March 31, 2008 and 2007,
respectively, access services revenue for the three months ended March 31, 2008
decreased $46.1 million, or 35%, as compared with the prior year period.
Switched access revenue of $59.3 million decreased $41.1 million, primarily due
to the first quarter of 2007 settlement of a carrier dispute resulting in a
favorable impact on our revenue of $38.7 million (a one-time event) and the
impact of a decline in minutes of use related to access line losses. Excluding
the impact of that one-time favorable settlement in the first quarter of 2007,
our switched access revenue for the first quarter of 2008 would have declined by
$2.5 million, or 4%, from the comparable period in 2007. Access services revenue
includes subsidy payments we receive from federal and state agencies. Subsidy
revenue of $27.9 million decreased $4.9 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).
Increases in the number of Competitive Eligible Telecommunications Companies
(CETC) (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 Federal
Communications Commission (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. On May 1, 2008
the FCC issued an order to cap CETC receipts from the high cost Federal
Universal Service Fund. While this order will have no impact on our current
receipt levels, we believe this is a positive first step to limit the rapid
growth of the fund. The CETC cap will remain in place until the Commission takes
additional steps towards needed reform. 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. In addition, we have been approached by various carriers
seeking reductions in intrastate access rates in certain states. 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.
24
Long Distance Services
Long distance services revenue for the three months ended March 31, 2008
increased $6.0 million, or 15%, as compared with the prior year period.
Excluding the additional long distance services revenue due to the CTE and GVN
acquisitions of $8.4 million and $2.0 million for the three months ended March
31, 2008 and 2007, respectively, long distance services revenue for the three
months ended March 31, 2008 decreased $0.3 million, or 1%, as compared with the
prior year period, despite an increase in our long distance minutes of use. We
have 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 these customers. This has lowered our overall average rate per minute
billed.
Our long distance minutes of use increased by 14% during the three months ended
March 31, 2008 compared to the three months of 2007 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. We
expect these factors will continue to adversely affect our long distance
revenues during the remainder of 2008.
Directory Services
Directory services revenue for the three months ended March 31, 2008 was
relatively unchanged as compared with the prior year period.
Other
Other revenue for the three months ended March 31, 2008 decreased $2.4 million,
or 9%, as compared with the prior year period. Excluding the additional other
revenue due to the CTE and GVN acquisitions of $4.2 million and $1.6 million for
the three months ended March 31, 2008 and 2007, respectively, other revenue for
the three months ended March 31, 2008 decreased $5.0 million, or 21%, as
compared with the prior year period, primarily due to higher bad debt expenses,
lower sales of customer premise equipment, decreased "bill and collect" fee
revenue and reduced cellular revenue from the Mohave Cellular Limited
Partnership.
OTHER FINANCIAL AND OPERATING DATA
As of As of %
March 31, 2008 March 31, 2007 Change
-------------- -------------- -----------
Access lines 2,387,108 2,538,471 -6%
High-speed internet (HSI)
subscribers 543,020 464,056 17%
Video subscribers 101,410 76,009 33%
For the three months ended March 31, 2008 For the three months ended March 31, 2007
-------------------------------------------- -------------------------------------------------
Citizens
As (excluding As Citizens %
Reported Acquisitions CTE and GVN) Reported Acquisition (excluding CTE) Change
-------------------------------------------- -------------------------------------------------
Switched access minutes of
use (in millions) 2,602 380 2,222 2,528 90 2,438 -9%
Average monthly revenue per
average access line $ 78.77 $ 63.77 $ 82.05 NA NA 84.38 * -3%
* For the three months ended March 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 $78.29 without the $38.7 million favorable impact
from the settlement.
NETWORK ACCESS EXPENSES
For the three months For the three months
ended March 31, 2008 ended March 31, 2007
------------------------------------ ----------------------------------------
Citizens
($ in thousands) As (excluding As Citizens
---------------- Reported Acquisitions CTE and GVN) Reported Acquisition (excluding CTE) $ Change % Change
--------- ------------ ------------ ----------- ------------ --------------- --------- ---------
Network access $ 60,549 $ 12,059 $ 48,490 $ 51,397 $ 4,453 $ 46,944 $ 1,546 3%
Consolidated network access expenses for the three months ended March 31, 2008
increased $9.2 million, or 18%, as compared with the prior year period.
Excluding the additional network access expenses due to the CTE and GVN
acquisitions, network access expenses for the three months ended March 31, 2008
increased $1.5 million, or 3%, as compared with the prior year period, primarily
due to increasing rates and usage related to our long distance product and our
data backbone. Additionally, the first quarter of 2008 included costs associated
25
with high-speed internet promotions that subsidized the cost of new televisions
provided to customers. As we continue to increase our sales of data products
such as high-speed internet and expand the availability of our unlimited long
distance calling plans, our network access expense is likely to continue to
increase. A decline in expenses associated with access line losses has offset
some of the increase.
OTHER OPERATING EXPENSES
For the three months ended March 31, 2008 For the three months ended March 31, 2007
-------------------------------------------- --------------------------------------------------------
Citizens
($ in thousands) As (excluding As Citizens
---------------- Reported Acquisitions CTE and GVN) Reported Acquisitions (excluding CTE) $ Change % Change
------------ ------------ ---------------- ---------- ------------- ----------------- ---------- ---------
Wage and benefit
expenses $100,146 $ 10,400 $ 89,746 $ 99,828 $ 3,977 $ 95,851 $ (6,105) -6%
Severance and early
retirement costs 2,891 - 2,891 182 - 182 2,709 NM
Stock based
compensation 3,019 - 3,019 3,407 - 3,407 (388) -11%
All other operating
expenses 97,208 20,577 * 76,631 85,850 5,423 * 80,427 (3,796) -5%
------------ ------------ ---------------- ---------- ------------- ----------------- ----------
$203,264 $ 30,977 $ 172,287 $189,267 $ 9,400 $ 179,867 $ (7,580) -4%
============ ============ ================ ========== ============= ================= ==========
*Includes $11.5 million and $3.8 million of common corporate costs allocated to
the CTE and GVN operations for the three months ended March 31, 2008 and 2007,
respectively.
Consolidated other operating expenses for the three months ended March 31, 2008
increased $14.0 million, or 7%, to $203.3 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 three months ended March 31, 2008 were
relatively unchanged as compared with the prior year period. Excluding the
additional wage and benefit expenses due to the CTE and GVN acquisitions of
$10.4 million and $4.0 million for the three months ended March 31, 2008 and
2007, respectively, wage and benefit expenses decreased $6.1 million, or 6%, for
the three months ended March 31, 2008, as compared with the prior year period,
primarily due to headcount reductions and associated decreases in compensation
and benefits.
Included in wage and benefit expenses is pension and other postretirement
benefit expenses. These costs for the three months ended March 31, 2008 and 2007
were approximately $1.6 million and $3.0 million, respectively. Based on current
assumptions and plan asset values, we estimate that our 2008 pension and other
postretirement benefit expenses will be approximately $5.0 million to $10.0
million and that no contribution will be made by us to our pension plan in 2008.
In future periods, if the value of our pension plan assets decline and/or
projected pension and/or postretirement benefit costs increase, we may have
increased pension and/or postretirement expenses.
Severance and early retirement costs
Severance and early retirement costs in the first quarter of 2008 increased $2.7
million as compared with the prior year period, primarily due to a charge
related to employee early retirements and terminations for 38 Rochester, New
York employees.
Stock based compensation
Stock based compensation for the three months ended March 31, 2008 decreased
$0.4 million, or 11%, as compared with the prior year period due to reduced
costs associated with stock units and stock options, since we have fewer stock
option grants that remain unvested compared to the prior year period, partially
offset by costs associated with the recently adopted long-term incentive
program.
All other operating expenses
All other operating expenses for the three months ended March 31, 2008 increased
$11.4 million, or 13%, as compared with the prior year period. Excluding the
additional expenses due to the CTE and GVN acquisitions of $20.6 million and
$5.4 million for the three months ended March 31, 2008 and 2007, respectively,
all other operating expenses for the three months ended March 31, 2008 decreased
$3.8 million, or 5%, as compared with the prior year period, primarily due to
the allocation of common corporate costs over a larger base of operations, which
now includes Commonwealth and Global Valley. Our purchases of CTE and GVN have
enabled us to realize cost savings by leveraging our centralized back office,
customer service and administrative support functions over a larger customer
base. An increase in consulting and other outside services of $3.8 million for
the three months ended March 31, 2008 offset some of the decrease in expenses
noted above.
26
DEPRECIATION AND AMORTIZATION EXPENSE
For the three months For the three months
ended March 31, 2008 ended March 31, 2007
---------------------------------------- --------------------------------------
Citizens
($ in thousands) As (excluding As Citizens
---------------- Reported Acquisitions CTE and GVN) Reported Acquisition (excluding CTE) $ Change % Change
---------- ------------ ------------- --------- ----------- ------------- ---------- --------
Depreciation expense $ 95,145 $ 15,298 $ 79,847 $ 86,647 $ 2,960 $ 83,687 $ (3,840) -5%
Amortization expense 45,935 14,340 * 31,595 35,534 3,939 * 31,595 - -
---------- ------------ ------------- --------- ----------- ------------- ----------
$ 141,080 $ 29,638 $ 111,442 $122,181 $ 6,899 $ 115,282 $ (3,840) -3%
========== ============ ============= ========= =========== ============= ==========
*Represents amortization expense related to the customer base acquired in the
CTE and GVN acquisitions and the Commonwealth trade name.
Consolidated depreciation and amortization expense for the three months ended
March 31, 2008 increased $18.9 million, or 15%, as compared with the prior year
period as a result of our 2007 acquisitions of CTE and GVN. Excluding the impact
of our 2007 acquisitions, depreciation and amortization expense for the three
months ended March 31, 2008 decreased $3.8 million, or 5%, as compared with the
prior year period, primarily 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 $375.0 million to
$385.0 million and amortization expense of $180.0 million to $190.0 million for
2008.
INVESTMENT AND OTHER (LOSS) INCOME, NET / INTEREST EXPENSE / INCOME TAX EXPENSE
For the three For the three
months ended months ended
($ in thousands) March 31, 2008 March 31, 2007 $ Change % Change
---------------- -------------- -------------- ----------- ----------
Investment and
other (loss) income, net $ (1,235) $ 10,017 $ (11,252) -112%
Interest expense $ 90,860 $ 93,964 $ (3,104) -3%
Income tax expense $ 26,628 $ 41,688 $ (15,060) -36%
Investment and other (loss) income, net
Investment and other (loss) income, net for the three months ended March 31,
2008 decreased $11.3 million, or 112%, as compared with the prior year period,
primarily due to the loss on retirement of debt of $6.3 million during the first
quarter of 2008, a decrease of $9.4 million in income from short-term
investments of cash, partially offset by the $4.0 million expense of a bridge
loan fee recorded during the first quarter of 2007.
Our average cash balance was $227.1 million and $1,039.4 million for the three
months ended March 31, 2008 and 2007, respectively.
Interest expense
Consolidated interest expense for the three months ended March 31, 2008
decreased $3.1 million, or 3%, as compared with the prior year period, primarily
due to the amortization of the deferred gain associated with the termination of
our interest rate swap agreements and retirement of related debt during the
first quarter of 2008. Our average debt outstanding was $4,759.5 million and
$4,945.8 million for the three months ended March 31, 2008 and 2007,
respectively. Our composite average borrowing rate as of March 31, 2008 as
compared with the prior year was 29 basis points lower, decreasing from 7.94% to
7.65%.
Income tax expense
Income tax expense for the three months ended March 31, 2008 decreased $15.1
million, or 36%, as compared with the prior year period, primarily due to
changes in taxable income. The effective tax rate on a fully consolidated basis
for the first three months of 2008 was 36.9% as compared with 38.1% for the
first three months of 2007. Our cash taxes paid for the three months ended March
31, 2008 were $1.9 million, a decrease of $4.9 million from the first three
months of 2007. We expect to pay approximately $110.0 million to $120.0 million
for the full year of 2008. Our 2008 cash tax estimate reflects the currently
estimated impact of the "Economic Stimulus Act of 2008."
27
There were no material changes to the liabilities on our books as of December
31, 2007 related to uncertain tax positions recorded under FASB Interpretation
No. (FIN) 48 for the three months ended March 31, 2008. As a result of the
expiration of certain statute of limitations on April 15, 2008, these
liabilities are being reduced by $16.2 million in the second quarter of 2008.
This reduction will lower income tax expense by $7.5 million, goodwill by $3.0
million and deferred income tax assets by $5.7 million during the second quarter
of 2008.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities, 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. 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. Our long-term debt as
of March 31, 2008 was approximately 94% fixed rate debt with minimal exposure to
interest rate changes after the termination of our remaining interest rate swap
agreements on January 15, 2008.
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 $283.1 million of our
borrowings at March 31, 2008 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. An 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 March 31, 2008, a near-term change in interest
rates would not materially affect our consolidated financial position, results
of operations or cash flows.
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 has
been deferred on the balance sheet, and is being amortized into interest expense
over the term of the associated debt.
Sensitivity analysis of interest rate exposure
At March 31, 2008, the fair value of our long-term debt was estimated to be
approximately $4.4 billion, based on our overall weighted average borrowing rate
of 7.65% 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, 2007.
Equity Price Exposure
Our exposure to market risks for changes in security prices as of March 31, 2008
is limited to our pension assets. We have no other security investments of any
material amount.
Item 4. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures
We carried out an evaluation, under the supervision and with the participation
of our management, including our principal executive officer and principal
financial officer, regarding the effectiveness of the design and operation of
our disclosure controls and procedures. Based upon this evaluation, our
principal executive officer and principal financial officer concluded, as of the
end of the period covered by this report, March 31, 2008, that our disclosure
controls and procedures are effective.
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(b) Changes in internal control over financial reporting
We reviewed our internal control over financial reporting at March 31, 2008.
There has been no change in our internal control over financial reporting
identified in an evaluation thereof that occurred during the first fiscal
quarter of 2008 that materially affected or is reasonably likely to materially
affect our internal control over financial reporting.
Item 1. Legal Proceedings
-----------------
There have been no material changes to our legal proceedings from the
information provided in Item 3. Legal Proceedings included in our Annual Report
on Form 10-K for the year ended December 31, 2007, except as set forth below:
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. In January 2008, we received notice of the accused services and 40
asserted claims from Katz Technology. The case is now in the discovery phase and
interrogatories have been served and answered. The parties have engaged in
settlement discussions but have not reached agreement. In the event that we are
not able to settle, we intend to vigorously defend against this lawsuit.
Item 1A. Risk Factors
------------
There have been no material changes to our risk factors from the information
provided in Item 1A. "Risk Factors" included in our Annual Report on Form 10-K
for the year ended December 31, 2007.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
There were no unregistered sales of equity securities during the quarter ended
March 31, 2008.
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ISSUER PURCHASES OF EQUITY SECURITIES
-----------------------------------------------------------------------------------------------------------
(d) Maximum
Approximate
Dollar Value of
(c) Total Number of Shares that May
(a) Total Shares Purchased as Yet Be Purchased
Number of (b) Average Part of Publicly Under the Plans or
Shares Price Paid Announced Plans Programs (in
Period Purchased per Share or Programs millions)
-----------------------------------------------------------------------------------------------------------
January 1, 2008 to January 31, 2008
Share Repurchase Program (1) - - - -
Employee Transactions (2) 1,399 $ 12.49 N/A N/A
February 1, 2008 to February 29, 2008
Share Repurchase Program (1) - - - $ 200.0
Employee Transactions (2) 60,313 $ 10.89 N/A N/A
March 1, 2008 to March 31, 2008
Share Repurchase Program (1) 2,316,768 $ 10.70 2,316,768 $ 175.2
Employee Transactions (2) 7,138 $ 10.31 N/A N/A
Totals January 1, 2008 to March 31, 2008
Share Repurchase Program (1) 2,316,768 $ 10.70 2,316,768 $ 175.2
Employee Transactions (2) 68,850 $ 10.86 N/A N/A
(1) 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. This share repurchase program commenced
on March 4, 2008.
(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.
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Item 6. Exhibits
--------
a) Exhibits:
10.1 Offer of Employment Letter between Citizens Communications Company and
Cecilia K. McKenney, effective January 13, 2006.
31.1 Certification of Principal Executive Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934.
31.2 Certification of Principal Financial Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
31
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
-------------------------------
(Registrant)
By: /s/ Robert J. Larson
---------------------------
Robert J. Larson
Senior Vice President and
Chief Accounting Officer
Date: May 6, 2008
32