CITIZENS UTILITIES COMPANY FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 ------------- |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________to__________ Commission file number 001-11001 --------- CITIZENS UTILITIES COMPANY ________________________________________________________________________________ (Exact name of registrant as specified in its charter) Delaware 06-0619596 ________________________________________ ___________________________________ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 3 High Ridge Park P.O. Box 3801 Stamford, Connecticut 06905 ________________________________________ ___________________________________ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (203) 614-5600 ------------------------------ NONE (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes X No --- --- The number of shares outstanding of the registrant's class of common stock as of July 31, 1999 was 260,553,664.
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES Index to Consolidated Financial Statements <TABLE> <CAPTION> <S> <C> Page No. -------- Part I. Financial Information Consolidated Balance Sheets at June 30, 1999 and December 31, 1998 2 Consolidated Statements of Income and Comprehensive Income for the Three Months Ended June 30, 1999 and 1998 3 Consolidated Statements of Income and Comprehensive Income for the Six Months Ended June 30, 1999 and 1998 4 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1999 and 1998 5 Notes to Consolidated Financial Statements 6 Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Quantitative and Qualitative Disclosures about Market Risk 23 Part II. Other Information Legal Proceedings 24 Submission of Matters to a Vote of Security Holders 25 Other Information 25 Exhibits and Reports on Form 8-K 25 Signatures 26 </TABLE> 1
PART I. FINANCIAL INFORMATION CITIZENS UTILITIES COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands) <TABLE> <CAPTION> <S> <C> <C> June 30, 1999 December 31, 1998 ------------- ----------------- ASSETS - ------ Current assets: Cash $ 27,596 $ 31,922 Accounts receivable, net 294,038 318,378 Other 56,649 63,741 -------------- -------------- Total current assets 378,283 414,041 -------------- -------------- Property, plant and equipment 6,262,406 5,947,353 Less accumulated depreciation 2,044,416 1,898,730 -------------- -------------- Net property, plant and equipment 4,217,990 4,048,623 -------------- -------------- Investments 435,762 414,761 Regulatory assets 204,875 204,703 Deferred debits and other assets 233,579 210,804 -------------- -------------- Total assets $ 5,470,489 $ 5,292,932 ============== ============== LIABILITIES AND EQUITY - ---------------------- Current liabilities: Long-term debt due within one year $ 23,878 $ 8,930 Short-term debt - 110,000 Accounts payable and current liabilities 430,604 388,801 -------------- -------------- Total current liabilities 454,482 507,731 Deferred income taxes 423,259 442,908 Customer advances for construction 201,305 211,941 Deferred credits and other liabilities 98,317 96,827 Regulatory liabilities 19,224 19,120 Long-term debt 2,106,514 1,900,246 -------------- -------------- Total liabilities 3,303,101 3,178,773 -------------- -------------- Company Obligated Mandatorily Redeemable Convertible Preferred Securities * 201,250 201,250 Contributions in aid of construction 95,713 90,353 Minority interest in subsidiary 19,658 29,785 Shareholders' equity: Common stock issued, $.25 par value 65,075 64,787 Additional paid-in capital 1,563,929 1,554,188 Retained earnings 179,482 117,104 Accumulated other comprehensive income 42,281 56,692 -------------- -------------- Total shareholders' equity 1,850,767 1,792,771 -------------- -------------- Total liabilities and shareholders' equity $ 5,470,489 $ 5,292,932 ============== ============== * Represents securities of a subsidiary trust, the sole assets of which are securities of a subsidiary partnership, substantially all the assets of which are convertible debentures of the Company. The accompanying Notes are an integral part of these Financial Statements. </TABLE> 2
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND 1998 (In thousands, except per-share amounts) <TABLE> <CAPTION> <S> <C> <C> 1999 1998 ------------ ------------ Revenues $ 414,847 $ 366,347 ------------ ------------ Operating expenses: Cost of services 89,617 80,695 Depreciation 76,484 64,765 Other operating expenses 217,325 179,382 ------------ ------------ Total operating expenses 383,426 324,842 ------------ ------------ Income from operations 31,421 41,505 Other income, net 6,344 7,683 Minority interest 5,693 3,053 Interest expense 30,553 28,589 ------------ ------------ Income before income taxes and dividend on convertible preferred securities 12,905 23,652 Income taxes 3,600 7,638 ------------ ------------ Income before dividend on convertible preferred securities 9,305 16,014 Dividend on convertible preferred securities, net of income tax benefit 1,552 1,552 ------------ ------------ Net income 7,753 14,462 Other comprehensive income (loss), net of tax and reclassification adjustment (293) 17,314 ------------ ------------ Total comprehensive income $ 7,460 $ 31,776 ============ ============ Net income per common share: Basic $ .03 $ .06 * Diluted $ .03 $ .06 * Dividend rate declared on common stock - .75% ============ ============ *Adjusted for subsequent stock dividends. The accompanying Notes are an integral part of these Financial Statements. </TABLE> 3
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (In thousands, except per-share amounts) <TABLE> <CAPTION> <S> <C> <C> 1999 1998 ------------ ------------ Revenues $ 852,361 $ 770,210 ------------ ------------ Operating expenses: Cost of services 197,299 188,727 Depreciation 152,125 128,362 Other operating expenses 435,193 355,338 ------------ ------------ Total operating expenses 784,617 672,427 ------------ ------------ Income from operations 67,744 97,783 Other income, net 81,536 18,321 Minority interest 11,686 5,136 Interest expense 60,366 55,395 ------------ ------------ Income before income taxes, dividends on convertible preferred securities and cumulative effect of change in accounting principle 100,600 65,845 Income taxes 35,118 19,166 ------------ ------------ Income before dividends on convertible preferred securities and cumulative effect of change in accounting principle 65,482 46,679 Dividends on convertible preferred securities, net of income tax benefit 3,104 3,104 ------------ ------------ Income before cumulative effect of change in accounting principle 62,378 43,575 Cumulative effect of change in accounting principle, net of income tax benefit and related minority interest - 2,334 ------------ ------------ Net income 62,378 41,241 Other comprehensive income (loss), net of tax and reclassification adjustment (14,411) 23,284 ------------ ------------ Total comprehensive income $ 47,967 $ 64,525 ============ ============ Netincome per common share before cumulative effect of change in accounting principle: Basic $ .24 $ .17 * Diluted $ .24 $ .17 * Net income per common share: Basic $ .24 $ .16 * Diluted $ .24 $ .16 * Compounded dividend rate declared on common stock - 1.51% ============ ============ *Adjusted for subsequent stock dividends. The accompanying Notes are an integral part of these Financial Statements. </TABLE> 4
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (In thousands) <TABLE> <CAPTION> <S> <C> <C> 1999 1998 ------------- ------------- Net cash provided by operating activities $ 245,524 $ 156,382 ------------- ------------- Cash flows from investing activities: Construction expenditures (326,167) (221,399) Securities purchased (629,546) (399,457) Securities sold 653,035 386,194 Securities matured - 2,000 Other 223 6,565 ------------- ------------- Net cash provided from investing activities (302,455) (226,097) ------------- ------------- Cash flows from financing activities: Long-term debt borrowings 320,150 96,627 Long-term debt principal payments (157,915) (11,658) Short-term debt repayments (110,000) - Issuance of common stock 4,088 5,008 Common stock buybacks (3,718) - ------------- ------------- Net cash provided from financing activities 52,605 89,977 ------------- ------------- Increase (decrease) in cash (4,326) 20,262 Cash at January 1, 31,922 35,163 ------------- ------------- Cash at June 30, $ 27,596 $ 55,425 ============= ============= The accompanying Notes are an integral part of these Financial Statements. </TABLE> 5
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Summary of Significant Accounting Policies: ------------------------------------------ (a) Basis of Presentation: The unaudited consolidated financial statements include the accounts of Citizens Utilities Company and its subsidiaries (the Company) and have been prepared in conformity with generally accepted accounting principles. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 1998 Annual Report on Form 10-K. These unaudited consolidated financial statements include all adjustments, which consist of normal recurring accruals necessary to present fairly the results for the interim periods shown. Certain information and footnote disclosures have been condensed pursuant to Securities and Exchange Commission rules and regulations. The results of the interim periods are not necessarily indicative of the results for the full year. Certain reclassifications of balances previously reported have been made to conform to current presentation. (b) Regulatory Assets and Liabilities: The Company's regulated operations are subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." SFAS 71 requires regulated entities to record regulatory assets and liabilities as a result of actions of regulators. (c) Net Income Per Common Share: Basic net income per common share is computed using the weighted average number of common shares outstanding during the period being reported on. Diluted net income per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock at the beginning of the period being reported on. In 1998, both Basic and Diluted net income per common share calculations are presented with adjustments for subsequent stock dividends. (d) Change in Accounting Principle: In April 1998, the Accounting Standards Executive Committee of the AICPA released Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-Up Activities." SOP 98-5 requires that the unamortized portion of deferred start-up costs be written off and reported as a change in accounting principle. Future costs of start-up activities should then be expensed as incurred. Certain third party direct costs incurred by Electric Lightwave, Inc. (ELI) in connection with negotiating and securing initial rights-of-way and developing network design for new market clusters or locations had been capitalized by ELI in previous years and were being amortized over five years. The Company adopted SOP 98-5 effective January 1, 1998. The net book value of these deferred amounts was $3,394,000 which has been reported as a cumulative effect of a change in accounting principle in the statements of income and comprehensive income for the first quarter 1998, net of income tax benefit of $577,000 and related minority interest of $483,000. (2) Separation: ---------- On May 18, 1998, the Company announced its plans to separate its communications businesses and public services businesses into two stand-alone publicly traded companies. The Company had planned to transfer to NewTelecom all of its telecommunications businesses, including its approximate 82% ownership interest in ELI. This separation was subject to federal and state regulatory approvals and was expected to be carried out through a distribution of the stock of NewTelecom to the Company's shareholders. The public services businesses were to continue to operate as Citizens Utilities Company and provide natural gas transmission and distribution, electric transmission and distribution, water distribution and wastewater treatment services. This separation was being made in recognition of the different investment features, performance criteria, capital structures, dividend policies, customers' requirements and regulatory designs of each business, and would have allowed each business to pursue its own strategy and to compete more effectively in its respective markets. Through May 1999, the Company had been pursuing its separation plans, however, other opportunities have since become available to acquire telecommunications properties which have resulted in the Company's desire to no longer pursue separation plans. On May 27, 1999 the Company announced that it has entered into definitive agreements to purchase from GTE Corporation 187,000 telephone access lines (as of year-end 1998) in Arizona, California and Minnesota for approximately $664,000,000 in cash. The Company expects that the acquisition, which is subject to various state and federal regulatory approvals, is expected to be completed in 2000. 6
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On June 16, 1999 the Company announced that it has entered into a series of definitive agreements to purchase from US West 530,000 telephone access lines (as of year-end 1998) in Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, North Dakota and Wyoming for approximately $1,650,000,000 in cash. The Company expects that the acquisition, which is subject to various state and federal regulatory approvals, will occur on a state-by-state basis, is expected to be completed in 2000. The Company expects to temporarily fund the access line purchases with cash and investment balances and bank credit facilities. The Company expects to permanently fund the purchases with proceeds from the sale of the Company's public services businesses and has appointed the investment banking firm Morgan Stanley Dean Witter as financial advisor to develop the divestiture plans. (3) Net Income Per Common Share: --------------------------- The reconciliation of the net income per common share calculation for the three and six months ended June 30, 1999 and 1998, respectively, is as follows: <TABLE> <CAPTION> <S> <C> <C> <C> <C> <C> <C> For the three months ended June 30, ----------------------------------------------------------------------------- 1999 1998 --------------------------------- ------------------------------------- ($ in thousands, except for per share amounts) Per Per Income Shares Share Income Shares Share --------------------------------- ------------------------------------- Net income per common share: Basic $ 7,753 260,143 $ .03 $ 14,462 259,619 $ .06 Effect of dilutive options - 1,412 - - 704 - Diluted $ 7,753 261,555 $ .03 $ 14,462 260,323 $ .06 For the six months ended June 30, ----------------------------------------------------------------------------- 1999 1998 -------------------------------- ------------------------------------ ($ in thousands, except for per share amounts) Per Per Income Shares Share Income Shares Share -------------------------------- ------------------------------------ Net income per common share: Basic $ 62,378 259,775 $ .24 $ 41,241 259,339 $ .16 Effect of dilutive options - 1,714 - - 669 - Diluted $ 62,378 261,489 $ .24 $ 41,241 260,008 $ .16 </TABLE> All share amounts represent weighted average shares outstanding for each respective period. 1998 per share amounts have been adjusted for subsequent stock dividends. The diluted net income per common share calculation excludes the effect of potentially dilutive shares when their exercise price exceeds the average market price over the period. The Company has 4,025,000 shares of potentially dilutive Mandatorily Redeemable Convertible Preferred Securities which are convertible into common stock at a 3.76 to 1 ratio at an exercise price of $13.30 per share and 6,794,530 potentially dilutive stock options at a range of $9.99 to $14.24 per share. These items were adjusted for subsequent stock dividends and were not included in the diluted net income per common share calculation for any of the above periods as their effect was antidilutive. 7
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (4) Sale of Investments: ------------------- In January 1999, Centennial Cellular Corp. (Centennial) was merged with CCW Acquisition Corp., a company organized at the direction of Welsh, Carson, Anderson & Stowe. The Company was a holder of 1,982,294 shares of Centennial Class B Common Stock. In addition, as a holder of 102,187 shares of Mandatorily Redeemable Convertible Preferred Stock of Centennial, the Company was required to convert the preferred stock into approximately 2,972,000 shares of Class B Common Stock. The Company received approximately $205,600,000 in cash for all of its Common Stock interests and approximately $17,500,000 related to accrued dividends on the preferred stock. The Company recorded a pre-tax gain of approximately $69,500,000 on this transaction in January 1999 which is included in other income, net. In March 1999, Adelphia Communication Corporation (Adelphia) and Century Communications Corp. (Century) announced the signing of a definitive agreement for the merger of Century with Adelphia. The Company currently owns 1,807,095 shares of Century Class A Common Stock. Pursuant to the merger agreement, each Century Class A Common Share will be exchanged for cash of $9.16 and .6122 of a share of Adelphia Class A Common Stock (for a total market value of $46.20 per Century Class A Common Share based on Adelphia's July 29, 1999 closing price of $60.50.) This transaction is expected to close during the fourth quarter of 1999. A subsidiary of the Company, in a joint venture with a subsidiary of Century, acquired and operates four cable television systems in southern California serving over 90,000 basic subscribers. The Company accounts for the joint venture following the equity method of accounting. The Company has entered into an agreement to sell its interest in the joint venture to Adelphia. Pursuant to this agreement, the Company will receive approximately $27,700,000 in cash and 1,852,302 shares of Adelphia Class A Common Stock (for a total market value of $139,764,000 based on Adelphia's July 29, 1999 closing price of $60.50.) This transaction is expected to close concurrent with the merger of Adelphia and Century. (5) Segment Information: ------------------- The Company is a diversified communications and public services company which is segmented into communications, CLEC, gas, electric and water and wastewater services. The communications sector provides both regulated and competitive communications services to residential, business and wholesale customers. The CLEC sector is a facilities based integrated communications provider providing a broad range of communications services throughout the United States through the Company's subsidiary, ELI. The gas sector provides gas transmission and distribution services to primarily residential customers. The electric sector provides electric transmission and distribution services to primarily residential customers. The water and wastewater sector provides water distribution, wholesale water transmission, wastewater treatment and public works consulting services to primarily residential customers and also provides marketing and billing services to others. Special items charged against operating income and sector EBITDA during 1999 and 1998 include Y2K and separation costs (see Note 2). Sector EBITDA consists of sector operating income plus depreciation. EBITDA is a measure commonly used to analyze companies on the basis of operating performance. It is not a measure of financial performance under generally accepted accounting principles and should not be considered as an alternative to net income as a measure of performance nor as an alternative to cash flow as a measure of liquidity and may not be compared to similarly titled measures of other companies. 8
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS <TABLE> <CAPTION> <S> <C> <C> <C> <C> For the three months For the six months ended June 30, ended June 30, ------------------------------- ------------------------------ ($ in thousands) ($ in thousands) 1999 1998 1999 1998 ------------- ------------- ------------- ------------- Communications: - -------------- Revenues $ 240,990 $ 211,431 $ 478,875 $ 424,592 Inter-sector revenues (12,369) (7,623) (23,022) (15,426) Revenues as reported 228,621 203,808 455,853 409,166 Operating income excluding special items 46,674 39,856 87,752 78,178 Operating income as reported 40,085 39,582 77,393 77,630 Depreciation 51,613 46,120 106,504 91,275 EBITDA excluding special items 98,287 85,976 194,256 169,453 EBITDA 91,698 85,702 183,897 168,905 CLEC: - ---- Revenues $ 46,095 $ 21,443 $ 84,311 $ 41,500 Inter-sector revenues (770) (740) (1,468) (1,615) Revenues as reported 45,325 20,703 82,843 39,885 Operating loss excluding special items (24,178) (16,091) (53,723) (30,321) Operating loss as reported (25,114) (16,091) (55,290) (30,321) Depreciation 8,150 3,780 15,144 7,664 EBITDA excluding special items (16,028) (12,311) (38,579) (22,657) EBITDA (16,964) (12,311) (40,146) (22,657) Public Services: - --------------- Gas: --- Revenues $ 68,955 $ 75,618 $ 172,911 $ 187,201 Operating income excluding special items 6,056 6,831 25,729 28,735 Operating income as reported 5,294 6,769 24,130 28,611 Depreciation 6,621 5,752 10,901 11,259 EBITDA excluding special items 12,677 12,583 36,630 39,994 EBITDA 11,915 12,521 35,031 39,870 Electric: -------- Revenues $ 47,162 $ 43,799 $ 93,236 $ 91,073 Operating income excluding special items 6,301 4,983 12,558 11,562 Operating income as reported 5,922 4,956 12,176 11,509 Depreciation 6,061 5,880 12,042 11,747 EBITDA excluding special items 12,362 10,863 24,600 23,309 EBITDA 11,983 10,836 24,218 23,256 Water and Wastewater: -------------------- Revenues $ 24,784 $ 22,419 $ 47,518 $ 42,885 Operating income excluding special items 6,794 6,326 12,073 10,429 Operating income as reported 5,234 6,289 9,335 10,354 Depreciation 4,039 3,233 7,534 6,417 EBITDA excluding special items 10,833 9,559 19,607 16,846 EBITDA 9,273 9,522 16,869 16,771 </TABLE> 9
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table is a reconciliation of certain sector items to the total consolidated amount. <TABLE> <CAPTION> <S> <C> <C> <C> <C> <C> <C> For the three months For the six months ended June 30, ended June 30, ------------------------------- ------------------------- ($ in thousands) ($ in thousands) 1999 1998 1999 1998 -------------- -------------- ----------- ---------- Operating income - ---------------- Total sector operating income excluding special items $ 41,647 $ 41,905 $ 84,389 $ 98,583 Y2K and separation costs (10,226) (400) (16,645) (800) -------------- -------------- ------------- ------------- Consolidated reported operating income $ 31,421 $ 41,505 $ 67,744 $ 97,783 ============== ============== ============== ============= EBITDA - ------ Total sector EBITDA excluding special items $ 118,131 $ 106,670 $ 236,514 $ 226,945 Investment and other income 6,344 7,683 12,037 18,321 Gain on sale of Centennial - - 69,499 - Minority interest 5,693 3,053 11,686 5,136 Y2K and separation costs (10,226) (400) (16,645) (800) -------------- ------------- ------------- ------------ Consolidated EBITDA $ 119,942 $ 117,006 $ 313,091 $ 249,602 ============== ============== ============= ============ </TABLE> 10
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operations --------------------- This quarterly report on Form 10-Q contains forward-looking statements that are subject to risks and uncertainties which could cause actual results to differ materially from those expressed or implied in the statements. All forward-looking statements (including oral representations) are only predictions or statements of current plans, which are constantly under review by the Company. All forward-looking statements may differ from actual future results due to, but not limited to, changes in the economy of the Company's markets, the nature and pace of technological changes, the number and effectiveness of competitors in the Company's markets, weather conditions, changes in legal and regulatory policy, success in overall strategy, the Company's ability to identify future markets and successfully expand existing ones, the mix of products and services offered in the Company's target markets, Y2K issues, the effects of separation and acquisitions and/or dispositions. Readers should consider these important factors in evaluating any statement in this Form 10-Q or otherwise made by the Company or on its behalf. The following information is unaudited and should be read in conjunction with the consolidated financial statements and related notes to consolidated financial statements included in this report and as presented in the Company's 1998 Annual Report on Form 10-K previously filed. The Company has no obligation to update or revise these forward-looking statements to reflect the occurrence of future events or circumstances. On May 18, 1998, the Company announced its plans to separate its communications businesses and public services businesses into two stand-alone publicly traded companies. The Company had planned to transfer to NewTelecom all of its communications businesses, including its approximate 82% ownership interest in ELI. This separation was subject to federal and state regulatory approvals and was expected to be carried out through a distribution of the stock of NewTelecom to the Company's shareholders. The public services businesses were to continue to operate as Citizens Utilities Company and provide natural gas transmission and distribution, electric transmission and distribution, water distribution and wastewater treatment services. This separation was being made in recognition of the different investment features, performance criteria, capital structures, dividend policies, customers' requirements and regulatory designs of each business, and would have allowed each business to pursue its own strategy and to compete more effectively in its respective markets. Through May 1999, the Company had been pursuing its separation plans, however, other opportunities have since become available to acquire communications properties which fit within the Company's acquisition criteria and have led the Company to discontinue its separation plans. On May 27, 1999 the Company announced that it has entered into definitive agreements to purchase from GTE Corporation 187,000 telephone access lines (as of year-end 1998) in Arizona, California and Minnesota for approximately $664,000,000 in cash. The Company expects that the acquisition, which is subject to various state and federal regulatory approvals, and is expected to be completed in 2000, at which time the total access lines should number approximately 200,000. On June 16, 1999 the Company announced that it has entered into a series of definitive agreements to purchase from US West 530,000 telephone access lines (as of year-end 1998) in Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, North Dakota and Wyoming for approximately $1,650,000,000 in cash. The Company expects that the acquisition, which is subject to various state and federal regulatory approvals, will occur on a state-by-state basis and is expected to be completed in 2000, at which time the total access lines should number approximately 570,000. The Company expects to temporarily fund the access line purchases with cash and investment balances and bank credit facilities. The Company expects to permanently fund the purchases with proceeds from the sale of the Company's public services businesses and has appointed the investment banking firm Morgan Stanley Dean Witter as financial advisor to develop the divestiture plans. 11
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES (a) Liquidity and Capital Resources ------------------------------- The Company considers its operating cash flows and its ability to raise debt and equity capital as the principal indicators of its liquidity. For the six months ended June 30, 1999, the Company used cash flow from operations and proceeds from net financings and parties desiring utility services to fund capital expenditures. Funds requisitioned from the Industrial Development Revenue Bond construction fund trust accounts were used to partially fund the construction of utility plant. The Company has committed revolving lines of credit with commercial banks under which it may borrow up to $575,000,000. There were no amounts outstanding under these lines at June 30, 1999. ELI has committed revolving lines of credit with commercial banks under which it may borrow up to $400,000,000. The Company has guaranteed all of ELI's obligations under these revolving lines of credit. As of June 30, 1999, $130,000,000 was outstanding under ELI's revolving lines of credit. In April 1999, ELI completed an offering of $325 million of five-year senior unsecured notes. The notes have an interest rate of 6.05% and mature on May 15, 2004. The Company has guaranteed the payment of principal, any premium and interest on the notes when due. In January 1999, Centennial Cellular Corp. (Centennial) was merged with CCW Acquisition Corp., a company organized at the direction of Welsh, Carson, Anderson & Stowe. The Company was a holder of 1,982,294 shares of Centennial Class B Common Stock. In addition, as a holder of 102,187 shares of Mandatorily Redeemable Convertible Preferred Stock of Centennial, the Company was required to convert the preferred stock into approximately 2,972,000 shares of Class B Common Stock. The Company received approximately $205,600,000 in cash for all of its Common Stock interests and approximately $17,500,000 related to accrued dividends on the preferred stock. The Company recorded a pre-tax gain of approximately $69,500,000 on this transaction in January 1999 which is included in other income, net. In March 1999, Adelphia Communication Corporation (Adelphia) and Century Communications Corp. (Century) announced the signing of a definitive agreement for the merger of Century with Adelphia. The Company currently owns 1,807,095 shares of Century Class A Common Stock. Pursuant to the merger agreement, each Century Class A Common Share will be exchanged for cash of $9.16 and .6122 of a share of Adelphia Class A Common Stock (for a total market value of $46.20 per Century Class A Common Share based on Adelphia's July 29, 1999 closing price of $60.50.) This transaction is expected to close during the fourth quarter of 1999. A subsidiary of the Company, in a joint venture with a subsidiary of Century, acquired and operates four cable television systems in southern California serving over 90,000 basic subscribers. The Company accounts for the joint venture following the equity method of accounting. The Company has entered into an agreement to sell its interest in the joint venture to Adelphia. Pursuant to this agreement, the Company will receive approximately $27,700,000 in cash and 1,852,302 shares of Adelphia Class A Common Stock (for a total market value of $139,764,000 based on Adelphia's July 29, 1999 closing price of $60.50.) This transaction is expected to close concurrent with the merger of Adelphia and Century. In May 1999, in connection with HTCC's debt restructuring, the Company cancelled HTCC's $8,400,000 note obligation and the seven-year consulting services agreement in exchange for the issuance by HTCC to the Company of 1,300,000 shares of HTCC common stock and 30,000 shares of HTCC's 5% convertible preferred stock. Each share of HTCC convertible preferred stock has a liquidation value of $70 and is convertible at the option of the Company into 10 shares of HTCC common stock. To the extent the 1,300,000 HTCC common shares and the 300,000 HTCC common shares underlying the HTCC convertible preferred stock do not achieve an average market closing price of at least $7 per share during a certain period prior to March 31, 2000, HTCC has agreed to issue additional HTCC convertible preferred shares with a value equal to any such shortfall. 12
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES Impact of the Year 2000 ----------------------- The Y2K issue results from computer programs using a two-digit format, as opposed to four, to indicate the year. Such computer systems may be unable to interpret dates beyond the year 1999, which could cause system failures or other computer errors. In late 1997, the Company developed a four-phase program to address the Y2K issue. The four-phase program was designed to protect the safety and continuity of the Company's service delivery and support capabilities, computer systems and other critical functions. The Company's Y2K program seeks to address problems that could arise: (1) in Information Technology (IT) areas including information systems and technologies; (2) in non-IT areas such as communications networks and switches, utility control and monitoring systems, premises, facilities and general business equipment; and (3) due to suppliers of products and services not being Y2K compliant. Phase I is inventory and identification of those systems with which the Company has exposure to Y2K issues. Phase II is the assessment and development of action plans. Phase III is the implementation of the Y2K remediation plans. Phase IV, which in some instances will run concurrent with Phase III, is the testing and validation of each remedial action to ensure compliance. This phase includes, in some cases, testing in an environment identical to, but separate from, the production environment. Each of the Company's sectors has a program office that manages the progress of the Y2K efforts. The Company has determined priorities for taking corrective actions on mission critical systems or products so as to ensure continued delivery of core business activities. The Company is and will continue to use both internal and external resources to reprogram, replace and test software and address remediation of IT and non-IT operational assets for Y2K compliance. The Company has contracted with consulting firms to provide direction, support, methodologies, reporting standards and templates. The following table includes information, by Phase, related to the Y2K program for both the Company's sectors. The timing of expenses may vary and is not necessarily indicative of readiness efforts or progress to date. Funding of the Y2K costs is expected to occur from operating cash flows, cash and investments and proceeds from the issuance of securities and/or other borrowings. <TABLE> <CAPTION> <S> <C> <C> <C> <C> <C> Estimated Expenditures --------------------------------------------------- Completion Dates Actual for Estimated for Total for Mission six months six months Estimated for Critical Systems ended ended the year ended and Products % Completed 6/30/99 12/31/99 12/31/99 ------------------- ----------- ------- -------- -------- Communications and Corporate IT $6,239,000 $ 10,953,000 $ 17,192,000 -- Inventory Completed 100% Assessment Completed 100% Remediation 9/30/99 98% Testing 9/30/99 93% Non-IT 173,000 1,611,000 1,784,000 ------ Inventory Completed 100% Assessment Completed 100% Remediation 9/30/99 96% Testing 9/30/99 67% Public Services IT 2,717,000 197,000 2,914,000 -- Inventory Completed 100% Assessment Completed 100% Remediation Completed 100% Testing 8/31/99 97% Non-IT 3,680,000 1,584,000 5,264,000 ------ Inventory Completed 100% Assessment Completed 100% Remediation Completed 100% Testing Completed 100% --------------- ---------------- ---------------- Total $ 12,809,000 $ 14,345,000 $ 27,154,000 ================ ================ ================ </TABLE> 13
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES Certain public services state regulatory commissions, where the Company operates, have issued orders allowing the deferral of Y2K costs for consideration in future rate proceedings. In accordance with these orders the Company deferred $2,388,000 in 1999. The systems of vendors and suppliers play a major role in the conduct of the business of the Company. As a result, as part of its Y2K program, the Company has been contacting software suppliers to determine major areas of exposure to Y2K issues. The Company has also been contacting its major suppliers and service providers to ascertain their ability to comply. In addition, the Company contracted with a consulting firm to review the Y2K programs of selected third party vendors. Thus far, most of these parties have stated that they intend to be Y2K compliant by the year 2000. However, there can be no guarantee that the systems of suppliers or service providers on which the Company's systems rely will be compliant, or that failure to be compliant by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. The Company's communications businesses rely, directly and/or indirectly, on a large number of traffic carriers to carry communications traffic through a series of interconnected chains of communications. Therefore, despite its efforts, the Company cannot ensure that each entity involved in the delivery of communications services will be Y2K compliant. In an effort to address third party compliance issues, the Company's communications sector has initiated testing activities with one of its major suppliers. The electric power-supply systems of North America are connected into four major interconnections called grids. Operational component failures of any entity connected to any of the grids could cause failures in that grid. The Company continues to assess these risks as the millennium approaches to evaluate the likelihood of failures and develop approaches for mitigating the risk of failures. In addition, the Company participates in trade associations such as the Electric Power Research Institute (EPRI) and the American Gas Association (AGA), which furthers the industry's efforts toward Y2K readiness. The Company uses these organizations' Y2K programs' vast resources to accelerate its Y2K program for embedded systems. They also provide a forum for working within the industry peer group whereby joint conclusions may be reached on other key aspects of Y2K readiness. EPRI's Y2K program participants represent more than 70% of the electric power generation capacity in the U.S. AGA represents 181 natural gas utilities that deliver gas to homes and businesses in all fifty states. The Company has completed approximately 90% of its Y2K remediation efforts on mission critical systems and products so as to ensure continued delivery of core business activities to our customers. Testing, remediation and monitoring will continue through the remainder of 1999 to verify that there are no outstanding problems that either were not captured during the initial Y2K efforts or arose after June 30, 1999. Also, review, modifications and testing of the contingency plans will take place throughout the remainder of 1999 and into the year 2000. The Contingency Plans for the Company was completed to meet the June 30, 1999 milestone. The plans are dedicated to ensuring that established and expected levels of customer service are maintained without interruption, while core business functionality is preserved during the millennium transition. Additionally, the plans utilize existing operating policies and procedures, disaster recovery plans, and enterprise prioritization of all systems and applications by examining potential exposures while documenting clear mitigation strategies. Contingency planning, risk mitigation, and testing activities will continue through the year rollover by all Company organizations. The extent and magnitude of the Y2K problem is difficult to predict or quantify. The above information is based on the Company's best estimates which were made using numerous assumptions, including the availability and future costs of certain technological and other resources, third party modification actions and other factors. Given the complexity of the issue and the possibility of unidentified risks, actual results may vary materially from those discussed above. Specific factors that might cause such differences include, among others, the availability and cost of the personnel trained in this area, the ability to locate and correct all affected computer codes, the timing and success of remedial efforts of third party suppliers and similar uncertainties. 14
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES (b) Results of Operations --------------------- REVENUES -------- Total revenues for the three and six months ended June 30, 1999 increased $48.5 million, or 13%, and $82.2 million, or 11%, respectively, as compared with the prior year periods primarily due to increases in communications and CLEC revenues. Communications/CLEC Revenues ---------------------------- Communications and CLEC revenues for the three and six months ended June 30, 1999 increased $49.4 million, or 22%, and $89.6 million, or 20%, respectively, as compared with the prior year periods primarily due to an increase in communications network access services and CLECs local telephone and long distance services. <TABLE> <CAPTION> <S> <C> <C> <C> <C> <C> <C> For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ Communications revenues 1999 1998 (Decrease) 1999 1998 (Decrease) - ----------------------- ----------- ----------- ------------ ----------- ----------- ------------ Network access services $ 128,524 $ 104,121 23% $ 257,204 $ 208,007 24% Local network services 72,079 64,896 11% 141,992 128,314 11% Long distance services 19,832 21,409 (7%) 40,933 48,187 (15%) Directory services 8,375 8,025 4% 16,772 15,808 6% Other 12,180 12,980 (6%) 21,974 24,276 (9%) Eliminations (12,369) (7,623) N/A (23,022) (15,426) N/A ----------- ----------- ----------- ----------- $ 228,621 $ 203,808 12% $ 455,853 $ 409,166 11% =========== =========== =========== =========== </TABLE> Network access services revenues for the three months ended June 30, 1999 increased $24.4 million, or 23%, as compared with the prior year period primarily due to increased minutes of use, an increase in special access and universal service fund revenues and the acquisition of Rhinelander Telecommunications, Inc. (RTI) in November 1998. Network access services revenues for the six months ended June 30, 1999 increased $49.2 million, or 24%, as compared with the prior year period primarily due to an interstate universal service fund settlement, increased minutes of use, an increase in special access revenues and the acquisition of RTI in November 1998. Local network services revenues for the three and six months ended June 30, 1999 increased $7.2 million, or 11%, and $13.7 million, or 11%, respectively, as compared with the prior year periods primarily due to access line growth, the acquisition of RTI and increased custom calling features and private line sales. Long distance services revenues for the three and six months ended June 30, 1999 decreased $1.6 million, or 7%, and $7.3 million, or 15%, respectively, as compared with the prior year periods primarily due to the elimination of long distance product offerings to out-of-territory customers. Directory services revenues for the three and six months ended June 30, 1999 increased $.4 million, or 4%, and $1 million, or 6%, respectively, as compared with the prior year periods primarily to the acquisition of RTI and an increase in advertising revenue. Other revenues for the three and six months ended June 30, 1999 decreased $.8 million, or 6%, and $2.3 million, or 9%, respectively, as compared with the prior year periods primarily due to the phasing out of certain surcharges resulting from regulatory decisions in California and New York. Eliminations represent network access revenues received by the Company's local exchange operations from its long distance operations and CLEC operations. 15
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES <TABLE> <CAPTION> <S> <C> <C> <C> <C> <C> <C> For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ CLEC revenues 1999 1998 (Decrease) 1999 1998 (Decrease) - ------------- ----------- ----------- ------------- ----------- ----------- ------------- Network services $ 12,983 $ 8,371 55% $ 23,407 $ 17,478 34% Local telephone services 18,600 7,769 139% 32,908 13,793 139% Long distance services 9,245 1,899 387% 17,775 3,721 378% Data services 5,267 3,404 55% 10,221 6,508 57% Eliminations (770) (740) N/A (1,468) (1,615) N/A ----------- ----------- ----------- ------------ $ 45,325 $ 20,703 119% $ 82,843 $ 39,885 108% =========== =========== =========== =========== Network services revenues for the three and six months ended June 30, 1999 increased $4.6 million, or 55%, and $5.9 million, or 34%, respectively, as compared with the prior year periods primarily due to sales of additional circuits to new and existing customers, partially offset by the expiration of a short-term contract with a significant customer in the first quarter of 1999. Local telephone services revenues for the three and six months ended June 30, 1999 increased $10.8 million, or 139%, and $19.1 million, or 139%, respectively, as compared with the prior year periods primarily due to an increase in reciprocal compensation revenues that are earned under various interconnection agreements. In addition, increased sales of the integrated service digital network (ISDN) product to Internet Service Providers and an increase in local dial tone services contributed to the increase. Long distance services revenues for the three and six months ended June 30, 1999 increased $7.3 million, or 387%, and $14.1 million, or 378%, respectively, as compared with the prior year periods primarily due to increases in prepaid services resulting from new large volume customers. Data services revenues for the three and six months ended June 30, 1999 increased $1.9 million, or 55%, and $3.7 million, or 57%, respectively, as compared with the prior year periods primarily due to increased sales from Internet and frame relay services. Eliminations reflect intercompany activity between the Company's CLEC and communications sectors. 16
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES Public Services Revenues ------------------------ Public services revenues for the three and six months ended June 30, 1999 decreased $.9 million, or 1%, and $7.5 million, or 2%, respectively, as compared with the prior year periods primarily due to decreased gas revenues, offset by increased electric and water and wastewater revenues. For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ Gas revenues 1999 1998 (Decrease) 1999 1998 (Decrease) - ------------ ----------- ----------- ------------ ----------- ----------- ------------- Residential $ 29,164 $ 33,297 (12%) $ 81,138 $ 95,400 (15%) Commercial 21,550 25,970 (17%) 53,236 61,748 (14%) Industrial 8,652 12,138 (29%) 23,691 19,570 21% Municipal 656 827 (21%) 1,922 2,672 (28%) ----------- ----------- ----------- ----------- Total Distribution 60,022 72,232 (17%) 159,987 179,390 (11%) Transportation 4,023 440 814% 5,050 1,392 263% Other 4,910 2,946 67% 7,874 6,419 23% ----------- ----------- ----------- ----------- $ 68,955 $ 75,618 (9%) $ 172,911 $ 187,201 (8%) =========== =========== =========== =========== Residential, commercial and municipal revenues for the three and six months ended June 30, 1999 decreased $8.7 million, or 15%, and $23.5 million, or 15%, respectively, as compared with the prior year periods primarily due to lower purchased gas costs passed on to customers and decreased consumption due to warmer weather conditions in certain of the Company's service territories. Industrial revenues for the three months ended June 30, 1999 decreased $3.5 million, or 29%, as compared with the prior year period primarily due to decreased consumption by a significant customer. Industrial revenues for the six months ended June 30, 1999 increased $4.1 million, or 21%, as compared with the prior year period primarily due to increased consumption and an increase in customers. Transportation and other revenues for the three and six months ended June 30, 1999 increased $5.5 million, or 164%, and $5.1 million, or 65%, respectively, primarily due to increased consumption by industrial customers, partially offset by decreased consumption by residential and commercial customers. 17
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ Electric revenues 1999 1998 (Decrease) 1999 1998 (Decrease) - ----------------- ----------- ----------- ------------ ----------- ----------- ------------- Residential $ 18,359 $ 17,732 4% $ 38,685 $ 38,511 0% Commercial 14,405 13,269 9% 27,998 26,433 6% Industrial 10,794 9,633 12% 20,053 19,710 2% Municipal 1,966 2,036 (3%) 3,944 3,931 0% ----------- ----------- ----------- ----------- Total Distribution 45,524 42,670 7% 90,680 88,585 2% Transportation 48 917 (95%) 953 1,488 (36%) Other 1,590 212 650% 1,603 1,000 60% ----------- ----------- ----------- ----------- $ 47,162 $ 43,799 8% $ 93,236 $ 91,073 2% =========== =========== =========== =========== Electric revenues for the three and six months ended June 30, 1999 increased $3.4 million, or 8%, and $2.2 million, or 2%, respectively, as compared with the prior year periods primarily due to higher purchased electric energy and fuel oil costs passed on to customers and increased consumption. For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ Water and Wastewater revenues 1999 1998 (Decrease) 1999 1998 (Decrease) - ----------------------------- ----------- ----------- ------------ ----------- ----------- ------------- Residential distribution $ 18,226 $ 17,784 2% $ 35,820 $ 34,197 5% Commercial distribution 4,657 3,347 39% 7,799 6,255 25% Industrial distribution 291 237 23% 523 447 17% Other 1,610 1,051 53% 3,376 1,986 70% ----------- ----------- ----------- ----------- $ 24,784 $ 22,419 11% $ 47,518 $ 42,885 11% =========== =========== =========== =========== Water and wastewater revenues for the three and six months ended June 30, 1999 increased $2.4 million, or 11%, and $4.6 million, or 11%, respectively, as compared with the prior year periods primarily due to customer growth, increased consumption and rate increases in Ohio in January 1999 and California in November 1998. 18
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES OPERATING EXPENSES ------------------ For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ Cost of Services 1999 1998 (Decrease) 1999 1998 (Decrease) - ---------------- ----------- ----------- ------------ ----------- ----------- ------------- Gas purchased $ 32,850 $ 38,973 (16%) $ 85,554 $ 98,167 (13%) Network expenses 47,033 29,991 57% 92,779 65,763 41% Electric energy and fuel oil purchased 22,873 20,094 14% 43,456 41,838 4% Eliminations (13,139) (8,363) N/A (24,490) (17,041) N/A ----------- ----------- ----------- ----------- $ 89,617 $ 80,695 11% $ 197,299 $ 188,727 5% =========== =========== =========== =========== Gas purchased expenses for the three and six months ended June 30, 1999 decreased $6.1 million, or 16%, and $12.6 million, or 13%, respectively, as compared with the prior year periods primarily due to a decrease in the cost of gas and lower consumption as a result of warmer weather conditions in the Company's service territories. Network expenses for the three and six months ended June 30, 1999 increased $17 million, or 57%, and $27 million, or 41%, respectively, as compared with the prior year periods primarily due to increases in long distance costs related to the Company's CLEC subsidiary's prepaid services programs and expenses related to the CLEC national data expansion. The increase in CLEC's network expenses was partially offset by decreased communications network expenses primarily due to decreased long distance minutes of use. Electric energy and fuel oil purchased expenses for the three and six months ended June 30, 1999 increased $2.8 million, or 14%, and $1.6 million, or 4%, respectively, as compared with the prior year periods primarily due to higher supplier prices and increased consumption. Eliminations represent network expenses incurred by the Company's long distance operation for services provided by its local exchange operations and intercompany activity between the Company's CLEC and communications sectors. For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ 1999 1998 (Decrease) 1999 1998 (Decrease) ----------- ----------- ------------ ----------- ----------- ------------- Depreciation expense $ 76,484 $ 64,765 18% $ 152,125 $ 128,362 19% Depreciation expense for the three and six months ended June 30, 1999 increased $11.7 million, or 18% and $23.8 million, or 19%, respectively, as compared with the prior year periods primarily due to increased property, plant and equipment. 19
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ Other Operating Expenses 1999 1998 (Decrease) 1999 1998 (Decrease) - ------------------------ ----------- ----------- ------------ ----------- ----------- ------------- Operating and maintenance $ 172,456 $ 146,930 17% $ 345,065 $ 286,863 20% Taxes other than income 27,239 21,899 24% 55,935 48,873 14% Sales and marketing 17,630 10,553 67% 34,193 19,602 74% ----------- ----------- ----------- ----------- $ 217,325 $ 179,382 21% $ 435,193 $ 355,338 22% =========== =========== =========== =========== Operating and maintenance expenses for the three and six months ended June 30, 1999 increased $25.5 million, or 17%, and $58.2 million, or 20%, respectively, as compared with the prior year periods primarily due to increased CLEC operating expenses as a result of the CLEC national data expansion, increased Y2K and separation expenses and the acquisition of RTI. Taxes other than income for the three and six months ended June 30, 1999 increased $5.3 million, or 24%, and $7.1 million or 14%, respectively, as compared with the prior year periods primarily due to an increase in payroll and property taxes. Sales and marketing expenses for the three and six months ended June 30, 1999 increased $7.1 million, or 67%, and $14.6 million, or 74%, respectively, as compared with the prior year periods primarily due to increased personnel and product advertising to support the delivery of services in existing and new markets including the CLEC national data expansion. OTHER INCOME, NET /MINORITY INTEREST /INTEREST EXPENSE /INCOME TAXES For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ Other Income, Net 1999 1998 (Decrease) 1999 1998 (Decrease) - ----------------- ----------- ----------- ------------ ----------- ----------- ------------- Investment income $ 6,191 $ 7,851 (21%) $ 80,802 $ 16,622 386% Other 153 (168) 191% 734 1,699 (57%) ----------- ----------- ----------- ----------- $ 6,344 $ 7,683 (17%) $ 81,536 $ 18,321 345% =========== =========== =========== =========== Investment income for the three months ended June 30, 1999 decreased $1.7 million or 21% as compared with the prior year period primarily due to lower average investment balances. Investment income for the six months ended June 30, 1999 increased $64.2 million, or 386%, as compared with the prior year period primarily due to the $69.5 million gain on the sale of the Company's investment in Centennial in January 1999 partially offset by lower investment income earned due to lower average investment balances. Other income for the three months ended June 30, 1999 increased $.3 million, or 191%, as compared with the prior year period primarily due to a supplemental sales program for the supply of natural gas, offset by a decrease in the equity component of Allowance for Funds Used during Construction. Other income for the six months ended June 30, 1999 decreased $1 million or 57% as compared with the prior year period primarily due to a decrease in the equity component of Allowance for Funds Used during Construction. 20
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ 1999 1998 (Decrease) 1999 1998 (Decrease) ----------- ----------- ------------ ----------- ----------- ------------ Minority interest $ 5,693 $ 3,053 86% $ 11,686 $ 5,136 128% Minority interest is a result of ELI's initial public offering in November 1997 and it represents 17.51% (the minority's share) of ELI's loss before the income tax benefit and the cumulative effect of change in accounting principle in 1998. Minority interest for the three and six months ended June 30, 1999 increased $2.6 million, or 86%, and $6.6 million, or 128%, respectively, as compared with the prior year periods primarily due to increased losses recorded by ELI. For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ 1999 1998 (Decrease) 1999 1998 (Decrease) ----------- ----------- ------------ ----------- ----------- ------------- Interest expense $ 30,553 $ 28,589 7% $ 60,366 $ 55,395 9% Interest expense for the three and six months ended June 30, 1999 increased $2 million, or 7% and $5 million, or 9%, respectively, as compared with the prior year periods primarily due to an increase in the usage of ELI's outstanding line of credit and the issuance of $325 million of five-year unsecured notes in April 1999 by ELI. For the three months For the six months ended June 30, ended June 30, --------------------------------------------- ------------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ 1999 1998 (Decrease) 1999 1998 (Decrease) ----------- ----------- ------------ ----------- ----------- ------------- Income taxes $ 3,600 $ 7,638 (53%) $ 35,118 $ 19,166 83% Income taxes for the three and six months ended June 30, 1999 decreased $4 million, or 53% and increased $16 million, or 83%, as compared with the prior year periods primarily due to changes in taxable income. 21
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES NET INCOME AND NET INCOME PER COMMON SHARE ------------------------------------------- For the three months For the six months ended June 30, ended June 30, ------------------------------------------ ----------------------------------------- ($ in thousands) ($ in thousands) % % Increase/ Increase/ 1999 1998 (Decrease) 1999 1998 (Decrease) ------------ ------------ -------------- ------------ ------------- -------------- Net income $ 7,753 $ 14,462 (46%) $ 62,378 $ 41,241 51% Net income per common share: Basic $ .03 $ .06 (50%) $ .24 $ .16 50% Diluted $ .03 $ .06 (50%) $ .24 $ .16 50% </TABLE> Net income and net income per share for the three months ended June 30, 1999 decreased $6.7 million, or 46%, and .03(cent), or 50%, respectively, as compared with the prior year period primarily due to increased losses from the Company's CLEC subsidiary and Y2K and separation costs. Net income and net income per share for the six months ended June 30, 1999 increased $21.1 million, or 51%, and .08(cent), or 50%, respectively, as compared with the prior year period primarily due to the first quarter $69.5 million gain on the sale of the Company's investment in Centennial. 22
PART I. FINANCIAL INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES Item 3. Quantitative and Qualitative Disclosures about Market Risk ---------------------------------------------------------- The Company is exposed to the impact of interest rate and market risks. In the normal course of business, the Company employs established policies, procedures and internal processes to manage its exposure to interest rate and market risks. The Company's objective in managing its interest rate risk is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve these objectives, the Company refinances debt when advantageous and maintains fixed rate debt on a majority of its borrowings. In an effort to reduce interest rate risk the Company's CLEC subsidiary issued $325 million, five-year senior unsecured notes in April 1999 that are guaranteed by the Company. The notes have a fixed interest rate. The net proceeds from the issuance were used to repay outstanding borrowings under the Company's floating rate bank credit facility. The Company maintains a portfolio of investments consisting of both equity and debt financial instruments. The Company's equity portfolio is comprised of primarily investments in communications companies. The Company's bond portfolio consists of government, corporate and municipal fixed-income securities. The Company does not hold or issue derivative or other financial instruments for trading purposes. The Company purchases monthly gas futures contracts to manage well-defined commodity price fluctuations, caused by weather and other unpredictable factors, associated with the Company's commitments to deliver natural gas to certain industrial customers at fixed prices. This derivative financial instrument activity is not material to the Company's consolidated financial position, results of operations or cash flows. 23
PART II. OTHER INFORMATION CITIZENS UTILITIES COMPANY AND SUBSIDIARIES Item 1. Legal Proceedings ----------------- In November 1995, the Company's Vermont electric division was permitted an 8.5% rate increase. Subsequently, the Vermont Public Service Board (VPSB) called into question the level of rates awarded the Company in connection with its formal review of allegations made by the Department of Public Service (the DPS), the consumer advocate in Vermont and a former Citizens employee. The major issues in this proceeding involved classification of certain costs to property, plant and equipment accounts and the Company's Demand Side Management program. In addition, the DPS believed that the Company should have sought and received regulatory approvals prior to construction of certain facilities in prior years. On June 16, 1997, the VPSB ordered the Company to reduce its rates for Vermont electric service by 14.65% retroactive to November 1, 1995 and to refund to customers, with interest, all amounts collected since that time in excess of the rates authorized by the VPSB. In addition, the VPSB assessed statutory penalties totaling $60,000 and placed the Company on regulatory probation for a period of at least five years. During this probationary period, the Company could lose its franchise to operate in Vermont if it violates the terms of probation prescribed by the VPSB. The VPSB prescribed final terms of probation in its final order issued September 15, 1998. In October 1998, the Company filed an appeal in the Vermont Supreme Court challenging certain of the penalties imposed by the VPSB. In August 1997, a lawsuit was filed in the United States District Court for the District of Connecticut (Leventhal vs. Tow, et al.) against the Company and five of its officers, one of whom is also a director, on behalf of all persons who purchased or otherwise acquired Series A and Series B shares of Common Stock of the Company between September 5, 1996 and July 11, 1997, inclusive. On February 9, 1998, the plaintiffs filed an amended complaint. The complaint alleged that Citizens and the individual defendants, during such period, violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 based upon certain public statements made by the Company, which are alleged to be materially false or misleading, or are alleged to have failed to disclose information necessary to make the statements made not false or misleading. The plaintiffs sought to recover unspecified compensatory damages. The Company and the individual defendants believed the allegations are unfounded and filed a motion to dismiss on March 27, 1998. On March 30, 1999 the Court dismissed the action. On April 29, 1999 the plaintiffs filed a notice of appeal with the Court of Appeals for the Second Circuit. In March 1998, a lawsuit was filed in the United States District Court for the District of Connecticut (Ganino vs. Citizens Utilities Company, et al.), against the Company and three of its officers, one of whom is also a director, on behalf of all purchasers of the Company's Common Stock between May 6, 1996 and August 7, 1997, inclusive. The complaint alleges that the Company and the individual defendants, during such period, violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by making materially false and misleading public statements concerning the Company's relationship with a purported affiliate, Hungarian Telephone and Cable Corp. (HTCC), and by failing to disclose material information necessary to render prior statements not misleading. The plaintiff seeks to recover unspecified compensatory damages. The Company and the individual defendants believe that the allegations are unfounded and filed a motion to dismiss. The plaintiff requested leave to file an amended complaint and an amended complaint was served on the Company on July 24, 1998. The Company's motion to dismiss the amended complaint was filed on October 13, 1998. The Court dismissed the action with prejudice on June 28, 1999. In November 1998, a class action lawsuit was filed in state District Court for Jefferson Parish, Louisiana, against the Company and three of its subsidiaries: LGS Natural Gas Company, LGS Intrastate, Inc. and Louisiana General Service Company. The lawsuit alleges that the Company and the other named defendants passed through in rates charged to Louisiana customers certain costs that plaintiffs contend were unlawful. The lawsuit seeks compensatory damages in the amount of the alleged overcharges and punitive damages equal to three times the amount of any compensatory damages, as allowed under Louisiana law. In addition, the Louisiana Public Service Commission has opened an investigation into the allegations raised in the lawsuit. The Company and its subsidiaries believe that the allegations made in the lawsuit are unfounded and the Company will vigorously defend its interests in both the lawsuit and the related Commission investigation. In addition, the Company is party to various other legal proceedings arising in the normal course of business. The outcome of individual matters is not predictable. However, management believes that the ultimate resolution of all such matters, including those discussed above, after considering insurance coverages, will not have a material adverse effect on the Company's financial position, results of operations, or its cash flows. 24
PART II. OTHER INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- (a) The Registrant held its 1999 Annual Meeting of the Stockholders on May 20, 1999. (b) Proxies for the Annual Meeting were solicited pursuant to Regulation 14; there was no solicitation in opposition to management's nominees for directors as listed in the Proxy Statement. All such nominees were elected. J. C. Goodale did not stand for re-election. The stockholders voted to elect all nominees as directors. Directors elected along with their respective percentage of total outstanding shares voted in the affirmative were: N.I.Botwinik (77.0%), A.I. Fleischman (77.3%), S. Harfenist (77.3%), A.N. Heine (77.2%), J.L.Schroeder (77.3%), R.D.Siff (77.2%), R.A. Stanger (77.3%), C.H. Symington, Jr. (77.3%), E. Tornberg (77.3%), C. Tow (75.1%) and L. Tow (75.4%). Directors elected along with their respective percentage of total outstanding shares voted in abstention were: N.I. Botwinik (5.9%), A.I. Fleischman (5.5%), S. Harfenist (5.6%), A.N. Heine (5.7%), J.L. Schroeder (5.5%), R.D. Siff (5.7%), R.A. Stanger (5.5%), C.H. Symington, Jr.(5.5%), E. Tornberg (5.6%), C. Tow (7.8%) and L. Tow (7.4%). Item 5. Other Information ----------------- As disclosed in the Company's proxy statement for the 1999 annual meeting, under the Company's bylaws, if any stockholder intends to propose any matter at the 2000 annual meeting, the proponent must give written notice to the Company not earlier than January 1, 1999 nor later than February 15, 2000. Proposals notice after February 15, 2000 will not be entertained at the meeting. Furthermore, in accordance with a recent amendment to the proxy rules and regulations of the Securities and Exchange Commission, if a stockholder does not notify the Company by February 14, 2000 of a proposal, then the Company's proxies would be able to use their discretionary voting authority when the stockholder's proposal is raised at the meeting. Item 6. Exhibits and Reports on Form 8-K -------------------------------- a) Exhibits: 3(ii) By-laws amended May 20, 1999 changing the number of Board Members from twelve to eleven. 27 Financial data schedule for the periods ended June 30, 1999 and June 30, 1998. b) Reports on Form 8-K: The Company filed on Form 8-K dated May 13, 1999 under Item 7 "Exhibits," a press release announcing financial results for the quarter ended March 31, 1999 and certain operating data. The Company filed on Form 8-K dated May 28, 1999 under Item 5 "Other Events" and Item 7 "Exhibits," a press release announcing definitive agreements to purchase 187,000 telephone access lines from GTE Corporation. The Company filed on Form 8-K dated June 17, 1999 under Item 5 "Other Events" and Item 7 "Exhibits," a press release announcing a series of definitive agreements to purchase 530,000 telephone access lines from US West. 25
PART II. OTHER INFORMATION (Continued) CITIZENS UTILITIES COMPANY AND SUBSIDIARIES SIGNATURES 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 UTILITIES COMPANY -------------------------- (Registrant) By: /s/ Robert J. DeSantis ---------------------------- Chief Financial Officer, Vice President and Treasurer By: /s/ Livingston E. Ross ----------------------------- Livingston E. Ross Vice President and Controller Date: August 5, 1999