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 SEPTEMBER 30, 1998
<PAGE>
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 September 30, 1998
|_| 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
October 30, 1998 were 258,610,612.
<PAGE>
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
Index to Consolidated Financial Statements
<TABLE>
<CAPTION>
<S> <C>
Page No.
Part I. Financial Information
Consolidated Balance Sheets at September 30, 1998 and December 31, 1997 2
Consolidated Statements of Income for the Three Months Ended
September 30, 1998 and 1997 3
Consolidated Statements of Income (Loss) for the Nine Months Ended
September 30, 1998 and 1997 4
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1998 and 1997 5
Notes to Consolidated Financial Statements 6
Management's Discussion and Analysis of Financial Condition and
Results of Operations 9
Quantitative and Qualitative Disclosures about Market Risk 23
Part II. Other Information
Legal Proceedings 24
Exhibits and Reports on Form 8-K 25
Signatures 26
1
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
<S> <C> <C>
September 30, 1998 December 31, 1997
------------------ -----------------
(Unaudited)
ASSETS
- ------
Current assets:
Cash $ 57,699 $ 35,163
Accounts receivable, net 298,081 277,405
Other 65,682 64,711
------------- --------------
Total current assets 421,462 377,279
------------- --------------
Property, plant and equipment 5,669,122 5,297,737
Less accumulated depreciation 1,849,087 1,629,944
------------- --------------
Net property, plant and equipment 3,820,035 3,667,793
------------- --------------
Investments 441,830 398,499
Regulatory assets 218,699 209,921
Deferred debits and other assets 199,882 219,360
------------- --------------
Total assets $ 5,101,908 $ 4,872,852
============= ==============
LIABILITIES AND EQUITY
- ----------------------
Current liabilities:
Long-term debt due within one year $ 22,253 $ 6,691
Accounts payable and current liabilities 374,691 411,179
------------- -------------
Total current liabilities 396,944 417,870
Deferred income taxes 427,931 420,708
Customer advances for construction and
Contributions in aid of construction 263,717 260,790
Deferred credits and other liabilities 135,203 128,984
Regulatory liabilities 19,526 20,881
Long-term debt 1,856,717 1,706,532
------------- --------------
Total liabilities 3,100,038 2,955,765
------------- --------------
Company Obligated Mandatorily Redeemable
Convertible Preferred Securities * 201,250 201,250
Minority interest in subsidiary 28,397 36,626
Shareholders' equity:
Common stock issued, $.25 par value 64,568 62,749
Additional paid-in capital 1,550,292 1,480,425
Retained earnings 133,569 132,217
Accumulated other comprehensive income 23,794 3,820
------------- --------------
Total shareholders' equity 1,772,223 1,679,211
------------- --------------
Total liabilities and shareholders' equity $ 5,101,908 $ 4,872,852
============= ==============
* 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.
2
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(In thousands, except per-share amounts)
(Unaudited)
1998 1997
------------- -------------
Revenues $ 378,279 $ 338,803
------------- -------------
Operating expenses:
Cost of services 79,934 68,174
Depreciation 65,117 58,827
Other operating expenses 192,892 159,554
------------- -------------
Total operating expenses 337,943 286,555
------------- -------------
Income from operations 40,336 52,248
Other income, net 7,695 10,794
Minority interest 3,794 -
Interest expense 29,178 25,640
------------- -------------
Income before income taxes and dividends on convertible preferred securities 22,647 37,402
Income taxes 6,633 12,342
------------- -------------
Income before dividends on convertible preferred securities 16,014 25,060
Dividend on convertible preferred securities, net of income tax benefit 1,553 1,553
------------- -------------
Net income $ 14,461 $ 23,507
============= =============
Net income per common share:
Basic $ .06 $ .09 *
Diluted $ .06 $ .09 *
Dividend rate declared on common stock .75% 1.00%
============= =============
*Adjusted for subsequent stock dividends.
The accompanying Notes are an integral part of these Financial Statements.
3
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(In thousands, except per-share amounts)
(Unaudited)
1998 1997
------------- -------------
Revenues $ 1,148,489 $ 1,022,751
------------- -------------
Operating expenses:
Cost of services 268,661 259,845
Depreciation 193,479 174,347
Other operating expenses 548,230 630,876
------------- -------------
Total operating expenses 1,010,370 1,065,068
------------- -------------
Income (loss) from operations 138,119 (42,317)
Other income, net 26,016 29,656
Minority interest 9,320 -
Interest expense 84,573 81,333
------------- -------------
Income (loss) before income taxes, dividends on convertible preferred securities
and cumulative effect of change in accounting principle 88,882 (93,994)
Income taxes (benefit) 26,189 (29,567)
------------- -------------
Income (loss) before dividends on convertible preferred securities and cumulative
effect of change in accounting principle 62,693 (64,427)
Dividend on convertible preferred securities, net of income tax benefit 4,657 4,657
------------- -------------
Income (loss) before cumulative effect of change in accounting principle 58,036 (69,084)
Cumulative effect of change in accounting principle, net of income tax benefit
and related minority interest 2,334 -
------------- -------------
Net income (loss) $ 55,702 $ (69,084)
============= =============
Net income (loss) per common share before cumulative effect of change in
accounting principle:
Basic $ .23 $ (.27) *
Diluted $ .23 $ (.27) *
Net income (loss) per common share:
Basic $ .22 $ (.27) *
Diluted $ .22 $ (.27) *
Compounded dividend rate declared on common stock 2.27% 4.26%
============= =============
*Adjusted for subsequent stock dividends.
The accompanying Notes are an integral part of these Financial Statements.
4
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(In thousands)
(Unaudited)
1998 1997
------------- --------------
Net cash provided by operating activities $ 227,196 $ 175,173
------------- --------------
Cash flows from investing activities:
Construction expenditures (351,777) (382,466)
Securities purchased (686,919) (206,758)
Securities sold 679,717 324,837
Securities matured 2,000 20,433
Other (4,717) 33,476
------------- --------------
Net cash provided from investing activities (361,696) (210,478)
------------- --------------
Cash flows from financing activities:
Long-term debt borrowings 157,823 78,619
Long-term debt principal payments (4,936) (2,494)
Issuance of common stock 5,010 3,514
Common stock buybacks (861) (41,791)
Other - (91)
------------- --------------
Net cash provided from financing activities 157,036 37,757
------------- --------------
Increase in cash 22,536 2,452
Cash at January 1, 35,163 24,230
------------- --------------
Cash at September 30, $ 57,699 $ 26,682
============= ==============
The accompanying Notes are an integral part of these Financial Statements.
5
<PAGE>
</TABLE>
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 1997 Annual Report on Form 10-K and the quarterly
reports on Form 10-Q previously filed in 1998. The 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 (Loss) Per Common Share:
Basic EPS is computed using the weighted average number of common
shares outstanding during the period being reported on. Diluted
EPS 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. Both basic and diluted EPS
calculations are presented with adjustments for subsequent
stock dividends.
(2) Net Income (Loss) Per Common Share:
----------------------------------
The reconciliation of the net income (loss) per common share calculation
for the three and nine months ended September 30, 1998 and 1997,
respectively, is as follows:
<TABLE>
<CAPTION>
For the three months ended September 30,
-----------------------------------------------------------------------
1998 1997
(In thousands, except for per share amounts)
-----------------------------------------------------------------------
Per Per
<S> <C> <C> <C> <C> <C> <C>
Income Shares Share Income Shares Share
------ ------ ----- ------ ------ -----
Net income per common share:
Basic $ 14,461 258,202 $ .06 $ 23,507 257,635 $ .09
Effect of dilutive options - 448 - - 76 -
Diluted $ 14,461 258,650 $ .06 $ 23,507 257,711 $ .09
For the nine months ended September 30,
-----------------------------------------------------------------------
1998 1997
(In thousands, except for per share amounts)
-----------------------------------------------------------------------
Per Per
Income Shares Share Income Shares Share
------ ------ ----- ------ ------ -----
Net income (loss) per common share:
Basic $ 55,702 257,478 $ .22 $ (69,084) 258,545 $ (.27)
Effect of dilutive options - 305 - - - -
Diluted $ 55,702 257,783 $ .22 $ (69,084) 258,545 $ (.27)
6
<PAGE>
</TABLE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All share amounts represent weighted average shares outstanding for each
respective period. All per share amounts have been adjusted for subsequent stock
dividends. The diluted earnings per 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 3.732 to 1 ratio at an exercise price of $13.40 per share
and 12,244,000 potentially dilutive stock options at a range of $8.28 to $14.34
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.
The Compensation Committee of the Board of Directors has determined that it is
in the best interests of both the Company and its employees to offer certain
employees (excluding senior executive officers) an opportunity to exchange
existing stock options for a lesser amount of new lower priced stock options.
(3) Comprehensive Income:
---------------------
Effective January 1, 1998, the Company adopted the provisions of
SFAS 130, "Reporting Comprehensive Income." SFAS 130 requires that other
comprehensive income and changes thereto are to be displayed
prominently in the financial statements. The Company's total comprehensive
income is as follows:
<TABLE>
<CAPTION>
Three months ended September Nine months ended
30, September 30,
-------------------------------- --------------------------------
<S> <C> <C> <C> <C>
1998 1997 1998 1997
------------- ------------- ------------- -------------
Net income (loss) $ 14,461 $ 23,507 $ 55,702 $ (69,084)
Unrealized gain (loss) on securities classified
as available for sale, net of income taxes (3,310) 12,333 19,974 13,478
------------- ------------- ------------- -------------
Total comprehensive income (loss) 11,151 $ 35,840 $ 75,676 $ (55,606)
============= ============= ============= =============
</TABLE>
(4) 1997 Charges to Earnings:
---------------------------
In 1996 and early 1997 the Company had been pursuing an aggressive growth
strategy to take advantage of opportunities in the emerging communications
marketplace. This strategy included the initiation and expansion of long
distance services which, in combination with other enhanced service
offerings, would enable the Company to offer an integrated package of
products and services.
Late in 1996,the Company began the transition of its long distance network,
primarily to fixed cost leases, in order to achieve the lowest cost of
providing long distance service. In addition, the Company initiated a brand
recognition program to support the sales and marketing initiatives designed
to increase the Company's market share. The increase in revenues resulting
from this growth strategy, though significant, did not offset the resulting
increase in incremental expenses from the branding, sales, and marketing
initiatives. As a result, the Company's long distance service operations
generated unexpected losses during the first half of 1997 which had an
adverse impact on the Company's earnings and cash flow. During the second
quarter 1997 management re-evaluated this growth strategy in light of this
continuing impact on earnings and cash flow.
In connection with the re-evaluation of the Company's communications growth
strategy, as well as a review of its employee benefit plans to determine if
such plans were competitive with those provided in the industry, several
public utility commission orders requiring the Company to record charges to
earnings, and other charges to earnings related to certain accounting
policy changes related to Electric Lightwave, Inc. ("ELI") in anticipation
of its initial public offering, the Company recorded approximately
$197,300,000 of charges to earnings in the second quarter of 1997 as
follows:
<TABLE>
<CAPTION>
<S> <C>
(In thousands)
--------------
Curtailment of certain long distance service operations $ 34,600
Benefit plan curtailments and related regulatory assets 34,700
Telecommunications information systems and software 67,400
Regulatory commission orders 47,200
Other 13,400
--------
Total $ 197,300
========
</TABLE>
7
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) 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 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
elected to early adopt 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 for the nine months ended September 30, 1998, net of an income tax
benefit of $577,000 and the related minority interest of $483,000.
(6) Hungarian Telephone and Cable Corp. ("HTCC"):
--------------------------------------------
Pursuant to a definitive agreement, the Company had been providing
requested management services to HTCC. Expenses incurred by the Company in
providing such services, including allocable overhead items, were required
to be reimbursed by HTCC. HTCC disputed certain provisions of this
definitive agreement and the associated management fee. In September 1998,
HTCC satisfied its current obligations with the Company by issuing to the
Company 100,000 shares of its common stock and an $8,400,000 note, dated
September 30, 1998, bearing interest payable annually at the rate of LIBOR
(for one-year dollar deposits) plus 2.5% maturing in 2004. Additionally,
the current management services agreement was terminated and a new
seven-year consulting services agreement between the Company and HTCC was
entered into with services to begin in 2004. HTCC has agreed to pay
the Company a combined termination / consulting fee in the aggregate amount
of $21,000,000 in equal installments of $3,000,000 beginning in 2004. The
Company has not recorded any income related to the HTCC management services
fee or the settlement in 1998.
(7) Separation:
----------
On May 18, 1998, the Company announced its plans to separate its
telecommunications businesses and public services businesses into two
stand-alone publicly-traded companies. The Company intends to establish and
transfer to a new company all of its telecommunications businesses,
including its 83% interest in ELI. This separation is subject to federal
and state regulatory approvals and is expected to be carried out through a
distribution in the stock of the new company to the Company's shareholders.
The public services businesses will continue to operate as Citizens
Utilities Company and intend to provide gas transmission and distribution,
electric transmission and distribution, water distribution and wastewater
treatment services. This separation is 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 allow each business to pursue its own strategy and
compete more effectively in its respective markets.
The Company received an order from the Federal Energy Regulatory Commission
that granted an approval necessary to proceed with its separation plans.
The Company filed petitions with five state regulatory agencies in Arizona,
California, Louisiana, Tennessee and West Virginia for approval to proceed
with its separation plans. Similar filings will also be made with other
state regulatory agencies. The Company will file a request with the
Internal Revenue Service for a private letter ruling that the transaction
is not subject to federal income tax. An application with the Federal
Communications Commission for the transfer of certain licenses and filings
with the Securities and Exchange Commission will also be made during the
separation process. The transaction is expected to be completed in the
second half of 1999.
8
<PAGE>
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 may contain 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 local and
overall economy, 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, year 2000 issues and the effects of the
separation. Readers should consider these important factors in evaluating
any statement contained herein and/or 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 notes thereto included in
this report and as presented in the Company's 1997 Annual Report on Form
10-K and the quarterly reports on Form 10-Q previously filed in 1998.
The Company is a diversified communications and public services company
which provides, either directly or through subsidiaries,
telecommunications, gas transmission and distribution, electric
transmission and distribution, water distribution and wastewater treatment
services to customers in areas of 21 states. The Company develops and
expands its businesses through internal investment, acquisitions and joint
ventures in the rapidly evolving telecommunications industry and in
traditional public services and related fields.
On May 18, 1998, the Company announced its plans to separate its
telecommunications businesses and public services businesses into two
stand-alone publicly-traded companies. The Company intends to establish and
transfer to a new company all of its telecommunications businesses,
including its 83% interest in ELI. This separation is subject to federal
and state regulatory approvals and is expected to be carried out through a
distribution in the stock of the new company to the Company's shareholders.
The public services businesses will continue to operate as Citizens
Utilities Company and intend to provide gas transmission and distribution,
electric transmission and distribution, water distribution and wastewater
treatment services. This separation is 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 allow each business to pursue its own strategy and
compete more effectively in its respective markets.
The Company received an order from the Federal Energy Regulatory Commission
that granted an approval necessary to proceed with its separation plans.
The Company filed petitions with five state regulatory agencies in Arizona,
California, Louisiana, Tennessee and West Virginia for approval to proceed
with its separation plans. Similar filings will also be made with other
state regulatory agencies. The Company will file a request with the
Internal Revenue Service for a private letter ruling that the transaction
is not subject to federal income tax. An application with the Federal
Communications Commission for the transfer of certain licenses and filings
with the Securities and Exchange Commission will also be made during the
separation process. The transaction is expected to be completed in the
second half of 1999.
(a) Liquidity and Capital Resources
-------------------------------
For the nine months ended September 30, 1998, the Company used cash flow
from operations and proceeds from net financings to fund capital
expenditures.
The Company considers its operating cash flows and its ability to raise
debt and equity capital as the principal indicators of its liquidity. The
Company has committed lines of credit with commercial banks under which it
may borrow up to $600,000,000. There were no amounts outstanding under
these lines at September 30, 1998. In addition, ELI, the Company's
competitive local exchange carrier ("CLEC") subsidiary, has committed 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 lines. As of September 30, 1998, only $194,000,000 was outstanding
under ELI's lines of credit.
In June 1998, the Company arranged for the issuance of $20,000,000 of
Industrial Development Revenue Bonds. These bonds were issued as demand
purchase bonds at par value with an interest rate of 5.45% and a maturity
date of June 1, 2033. Proceeds from these bonds will be used to fund the
construction of the Company's gas facilities located in Yavapai County,
Arizona.
9
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
In July 1998, Centennial Cellular Corp. ("Centennial") announced that it
plans to merge with Welsh, Carson, Anderson & Stowe ("Welsh") in a
transaction valued at $43.50 per Centennial share. In October 1998,
Centennial issued a press release announcing that a condition for funding
from Merrill Lynch Capital Corporation ("Merrill Lynch") may not be
satisfied. The condition referred to is that no material adverse change
shall have occurred in the domestic or international financial, banking or
capital markets since the date of its commitment. Although Merrill Lynch
has acknowledged that a condition may not be satisfied, it has not
terminated its agreement to fund the acquisition, and the commitment letter
and merger agreement each have an expiration date of January 31, 1999. If
the conditions for funding and other conditions for the transaction are met
and the transaction is consummated, the Company will realize up to
$215,500,000 in cash from its 16% fully-diluted stake in Centennial.
In July 1998, the Company announced that it agreed to acquire Rhinelander
Telecommunications, Inc. ("RTI") in a cash-for-stock transaction. RTI is a
diversified telecommunications company engaged in providing local exchange,
long distance, Internet, wireless and cable television services to its
franchised service areas in north-central Wisconsin. The acquisition is
expected to be completed by year end 1998.
In October 1998, the Company acquired St. Charles Natural Gas Company
("NGC") for $5,000,000 in cash. NGC is a natural gas distribution Company
serving residential, commercial and industrial customers in Louisiana. NGC
will become part of the Company's Louisiana Gas Services operations.
The Company has requests for increases in annual revenues pending before
regulatory commissions for the Ohio water operations totaling approximately
$1,300,000. During the fourth quarter, the Company received increases in
annual revenues from regulatory commissions in California totaling
$900,000.
Pursuant to a definitive agreement, the Company had been providing
requested management services to Hungarian Telephone and Cable Corp.
("HTCC"). Expenses incurred by the Company in providing such services,
including allocable overhead items, were required to be reimbursed by HTCC.
HTCC disputed certain provisions of this definitive agreement and the
associated management fee. In September 1998, HTCC satisfied its current
obligations with the Company by issuing to the Company 100,000 shares of
its common stock and an $8,400,000 note, dated September 30, 1998, bearing
interest payable annually at the rate of LIBOR (for one-year dollar
deposits) plus 2.5% maturing in 2004. Additionally, the current management
services agreement was terminated and a new seven-year consulting services
agreement between the Company and HTCC was entered into with services to
begin in 2004. HTCC has agreed to pay the Company a combined termination /
consulting fee in the aggregate amount of $21,000,000 in equal annual
installments of $3,000,000 beginning in 2004.
The Company also has an approximately $30,830,000 investment in HTCC which
it has been closely monitoring. Earlier this year HTCC issued its 1997
financial statements in which it stated that there was substantial doubt
about its ability to continue as a going concern. HTCC attributed its
concern to, among other things, its potential inability to satisfy current
obligations as they come due including its management services fees due to
the Company and its Multi-Currency Credit Facility agreement (the
"Facility") with Postabank. Since the issuance of its 1997 financial
statements, HTCC's common stock value has declined.
As noted above, HTCC has satisfied all of its current obligations to the
Company. The Company has been advised by HTCC and its financial advisors
that HTCC is working with Postabank to modify the terms of the Facility.
The Company's investment in HTCC has been written down to market value with
the offsetting charge reported as a separate component of shareholders'
equity in accordance with generally accepted accounting principles.
If the decline in the Company's investment in HTCC is deemed to be other
than temporary, the amount of the write down of the investment from cost
to market will be charged to earnings as a realized loss. As of
September 30, 1998 the charge reported as a separate component of
shareholders' equity was approximately $19,600,000. The Company will
continue to monitor the progress of HTCC's renegotiation of the Facility
with Postabank.
10
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
Impact of the Year 2000
-----------------------
The Year 2000 ("Y2K") issue is the result of computer programs using a
two-digit format, as opposed to four digits, to indicate the year. Such
computer systems may be unable to interpret dates beyond the year 1999,
which could cause a system failure or other computer errors, leading to
disruptions in operations. In late 1997, the Company developed a four-phase
program for Y2K information technology ("IT") and non-IT systems
compliance. Phase I is to inventory and identify 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 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 is
presently determining priorities for taking corrective actions on mission
critical systems or products in an effort to ensure continued delivery of
core business activities. The Company's Y2K project seeks to address
problems that could arise in IT areas including information systems and
technologies; non-IT areas such as telecommunications networks and
switches, utility control and monitoring systems, premises and facilities,
general business equipment; and suppliers of products and services. 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 following table includes information as of September 30, 1998, by
phase, related to the Y2K project for both the Company's sectors.
<TABLE>
<CAPTION>
Expenditures
--------------------------------------------------
Total
Estimated Actual to Estimated to Estimated to
<S> <C> <C> <C> <C> <C>
Completion Dates % Completed Sept. 30,1998 Dec. 31, 1999 Dec. 31, 1999
---------------- ----------- ------------- -------------- ----------------
Telecommunications
------------------
and Corporate
-------------
IT $ 3,039,000 $ 16,002,000 $ 19,041,000
Inventory Completed 100%
Assessment 12/31/98 80%
Remediation 6/30/99 30%
Testing 6/30/99 30%
Non-IT $ 312,000 $ 2,259,000 $ 2,571,000
Inventory 11/30/98 99%
Assessment 12/31/98 63%
Remediation 4/30/99 15%
Testing 6/30/99 0%
Public Services
---------------
IT $ 981,000 $ 2,304,000 $ 3,285,000
Inventory Completed 100%
Assessment 11/30/98 96%
Remediation 2/1/99 84%
Testing 5/31/99 30%
Non-IT $ 528,000 $ 13,531,000 $ 14,059,000
Inventory Completed 100%
Assessment 11/30/98 40%
Remediation 3/31/99 25%
Testing 6/30/99 5%
---------------- ---------------- ----------------
Total $ 4,860,000 $34,096,000 $ 38,956,000
================ ================ ================
</TABLE>
11
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
Funding of the Y2K costs is expected to occur from operating cash flows,
cash and investments, proceeds from the issuance of securities and/or other
short term borrowings. The Company is required to expense costs related to
Y2K remediation.
The course of action taken by the Company recognizes that the systems of
vendors or suppliers play a major role in the conduct of the business of
the Company. As a result, in accordance with Phases I and II of the
program, the Company is in the process of 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. The Company also contracted with a consulting firm,
which has reviewed the Y2K programs of selected third party vendors. Thus
far, most of these parties have stated that they intend to be Y2K compliant
by 2000. However, there can be no guarantee that the systems of suppliers
or service providers on which the Company's systems rely will be timely
converted, or that a failure to convert by another company, or a conversion
that is incompatible with the Company's systems, would not have material
adverse effect on the Company.
In the event of non-remediation of the Y2K issues by the Company or certain
of its vendors, the worst case scenario would be disruption of the
Company's operations, possibly impacting the provision of services to
customers and the Company's ability to bill or collect revenues. However,
management believes that the Company's efforts to mitigate Y2K issues will
be successful. Contingency planning is an ongoing process as part of the
Company's Y2K remediation methodology. While the Company's overall
contingency plan is now being devised and documented specifically for Y2K,
existing disaster recovery documentation and procedures remain the first
line of defense.
In addition, the Company participates in trade associations such as the
Electric Power Research Institute to further industry efforts toward Y2K
readiness.
The Company intends to complete its efforts related to Y2K by June 1999,
however, one major service provider has notified the Company that it does
not anticipate being compliant until November 1999.
From a forward-looking perspective, 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 determined using numerous
assumptions of future events, including the availability and future costs
of certain technological and other resources, third party modification
actions and other factors. Given the complexity of these issues and
possible as yet 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 code,
the timing and success of remedial efforts of third party suppliers and
similar uncertainties.
A number of financial and information system applications have been
identified as being Y2K compliant due to their recent implementation. The
Company's core financial systems are being replaced pursuant to the
information systems initiative discussed below.
Other Information Systems Initiatives
-------------------------------------
The Company has other information systems initiatives in process which are
not due to the Y2K issue. These include implementation of enterprise wide
core financial systems as well as the development of technology to bring
the Company into full compliance with services to be provided pursuant to
the Telecommunications Act of 1996 Interconnection Order. For these two
projects, the Company expects to incur at least $30,000,000 in costs over
the next fifteen months. The Company will be required to expense certain
amounts of the cost of these projects pursuant to generally accepted
accounting principles. For the nine months ended September 30, 1998, the
Company incurred approximately $22,000,000 in total costs in connection
with this process, of which approximately $4,000,000 has been expensed.
12
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
Effects of Newly-Issued Accounting Pronouncements
-------------------------------------------------
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures
about Segments of an Enterprise and Related Information." SFAS 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. This Statement supersedes SFAS 14,
"Financial Reporting for Segments of a Business Enterprise," but retains
the requirement to report information about major customers. This statement
is effective for fiscal years beginning after December 15, 1997. The
Company does not expect the adoption of SFAS 131 to have a material effect
on the Company's financial position, operations or cash flows.
In February 1998, the FASB issued SFAS 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits an amendment of FASB Statements
No. 87, 88, and 106." SFAS 132 revises employers' disclosures about pension
and other postretirement benefit plans. It does not change the measurement
or recognition of those plans. SFAS 132 standardizes the disclosure
requirements for pensions and other postretirement benefits to the extent
practicable, requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate financial
analysis, and eliminates certain disclosures that are no longer as useful
as they were when SFAS 87, "Employers' Accounting for Pensions," SFAS 88,
"Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits," and SFAS 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions," were issued.
SFAS 132 suggests combined formats for presentation of pension and other
postretirement benefit disclosures. This statement is effective for fiscal
years beginning after December 15, 1997.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued a Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP
98-1 requires that certain costs related to the development or purchase of
internal-use software be capitalized and amortized over the estimated
useful life of the software, and costs related to the preliminary project
stage and the post-implementation/operations stage of an internal-use
computer software development project be expensed as incurred. SOP 98-1 is
effective for financial statements issued for fiscal years beginning after
December 15, 1998. The Company does not expect the adoption of SOP 98-1 to
have a material effect on the Company's financial position, operations or
cash flows.
In June 1998, the FASB issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities. "SFAS 133 requires companies to record
derivatives on the balance sheet as assets or liabilities measured at fair
value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative
and whether it qualifies for hedge accounting. The key criterion for hedge
accounting is that the hedging relationship must be highly effective in
achieving offsetting changes in fair value or cash flows. This statement is
effective for all fiscal quarters of all fiscal years beginning after June
15, 1999. The Company does not expect the adoption of SFAS 133 to have
a material effect on the Company's financial position, operations or cash
flows.
1997 Charges to Earnings
------------------------
In 1996 and early 1997 the Company had been pursuing an aggressive growth
strategy to take advantage of opportunities in the emerging communications
marketplace. This strategy included the initiation and expansion of long
distance services which, in combination with other enhanced service
offerings, would enable the Company to offer an integrated package of
products and services.
Late in 1996, the Company began the transition of its long distance
network, primarily to fixed cost leases, in order to achieve the lowest
cost of providing long distance service. In addition, the Company initiated
a brand recognition program to support the sales and marketing initiatives
designed to increase the Company's market share. The increase in revenues
resulting from this growth strategy, though significant, did not offset the
resulting increase in incremental expenses from the branding, sales, and
marketing initiatives. As a result, the Company's long distance service
operations generated unexpected losses during the first half of 1997 which
had an adverse impact on the Company's earnings and cash flow. During the
second quarter 1997 management re-evaluated this growth strategy in light
of this continuing impact on earnings and cash flow.
13
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
In connection with the re-evaluation of the Company's communications growth
strategy, as well as a review of its employee benefit plans to determine if
such plans were competitive with those provided in the industry, several
public utility commission orders requiring the Company to record charges to
earnings, and other charges to earnings related to certain accounting
policy changes related to ELI in anticipation of its initial public
offering, the Company recorded approximately $197,300,000 of charges to
earnings in the second quarter of 1997 as follows:
<TABLE>
<CAPTION>
(In thousands)
-------------
<S> <C>
Curtailment of certain long distance service operations $ 34,600
Benefit plan curtailments and related regulatory assets 34,700
Telecommunications information systems and software 67,400
Regulatory commission orders 47,200
Other 13,400
--------
Total $ 197,300
========
</TABLE>
14
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
(b) Results of Operations
--------------------------
REVENUES
--------
Total revenues for the three and nine months ended September 30, 1998
increased $39.5 million, or 12%, and $125.7 million, or 12%, respectively,
as compared with the prior year periods primarily due to increases in
communications, CLEC and natural gas revenues.
Telecommunications
------------------
Telecommunications revenues for the three and nine months ended September
30, 1998 increased $12.4 million, or 6%, and $46.8 million, or 7%,
respectively, as compared with the prior year periods primarily due to
increased network access services within the Communications sector and
local dial tone services within the CLEC sector.
<TABLE>
<CAPTION>
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
<S> <C> <C> <C> <C> <C> <C>
Communications revenues 1998 1997 (Decrease) 1998 1997 (Decrease)
- ----------------------- ----------- ----------- ------------- ----------- ------------ -------------
Network access services $ 107,325 $ 103,001 4% $ 315,332 $ 303,384 4%
Local network services 66,439 64,756 3% 194,753 189,228 3%
Long distance services 26,435 27,635 (4)% 74,622 63,041 18%
Directory services 7,949 8,720 (9)% 23,757 24,289 (2)%
Other 10,822 10,687 1% 35,098 36,426 (4)%
Eliminations (7,660) (6,938) (23,086) (17,331)
----------- ----------- ----------- -----------
$ 211,310 $ 207,861 2% $ 620,476 $ 599,037 4%
=========== =========== =========== ===========
</TABLE>
Network access services revenues for the three and nine months ended
September 30, 1998 increased $4.3 million, or 4%, and $11.9 million, or 4%,
respectively, as compared with the prior year periods primarily due to
increased minutes of use, new product offerings and growth of services
provided to Internet service providers.
Local network services revenues for the three and nine months ended
September 30, 1998 increased $1.7 million, or 3%, and $5.5 million, or 3%,
respectively, as compared with the prior year periods primarily due to
access line growth.
Long distance services revenues decreased $1.2 million, or 4%, as compared
with the third quarter of 1997 primarily due to decreased minutes of use.
Long distance services revenues for the nine months ended September 30,
1998 increased $11.6 million, or 18%, as compared with the prior year
period primarily due to a $14.2 million second quarter 1997 charge to
revenue related to the curtailment of long distance service operations in
adjacent markets. Absent the 1997 charge, long distance revenues for the
nine months ended September 30, 1998 decreased 3% primarily due to
decreased minutes of use as a result of the curtailment of long distance
service operations in adjacent markets, partially offset by increased
in-territory minutes of use.
Other revenues for the nine months ended September 30, 1998 decreased $1.3
million, or 4%, as compared with the prior year period primarily due to
decreased surcharges in California and New York. Additionally, the Company
has not recorded HTCC management services fees in 1998 as a result of its
dispute with HTCC.
Eliminations represent network access revenues received by the Company's
local exchange operations from its long distance operations.
15
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
<TABLE>
<CAPTION>
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
<S> <C> <C> <C> <C> <C> <C>
CLEC revenues 1998 1997 (Decrease) 1998 1997 (Decrease)
------------- ----------- ----------- ------------- ----------- ----------- -------------
Dedicated services $ 9,009 $ 9,184 (2)% $ 26,487 $ 23,300 14%
Local dial tone services 9,987 2,893 245% 23,780 6,136 288%
Long distance services 2,512 2,387 5% 6,233 6,098 2%
Enhanced services 4,156 2,561 62% 10,664 6,590 62%
Eliminations (650) (925) (2,265) (2,615)
----------- ----------- ----------- -----------
$ 25,014 $ 16,100 55% $ 64,899 $ 39,509 64%
=========== =========== =========== ===========
</TABLE>
Dedicated services revenues decreased $.2 million, or 2%, as compared with
the third quarter of 1997 primarily due to the expiration of a short-term
contract in the first quarter of 1998, partially offset by increased
customers and route miles in new and existing markets. Dedicated services
revenues increased $3.2 million, or 14%, for the nine months ended
September 30, 1998 as compared with the prior year period primarily due to
increased customers and route miles in new and existing markets, partially
offset by the expiration of a short-term contract in the first quarter of
1998.
Local dial tone services revenues for the three and nine months ended
September 30, 1998 increased $7.1 million, or 245%, and $17.6 million, or
288%, respectively, as compared with the prior year periods primarily due
to increased access line equivalents, increased sales of the integrated
service digital network (ISDN) product and increased carrier and local
access revenue.
Enhanced services revenues for the three and nine months ended September
30, 1998 increased $1.6 million, or 62%, and $4.1 million, or 62%,
respectively, as compared with the prior year periods primarily due to
increased sales of frame relay and Internet services in new and existing
markets.
Eliminations reflect intercompany activity between the Company's CLEC and
Communications sectors.
16
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
Public Services Revenues
Public services revenues for the three and nine months ended September 30,
1998 increased $27.1 million, or 24%, and $78.9 million, or 21%,
respectively, as compared with the prior year periods primarily due to
increased natural gas revenues.
<TABLE>
<CAPTION>
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
<S> <C> <C> <C> <C> <C> <C>
Gas revenues 1998 1997 (Decrease) 1998 1997 (Decrease)
------------ ----------- ----------- ------------- ----------- ------------ ------------
Residential $ 22,413 $ 17,450 28% $ 117,813 $ 101,675 16%
Commercial 21,721 7,436 192% 83,469 38,203 118%
Industrial 15,022 7,573 98% 34,592 21,871 58%
Municipal 282 272 4% 2,954 2,316 28%
----------- ----------- ----------- ------------
Total distribution 59,438 32,731 82% 238,828 164,065 46%
Transportation 421 437 (4)% 1,813 1,819 0%
Other 2,812 2,185 29% 9,231 6,966 33%
----------- ----------- ----------- ------------
$ 62,671 $ 35,353 77% $ 249,872 $ 172,850 45%
=========== =========== =========== ============
</TABLE>
Residential revenues increased $5 million, or 28%, as compared with the
third quarter of 1997 primarily due to the acquisition of The Gas Company
("TGC") in October 1997. Residential revenues for the nine months ended
September 30, 1998 increased $16.1 million, or 16%, as compared with the
prior year period primarily due to the acquisition of TGC, customer growth
and increased consumption in Arizona, partially offset by lower purchased
gas costs passed on to customers in Louisiana.
Commercial revenues increased $14.3 million, or 192%, as compared with the
third quarter of 1997 primarily due to the acquisition of TGC. Commercial
revenues for the nine months ended September 30, 1998 increased $45.3
million, or 118%, as compared with the prior year period primarily due to
the acquisition of TGC, customer growth and increased consumption in
Arizona, partially offset by lower purchased gas costs passed on to
customers in Louisiana.
Industrial revenues increased $7.4 million, or 98%, as compared with the
third quarter of 1997 primarily due to the acquisition of TGC and increased
consumption in Louisiana. Industrial revenues for the nine months ended
September 30, 1998 increased $12.7 million, or 58%, as compared with the
prior year period primarily due to the acquisition of TGC and increased
consumption in Louisiana and Arizona.
Municipal revenues for the nine months ended September 30, 1998 increased
$.6 million, or 28%, as compared with the prior year period primarily due
to customer growth.
17
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
<TABLE>
<CAPTION>
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
<S> <C> <C> <C> <C> <C> <C>
Electric revenues 1998 1997 (Decrease) 1998 1997 (Decrease)
----------------- ----------- ----------- ------------- ----------- ------------ ------------
Residential $ 24,458 $ 23,754 3% $ 62,969 $ 60,264 4%
Commercial 16,774 15,841 6% 43,207 41,896 3%
Industrial 10,085 11,076 (9)% 29,795 31,362 (5)%
Municipal 2,315 2,299 1% 6,246 6,040 3%
----------- ----------- ----------- ------------
Total distribution 53,632 52,970 1% 142,217 139,562 2%
Transportation 749 709 6% 2,237 2,020 11%
Other (235) 1,303 (118)% 765 3,232 (76)%
----------- ---------- ----------- ------------
$ 54,146 $ 54,982 (2)% $ 145,219 $ 144,814 0%
=========== =========== =========== ============
Electric revenues decreased $.8 million, or 2%, as compared with the third
quarter of 1997 primarily due to lower fuel costs passed onto customers in
Hawaii and a commission ordered rate reduction in Vermont. Electric
revenues for the nine months ended September 30, 1998 increased $.4
million, or 0%, as compared with the prior year period primarily due to a
$6.6 million second quarter 1997 charge to revenue related to a Vermont
public utility commission order requiring a refund to customers. Absent the
1997 charge, electric revenues for the nine months ended September 30, 1998
decreased 4% primarily due to lower fuel costs passed onto customers in
Hawaii and a commission ordered rate reduction in Vermont.
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
Water and Wastewater revenues 1998 1997 (Decrease) 1998 1997 (Decrease)
----------------------------- ----------- ----------- ------------ ----------- ----------- ------------
Residential distribution $ 19,413 $ 19,071 2% $ 53,610 $ 52,932 1%
Commercial distribution 4,170 4,259 (2)% 10,425 10,357 1%
Industrial distribution 324 296 9% 771 729 6%
Other 1,231 881 40% 3,217 2,523 28%
----------- ----------- ----------- -----------
$ 25,138 $ 24,507 3% $ 68,023 $ 66,541 2%
=========== =========== =========== ===========
Water and wastewater revenues for the three and nine months ended September
30, 1998 increased $.6 million, or 3%, and $1.5 million, or 2%,
respectively, as compared with the prior year periods primarily due to
increased consumption and customer growth.
18
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
OPERATING EXPENSES
------------------
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
Cost of Services 1998 1997 (Decrease) 1998 1997 (Decrease)
---------------- ----------- ----------- ------------- ----------- ------------ ------------
Natural gas purchased $ 29,066 $ 16,419 77% $ 127,233 $ 94,598 34%
Network expenses 33,241 31,852 4% 99,004 112,257 (12)%
Electric energy and fuel oil
purchased for energy
production 25,937 27,766 (7)% 67,775 72,936 (7)%
Eliminations (8,310) (7,863) (25,351) (19,946)
----------- ----------- ----------- ------------
$ 79,934 $ 68,174 17% $ 268,661 $ 259,845 3%
=========== =========== =========== ============
Natural gas purchased for the three and nine months ended September 30,
1998 increased $12.6 million, or 77%, and $32.6 million, or 34%,
respectively, as compared with the prior periods primarily due to the
acquisition of TGC in October 1997.
Network expenses increased $1.4 million, or 4%, as compared with the third
quarter of 1997 primarily due to expansion of the Company's CLEC frame
relay and Internet services and customer growth. Network expenses for the
nine months ended September 30, 1998 decreased $13.3 million, or 12%, as
compared with the prior year period primarily due to a $11.1 million second
quarter 1997 charge related to lease terminations as a result of the
curtailment of certain long distance service operations. Absent the 1997
charge, network expense for the nine months ended September 30, 1998
decreased 2% primarily due to the curtailment of long distance service
operations in adjacent markets and lower negotiated rates in 1998.
Electric energy and fuel oil purchased for energy production for the three
and nine months ended September 30, 1998 decreased $1.8 million, or 7%, and
$5.2 million, or 7%, respectively, as compared with the prior year periods
primarily due to lower supplier prices in Hawaii and Arizona.
Eliminations represent network expenses incurred by the Company's long
distance operation for services provided by its local exchange operations
and intercompany activity between the Company's CLEC and Communications
sectors.
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
1998 1997 (Decrease) 1998 1997 (Decrease)
----------- ----------- ------------- ----------- ------------ ------------
Depreciation expense $ 65,117 $ 58,827 11% $ 193,479 $ 174,347 11%
Depreciation expense for the three and nine months ended September 30, 1998
increased $6.3 million, or 11%, and $19.1 million, or 11%, respectively, as
compared with the prior year periods primarily due to the acquisition of
TGC and increased property, plant and equipment.
19
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
Other Operating Expenses 1998 1997 (Decrease) 1998 1997 (Decrease)
------------------------ ----------- ----------- ------------- ----------- ------------ ------------
Operating and maintenance $ 152,755 $ 128,626 19% $ 439,618 $ 512,236 (14)%
Taxes other than income 25,943 22,840 14% 74,816 71,250 5%
Sales and marketing 14,194 8,088 75% 33,796 47,390 (29)%
----------- ----------- ----------- ------------
$ 192,892 $ 159,554 21% $ 548,230 $ 630,876 (13)%
=========== =========== =========== ============
Operating and maintenance expenses increased $24.1 million, or 19%, as
compared with the third quarter of 1997 primarily due to increases in
personnel and related costs to support the Company's expanded CLEC service
offerings and the acquisition of TGC in October 1997. Operating and
maintenance expenses for the nine months ended September 30, 1998 decreased
$72.6 million, or 14%, as compared with the prior year period primarily due
to a $150.6 million second quarter 1997 charge. Absent the 1997 charge,
operating and maintenance expenses for the nine months ended September 30,
1998 increased 22% primarily due to the acquisition of TGC and increased
payroll related costs.
Taxes other than income for the three and six months ended September 30,
1998 increased $3.1 million, or 14%, and $3.6 million, or 5%, respectively,
as compared with the prior year periods primarily due to the acquisition of
TGC.
Sales and marketing expenses increased $6.1 million, or 75%, as compared
with the third quarter of 1997 primarily due to increases in personnel and
related costs to support the Company's expanded CLEC service. Sales and
marketing expenses for the nine months ended September 30, 1998 decreased
$13.6 million, or 29%, as compared with the prior year period primarily due
to an $8.6 million second quarter 1997 charge related to the curtailment of
certain long distance service operations. Absent the 1997 charge, sales and
marketing expenses for the nine months ended September 30, 1998 decreased
13% primarily due to decreased salaries, wages and commissions resulting
from reductions in communications' sales and marketing workforce, partially
offset by increases in personnel and related expenses to support expanded
CLEC service offerings.
OTHER INCOME, NET/MINORITY INTEREST/INTEREST EXPENSE/INCOME TAXES
-----------------------------------------------------------------
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
Other Income, Net 1998 1997 (Decrease) 1998 1997 (Decrease)
----------------- ----------- ----------- ------------- ----------- ------------ ------------
Investment income $ 8,243 $ 8,048 2% $ 24,865 $ 26,349 (6)%
Other (548) 2,746 (120)% 1,151 3,307 (65)%
----------- ----------- ----------- ------------
$ 7,695 $ 10,794 (29)% $ 26,016 $ 29,656 (12)%
=========== =========== =========== ============
Investment income increased $.2 million, or 2%, as compared with the third
quarter of 1997 primarily due to increased average investment balances.
Investment income for the nine months ended September 30, 1998 decreased
$1.5 million, or 6% as compared with the prior year period primarily due to
lower average investment balances.
Other income decreased $3.3 million, or 120%, as compared with the third
quarter 1997 primarily due to a decrease in the equity component of the
Allowance for Funds Used During Construction ("AFUDC") in 1998. Other
income for the nine months ended September 30, 1997 decreased $2.2 million,
or 65%, as compared with the prior year period primarily due to a decrease
in the equity component of AFUDC in 1998, partially offset by a $4.5
million second quarter 1997 charge related to an Arizona public utility
commission order disallowing recovery of certain amounts of the equity
component of AFUDC. Absent the 1997 charge, other income for the nine
months ended September 30, 1998 decreased 85% compared to the prior year
period primarily due to a decrease in the equity component of AFUDC in
1998.
20
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
1998 1997 (Decrease) 1998 1997 (Decrease)
----------- ----------- ------------- ----------- ------------ -------------
Minority interest $ 3,794 $ - n/a $ 9,320 $ - n/a
Minority interest is a result of the sale in an initial public offering in
November 1997 of 17.19% of the economic interest in the Company's CLEC
subsidiary, ELI, and represents the minority's share of ELI's loss before
income tax benefit and the cumulative effect of change in accounting
principle.
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
1998 1997 (Decrease) 1998 1997 (Decrease)
----------- ----------- ------------- ----------- ------------ ------------
Interest expense $ 29,178 $ 25,640 14% $ 84,573 $ 81,333 4%
Interest expense increased $3.5 million, or 14%, as compared with the third
quarter of 1997 primarily due to increased long-term debt outstanding.
Interest expense for the nine months ended September 30, 1998 increased
$3.2 million, or 4%, as compared with the prior year period primarily due
to increased long-term debt, partially offset by a $1.7 million second
quarter 1997 charge related to an Arizona public utility commission order
disallowing recovery of certain amounts of the debt component of AFUDC.
Absent the 1997 charge, interest expense for the nine months ended
September 30, 1998 increased 6% primarily due to increased long-term debt
outstanding, partially offset by an increase in the debt component of
AFUDC.
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- -------------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
1998 1997 (Decrease) 1998 1997 (Decrease)
----------- ----------- ------------- ----------- ------------ ------------
Income taxes $ 6,633 $ 12,342 (46)% $ 26,189 $ (29,567) 189%
Income taxes decreased $5.7 million, or 46%, as compared with the third
quarter of 1997 primarily due to decreased taxable income. Income taxes for
the nine months ended September 30, 1998 increased $55.8 million, or 189%,
as compared with the prior year period primarily due to the $62.1 million
tax benefit associated with the second quarter 1997 charge to earnings. The
effective annual tax rate (benefit) is approximately 29% and 31% in 1998
and 1997, respectively.
21
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
NET INCOME (LOSS) AND NET INCOME (LOSS) PER COMMON SHARE
--------------------------------------------------------
For the three months For the nine months
ended September 30, ended September 30,
------------------------------------------- ----------------------------------------
($ in thousands) ($ in thousands)
% %
Increase/ Increase/
1998 1997 (Decrease) 1998 1997 (Decrease)
--------- ---------- ------------ ---------- ----------- ------------
Income (loss) before cumulative
effect of change in
accounting principle $ 14,461 $ 23,507 (38)% $ 58,036 $ (69,084) 184%
Cumulative effect of change in
accounting principle, net of income
tax benefit and related minority
interest - - 2,334 -
------------ ------------ ------------ -------------
Net income (loss) $ 14,461 $ 23,507 (38)% $ 55,702 $ (69,084) 181%
============ ============ ============ =============
Net income (loss) per common
share before cumulative effect
of change in accounting principle:
Basic $ .06 $ .09 (33)% $ .23 $ (.27) 185%
Diluted $ .06 $ .09 (33)% $ .23 $ (.27) 185%
Net income (loss) per common share:
Basic $ .06 $ .09 (33)% $ .22 $ (.27) 181%
Diluted $ .06 $ .09 (33)% $ .22 $ (.27) 181%
</TABLE>
Income before cumulative effect of change in accounting principle increased
$127.1 million, or 184%, as compared with the nine months ended September
30, 1997 primarily due to a $135.2 million second quarter 1997 after tax
charge. Absent the 1997 charge, income before cumulative effect decreased
12% as compared with the nine months ended September 30, 1997. In addition,
the Company recorded $3.4 million as a cumulative effect of change in
accounting principle in the statements of income in the first quarter 1998,
net of income tax benefit of $.6 million and related minority interest of
$.5 million, in connection with the write-off of capitalized start-up costs
incurred by the Company's CLEC subsidiary. Net income decreased $9 million,
or 38%, as compared with the third quarter of 1997 primarily due to an
increased net loss from the Company's CLEC subsidiary. Net income for the
nine months ended September 30, 1998 increased $124.8 million, or 181%, as
compared with the prior year period primarily due to the second quarter
1997 after tax charge. Absent the 1997 charge, net income decreased 16% as
compared with the nine months ended September 30, 1997.
Net income per common share before cumulative effect of change in
accounting principle for the nine months ended September 30, 1998 increased
$.50, or 185%, as compared with the prior year period primarily due to the
second quarter 1997 after tax charge. Absent the 1997 charge, net income
per common share before cumulative effect of change in accounting principle
decreased 12% as compared with the nine months ended September 30, 1997
primarily due to an increased net loss from the Company's CLEC subsidiary.
Net income per common share decreased $.03, or 33%, as compared with the
third quarter of 1997 primarily due to an increased net loss from the
Company's CLEC subsidiary. Net income per common share for the nine months
ended September 30, 1998 increased $.49, or 181%, as compared with the
prior year period primarily due to the second quarter 1997 after tax
charge. Absent the 1997 charge, net income per common share decreased 15%
as compared with the nine months ended September 30, 1997 primarily due to
an increased net loss from the Company's CLEC subsidiary. Prior year
per-share amounts have been adjusted for subsequent stock dividends.
22
<PAGE>
PART I. FINANCIAL INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
-------------------------------------------
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
The Company is exposed to market risks and has established policies,
procedures and internal processes governing its management of market risks
and the use of financial instruments to manage its exposure to such risks.
Sensitivity of earnings to these risks is managed by maintaining a
conservative investment portfolio, primarily including state and municipal
and other fixed income securities, and entering into long-term debt
obligations with appropriate price and term characteristics, primarily
including fixed rate obligations. 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
<PAGE>
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 (the
"Board") 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 Board 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 Board. The Company estimates that
the future annual effect of the rate reduction ordered by the Board is
approximately $3.9 million. The Company made a $6.6 million refund to its
customers in 1997 by issuing a credit to the utility bills of each
customer. In addition, the Board 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 Board. The Board prescribed final terms of probation in
its final order issued September 15, 1998. The Company filed an appeal in
October 1998 challenging certain of the penalties imposed by the Board.
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 alleges 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 seek to recover unspecified
compensatory damages. The Company and the individual defendants filed a
motion to dismiss on March 27, 1998. On April 28, 1998 the plaintiffs
served a Memorandum of Law in Opposition to Defendants Motion to Dismiss.
Subsequent to that date, the parties filed reply memoranda. The court has
the motion under consideration but has not yet established a schedule of
oral arguments.
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
Citizens 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 have 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 has established a schedule of oral arguments leading through January
25, 1999.
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
<PAGE>
PART II. OTHER INFORMATION (Continued)
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a) Exhibits:
27 Financial Data Schedule for the nine months ended
September 30, 1998.
b) Reports on Form 8-K:
The Company filed on Form 8-K dated August 13, 1998 under Item 7
"Exhibits" a press release announcing financial results and
certain operating data for the period ended June 30, 1998 and a
press release announcing the Company's separation strategy.
25
<PAGE>
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
-----------------------------
Robert J. DeSantis
Chief Financial Officer,
Vice President and Treasurer
By: /s/ Livingston E. Ross
-----------------------------
Livingston E. Ross
Vice President and Controller
Date: November 10, 1998
26
<TABLE> <S> <C>
<ARTICLE> UT
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
CITIZENS UTILITIES COMPANY AND SUBSIDIARIES' CONSOLIDATED FINANCIAL
STATEMENTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000020520
<NAME> CITIZENS UTILITIES COMPANY
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 3,820,035
<OTHER-PROPERTY-AND-INVEST> 441,830<F1>
<TOTAL-CURRENT-ASSETS> 421,462
<TOTAL-DEFERRED-CHARGES> 218,699<F2>
<OTHER-ASSETS> 199,882<F3>
<TOTAL-ASSETS> 5,101,908
<COMMON> 64,568
<CAPITAL-SURPLUS-PAID-IN> 1,550,292
<RETAINED-EARNINGS> 133,569
<TOTAL-COMMON-STOCKHOLDERS-EQ> 1,772,223
201,250<F4>
0
<LONG-TERM-DEBT-NET> 1,856,717
<SHORT-TERM-NOTES> 0
<LONG-TERM-NOTES-PAYABLE> 0
<COMMERCIAL-PAPER-OBLIGATIONS> 0
<LONG-TERM-DEBT-CURRENT-PORT> 22,253
0
<CAPITAL-LEASE-OBLIGATIONS> 0
<LEASES-CURRENT> 0
<OTHER-ITEMS-CAPITAL-AND-LIAB> 1,249,465
<TOT-CAPITALIZATION-AND-LIAB> 5,101,908
<GROSS-OPERATING-REVENUE> 1,148,489
<INCOME-TAX-EXPENSE> 26,189
<OTHER-OPERATING-EXPENSES> 195,008<F5>
<TOTAL-OPERATING-EXPENSES> 1,010,370
<OPERATING-INCOME-LOSS> 138,119
<OTHER-INCOME-NET> 35,336
<INCOME-BEFORE-INTEREST-EXPEN> 173,455
<TOTAL-INTEREST-EXPENSE> 84,573
<NET-INCOME> 55,702
4,657<F4>
<EARNINGS-AVAILABLE-FOR-COMM> 55,702
<COMMON-STOCK-DIVIDENDS> 0
<TOTAL-INTEREST-ON-BONDS> 0
<CASH-FLOW-OPERATIONS> 227,196
<EPS-PRIMARY> .22
<EPS-DILUTED> .22
<FN>
<F1>REPRESENTS INVESTMENT FUNDS.
<F2>REPRESENTS REGULATORY ASSETS.
<F3>DEFERRED DEBITS AND OTHER ASSETS.
<F4>COMPANY OBLIGATED MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED 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.
<F5>REPRESENTS COMMODITIES PURCHASED.
</FN>
</TABLE>
